14th Mar 2008 07:00
Prudential PLC14 March 2008 Embargo: 7.00am Friday 14 March 2008 PRUDENTIAL PLC DELIVERS OUTSTANDING 2007 FULL YEAR RESULTS EEV operating profit up 25%, doubled over past three years • New business APE of £2,874 million, up 21% • EEV operating profit of £2,542 million, up 25% • New business profit of £1,215 million, up 22%, with Group margin of 42% (2006: 42%) • Asia new business profit up 34% at £653m • Asia is expected to deliver doubling of 2005 EEV new business profit a year early • Jackson new business profit up 19% at £285m • UK retail new business profit up 17%, with total new business profit up 4% at £277m • Asset management operating profit £334m up 28% on last year • IFRS statutory operating profit of £1,213 million, up 20% • EEV shareholders' funds up 24% to £14.8 billion • 2007 dividend increased by 5% to 18 pence per share All figures compared to 2006 at constant exchange rates Commenting, Mark Tucker, Group Chief Executive said: "These outstanding results, with new business profit up 22 per cent to £1,215million, demonstrate excellent and continued momentum in the successful deliveryof the Group's retirement led strategy. Group EEV operating profit has doubledover the past three years. "Each of our businesses is performing strongly representing a powerfulgeographic spread to our growth platform. Spectacular growth in Asia has beenaccompanied by a very strong performance by the US and clear profit growth inthe UK. Combined with our excellent performance in asset management across theGroup, these results demonstrate the benefits of Prudential's diversified,international strategy. "That strategy is focused on continued and profitable growth. Our marketpresence and product capability, coupled with strong management teams, puts usin a great position for continued value creation. Overall, the prospects for theGroup in 2008 remain positive. Over the longer-term the demographic, economicand social factors driving our business will continue and we are well positionedto capture a greater share of that growth." Group Chief Executive's Review In 2007, the Group's operating performance was outstanding building on the verystrong momentum established in 2005 and 2006. The combination of our retirement-led strategy, a clear focus on generatingprofitable growth and excellence in the delivery of our plans are drivingshorter-term performance and also placing the Group in a strong position fromwhich to outperform in the longer-term. The retirement market offers significant long-term sustainable growthopportunities as the biggest demographic wave in history transitions out of thework-force and into retirement. The Prudential Group has a strong presence inthis sector based on our financial strength, our investment and risk managementskills, our brands and our product and distribution expertise. The Group has the flexibility to optimise its capture of the retirementopportunity as it develops in each of our chosen markets and our business modelcreates significant financial and operational synergies. Within each market ourfocus is to operate in areas where we see sustainable competitive advantage andin products and distribution channels that have sound and sustainable economics. Group performance Group operating profit before tax from continuing operations, on the EuropeanEmbedded Value (EEV) basis increased by 25 per cent in the year to £2,542million and has doubled over a three year period. The Group's return on embeddedvalue was 15.4 per cent (2006: 14.5 per cent). On the statutory IFRS basis, operating profit before tax from continuingoperations was up 20 per cent to £1,213 million, almost doubling over a threeyear period. Across the Group's insurance operations new business increased by 21 per cent to£2,874 million, on an APE basis and profit on new business was £1,215 million,up 22 per cent. Average margin across the Group was maintained at 42 per cent(2006: 42 per cent). Operating profit in the Group's asset management operations increased by 28 percent, to £334 million in what was an excellent year for these businesses inincreasingly challenging conditions. The cash flow position continued to improve and we are progressing well towardsour target of being operating cash flow positive at the Group level in 2008. TheGroup's operating cash flow in 2007 was negative £82 million. During the yearthe Group received £527 million from the sale of Egg, the UK internet bankingoperation, this resulted in an overall Group cash inflow of £445 million. The Group's balance sheet and regulatory capital position remain robust. Inparticular, across the Group we have been cautious on credit for some time andwe have been increasingly moving the portfolio to a more defensive position.Outside the normal market value movements across the Group related to interestrates and widening credit spreads net credit losses on debt securities in the USwere £78 million. The Board has recommended a final dividend of 12.3 pence per share, bringing thefull year dividend to 18 pence per share, an increase of 5 per cent. Thedividend was covered 1.9 times by post-tax IFRS operating profit from continuingoperations. The Board will focus on delivering a growing dividend, which will continue to bedetermined after taking into account the Group's financial flexibility andopportunities to invest in areas of the business offering attractive returns.The Board believes that in the medium-term a dividend cover of around two-timesis appropriate. Insurance operations In Asia we continue to power ahead with the region accounting for 54 per cent ofnew business profits. New business on an APE basis, increased by 44 per cent to£1,306 million and all businesses across the region grew by 15 per cent or more. New business profit was £653 million, up 34 per cent. Having achieved compoundgrowth of 26 per cent since 2005 we expect to deliver, one year earlier thanpreviously stated, on our target of at least doubling 2005 new business profitby 2009. EEV operating profit in Asia exceeded £1 billion for the first timethis year as the business goes from strength to strength. Growth in our proprietary agency force, greater agency productivity and thecontinuing development of non-agency distribution, in particular bancassurance,remain central to our success. The agency force across the region increased by 125,000 to 410,000 during theyear and there was significant expansion in India where average agent numbersmore than doubled to 238,000. Throughout the rest of the region the averagenumber of agents increased by 10 per cent 112,000. Agency productivity has alsomoved ahead strongly in a number of markets including Singapore, Hong Kong andVietnam. The continuing success of our multi-distribution approach led to salesthrough non-agency channels increasing by 44 per cent and we added a number ofimportant new distribution relationships. The retirement opportunity in the region is emerging rapidly and we aredeveloping innovative integrated savings and protection solutions to meetconsumers' increasingly sophisticated needs. Our retirement campaigns under thebanner "What's your number?" have had considerable success in Korea, Taiwan andHong Kong and we are now rolling this concept out into other markets. There is also significant scope to develop our positioning in the healthinsurance market across the region and, with the launch of a number of newproducts, notably in Singapore and India, sales of health products in the yearhave increased by 45 per cent. The US is the largest retirement market in the world and our long-term strategyhas been to position Jackson to meet the pre and post-retirement needs of thebaby boomer generation. In 2007, variable annuity new business increased by 29per cent to £455 million, on an APE basis. Jackson has been the fastest growingvariable annuity provider in the US over the past six years, clearlydemonstrating the success of our strategy and our advice based approach. The variable annuity product in the US is increasingly being used by theconsumer to provide an income in retirement. In 2007, almost two-thirds ofJackson's customers were over 55 and two-thirds of all variable annuity salesincluded a guaranteed minimum withdrawal benefit. Jackson continues to innovateand develop its market leading Perspective II product, which has been thetop-selling variable annuity contract in the fast growing Independent Brokerchannel for each of the last 5 years. Overall new business in the US increased by 19 per cent to £671 million, on anAPE basis, new business profit also increased by 19 per cent with marginsmaintained at 42 per cent and an internal rate of return of 19 per cent. In 2007 we set out our strategy in the UK to focus primarily on the retirementincome market based in particular on our strengths in the annuity market butalso the developing lifetime mortgage and income drawdown markets. In theretirement savings market we have exited those product areas that arestructurally unprofitable and launched a new range of factory gate pricedsavings products. Retail new business increased by 4 per cent in a market where the competitivepressures increased still further during the year. In 2007 we also completed thetransfer of Equitable Life's £1.7 billion in-force portfolio of with-profitsannuities: however in general pricing across the bulk market was not adequate tomeet our return on capital requirements and we chose not to write business atuneconomic levels. The margin at 31 per cent (2006: 30 per cent) remained high in comparison to theoverall UK market as did the internal rate of return which was 18 per centincluding the Equitable Life transaction and 14 per cent excluding it. Ourtarget internal rate of return in the UK is 14%. By the end of 2007, £115 million of the cost saving target of £195 million hadbeen delivered and plans are in place to deliver the additional £80 million. Akey milestone this year in the UK was the signing of a major contract tooutsource a large proportion of its back book and new business policyadministration. The outsource agreement will allow us to remove fixed costs fromour operations and to achieve significant operating efficiencies with anexpected positive effect on embedded value estimated at £60 million by 2011. The in-force profit for the UK business includes a charge in respect of amortality assumption change on the annuity business of £312 million which isfully offset by a release of excess margins previously held. In 2007 we announced that the Group would consider a reattribution of theinherited estate held in the with-profits sub fund of The Prudential AssuranceCompany Limited. We are continuing to explore the possibility of a reattributionand we aim to be in a position in the first half of 2008 to determine whetherthis would be in the best interests of policyholders and shareholders. Asset management The Group's asset management businesses had another excellent year. Ourinternational investment management expertise continues to add value to ourinsurance operations and also supported the growth in external funds undermanagement to £69 billion at the end of 2007 (2006: £57 billion). M&G's net inflows were the second highest on record at £5 billion and profitincreased by 25 per cent to £254 million. Our business in Asia continued itsexcellent growth record with net inflows of £3 billion and operating profitgrowing to £72 million, up 53 per cent. Our skills in risk management and our strength across all asset classes in theUK, the US and in Asia combined with our multi-asset allocation capabilities,position us well to meet the diverse needs of our customers for savings,retirement income and protection products. This is clearly evidenced in the UK where the main with-profits fund, withassets of over £74 billion, was ranked first in 2006 in the WM Company's surveyof with-profits funds, based on gross investment performance over 1, 3, 5 and 10years. In the US, one of the key drivers of our success is our ability toprovide customised and highly flexible benefit options within our main variableannuity product that are individually priced for the customer and, in Asia wecontinue to see success in our targeted unit-linked and protection products. Priorities for the Group in 2008 Our overriding objective for 2008 remains that of continuing to create value forour shareholders by fully exploiting the power of our retirement-led strategyand continuing to expand the excellent businesses that we have in place today. Life insurance In Asia: • Expand the agency force and continue to improve productivity• Maximise the potential from non-agency distribution and add new partners• Further develop direct marketing channels and up-sell and cross-sell• Increased focus on retirement services and health products In the US: • Continue to innovate around our key variable annuity product• Enhance further our already world-class operating platform• Expand retail distribution• Selectively participate in the institutional market In the UK: • Build on our strengths in the retirement market and risk products• Migrate to factory-gate cautiously managed asset accumulation products• Deliver on the cost reduction program including the outsource program • Selectively participate in the wholesale market• Determine whether it is in the best interest of policyholders and shareholders to pursue a reattribution of the inherited estate Asset management: • Maintain superior investment performance for both internal and external funds• Extend third party retail and institutional businesses Outlook There is significant volatility and nervousness in markets and it seems clearthat there will be a period of less attractive economic growth trends in the USand in the UK than we have seen in recent years. Notwithstanding this, webelieve that our strategy and our business model are very robust and willcontinue to deliver sustainable value. In Asia, the fundamentals underpinning economic growth remain powerful and ourbusinesses are very well placed to benefit. We expect to deliver, one yearearlier than previously stated, on our target of at least doubling 2005 newbusiness profit by 2009. In the US, our record of out performance is set to continue and our value drivenstrategy in the UK is on track. In the UK we have already de-emphasised thoseproducts which might have been more sensitive to market conditions. Our asset management businesses, although more directly influenced by marketmovements, are well placed to capitalise on their strong market positions andinvestment performance to deliver net flows and profit growth. Overall the prospects for the Group in 2008 remain positive. Over thelonger-term the demographic, economic and social factors driving our businesswill continue and we are ideally positioned to capture a greater share of thatgrowth. ENDS Enquiries: Media Investors/AnalystsJon Bunn +44 20 7548 3559 James Matthews +44 20 7548 3561William Baldwin-Charles +44 20 7548 3719 Jessica Stalley +44 20 7548 3511 Notes to Editors: 1. In addition to the financial statements provided with this pressrelease, additional financial schedules, including full details of the Group'sinvestments, are available on the Group's website at www.prudential.co.uk 2. The results in this announcement are prepared on two bases:International Financial Reporting Standards ('IFRS') and European Embedded Value('EEV'). The IFRS basis results form the basis of the Group's statutoryfinancial statements. The supplementary EEV basis results have been prepared inaccordance with the principles issued by the CFO Forum of European InsuranceCompanies in May 2004 and expanded by the Additional Guidance on EEV disclosurespublished in October 2005. Where appropriate the EEV basis results include theeffects of IFRS. Period on period percentage increases are stated on a constant exchange ratebasis. 3. Annual premium equivalent (APE) sales comprise regular premium salesplus one-tenth of single premium insurance sales. 4. Present value of new business premiums (PVNBP) are calculated asequalling single premiums plus the present value of expected new businesspremiums of regular premium business, allowing for lapses and other assumptionsmade in determining the EEV new business contribution. 5. An interview with Mark Tucker, Group Chief Executive, (in video/audio/text) will be available on www.cantos.com and www.prudential.co.uk from 7.00amtoday. 6. There will be a conference call today for wire services at 7.30am (GMT)hosted by Mark Tucker, Group Chief Executive and Philip Broadley, Group FinanceDirector. Dial in telephone number: 020 8609 0793. Passcode: 155439#. 7. A presentation to analysts will take place at 9.30am (GMT) at Governor'sHouse, Laurence Pountney Hill, London, EC4R 0HH. An audio cast of thepresentation and the presentation slides will be available on the Group'swebsite, www.prudential.co.uk 8. A media conference will take place at 11.30am (GMT) at 12 Arthur Street,London, EC4R 9AQ. To attend please call Claire Glover on 020 7548 2007. 9. High resolution photographs are available to the media free of charge atwww.newscast.co.uk on +44 (0) 207 608 1000 or by calling Claire Glover on 0207548 2007. 10. Total number of Prudential plc shares in issue as at 31 December 2007 was2,470,017,240. 11. Financial Calendar 2008: First Quarter New Business Results 17 April 2008Annual General Meeting 15 May 2008Interim Results 31 July 2008Third Quarter 2008 New Business Results 21 October 2008 2007 Final DividendEx-dividend date 9 April 2008Record date 11 April 2008Payment of dividend 20 May 2008 2008 Interim DividendEx-dividend date 13 August 2008Record date 15 August 2008Payment of dividend 23 September 2008 About Prudential Prudential plc is a company incorporated and with its principal place ofbusiness in England, and its affiliated companies constitute one of the world'sleading financial services groups. It provides insurance and financial servicesdirectly and through its subsidiaries and affiliates throughout the world. Ithas been in existence since 1848 and has £267 billion in assets under managementas at 31 December 2007. Prudential plc is not affiliated in any manner withPrudential Financial, Inc, a company whose principal place of business is in theUnited States of America. Forward-Looking Statements This statement may contain certain "forward-looking statements" with respect tocertain of Prudential's plans and its current goals and expectations relating toits future financial condition, performance, results, strategy and objectives.Statements containing the words "believes", "intends", "expects", "plans", "seeks" and "anticipates", and words of similar meaning, are forward-looking. Bytheir nature, all forward-looking statements involve risk and uncertaintybecause they relate to future events and circumstances which are beyondPrudential's control including among other things, UK domestic and globaleconomic and business conditions, market related risks such as fluctuations ininterest rates and exchange rates, and the performance of financial marketsgenerally; the policies and actions of regulatory authorities, the impact ofcompetition, inflation, and deflation; experience in particular with regard tomortality and morbidity trends, lapse rates and policy renewal rates; thetiming, impact and other uncertainties of future acquisitions or combinationswithin relevant industries; and the impact of changes in capital, solvency oraccounting standards, and tax and other legislation and regulations in thejurisdictions in which Prudential and its affiliates operate. This may forexample result in changes to assumptions used for determining results ofoperations or re-estimations of reserves for future policy benefits. As aresult, Prudential's actual future financial condition, performance and resultsmay differ materially from the plans, goals, and expectations set forth inPrudential's forward-looking statements. Prudential undertakes no obligation toupdate the forward-looking statements contained in this statement or any otherforward-looking statements it may make. PRUDENTIAL PLC 2007 PRELIMINARY ANNOUNCEMENT RESULTS SUMMARY European Embedded Value (EEV) Basis Results* 2007 2006 £m £m Asian operations 1,103 864US operations 635 718UK operations: UK insurance operations 859 686 M&G 254 204 1,113 890Other income and expenditure (289) (298)Restructuring costs (20) (41) Operating profit from continuing operations based on longer-term investment returns* 2,542 2,133Short-term fluctuations in investment returns 174 738Mark to market value movements on core borrowings 223 85Shareholders' share of actuarial gains and losses on defined benefit pension schemes 116 207Effect of changes in economic assumptions and time value of cost of options and guarantees 748 59 Profit from continuing operations before tax (including actual investment returns) 3,803 3,222 Operating earnings per share from continuing operations after related tax and minority interests* 74.9p 62.1pBasic earnings per share 125.2p 91.7pShareholders' equity, excluding minority interests £14.8bn £11.9bn International Financial Reporting Standards (IFRS) Basis Results* Statutory IFRS basis results 2007 2006 Profit after tax attributable to equity holders of the Company £1,022m £874mBasic earnings per share 41.8p 36.2pShareholders' equity, excluding minority interests £6.2bn £5.5bn Supplementary IFRS basis information 2007 2006 Operating profit from continuing operations based on longer-term investment returns* £1,213m £1,050mOperating earnings per share from continuing operations after related tax and minority interests* 33.8p 30.9p 2007 2006 Dividends per share declared and paid in reporting period 17.42p 16.44p Dividends per share relating to reporting period 18.00p 17.14p Funds under management £267bn £251bn *Basis of preparation Results bases The EEV basis results have been prepared in accordance with the EuropeanEmbedded Value Principles issued by the CFO Forum of European InsuranceCompanies in May 2004 and expanded by the Additional Guidance on EEV disclosurespublished in October 2005. The basis of preparation of statutory IFRS basisresults and supplementary IFRS basis information is consistent with that appliedfor the 2006 results and financial statements. Operating profit based on longer-term investment returns Consistent with previous reporting practice, the Group analyses its EEV basisresults and provides supplementary analysis of IFRS profit before taxattributable to shareholders, so as to distinguish operating profit based onlonger-term investment returns from other elements of total profit. On both theEEV and IFRS bases, operating earnings per share are calculated using operatingprofits from continuing operations based on longer-term investment returns,after related tax and minority interests. These profits exclude short-termfluctuations in investment returns and the shareholders' share of actuarialgains and losses on defined benefit pension schemes. Under the EEV basis, whereadditional profit and loss effects arise, operating profit based on longer-terminvestment returns also excludes the mark to market value movements on coreborrowings and the effect of changes in economic assumptions and changes in thetime value of cost of options and guarantees arising from changes in economicfactors. After adjusting for related tax and minority interests, the amounts forthese items are included in the calculation of basic earnings per share. Discontinued operations The results for continuing operations shown above and throughout thispreliminary announcement exclude those in respect of discontinued bankingoperations. On 1 May 2007, the Company sold Egg. Accordingly, the presentationof the comparative results for 2006 has been adjusted from those published inMarch 2007. REVIEW OF OPERATING AND FINANCIAL RESULTS Results highlights CER RER (4)(5) 2007 2006 Change 2006 Change £m £m % £m % Annual premium equivalent (APE) sales 2,874 2,374 21% 2,470 16%Present value of new business premiums (PVNBP) 21,302 18,192 17% 18,947 12%Net investment flows 7,975 8,511 (6%) 8,633 (8%)External funds under management 68,669 57,497 19% 57,199 20%New business profit (NBP) 1,215 992 22% 1,039 17%NBP Margin (% APE) 42% 42% 42%NBP Margin (% PVNBP) 5.7% 5.5% 5.5%EEV basis operating profit from long-term business 2,517 2,103 20% 2,208 14%from continuing operations (1) (2)Total EEV basis operating profit from continuing 2,542 2,030 25% 2,133 19%operations (2)Total IFRS operating profit from continuing 1,213 1,008 20% 1,050 16%operations (3)EEV basis shareholders' funds (£bn) 14,779 11,910 24% 11,883 24%IFRS shareholders' funds (£bn) 6,201 5,483 13% 5,488 13%Holding company operating cash flow (82) (104) 21% (104) 21%Holding company operating cash flow 445 (104) 528% (104) 528%plus proceeds from the sale of EggReturn on Embedded Value (6) 15.4% 14.5% 6% (1)Long-term business profits after deducting Asia development expenses andbefore restructuring costs. (2) Based on longer-term investment returns from continuing operations.Operating profit is stated excluding the effect of short-term fluctuations ininvestment returns against the long-term assumptions, the effect of changes ineconomic assumptions and changes in the time value of cost of options andguarantees arising from changes in economic factors, actuarial gains and losseson defined benefit schemes and the mark to market value movements on borrowings. (3) Based on longer-term investment returns from continuing operations.Operating profit is stated excluding the effect of short-term fluctuations ininvestment returns against the long-term assumptions, the effect of changes ineconomic assumptions, actuarial gains and losses on defined benefit schemes andthe mark to market value movements on borrowings. (4) Prior year restated excludes Egg, and shows continuing operations only. (5) Reported exchange rate (RER). (6) Return on Embedded value is based on EEV operating profit from continuingoperations after tax and minority interests as a percentage of opening embeddedvalue (shareholder's funds on a EEV basis) In the Operating and Financial Review (OFR), year-on-year comparisons offinancial performance are on a constant exchange rate (CER) basis, unlessotherwise stated. These results show the strong performance of the Group in 2007. The KPIs aboveshow growth in sales and profits and an improvement in cashflow. The surpluscapital position of Prudential plc, measured under the Insurance Group Directivebasis, will be submitted to the FSA by 30 April 2008 but is currently estimatedto be in the region of £ 1.4 billion. This includes a benefit of around £0.3billion that arose during 2007 from the sale of Egg Banking plc. At 31 December 2007, total insurance and investment funds under management are£267 billion up from £251 billion at the end of 2006, at RER. Basis of preparation of results The European Union (EU) requires that all listed European groups prepare theirfinancial statements in accordance with EU approved IFRS. Since 1 January 2005,Prudential has been reporting its primary results on an IFRS basis. As a signatory to the European Chief Financial Officers' (CFO) Forum's EEVPrinciples, Prudential also reports supplementary results on an EEV basis forthe Group's long-term business. These results are combined with the IFRS basisresults of the non long-term businesses to provide a supplementary operatingprofit under EEV. Reference to operating profit relates to profit based onlong-term investment returns. Under both EEV and IFRS, operating profits fromcontinuing operations based on longer-term investment returns exclude short-termfluctuations in investment returns and shareholders' share of actuarial gainsand losses on defined benefit pension schemes. Under EEV, where additionalprofit and loss effects arise, operating profits based on longer-term investmentreturns also exclude the mark to market value movement on core borrowings andthe effect of changes in economic assumptions and changes in the time value ofthe cost of options and guarantees arising from changes in economic factors. In broad terms, IFRS profits for long-term business contracts reflect theaggregate of statutory transfers from with-profits funds and profits on atraditional accounting basis for other long-term business. Although thestatutory transfers from with-profits funds are closely aligned with cash flowgeneration, the pattern of IFRS profits over time from shareholder-backedlong-term businesses will generally differ from the cash flow pattern. Over thelife of a contract, however, aggregate IFRS profits will be the same asaggregate cash flow. Life insurance products are, by their nature, long term and the profit on thisbusiness is generated over a significant number of years. Accounting under IFRSdoes not, in Prudential's opinion, properly reflect the inherent value of thesefuture profit streams. Prudential believes that embedded value reporting provides investors with abetter measure of underlying profitability of the Group's long-term businessesand is a valuable supplement to statutory accounts. EEV basis operating profit CER RER(4)(5)EEV basis operating profit from continuing 2007 2006 Change 2006 Changeoperations £m £m % £m %Insurance business: Asia 1,046 779 34% 829 26% US 627 652 (4%) 708 (11%) UK 859 686 25% 686 25% Development expenses (15) (14) (7%) (15) 0%Long-term business profit 2,517 2,103 20% 2,208 14%Asset management business: M&G 254 204 25% 204 25% Asia asset management 72 47 53% 50 44% Curian (5) (7) 29% (8) 38% US broker-dealer and asset management 13 16 (19%) 18 (28%) 334 260 28% 264 27% Other income and expenditure (289) (292) 1% (298) 3%Total EEV basis operating profit from continuing operations 2,562 2,071 24% 2,174 18%Restructuring costs (20) (41) 51% (41) 51%Total EEV basis operating profit from continuing operations 2,542 2,030 25% 2,133 19%after restructuring costs Total EEV basis operating profit from continuing operations based on longer-terminvestment returns was £2,542 million, up 25 per cent from 2006 at CER and up 19per cent at RER. This result reflects the significant growth of new businessprofit of £1,215 million and in-force profit of £1,317 million by insurancebusinesses, up 17 per cent over 2006, and strong asset management profit growth. Record new business profit from insurance business of £1,215 million, was 22 percent higher than in 2006, driven by strong sales momentum in Asia and the US. AtRER, new business profit was up 17 per cent. The average Group new businessprofit margin was 42 per cent (2006: 42 per cent) on an APE basis and 5.7 percent (2006: 5.5 per cent) on a PVNBP basis. This reflects an increase in theaverage UK margin offset by a fall in the average Asia margin. In-force profitincreased 17 per cent on 2006 to £1,317 million. At RER, in-force profit was up11 per cent. In aggregate, net assumption changes were £97 million positive, andexperience variances and other items were £48 million positive. The in-force profit in 2007 for the UK business included a charge in respect ofa mortality operating assumption change on annuity and deferred annuity pensionbusiness of £312 million, which is fully offset by a release of excess marginspreviously held. Asia's development expenses (excluding the regional head office expenses) were£15 million, (2006: £14 million). Operating profit from the asset management business was £334 million (2006: £260million), up 28 per cent on 2006, driven by growth in M&G and Asia AssetManagement. Other income and expenditure totalled a net expense of £289 million comparedwith £298 million in 2006 at RER. This result primarily includes interestexpense on central borrowings of £168 million (2006: £177 million); £117 millionof Group head office costs (2006: £83 million) and £38 million of costs for theAsia head office (2006: £36 million). The increase in Group head office costsreflects costs in respect of the process to consider a reattribution of theinherited estate. New business capital usage 2007 2007 2007 2007 2007 £m £m £m £m £m Free surplus Required Total net Value of Total long-term capital worth in-force businessNew business capital usage business Asia (194) 21 (173) 653 480 US (200) 183 (17) 202 185 UK (150) 104 (46) 246 200 (544) 308 (236) 1,101 865 The Group wrote £2,874 million of sales on an APE basis. To support these sales,the Group invested £544 million of capital. This amount covers both new businessacquisition expenses, including commission of £236 million and the requiredcapital of £308 million. The total investment of capital for new businessamounts to approximately £19 million per £100 million of APE sales. These salesprovided a post-tax new business contribution to embedded value of £865 million. In Asia, capital was invested to support sales at an average rate of £15 millionper £100 million of APE sales. In the US, capital was invested to support sales at an average rate of £30million per £100 million of APE sales. In the UK, capital was invested to support sales at an average rate of £17million per £100 million of APE sales. EEV basis profit after tax and minority interests RER(4)(5) 2007 2006 Change £m £m %Total EEV basis operating profit from continuing operationsafter restructuring costs 2,542 2,133 19% Short term fluctuations in investment returns: 174 738Asia 226 286US (8) 64UK (42) 378Other (2) 10Actuarial gains and losses on definedbenefit pension schemes: 116 207Effect of change in economicassumptions: 748 (1)Asia 201 (132)US 81 (51)UK 466 182Effect of change in time value of costof options and guarantees: 0 60Asia 9 14US 8 6UK (17) 40Movement in mark to market value of core borrowings: 223 85 US 9 3Other 214 82 Profit from continuing operations before tax 3,803 3,222 18% Tax (961) (904) Profit from continuing operations 2,842 2,318 23%after tax before minority interests Discontinued operations (net of tax) 241 (105)Minority interests (21) (1) Profit for the period 3,062 2,212 38% The following year-on-year comparisons are presented on a RER basis. In the calculation of EEV operating profit longer-term investment returnassumptions are used rather than actual investment returns achieved. Short-termfluctuations in investment returns are reported separately in the analysis ofprofit. In Asia, long-term business short-term investment fluctuations were £226million, compared to £286 million last year. This reflects favourable equityperformance in most territories, principally Hong Kong, Vietnam and Singaporeoffset by an unfavourable valuation movement of £30 million on a Taiwan CDO. The US business short-term fluctuations in investment returns of £(8) millionprimarily include: a negative £44 million in respect of the difference betweenactual investment returns and longer-term returns included in operating profitin respect of fixed income securities and related swap transactions; a negative£16 million in relation to changed expectations of future profitability onvariable annuity business in force due to the actual variable investment account("separate account") return being lower than the long-term return reportedwithin operating profit, offset by the impact of the associated hedgingposition; and a positive £51 million in respect of the difference between actualinvestment returns and long-term returns included within operating profit inrespect of equity-based investments and other items. The UK business component of short-term fluctuations in investment returns ofnegative £42 million primarily reflects reduced asset values in PRIL, theshareholder-backed annuity business, from widened credit spreads and thedifference between the actual investment return for the with-profits life fundof 7.2 per cent and the long-term assumed return of 7.85 per cent. The actuarial gain of £116 million (2006: £207 million) included in total profitreflects the shareholders' share of actuarial gains and losses on the Group'sdefined benefit pension schemes. On the EEV basis, this gain includes a 10 percent share of the actuarial gains and losses on the share attributable to thePAC with-profits sub-fund for the Prudential Staff and Scottish Amicable PensionSchemes. The full year 2007 gains mainly reflect changes in economicassumptions, partly offset by the effect of strengthened mortality assumptions.The very high level of gains in 2006 reflected the excess market returns overthe long-term assumption and the increase in discount rate applied indetermining the present value of projected pension payments from 4.8 per cent at31 December 2005 to 5.2 per cent at December 2006. In Asia positive economic assumption changes were £201 million, of which £110million is due to Taiwan and £80 million is due to Hong Kong. The Taiwan creditprimarily reflects a change of projected fund earned rate, offset by an increasein risk discount rate, whereas Hong Kong primarily reflects a decrease in therisk discount rate. Taiwan interest rates performed in line with the assumed EEVtrended basis. In the US, economic assumption changes of positive £81 million primarily reflecta reduction in the risk discount rates following a reduction in the US 10-yearTreasury rate, partially offset by a reduction in the separate account returnassumption. In the UK, economic assumption changes of positive £466 million primarilyreflect the impact of the increase in the investment return assumption and adecrease in the risk free rate. The mark to market movement on core borrowings was a positive £223 millionreflecting the reduction in fair value of core borrowings as the decrease ininterest rates is more than offset by the widening of the credit spread,thereby increasing overall market yields on comparable debt securities. The effective tax rate at an operating tax level was 27 per cent (2006: 30 percent), generally reflecting expected tax rates. The effective tax rate at atotal EEV level was 25 per cent (2006: 28 per cent) on a profit of £3,803million. On 1 May 2007, Prudential completed the sale of Egg Banking plc to Citi for aconsideration, net of transaction expenses, of £527 million. The profit fromdiscontinued operations is £241 million being the profit on disposal of £290million, net of the post-tax loss of £49 million from 1 January 2007 to the dateof sale. IFRS basis operating profit CER RER (4)(5)IFRS basis operating profit from longer term 2007 2006 Change 2006 Changeinvestment returns £m £m % £m % Insurance business: Asia 189 177 7% 189 0% US 444 367 21% 398 12% UK 528 500 6% 500 6% Development expenses (15) (14) 7% (15) 0% Long-term business profit 1,146 1,030 11% 1,072 7% Asset management business: M&G 254 204 25% 204 25% Asia asset management 72 47 53% 50 44% Curian (5) (7) 29% (8) 38% US broker-dealer and asset management 13 16 (19%) 18 (28%) 334 260 28% 264 27% Other income and expenditure (248) (244) (2%) (248) 0% Total IFRS basis operating profit based from longer term 1,232 1,046 18% 1,088 13%investment returns Restructuring costs (19) (38) (50%) (38) (50%) Total IFRS basis operating profit based from longer term 1,213 1,008 20% 1,050 16%investment returns after restructuring costs The increase in Prudential Corporation Asia's operating profit of seven per centfor long-term business before development expenses reflects improvedprofitability in mature markets with significant contributions to operatingprofit from Singapore, Malaysia and Hong Kong, representing £153 million of thetotal operating profit in 2007, up 15 per cent on 2006. There were increasedcontributions from each of Indonesia, Taiwan and Vietnam as these operationscontinue to build scale. Five life operations made IFRS losses: £43 million inIndia which is a relatively new business, incurring costs in rapidly buildingscale through its expansion strategy and losses of £16 million in Japan. Korea'sloss reflects new business growth. China and Thailand are marginally lossmaking. In the US, IFRS operating profit of £444 million was up 21 per cent on 2006 atCER. The US operations' results are based on US GAAP, adjusted where necessaryto comply with IFRS as the Group's basis of presenting operating profit is basedon longer-term investment returns. Longer-term returns for the US operations'fixed income securities incorporate a risk margin reserve (RMR) charge forlonger-term defaults and amortisation of interest-related realised gains andlosses. The growth in the US operations' long-term IFRS operating profit mainlyreflects increased fee income driven by a 34 per cent increase in separateaccount assets during the year and higher overall election of optional benefits.Profits from the annuities spread business were broadly in line with prior yearand continue to represent the key contributor to overall IFRS operating profit.One-off items affecting the spread-based income were £26 million, net of DACamortisation In the UK, IFRS operating profit for the long-term business increased six percent to £528 million in 2007. This reflected a seven per cent increase inprofits attributable to the with-profits business to £394 million, representingthe continued strong investment performance of the Life Fund and its impact onterminal bonuses. 2007 includes the net impact of the mortality strengtheningand a release of excess margins previously held in other assumptions which was apositive £34 million. M&G's operating profit for 2007 was £254 million, an increase of 25 per centover 2006, due to strong net investment inflows and positive market conditionsfor the first three quarters of 2007. The Asian asset management operations reported operating profits of £72 million,a growth of 53 per cent over 2006, driven by strong contributions from Vietnam,India and Taiwan. The operating profit from the US broker-dealer and asset management businesseswas £13 million, a 19 per cent decrease on 2006. Curian recorded losses of £5million in 2007, up from losses of £7 million in 2006, as the business continuesto build scale. IFRS basis profit after tax RER(4)(5) 2007 2006 Change £m £m % Operating profit from continuing operationsbased on longer-term investment returnsafter restructuring costs 1,213 1,050 16% Short-term fluctuations in investment returns (137) 155Shareholders' share of actuarial and 90 167other gains and losses on defined benefit pension schemes Profit before tax from continuing operations attributable to shareholders 1,166 1,372 (15%) Tax (382) (392) Profit from continuing operationsfor the financial year after tax 784 980 (20%) Discontinued operations (net of tax) 241 (105)Minority interests (3) (1) Profit for the year attributable to equity holders of the company 1,022 874 17% The following year-on-year comparisons are presented on a RER basis. Total IFRS basis profits before tax and minority interests were £1,166 millionin 2007, compared with £1,372 million for 2006. The decrease reflects areduction in short-term fluctuations in investment returns of £292 million and areduced positive movement from the prior year in actuarial gains and lossesattributable to shareholder-backed operations in respect of the Group's definedbenefit pension schemes. In the calculation of IFRS operating profit longer-term investment returnassumptions are used rather than actual investment returns achieved. The actualmovements in asset values beyond the longer-term assumptions appear in theprofit and loss account as short-term fluctuations in investment returns, withthe exception of Jackson where unrealised gains or losses on debt securitiesfeature directly as movements to shareholder reserves. The £137 million charge for short-term fluctuations in investment returnscomprises £71 million, £18 million and £47 million in respect of Asianoperations, US operations and UK operations respectively. The fluctuations for the Asian operations primarily reflect reduced values fordebt securities in Taiwan and a £30 million reduction in the value of aninvestment in a CDO fund, partially offset by strong equity movements inVietnam. In the US there was a £18 million charge for short-term fluctuations ininvestment returns. During 2007 the US life insurance operations recorded netcredit losses of £78 million (2006: £25 million). This charge is reflected intwo parts of the accounting presentation of the results. Included within theIFRS operating profit based on longer-term investment returns is a risk marginreserve (RMR) charge, representing long-term expected credit defaults, of £48million (2006: £54 million). The difference between the credit related lossesand the RMR charge in the year was, therefore, a charge of £30 million (2006:£29 million credit) which is recorded within short-term fluctuations ininvestment returns, within the overall £18 million charge for US life insuranceoperations. The fluctuations for the UK operations primarily reflect reduced asset values inPRIL, the shareholder-backed annuity business, from widened credit spreads oncorporate bond securities. Profit after tax and minority interests was £1,022 million compared with £874million in 2006. The effective rate of tax on operating profits, based onlonger-term investment returns, was 32 per cent (2006: 29 per cent). Theeffective rate of tax at the total IFRS profit level for continuing operationswas 33 per cent (2006: 29 per cent). The effective tax rates in 2007 werebroadly in line with those expected except for some Asian operations where thereis a restriction on the ability to recognise deferred tax assets on regulatorybasis losses. Earnings per share Earnings per Share (EPS) 2007 2006 £p £p EPS based on operating profit from continuing EEV 74.9 62.1 operations after tax and minority interest IFRS 33.8 30.9 Basic EPS based on total profit after minority interest EEV 125.2 91.7 IFRS 41.8 36.2 Dividend per share The directors recommend a final dividend for 2007 of 12.30 pence per sharepayable on 20 May 2008 to shareholders on the register at the close of businesson 11 April 2008. The interim dividend for 2007 was 5.70 pence per share. Thetotal dividend for the year, including the interim dividend and the recommendedfinal dividend, amounts to 18.00 pence per share compared with 17.14 pence pershare for 2006, an increase of five per cent. The total cost of dividends inrespect of 2007 was £444 million. The full year dividend is covered 1.9 times by post-tax IFRS operating profitfrom continuing operations. Dividend cover is calculated as operating profit after tax on an IFRS basis,divided by the current year interim dividend plus the proposed final dividend. The Board will focus on delivering a growing dividend, which will continue to bedetermined after taking into account the Group's financial flexibility andopportunities to invest in areas of the business offering attractive returns.The Board believes that in the medium term a dividend cover of around two timesis appropriate. Shareholders' funds On the EEV basis, which recognises the shareholders' interest in long-termbusinesses, shareholders' funds at 31 December 2007 were £14.8 billion, anincrease of £2.9 billion from the 2006 year-end level (2006: £11.9 billion atRER). This 24 per cent increase primarily reflects: total EEV basis operatingprofit of £2,542 million; a £174 million favourable movement in short-termfluctuations in investment returns; a £748 million positive movement due tochanges in economic assumptions and in time value of cost of options andguarantees; a positive movement on the mark to market of core debt of £223million; the proceeds for the share capital issue of the parent company for £182million; a positive movement in the actuarial gains on the defined benefitpension schemes of £116 million and the positive impact of £64 million forforeign exchange movements. These were offset by: a tax charge of £961 millionand dividend payments of £426 million made to shareholders. The shareholders' funds at 2007 of £14.8 billion comprise, £3.7 billion for theAsian long-term business operations, £3.6 billion for the US long-term businessoperations, £6.5 billion for the UK long-term business operations and £1 billionfor other operations. At the year end the embedded value for the Asian long-term business was £3.7billion. The established markets of Hong Kong, Singapore and Malaysia contribute£2,704 million to the embedded value generated across the region with Korea(£304 million) and Vietnam (£234 million) making further substantialcontributions. Prudential's other markets, excluding Taiwan in aggregatecontribute £496 million in embedded value. Taiwan has a negative embedded valueof £12 million, this positive movement against prior year (2006: negative £216million) is a reflection of an increase in new business and a change in economicassumptions. The current mix of new business in Taiwan is weighted heavily towardsunit-linked and protection products, representing 75 per cent and 15 per cent ofnew business APE in 2007, respectively. As a result, interest rates have littleeffect on new business profitability and a one per cent reduction in assumedinterest rates would reduce new business margins in Taiwan by less than onepercentage point. However, the in-force book in Taiwan, predominantly made up ofwhole of life policies, has an embedded value that is sensitive to interest ratechanges. A one per cent decrease in interest rates, along with consequentialchanges to assumed investment returns for all asset classes, market values offixed interest assets and risk discount rates, would result in a £91 milliondecrease in Taiwan's embedded value. A similar one per cent positive shift ininterest rates would increase embedded value by £67 million. On the assumptionthat bond yields remained flat during 2008 and then trended towards 5.5 per centin December 2014, this would have reduced the 2007 Taiwan embedded value by £70million. Sensitivity of the embedded value to interest rate changes variesconsiderably across the region. In aggregate, a one per cent decrease ininterest rates, along with all consequential changes noted above, would resultin a negligible percentage change to Asia's embedded value. Statutory IFRS basis shareholders' funds at 31 December 2007 were £6.2 billion.This compares with £5.5 billion at 31 December 2006 at RER. The increaseprimarily reflects: profit after tax and minority interests of £1,022 million,the proceeds from the share capital issue of the Company for £182 million,offset by the impact of negative unrealised holding losses on available for saleinvestments of £231 million, and dividend payments to shareholders of £426million. Holding company cash flow 2007 2006 £m £mCash remitted by business units: UK life fund transfer 261 217 UK other 3 0 US 122 110 Asia 186 175 M&G 139 94 Total cash remitted to Group 711 596Net interest paid (96) (128)Dividends paid (426) (399)Scrip dividends and share options 183 91 Cash remittances after interest and 372 160dividendsTax received 40 122Corporate activities (200) (67) Cash flow before investment in businesses 212 215Capital invested in business units: Asia (149) (147)UK (145) (172) Total capital invested in business units (294) (319) Increase/(Decrease) in operating cash (82) (104)Egg sale net proceeds 527 0 Total holding company cash flow 445 (104) The Group holding company received £711 million in cash remittances frombusiness units in 2007 including the shareholders' statutory life fund transferof £261 million from the UK business. After dividends and net interest paid, there was a net cash inflow of £372million (2006: £160 million). There was a high take up of scrip dividends in2007. During 2007, the Group holding company paid £200 million in respect of corporateactivities, which included costs in respect of the process to consider areattribution of the inherited estate together with a repayment to HMRC inrespect of tax recoveries in previous years following a change in taxlegislation. Tax received of £40 million (2006: £122 million) was lower thanprior year as a result of foreign exchange gains reducing the level of taxablelosses and a payment to HMRC. Asia contributed a net remittance of £37 millionto the holding company cash flow. In aggregate this gave rise to an improvement in operating cash outflow to £82million from £104 million in 2006. The Group received £527 million from the disposal of Egg (net of expenses), andthe reduction in net interest paid in 2007 includes the investment income earnedon these proceeds. In 2008, the UK shareholders' statutory transfer relating to the bonusdeclarations is expected to be £279 million. Depending on the mix of business written and the opportunities available,Prudential expects that the UK shareholder backed business will become cashpositive in 2010. Taking into account plans for future growth, our ability to surrender group taxrelief, a normalised level of scrip dividend, the reducing UK capitalrequirement and increased remittances from the other life and asset managementoperations it is expected that the operating cash flow of the Group holdingcompany will be positive in 2008. BUSINESS UNIT REVIEW Insurance Operations Asia Asia CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %APE sales 1,306 909 44% 956 37%NBP 653 487 34% 514 27%NBP margin (% APE) 50% 54% 54%NBP margin (% PVNBP) 9.3% 10.0% 10.0%Total EEV basis operating profit* 1,046 779 34% 829 26%Total IFRS operating profit* 189 177 7% 189 0%*Based on longer-term investment returns excluding fund management operations, development and regional headoffice expenses. Prudential's strategy in Asia is to build quality, multi-channel distributionthat delivers customer centric and profitable products in segments with thepotential for sustained growth. By necessity, the approach to each marketvaries, but all operations are unified under the Prudence icon and common brandvalues and Prudential has the proven ability to leverage learning and expertisefrom within the region and the wider Group to accelerate the development ofunique opportunities as they arise in each market. The ability to execute the strategy is highly dependent on the strength anddepth of the management talent pool in the region and consequently Prudentialinvests in continually strengthening and developing its teams. The operatingmodel empowers local management teams with a regional team overseeing controlfunctions such as risk management and providing strategic guidance andtechnical support in areas such as distribution optimization and product design. Prudential has a market leading platform with top five market share positions,in terms of new business APE, in seven of its twelve markets. Prudential has theleading private sector life insurance joint ventures in China and India. Current year initiatives The core business priorities were outlined as: • Building on existing strengths in agency • Improving and extending partnership distribution • Continuing product innovation • Strengthening and deepening customer relationships • Developing retirement solutions • Starting work on direct distribution • Re-examining approach to health products Agency is the predominant distribution channel in Asia and for Prudential, theagency force again generated 70 per cent of new business volumes in 2007.Success in agency distribution requires building and maintaining meaningfulscale in terms of agent numbers whilst also providing the infrastructure tomanage agent training and skills development to drive agency productivity.Prudential's agency priority depends on the stage of development of eachindividual market and Prudential's operation within it. For example in India,Prudential's joint venture with ICICI has been rapidly expanding, with theaddition of 593 new branches during the year to give a total 1,065 andcorrespondingly average agent numbers in 2007 increased by 123 per cent and at31 December there were 277,000 agents. Similarly in China, although the rate of geographic expansion is slower as eachnew city requires separate regulatory approvals the emphasis is also onexpanding the agency channel; average numbers were up 38 per cent and at 31December there were 20,500 agents. In markets where we have sufficient agencyscale, the emphasis is on helping those agents become more productive throughintensified training and sales management support. Agent productivity, in termsof average APE per agent, increased by 67 per cent in Vietnam and 21 per cent inSingapore during 2007. Prudential has a large partnership distribution network in Asia. During 2007,Prudential extended its agreements with Standard Chartered Bank to includeTaiwan where it will exclusively provide bancassurance products in their newlyacquired HsinChu International Bank with its 83 branches and 2.4 millioncustomers. In Korea regulation states that a bank can only source a maximum of25 per cent of its total insurance sales from any one insurer, and withPrudential's sales existing bank partners regularly reaching their maximumshares, adding new banks is a priority. In 2007 Prudential secured two major newbanks, Industrial Bank of Korea and Kookmin Bank. Prudential's regionalbancassurance relationship with Citibank also grew strongly with new businessAPE generated of £23 million being 12 per cent of total bank distribution for2007. In 2007 Prudential continued to broaden its range of linked products. Theseincluded the new Global Property Fund in Singapore and a new Takaful range inIndonesia, launched in September 2007. In Taiwan, a new variable annuity productand an agency incentive programme contributed to the growth in new business of71 per cent for the year. Good results were attained from systematic cross-sell campaigns across theregion, contacting more than 2 million of our existing customers. Theseincluded the initiation of a regular up-sell in Hong Kong through the indexationof policy benefits and initiatives to capture maturity proceeds in Singapore anda targeted offer of guaranteed increases in protection benefits in Malaysia. Although still small, new business from direct marketing grew by 65 per centover 2006 with Thailand performing well and recording growth of 52 per cent. Theregional Direct Marketing team has been strengthened and work is now underway onexploring further opportunities. In Asia, there are very material opportunities arising in the provision ofhealthcare solutions. Prudential successfully piloted new supplemental healthproducts in Singapore, India and Hong Kong during the year selling over 125,000new policies. Helping people address their financial needs for retirement is also a majorgrowth opportunity and whilst Prudential already has a number of productsdesigned to support the accumulation phase of a retirement fund, work is nowunderway on drawdown options and supporting related protection and healthproducts. Prudential has already begun positioning itself as a provider ofretirement solutions through the roll out of the successful 'What's your number?' campaigns in six countries that encourage people to think about what resourcesthey are likely to need to finance their retirement aspirations. Prudential has a unique position in Vietnam with its market leading lifeinsurance business and well respected brand. To further leverage this platform,Prudential launched a consumer finance company in September 2007. Financial performance In 2007 Prudential delivered new business APE of £1,306 million from Asiarepresenting very strong growth that averaged 44 per cent over 2006 and with alloperations delivering double digit growth including Taiwan, India and Indonesia,up 71 per cent, 67 per cent and 75 per cent respectively. New business profit increased by 34 per cent as the average profit marginreduced from 54 per cent to 50 per cent mainly due to a change in the countrymix of the sales. China, Hong Kong, Korea and Taiwan all reported increases innew business profit margins compared to 2006. In India, the branch expansionprogramme, has led to an increase in policy acquisition and maintenance costsand therefore a rebasing of the expense assumptions. The reduction in averagemargin for the other countries was due to a change in country mix. In-force embedded value profits of £393 million are driven principally by theunwind of discount, with net assumption changes of £54 million and netexperience variances of £(1) million. Assumption changes were principally dueto favourable changes in corporation tax and positive mortality assumptionchanges. Negative persistency assumption changes are offset by positive expenseassumption changes. Experience variances mainly reflected positive mortalityacross all operations partially offset by expense overruns in the neweroperations of China, India and Vietnam. IFRS Profits CER 2007 2006 Change £m £m %Established markets (Hong Kong,Singapore, Malaysia) 153 134 15%North Asia (Taiwan, Korea, Japan) 16 20 (20%)Joint Venture markets (China, India) (49) (20) (146%)Other SE Asian markets ( Indonesia, Vietnam, Thailand, Phillipines) 68 43 58%Total Life IFRS Profits 189 177 7% The total IFRS Operating profit of £189 million was up seven per cent on 2006.Within this, the Established markets (Singapore, Hong Kong and Malaysia)generated £153 million up 15 per cent from 2006. The North Asia markets (Taiwan,Japan, and Korea) generated £16 million, down 20 percent from last yearreflecting increased losses in Japan. Excluding Japan, profits from North Asiaalmost doubled reflecting a strong increase in Taiwan of 47 per cent due toin-force profits, especially from long term health products and favourable otherexperience. Losses from the joint ventures in India increased to £43 million,reflecting the fast pace of new business growth and investment in growing thebranch networks. Losses from the joint venture in China reduced to £6 million.In the other markets (Vietnam, Thailand, Indonesia and Philippines), profitsgrew by 58 per cent to £68 million reflecting the expected emergence of IFRSprofits and a one off £16 million favourable item in Vietnam. In 2007 the Asian Life operations were again net remitters of cash to the Groupof £56 million. Remittances totalling £148 million were from Hong Kong,Indonesia, Malaysia, Singapore and included the first remittance from Vietnam.The Life operations received injections of £92 million, of which £49 million wasinjected into India to support branch expansion with the balance primarilyinjected into China and Korea to support solvency requirements as a result ofnew business growth. IRR for Asia was in excess of 20 per cent for 2007. In Asia, Prudential targetsIRRs on new business to be at least 10 percentage points over the country riskdiscount rate, where these vary from five per cent to 17 per cent. During 2007all markets except India and Japan met this target. Having achieved compound growth of 26 per cent since 2005, Asia expects todeliver doubling of 2005 EEV NBP a year early by 2008. United States United States CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %APE sales 671 565 19% 614 9%NBP 285 239 19% 259 10%NBP margin (% APE) 42% 42% 42%NBP margin (% PVNBP) 4.3% 4.2% 4.2%Total EEV basis operating profit* 627 652 (4%) 708 (11%)Total IFRS operating profit* 444 367 21% 398 12%*Based on longer-term investment returns excludes broker dealer, fund management and Curian The United States is the largest retirement savings market in the world andcontinues to grow rapidly. By mid-2007, total retirement assets in the USexceeded $17.4 trillion, up from $16.5 trillion at the end of 2006 (Source:Investment Company Institute). As 78 million baby boomers (Source: US CensusBureau) move into retirement age, these assets will shift from assetaccumulation to income distribution. Currently, $1.6 trillion of assets aregenerating retirement income. This amount is estimated to grow to $7.3 trillionby 2017 (Source: Financial Research Corporation). Despite these favourable demographics, US life insurers face challenges fromboth within and outside the industry. The industry remains highly fragmented,with the top 15 annuity companies sharing only 74 per cent of the total marketshare in 2007 (source: LIMRA). Competition is intensifying through aggressiveprice competition. Life insurers also find themselves competing with otherfinancial services providers, particularly mutual fund companies and banks, fora share of US retirement savings assets. During 2007, the S&P index increased 3.5 per cent (2006: 13.6 per cent), and theUS equity markets experienced significant volatility during the second half ofthe year. The S&P index increased 6 per cent through June 2007, yet ended theyear 2.5 per cent lower than in June and 5.7 per cent lower than at the end ofOctober. This volatility and concerns about the US economy are expected toincrease investors' interest in guarantees on products with equity-basedreturns. In addition, for much of 2007, the yield curve was flat and credit spreads wererelatively low, resulting in a difficult environment for the sale of properlypriced fixed annuities. During the second half of 2007, the yield began tonormalise and credit spreads began to widen, ending closer to normalisedhistorical levels. The market for fixed annuities was further complicated duringthe year by artificially high deposit rates offered by banks to attract assets. Jackson's primary focus is manufacturing profitable, capital-efficient products,such as variable annuities, and marketing these products to advice-basedchannels through its relationship-based distribution model. In developing newproduct offerings, Jackson leverages a low-cost, flexible technology platform tomanufacture innovative, customisable products that can be brought to the marketquickly. Jackson markets its retail products primarily through advice-based distributionchannels, including independent agents, independent broker-dealer firms,regional broker-dealers, banks and registered investment advisors. Jackson alsomarkets life insurance and fixed annuity products through its captive insuranceagency, which is concentrated in the south-eastern United States. Current year initiatives During 2007 significant progress was made against the business priorities whichincluded: • continued enhancement and expansion of the existing product offering • continue to take profitable share of variable annuities market • increased penetration of existing distribution channels • increase share of the US retail asset management market. Jackson continues to base its success in the evolving US market on industryleading distribution and product innovation coupled with sound evaluation ofproduct economics. Jackson's long-term goals include the continued expansion ofits share of the US annuities and retail asset management markets, which itplans to achieve by leveraging its relationship-based distribution advantage inthe advice-based channels. Growth in Jackson's share of the US annuities marketwill be largely contingent upon continued enhancement and expansion of theexisting product offering, increased penetration of existing distributionchannels and entry into new distribution channels, as well as opportunisticacquisition activity. Innovation in product design and speed to market continue to be key drivers ofJackson's competitiveness in the variable annuity market. High quality,cost-effective technology has allowed Jackson to offer a comprehensive productportfolio that can be customised to meet the needs of individual customers.Products are offered on an unbundled basis, allowing customers to select thosebenefits that meet their unique financial needs and pay only for those benefitsthat they truly need. This advantage, coupled with distribution throughadvice-based channels, allows Jackson to effectively meet individuals' long-termretirement savings and income needs. Jackson believes that leveraging thisadvantage is a more sustainable long-term strategy than price competition and,as a result, will not sacrifice product economics for a short-term increase inmarket share. Jackson supports its network of independent agents and advisors withaward-winning customer service and marketing support. In 2007, the ServiceQuality Measurement Group rewarded Jackson with its third World Class CustomerSatisfaction Award. Jackson's marketing campaigns continue to win awards forachievement in graphic design, editorial content and overall communicationsexcellence. Through organisational flexibility and excellence in execution, coupled withproduct innovation, a successful distribution model and a strong serviceoffering, Jackson increased its share of the US variable annuity market to 5.1per cent for full-year 2007 (source: Morningstar Annuity Research Center), upfrom 4.6 per cent for the full-year 2006. Jackson continues to expand its product portfolio, adding a variety of newfeatures during 2007. The company enhanced its variable annuity portfolio byadding 20 new underlying investment options, four new guaranteed minimumwithdrawal benefits (GMWBs), one new guaranteed minimum income benefit (GMIB)and its first guaranteed minimum accumulation benefit (GMAB). In 2007, Jackson also introduced a line of retail mutual funds and launched twonew fixed index annuity products that offer new index options and multiplecrediting methods. These additions provide even more product choices to advisorsand create more opportunities to capture a larger portion of the US retirementmarket. Jackson continues to seek bolt-on acquisitions that will complement itslong-term organic growth strategy. Transactions will need to meet or exceedJackson's targeted rate of return and will likely be in the life insurancechannel, which provides stable future cash flows. Depending on the opportunitiesthat become available, Jackson may consider utilising securitisation financingfor these bolt-on transactions. Financial performance Jackson achieved record APE sales of £671 million in 2007, representing a 19 percent increase on 2006. This growth was led by a continued increase in variableannuity sales. On a PVNBP basis, new business sales were £6.7 billion. RetailAPE sales in 2007 of £577 million were up 19 per cent over 2006. Jackson delivered record variable annuity APE sales of £455 million in 2007, up29 per cent over 2006. In 2007, Jackson maintained its ranking of 12th in grossvariable annuity sales (Source: Morningstar Annuity Research Centre). Fixed annuity APE sales of £57 million were 10 per cent down on 2006, whileindustry sales of traditional individual deferred fixed annuities were 13 percent lower in 2007 compared to 2006 (Source: LIMRA). Fixed index annuity sales continued to be affected by the uncertain regulatoryenvironment in the US and the impact of low interest rates on caps andparticipation rates that are offered. As a result, industry sales were nearly 1per cent lower in 2007 compared to 2006 (Source: Advantage Group Associate).Jackson's APE sales of £45 million were 12 per cent down on 2006. In the thirdquarter of 2007, Jackson ranked first in fixed index annuity sales through banksfor the ninth consecutive quarter (Source: The Kehrer-LIMRA Report). Jacksoncontinues to pursue profitable growth and hence has been unwilling to compromisetarget margins in this market. Institutional APE sales of £94 million were up 15 per cent on 2006. Jacksoncontinues to participate in this market on an opportunistic basis when marginsare attractive. EEV basis new business profits of £285 million were 19 per cent above the prioryear, reflecting a 19 per cent increase in APE sales with a shift in the mix ofbusiness toward variable annuities as well as increased sales of institutionalbusiness with longer duration. Total new business margin was 42 per cent, inline with 2006. The variable annuity new business margin decreased from 49 per cent in 2006 to42 per cent in 2007, primarily due to a 70 basis point decrease in the risk-freerate from 2006 to 2007. The lower risk-free rate resulted in a decrease in theassumed separate account return that was partially offset by a decrease in therisk discount rate. In addition, Jackson reviewed its experience assumptionsduring the year and revised certain partial withdrawal and expense assumptions,which also decreased the new business margin. The fixed index annuity new business margin decreased from 31 per cent in 2006to 26 per cent in 2007, primarily as a result of a change in expected futuresurrender charges. The fixed annuity new business margin increased significantly from 16 per centto 28 per cent, primarily as a result of a decrease in the risk discount ratefor the year. The new business margin on institutional business improved significantly, from39 per cent in 2006 to 58 per cent in 2007 due to the much longer averageduration contracts written during 2007 and a lower risk discount rate. Total EEV basis operating profit for the long-term business for 2007 was £627million compared to £652 million in the prior year at CER. In-force EEV profitsof £342 million were 17 per cent below prior year profit of £413 million at CER.Experience variances were £58 million lower in 2007 due to lower spread incomeand the impact of persistency adjustments. Operating assumption changes wereless favourable than the prior year by £17 million including the impact ofupdated persistency and lapse rates during 2007. One-off items favourablyaffected the spread income variance by £40 million during 2007. IFRS operating profit for the long-term business was £444 million, up 21 percent on the prior year of £367 million at CER, primarily reflecting an increasein fee income and continued low mortality rates during 2007. Higher fee incomewas driven primarily by higher separate account assets given the growth invariable annuity sales, and an improvement in the average fees generated fromthose assets given the increase in election of guaranteed optional benefits. In2007, IFRS spread income included a number of non-recurring items, totalling £26million net of DAC amortisation (2006: £31 million at CER). At 31 December 2007, Jackson had more than £41 billion in US GAAP assets. Ofthis total, £15 billion were separate account assets, an increase of £4 billionfrom year-end 2006, further increasing Jackson's earnings from fee-basedproducts. During the second half of 2007, equity market volatility increased materiallyprimarily due to liquidity concerns and valuation issues in the US sub-primemortgage market. Much of the market movement was due to concerns regarding therisk in this market that resulted in a tightening in the level of creditavailable. While the financial services industry was hardest hit by theseevents, losses were generally limited to those companies with significant levelsof sub-prime or Alt-A mortgage exposure. Jackson's exposure to the sub-primemortgage market is limited at only £237 million at the end of 2007. Most ofthis exposure is in fixed rate, residential mortgage backed securities that areAAA rated and hold first liens on the underlying collateral. Exposure to Alt-Awas £660 million and direct exposure to monoline insurers was £23 million. The average IRR on new business was up slightly to 19 per cent, primarily due toa larger proportion of variable annuity sales in 2007. United Kingdom United Kingdom CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %APE sales 897 900 (0%) 900 (0%)NBP 277 266 4% 266 4%NBP margin (% APE) 31% 30% 30%NBP margin (% PVNBP) 3.6% 3.4% 3.4%Total EEV basis operating profit* 859 686 25% 686 25%Total IFRS operating profit* 528 500 6% 500 6%*Based on longer-term investment returns. In 2007, Prudential UK continued its strategy of selectively competing in areasof the retirement savings and income markets where it can generate attractivereturns. The UK business remains focused on maximising value from the opportunityafforded by the fast growing need for retirement solutions. With an ageingpopulation and the concentration of UK wealth in the mass affluent and high networth sectors, the retirement and near-retirement population will represent thefastest growing segments of the market over the next 10 years. Low savings ratesand high levels of consumer debt, combined with a shift in responsibility forproviding income during retirement from Government and employers towardsindividuals, have resulted in individuals being inadequately provided for duringincreasingly long periods of retirement. These consumers will have a need forhigh quality financial advice and service and are increasingly seekingguarantees and longevity protection from their financial products. Prudential UK has a unique combination of competitive advantages including itssignificant longevity experience, multi-asset management capabilities and itsbrand and financial strength. These put it in a strong position to pursue itsvalue driven strategy in its two principal businesses: Retail and Wholesale. Prudential UK's Retail business is focusing on savings and income for thosecustomers nearing or in retirement. Its retirement income business aims tocontinue to drive profitable growth in its core annuities operation and grow itspresence in the equity release market. The significant 25-year pipeline ofinternal vestings annuity business from maturing individual and corporatepensions policies is enhanced by strategic partnerships with third parties,where Prudential UK is the recommended annuity provider for customers vestingtheir pension at retirement. This scale enables our selective value-basedparticipation in the external vestings market. Annuities remain core drivers ofthe sales and profit derived by Prudential UK, which now has approximately 1.5million annuities in payment. Prudential UK remains a market leader in the with-profits market. These productsoffer a medium to long-term, medium risk investment with exposure to a diverserange of assets that is particularly important to many customers against thebackdrop of market uncertainty. In the Retail accumulation business, Prudential UK continues to be a marketleader in the corporate pensions market where it is a provider of over 20 percent of FTSE 350 companies and the largest provider of pension schemes to the UKpublic sector. Prudential now administers corporate pensions for over 600,000members. In addition, the Retail business has used its brand and strength with Discoveryto build branded distribution in Health and Protection, further using the jointventure to access Discovery's Vitality concept and lifestyle protectioncapabilities. Prudential UK's strategy in the Wholesale market is to participate selectivelyin bulk annuity and back-book buy-outs, where Prudential UK is able to winbusiness based on its financial strength, superior track record, market leadinginvestment capability as well as its extensive annuitant mortality riskassessment capabilities. The Wholesale business, which has been in operation forover 10 years and has already written more than 400 bulk buy-outs, has a strongtrack record in the risk management of pension schemes for corporate clients andinsurers wishing to reduce or eliminate their investment or longevityliabilities. Prudential UK will maintain a strict focus on value, onlyparticipating in transactions that generate an acceptable rate of return. Current year initiatives Prudential UK's key priorities in 2007 were: • Maintaining leadership position in individual annuities • Building share of the equity release market • Growing the volume of products that utilise Prudential's multi-asset management expertise • Deepening relationships with chosen distributors including the introduction of customer-agreed remuneration across some product lines • Realigning cost base to the selective business strategy • Delivering wholesale transactions with attractive rates of return During 2007, Prudential UK maintained its market leadership in individualannuities, where it has continued to create value by maintaining high retentionrates. This has been augmented by partnership deals with insurers such asZurich, Royal London and Save and Prosper. We also announced a new partnershipwith Barclays, where Prudential will be the preferred supplier of conventionalannuity products to their retail customers in the UK. Capitalising on the need for inflation protection in retirement, Prudentialremains the market leader in the growing with-profits annuity market with over75 per cent market share. Early in 2007 Prudential made a number of productenhancements including the facility to accept Protected Rights monies, which wasa first in the with-profit annuity market. In the fourth quarter, Prudential UK launched an income drawdown product. Thisproduct helps customers manage their pension through the various stages ofretirement, and offers flexibility whilst providing potential for growth throughinvestment. Together with the Flexible Lifetime Annuity this gives Prudential afull range of retirement income solutions. Investing in property has been an increasingly important component for manypeople saving for their retirement. However this has left many retirees incomepoor but asset rich. Prudential UK's lifetime mortgage business grew its shareof the lifetime mortgage market to 14 per cent through its distinctive drawdownproduct and strong brand. In the third quarter a number of product enhancementswere introduced, including an inheritance guarantee and a new lump sum product.Prudential expects both its market share and the overall market size to grow. In a relatively volatile investment market there has been a marked increase indemand for cautious managed solutions providing enhanced returns. In February2007, Prudential UK launched the Cautious Managed Growth Fund and the ManagedDefensive Fund, using Prudential's strengths in investment expertise and indisciplined approach to asset allocation. These funds have the potential tooffer a better longer-term return than a bank or building society account andallow the customer to access real returns with lower volatility. These funds areavailable across the full tax wrapper suite, including onshore and offshorebonds, individual pensions and mutual funds. During 2007, Prudential UK introduced customer-agreed remuneration across someof its product lines. Under this model, financial advisors agree theirremuneration directly with the customer and not with the product provider and indoing so make commission structures far more transparent. This is in line withPrudential UK's focus on building strong long-term relationships with advisorsas well as offering market-leading retirement solutions. The agreement announced in 2007 with Capita to outsource a large proportion ofits in-force and new business policy administration is another importantmilestone for the UK business. This agreement will deliver £60 million per annumof savings to Prudential UK, and is an important element in achieving its totalcost savings target of £195 million. The contract will result in approximately3,000 employees transferring to Capita and helps the UK deliver its long-termcost savings strategy by removing fixed costs from the business and achievingsignificant operating efficiencies. This provides a significant reduction inlong-term expense risk by providing certainty on per-policy costs as the numberof policies in the mature life and pensions book decreases over the comingyears. Unit costs per policy are expected to reduce by over 30 per cent by 2011. By the end of 2007 £115 million of the cost saving target had been delivered.The remaining £80 million, including the £60 million generated from the Capitacontract, will be delivered by the end of 2010. In December, Prudential completed the transfer of Equitable Life's portfolio ofin-force with-profits annuities. This book covers approximately 62,000 policieswith assets of approximately £1.74 billion. This deal grows Prudential'swith-profits business and creates value for both Equitable policyholders andPrudential's shareholders and policyholders. Financial performance Total APE sales of £897 million were in line with 2006 and there was a fourpercent increase in new business profit to £277 million, reflecting an improvednew business margin of 31 per cent in an increasingly competitive market. The2006 comparator included credit life sales of £63 million and associated newbusiness profit of £20 million written under a single contract that was notrenewed in 2007. A strong Retail performance saw a four per cent increase in sales and a 17 percent increase in new business profit to £223 million demonstrating thecontinuing benefits of selectively participating in product lines that candeliver attractive returns. Retail sales growth was driven by strongperformances in individual annuities, corporate pensions, with-profits bonds andlifetime mortgages. In the wholesale bulk annuity and insurer back-book market, Prudential UKachieved a 26 per cent year-on-year increase with sales in 2007 of £180 million.In the fourth quarter Prudential completed the transfer of Equitable Life'sportfolio of in-force with-profit annuities. In the previous year, Prudential UKcompleted two back-book insurer deals with a total volume of £143 million. Newbusiness profits relating to the Wholesale business were £54 million in 2007. EEV basis operating profit based on longer-term investment returns of £859million, before restructuring costs of £8 million, were up 25 per cent on 2006.The in-force operating profit of £582 million was up 39 per cent on 2006, due tothe increase in profits arising from the unwind of the in-force book (reflectingan increased opening embedded value) and a £67 million positive operatingassumption change in 2007 reflecting the change in the long term tax rateassumption from 30 per cent to 28 per cent. A charge in respect of a mortalityoperating assumption change on annuity and deferred annuity pension business of£312 million was fully offset by the release of excess margins previously held. Other charges of £77 million include £36 million of costs associated withproduct and distribution development; £13 million for an annual fee paid by theshareholder business to the Prudential Assurance Company's (PAC) with-profitssub-fund for the use of the Prudential and Scottish Amicable trademarks; £14million in respect of the tariff arrangement with Scottish Amicable InsuranceFinance (SAIF), which terminates at the end of 2007 and £14 million in relationto other items. Prudential continues to manage actively the retention of the in-force book.During 2007, experience at an aggregate level has been in line with ourlong-term assumptions as evidenced by the small positive experience variance. IFRS operating profit increased six per cent to £528 million beforerestructuring costs of £7 million. This reflects a seven per cent increase inprofits attributable to the with-profits business, which contributed £394million reflecting strong investment performance and its impact on terminalbonuses. The net impact of the mortality strengthening and release of marginsheld in other assumptions under the IFRS basis was a positive net £34 million. In 2007, Prudential received a £4 million net commission payment from Winterthurrelating to general insurance sales under the Prudential brand in the UK. Fromearly 2008, on settlement of an advance payment made by Winterthur in 2002, thebusiness expects to receive approximately £30 million a year in commissionpayments, although this will depend on the new business volumes and persistencyrates. Prudential UK writes with-profit annuity, with-profits bond and with-profitscorporate pension business in its life fund with other products backed byshareholder capital. The weighted average post-tax IRR on the shareholdercapital allocated to new business growth in the UK was 14 per cent, excludingthe Equitable Life deal (18 per cent including this business). Asset Management Global The Prudential Group's asset management businesses provide value to theinsurance businesses within the Group by delivering sustained superiorperformance. They are also important profit generators in their own right,having low capital requirements and generating significant cash flow for theGroup. The asset management businesses are well placed to capitalise on their leadingmarket positions and strong track records in investment performance to delivernet flows and profit growth as well as strategically diversifying the Group'sinvestment propositions in retail financial services (RFS) markets that areincreasingly favouring greater product transparency, greater cross-borderopportunities and more open-architecture investment platforms. Wholesale profitstreams are also growing. The Group's asset management businesses operate different models and underdifferent brands tailored to their markets and strengths, however they continueto work together by managing money for each other with clear regionalspecialism, distribute each others' products and share knowledge and expertise,such as credit research. Each business and its performance in 2007 is summarised below. M&G M&G is comprised of the M&G asset management business and Prudential Capital. M&G CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %Net investment flows 4,958 6,101 (19%) 6,101 (19%)Revenue 482 429 12% 429 12%Other income 30 27 11% 27 11%Staff Costs (224) (216) (4%) (216) (4%)Other Costs (113) (106) (7%) (106) (7%) Underlying profit before Performance-related Fees 175 134 31% 134 31%Performance-related fees 28 27 4% 27 4% Operating profit from asset management operations 203 161 26% 161 26%Operating profit from Prudential Capital 51 43 19% 43 19% Total IFRS operating profit 254 204 25% 204 25% M&G Asset Management M&G is an investment-led business with a demonstrable focus on performancedelivery and aims to offer attractive products in a variety of macro-economicenvironments. M&G aims to deliver superior investment performance and maximiserisk-adjusted returns for our retail, wholesale and internal clients. Externalfunds under management account for nearly a third of M&G's total funds undermanagement and it is this higher-margin external business that drivesprofitability and cash generation for the Group. M&G's retail strategy is based on obtaining maximum value from a singlemanufacturing function through a multi-channel, multi-geography distributionapproach. Over the last five years, M&G's retail business has expanded beyondthe UK into the major European markets, the Middle East, South America and Asia.By operating through multiple channels, M&G's retail business is well placed toprofit from current trends away from direct selling towards intermediation, andthe growth of on-line fund platforms and third-party product wrappers. M&G's wholesale strategy centres on leveraging the skills developed primarilyfor internal funds to create higher margin products for external clients. Inrecent years, this strategy has consolidated M&G's position at the forefront ofthe leveraged finance, structured credit and infrastructure investment markets.The same strategy is now being applied to develop the more traditional pooledand segregated fixed income areas of M&G's wholesale business. M&G has significant scale in all major asset classes: it is believed to be oneof the largest active managers in the UK stock market, one of the largest bondinvestors in the UK and one of the UK's largest property investors. In addition,M&G has profitable businesses in a number of specialist areas such as leveragedloans, structured credit, infrastructure finance and macro investment. Current year initiatives Delivering fund performance remains critical and is the key determinant ofsuccess for an asset management business. M&G has continued to delivermarket-leading investment performance in 2007 with impressive results. M&G'sretail funds have performed exceptionally well, with 45 per cent deliveringtop-quartile performance(1). In addition, 86 per cent of M&G's segregatedinstitutional funds have met or exceeded their benchmark performance1. Returns1 on Prudential's Life Fund assets were 66 basis points ahead ofbenchmark and 143 basis points better than peer group. Overall, the demand for asset management products in M&G's distribution marketscontinued to grow strongly in 2007 driven, in part, by the sameretirement-related demographic trends that are creating opportunities for theGroup as a whole. With a diversified business across different asset classes and across retail andwholesale markets, both in the UK and internationally, M&G remains wellpositioned for a variety of macro-economic and market conditions. The way that clients purchase asset management products continued to evolveduring 2007. The retail asset management sector benefited from the increasingshift by retail investors towards more transparent investment products, such asunit trusts, and M&G's range of market leading funds has positioned it well tobenefit from this trend. M&G extended its range of innovative new funds during2007 with the launch of the M&G Cautious Multi Asset Fund and M&G GlobalConvertibles Fund. European cross-border distribution of retail funds has accelerated and the trendin favour of 'Open Architecture' in both the UK and Europe continues to open upsignificant bank and life company distribution opportunities. Parallel to this,distribution of mutual funds has become increasingly intermediated and has beenaccompanied by the rise of professional buyers who demand higher levels ofservice and investment information, areas in which M&G has considerableexpertise. M&G has continued to expand its geographic coverage in Europe withthe first full year of operations in Spain and the launch of M&G's funds inFrance in October 2007 which has given M&G access to Europe's largest mutualfund market. Wholesale markets are demanding increasingly sophisticated and tailored productsand there is a continued shift from balanced to specialist mandates. Thesetrends, plus the increased role of fixed income within portfolios, continue toplay to the strength and scale of M&G's wholesale business. In 2007, M&Glaunched three new funds aimed at the institutional and pensions markets - the M&G Alpha Opportunities Fund, M&G Secured Property Income Fund and the M&GSecured Debt Fund. All of these funds offer innovative alternatives totraditional fixed income assets and leverage off M&G's expertise and scale inboth property and private finance. M&G's infrastructure investment business has grown from inception in 2005 tomanage £471 million (2007 year end fair value) in its principal fund,Infracapital. The business contributed £7.1 million to M&G profits in 2007. M&G's global macro investment business was established in 2005 and has grown to£1.5 billion in external funds under management as at the end of 2007. Itcontributed £11.2 million in profits to M&G in 2007, including performancerelated fees. In order to support its retail and wholesale strategy, M&G places a highpriority on the recruitment, development and retention of top-quality staff. Ina highly competitive market for the best talent, this entails providing aninclusive and supportive environment as well as offering appropriate levels ofcompensation. At the same time, M&G has a policy of prudent cost control,ensuring that top-line growth is translated into enhanced operational gearing.During 2007 turnover of staff remained in line with industry averages at 10 percent and the company spent £2.1 million on training and development programmes. Financial performance M&G recorded another year of record profits in 2007 with an operating result of£203 million (2006: £161 million), representing profit CAGR of 34 per cent since2003. Underlying profit growth, which excludes volatile performance relatedfees (PRFs) and carried interest earned on private equity investments, has grownat 36 per cent CAGR over the same period to £175 million (2006: £134 million). M&G continues to target increased diversity in profit generating activities. In2007, 80 per cent of underlying profits were generated as a result of managingexternal funds, compared to 23 per cent in 2003. Profit growth is driven byfour key factors: appreciation of underlying assets, positive net sales,increasing mix of higher-margin business and decreasing cost/income ratio. The underlying growth in M&G's principal investment markets over recent yearshas been strongly supportive of its performance. While this growth is beyond thecompany's control, M&G has been successful at increasing diversity in terms ofboth asset class and distribution channel in order to reduce exposure tocyclical downturns in individual markets. M&G has performed strongly against the other three measures. Net sales for 2007of £5.0 billion (2006: £6.1 billion) were driven by both the retail £2.7billion, (2006: £3.1 billion) and wholesale £2.3 billion, (2006: £3.0 billion)businesses. Gross inflows of £14.7 billion were the highest on record, offset tosome extent by higher gross redemptions, particularly in the more volatileinternational retail marketplace. The continued strong growth in external funds under management, coupled with asmall decline in the value of funds managed for Prudential, has resulted inan increasing mix of higher-yielding business for M&G. This has supported anincrease in gross margin (revenue as a proportion of FUM) from 28.0 basis pointsin 2003 to 30.8 in 2007. During 2007, M&G has exercised continued cost discipline to ensure that top-linegrowth feeds through to profitability and cash generation. M&G's cost/incomeratio for 2007 was 66 per cent (2006: 71 per cent) having fallen from 83 percent in 2003. M&G continues to provide capital efficient profits and cash generation for thePrudential group, as well as strong investment returns on its long-term businessfunds. Cash remittances were £99 million in 2007. Prudential Capital Prudential Capital (re-branded from Prudential Finance in 2007) managesPrudential's balance sheet for profit through leveraging Prudential's marketposition. The business has three strategic objectives: to operate a first classwholesale and capital markets interface; to realise profitable proprietaryopportunities within a tightly controlled risk framework; and to provideprofessional treasury services to Prudential. Prudential Capital generatesrevenue by structuring transactions, providing bridging finance, and operating asecurities lending and cash management business for Prudential and its clients. The business has continued to grow in terms of investment, infrastructure andpersonnel in a controlled way while maintaining the dynamism and flexibilitythat it requires to identify and realise opportunities for profit. PrudentialCapital is committed to working closer with other Group business units todeliver opportunities and to improve value creation for the Group. PrudentialCapital is also taking a more holistic view on hedging strategy, liquidity andcapital management for the Group. Prudential Capital has a diversified earnings base derived from bridging,structured finance and wholesale markets. Prudential Capital delivered a goodfinancial result in 2007, driven by increased investment activity and strongsecurities lending performance. As a result of increased revenue and maintaininga low cost/income ratio, operating profits increased by 19 per cent to £51million, resulting in a cash remittance to the holding company of £40 million. Asia Asia CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %Net investment flows 2,961 2,410 23% 2,532 17%Total IFRS operating profit* 72 47 53% 50 44%*Based on longer-term investment returns. Prudential's asset management business in Asia supports the Life Business, andhas established itself as an increasingly material retail business in its ownright. Today it has retail operations in ten markets and, is the only foreignfund manager with a top five market share position in more than one Asiancountry. The mutual fund industry continues to diversify its investments, expectationsare for a significant increase in net flows over the coming years. Bankdistribution continues to dominate in most markets in Asia, and Prudential hasestablished strong relationships with both regional and local banks and placesgreat emphasis on providing good service. Current Initiatives Fund innovation is essential in maintaining sales levels and distributionagreements and during 2007 Prudential's operations launched 71 new funds. Thelargest of which include two India funds for Japan; the India Equity Fund andthe India Infrastructure Fund. The China Dragon A Share Equity Fund in Koreareached its regulatory cap in two weeks and the Asia Pacific REIT in Taiwan alsoreached its regulatory cap. A key achievement in 2007 was the expansion of regional distributionrelationships with Citi and HSBC. The Asian asset management business alsosigned a global partnership agreement with HSBC Private Banking and is now partof the Credit Suisse Fundslab platform. Greater deregulation and higher allocations by sovereign wealth and otherinstitutional investors in foreign investments is driving the growth of offshorefunds in the market and Prudential is also developing its institutional assetmanagement business in Asia winning mandates of £0.5 billion during 2007. Prudential launched a retail mutual fund business in Hong Kong in October 2007.Since launch six distribution relationships have been signed, including banks,financial advisers and an on-line portal. The United Arab Emirates operation also made good progress with 13 distributionagreements signed since launch a year ago and with funds under management of£397 million. In August 2007, Prudential increased its stake in CITIC Prudential FundManagement, its joint venture with CITIC Group in China from 33 per cent to 49per cent, following approval from regulators. This joint venture launched itsfirst Qualified Foreign Institutional Investor fund in Korea in May 2007 and hitits £100 million quota. Financial Performance Prudential's asset management business achieved record net inflows for 2007 of£3 billion, up 23 per cent on 2006. The growth in net flows was primarily drivenby strong performance in India, Taiwan and Japan. Funds under management inthese three countries increased by 65 per cent, 49 per cent and 46 per centrespectively. In total during 2007, retail funds under management grew by 39 percent to £17.4 billion. IFRS profits from asset management operations were £72 million, up 53 per centon 2006. Operating profits in terms of basis points on funds under managementincreased from 18 basis points in 2006 to 21 in 2007. The asset managementbusiness requires very little capital to support its growth and in 2007 itremitted a net £31 million to the Group. United States US Asset Management PPM America CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %Total IFRS operating profit* 4 10 (60%) 12 (67%)*Based on longer-term investment returns. PPM America (PPMA) manages assets for Prudential's US, UK and Asian affiliates.PPMA also provides investment services to other affiliated and unaffiliatedinstitutional clients including collateralised debt obligations (CDOs), privateequity funds, institutional accounts and mutual funds. PPMA's strategy isfocused on effectively managing existing assets, maximising synergies withinternational asset management affiliates and leveraging investment managementcapabilities across the Prudential Group. PPMA also opportunistically pursuesthird-party mandates. Current year initiatives During 2007, PPMA successfully leveraged its investment management capabilitiesas evidenced by: • Obtaining over £329 million of funds under management in the Jacksonvariable annuity programme. • Assuming management of over £194 million of funds under management fromCurian. • Assuming additional responsibilities for the UK life fund, growingassets by £2 billion. • Launching three new products offered by Prudential Corporation Asia. • Raising over £638 million of third-party funds under management. Financial performance IFRS operating profit in 2007 was £4 million, down from £10 million in 2006,primarily due to lower investment income and performance-related fees, partiallyoffset by asset-driven fee growth. Year-end 2007 funds under management of £39 billion were as follows: PPMA funds under management (£ billions) Asia US UK TotalInsurance 0 23 10 33Unitised 3 0 1 4Institutional 0 0 0 0CDOs 0 2 0 2 Total 3 25 11 39 US Broker dealer Broker dealer CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %Revenue 300 246 22% 267 12%Costs (291) (240) 21% (261) 11%Total IFRS operating profit* 9 6 50% 6 50%*Based on longer-term investment returns. National Planning Holdings (NPH), Jackson's affiliated independent broker-dealernetwork, is comprised of four broker-dealer firms, including INVEST FinancialCorporation, Investment Centers of America, National Planning Corporation andSII Investments. NPH continues to grow through significant recruiting efforts. By leveraging itshigh-quality, state-of-the-art technology, NPH provides its advisors with thetools they need to operate their practices more efficiently. Through itsrelationship with NPH, Jackson continues to benefit from an important retaildistribution outlet, in addition to receiving valuable insight into the needs offinancial advisors and their clients. Current year initiatives NPH increased sales of Jackson's enhanced product offering and the overalldistribution of the network during the year. NPH also introduced severaloperational enhancements, which increased the efficiency of its productionprocesses. In addition, NPH executed a focused recruitment initiative to expandthe total assets under management and the representative base of INVESTFinancial Corporation. Financial performance NPH had a very successful year in 2007, generating record revenues of £300million versus £246 million in 2006 on gross product sales of £7.1 billion. Thenetwork continues to generate profitable growth with 2007 IFRS operating profitof £9 million, a 50 per cent increase at CER from £6 million in 2006. NPH alsoincreased the number of registered advisors in its network to 3,000 at year-end. Curian Curian CER RER(5) 2007 2006 Change 2006 Change £m £m % £m %Gross investment flows 663 422 57% 459 44%Revenue 20 15 33% 16 25%Costs (25) (22) 14% (24) 4%Total IFRS operating profit* (5) (7) (29%) (8) (38%)*Based on longer-term investment returns. Curian Capital (Curian), Jackson's registered investment advisor, providesinnovative fee-based separately managed accounts and investment products toadvisors through a sophisticated technology platform. Curian expands Jackson'saccess to advisors and provides a complement to Jackson's core annuity productlines. Current year initiatives During 2007, Curian implemented its Simplified Proposal Process, which allowsfinancial professionals to generate proposals in a matter of minutes, whilemaintaining the flexibility and customisation that make separately managedaccounts an attractive alternative to traditional investment vehicles. Curianalso expanded its wholesaling force during the year in an effort to accelerategrowth. Financial performance As a result of these initiatives, Curian continued to build its position in theUS retail asset management market with total assets under management at the endof December 2007 of £1.7 billion, up from £1.2 billion at the end of December2006. Curian also generated record deposits in 2007 of £663 million, up 57 percent over 2006. Curian's IFRS operating loss declined to £5 million in 2007(2006: £7 million at CER). OTHER CORPORATE INFORMATION Balance sheet Explanation of balance sheet structure The Group's capital on an IFRS basis comprises of shareholders' funds of £6,201million, subordinated long-term and perpetual debt of £1,570 million, other corestructural borrowings of £922 million and the unallocated surplus ofwith-profits funds of £14.4 billion. Subordinated or hybrid debt is debt capital which has some equity-like featuresand which would rank below other senior debt in the event of a liquidation.These features allow hybrid debt to be treated as capital for FSA regulatorypurposes. All of the Group's hybrid debt which qualifies in this way is held atthe Group level and is therefore taken as capital into the parent solvency testunder the IGD. The FSA has established a structure for determining how much hybrid debt cancount as capital which is similar to that used for banks. It categorises capitalas Tier 1 (equity and preference shares), Upper Tier 2 and Lower Tier 2. Up to15 per cent of Tier 1 can be in the form of hybrid debt and called 'InnovativeTier 1'. At 31 December 2007, the Group held £763 million of Innovative Tier 1capital, in the form of perpetual securities, and £932 million of Lower Tier 2capital. Following the implementation of the IGD, it is advantageous to theGroup from a regulatory capital standpoint to raise its long-term debt in hybridform and it is the Group's policy to take advantage of favourable marketconditions as they arise to do so. The unallocated surplus of the with-profits funds represents assets in the lifefund which have not yet been allocated either to policyholders or shareholders.They are not generally available to the Group other than as they emerge throughthe statutory transfer of the shareholders' share of the surplus as it emergesfrom the fund over time. Shareholders' borrowings and financial flexibility Core structural borrowings of shareholder-financed operations at 31 December2007 totalled £2,492 million, compared with £2,612 million at the end of 2006.This decrease reflected the repayment of £150 million long-term borrowings uponmaturity, exchange conversion losses of £16 million and other adjustments ofnegative £14 million. After adjusting for holding company cash and short-term investments of £1,456million, net core structural borrowings at 31 December 2007 were £1,036 millioncompared with £1,493 million at 31 December 2006. This reflects the net cashinflow of £445 million (including £527 million net proceeds from the sale ofEgg), exchange conversion gains of £49 million and other adjustments of negative£37 million. Core structural borrowings at 31 December 2007 included £1,473 million at fixedrates of interest with maturity dates ranging from 2009 to perpetuity. £888million of the core borrowings were denominated in US dollars, to hedgepartially the currency exposure arising from the Group's investment in Jackson. Prudential has in place an unlimited global commercial paper programme. At 31December 2007, commercial paper of £320 million, US$3,479 million and €483million has been issued under this programme. Prudential also has in place a£5,000 million medium-term note (MTN) programme. At 31 December 2007,subordinated debt outstanding under this programme was £435 million and €520million, and senior debt outstanding was €65 million and US$12 million. Inaddition, the holding company has access to £1,600 million committed revolvingcredit facilities, provided in equal tranches of £100 million by 16 majorinternational banks renewable in December 2009 and an annually renewable £500million committed securities lending liquidity facility. These facilities havenot been drawn on during the year. The commercial paper programme, the MTNprogramme, the committed revolving credit facilities and the committedsecurities lending liquidity facility are available for general corporatepurposes and to support the liquidity needs of the parent company. The Group's core debt is managed to be within a target level consistent with itscurrent debt ratings. At 31 December 2007, the gearing ratio (debt, net of cashand short-term investments, as a proportion of EEV shareholders' funds plusdebt) was 6.6 per cent compared with 11.2 per cent at 31 December 2006. Prudential plc enjoys strong debt ratings from Standard & Poor's, Moody's andFitch. Prudential long-term senior debt is rated A+ (stable outlook), A2 (stableoutlook) and AA- (stable outlook) from Standard & Poor's, Moody's and Fitchrespectively, while short-term ratings are A-1, P-1 and F1+. Based on EEV basis operating profit from continuing operations and interestpayable on core structural borrowings, interest cover was 16.1 times in 2007compared with 13.1 times in 2006. Treasury policy The Group operates a central treasury function, which has overall responsibilityfor managing its capital funding programme as well as its central cash andliquidity positions. The aim of Prudential's capital funding programme, which includes the £5,000million MTN programme together with the unlimited commercial paper programme, isto maintain a strong and flexible funding capacity. Prudential UK and Prudential Corporation Asia use derivatives to reduce equityrisk, interest rate and currency exposures, and to facilitate efficientinvestment management. In the US, Jackson uses derivatives to reduce interestrate risk, to facilitate efficient portfolio management and to match liabilitiesunder fixed index policies. It is Prudential's policy that all free-standing derivatives are used to hedgeexposures or facilitate efficient portfolio management. Amounts at risk are covered by cash or by corresponding assets. Due to the geographical diversity of Prudential's businesses, it is subject tothe risk of exchange rate fluctuations. Prudential's international operations inthe US and Asia generally write policies and invest in assets denominated inlocal currency. Although this practice limits the effect of exchange ratefluctuations on local operating results, it can lead to significant fluctuationsin Prudential's consolidated financial statements upon conversion of resultsinto pounds sterling. The currency exposure relating to the conversion ofreported earnings is not separately managed, as it is not in the economicinterests of the Group to do so. The impact of gains or losses on currencyconversions is recorded as a component of shareholders' funds within thestatement of recognised income and expense. The impact of exchange ratefluctuations in 2007 is discussed elsewhere in this financial review. Unallocated surplus of with-profits During 2007, the unallocated surplus, which represents the excess of assets overpolicyholder liabilities for the Group's with-profits funds on a statutorybasis, grew from £13.6 billion at 1 January to £14.4 billion at 31 December.This reflects an increase in the cumulative retained earnings arising onwith-profits business that have yet to be allocated to policyholders orshareholders. Regulatory capital requirements Prudential is subject to the capital adequacy requirements of the InsuranceGroups Directive ("IGD") as implemented by the Financial Services Authority ("FSA"). The IGD pertains to groups whose activities are primarily concentrated inthe insurance sector, and applies for Prudential from December 2007, followingthe sale of Egg Banking during 2007. Prior to this, Prudential was required tomeet the requirements of the Financial Conglomerates Directive ("FCD"), whichapplies to groups with significant cross-sector activities in insurance andbanking/investment services. The FSA implemented the FCD by applying the sectoral rules of the largest sectorof the group. Prudential was therefore classified as an insurance conglomerateunder the FCD, and was required to focus on the capital adequacy requirementsrelevant to that sector. Prudential's move from FCD to IGD during 2007,therefore, did not have a significant impact on the Group, as the FSA'simplementation of both directives is closely aligned. In particular, from 31December 2006 the FSA made the continuous parent solvency testing mandatory forall insurance groups covered by the IGD. This involves the aggregating ofsurplus capital held in the regulated subsidiaries, from which Group borrowings,except those subordinated debt issues which qualify as capital, are deducted. Nocredit for the benefit of diversification is allowed for under this approach.The test is passed when this aggregate number is positive, and a negative resultat any point in time is a notifiable breach of UK regulatory requirements. Due to the geographically diverse nature of Prudential's operations, theapplication of these requirements to Prudential is complex. In particular, formany of our Asian operations, the assets, liabilities and capital requirementshave to be recalculated based on FSA regulations as if the companies weredirectly subject to FSA regulation. The IGD surplus as at 31 December 2007 will be submitted to the FSA by 30 April2008 but is currently estimated to be around £1.4 billion. This includes a gainof around £0.3billion that arose during 2007 from the sale of Egg Banking plc. The European Union ("EU") is continuing to develop a new prudential frameworkfor insurance companies, 'the Solvency II project' that will update the existinglife, non-life and insurance groups directives. The main aim of this frameworkis to ensure the financial stability of the insurance industry and protectpolicyholders through establishing solvency requirements better matched to thetrue risks of the business. Like Basel 2, the new approach is expected to bebased on the concept of three pillars - minimum capital requirements,supervisory review of firms' assessments of risk and enhanced disclosurerequirements. However, the scope is wider than Basel 2 and will covervaluations, the treatment of insurance groups, the definition of capital and theoverall level of capital requirements. A key aspect of Solvency II is the focus on risks and, for example, capitalrequirements will be calibrated to a one year Value at Risk with a 99.5 per centconfidence level. Companies will be encouraged to improve their risk managementprocesses and will be allowed to make use of internal economic capital models toenable a better understanding of risks. The emphasis on transparency andcomparability would ensure a level playing field but not delivering this remainsone of the key risks for the project. The European Commission ("EC") published a draft framework directive on 10 July2007 containing high-level principles. The directive is now being reviewed bythe European Parliament and the Council of Ministers. The EC expects theinstitutions to agree the Solvency II framework directive in the second half of2008. The principles in the directive will be supplemented by implementingmeasures that will be adopted by the EC and EU member states. Solvency II is then intended to be implemented during 2012. It is important that the EU policy makers keep up the progress to enable implementation by the suggested date. During 2007, the Committee of European Insurance and Occupational PensionsSupervisors (CEIOPS) invited the EU insurance industry to participate in thethird quantitative impact study, which provided useful input for supervisors andindustry alike. The EU insurance industry will be participating in a fourthquantitative impact study during the first half of 2008 with a view to providingfurther quantitative input into the calibration of the capital requirements.This study will include a particular focus on groups. Participation in theseexercises involves a substantive commitment and is expected to yield benefits byproviding evidence leading to a truly risk-based capital requirement. Prudential is also actively engaged in policy discussions mainly through itsparticipation in the Chief Risk Officer (CRO) Forum of major European insurancefirms. We have been emphasising the importance of Solvency II delivering aneconomic based approach for groups reflecting diversification benefits acrossall the group's insurance activities; an appropriate level playing field, inparticular in connection with the treatment of operations outside the EuropeanEconomic Area (EEA); and the provision of instruments of group support thatenhance the efficiency of capital management within the EEA. Financial strength of insurance operations Asia Prudential Corporation Asia maintains solvency margins in each of its operationsso that these are at or above the local regulatory requirements. Across theregion less than 40 per cent of non-linked funds are invested in equities. BothSingapore and Malaysia have discrete life funds, and have strong free assetratios. The Hong Kong life operation is a branch of Prudential Assurance CompanyLimited and its solvency is covered by that business. Taiwan has Risk BasedCapital regulatory solvency margins and Prudential ensures sufficient capital isretained in the business to cover these requirements. Asia 2007 2006 2005 per cent per cent per centEquities 10 3 9Bonds 67 60 59Other asset classes 24 37 33 Total 100 100 100 United States The capital adequacy position of Jackson remains strong, with the capital ratioimproving from 9.8 per cent in 2006 to 10.6 per cent in 2007. Jackson'sstatutory capital, surplus and asset valuation reserve position of £2,251million at 31 December 2007 improved year-on-year by £327 million, afterdeducting the £122 million of capital remitted to the parent company. Jackson'sfinancial strength is rated AA by Standard & Poor's and A1 by Moody's. Jackson's invested asset mix on a US regulatory basis (excludes policy loans andreverse repo leverage) is as follows: Jackson 2007 2006 2005 per cent per cent per centBonds:Investment Grade Public 59 60 58Investment Grade Private 18 18 19Non-Investment Grade Public 3 4 5Non-Investment Grade Private 2 1 2Commercial mortgages 12 12 11Private equities and real estate 3 3 3Equities, cash and other assets 3 2 2 Total 100 100 100 United Kingdom The PAC's long-term fund remains very strong. On a realistic valuation basis,with liabilities recorded on a market consistent basis, the free assets arevalued at approximately £8.7 billion at 31 December 2007, before a deduction forthe risk capital margin. The financial strength of PAC is rated AA+ (stableoutlook) by Standard & Poor's, Aa1 (negative outlook) by Moody's and AA+ (stableoutlook) by Fitch Ratings. The with-profits sub-fund delivered a pre-tax return of 7.2 per cent in 2007,and over the last five years the fund has achieved a total return of 91 percent. Much of this excellent investment performance was achieved through theactive asset allocation of the fund. As part of its asset allocation process,Prudential UK constantly evaluates prospects for different markets and assetclasses. During the year PAC's Long Term Fund reduced its exposure to propertyand increased the quality of its corporate bond portfolio. The fund includes theassets of the Equitable Life with-profit annuity business, transferred duringthe year, which were almost entirely fixed interest corporate bonds. UK fund 2007 2006 2005 per cent per cent per centUK equities 35 36 40International equities 17 17 19Property 14 15 15Bonds 27 26 21Cash and other assets classes 7 6 5 Total 100 100 100 Inherited estate of Prudential Assurance The assets of the main with-profits fund within the long-term insurance fund ofPAC comprise the amounts that it expects to pay out to meet its obligations toexisting policyholders and an additional amount used as working capital. Theamount payable over time to policyholders from the with-profits fund is equal tothe policyholders' accumulated asset shares plus any additional payments thatmay be required by way of smoothing or to meet guarantees. The balance of theassets of the with-profits fund is called the 'inherited estate' and hasaccumulated over many years from various sources. The inherited estate represents the major part of the working capital of PAC'slong-term insurance fund. This enables PAC to support with-profits business byproviding the benefits associated with smoothing and guarantees, by providinginvestment flexibility for the fund's assets, by meeting the regulatory capitalrequirements that demonstrate solvency and by absorbing the costs of significantevents or fundamental changes in its long-term business without affecting thebonus and investment policies. The size of the inherited estate fluctuates fromyear to year depending on the investment return and the extent to which it hasbeen required to meet smoothing costs, guarantees and other events. PAC believes that it would be beneficial if there were greater clarity as to thestatus of the Inherited Estate. As a result PAC has announced that it has beguna process to determine whether it can achieve that clarity through areattribution of the inherited estate. As part of this process a PolicyholderAdvocate has been nominated to represent policyholders' interests. Thisnomination does not mean that a reattribution will occur. Given the size of the Group's with-profits business any proposal is likely to betime consuming and complex to implement and is likely to involve a payment topolicyholders from shareholders funds. If a reattribution is completed theinherited estate will continue to provide working capital for the long-terminsurance fund. Prudential aims to be in a position to determine whether reattribution is in thebest interests of policyholders and shareholders in the first half of 2008. Defined benefit pension schemes The Group operates four defined benefit schemes, three in the UK, of which theprincipal scheme is the Prudential Staff Pension Scheme (PSPS), and a smallscheme in Taiwan. The level of surplus or deficit of assets over liabilities fordefined benefit schemes is currently measured in three ways: the actuarialvaluation, FRS 17 (for subsidiary accounting in the UK), and IAS 19 for theGroup financial statements. FRS 17 and IAS 19 are very similar. As at 31December 2007 the shareholders' share of the £447 million surplus for PSPS andthe deficits of the other schemes amounted to an £76 million surplus net ofrelated tax relief. Defined benefit schemes in the UK are generally required to be subject to fullactuarial valuation every three years to assess the appropriate level of fundingfor schemes having regard to their commitments. These valuations includeassessments of the likely rate of return on the assets held within the separatetrustee administered funds. PSPS was last actuarially valued as at 5 April 2005and this valuation demonstrated the Scheme to be 94 per cent funded, with ashortfall of actuarially determined assets to liabilities of 6 per cent,representing a deficit of £243 million. The finalisation of the valuation as at 5 April 2005 was accompanied by changesto the basis of funding for the scheme with effect from that date. Deficitfunding amounts designed to eliminate the actuarial deficit over a 10-yearperiod have been and are being made based on that valuation. Total contributionsto the Scheme for deficit funding and employer's contributions for ongoingservice for current employees are expected to be of the order of £70-75 millionper annum over a 10-year period. In 2007, total contributions for the calendaryear including expenses and augmentations were £82 million. Under IAS 19 the basis of valuation differs markedly from the full triennialvaluation basis. In particular, it requires assets of the Scheme to be valued attheir market value at the year-end, while pension liabilities are required to bediscounted at a rate consistent with the current rate of return on a highquality corporate bond. As a result, the difference between IAS 19 basis assetsand liabilities can be volatile. For those schemes such as PSPS, which hold asignificant proportion of their assets in equity investments, the volatility canbe particularly significant. For 2007, a £23 million pre-tax shareholder chargeto operating results based on longer-term returns arises. In addition, outsidethe operating result, but included in total profits is a pre-tax shareholdercredit of £90 million for net actuarial gains. These gains primarily representthe effect of changes in economic assumptions which more than offsets the lossesfrom the effect of strengthened mortality assumptions for the UK pensionschemes. Surpluses and deficits on the Group's defined benefit schemes are apportioned tothe PAC life fund and shareholders' funds based on estimates of employees'service between them. At 31 December 2005, the deficit of PSPS was apportionedin the ratio 70/30 between the life-fund and shareholders' backed operationsfollowing detailed consideration of the sourcing of previous contributions. Thisratio was applied to the base deficit position at 1 January 2006 and for thepurpose of determining the allocation of the movements in that position up to 31December 2007. The IAS 19 service charge and ongoing employer contributions areallocated by reference to the cost allocation for current activity. The deficitof the Scottish Amicable Pension Scheme has been allocated 50 per cent to thePAC with profits fund and 50 per cent to the PAC shareholder fund. Reflecting these two elements, at 31 December 2007, the total share of thesurplus on PSPS and the deficit on the smaller Scottish Amicable schemeattributable to the PAC with-profits fund amounted to a net surplus of £304million net of related tax relief. RISK MANAGEMENT Philosophy, principles and objectives Philosophy As a provider of financial services, including insurance, the Group's businessis the managed acceptance of risk. Prudential believes that effective riskmanagement capabilities are a key competitive advantage. A strategic risk,capital and value management framework and risk management culture has beendeveloped to enhance the Group's embedded and franchise value. Principles Risk is defined as the uncertainty that Prudential faces in successfullyimplementing its strategies and objectives. This includes all internal orexternal events, acts or omissions that have the potential to threaten thesuccess and survival of Prudential. The control procedures and systems established within the Group are designed tomanage, rather than eliminate, the risk of failure to meet business objectives.They can only provide reasonable and not absolute assurance against materialmisstatement or loss, and focus on aligning the levels of risk-taking with theachievement of business objectives. The Group's policy is to proactively identify, assess, control, and monitorrisk. This forms an essential element of delivering the Group's performanceambition. In so doing, material risks will only be retained where this isconsistent with Prudential's risk appetite framework, ie: • The retention of the risk contributes to value creation. • The Group is able to withstand the impact of an adverse outcome. • The Group has the necessary capabilities, expertise, processes and controls to manage the risk. Objectives The Group has five objectives for risk and capital management: a) Framework: Design, implement and maintain a consistent risk managementframework and policies spanning: economic, regulatory and rating agency capitalmanagement; risk appetite; and risk-adjusted profitability (RAP). b) Monitoring: Establish a 'no surprises' risk management culture byidentifying the risk landscape, assessing and monitoring risk exposures andunderstanding change drivers. c) Control: Implement risk mitigation strategies and remedial actions whereexposures are deemed inappropriate' and manage the response to extreme events. d) Communication: Communicate the Group risk, capital and profitabilityposition to internal and external stakeholders and rating agencies. e) Culture: Foster a risk management culture, providing quality assuranceand facilitating the sharing of best practice risk measurement and managementacross the Group and industry. Categorisation model A common risk language is used across the Group, which allows meaningfulcomparisons to be made between different business units. Risks are broadlycategorised as shown below. Category Risk type Definition Financial risks Market risk The risk that arises from adverse changes in the value of, or income from, assets and changes in interest rates or exchange rates. Credit risk The risk of loss if another party fails to perform its obligations, or fails to perform them in a timely fashion. Insurance risk The inherent uncertainty as to the occurrence, amount and timing of insurance liabilities. This includes adverse mortality, morbidity and persistency experience. Liquidity risk The risk that a business, though solvent on a balance sheet basis, either does not have the financial resources to meet its obligations as they fall due or can secure them only at excessive cost. Non-financial risks Operational risk The risk of direct or indirect loss resulting from inadequate or failed internal processes, people or systems, or from external events. This includes legal and regulatory compliance risk. Business environment risk Exposure to forces in the external environment that could significantly change the fundamentals that drive the business's overall objectives and strategy. Strategic risk Ineffective, inefficient or inadequate senior management processes for the development and implementation of business strategy in relation to the business environment and the Group's capabilities. Governance The Group's internal control processes are detailed in the Group GovernanceManual. This is supported by the Group Risk Framework, which provides anoverview of the Group-wide philosophy and approach to risk management. For joint ventures where the Group does not control management, the businessunit party to the arrangement must: satisfy itself that suitable governance andrisk management arrangements are in place to protect the Group's interests; andcomply with the Group's requirements in respect of any operations it performs insupport of the joint venture's activities. Prudential's risk governance framework requires that all of the Group'sbusinesses and functions establish processes for identifying, evaluating andmanaging the key risks faced by the Group. The risk governance framework isbased on the concept of 'three lines of defence': risk management, riskoversight and independent assurance (see diagram opposite). Risk management Primary responsibility for strategy, performance management and risk controllies with the Prudential plc Board of directors (the Board), the Group ChiefExecutive and the chief executives of each business unit. Additionally, theBoard has delegated responsibility to the Approvals Committee to approve actionswhich could significantly change the risk profile of any business, capitalcommitments and divestments within defined materiality thresholds, and certainlegal matters involving trademarks, contracts, material guarantees and specificinteractions with third parties. Where appropriate, more detailed policies and procedures have been developed atGroup and/or business unit levels. These include Group-wide mandatory policieson certain operational risks, including: health, safety, fraud, moneylaundering, bribery, business continuity, information security and operationalsecurity. Additional guidelines are provided for some aspects of actuarial andfinance activity. Board: The Board has overall responsibility for the system of internal controland risk management. It approves the overall framework for managing the risksfaced by the Group and provides strategic direction on the amount and type ofrisk that the Group is prepared to accept. Group executive management: The Group Chief Executive has overall responsibilityfor the risks facing the Group. The Group Chief Executive recommends to theBoard the amount and type of risk that the Group is prepared to accept, andrecommends risk management strategies as well as an overall framework formanaging the risks faced by the Group with support from the Group ExecutiveCommittee, Group Finance Director and Group level risk committees. The GroupChief Executive provides regular updates to the Board on the risk position andrisk policy. Business unit management: Business unit chief executives are accountable for theimplementation and operation of appropriate business unit risk frameworks andfor ensuring compliance with the policy and minimum standards set by the Group.Business units must establish suitable governance structures that are based onthe concept of 'three lines of defence', tailored as appropriate to the scaleand complexity of the business unit. As the first line of defence, business unitmanagement is responsible for identifying and managing business unit risks andproviding regular risk reporting to the Group. Risk oversight Risk oversight: Risk management oversight is provided by Group-level riskcommittees, the Group Finance Director and the Group Risk function, working withcounterparts in the business units in addition to other Group Head Office (GHO)oversight functions. Group-level risk committees Group Asset Liability Committee (Group ALCo): The Group ALCo is responsible foroversight of financial risks (market, credit, liquidity and insurance risks)across the Group. It is chaired by the Group Finance Director and its membershipincludes senior business unit and Group executives (chief actuaries, principalasset liability management officers and chief investment officers) who areinvolved in the management of the aforementioned risks. Group ALCo meetings areheld on a monthly basis. Balance Sheet and Capital Management Committee (BSCMC): The BSCMC is responsiblefor managing the balance sheets of Prudential plc and oversight of thePrudential Capital business unit. It is chaired by the Group Finance Directorand its membership includes senior representatives from GHO, M&G and PrudentialCapital. BSCMC meetings are held on a monthly basis. Group Operational Risk Committee (GORC): The GORC is responsible for theoversight of non-financial risks (operational, business environment andstrategic risks) across the Group. Responsibilities include monitoringoperational risk and related policies and processes as they are appliedthroughout the Group. It is chaired by the Group Finance Director and itsmembership includes senior representatives of the Group and business unit riskfunctions. GORC meetings are held on a quarterly basis. Group Risk Group Risk's mandate is to establish and embed a strategic risk, capital andvalue management framework and risk management culture, consistent withPrudential's risk appetite, that protects and enhances the Group's embedded andfranchise value. Group Risk is responsible for the continued enhancement and evolution of theGroup Risk Framework; provides functional leadership to the business units forthe oversight of risk management across the Group; and acts as secretariat tothe Group ALCo and GORC. Group Risk also has certain finance and actuarial responsibilities related toGroup regulatory and rating agency capital requirements, development ofactuarial and financial reporting requirements and the RAP value managementframework. Independent assurance Group Audit Committee: The Group Audit Committee provides independent assuranceto the Board on the effectiveness of the Group's system of internal controls andrisk management. The Group Audit Committee reviews the Group's risk managementframework, and regular risk reports. The Group Audit Committee is supported byGroup-wide Internal Audit. Group-wide Internal Audit (GwIA): The GwIA function independently assures theeffective operation of the Group's risk management framework. This involves thevalidation of methodology application, policy compliance and control adequacy.The GwIA Director reports all audit related matters to the Group Audit Committee(and business unit audit committees where appropriate) and reports formanagement purposes (but not audit-related matters) to the Group ChiefExecutive. Risk appetite The Group risk appetite framework sets out the Group's overall tolerance to riskexposures, approach to risk and return optimisation and management of risk. TheBoard and Group Executive Committee have set up Group-level risk appetitestatements concerning the key risk exposures faced by the Group. The Group riskappetite statements set out the Group's risk tolerance, or risk appetite, to 'shocks' to the key financial risk exposures (market, credit and insurance risk). Limits Aggregate risk limits are defined in terms of earnings volatility and capitalrequirements: (a) Earnings volatility: The objectives of the limits are to ensure that (a)the volatility of earnings is consistent with stakeholder expectations: (b) theGroup has adequate earnings (and cash flows) to service debt and expecteddividends: and (c) that earnings (and cash flows) are managed properly acrossgeographies and are consistent with the Group's funding strategies. The twomeasures used are European Embedded Value (EEV) operating profit andInternational Financial Reporting Standards (IFRS) operating profit. (b) Capital requirements: The objectives of the limits are to ensure that (a)the Group is economically solvent: (b) the Group achieves its desired targetrating to meet its business objectives: (c) supervisory intervention is avoided:(d) any potential capital strains are identified: and (e) accessible capital isavailable to meet business objectives. The two measures used are EU InsuranceGroups Directive (IGD) capital requirements and economic capital requirements. Business units must establish suitable market, credit, underwriting andliquidity limits that maintain financial risk exposures within the defined riskappetite. In addition to business unit operational limits on credit risk, counterpartyrisk limits are also set at the Group level. Limits on total Group-wideexposures to a single counterparty are specified for different credit rating 'buckets'. Actual exposures are monitored against these limits on a quarterlybasis. Usage by business units Risk appetite is part of the annual business planning cycle. The risk profile ofthe Group is monitored against the agreed limits throughout the year by GroupRisk. Using submissions from business units, Group Risk calculates the Group'sposition (allowing for diversification effects between business units) relativeto the limits implied by the risk appetite statements. In order to determine its risk position, each business unit calculates theimpacts (on earnings and capital measures) of a shock to market, credit,insurance and operational risk exposures. A two-tier approach is used to apply the limits at business unit level. Firstly,indicative business unit risk limits are calculated; these ensure that, if eachbusiness unit keeps within its limits, the Group risk position would be withinthe Group limits. Secondly, the impact on the risk position is considered aspart of Group Risk's scrutiny of large transactions or departures from planproposed by individual business units. Any potential breaches of the risk limits implied by a business unit plan willnecessitate a dialogue process between GHO and the business units. Group limitsmay not be breached if, for example, limits in other business units are notfully utilised, or the diversification effect at Group level of a particularrisk with other business units means that the Group limit is not breached.Ultimately, authorisation to breach Group limits would require Group ExecutiveCommittee approval. Risk management process Risk mitigation The Group expects active management of its actual risk profile against itstolerance of risk. Primary responsibility for identifying and implementingcontrols and mitigation strategies rests with the business units. Group Riskprovides oversight and advice. Risk registers are maintained that include details of the controls andmitigating actions being employed for identified risks. The effectiveness ofcontrols and progress with actions are routinely assessed. Any mitigationstrategies involving large transactions (eg. a material derivative transaction)would be subject to scrutiny at Group level before implementation. Prudential employs a range of risk mitigation strategies aimed at reducing theimpact of a variety of risks. Key mitigation strategies include: adjustment ofasset portfolios to reduce investment risks (such as duration mismatches oroverweight counterparty exposures); use of derivatives to hedge market risks;reinsurance programmes to limit insurance risk; and corporate insuranceprogrammes to limit impact of operational risks. Revisions to business plans(such as reassessment of bonus rates on participating business and scaling backof target new business volumes) may be also be used as a mitigating strategy. Contingency plans are in place for a range of operational risk scenarios,including incident management and business continuity plans. As a contingencyplan for liquidity risk, the Group has arranged access to committed revolvingcredit facilities and committed securities lending facilities. Asset liability management Prudential manages its assets and liabilities locally, in accordance with localregulatory requirements and reflecting the different types of liabilities ofeach business unit. Stochastic asset-liability modelling is carried out locallyby the business units to perform dynamic solvency testing and assess economiccapital requirements. Reserve adequacy testing under a range of scenarios isalso carried out, including scenarios prescribed by local regulatory bodies. The investment strategy for assets held to back liabilities is set locally bybusiness units, taking into account the nature, term and currency of theliabilities, and any local regulatory requirements. The main principles are asfollows: • For liabilities that are sensitive to interest rate movements (inparticular, UK non-profit annuities and Jackson fixed annuities), cash flowanalysis is used to construct a portfolio of fixed income securities whose valuechanges in line with the value of liabilities when interest rates change; • For participating business (in particular, the UK with-profits fund),stochastic asset-liability modelling is used to derive a strategic assetallocation and policyholder bonus strategy that (based on the model assumptions)will optimise policyholder and shareholder returns, while maintaining financialstrength. The bonus strategy on participating business is an integral part ofthe asset-liability management approach for participating business; and • For unit-linked business, the assets held to cover policyholder unitaccounts are invested as per the stated investment strategy or benchmark indexgiven in the product marketing literature. Assets in respect of non-unitreserves (e.g. sterling reserves) are invested in fixed income securities (usinga cash flow matching analysis). Derivative hedging strategies are also used on a controlled basis across theGroup to manage exposure to market risks. Surplus assets held centrally arepredominantly invested in short-term fixed income securities. The Group'scentral treasury function actively manages the surplus assets to maximisereturns, subject to maintaining an acceptable degree of liquidity. Risk reporting Group Risk and other GHO oversight functions have individually defined andpublicised frameworks, escalation criteria and processes for the timelyreporting of risks and incidents by business units. As appropriate, these risksand incidents are escalated to the various Group-level oversight and riskcommittees and the Board. Internal business unit routine reporting requirements vary according to thenature of the business. Each business unit is responsible for ensuring that itsrisk reporting framework meets both the needs of the business unit (for examplereporting to the business unit risk and audit committees) and the minimumstandards set by the Group (for example, to meet Group-level reportingrequirements). Business units review their risks as part of the annual preparation of theirbusiness plans, and review opportunities and risks to business objectivesregularly with Group executive management. Group Risk reviews, and reports toGroup executive management, on the impact of large transactions or divergencesfrom business plan. The Group Executive Committee and Board are provided with regular updates on theGroup's economic capital position, overall position against risk limits and RAP.They also receive the annual financial condition reports prepared by the Group'sinsurance operations. EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS SUMMARY CONSOLIDATED INCOME STATEMENT 2007 2006 £m £m Asian operations 1,103 864US operations 635 718 UK operations: UK insurance operations 859 686 M&G 254 204 1,113 890Other income and expenditure (289) (298)Restructuring costs (20) (41) Operating profit from continuing operations based on longer-term investment returns 2,542 2,133 Short-term fluctuations in investment returns 174 738 Mark to market value movements on core borrowings 223 85 Shareholders' share of actuarial gains and losses on defined benefit pension schemes 116 207 Effect of changes in economic assumptions and time value of cost of options and guarantees 748 59 Profit from continuing operations before tax (including actual investment returns) 3,803 3,222 Tax attributable to shareholders' profit (961) (904) Profit from continuing operations for the financial year after tax before minority interests 2,842 2,318 Discontinued operations (net of tax) 241 (105) Profit for the year 3,083 2,213 Attributable to:Equity holders of the Company 3,062 2,212 Minority interests 21 1 Profit for the year 3,083 2,213 Earnings per share (in pence) 2007 2006Continuing operationsFrom operating profit, based on longer-term investment returns, after related tax and minority interests 74.9p 62.1pAdjustment from post-tax longer-term investment returns to post-tax actual investment returns (after minority interests) 6.1p 21.8pAdjustment for effect of mark to market value movements on core borrowings 9.1p 3.5pAdjustment for post-tax effect of shareholders' share of actuarial gains and losses on defined benefit pension schemes 3.4p 6.0pAdjustment for post-tax effect of changes in economic assumptions and time value of cost of options and guarantees (after minority interests) 21.8p 2.6p Based on profit from continuing operations after tax and minority interests 115.3p 96.0p Discontinued operationsBased on profit (loss) from discontinued operations after tax and minority interests 9.9p (4.3)p Based on profit for the year after minority interests 125.2p 91.7p Average number of shares (millions) 2,445 2,413 Dividends per share (in pence) 2007 2006Dividends relating to reporting period:Interim dividend (2007 and 2006) 5.70p 5.42pFinal dividend (2007 and 2006) 12.30p 11.72p Total 18.00p 17.14p Dividends declared and paid in reporting period:Current year interim dividend 5.70p 5.42pFinal dividend for prior year 11.72p 11.02p Total 17.42p 16.44p EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS OPERATING PROFIT FROM CONTINUING OPERATIONS BASED ON LONGER-TERM INVESTMENTRETURNS* Results Analysis by Business Area 2007 2006 £m £mAsian operationsNew business 653 514Business in force 393 315 Long-term business 1,046 829Asset management 72 50Development expenses (15) (15) Total 1,103 864 US operationsNew business 285 259Business in force 342 449 Long-term business 627 708Broker-dealer and asset management 13 18Curian (5) (8) Total 635 718 UK operationsNew business 277 266Business in force 582 420 Long-term business 859 686M&G 254 204 Total 1,113 890 Other income and expenditureInvestment return and other income 45 8Interest payable on core structural borrowings (168) (177)Corporate expenditure:Group Head Office (117) (83)Asia Regional Head Office (38) (36)Charge for share-based payments for Prudential schemes (11) (10) Total (289) (298) Restructuring costs (20) (41) Operating profit from continuing operations based on longer-term investment returns 2,542 2,133 Analysed as profits (losses) from:New business 1,215 1,039Business in force 1,317 1,184 Long-term business 2,532 2,223Asset management 334 264Other results (324) (354) Total 2,542 2,133 * EEV basis operating profit from continuing operations based on longer-terminvestment returns excludes short-term fluctuations in investment returns, themark to market value movements on core borrowings, the shareholders' share ofactuarial gains and losses on defined benefit pension schemes, the effect ofchanges in economic assumptions and changes in the time value of cost of optionsand guarantees arising from changes in economic factors. The amounts for theseitems are included in total EEV profit. The directors believe that operatingprofit, as adjusted for these items, better reflects underlying performance.Profit before tax and basic earnings per share include these items together withactual investment returns. This basis of presentation has been adoptedconsistently throughout this preliminary announcement. For 2007, the EEV basis operating profit from continuing operations based onlonger-term investment returns before tax of £2,542m includes a credit of £99mthat arises from including the benefits, grossed up for notional tax, of alteredcorporate tax rates for China, Malaysia, Singapore and the UK. Further detailsare explained in note 5. The results for continuing operations shown above exclude those in respect ofdiscontinued banking operations. On 1 May 2007, the Company sold Egg.Accordingly, the presentation of the comparative results for 2006 has beenadjusted from those published in March 2007. 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