51

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PRUDENTIAL PLC 2008 PRELIMINARY ANNOUNCEMENT

EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS

SUMMARY CONSOLIDATED INCOME STATEMENT

			2008 £m				2007 £m
Asian operations			1,335				1,099
US operations			593				635
UK operations:
UK insurance operations			1,081				859
M&G			286				254
			1,367				1,113
Other income and expenditure			(302	)			(297	)
Restructuring costs			(32	)			(20	)
Operating profit from continuing operations based on longer-term investment returns			2,961				2,530
Short-term fluctuations in investment returns			(5,127	)			174
Mark to market value movements on core borrowings			656				223
Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes			(15	)			(5	)
Effect of changes in economic assumptions and time value of cost of options and guarantees			(581	)			748
(Loss) profit from continuing operations before tax (including actual investment returns)			(2,106	)			3,670
Tax attributable to shareholders’ (loss) profit			771				(927	)
(Loss) profit from continuing operations for the financial year after tax before minority interests			(1,335	)			2,743
Discontinued operations (net of tax)			-				241
(Loss) profit for the year			(1,335	)			2,984
Attributable to:
Equity holders of the Company			(1,338	)			2,963
Minority interests			3				21
(Loss) profit for the year			(1,335	)			2,984

Earnings per share (in pence)	2008	2007
Continuing operations
From operating profit, based on longer-term investment returns, after related tax and minority interests	88.6p	74.5p
Adjustment from post-tax longer-term investment returns to post-tax actual investment returns (after minority interests)	(150.3)p	6.1p
Adjustment for effect of mark to market value movements on core borrowings	26.6p	9.1p
Adjustment for post-tax effect of shareholders' share of actuarial and other gains and losses on defined benefit pension schemes	(0.5)p	(0.2)p
Adjustment for post-tax effect of changes in economic assumptions and time value of cost of options and guarantees (after minority interests)	(18.5)p	21.8p
Based on (loss) profit from continuing operations after tax and minority interests	(54.1)p	111.3p
Discontinued operations
Based on profit from discontinued operations after tax and minority interests	-	9.9p
Based on (loss) profit for the year after tax and minority interests	(54.1)p	121.2p
Average number of shares (millions)	2,472	2,445

Dividends per share (in pence)	2008	2007
Dividends relating to reporting period:
Interim dividend (2008 and 2007)	5.99p	5.70p
Final dividend (2008 and 2007)	12.91p	12.30p
Total	18.90p	18.00p
Dividends declared and paid in reporting period:
Current year interim dividend	5.99p	5.70p
Final dividend for prior year	12.30p	11.72p
Total	18.29p	17.42p

 

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EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS

OPERATING PROFIT FROM CONTINUING OPERATIONS BASED ON LONGER-TERM INVESTMENT RETURNS*

Results Analysis by Business Area			2008 £m				2007 £m
Asian operations
New business			741				643
Business in force			568				399
Long-term business			1,309				1,042
Asset management			52				72
Development expenses			(26	)			(15	)
Total			1,335				1,099
US operations
New business			293				285
Business in force			293				342
Long-term business			586				627
Broker-dealer and asset management			10				13
Curian			(3	)			(5	)
Total			593				635
UK operations
New business			273				277
Business in force			764				578
Long-term business			1,037				855
General insurance commission			44				4
Total UK insurance operations			1,081				859
M&G			286				254
Total			1,367				1,113
Other income and expenditure
Investment return and other income			47				49
Interest payable on core structural borrowings			(172	)			(168	)
Corporate expenditure:
Group Head Office			(130	)			(129	)
Asia Regional Head Office			(41	)			(38	)
Charge for share-based payments for Prudential schemes			(6	)			(11	)
Total			(302	)			(297	)
Restructuring costs**			(32	)			(20	)
Operating profit from continuing operations based on longer-term investment returns			2,961				2,530
Analysed as profits (losses) from:
New business			1,307				1,205
Business in force			1,625				1,319
Long-term business			2,932				2,524
Asset management			345				334
Other results			(316	)			(328	)
Total			2,961				2,530

* EEV basis operating profit from continuing operations based on longer-term investment returns excludes short-term fluctuations in investment returns, the mark to market value movements on core borrowings, the shareholders' share of actuarial and other gains and losses on defined benefit pension schemes, and the effect of changes in economic assumptions and changes in the time value of cost of options and guarantees arising from changes in economic factors. The amounts for these items are included in total EEV profit attributable to shareholders. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit before tax and basic earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout this preliminary announcement.

**Restructuring costs comprise the charge of £28 million recognised on an IFRS basis and an additional £4 million recognised on the EEV basis for the shareholders’ share of costs incurred by the PAC with-profits fund.

The results for continuing operations shown above exclude those in respect of discontinued banking operations, which were sold on 1 May 2007.   In addition, there have been some minor adjustments to 2007 comparatives, as detailed in notes 4, 5 and 10.

 

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EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS

MOVEMENT IN SHAREHOLDERS' EQUITY (excluding minority interests)

			2008 £m				2007 £m
(Loss) profit for the year attributable to equity shareholders			(1,338	)			2,963
Items taken directly to equity:
Exchange movements (note 14)			2,010				64
Unrealised valuation movements on securities classified as available-for-sale of discontinued banking operations			-				(2	)
Movement on cash flow hedges			-				(3	)
Related tax			119				3
Dividends			(453	)			(426	)
New share capital subscribed			170				182
Reserve movements in respect of share-based payments			18				18
Treasury shares:
Movement in own shares in respect of share-based payment plans			3				7
Movement on Prudential plc shares purchased by unit trusts consolidated under IFRS			(25	)			4
Mark to market value movements on Jackson assets backing surplus and required capital			(148	)			(13	)
Net increase in shareholders' equity			356				2,797
Shareholders’ equity at beginning of year (excluding minority interests):
As previously reported			14,779				11,883
Effect of adoption of principles of IFRIC 14 for pension schemes (note 10)			(179	)			(80	)
After adoption of IFRIC 14			14,600				11,803
Shareholders' equity at end of year (excluding minority interests)			14,956				14,600
Comprising:
Asian operations:
Net assets			5,431				3,837
Acquired goodwill			172				172
			5,603				4,009
US operations			4,453				3,686
UK operations:
Insurance business			4,919				6,497
M&G:
Net assets			147				271
Acquired goodwill			1,153				1,153
			6,219				7,921
Other operations:
Holding company net borrowings at market value (note 9)			(818	)			(873	)
Other net liabilities			(501	)			(143	)
Shareholders' equity at end of year (excluding minority interests)			14,956				14,600
Representing:
Long-term business operations (note 12)			14,522				13,828
Other operations			434				772
			14,956				14,600

 

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EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS

SUMMARISED CONSOLIDATED BALANCE SHEET

			2008 £m				2007 £m
Total assets less liabilities, excluding insurance funds			186,209				195,596
Less insurance funds*:
Policyholder liabilities (net of reinsurers' share) and unallocated surplus of with-profits funds			(181,151	)			(189,534	)
Less shareholders' accrued interest in the long-term business			9,898				8,538
			(171,253	)			(180,996	)
Total net assets			14,956				14,600
Share capital			125				123
Share premium			1,840				1,828
IFRS basis shareholders’ reserves			3,093				4,111
Total IFRS basis shareholders’ equity			5,058				6,062
Additional EEV basis retained profit			9,898				8,538
Shareholders' equity (excluding minority interests)			14,956				14,600

* Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.

NET ASSET VALUE PER SHARE (in pence)

		2008				2007
Based on EEV basis shareholders' equity of £14,956m (2007: £14,600m)			599	p			591	p
Number of issued shares at year end (millions)			2,497				2,470
RETURN ON EMBEDDED VALUE**			15.0	%			15.4	%

** Return on embedded value is based on EEV operating profit from continuing operations after tax and minority interests as a percentage of opening EEV basis shareholders’ equity.

 

 

 

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EUROPEAN EMBEDDED VALUE (EEV) BASIS RESULTS

NOTES ON THE EEV BASIS RESULTS

1.       Basis of preparation of results

The EEV basis results have been prepared in accordance with the EEV Principles issued by the CFO Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance on EEV Disclosures published in October 2005. Where appropriate the EEV basis results include the effects of adoption of International Financial Reporting Standards (IFRS).

The EEV results for the Group are prepared for 'covered business', as defined by the EEV Principles. Covered business represents the Group's long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The EEV basis results for the Group's covered business are then combined with the IFRS basis results of the Group’s other operations.

The definition of long-term business operations is consistent with previous practice and comprises those contracts falling under the definition of long-term insurance business for regulatory purposes together with, for US operations, contracts that are in substance the same as guaranteed investment contracts (GICs) but do not fall within the technical definition. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management.

With two principal exceptions, covered business comprises the Group’s long-term business operations. The principal exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and for the presentational treatment of the financial position of two of the Group’s defined benefit pension schemes. A very small amount of UK group pensions business is also not modelled for EEV reporting purposes.

SAIF is a ring-fenced sub-fund of the Prudential Assurance Company (PAC) long-term fund, established by a Court approved Scheme of Arrangement in October 1997. SAIF is closed to new business and the assets and liabilities of the fund are wholly attributable to the policyholders of the fund.

As regards the Group’s defined benefit pension schemes, the liabilities attaching to the Prudential Staff Pension Scheme (PSPS) and Scottish Amicable Pension Scheme are excluded from the EEV value of UK operations and included in the total for Other operations. The amounts are partially attributable to the PAC with-profits fund and shareholder-backed long-term business and partially to other parts of the Group. In addition to the amounts recognised as attributable to shareholders under IFRS, a 10 per cent share of the amount attributable to the PAC with-profits fund is recognised for EEV reporting purposes.

The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles.

The EEV basis results for 2008 and 2007 have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2008. The supplement included an unqualified audit report from the auditors.

2.       Methodology

Embedded value

Overview

 

The embedded value is the present value of the shareholders' interest in the earnings distributable from assets allocated to covered business after sufficient allowance has been made for the aggregate risks in that business. The shareholders' interest in the Group's long-term business comprises:

-

present value of future shareholder cash flows from in-force covered business (value of in-force business), less a deduction for the cost of locked-in (encumbered) capital;

-

locked-in (encumbered) capital; and

-

shareholders' net worth in excess of encumbered capital (free surplus).

The value of future new business is excluded from the embedded value.  In determining the embedded value or the profit before tax no smoothing of market account balance values, unrealised gains or investment returns is applied. Separately the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items, as explained in note 4.

 

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Valuation of new business

The contribution from new business represents profits determined by applying non-economic assumptions as at the end of the year.

In determining the new business contribution for UK immediate annuity and lifetime mortgage business, which is interest rate sensitive, it is appropriate to use point of sale economic assumptions, consistent with how the business is priced. For other business within the Group end of period economic assumptions are used.

Level of encumbered capital

In adopting the EEV Principles, Prudential has based encumbered capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements. Economic capital is assessed using internal models but, when applying the EEV Principles, Prudential does not take credit for the significant diversification benefits that exist within the Group. For with-profits business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is sufficient to meet the encumbered capital requirements.  For shareholder-backed business the following capital requirements apply:

·	Asian operations: the economic capital requirement is substantially higher than local statutory requirements in total. Economic capital requirements vary by territory, but in aggregate, the encumbered capital is broadly equivalent to the amount required under the Insurance Groups Directive (IGD).

 

·	US operations: the level of encumbered capital has been set to an amount at least equal to 235 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL), which is sufficient to meet the economic capital requirement.

 

·

UK insurance operations: the economic capital requirements for annuity business are fully met by Pillar I requirements being four per cent of mathematical reserves, which are also sufficient to meet Pillar II requirements.  For unit-linked and other shareholder-backed business the encumbered capital held reflects the statutory minimum Pillar I requirement, as required by the UK regulatory authorities.

 

Valuation movements on investments

With the exception of debt securities held by Jackson, investment gains and losses during the period (to the extent that changes in capital values do not directly match changes in liabilities) are included directly in the profit for the period and shareholders’ funds as they arise.

The results for any covered business conceptually reflects the aggregate of the IFRS results and the movements on the additional shareholders’ interest recognised on the EEV basis. Thus the start point for the calculation of the EEV results for Jackson, as for other businesses, reflects the market value movements recognised on the IFRS basis.

However, in determining the movements on the additional shareholders’ interest, the basis for calculating the Jackson EEV result acknowledges that for debt securities backing liabilities the aggregate EEV results reflect the fact that the value of in-force business instead incorporates the discounted value of future spread earnings. This value is not affected generally by short-term market movements on securities that are broadly speaking held with the intent and ability to be retained for the longer term.

Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for securities classified as available-for-sale, movements in unrealised appreciation on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.

3.       Economic assumptions

(a)                         Deterministic assumptions

In most countries, the long-term expected rates of return on investments and risk discount rates are set by reference to period end rates of return on cash or fixed interest securities. For the Group’s Asian operations, the active basis is appropriate for business written in Japan, Korea and US dollar denominated business written in Hong Kong. Except in respect of the projected returns of holdings of Asian debt and equity securities for those countries where long-term fixed interest markets are less established, the ‘active’ basis of assumption setting has been applied in preparing the results of all the Group’s US and UK long-term business operations.

For countries where long-term fixed interest markets are less established, investment return assumptions and risk discount rates are based on an assessment of longer-term economic conditions. Except for the countries listed above, this basis is appropriate for the Group’s Asian operations. Similarly, the projected returns on holdings of Asian securities in these territories by other Group business are set on the same basis.

Expected returns on equity and property asset classes in respect of each territory are derived by adding a risk premium, also based on the long-term view of Prudential’s economists, to the risk-free rate. In Asia, equity risk premiums range from 3.0 per cent to 7.0 per cent (2007: 3.0 per cent to 6.0 per cent). In the US and the UK, the equity risk premium is 4.0 per cent above risk-free rates for both 2008 and 2007.

 

Assumed investment returns reflect the expected future returns on the assets held and allocated to the covered business at the valuation date.

 

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The tables below summarise the principal financial assumptions:

Asian operations

			China	Hong Kong	India	Indonesia	Japan	Korea	Malaysia	Philippines	Singapore	Taiwan	Thailand	Vietnam
				(notes iii, iv, v)					(notes iv, v)		(notes iv,v)	(notes ii, v)
			31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec
			2008	2008	2008	2008	2008	2008	2008	2008	2008	2008	2008	2008
			%	%	%	%	%	%	%	%	%	%	%	%
Risk discount rate:
New business			11.75	3.8	14.25	15.25	4.8	8.2	9.1	15.75	6.15	9.1	13.0	16.75
In force			11.75	3.9	14.25	15.25	4.8	8.2	9.0	15.75	6.85	9.7	13.0	16.75
Expected long-term rate of inflation			4.0	2.25	5.0	6.0	0.7	2.75	2.75	5.0	1.75	2.25	3.0	6.0
Government bond yield			8.25	2.3	9.25	10.25	1.6	4.3	6.5	9.25	4.25	5.5	6.75	10.25
			China	Hong Kong	India	Indonesia	Japan	Korea	Malaysia	Philippines	Singapore	Taiwan	Thailand	Vietnam
				(notes iii, iv, v)					(notes iv, v)		(notes iv, v)	(notes ii, v)
			31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec	31 Dec
			2007	2007	2007	2007	2007	2007	2007	2007	2007	2007	2007	2007
			%	%	%	%	%	%	%	%	%	%	%	%
Risk discount rate:
New business			11.75	5.7	15.75	16.75	5.1	9.7	9.3	15.75	6.4	9.1	13.0	16.75
In force			11.75	6.0	15.75	16.75	5.1	9.7	9.1	15.75	6.8	9.8	13.0	16.75
Expected long-term rate of inflation			4.0	2.25	5.0	6.0	0.0	2.75	2.75	5.0	1.75	2.25	3.0	6.0
Government bond yield			8.25	4.1	9.25	10.25	2.0	5.8	6.5	9.25	4.25	5.5	6.75	10.25

		Asia total				Asia total
		31 Dec 2008				31 Dec 2007
		%				%
Weighted risk discount rate (note (i)):
New business			8.8				9.5
In force			7.8				8.7

Notes

(i)	The weighted risk discount rates for Asian operations shown above have been determined by weighting each country’s risk discount rates by reference to the EEV basis operating result for new business and the closing value of in-force business.

 

(ii)	For traditional business in Taiwan, the economic scenarios used to calculate the 2008 and 2007 EEV basis results reflect the assumption of a phased progression of the bond yields from the current rates applying to the assets held to the long-term expected rates.

 

For 2008 the projections assume that in the average scenario, the current bond yields at 31 December 2008 of 1.4 per cent trend towards 5.5 per cent at 31 December 2018.  This compares to the 2007 results for which the projections assume that in the average scenario, the current bond yields at 31 December 2007 of around 2.5 per cent trend towards 5.5 per cent at 31 December 2013.

 

The expected long term rate is a function of expectation of inflation and real rates of interest, on which the Company has taken external expert advice. It is considered that the outlook for long-term interest rates in Asia will be strongly influenced by the trend in the projection of comparable US long-term real interest rates.  Consequently assessment of the expected rates for Taiwan has taken into account the structural factors of government borrowing, savings rates, short-term interest rates, government intervention and non-market influences that could affect Taiwanese real interest rates over the projection period. Together with a central inflation projection for Taiwan, the Company considers that the long term rate of 5.5 per cent is appropriate in the longer-term.

 

In projecting forward the Fund Earned Rate, allowance is made for the mix of assets in the fund, future investment strategy, and further market value depreciation of bonds held as a result of assumed future yield increases. These factors, together with the assumption of the phased progression in bond yields, give rise to an average assumed Fund Earned Rate that changes from 6.6 per cent for 2008 to 6.7 per cent for 2019. The assumed Fund Earned Rate falls to 3.35 per cent in 2009 and subsequently to 1.2 per cent in 2010, then increases to 5.15 per cent by 2018. Thereafter, the assumed Fund Earned Rate fluctuates around a target of 6.7 per cent. This projection compares with that applied for the 2007 results of a grading from an assumed rate of 0.5 per cent for 2007 to 6.4 per cent for 2014.

 

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Consistent with the EEV methodology applied, a constant discount rate has been applied to the projected cash flows.

 

On 20 February 2009, the Company announced that it had agreed to transfer the agency business of the Taiwan Life business to China Life.  Further details are given in note 11.

 

(iii)

The assumptions shown are for US dollar denominated business which comprises the largest proportion of the in-force Hong Kong business.

 

(iv)	The mean equity return assumptions for the most significant equity holdings in the Asian operations were:

 

	31 Dec 2008	31 Dec 2007
	%	%
Hong Kong	6.2	8.1
Malaysia	12.5	12.5
Singapore	10.2	9.3

To obtain the mean, an average over all simulations of the accumulated return at the end of the projection period is calculated. The annual average return is then calculated by taking the root of the average accumulated return minus 1.

 

(v)	For 2008 and 2007, cash rates rather than government bond yields were used in setting risk discount rates for Malaysia, Singapore, Taiwan and for Hong Kong dollar denominated business.

 

		31 Dec 2008				31 Dec 2007
US operations (Jackson)		%				%
Risk discount rate (note (i)):
New business			4.6				7.0
In force			3.9				6.0
Expected long-term spread between earned rate and rate credited to policyholders forsingle premium deferred annuity business			1.75				1.75
US 10-year treasury bond rate at end of period			2.3				4.1
Pre-tax expected long-term nominal rate of return for US equities			6.3				8.1
Expected long-term rate of inflation			1.5				2.4

Notes

(i)

The risk discount rates at 31 December 2008 for new business and business in-force for US operations reflect weighted rates based on underlying rates of 6.2 per cent for variable annuity (VA) business and 3.0 per cent for other business.  The decrease in the weighted discount rates reflects the decrease in the US 10-year treasury bond rate of 180 bps and a change in the product mix with the 2008 results seeing an increase in the proportion of new and in-force business arising from other than VA business.

 

(ii)

Credit risk treatment   The projected cash flows incorporate the expected long-term spread between the earned rate and the rate credited to policyholders.  The projected earned rates reflect book value yields which are adjusted over time to reflect projected reinvestment rates.  The expected spread incorporates a Risk Margin Reserve (RMR) allowance of 25 basis points for longer-term defaults as described in note 4.   In the event that longer-term default levels are higher then, unlike for UK annuity business where policyholder benefits are not changeable, Jackson has some discretion to adjust crediting rates, subject to contract guarantee levels and general market competition considerations.   The results for Jackson reflect the application of the low discount rates shown above.  In the event that US 10-year treasury rates increase, the altered embedded value results would reflect a lower contribution from fixed annuity business and a partially offsetting increase for variable annuity business as the projected earned rate, as well as the discount rate, would increase for this type of business.   The book value yields, net of RMR allowance, are in excess of the risk discount rate.  To correct for the anomalous effect that would otherwise occur no credit has been taken for the cost of capital benefit that this feature would give rise to for fixed annuity business.

 

 

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		31 Dec 2008				31 Dec 2007
UK insurance operations		%				%
Shareholder-backed annuity business:
Risk discount rate (notes (i) and (iv))
New business			9.6				7.8
In force			12.0				7.8
Pre-tax expected long-term nominal rate of return for shareholder-backed annuity business (note (iii)):
Fixed annuities		6.4 to 6.7				5.4 to 5.6
Inflation-linked annuities		5.7 to 5.8				5.0 to 5.2
Other business:
Risk discount rate (notes (ii) and (iv))
New business			6.7				7.0
In force			6.75				7.9
Pre-tax expected long-term nominal rates of investment return:
UK equities			7.7				8.55
Overseas equities		6.3 to 10.25				8.1 to 10.2
Property			6.0				6.8
Gilts			3.7				4.55
Corporate bonds – with-profits funds (notes (iv) and (v))			5.2				6.0
– other business			5.2				6.25
Expected long-term rate of inflation			3.0				3.2
Post-tax expected long-term nominal rate of return for the PAC with-profits fund:
Pension business (where no tax applies)			6.6				7.85
Life business			5.8				6.9

Notes

(i)

The new business risk discount rate for shareholder-backed annuity business for 2008 reflects the assets allocated to back new business with an allowance for credit risk based on point of sale market conditions, consistent with how the business was priced.  The allowance for credit risk for new business at point of sale is determined using the same methodology for in-force business described in note (iv) below.

 

(ii)	The risk discount rate for new business and business in force for UK insurance operations other than shareholder-backed annuities reflect weighted rates based on the type of business.

 

(iii)

The pre-tax rates of return for shareholder-backed annuity business are based on the gross redemption yield on the backing assets net of a best estimate allowance for future defaults.

 

(iv)

Credit spread treatment   For with-profits business, the embedded value reflects the discounted value of future shareholder transfers. These transfers are directly affected by the level of projected rates of return on investments, including debt securities.  Given the current exceptional fixed interest market conditions, and the Company's expectation that the widening of credit spreads observed in 2008 will not be maintained, the Company considers that it is most appropriate to assume an unchanged level of credit spreads, an unchanged level of longer-term default allowance and an unchanged risk discount rate methodology relative to those used at 31 December 2007.   For UK annuity business, different dynamics apply both in terms of the nature of the business and the EEV methodology applied. For this type of business the assets are generally held to maturity to match long duration liabilities. It is therefore appropriate under EEV methodology to include a liquidity premium in the economic basis used. The appropriate EEV risk discount rate is set in order to equate the EEV with a "market consistent embedded value" including liquidity premium. The liquidity premium is derived from the yield on the assets held after deducting an appropriate allowance for credit risk. For Prudential Retirement Income Limited (PRIL), which has approximately 90 per cent of UK shareholder-backed annuity business, the allowance for credit risk at 31 December 2008 is made up of:

 

a

16 bps for fixed annuities and 13 bps for inflation-linked annuities in respect of long-term expected defaults; this is derived by applying Moody's data from 1970 onwards uplifted by between 100 per cent (B) and 200 per cent (AAA) according to credit rating, to the asset portfolios.

 

b

11 bps for fixed annuities and 9 bps for inflation-linked annuities in respect of long-term credit risk premium for the potential volatility in default levels; this is derived by applying the 95th worst percentile from Moody's data from 1970 onwards, to the asset portfolios.

 

c

56 bps for fixed annuities and 48 bps for inflation-linked annuities in respect of additional short-term credit risk, reflecting the extreme market conditions at 31 December 2008; this is derived as 25 per cent of the increase in credit spreads over swaps that has occurred since 31 December 2006 based on a set of externally published indices weighted to reflect the asset mix.

 

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On a weighted basis for fixed annuities and inflation-linked annuities the allowance is 15 bps for long-term expected defaults, 11 bps for long-term credit risk premium, and 54 bps for short-term credit risk.

 

Pillar I reserves are calculated using a similar allowance for credit risk. For EEV reporting the allowance for short-term credit risk is assumed to be released gradually over the five year period following the valuation date.

The Pillar I allowance of 80 bps per annum is financially equivalent to 185 bps for the years 2009 to 2011 and 45 bps thereafter for the life of the book.

 

The overall allowance for credit risk is prudent by comparison with historic rates of default and would be sufficient to withstand a wide range of extreme credit events over the expected lifetime of the annuity business.

 

The risk discount rate for new business profits reflects the assets allocated to back new business and an allowance for credit risk based on point of sale market conditions, consistent with how the business was priced. The allowance for credit risk at the point of sale is determined using the same methodology for in-force business. In both cases, the allowance for credit risk included in setting the discount rate reflects the three constituent elements of long-term expected defaults, long-term credit risk premiums, and additional short-term credit risk.

 

(v)	The assumed long-term rate for corporate bonds for 2007 for with-profits business was determined after taking account of the purchase of credit default swaps.

 

(b)       Stochastic assumptions

The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations described above. Assumptions specific to the stochastic calculations, such as the volatilities of asset returns, reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of longer-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with allowance for correlation between the various asset classes.

Details are given below of the key characteristics and calibrations of each model.

Asian operations

The same asset return models as used in the UK, appropriately calibrated, have been used for the Asian operations as described for UK insurance operations below. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK whilst property holdings do not represent a significant investment asset.

The stochastic cost of guarantees is primarily only of significance for the Hong Kong, Malaysia, Singapore and Taiwan operations.

The mean stochastic returns are consistent with the mean deterministic returns for each country. The expected volatility of equity returns for 2008 ranges from 18 per cent to 30 per cent (2007: 18 per cent to 25 per cent), and the volatility of government bond yields ranges from 1.4 per cent to 2.4 per cent (2007: 1.3 per cent to 2.5 per cent).

US operations (Jackson)

·	Interest rates are projected using a log-normal generator calibrated to actual market data;

 

·	Corporate bond returns are based on Treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and

 

·

Variable annuity equity and bond returns have been stochastically generated using a log-normal model with parameters determined by reference to historical data. The volatility of equity fund returns for both 2008 and 2007 ranges from 18.6 per cent to 28.1 per cent, depending on risk class, and the standard deviation of bond returns ranges from 1.5 per cent to 1.6 per cent (2007: 1.4 per cent to 1.7 per cent).

 

UK insurance operations

·	Interest rates are projected using a two-factor model calibrated to actual market data;

 

·	The risk premium on equity assets is assumed to follow a log-normal distribution;

 

·	The corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and

 

·	Property returns are modelled in a similar fashion to corporate bonds, namely as the return on a riskless bond, plus a risk premium, plus a process representative of the change in residual values and the change in value of the call option on rents.

 

Mean returns have been derived as the annualised arithmetic average return across all simulations and durations.

 

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For each projection year, standard deviations have been calculated by taking the square root of the annualised variance of the returns over all the simulations. These have been averaged over all durations in the projection. For equity and property, the standard deviations relate to the total return on these assets. The standard deviations applied to both 2008 and 2007 are as follows:

		%
Equities:
UK		18.0
Overseas		16.0
Property		15.0

 

4.       Accounting presentation

Analysis of profit before tax

To the extent applicable, presentation of the EEV profit for the year is consistent with the basis that the Group applies for analysis of IFRS basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results of the Group’s continuing operations including longer-term investment returns. Operating results include the impact of routine changes of estimates and non-economic assumptions. Non operating results comprise short-term fluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, the mark to market value movements on core borrowings and the effect of changes in economic assumptions and changes in the time value of cost of options and guarantees.

Operating profit

Investment returns, including investment gains, in respect of long-term insurance business are recognised in operating results at the expected long-term rate of return. For the purpose of calculating the longer-term investment return to be included in the operating results of UK operations, where equity holdings are a significant proportion of investment portfolios, values of assets at the beginning of the reporting period are adjusted to remove the effects of short-term market volatility.

For the purposes of determining the long-term returns for debt securities of shareholder-backed operations, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of risk-free rates and equity risk premium.  For US variable annuity separate account business, operating profit reflects the expected longer-term rate of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.

For UK annuity business, rebalancing of the asset portfolio backing the liabilities to policyholders may from time to time take place to align it more closely with the internal benchmark of credit quality that management applies.  Such rebalancing will result in a change in the risk adjusted yield on the assets used to determine the valuation interest rate for calculating the carrying value of policyholder liabilities.  Operating profit includes the effect of rebalancing the portfolio calibrated to investment conditions at 31 December 2006 i.e. prior to the exceptional spread widening in 2007 and 2008.  Non-operating profit incorporates the effect of rebalancing calibrated by reference to changes to credit spreads since 31 December 2006.

Previously, for the purpose of presentation of the Group’s operating results, the return on capital held centrally to back the economic capital requirements for the Taiwan life business has been allocated to the operating result for Asian operations with a consequent reduction in Group shareholders’ other income for EEV basis reporting. In the 2008 results this approach has no longer been applied. The presentation of the 2007 comparative results has been adjusted accordingly, as explained in note 6(iv).

Effect of changes in economic assumptions and time value of cost of options and guarantees

Movements in the value of in-force business caused by changes in economic assumptions and the time value of cost of options and guarantees resulting from changes in economic factors are recorded in non-operating results.

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5.       Margins on new business premiums

2008	New Business Premiums		Annual Premium and Contribution Equivalents (APE)	Present Value of New Business Premiums (PVNBP)	Pre-Tax New Business Contribution (notes (ii) and (iii))	New Business Margin (note (i))
	Single	Regular				(APE)	(PVNBP)
	£m	£m	£m	£m	£m	%	%
Asian operations (note (iv))	1,457	1,216	1,362	7,308	741	54	10.1
US operations	6,917	24	716	7,140	293	41	4.1
UK insurance operations (note (vi))	6,929	254	947	8,081	273	29	3.4
Total	15,303	1,494	3,025	22,529	1,307	43	5.8

 

2007	New Business Premiums		Annual Premium and Contribution Equivalents (APE)	Present Value of New Business Premiums (PVNBP)	Pre-Tax New Business Contribution (notes (ii) and (iii))	New Business Margin (note (i))
	Single	Regular				(APE)	(PVNBP)
	£m	£m	£m	£m	£m	%	%
Asian operations (notes (iv) and (v))	1,793	1,108	1,287	6,906	643	50	9.3
US operations	6,515	19	671	6,666	285	42	4.3
UK insurance operations (note (vi))	6,632	247	910	7,736	277	30	3.6
Total	14,940	1,374	2,868	21,308	1,205	42	5.7

Notes

(i)

New business margins are shown on two bases, namely the margins by reference to Annual Premium and Contribution Equivalents (APE) and the Present Value of New Business Premiums (PVNBP). APEs are calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts. PVNBPs are calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.

 

(ii)	In determining the EEV basis value of new business written in the year the policies incept, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out for statutory basis reporting.

 

(iii)

In general, as described in note 3, the use of point of sale or end of period economic assumptions is not significant in determining the new business contribution for different types of business and across financial reporting periods.  However, to obtain proper measurement of the new business contribution for business which is interest rate sensitive, it is appropriate to use point of sale economic assumptions, consistent with how the business was priced.  In practice, the only area within the Group where this has a material effect, particularly in light of the dislocation of markets in 2008, is for UK shareholder-backed annuity and lifetime mortgage business.  The 2008 results for shareholder-backed annuity and lifetime mortgage business have been prepared on the basis of point of sale rather than end of period economic assumptions which previously applied for EEV reporting.  New business profits would have been £111 million lower if end of year economic assumptions had been applied.  The reduction is reflected in non-operating profit.  The £111 million primarily reflects the level of credit spread widening since the point of sale.  For 2007, the effect of the use of point of sale market conditions would not have been material.

 

New business contributions for all business represent profits determined by applying non-economic assumptions as at the end of the year.

 

(iv)	The results for Asian operations include those of the Taiwanese life operations for which the Company agreed to transfer its agency business to China Life on 20 February 2009.  Details are included in note 11.

 

(v)

The tables for Asian operations above reflect the inclusion of CITIC-Prudential Life Insurance Company Ltd, the Group’s life operation in China as a 50 per cent held joint venture for 2008 and 2007 reflecting the economic interest throughout both years.  Previously, for presentational purposes, the 2007 results reflected the inclusion of CITIC-Prudential as a subsidiary undertaking up to 29 September 2007 and 50 per cent thereafter following the change of management arrangement after this date, with appropriate minority interest accounting to reflect the 50 per cent economic interest.  The presentation of the operating profit for 2007 has been adjusted to allocate £10 million of profit from the result for new business to business in-force to prevent distortion of the published new business margin.

 

(vi)	To align with the treatment in the 2008 results, the tables for UK insurance operations above for 2007 reflect the inclusion of the Group’s UK health insurance joint venture operation, PruHealth, with an APE of £13 million and PVNBP of £107 million.

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6.       Operating profit from business in-force

 

		Unwind of discount and other expected returns (note (i))				Effect of change in operating assumptions (note (ii))				Experience variances and other items (note (iii))				Total
2008		£m				£m				£m				£m
Asian operations			434				135				(1	)			568
US operations			233				(17	)			77				293
UK insurance operations			569				-				195				764
Total			1,236				118				271				1,625

 

		Unwind of discount and other expected returns (note (i))				Effect of change in operating assumptions				Experience variances and other items (notes (iii), (iv) and (v))				Total
2007			£m				£m				£m				£m
Asian operations			340				54				5				399
US operations			240				(24	)			126				342
UK insurance operations			592				67				(81	)			578
Total			1,172				97				50				1,319

Notes

(i)	The increase in unwind of discount and other expected returns in 2008 over 2007 mainly arises in Asian operations, reflecting the growth in opening value from 1 January 2007 to 1 January 2008 on which the value of in-force business unwinds.

 

(ii)

The effect of changes in operating assumptions for Asian operations in 2008 of a credit of £135 million reflects favourable effects arising from changes in mortality and morbidity assumptions of £58 million, the effect of changes in lapse rates of £36 million, the effect of changes in expense assumptions of £26 million and the impact of incorporating the benefit arising on the change of corporate tax rate in Indonesia of £15 million.

 

(iii)

Experience variances and other items for UK insurance operations in 2008 are in aggregate a credit of £195 million.  Consistent with the methodology applied in previous years, this amount includes a credit of £118 million resulting from part of the effect of rebalancing the asset portfolio backing annuity business on the valuation interest rate for determining Pillar I liabilities.  The rebalancing reflects changes to the portfolio to more closely align the credit quality with management benchmark.  The £118 million effect of rebalancing included in operating profit reflects longer-term levels of credit spread evident as at 31 December 2006 i.e. prior to the exceptional credit spread widening in 2007 and 2008.  The additional increase in the Pillar I valuation interest rate due to rebalancing at the credit spreads at which assets were traded in 2008 is reflected within non-operating profit together with, via the increase in discount rate, the additional allowance for credit risk for the portfolio as a whole as described in note 8.  The £195 million credit also includes a cost of capital charge of £(34) million for the effect of holding the short-term credit risk reserve for statutory reporting, as described in note 3, and releasing it over an assumed five year period.  Also included in operating profit for business in-force is a credit of £56 million in respect of the release of certain annuity business reserves, a credit of £24 million in respect of the release of prior period provisions relating to Credit Life business, and a net credit of £31 million for other items.

 

Experience variances and other items for US operations of £77 million for 2008 include a credit of £54 million in respect of spread experience variance.

 

(iv)

The 2007 comparative result for Asian operations has been increased by £10 million for the adjustment in respect of China (as explained in note 5) and reduced by £(4) million for the discontinuance of the allocation of notional return on centrally held economic capital in respect of Taiwan from shareholders’ other income to the result for Asian operations, as explained in note 4.  Other income is increased by an equivalent amount.  Total profits are unaffected by these adjustments.

(v)	The 2007 comparative result for UK insurance operations has been reduced by £4 million in respect of the separate disclosure of UK general insurance commission.  Total operating profit from UK insurance operations is unaffected by this adjustment.

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7.       Short-term fluctuations in investment returns

			2008 £m				2007 £m
Insurance operations:
Asia (note (i))			(1,063	)			226
US (note (ii))			(1,344	)			(9	)
UK (note (iii))			(2,407	)			(42	)
Other operations (note (iv))			(313	)			(1	)
Total			(5,127	)			174

Notes

(i)       Asian operations

		2008
		£m
Singapore			(310	)
Hong Kong			(284	)
Taiwan			(163	)
Other operations			(306	)
			(1,063	)

For Singapore and Hong Kong, the short-term fluctuations primarily reflect the effect of substantial equity market falls on unit-linked and with-profits business. The short-term fluctuations for Taiwan principally reflect the equity market fall and a £(40) million value reduction for an investment in a CDO fund.

 

(ii)       US operations (Jackson)

The short-term fluctuations in investment returns for US operations primarily reflect the impact of impairment losses on debt securities and the effects on the value of variable annuity business of adverse movements in US equity markets. The fluctuations for US operations comprise the following items:

		2008				2007
		£m				£m
Realised impairment losses:
Actual losses on fixed income securities			(466	)			(78	)
Less: Risk margin charge included in operating profit			54				48
			(412	)			(30	)
Loss due to changed expectation of profits from fees on in-force variable annuity business in future periodsbased on current period equity returns, net of related hedging activity*			(733	)			(16	)
Actual less longer-term return on equity-type securities			(148	)			51
Other			(51	)			(14	)
			(1,344	)			(9	)

 

* This adjustment arises due to the market returns being lower than the assumed longer-term rate of return. This gives rise to lower than expected year end values of variable annuity assets under management with a resulting effect on the projected value of future account values and hence future profitability from altered fees. For 2008, the US equity market returns were approximately negative 38.5 per cent compared to the assumed longer-term rate of return of 5.8 per cent.

 

 

(iii)      UK insurance operations

The short-term fluctuations in investment returns for UK insurance operations for 2008 arise on the following types of business:

		2008
		£m
With-profits (note (a))			(2,083	)
Shareholder-backed annuity (note (b))			(213	)
Unit-linked and other (note (c))			(111	)
			(2,407	)

       Notes

(a)

For with-profits business the charge represents the negative actual investment return on the PAC with-profits fund of (19.7) per cent against an assumed rate of 6.6 per cent.

 

(b)

Short-term fluctuations on shareholder-backed annuity business represents the unrealised loss on surplus assets and default experience.

 

(c)

The charge of £(111) million relates primarily to unit-linked business and predominantly represents the capitalised loss of future fees from the fall in market values experienced during the year.

 

 

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(iv)       Other operations

Details on the charge of £(313) million for short-term fluctuations for other operations is shown in note F to the IFRS basis results.

8.       Effect of changes in economic assumptions and time value of cost of options and guarantees

The (losses) profits on changes in economic assumptions and time value of cost of options and guarantees resulting from changes in economic factors for in-force business included within the (loss) profit from continuing operations before tax (including actual investment returns) arise as follows:

 

 

			2008												2007
			Change in economic assumptions				Change in time value of cost of options and guarantees				Total				Change in economic assumptions				Change in time value of cost of options and guarantees				Total
			£m				£m				£m				£m				£m				£m
Asian operations (note (i))			(34	)			8				(26	)			201				9				210
US operations (note (ii))			267				11				278				81				8				89
UK insurance operations (notes (iii) and (iv))			(783	)			(50	)			(833	)			466				(17	)			449
TotaTotal			(550	)			(31	)			(581	)			748				0				748

 

Notes

(i)

The effect of changes in economic assumptions in Asia for 2008 of a charge of £(34) million includes a negative effect in Taiwan of £(185) million reflecting a charge of £(239) million for the impact of extending the phased bond yield progression period in Taiwan out by five years from 31 December 2013 to 31 December 2018, as described in note 3, offset by the impact in other territories, mainly reflecting the reduction in risk discount rates.

 

(ii)

The credit for the effect of changes in economic assumptions for 2008 for US operations of £267 million primarily arises as a result of the impact of a change in the risk discount rate of £454 million, partially offset by the impact of a decrease in the variable annuity separate account return of £(230) million, both movements reflecting the 180 bps reduction in the 10-year Treasury rate as shown in note 3.

 

(iii)      The effect of changes in economic assumptions of a charge of £(783) million for UK insurance operations comprises the effect of:

 

		Shareholder-backed annuity  business				With-profits  and other  business				2008
		(note (a))				(note (b))
		£m				£m				£m
Increase (decrease) in portfolio yields			83				(1,082	)			(999	)
(Increase) decrease in risk discount rates			(394	)			668				274
Other changes			(6	)			(52	)			(58	)
			(317	)			(466	)			(783	)

Notes

(a)

For shareholder-backed annuity business (i.e. held in PRIL and the PAC non-profit sub-fund) the impact of the change in risk discount rate of £(394) million includes £(400) million in respect of strengthening credit risk assumptions (excluding the strengthening required in respect of the £2.8 billion rebalancing of the asset portfolios).  The impact of the change in portfolio yields of £83 million includes a profit of £231 million in respect of the rebalancing, calculated by reference to changes in credit spreads since 31 December 2006.

(b)

For with-profits and other business the decrease in fund earned rates and risk discount rates primarily reflects the reduction in gilt rates of (0.85) per cent.

 

(iv)	The effect of changes in time value of cost of options and guarantees of a charge of £(50) million primarily relates to with-profits business reflecting the effect of the reduction in fund earned rates, as described in note (iii)(b) above.

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9.       Holding company net borrowings at market value

Holding company net borrowings at market value comprise:

		31 Dec 2008				31 Dec 2007
			£m				£m
Holding company borrowings:
IFRS basis			2,785				2,367
Mark to market value adjustment			(802	)			(38	)
EEV basis (note)			1,983				2,329
Holding company* cash and short-term investments			(1,165	)			(1,456	)
Holding company net borrowings			818				873

*Including central finance subsidiaries.

 

Note   EEV basis holding company borrowings comprising:

 

			2008 £m				2007 £m
Perpetual subordinated capital securities (Innovative Tier 1)			513				679
Subordinated debt (Lower Tier 2)			737				817
Senior debt			733				833
			1,983				2,329

 

10.                 Adoption of the principles of IFRIC 14 for pension schemes

To provide consistency with the basis applied for IFRS reporting, the EEV basis results reflect adoption of the principles of IFRIC 14 for pension schemes. The impact of the adoption is as follows:

 

		2008												2007
		Previous basis				Effect of adoption				Revised basis				As published				Effect of adoption				After change
		£m				£m				£m				£m				£m				£m
Operating profit from continuing operations based on longer-term investment returns			2,992				(31	)			2,961				2,542				(12	)			2,530
Short-term fluctuations in investment returns			(5,127	)							(5,127	)			174								174
Mark to market value movements on core borrowings			656								656				223								223
Shareholders' share of actuarial and other gains andlosses on defined benefit pension schemes			17				(32	)			(15	)			116				(121	)			(5	)
Effect of changes in economic assumptions and time value of cost of options and guarantees			(581	)							(581	)			748								748
(Loss) profit before tax			(2,043	)			(63	)			(2,106	)			3,803				(133	)			3,670
Tax			754				17				771				(961	)			34				(927	)
(Loss) profit after tax			(1,289	)			(46	)			(1,335	)			2,842				(99	)			2,743
Discontinued operations			-				-				-				241				-				241
Less minority interests			(3	)			-				(3	)			(21	)			-				(21	)
(Loss) profit for the year			(1,292	)			(46	)			(1,338	)			3,062				(99	)			2,963
Other movements in reserves			1,694				-				1,694				(166	)			-				(166	)
Shareholders’ equity at beginning of year			14,779				(179	)			14,600				11,883				(80	)			11,803
Shareholders’ equity at end of year			15,181				(225	)			14,956				14,779				(179	)			14,600

The changes reflect the aggregate of those under IFRS, as shown in note Q to the Group IFRS results, and the shareholders’ 10 per cent interest in the PAC with-profits element of the effect of the change in accounting policy reflected under EEV reporting.

 

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11.                 Intended sale of legacy agency book and agency force in Taiwan to China Life Insurance of Taiwan

On 20 February 2009, the Company announced that it had entered into an agreement to sell the assets and liabilities of its agency distribution business and its agency force in Taiwan to China Life Insurance Company Ltd of Taiwan for the nominal sum of NT$1.  In addition, Prudential will invest £45 million to purchase a 9.95 per cent stake in China Life through a share placement. The business being transferred represents 94 per cent of Prudential’s in-force liabilities in Taiwan and includes Prudential’s legacy interest rate guaranteed products.  The transfer is subject to regulatory approval.

After taking account of EEV shareholders’ funds at 31 December 2008 of the business and restructuring and other costs the Group’s EEV shareholders’ equity is expected to increase by approximately £90 million.

The movement in shareholders’ EEV equity of the total Taiwan life business for 2008 comprised:

		£m
Operating profit based on longer-term investment returns from:
New business			120
Business in force			(16	)
Total			104
Short-term fluctuations in investment returns			(163	)
Effect of changes in economic assumptions and time value of cost of options and guarantees			(185	)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes			(3	)
Loss before tax			(247	)
Total tax			12
Minority interests			2
Loss for the financial year			(233	)
Investment by parent company (note (i))			93
Exchange and other reserve movements			(53	)
Net movement			(193	)
Shareholders’ equity at 1 January 2008			(12	)
Shareholders’ equity at 31 December 2008			(205	)

Note

(i)       Comprising £66 million for solvency capital and £27 million for business developments.

12.                 Movement in Embedded value

The following analysis shows the movements in embedded value arising from the Group’s underlying business activity and the effects of the current extraordinary market conditions.

		Free Surplus (note (ii))				Required Capital (note (iii))				Net Worth				Value of in-force				Total
Group		£m				£m				£m				£m				£m
Underlying movement
New business			(825	)			472				(353	)			1,290				937
Business in force - expected transfer			1,413				(416	)			997				(997	)			-
- unwind of discount, effects of changes in operating assumptions, operating experience variances and other operating items (note (vii))			(11	)			299				288				928				1,216
			577				355				932				1,221				2,153
Investment movements and economic effects:
UKIO additional credit provisions (note (iv))			(770	)			41				(729	)			705				(24	)
Jackson impairment losses in excess of longer term expected returns net of defaults			(268	)			0				(268	)			0				(268	)
Other investment movements and effect of changes in economic assumptions (note (v))			(647	)			165				(482	)			(3,145	)			(3,627	)
			(1,685	)			206				(1,479	)			(2,440	)			(3,919	)
Net cash flows to parent company (note (viii))			(166	)			0				(166	)			(132	)			(298	)
Other items (note (ix))			253				686				939				1,819				2,758
Net movement			(1,021	)			1,247				226				468				694
Balance at 1 January 2008			1,468				2,870				4,338				9,490				13,828
Balance at 31 December 2008			447				4,117				4,564				9,958				14,522

 

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Notes

(i)	All figures are shown net of tax.

 

(ii)

Free surplus is the market value of the net worth in excess of the capital required to support the covered business.  Where appropriate, adjustments are made to the regulatory basis net worth from the local regulatory basis so as to include backing assets movements at fair value rather than cost so as to comply with the EEV principles.

 

(iii)

Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements, as described in note 2.

 

(iv)	The increase in UKIO credit provisions reflects the allowances explained in note 3.

 

(v)	Other investment movements and effect of changes in economic assumptions represent:

 

		Free Surplus (note ii)				Required Capital (note iii)				Net Worth				Value of  in-force				Total
		£m				£m				£m				£m				£m
Other investment movements (note (vi))			(681	)			(27	)			(708	)			(2,496	)			(3,204	)
Effect of changes in economic assumptions (note (vii))			34				192				226				(649	)			(423	)
			(647	)			165				(482	)			(3,145	)			(3,627	)

 

(vi)	Other investment movements primarily reflect temporary market movements on the portfolio of investments held by the Group’s shareholder-backed operations together with the shareholders’ 10 per cent interest in the value movements on the assets in the with-profits funds.

 

(vii)

The underlying movement in free surplus includes £85 million for the effect of rebalancing the asset portfolio for UK annuity business, as described in note 6.  The effect of changes in economic assumptions on free surplus includes a credit of £166 million in respect of rebalancing as described in note 8.

 

(viii)

Net cash flows to or from parent company reflect the flows for long-term business operations as included in the holding company cash flow at transaction rate.

 

(ix)	Other items represent:

 

		Free Surplus (note ii)				Required Capital (note iii)				Net Worth				Value of in-force				Total
		£m				£m				£m				£m				£m
Exchange movements (note 14)			76				823				899				1,535				2,434
Mark to market value movements on Jackson assets backing surplus and required capital			(148	)							(148	)							(148	)
Other (note x)			325				(137	)			188				284				472
			253				686				939				1,819				2,758

 

 

(x)

The effect of other items on total embedded value of £472 million primarily relate to the impact on free surplus of an intra-group capital adjustment in respect of UK insurance operations of £320 million, an adjustment for funds loaned to the parent company of £133 million from Singapore and an adjustment of £50 million to reflect the cash flows to parent company at year end rates of exchange consistent with the closing embedded value.  Also included is a net overall charge of £(40) million for the reallocation of certain statutory reserves for UK insurance and US operations, an adjustment to required capital and the reallocation of surplus note borrowings for US operations.  The effect of these adjustments is a decrease in free surplus of £(187) million, a reduction in required capital of £(137) million and an increase in the value of in-force business of £284 million.

 

13.      Expected transfer of value of in-force business to free surplus

The discounted value of in-force and required capital at 31 December 2008 can be reconciled to the analysis of free surplus crystallisation as follows:

			2008 £m
Required capital (note 12)			4,117
Value of in-force (VIF) (note 12)			9,958
Add: Cost of time value of guarantees			474
Other items			(181	)
			14,368

 

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Other items includes the deduction of the value of the shareholders’ interest in the Estate, the value of which is derived by increasing final bonus rates so as to exhaust the Estate over the lifetime of the in-force with-profits business.  This is an assumption to give an appropriate valuation.  To be conservative this item is excluded from the value of the Estate from the expected free surplus generation profile below.  Offset against this value are amounts treated as capital for regulatory purposes (and hence treated as capital for net worth purposes) but which are deducted in full against the VIF (i.e. the full undiscounted value).

Cash flows are projected on a certainty equivalent basis and are discounted at the appropriate risk discount rate.  The modelled cash flows use the same methodology underpinning the Group’s embedded value methodology reporting and so is subject to the same assumptions and sensitivities.

The table below shows how the VIF generated by the in-force business at 31 December 2008 and the associated required capital is modelled as emerging into free surplus over future years.

		2008
		Expected period of conversion of future post tax distributable earnings  and required capital flows to free surplus
	Total £m	1-5 years £m	6-10 years £m	11-15 years £m	16-20 years £m	20+ years £m
Asian operations	5,373	1,746	1,150	859	564	1,054
US operations	4,374	2,415	1,167	460	180	152
UK insurance operations	4,621	2,297	975	600	389	360
Total	14,368	6,458	3,292	1,919	1,133	1,566
		45%	23%	13%	8%	11%

 

14.                 Exchange movements

To be consistent with the basis applied for IFRS reporting, EEV basis results for the year are translated at average exchange rates.  Shareholders’ funds are translated at year end rates with exchange movements recognised in EEV basis shareholders’ equity as follows:

			2008 £m				2007 £m
Long-term business operations:
Asian operations			1,170				80
US operations			1,264				(53	)
			2,434				27
Other operations (primarily reflecting US$ denominated holding company borrowings and hedge positions)			(424	)			37
Total			2,010				64

TOTAL INSURANCE AND INVESTMENT PRODUCTS NEW BUSINESS

INSURANCE PRODUCTS AND INVESTMENT PRODUCTS

		Insurance products								Investment products								Total
			2008 £m				2007 £m				2008 £m				2007 £m				2008 £m				2007 £m
Asian operations			2,673				2,901				46,957				38,954				49,630				41,855
US operations			6,941				6,534				36				60				6,977				6,594
UK operations			7,183				6,879				16,154				14,745				23,337				21,624
Group Total			16,797				16,314				63,147				53,759				79,944				70,073

 

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INSURANCE PRODUCTS - NEW BUSINESS PREMIUMS AND CONTRIBUTIONS (note (i))

	Single		Regular		Annual Premium and Contribution Equivalents (APE)		Present Value of New Business Premiums (PVNBP)
	2008 £m	2007  £m	2008  £m	2007  £m	2008  £m	2007  £m	2008  £m	2007  £m
Asian operations
China (note (iv))	63	45	32	24	38	29	230	167
Hong Kong	507	501	154	117	205	167	1,612	1,196
India (Group's 26% interest)	60	26	202	177	208	180	747	728
Indonesia	94	118	167	109	176	121	649	494
Japan	115	122	30	22	42	34	217	214
Korea	78	179	211	241	219	259	1,097	1,267
Malaysia	28	41	99	78	102	82	570	472
Singapore	341	593	78	67	112	126	961	1,047
Taiwan	153	132	189	218	204	231	1,037	1,121
Other	18	36	54	55	56	58	188	200
Total Asian operations	1,457	1,793	1,216	1,108	1,362	1,287	7,308	6,906
US operations
Fixed annuities	1,724	573	-	-	172	57	1,724	573
Fixed index annuities	501	446	-	-	50	45	501	446
Variable annuities	3,491	4,554	-	-	349	455	3,491	4,554
Life	7	7	24	19	25	20	230	158
Guaranteed Investment Contracts	857	408	-	-	86	41	857	408
GIC-Medium Term Notes	337	527	-	-	34	53	337	527
Total US operations	6,917	6,515	24	19	716	671	7,140	6,666
UK operations
Product summary
Internal vesting annuities	1,600	1,399	-	-	160	140	1,600	1,399
Direct and partnership annuities	703	842	-	-	70	84	703	842
Intermediated annuities	497	555	-	-	50	56	497	555
Total individual annuities	2,800	2,796	-	-	280	280	2,800	2,796
Income drawdown	75	34	-	-	8	3	75	34
Equity release	242	156	-	-	24	16	242	156
Individual pensions	115	38	3	1	14	5	124	42
Corporate pensions	221	283	88	84	110	112	645	737
Unit-linked bonds	109	243	-	-	11	24	109	243
With-profit bonds	869	297	-	-	87	30	869	297
Protection	-	-	6	5	6	5	38	26
Offshore products	551	434	4	4	59	47	573	455
PruHealth (note (v))	-	-	16	13	16	13	146	107
Total retail retirement	4,982	4,281	117	107	615	535	5,621	4,893
Corporate pensions	227	198	116	115	139	135	653	604
Other products	132	190	21	25	34	44	219	276
DWP rebates	153	143	-	-	15	14	153	143
Total mature life and pensions	512	531	137	140	188	193	1,025	1,023
Total retail	5,494	4,812	254	247	803	728	6,646	5,916
Wholesale annuities (note (iii))	1,417	1,799	-	-	142	180	1,417	1,799
Credit life	18	21	-	-	2	2	18	21
Total UK operations	6,929	6,632	254	247	947	910	8,081	7,736
Channel Summary
Direct and partnership	2,352	2,385	215	212	450	451	3,268	3,313
Intermediated	2,990	2,284	39	35	338	263	3,226	2,460
Wholesale (note (iii))	1,434	1,820	-	-	144	182	1,434	1,820
Sub-total	6,776	6,489	254	247	932	896	7,928	7,593
DWP rebates	153	143	-	-	15	14	153	143
Total UK operations	6,929	6,632	254	247	947	910	8,081	7,736
Group Total	15,303	14,940	1,494	1,374	3,025	2,868	22,529	21,308

 

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INVESTMENT PRODUCTS – FUNDS UNDER MANAGEMENT (note (ii))

		1 Jan 2008				Market gross inflows				Redemptions				Market and other movements				31 Dec 2008
		£m				£m				£m				£m				£m
Asian operations			17,393				46,957				(46,102	)			(3,016	)			15,232
US operations			55				36				(32	)			(9	)			50
UK operations			51,221				16,154				(12,747	)			(7,631	)			46,997
Group Total			68,669				63,147				(58,881	)			(10,656	)			62,279

Notes

(i)	The tables shown above are provided as an indicative volume measure of transactions undertaken in the reporting period that have the potential to generate profits for shareholders. The amounts shown are not, and not intended to be, reflective of premium income recorded in the IFRS income statement.

 

Annual premium and contribution equivalents are calculated as the aggregate of regular new business amounts and one tenth of single new business amounts. PVNBPs are calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution. New business premiums reflect those premiums attaching to covered business, including premiums for contracts classified as investment products for IFRS reporting. New business premiums for regular premium products are shown on an annualised basis. Department of Work and Pensions rebate business is classified as single recurrent business. Internal vesting business is classified as new business where the contracts include an open market option.

 

The format of the tables shown above is consistent with the distinction between insurance and investment products as applied for previous financial reporting periods. With the exception of some US institutional business, products categorised as "insurance" refer to those classified as contracts of long-term insurance business for regulatory reporting purposes, i.e. falling within one of the classes of insurance specified in part II of Schedule 1 to the Regulated Activities Order under FSA regulations.

 

The details shown above for insurance products include contributions for contracts that are classified under IFRS 4 "Insurance Contracts" as not containing significant insurance risk. These products are described as investment contracts or other financial instruments under IFRS. Contracts included in this category are primarily certain unit-linked and similar contracts written in UK insurance operations and Guaranteed Investment Contracts and similar funding agreements written in US operations.

 

(ii)

Investment products referred to in the table for funds under management above are unit trust, mutual funds and similar types of retail asset management arrangements. These are unrelated to insurance products that are classified as "investment contracts" under IFRS 4, as described in the preceding paragraph, although similar IFRS recognition and measurement principles apply to the acquisition costs and fees attaching to this type of business.

 

(iii)

The tables above include for 2007 the transfer of 62,000 with-profits annuity policies from Equitable Life on 31 December 2007 with assets of approximately £1.7 billion. The transfer represented an APE of £174 million.

 

(iv)

Subsequent to 29 September 2007 following expiry of the previous management agreement CITIC–Prudential Life Insurance Company Ltd (CITIC-Prudential), the Group’s life operation in China, has been accounted for as a 50 per cent joint venture. Prior to this date CITIC–Prudential was consolidated as a subsidiary undertaking. All premiums for CITIC–Prudential are shown at 50 per cent on a like for like basis, reflecting the constant economic interest before and after the management changes in line with the original agreement with CITIC.

 

(v)	The tables above for full year 2008 and 2007 reflect the inclusion of the Group's UK health insurance joint venture operation, PruHealth.

 

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PRUDENTIAL PLC 2008 PRELIMINARY ANNOUNCEMENT

INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS

CONSOLIDATED INCOME STATEMENT

 

			2008 £m				2007* £m
Gross premiums earned			18,993				18,359
Outward reinsurance premiums			(204	)			(171	)
Earned premiums, net of reinsurance			18,789				18,188
Investment return			(30,202	)			12,225
Other income			1,146				2,457
Total revenue, net of reinsurance (note C)			(10,267	)			32,870
Benefits and claims			4,620				(26,224	)
Outward reinsurers’ share of benefits and claims			389				(20	)
Movement in unallocated surplus of with-profits funds			5,815				(541	)
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance			10,824				(26,785	)
Acquisition costs and other operating expenditure			(2,459	)			(4,859	)
Finance costs: interest on core structural borrowings of shareholder-financed operations			(172	)			(168	)
Total charges, net of reinsurance (note C)			8,193				(31,812	)
(Loss) profit before tax (being tax attributable to shareholders’ and policyholders’ returns)** (note C)			(2,074	)			1,058
Tax credit attributable to policyholders' returns			1,624				5
(Loss) profit before tax attributable to shareholders (note D)			(450	)			1,063
Tax credit (charge) (note G)			1,683				(349	)
Less: tax credit attributable to policyholders' returns			(1,624	)			(5	)
Tax credit (charge) attributable to shareholders' (loss) profit (note G)			59				(354	)
(Loss) profit from continuing operations after tax (note C)			(391	)			709
Discontinued operations (net of tax) (note H)			-				241
(Loss) profit for the year			(391	)			950
Attributable to:
Equity holders of the Company			(396	)			947
Minority interests			5				3
(Loss) profit for the year			(391	)			950
Earnings per share (in pence)		2008				2007
Basic (based on 2,472m and 2,445m shares respectively):
Based on (loss) profit from continuing operations attributable to the equity holders of the Company (note I)			(16.0	)p			28.8	p
Based on profit from discontinued operations attributable to the equity holders of the Company			-				9.9	p
			(16.0	)p			38.7	p
Diluted (based on 2,473m and 2,448m shares respectively):
Based on (loss) profit from continuing operations attributable to the equity holders of the Company			(16.0	)p			28.8	p
Based on profit from discontinued operations attributable to the equity holders of the Company			-				9.8	p
			(16.0	)p			38.6	p
Dividends per share (in pence)		2008				2007
Dividends relating to reporting period:
Interim dividend (2008 and 2007)			5.99	p			5.70	p
Final dividend (2008 and 2007) (note J)			12.91	p			12.30	p
Total			18.90	p			18.00	p
Dividends declared and paid in reporting period:
Current year interim dividend			5.99	p			5.70	p
Final dividend for prior year			12.30	p			11.72	p
Total			18.29	p			17.42	p

* The Company has adopted the principles of IFRIC 14 in accounting for pension schemes.  The adoption gives rise to consequential changes to the comparative results for 2007 (see note B and note Q).

** This measure is the formal (loss) profit before tax measure under IFRS but it is not the result attributable to shareholders.

 

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CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 

		2008
		Share capital				Share premium				Retained earnings				Translation reserve				Available-for-sale securities reserve				Shareholders' equity				Minority interests				Total equity
		£m				£m				£m				£m				£m				£m				£m				£m
Reserves
Loss for the year											(396	)											(396	)			5				(391	)
Items recognised directly in equity:
Exchange movements															631								631								631
Unrealised valuation movements on securities of US insurance operations classified as available-for-sale:
Unrealised holding losses arising during the year																			(3,197	)			(3,197	)							(3,197	)
Less net losses included in the income statement on disposal and impairment																			487				487								487
Total (note N)																			(2,710	)			(2,710	)							(2,710	)
Related change in amortisation of deferred income and acquisition costs (note E(ii)(b))																			1,070				1,070								1,070
Related tax															119				569				688								688
Total items of income and expense recognised directly in equity															750				(1,071	)			(321	)							(321	)
Total income and expense for the year											(396	)			750				(1,071	)			(717	)			5				(712	)
Dividends											(453	)											(453	)			(2	)			(455	)
Reserve movements in respect of share-based payments											18												18								18
Change in minority interests arising principally from purchase and sale of property partnerships of the PAC with-profits fund and other consolidated investment funds																											(50	)			(50	)
Share capital and share premium
New share capital subscribed			2				168																170								170
Transfer to retained earnings in respect of shares issued inlieu of cash dividends							(156	)			156
Treasury shares
Movement in own shares in respect of share-based payment plans											3												3								3
Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS											(25	)											(25	)							(25	)
Net increase (decrease) in equity			2				12				(697	)			750				(1,071	)			(1,004	)			(47	)			(1,051	)
At beginning of year:
As previously reported			123				1,828				4,440				(112	)			(78	)			6,201				102				6,303
Effect of adoption of principles of IFRIC 14 for accounting for pension schemes (note Q)											(139	)											(139	)							(139	)
After adoption of IFRIC 14			123				1,828				4,301				(112	)			(78	)			6,062				102				6,164
At end of year			125				1,840				3,604				638				(1,149	)			5,058				55				5,113

 

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		2007
		Share capital				Share premium				Retained earnings				Translation reserve				Available-for-sale securities reserve				Hedging reserve				Shareholders' equity				Minority interests				Total equity
		£m				£m				£m				£m				£m				£m				£m				£m				£m
Reserves
Profit for the year											947																947				3				950
Items recognised directly in equity:
Exchange movements															11												11								11
Movement on cash flow hedges																							(3	)			(3	)							(3	)
Unrealised valuation movements on securities classified as available-for-sale of discontinued banking operations																			(2	)							(2	)							(2	)
Unrealised valuation movements on securities of US insurance operations classified as available-for-sale:
Unrealised holding losses arising during the year																			(231	)							(231	)							(231	)
Less net gains included in the income statement on disposal and impairment																			(13	)							(13	)							(13	)
Total																			(244	)							(244	)							(244	)
Related change in amortisation of deferred income and acquisition costs (note E(ii)(b))																			88								88								88
Related tax															2				53				1				56								56
Total items of income and expense recognised directly in equity															13				(105	)			(2	)			(94	)							(94	)
Total income and expense for the year											947				13				(105	)			(2	)			853				3				856
Dividends											(426	)															(426	)			(5	)			(431	)
Reserve movements in respect of share-based payments											18																18								18
Change in minority interests arising principally from purchase and sale of venture investment companies and property partnerships of the PAC with-profits fund and other consolidated investment funds																															(28	)			(28	)
Share capital and share premium
New share capital subscribed			1				181																				182								182
Transfer to retained earnings in respect of shares issued in lieu of cash dividends							(175	)			175
Treasury shares
Movement in own shares in respect of share-based payment plans											7																7								7
Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS											4																4								4
Net increase (decrease) in equity			1				6				725				13				(105	)			(2	)			638				(30	)			608
At beginning of year:
As previously reported			122				1,822				3,640				(125	)			27				2				5,488				132				5,620
Effect of adoption of principles of IFRIC 14 for accounting for pension schemes (note Q)											(64	)															(64	)							(64	)
After adoption of IFRIC 14			122				1,822				3,576				(125	)			27				2				5,424				132				5,556
At end of year			123				1,828				4,301				(112	)			(78	)			0				6,062				102				6,164

 

 

 

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INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS

CONSOLIDATED BALANCE SHEET

			2008 £m		2007* £m
Assets
Intangible assets attributable to shareholders:
Goodwill			1,341		1,341
Deferred acquisition costs and other intangible assets (note S)			5,349		2,836
			6,690		4,177
Intangible assets attributable to with-profits funds:
In respect of acquired subsidiaries for venture fund and other investment purposes			174		192
Deferred acquisition costs and other intangible assets			126		19
			300		211
Total			6,990		4,388
Other non-investment and non-cash assets:
Property, plant and equipment			635		1,012
Reinsurers' share of insurance contract liabilities			1,240		783
Deferred tax assets			2,886		951
Current tax recoverable			657		285
Accrued investment income			2,513		2,023
Other debtors			1,232		909
Total			9,163		5,963
Investments of long-term business and other operations:
Investment properties			11,992		13,688
Investments accounted for using the equity method			10		12
Financial investments:
Loans (note L)			10,491		7,924
Equity securities and portfolio holdings in unit trusts			62,122		86,157
Debt securities (note M)			95,224		83,984
Other investments			6,301		4,396
Deposits			7,294		7,889
Total			193,434		204,050
Held for sale assets			-		30
Cash and cash equivalents			5,955		4,951
Total assets (note K)			215,542		219,382

 

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			2008 £m		2007* £m
Equity and liabilities
Equity
Shareholders' equity			5,058		6,062
Minority interests			55		102
Total equity			5,113		6,164

Liabilities
Policyholder liabilities and unallocated surplus of with-profits funds:
Insurance contract liabilities			136,030	132,776
Investment contract liabilities with discretionary participation features			23,446	29,550
Investment contract liabilities without discretionary participation features			14,501	14,032
Unallocated surplus of with-profits funds			8,414	13,959
Total			182,391	190,317
Core structural borrowings of shareholder-financed operations (note O):
Subordinated debt			1,987	1,570
Other			971	922
Total			2,958	2,492

Other borrowings:
Operational borrowings attributable to shareholder-financed operations (note P)		1,977	3,081
Borrowings attributable to with-profits funds (note P)		1,308	987
Other non-insurance liabilities:
Obligations under funding, securities lending and sale and repurchase agreements		5,572	4,081
Net asset value attributable to unit holders of consolidated unit trusts and similar funds		3,843	3,556
Current tax liabilities		842	1,237
Deferred tax liabilities		3,229	3,402
Accruals and deferred income		630	599
Other creditors		1,496	1,020
Provisions		461	575
Derivative liabilities		4,832	1,080
Other liabilities		890	791
Total		21,795	16,341
Total liabilities		210,429	213,218
Total equity and liabilities (note K)		215,542	219,382

* The Company has adopted the principles of IFRIC 14 in accounting for pension schemes giving rise to consequential changes to the comparative results for 2007 (see notes B and Q).

 

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CONSOLIDATED CASH FLOW STATEMENT

			2008 £m				2007* £m
Cash flows from operating activities
(Loss) profit before tax from continuing operations (being tax attributable to shareholders’ and policyholders’ returns) (note (i) and C)			(2,074	)			1,058
Profit before tax from discontinued operations (note H)			-				222
Total (Loss) profit before tax			(2,074	)			1,280
Changes in operating assets and liabilities:
Investments			33,255				(11,730	)
Other non-investment and non-cash assets			(1,659	)			(466	)
Policyholder liabilities (including unallocated surplus)			(26,987	)			11,845
Other liabilities (including operational borrowings)			(631	)			902
Interest income and expense and dividend income included in profit before tax			(4,989	)			(8,201	)
Other non-cash items			(74	)			(141	)
Operating cash items:
Interest receipts			2,937				5,541
Dividend receipts			2,019				2,732
Tax paid			(653	)			(624	)
Net cash flows from operating activities			1,144				1,138.
Cash flows from investing activities
Purchases of property, plant and equipment			(240	)			(231	)
Proceeds from disposal of property, plant and equipment			11				61
Acquisition of subsidiaries, net of cash balances (note (ii))			-				(77	)
Disposal of Egg, net of cash balances (note (iii))			-				(538	)
Disposal of other subsidiaries, net of cash balances (note (ii))			-				157
Deconsolidation of investment subsidiaries (note (iv))			-				(91	)
Net cash flows from investing activities			(229	)			(719	)
Cash flows from financing activities
Structural borrowings of the Group:
Shareholder-financed operations (notes (v) and O):
Redemption			-				(150	)
Interest paid			(167	)			(171	)
With-profits operations (notes (vi) and P):
Interest paid			(9	)			(9	)
Equity capital (note (vii)):
Issues of ordinary share capital			12				6
Dividends paid			(297	)			(255	)
Net cash flows from financing activities			(461	)			(579	)
Net increase (decrease) in cash and cash equivalents			454				(160	)
Cash and cash equivalents at beginning of year			4,951				5,071
Effect of exchange rate changes on cash and cash equivalents			550				40
Cash and cash equivalents at end of year (note (viii))			5,955				4,951

* The Company has adopted the principles of IFRIC 14 for pension schemes, giving rise to consequential changes to the 2007 comparative results.  Note Q explains the effect of the change.

 

Notes

(i)       This measure is the formal (loss) profit before tax measure under IFRS but it is not the result attributable to shareholders.

 

(ii)	Acquisitions and disposals of subsidiaries for 2007 shown above include venture investments and other investment subsidiaries of the PAC with-profits fund.

 

(iii)

The amount of £(538) million in respect of the disposal of Egg in 2007, net of cash balances shown above, represents the net sale proceeds of £527 million less cash and cash equivalents of £1,065 million held by Egg and transferred on disposal.

 

(iv)	In November 2007, the Company sold its venture fund management subsidiary, PPM Capital. As a result of the arrangements attaching to the sale, it is no longer appropriate to consolidate the holdings managed by that company.

 

(v)

Structural borrowings of shareholder-financed operations comprise core debt of the holding company and Jackson surplus notes. Core debt excludes borrowings to support short-term fixed income securities programmes and non-recourse borrowings of investment subsidiaries of shareholder-financed operations. Cash flows in respect of these borrowings are included within cash flows from operating activities.

 

(vi)

Structural borrowings of with-profits operations relate solely to the £100 million 8.5 per cent undated subordinated guaranteed bonds which contribute to the solvency base of the Scottish Amicable Insurance Fund (SAIF), a ring-fenced sub-fund of the PAC with-profits fund. Cash flows in respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash flows from operating activities.

 

(vii)

Cash movements in respect of equity capital exclude scrip dividends.

 

(viii)

Of the cash and cash equivalents amounts reported above, £165 million (2007: £394 million) are held centrally.

 

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INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) BASIS RESULTS

NOTES ON THE STATUTORY IFRS BASIS RESULTS

A       Basis of preparation and audit status

The statutory basis results included in this announcement have been extracted from the audited financial statements of the Group for the year ended 31 December 2008. These statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) as required by EU law (IAS Regulation EC1606/2002).

The auditors have reported on the 2008 statutory accounts. The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 December 2008 or 2007 but is derived from those accounts. Statutory accounts for 2007 have been delivered to the registrar of companies, and those for 2008 will be delivered in due course.  The auditors have reported on those accounts; their report was (i) unqualified, (ii) did not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying their report and (iii) did not contain a statement under section 237(2) or (3) of the Companies Act 1985.

B       Significant accounting policies

The accounting policies applied by the Group in determining the IFRS basis results in this announcement are the same as those previously applied in the Group’s consolidated financial statements for the year ended 31 December 2007, except for the effect of the adoption of the principles of IFRIC 14 “The limit on Defined Benefit Asset Minimum Funding Requirements and their Interaction” (see note Q).

In addition, the Group adopted the ‘Reclassification of Financial Assets: Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures’.  This amendment was issued in October 2008 and permits the reclassification of non-derivative financial assets into the ‘loans and receivables’ category under which assets are carried at amortised cost, if specific conditions are met. The Group has not made any such reclassification of financial assets as permitted by the amendments.

C       Segment disclosure

		2008				2007
		£m				£m
Revenue
Insurance operations			(10,798	)			31,555
Asset management			664				1,397
Unallocated corporate			157				186
Intra-group revenue eliminated on consolidation			(290	)			(268	)
Total revenue, net of reinsurance, per income statement (note (i))			(10,267	)			32,870
Analysed as:
Investment return (note (iii))			(30,202	)			12,225
Other items			19,935				20,645
			(10,267	)			32,870
Charges (before income tax attributable to policyholders and unallocated surplus of long-term insurance funds)
Insurance operations, including post-tax transfers to unallocated surplus of with-profits funds			8,980				(30,533	)
Asset management			(524	)			(1,053	)
Unallocated corporate			(553	)			(494	)
Intra-group charges eliminated on consolidation			290				268
Total charges, net of reinsurance, per income statement (note (i))			8,193				(31,812	)
Segment results - revenue less charges (continuing operations)
Insurance operations			(1,818	)			1,022
Asset management			140				344
Unallocated corporate			(396	)			(308	)
(Loss) profit before tax (note (ii)) (being tax attributable to shareholders’ and policyholders’ returns)			(2,074	)			1,058
Tax attributable to policyholders' returns			1,624				5
(Loss) profit before tax attributable to shareholders			(450	)			1,063
Tax credit (charge) attributable to shareholders' (loss) profit			59				(354	)
(Loss) profit from continuing operations after tax			(391	)			709
Segment results - discontinued operations (net of tax)
Banking (note H)			-				241
(Loss) profit for the year			(391	)			950

 

 

(i)

Total revenue for 2008 is negative £10,267 million whilst charges are a credit of £8,193 million.  These abnormal features arise from the basis of preparation whereby revenue includes investment return, which is negative 2008, and charges reflect the allocation, where appropriate, of investment return to policyholder benefits.

 

 

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(ii)	This measure is the formal (loss) profit before tax measure under IFRS but is not the results attributable to shareholders.

 

(iii)

Investment return principally comprises:

-

Interest and dividends;

-

Realised and unrealised gains and losses on securities and derivatives classified as fair value through profit and loss under IAS 39; and

-

Realised gains and losses, including impairment losses, on securities classified as available-for-sale under IAS 39.

D       Supplementary analysis of (loss) profit from continuing operations before tax attributable to shareholders

		2008				2007
Results analysis by business area		£m				£m
Asian operations
Insurance operations (note E(i))			321				189
Asset management			52				72
Development expenses			(26	)			(15	)
Total			347				246
US operations
Jackson (note E(ii))			406				444
Broker-dealer and asset management			10				13
Curian			(3	)			(5	)
Total			413				452
UK operations
UK insurance operations:
Long-term business (note E(iii))			545				524
General insurance commission (note (i))			44				4
Total			589				528
M&G			286				254
Total			875				782
Other income and expenditure
Investment return and other income			89				86
Interest payable on core structural borrowings			(172	)			(168	)
Corporate expenditure:
Group Head Office			(130	)			(129	)
Asia Regional Head Office			(41	)			(38	)
Charge for share-based payments for Prudential schemes (note (ii))			(6	)			(11	)
Total			(260	)			(260	)
Restructuring costs			(28	)			(19	)
Operating profit from continuing operations based on longer-term investment returns (note (iii))			1,347				1,201
Short-term fluctuations in investment returns on shareholder-backed business (note F)			(1,783	)			(137	)
Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes			(14	)			(1	)
(Loss) profit from continuing operations before tax attributable to shareholders (note (iv))			(450	)			1,063

Notes

(i)	UK operations transferred its general insurance business to Churchill in 2002, with general insurance commission representing the net commission receivable for Prudential-branded general insurance products as part of this arrangement.

 

(ii)       The charge for share-based payments for Prudential schemes is for the SAYE and Group performance-related schemes.

 

(iii)       Basis of determining longer-term investment returns

The Group continues to use operating profit based on longer-term investment returns as a supplemental measure of its results. For the purposes of measuring operating profit, investment returns on shareholder-financed business are based on the expected longer-term rates of return. This reflects the particular features of long-term insurance business where assets and liabilities are held for the long-term and for which the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying performance for life businesses exclusive of changes in market conditions.  In determining profit on this basis, the following key elements are applied to the results of the Group’s shareholder-financed operations.

(a)                Debt and equity securities

Longer-term investment returns comprise income and longer-term capital returns. For debt securities the longer-term capital returns comprise two elements. These are a risk margin reserve based charge for expected defaults, which is determined by reference to the credit quality of the portfolio, and amortisation of interest-related realised gains and losses to operating results based on longer-term investment returns to the date when sold bonds would have otherwise matured.

(b)                Derivative value movements

Value movements for Jackson’s equity-based derivatives and variable annuity product embedded derivatives are included in operating profits based on longer-term investment returns. The inclusion of these movements is so as to broadly match with the results on the Jackson variable annuity book that pertain to equity market movements.

 

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Other derivative value movements are excluded from operating results based on longer-term investment returns. These derivatives are primarily held by Jackson as part of a broadly-based hedging programme for features of Jackson’s bond portfolio (for which value movements are booked directly to shareholders’ equity rather than income statement) and product liabilities (for which US GAAP accounting does not reflect the economic features being hedged).

These key elements are of most importance in determining the operating results based on longer-term investment returns of Jackson.

There are two exceptions to the basis described above for determining operating results based on longer-term investment returns. These are for:

—    Unit-linked and US variable annuity business.

For such business the policyholder liabilities are directly reflective of the asset value movements. Accordingly all asset value movements are recorded in the operating results based on longer-term investment returns.

—   Assets covering non-participating business liabilities that are interest rate sensitive.

For UK annuity business policyholder liabilities are determined by reference to current interest rates. The value movements of the assets covering liabilities are closely correlated with the related change in liabilities. Accordingly asset value movements are recorded within the operating results based on longer-term investment returns. Policyholder liabilities include a margin for asset defaults which, if they occur, are recorded as a component of short-term fluctuations in investment returns.

(c)   Liabilities to policyholders and embedded derivatives for product guarantees

Under IFRS, the degree to which the carrying values of liabilities to policyholders are sensitive to current market conditions varies between territories depending upon the nature of the ‘grandfathered’ measurement basis.  In general, in those instances where the liabilities are particularly sensitive to routine changes in market conditions, the accounting basis is such that the impact of market movements on the assets and liabilities are broadly equivalent in the income statement, and operating profit based on longer-term investments returns is not distorted.  In these circumstances there is no need for the movement in the liability to be bifurcated between the element that relates to longer-term market conditions and short-term effects.

However, some types of business movements in liabilities do require bifurcation to ensure that at the net level (i.e. after allocated investment return and change for policyholder benefits) the operating result reflects longer-term market returns.

Examples where such bifurcation is necessary are:

 

(i)       Asia

·

Vietnamese participating business   For the participating business in Vietnam the liabilities include policyholders’ interest in investment appreciation and other surplus.  Bonuses paid in a reporting period and accrued policyholder interest in investment appreciation and other surpluses primarily reflect the level of realised investment gains above contract specific hurdle levels. For this business operating profit based on longer-term investment returns includes the aggregate of longer-term returns on the relevant investments, a credit or charge equal to movements on the liability for the policyholders’ interest in realised investment gains (net of any recovery of prior deficits on the participating pool), less amortisation over five years of current and prior movements on such credits or charges. The overall purpose of these adjustments is to ensure that investment returns included in operating results equal longer-term returns but that in any one reporting period movements on liabilities to policyholders caused by investment returns are substantially matched in the presentation of the supplementary analysis of profit before tax attributable to policyholders.

·

Non-participating business Bifurcation for the effect of determining the movement in the carrying value of liabilities to be included in operating results based on longer-term investment returns, and the residual element for the effect of using year end rates in the balance sheet.

 

·

Guaranteed Minimum Death Benefit (GMDB) product features For unhedged GMDB liabilities accounted for under IFRS using ‘grandfathered’ US GAAP, such as in the Japanese business, the change in carrying value is determined under SOP 03-01, which partially reflects changes in market conditions.  Under the Company’s supplementary basis of reporting the operating profit reflects the change in liability based on longer-term market conditions with the difference between the charge to the operating result and the movement reflected in the total result included in short-term fluctuations in investment returns.

 

(ii)    US operations – Embedded derivatives for variable annuity guarantee features

Under IFRS, the Guaranteed Minimum Withdrawal Benefit (GMWB) and Guaranteed Minimum Income Benefit (GMIB) reinsurance are required to be fair valued as embedded derivatives.  The movements in carrying values are affected by changes in the level of observed implied equity volatility and changes to the discount rate applied from period to period.  For these embedded derivatives, as described in note E(ii)(a), the discount rate applied reflects AA corporate bond curve rates.  For the purposes of determining operating profit based on longer-term investment returns the charge for these features is determined using historical longer-term equity volatility levels and long-term average AA corporate bond rate curves.  Further details are shown in note F.

 

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(iii)    UK shareholder-backed annuity business

With one exception, the operating result based on longer-term investment returns reflects the impact of all value movements on policyholder liabilities for annuity business in PRIL and the PAC non-profit sub-fund.

The exception is for the impact on credit risk provisioning of actual downgrades during the year.  As this feature arises due to short-term market conditions the effect on the altered valuation rate of interest is included in the category of short-term fluctuations in investment returns as shown in note F.

The effects of other changes to credit risk provisioning including the introduction of the short-term allowance for credit risk described in note E(iii) are included in the operating result, as in the net effect of changes to the valuation rate of interest applied to portfolio rebalancing to align more closely with management benchmark.

(d)   Fund management and other non-insurance businesses

For these businesses, where the business model is more conventional than that for life assurance, it is inappropriate to include returns in the operating result on the basis described above.  Instead it is appropriate to generally include realised gains and losses (including impairments) in the operating result with unrealised gains and losses being included in short-term fluctuations.  In some instances it may also be appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time period that reflects the underlying substance of the arrangements.

(iv)	The results for continuing operations shown above exclude those in respect of discontinued banking operations which were sold on 1 May 2007. Note H shows the composition of the contribution from discontinued operations.

E       Key assumptions, estimates and bases used to measure insurance assets and liabilities

(i)       Asian operations

(a)    Changes in key assumptions

Effect of 2008 changes

For 2008, the result for Asian operations was reduced by the effect of a number of individually small assumption changes of, in aggregate, £21 million.  There were no changes of assumptions that had a material impact on the 2007 results.

Taiwan interest rate assumption

For the Taiwanese life operation the profits attaching to legacy interest rate guaranteed products are particularly affected by the rates of return earned, and estimated to be earned on the assets held to cover liabilities and on future investment income and contract cash flows.  Under IFRS, the insurance contract liabilities of the Taiwan business are determined on the US GAAP basis previously applied under UK GAAP.  Under this basis, the policy liabilities are calculated on sets of assumptions, which are locked in at the point of policy inceptions, and a deferred acquisition cost is held in the balance sheet.

The adequacy of the insurance contract liabilities is tested by reference to best estimates of expected investment returns on policy cash flows and reinvestment income.  The assumed earned rates are used to discount the future cash flows.  For 2008 the projection assumes that the current bond yields at 31 December 2008 of 1.4 per cent trend towards 5.5 per cent at 31 December 2018.  This compares to the 2007 results for which the projections assumed the then current bond yields of around 2.5 per cent would trend towards 5.5 per cent at 31 December 2013.  Under the liability adequacy testing applied for IFRS the change of progression period has no effect on the carrying value of the deferred acquisition costs or liability to policyholders.

The liability adequacy test is more sensitive to changes in the expected long-term rate, further delays in the assumed progression period, or a combination thereof.  However, as explained in note R, on 20 February 2009 the Company announced the intended transfer of the legacy agency book and agency force in Taiwan to China Life Insurance of Taiwan.

(b)     Deferral and amortisation of acquisition costs

Under IFRS, the basis of accounting for insurance assets and liabilities reflects ‘grandfathered’ GAAP under the Modified Statutory Basis.  In general, this requires the deferral and amortisation of acquisition costs in line with the emergence of margins.  In 2008, the basis of deferral and amortisation has been adjusted for a number of territories to better reflect the MSB requirement as follows:

 

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For the India life operation, reflecting the initial development stage of the business, acquisition costs had previously not been deferred.  In 2008, £19 million deferral of acquisition costs, net of amortisation in the year, has been established.

For the Korea life business, the deferral of acquisition costs had previously followed the local regulatory basis as being an appropriate proxy for the MSB basis.  The regulatory basis is subject to constraints in respect of assumptions for expense loadings, the amortisation period, and the DAC balance not being higher than the cash surrender value.  This basis is no longer appropriate and on adjusting the basis £9 million of DAC has been established that reflects a revised estimate of the 1 January 2008 balance and a change of £26 million for current year acquisition costs (net of amortisation) for applying the more appropriate basis.

For Singapore, refinements have been made with a £21 million benefit (of which £7 million relates to the 1 January 2008 position) where the local risk based capital approach does not provide an appropriate basis of implicit allowance for acquisition costs for certain products.

In Hong Kong, adjustments have been made with a net overall effect of £10 million.

(ii)                 US operations

(a)     Measurement basis for embedded derivatives of variable annuity business

There were no changes of assumptions that had a material effect on the Jackson results.  However, there has been a significant change of estimation technique for two aspects of the basis of measuring ‘embedded derivatives’ for Guaranteed Minimum Withdrawal Benefit (GMWB) features of Jackson’s variable annuity products and the reinsurance of the Guaranteed Minimum Income Benefit (GMIB).  The two aspects are for the application of:

(i)	Implied current equity volatility levels rather than historic long-term average levels, which had been applied previously, and

(ii)

The reference basis for determining the rate of discount future cash flows in the projection of the effect of the guarantees.  The change is to apply AA corporate bond rates based off appropriate Merrill Lynch indices, rather than LIBOR based swap rates that, in 2008, had become both anomalously low and distorted by comparison to US Treasury bond curve rates.  In broad terms, corporate AA rates were approximately 400 basis points higher than the LIBOR based swap rates at the end of 2008. Similarly, at the beginning of 2008 corporate AA rates were approximately 100 basis points higher than the LIBOR based swap rate.

The effect of the change in respect of equity volatility is to increase the total loss for 2008 for Jackson by £126 million.  The effect of the change for the reference basis for discounting is to reduce the total loss by £173 million.

(b)     Deferred acquisition costs

·	Income statement – amortisation for variable annuity business

Under IFRS 4, the Group applies US GAAP to the insurance assets and liabilities of Jackson.  Under the US GAAP standard FAS 97, acquisition costs for Jackson’s fixed and variable annuity business are deferred and then amortised in line with the expected emergence of margins.  The amortisation profile is dependant on assumptions of which, for variable annuity business, the key assumption is the expected level of equity market returns.  For 2008 and recent previous years a rate of 8.4 per cent has been applied using, as is industry practice, a mean reversion methodology.

The mean reversion methodology is applied with the objective of adjusting the amortisation of deferred acquisition costs that would otherwise be highly volatile for the fact that the expected level of future gross profits fluctuates for altered variable annuity asset values arising from changes in equity market levels at the end of each reporting period.

The mean reversion methodology achieves this objective by dynamic adjustment to the level of expectations of short-term future investment returns.  Under the methodology the projected returns for the next five years are, for the purposes of determining the amortisation profile, set so that normally combined with the actual returns for the current and preceding two years the average rate of return is 8.4 per cent.  The mean reversion methodology does, however, include a cap of 15 per cent per annum on the project return for each of the next five years.  For 2008 this capping effect applied to restrict the projected returns below the rate of approximately 20 per cent per annum level that would have otherwise applied.  Projected returns after the next five years are set at 8.4 per cent.

In 2008, US equity market indices fell by some 38.5 per cent.  If there had been no mean reversion methodology in place there would have been an increased amortisation charge of approximately £250 million.

 

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However, as noted above, the mean reversion methodology allows for a substantial, but not complete, recovery of the lost fund value.  As a result, DAC amortisation, reflected in the 2008 results after incorporating the mean reversion, has instead increased by some £140 million, of which £40 million arises due to the capping feature.

·	Statement of changes in equity – ‘shadow DAC adjustments’

Consequent upon the negative unrealised valuation movement in 2008 of £(2,710) million (2007: £(244) million) there is a credit of £1,070 million (2007: £88 million) for altered ‘shadow’ DAC amortisation booked within the statement of changes in equity. These adjustments reflect the changes in the pattern of reported gross profits that would have happened if the assets had been sold crystallising the loss, and the proceeds reinvested at correspondingly higher curve yields.

In the event of further unrealised losses, this dynamic would be constrained under two circumstances. Firstly, the DAC asset would not be written up any further beyond the original deferred amount plus a provision for interest accrual on the asset. Secondly, and more generally, the write up of DAC would be constrained if not supported by expectations of future profitability.

(iii)     UK insurance operations – annuity business

(a)     Allowance for credit risk

For IFRS reporting, the results for UK shareholder-backed annuity business are particularly sensitive to the allowances made for credit risk.  The allowance is reflected in the deduction from the valuation rate of interest for discounting projected future annuity payments to policyholders that would have otherwise applied.  The valuation rate that is applied includes a liquidity premium that reflects the residual element of current bond spreads over swap rates after providing for the credit risk allowance.

The weighted components of the bond spread over swap rates for shareholder-backed fixed and linked annuity business for PRIL based on the asset mix at that date on the IFRS basis at 31 December 2008 are as follows:

2008		Pillar I regulatory basis (bps)				Adjustment from regulatory to IFRS basis (bps)				IFRS (bps)
Bond spread over swap rates (note (i))			323				-				323
Credit risk allowance
Long-term expected defaults (note (ii))			15				-				15
Long-term credit risk premium (note (iii))			11				-				11
Short-term allowance for credit risk (note (iv))			54				(25	)			29
Total credit risk allowance			80				(25	)			55
Liquidity premium			243				25				268

By comparison, for 2007, the weighted components of the bond spread over swap rates for shareholder-backed fixed and linked annuity business for PRIL on the IFRS basis at 31 December 2007 based on the asset mix of the portfolio at that date were as follows:

2007		Pillar I regulatory basis (bps)				Adjustment from regulatory to IFRS basis (bps)				IFRS (bps)
Bond spread over swap rates (note (i))			76				-				76
Credit risk allowance
Long-term expected defaults (note (ii))			13				-				13
Long-term credit risk premium (note (iii))			10				(3	)			7
Short-term allowance for credit risk (note (iv))			10				(10	)			-
Total credit risk allowance			33				(13	)			20
Liquidity premium			43				13				56

Notes

(i)	Bond spread over swap rates reflect market observed data to credit spreads.

 

(ii)

Long-term expected defaults; this is derived by applying Moody’s data from 1970 to 2004 uplifted by between 100 per cent (B) and 200 per cent (AAA) according to credit rating on the annuity asset portfolio.  The credit rating assigned to each asset held is based on external credit rating and for this purpose the credit rating assigned to each asset held is the lowest credit rating published by Moody’s, Standard and Poors and Fitch.

 

(iii)

Long-term credit risk premium; this provides compensation against the risk of potential volatility in the level of defaults and is derived by applying the 95th percentile from Moody’s data from 1970 to 2004 to the annuity asset portfolio.

 

 

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(iv)

During the second half of 2007, corporate bond spreads widened significantly and the methodology was reviewed to ensure that it still made appropriate allowance for credit risk.  As a result of this review a short-term allowance for credit risk was established to allow for the concern that credit ratings applied by rating agencies to individual bonds might be over optimistic.

 

The short-term allowance for credit risk assumed in the Pillar I solvency valuation has been determined as 25 per cent of the increase in corporate bond spreads (as estimated from the movements in published corporate bond indices) since 31 December 2006.

 

The approach for IFRS, however, aims to establish liabilities that are closer to ‘best estimate’.  The very prudent Pillar I regulatory basis reflects the overriding objective of ensuring sufficient provisions and capital to ensure payments to policyholders can be made.  In previous years long-term IFRS default assumptions where set mid-way between the EEV and Pillar I assumptions.  At 31 December 2008, in light of the increase uncertainty surrounding future credit default experience, the IFRS long-term assumptions have been strengthened to bring them into line with the long-term Pillar I default assumptions.  In addition a short-term allowance for credit risk has been established but at a lower level than allowed for in the Pillar I regulatory basis.

 

In total, for 2008, the effect of changes to the allowance for credit risk and the effect of portfolio rebalancing gives rise to a charge of £23 million. This amount comprises a charge of £413 million for additional credit risk allowance in line with the assumptions shown above for the portfolio as a whole.  Partially offsetting this is a credit of £390 million for the effect of £2.8 billion of portfolio rebalancing to more closely align with management benchmark.  The credit reflects the additional yield expected after allowing for additional credit risk arising from the rebalancing.

(b)     Mortality assumptions and margins in the liabilities

Recent mortality experience has been in line with expectations and no change is therefore required to the overall strength of mortality assumptions at 31 December 2008.  However, current mortality assumptions have been rebalanced across different categories of business so that they are more closely aligned to the actual experience of each product category.  The overall effect of rebalancing the assumptions between different product groups is financially neutral.

The 2007 results for shareholder-backed annuity business were determined after making changes to mortality assumptions with a resulting charge of £276 million and releasing excess margins in the aggregate liabilities that had previously been set aside as an indirect extra allowance for longevity related risks of £310 million.

F      Short-term fluctuations in investment returns on shareholder-backed business

		2008	2007
		£m	£m
Insurance operations:
Asian (note (ii))		(200)	(71)
US (note (iii))		(1,058)	(18)
UK (note (iv))		(212)	(47)
Other operations (note (v))		(313)	(1)
Total (note (i))		(1,783)	(137)

Notes

(i)       General

The short-term fluctuations in investment returns for 2008 primarily reflect temporary market value movements on the portfolio of investments held by the Group’s shareholder-backed operations. Default losses were incurred during 2008 in respect of Lehman Brothers and Washington Mutual, with total losses (including losses on disposal) for these in respect of the Group's shareholder-backed business operations being £110 million and £91 million respectively of which the majority was incurred in Jackson. Excluding Lehman Brothers and Washington Mutual there was only one other default in 2008 which resulted in a loss of £5 million. There were no default losses in 2007.

(ii)      Asian insurance operations

The fluctuations for Asian operations in 2008 primarily relate to £(81) million for Vietnam, reflecting a significant fall in the Vietnamese bond and equity markets, and £(65) million for Taiwan, which reflects the decrease in Taiwanese equity markets and a £(40) million reduction in the value of an investment in a CDO fund. For 2007, the £(71) million of short-term fluctuations primarily reflect value movements in Taiwan on the value of debt securities arising from increases in interest rates and a £30 million reduction in the value of an investment in a CDO fund, partially offset by the effects of strong equity market movements in Vietnam.

 

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(iii)      US insurance operations

The short-term fluctuations in investment returns for US insurance operations for the year comprise the following items:

		2008				2007
		£m				£m
Short-term fluctuations relating to debt securities:
Charges in the year
Defaults			(78	)			0
Losses on sales of impaired and deteriorating bonds			(130	)			(51	)
Bond write downs			(419	)			(35	)
Recoveries / reversals			3				8
			(624	)			(78	)
Less: Risk margin charge included in operating profit based on longer-term investment returns			54				48
			(570	)			(30	)
Interest related realised (losses) gains:
Arising in the year			(25	)			31
Less: Amortisation of gains and losses arising in current and prior years to operating profit based on longer-term investment returns			(28	)			(37	)
			(53	)			(6	)
Related change to amortisation of deferred acquisition costs			88				9
Total short-term fluctuation related to debt securities			(535	)			(27	)
Derivatives (other than equity related): market value movement (net of related change to amortisation of deferred acquisition costs) *			(369	)			(19	)
Equity type investments : actual less longer-term return (net of related change to amortisation ofdeferred acquisition costs)			(69	)			42
Other items (net of related change to amortisation of deferred acquisition costs) **			(85	)			(14	)
Total			(1,058	)			(18	)

* The £369 million value movement is for freestanding derivatives held to manage the fixed annuity and other general account business.  Under IAS 39, unless hedge accounting is applied value movements on derivatives are recognised in the income statement.  Except in respect of variable annuity business, the value movements on derivatives held by Jackson are separately identified within short-term fluctuations in investment returns.

 

Derivative value movements in respect of variable annuity business are included within the operating profit based on longer-term investment returns to broadly match with the commercial effects to which the variable annuity derivative programme relates.

 

For the derivatives programme attaching to the fixed annuity and other general account business the Group has continued in its approach of not seeking to apply hedge accounting under IAS 39.  This decision reflects the inherent constraints of IAS 39 for hedge accounting investments and life assurance assets and liabilities under ‘grandfathered’ US GAAP under IFRS 4.

 

** The £85 million charge for 2008 for other items shown above comprises £70 million for the difference between the charge for embedded derivatives included in the operating result and the charge to the total result and £15 million of other items.  For embedded derivatives the operating result reflects the application of 10-year average AA corporate bond rate curves and a static historical equity volatility assumption.  The total result reflects the application of year-end AA corporate bond rate curves and current equity volatility levels.  Additional details are explained in note E(ii)(a).

In addition, for US insurance operations, included within the statement of changes in equity, is a net reduction (translated at the 2008 year-end exchange rate of 1.44) in the value of debt securities classified as available-for-sale of £2,710 million (2007: £244 million). This reduction reflects the effect of widened credit spreads and global credit concerns partially offset by the effect of reductions in US interest rates and a steepening yield curve. These temporary market value movements do not reflect defaults or impairments. Additional details on the movement in the value of the Jackson portfolio are included in note N.

(iv)      UK insurance operations

The short-term fluctuations charge for UK insurance operations for 2008 of £212 million reflects £170 million for asset value movements, principally for shareholder-backed annuity business, and £42 million for the effect of credit downgrades on the calculation of liabilities for shareholder-backed annuity business in PRIL and the PAC non-profit sub-fund, as discussed in note E(iii)(a).  The short-term fluctuations charge for 2007 arose mostly in PRIL.  The fluctuations principally reflected the impact of widened credit spreads on the corporate bond securities backing the shareholders’ equity of the business.

(v)      Other

The charge of £313 million for short-term fluctuations for other operations arises from:

			2008 £m
Sale of investment in India mutual fund in May 2008 giving rise to a transfer to operating profit of £47m for the crystallised gain, and value reduction in the period, prior to sale, of £24m			(71	)
Unrealised value movements on swaps held centrally to manage Group assets and liabilities			(38	)
Unrealised value movements on Prudential Capital’s bond portfolio			(190	)
Unrealised value movements on a centrally held investment			(14	)
			(313	)

 

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G       Tax credit

The total tax credit of £1,683 million for 2008 (2007: charge of £349 million) comprises a credit of £1,758 million (2007: charge of £28 million) for UK tax and a charge of £75 million (2007: £321 million) for overseas tax. This tax credit comprises tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders. The tax credit attributable to shareholders of £59 million for 2008 (2007: charge of £354 million) comprises a credit of £95 million (2007: charge of £148 million) for UK tax and a charge of £36 million (2007: £206 million) for overseas tax.

A tax credit related to discontinued banking operations, which was all attributable to shareholders, amounted to £19 million in 2007.

In April 2008 the standard corporation tax rate for the UK changed from 30 per cent to 28 per cent. Deferred tax at the end of 2007 for UK operations had been provided at the new rate of 28 per cent on the basis that materially all of the temporary differences are expected to reverse once the new rate took effect. The effect on the deferred tax assets and liabilities at 31 December 2007 was £20 million.

H       Discontinued operations

Discontinued operations for 2007 related entirely to UK banking operations following the sale on 1 May 2007 of Egg Banking plc to Citi.

The profit from discontinued operations of £241 million comprises an operating loss based on longer-term investment returns for the period of ownership of £68 million, a tax credit on the loss of £19 million and a profit on sale (both before and after tax) of £290 million.

I       Supplementary analysis of earnings per share from continuing operations

Earnings per share (in pence)	2008	2007
From operating profit based on longer-term investment returns after related tax and minority interests	42.5p	33.3p
Adjustment from post-tax longer-term investment returns to post-tax actual investment returns (after related minority interests)	(58.1)p	(4.5)p
Adjustment for post-tax shareholders' share of actuarial and other gains and losses on defined benefit pension schemes	(0.4)p	0.0p
Based on (loss) profit from continuing operations after tax and minority interests	(16.0)p	28.8p

J       Dividend

A final dividend for 2008 of 12.91p per share was proposed by the directors on 18 March 2009. Subject to shareholder approval, the dividend will be paid on 22 May 2009 to shareholders on the register at the close of business on 14 April 2009. This dividend will absorb an estimated £322 million of shareholders' funds. A scrip dividend alternative will be offered to shareholders.

 

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K       Balance sheet analysis

(i)       Group balance sheet - analysis by business unit

For an appreciation of the shareholder exposure to investment value movements it is necessary to distinguish the effects of fund structure and type of business for the Group's operations.

	Insurance operations			Total insurance operations	Asset management operations	Unallocated to a segment (central operations)	Intra-group eliminations	31 Dec 2008  Group total	31 Dec 2007 Group total
	UK	US	Asia
	£m	£m	£m	£m	£m	£m	£m	£m	£m
Assets
Intangible assets attributable to shareholders):
Goodwill	-	-	111	111	1,230			1,341	1,341
Deferred acquisition costs and other intangible assets	134	3,962	1,247	5,343	6			5,349	2,836
Total	134	3,962	1,358	5,454	1,236	-	-	6,690	4,177
Intangible assets attributable to with-profits funds:
In respect of acquired subsidiaries for venture fund and other investment purposes	174	-	-	174	-			174	192
Deferred acquisition costs and other intangible assets	13	-	113	126	-	-		126	19
Total	187	-	113	300	-	-	-	300	211
Total	321	3,962	1,471	5,754	1,236	-	-	6,990	4,388
Deferred tax assets	513	1,969	101	2,583	160	143		2,886	951
Other non-investment and non-cash assets	4,962	1,819	1,416	8,197	135	3,553	(5,608)	6,277	5,012
Investment of long-term business and other operations:
Investment properties	11,959	13	20	11,992	-	-		11,992	13,688
Investments accounted for using the equity method	-	-	-	-	-	10		10	12
Loans and receivables	1,902	5,121	1,705	8,728	1,763	-		10,491	7,924
Equity securities and portfolio holdings inunit trusts	38,880	15,142	8,077	62,099	23	-		62,122	86,157
Debt securities (see note M for analysis of credit quality)	58,871	24,249	11,113	94,233	991	-		95,224	83,984
Other investments	4,160	1,256	144	5,560	462	279		6,301	4,396
Deposits	6,090	390	750	7,230	64	-		7,294	7,889
Total Investments	121,862	46,171	21,809	189,842	3,303	289	-	193,434	204,050
Held-for-sale assets	-	-	-	-	-	-		-	30
Cash and cash equivalents	2,571	246	1,501	4,318	1,472	165		5,955	4,951
Total assets	130,229	54,167	26,298	210,694	6,306	4,150	(5,608)	215,542	219,382

 

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Equity and liabilities
Equity
Shareholders’ equity	1,655	1,698	2,167	5,520	1,642	(2,104)		5,058	6,062
Minority interests	47	-	7	54	1			55	102
Total equity	1,702	1,698	2,174	5,574	1,643	(2,104)	-	5,113	6,164
Liabilities
Policyholder liabilities and unallocated surplus of with-profits funds:
Insurance contract liabilities	72,756	42,476	20,798	136,030	-	-		136,030	132,776
Investment contract liabilities with discretionary participation features	23,367	-	79	23,446	-	-		23,446	29,550
Investment contract liabilities without discretionary participation features	11,584	2,885	32	14,501	-	-		14,501	14,032
Unallocated surplus of with-profits funds(reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds)	8,254	-	160	8,414	-	-		8,414	13,959
Total policyholder liabilities and unallocated surplus of with-profits funds	115,961	45,361	21,069	182,391	-	-	-	182,391	190,317
Core structural borrowings of shareholder-financed operations:
Subordinated debt	-	-	-	-	-	1,987		1,987	1,570
Other	-	173	-	173	-	798		971	922
Total	-	173		173	-	2,785	-	2,958	2,492
Operational borrowings attributable to shareholder-financed operations	54	511	130	695	4	1,278		1,977	3,081
Borrowings attributable to with-profits funds	1,308	-	-	1,308	-	-		1,308	987
Deferred tax liabilities	1,421	1,337	441	3,199	11	19		3,229	3,402
Other non-insurance liabilities	9,783	5,087	2,484	17,354	4,648	2,172	(5,608)	18,566	12,939
Total liabilities	128,527	52,469	24,124	205,120	4,663	6,254	(5,608)	210,429	213,218
Total equity and liabilities	130,229	54,167	26,298	210,694	6,306	4,150	(5,608)	215,542	219,382

 

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(ii)     Group balance sheet - analysis by type of business

		Shareholder-backed
	Participating funds	Unit-linked and variable annuity	Non-linked business	Asset management operations	Unallocated to a segment (central operations)	Intra-group eliminations	31 Dec 2008 Group  total	31 Dec 2007 Group total
	£m	£m	£m	£m	£m	£m	£m	£m
Assets
Intangible assets attributable to shareholders:
Goodwill	-	-	111	1,230	-	-	1,341	1,341
Deferred acquisition costs and other intangible assets	-	-	5,343	6	-	-	5,349	2,836
Total	-	-	5,454	1,236	-	-	6,690	4,177
Intangible assets attributable to with-profits funds:
In respect of acquired subsidiaries forventure fund and other investment purposes	174	-	-	-			174	192
Deferred acquisition costs and other intangible assets	126	-	-	-	-	-	126	19
Total	300	-	-	-	-	-	300	211
Total	300	-	5,454	1,236	-	-	6,990	4,388
Deferred tax assets	279	-	2,304	160	143	-	2,886	951
Other non-investment and non-cash assets	3,095	579	4,523	135	3,553	(5,608)	6,277	5,012
Investment of long-term business and other operations:
Investment properties	9,911	710	1,371	-	-	-	11,992	13,688
Investments accounted for using the equity method	-	-	-	-	10	-	10	12
Loans and receivables	2,154	113	6,461	1,763	-	-	10,491	7,924
Equity securities and portfolio holdings in unit trusts	31,821	29,211	1,067	23	-	-	62,122	86,157
Debt securities (see section M for analysis of credit quality)	42,965	6,298	44,970	991	-	-	95,224	83,984
Other investments	3,768	204	1,588	462	279	-	6,301	4,396
Deposits	4,828	903	1,499	64	-	-	7,294	7,889
Total Investments	95,447	37,439	56,956	3,303	289	-	193,434	204,050
Held-for-sale assets	-	-		-	-	-	-	30
Cash and cash equivalents	1,733	1,148	1,437	1,472	165	-	5,955	4,951
Total assets	100,854	39,166	70,674	6,306	4,150	(5,608)	215,542	219,382

 

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Equity and liabilities
Equity
Shareholders’ equity	-	-	5,520	1,642	(2,104)	-	5,058	6,062
Minority interests	47	-	7	1			55	102
Total equity	47	-	5,527	1,643	(2,104)	-	5,113	6,164
Liabilities
Policyholder liabilitiesand unallocated surplus of with-profits funds:
Insurance contract liabilities	58,310	27,799	49,921	-	-	-	136,030	132,776
Investment contract liabilities with discretionary participation features	23,446	-	-	-	-	-	23,446	29,550
Investment contract liabilities without discretionary participation features	32	10,277	4,192	-	-	-	14,501	14,032
Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds)	8,414	-		-	-	-	8,414	13,959
Total policyholder liabilities and unallocated surplusof with-profits funds	90,202	38,076	54,113	-	-	-	182,391	190,317
Core structuralborrowings of shareholder-financed operations:
Subordinated debt	-	-	-	-	1,987	-	1,987	1,695
Other	-	-	173	-	798	-	971	797
Total	-	-	173	-	2,785	-	2,958	2,492
Operational borrowings attributable to shareholder-financed operations	-	-	695	4	1,278	-	1,977	3,081
Borrowings attributable to with-profits funds	1,308	-	-	-	-	-	1,308	987
Deferred tax liabilities	1,225	-	1,974	11	19	-	3,229	3,402
Other non-insurance liabilities	8,072	1,090	8,192	4,648	2,172	(5,608)	18,566	12,939
Total liabilities	100,807	39,166	65,147	4,663	6,254	(5,608)	210,429	213,218
Total equity and liabilities	100,854	39,166	70,674	6,306	4,150	(5,608)	215,542	219,382

 

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L       Loans portfolio

Loans are accounted for at amortised cost unless impaired. The amounts included in the balance sheet are analysed as follows:

	2008	2007
	£m	£m
Insurance operations
UK (note(i))	1,902	1,245
US (note (ii))	5,121	3,258
Asia (note (iii))	1,705	1,087
Asset management operations
M&G (note (iv))	1,763	2,334
Total	10,491	7,924

Notes

(i)       UK insurance operations

The loans of the Group’s UK insurance operations of £1,902 million at 31 December 2008 (2007: £1,245 million) comprise mortgage loans of £701 million, policy loans of £29 million and other loans of £1,172 million (2007: £449 million, £35 million and £761 million respectively). The mortgage loans are collateralised by properties. Other loans are all commercial loans and comprise mainly syndicated loans held by the PAC with-profits fund.

(ii)       US insurance operations

The loans of the Group’s US insurance operations of £5,121 million at 31 December 2008 (2007: £3,258 million) comprise mortgage loans of £4,534 million and policy loans of £587 million (2007: £2,841 million and £417 million respectively). All of the mortgage loans are commercial mortgage loans which are collateralised by properties. The property types are mainly industrial, multi-family residential, suburban office, retail and hotel.

The US insurance operations’ mortgage loan portfolio does not include any single-family residential mortgage loans and is therefore not exposed to the risk of defaults associated with residential sub-prime mortgage loans.

The policy loans are fully secured by individual life insurance policies or annuity policies.  These loans are accounted for at amortised cost, less any impairment.

(iii)      Asian insurance operations

The loans of the Group’s Asian insurance operations of £1,705 million at 31 December 2008 (2007: £1,087 million) comprise mortgage loans of £238 million, policy loans of £675 million and other loans of £792 million (2007: £132 million, £430 million and £525 million respectively). The mortgage and policy loans are secured by properties and life insurance policies respectively.

The majority of the other loans are commercial loans held by the Malaysian operation and which are all investment graded by two local rating agencies.

(iv)      M&G

The M&G loans of £1,763 million relate to bridging loan finance managed by Prudential Capital. The bridging loan finance assets generally have no external credit ratings available, with internal ratings prepared by the Group’s asset management operations as part of the risk management process rating £1,100 million BBB+ to BBB- and £663 million BB+ to BB-.

M       Debt securities portfolio

Debt securities are accounted for at fair value. The amounts included in the balance sheet are analysed as follows, with further information relating to the credit quality of the Group’s debt securities at 31 December 2008 provided in the notes below.

	2008	2007
	£m	£m
Insurance operations
UK (note(i))	58,871	57,180
US (note (ii))	24,249	19,002
Asia (note (iii))	11,113	6,920
Asset management operations (note (iv))	991	882
Total	95,224	83,984

 

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Notes

In the tables below, Standard and Poor’s (S&P) ratings have been used where available. For securities where S&P ratings are not available, those produced by Moody’s and then Fitch have been used as an alternative.

 (i)     UK insurance operations

						PAC-with profits sub-fund												Other funds and subsidiaries								UK insurance operations
		Scottish Amicable Insurance Fund				Excluding Prudential Annuities Limited				Prudential Annuities Limited				Total				Unit-linked assets and liabilities				Annuity and other long-term business				2008 Total				2007 Total
			£m				£m				£m				£m				£m				£m				£m				£m
S&P – AAA			1,139				5,765				3,176				8,941				2,866				6,035				18,981				21,556
S&P – AA+ to AA-			318				1,817				1,389				3,206				423				2,065				6,012				6,173
S&P – A+ to A-			1,058				5,804				3,295				9,099				815				4,957				15,929				12,557
S&P – BBB+ to BBB-			789				3,875				919				4,794				210				1,620				7,413				5,409
S&P – Other			152				794				16				810				71				-				1,033				942
			3,456				18,055				8,795				26,850				4,385				14,677				49,368				46,637
Moody’s – Aaa			111				344				89				433				9				128				681				1,021
Moody’s – Aa1 to Aa3			66				353				255				608				-				159				833				587
Moody’s – A1 to A3			43				222				232				454				-				181				678				944
Moody’s – Baa1 to Baa3			35				146				138				284				-				135				454				490
Moody’s – Other			4				136				12				148				-				10				162				410
			259				1,201				726				1,927				9				613				2,808				3,452
Fitch			34				181				188				369				-				157				560				682
Other			469				2,221				2,179				4,400				15				1,251				6,135				6,409
Total debt securities			4,218				21,658				11,888				33,546				4,409				16,698				58,871				57,180

Where no external ratings are available, internal ratings produced by the Group’s asset management operation, which are prepared on the Company’s assessment of a comparable basis to external ratings, are used where possible. Of the £6,135 million total debt securities held at 31 December 2008 (2007: £6,409 million) which are not externally rated, £2,325 million were internally rated AAA to A-, £3,149 million were internally rated BBB to B- and £661 million were unrated (2007: £2,972 million, £2,844 million and £593 million respectively). The majority of unrated debt security investments were held in SAIF and the PAC with-profits fund and relate to convertible debt and other investments which are not covered by ratings analysts nor have an internal rating attributed to them.

The change in ratings for annuity and other long-term business incorporates the effect of the portfolio rebalancing discussed in note E(iii)(a).

(ii)   US insurance operations

		2008				2007
			£m				£m
S&P – AAA			5,321				3,896
S&P – AA+ to AA-			853				1,187
S&P – A+ to A-			5,244				3,657
S&P – BBB+ to BBB-			7,077				5,415
S&P – Other			1,321				1,113
			19,816				15,268
Moody’s – Aaa			458				549
Moody’s – Aa1 to Aa3			100				118
Moody’s – A1 to A3			111				47
Moody’s – Baa1 to Baa3			100				79
Moody’s – Other			95				78
			864				871
Fitch			464				380
Other*			3,105				2,483
Total debt securities			24,249				19,002

* The amounts within Other which are not rated by S&P, Moody or Fitch have the following National Association of Insurance Commissioners (NAIC) classifications:

		2008				2007
			£m				£m
NAIC 1			1,334				1,079
NAIC 2			1,650				1,311
NAIC 3-6			121				93
			3,105				2,483

 

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(iii)     Asian insurance operations

		With-profits business				Unit-linked assets and liabilities				Other business				2008 Total				2007 Total
			£m				£m				£m				£m				£m
S&P – AAA			2,085				341				206				2,632				2,284
S&P – AA+ to AA-			997				303				2,446				3,746				1,994
S&P – A+ to A-			640				96				72				808				675
S&P – BBB+ to BBB-			198				184				520				902				193
S&P – Other			77				63				113				253				149
			3,997				987				3,357				8,341				5,295
Moody’s – Aaa			382				54				58				494				201
Moody’s – Aa1 to Aa3			77				20				11				108				45
Moody’s – A1 to A3			80				287				31				398				28
Moody’s – Baa1 to Baa3			50				6				4				60				19
Moody’s – Other			8				39				3				50				58
			597				406				107				1,110				351
Fitch			7				30				4				41				0
Other			600				466				555				1,621				1,274
Total debt securities			5,201				1,889				4,023				11,113				6,920

The increase in holdings of debt securities for Asian insurance operations was principally due to exchange rate movements, a rise in the number of unit trusts and similar funds requiring consolidation and portfolio changes from equities to bonds.

Of the £555 million (2007: £598 million) of debt securities for other business which are not rated in the table above, £231 million (2007: £317 million) are in respected of government bonds, £221 million (2007: £83 million) corporate bonds rated as investment grade by local external ratings agencies and nil (2007: £71 million) structured deposits issued by banks which are themselves rated but where the specific deposits have not been.

(iv)      Asset management operations

Total debt securities for asset management operations of £991 million (2007: £882 million), include £959 million (2007: £841 million) related to M&G’s Prudential Capital operations which were all AAA to A- where S&P rated or Aaa by Moody’s.

(v)       Group exposure to holdings in asset-backed securities and monoline insurers

(a)       Asset-backed securities

The Group’s exposure to holdings in asset-backed securities, which comprise residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), CDO funds and other asset-backed securities (ABS), at 31 December 2008 is as follows:

			2008 £m
Shareholder-backed operations:
UK insurance operations (note (i))			1,075
US insurance operations (note (ii))			7,464
Asian insurance operations (note (iii))			15
Other operations (note (iv))			407
			8,961
With-profits operations:
UK insurance operations (note (i))			4,977
Asian insurance operations (note (iii))			328
			5,305
Total			14,266

 

 

 

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 (i)       UK insurance operations

The UK insurance operations’ exposure to asset-backed securities at 31 December 2008 comprises:

			2008 £m
Shareholder-backed business (70% AAA, 19% AA)			1,075
With-profits operations (74% AAA, 10% AA)			4,977
Total			6,052

The UK insurance operations’ exposure to asset-backed securities is mainly made up of exposure to AAA rated securities as shown in the table above.

All of the £1,075 million exposure of the shareholder-backed business relates to the UK market and primarily relates to investments held by PRIL. £2,721 million of the £4,977 million (2007: £5,565 million) exposure of the with-profits operations relates to exposure to the UK market while the remaining £2,256 million relates to exposure to the US market.

(ii)           US insurance operations

US insurance operations’ exposure to asset-backed securities at 31 December 2008 comprises:

			2008 £m
RMBS Sub-prime (91% AAA, 3% AA)			291
Alt-A (60% AAA, 15% AA)			646
Prime (87% AAA, 5% AA)			3,572
CMBS (85% AAA, 9% AA)			1,869
CDO funds (34% AAA, 14% AA)*, including £6m exposure to sub-prime			320
ABS (31% AAA, 16% AA), including £51m exposure to sub-prime			766
Total			7,464

* Including the Group's economic interest in Piedmont and other consolidated CDO funds.

(iii)           Asian insurance operations

The Asian insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations.

The £328 million asset-backed securities exposure of the Asian with-profit operations comprises:

			2008 £m
RMBS – all without sub-prime exposure			46
CMBS			88
CDO funds and ABS			194
Total			328

The £328 million includes £259 million held by investment funds consolidated under IFRS in recognition of the control arrangements for those funds and included an amount not owned by the Group with a corresponding liability of £32 million on the balance sheet for net asset value attributable to external unit-holders in respect of these funds, which are non-recourse to the Group. Of the £328 million, 70% are investment graded by Standard & Poor’s.

(iv)           Other operations

Other operations’ exposure to asset-backed securities at 31 December 2008 is held by Prudential Capital and comprises:

			2008 £m
RMBS Prime (75% AAA, 10% AA)			106
CMBS (68% AAA, 20% AA)			230
CDO funds - all without sub-prime exposure (AAA)			38
ABS (92% AAA)			33
Total			407

(b)       Direct holdings in monoline insurers

The Group has no significant exposure to direct holdings in monoline insurers at 31 December 2008.

 

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N	Debt securities of US insurance operations: Valuation basis, accounting presentation of gains and losses and securities in an unrealised loss position

(i)       Valuation basis

Under IAS 39, unless categorised as ‘held to maturity’ debt securities are required to be fair valued.  Where available, quoted market prices are used.  However, where securities are in inactive markets, IAS 39 requires that valuation techniques be applied.

Jackson has previously utilised prices provided by a pricing service or has used various broker quotes to value debt securities. For most securities in the portfolio this practice has continued where the valuation basis reflects either quoted prices or fair values using valuation techniques of these providers that correspond to the requirements of IAS 39.

However, the current market dislocations have caused a reassessment of the valuation process for certain securities in inactive markets.  In particular, beginning at the end of the third quarter of 2008, the external prices obtained for certain asset-backed securities were deemed to be inappropriate in the current market conditions.

For the valuations at 31 December 2008, Jackson has therefore utilised internal valuation models, provided by PPM America, to derive fair values of all non agency Residential Mortgage-backed Securities and Asset-backed Securities and certain Commercial Mortgage-backed securities.  The use of internal valuation models has resulted in a fair value of these securities that was higher than those provided from pricing services and brokers of £760 million on a total amortised cost of £3.5 billion.

(ii)      Accounting presentation of gains and losses

With the exception of debt securities of US insurance operations classified as ‘available-for-sale’ under IAS 39, unrealised value movements on the Group’s investments are booked within the income statement. For with-profits operations, such value movements are reflected in changes to asset share liabilities to policyholders or the liability for unallocated surplus. For shareholder-backed operations, the unrealised value movements form part of the total return for the year booked in the profit before tax attributable to shareholders. Separately, as noted elsewhere and in note D in this announcement, and as applied previously, the Group provides a supplementary analysis of this profit distinguishing operating profit based on longer-term investment return and short-term fluctuations in investment returns.

However, for debt securities classified as ‘available-for-sale’, unless impaired, fair value movements are recorded as a movement in shareholder reserves direct to equity. Impairments are recorded in the income statement as shown in note F of this announcement. This classification is applied for most of the debt securities of the Group’s US insurance operations.

(iii)    2008 movements in unrealised gains and losses

In general, the debt securities of the Group’s US insurance operations are purchased with the intention and the ability to hold them for the longer-term. In 2008 there was a movement in the balance sheet value for these debt securities classified as available-for-sale from a net unrealised loss of £136 million to a net unrealised loss of £2,897 million. During 2008, US interest rates continued to fall and the yield curve further steepened. Offsetting the positive effect on bond values for these changes were adverse market price effects resulting from increasing credit spreads and global credit concerns. As a result of these factors, the gross unrealised gain in the balance sheet decreased from £303 million at 31 December 2007 to £281 million at 31 December 2008, while the gross unrealised loss increased from £439 million at 31 December 2007 to £3,178 million at 31 December 2008.

These features are included in the table shown below of the movements in the values of available-for-sale securities.

		31 Dec 2008				Changes in unrealised appreciation*				Foreign Exchange translation				31 Dec 2007
			£m				£m				£m				£m
Assets fair valued at below book value
Book value			20,600												10,730
Unrealised loss			(3,178	)			(2,572	)			(167	)			(439	)
Fair value (as included in balance sheet)			17,422												10,291
Assets fair valued at or above book value
Book value			6,296												8,041
Unrealised gain			281				(138	)			116				303
Fair value (as included in balance sheet)			6,577												8,344
Total
Book value			26,896												18,771
Net unrealised (loss) gains			(2,897	)			(2,710	)			(51	)			(136	)
Fair value (as included in balance sheet)**			23,999												18,635
Reflected as part of movement in shareholders’ equity
Movement in unrealised appreciation			(2,710	)
Exchange movements			(51	)
			(2,761	)

*Translated at the closing rate of $1.44 : £1

** Debt securities for US operations included in the balance sheet of £24,249 million, and as referred to in note M, comprise £23,999 million for securities classified as available-for-sale, as shown above, and £250 million for securities of consolidated investment funds classified as fair value through profit and loss.

Included within the movement in unrealised valuation losses for the debt securities of Jackson of £2,572 million was an amount of £134 million relating to the sub-prime and Alt-A securities for which the carrying values at 31 December 2008 are shown in the note below.

 

 

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(iv)      Securities in unrealised loss position

The following tables show some key attributes of those securities that are in an unrealised loss position at 31 December 2008.

(a)       Fair value of securities as a percentage of book value

The unrealised losses in the Jackson balance sheet on unimpaired securities are £3,178 million (2007: £439 million) relating to assets with fair market value and book value of £17,422 million (2007: £10,291 million) and £20,600 million (2007: £10,730 million) respectively. The following table shows the fair value of the securities in a gross unrealised loss position for various percentages of book value:

 

		2008								2007
		Fair value  £m				Unrealised loss £m				Fair value  £m				Unrealised loss £m
Between 90% and 100%			8,757				(431	)			9,370				(274	)
Between 80% and 90%			4,581				(809	)			784				(122	)
Below 80%			4,084				(1,938	)			137				(43	)
			17,422				(3,178	)			10,291				(439	)

Included within the table above, showing the fair value of securities in an unrealised loss position at 31 December 2008 as a percentage of book value, are amounts relating to sub-prime and Alt-A securities of:

		2008								2007
		Fair value  £m				Unrealised loss £m				Fair value £m				Unrealised loss £m
Between 90% and 100%			479				(27	)			572				(24	)
Between 80% and 90%			120				(19	)			132				(22	)
Below 80%			192				(166	)			28				(10	)
			791				(212	)			732				(56	)

 (b)     Aged analysis of unrealised losses for the periods indicated

The following table shows the age analysis of all the unrealised losses in the portfolio by reference to the length of time the securities have been in an unrealised loss position:

		2008												2007
		Non investment grade				Investment grade				Total				Non investment grade				Investment grade				Total
			£m				£m				£m				£m				£m				£m
Less than 6 months			(108	)			(362	)			(470	)			(9	)			(58	)			(67	)
6 months to 1 year			(125	)			(1,164	)			(1,289	)			(21	)			(115	)			(136	)
1 year to 2 years			(154	)			(622	)			(776	)			(2	)			(21	)			(23	)
2 years to 3 years			(15	)			(91	)			(106	)			(34	)			(140	)			(174	)
More than 3 years			(61	)			(476	)			(537	)			(2	)			(37	)			(39	)
			(463	)			(2,715	)			(3,178	)			(68	)			(371	)			(439	)

At 31 December 2008, the gross unrealised losses in the balance sheet for the sub-prime and Alt-A securities in an unrealised loss position were £212 million (2007: £56 million), as shown above in note (a). Of these losses £91 million (2007: £37 million) relate to securities that have been in an unrealised loss position for less than one year and £121 million (2007: £19 million) to securities that have been in an unrealised loss position for more than one year.

(c)       Unrealised losses by maturity of security

			2008 £m				2007 £m
Less than 1 year			(21	)			(1	)
1 year to 5 years			(537	)			(54	)
5 years to 10 years			(1,236	)			(164	)
More than 10 years			(395	)			(60	)
Mortgage-backed and other debt securities			(989	)			(160	)
Total			(3,178	)			(439	)

 

 

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O       Net core structural borrowings of shareholder-financed operations

		2008				2007
			£m				£m
Core structural borrowings of shareholder-financed operations:
Perpetual subordinated capital securities (Innovative Tier 1*)			1,059				763
Subordinated notes (Lower Tier 2*)			928				807
Senior debt ***:
2009			249				248
2023			300				300
2029			249				249
Holding company total			2,785				2,367
Jackson surplus notes (Lower Tier 2*)			173				125
Total (per consolidated balance sheet)			2,958				2,492
Less: Holding company** cash and short-term investments (recorded within the consolidated balance sheet)			(1,165	)			(1,456	)
Net core structural borrowings of shareholder-financed operations			1,793				1,036

 

*	These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the FSA handbook.

**	Including central finance subsidiaries.

***	The senior debt ranks above subordinated debt in the event of liquidation.

 

P       Other borrowings

		2008				2007
			£m				£m
Operational borrowings attributable to shareholder-financed operations
Borrowings in respect of short-term fixed income securities programmes			1,278				2,477
Non-recourse borrowings of US operations			511				591
Other borrowings			188				13
Total			1,977				3,081
Borrowings attributable to with-profits operations
Non-recourse borrowings of consolidated investment funds			1,161				789
£100m 8.5%undated subordinated guaranteed bonds of the Scottish Amicable Insurance Fund			100				100
Other borrowings (predominantly obligations under finance leases)			47				98
Total			1,308				987

Q       Adoption of the principles of IFRIC 14 for accounting for pension schemes

As mentioned in note B, the Group has adopted IFRIC 14 for pension schemes in 2008. IFRIC 14 gives guidance on assessing the limit in IAS 19 on the amount of surplus in a defined benefit pension scheme that can be recognised as an asset thereby providing reliable and more relevant information. The recognition of an asset is restricted to those that are demonstrably recoverable, either by refund or reduction in future contributions. It also addresses when a minimum funding requirement might give rise to a liability. The assessment of recoverability and any additional liability is made by reference to the terms of the Trust Deed of pension schemes and, unless substantively enacted or contractually agreed, with no account taken of potential changes to current funding arrangements.

This adoption of the principles of IFRIC 14 has had an effect on the Group’s interest in the financial position of the Group’s main UK defined benefit pension scheme, the Prudential Staff Pension Scheme (PSPS). The change relates solely to the accounting measurement of the Group’s interest in the financial position of PSPS. Adoption of the principles of IFRIC 14 does not affect the Group’s interest in the Group’s other defined benefit pension schemes.

Under the terms of the Trust Deed, the Group has no unconditional right of refund to any surplus in PSPS. Also, the Group has no ability under the guidance in IFRIC 14 to anticipate a reduction in the level of future contributions for ongoing services from those currently being paid. In addition, the Group currently has a committed five-year deficit funding arrangement in place as agreed with the Trustees of PSPS following the last triennial valuation of PSPS as at 5 April 2005.

The asset and liabilities of PSPS are unaffected by the impact of the change in accounting policy. PSPS is managed on an economic basis for the longer-term benefit of its current and deferred pensioners and active members. The surplus in PSPS is available to absorb future adverse asset value movements and, if required, strengthening in mortality assumptions. The fluctuating nature of the surplus is demonstrated by the increase in the underlying gross surplus from £528 million at 31 December 2007 to £728 million at 31 December 2008.

 

 

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The summary effect of the adoption of IFRIC 14

In respect of the position at 31 December 2008, the Group has not recognised the underlying PSPS pension surplus of £728 million (£615 million net of deferred tax), reflecting the difference between the market value of the scheme assets and the discounted value of the liabilities, which would have otherwise been recognised as an asset on its balance sheet under the previous policy. In addition, the Group has recognised a liability for deficit funding to 5 April 2010 of £65 million (£55 million net of deferred tax) in respect of PSPS.  The amounts attributable to shareholders are £223 million (£160 million net of deferred tax) for the surplus not recognised as an asset and £20 million (£15 million net of deferred tax) for the additional liability for deficit funding. In total the impact on shareholders’ equity at 31 December 2008 is a reduction of £175 million as shown below.

The 2007 comparative figures in these statutory basis results have been adjusted accordingly for the adoption of IFRIC 14.

The effect of the change on the consolidated income statement, earnings per share and consolidated balance sheet are as follows:

	Adjustments incorporated in the results		Adjustments made to the previously published results
Consolidated Income Statement	2008 £m			2007 £m
	Increase (decrease) in profit
Investment return	47			4
Benefit and claims and movement in unallocated surplus of with-profits funds	66			205
Other operating expenditure	(173	)		(336	)
(Loss) profit before tax (being tax attributable to shareholders’ and the policyholders’ returns)	(60	)		(127	)
Tax attributable to policyholders’ returns	11			24
(Loss) profit before tax attributable to shareholders	(49	)		(103	)
Tax attributable to shareholders’ (loss) profit	13			28
Loss from continuing operations after tax / loss for the year	(36	)		(75	)
Earnings per share	Decrease in earning per share (in pence)
Basic and diluted based on (loss) profit from continuing operations attributable to equity holders of the company	(1.5	)p		(3.1	)p
Consolidated balance sheet	Increase (decrease) in shareholders’ equity
	£m			£m
Deferred tax assets	10			26
Other debtors	(625	)		(388	)
Policyholders liability – contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4)	(103	)		(140	)
Unallocated surplus of with-profits funds	495			392
Deferred tax liabilities	113			73
Provisions	(65	)		(102	)
Shareholders’ equity	(175	)		(139	)

Effect on the Group’s supplementary analysis of (loss) profit and movements in shareholders’ equity:

		2008												2007
		Previous basis				Effect of adoption of IFRIC 14				Revised basis				As previously published				Effect of adoption of IFRIC 14				After change
			£m				£m				£m				£m				£m				£m
Operating profit based on longer-term investment returns			1,371				(24	)			1,347				1,213				(12	)			1,201
Short-term fluctuations in investment returns on shareholder-backed business			(1,783	)			–				(1,783	)			(137	)			–				(137	)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes			11				(25	)			(14	)			90				(91	)			(1	)
(Loss) profit before tax			(401	)			(49	)			(450	)			1,166				(103	)			1,063
Tax			46				13				59				(382	)			28				(354	)
(Loss) profit after tax			(355	)			(36	)			(391	)			784				(75	)			709
Profits from discontinued operations			–				–				–				241				–				241
Less minority interests			(5	)			–				(5	)			(3	)			–				(3	)
(Loss) profit for the year			(360	)			(36	)			(396	)			1,022				(75	)			947
Other movements in reserves			(608	)			–				(608	)			(309	)			–				(309	)
Shareholders’ equity at the beginning of the year			6,201				(139	)			6,062				5,488				(64	)			5,424
Shareholders’ equity at the end of the year			5,233				(175	)			5,058				6,201				(139	)			6,062

 

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R       Intended sale of legacy agency book and agency force in Taiwan to China Life Insurance of Taiwan

On 20 February 2009, the Company announced that it had entered into an agreement to sell the assets and liabilities of its agency distribution business and its agency force in Taiwan to China Life Insurance Company Ltd of Taiwan for the nominal sum of NT$1 subject to regulatory approval.  In addition, the Company will invest £45 million to purchase a 9.95 per cent stake in China Life through a share placement.  The business to be transferred represents 94 per cent of Prudential’s’ in-force liabilities in Taiwan and includes Prudential’s legacy interest rate guaranteed products with IFRS basis gross assets at 31 December 2008 of £4.5 billion.

After taking account of IFRS shareholders’ funds of the business at 31 December 2008 and restructuring and other costs the Group’s IFRS shareholders’ funds are expected to decrease by approximately £595 million.  In addition, on completion, there will be a net increase in the Company’s Insurance Group’s Directive surplus of approximately £800 million.

The movement in shareholders’ IFRS equity for the total Taiwan life business for 2008 comprised:

			£m
Operating profit based on longer-term investment returns			60
Short-term fluctuations in investment returns			(65	)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes			(3	)
Loss before tax			(8	)
Total tax			(8	)
Loss for the financial year			(16	)
Minority interests			0
Investments by Parent Company (note (ii))			93
Exchange and other reserve movements			111
Net movement			188
Equity brought forward at 1 January 2008			289
Equity carried forward at 31 December 2008 (note(i))			477

(i)

The carrying value of the IFRS equity reflects the application of ‘grandfathered’ US GAAP under IFRS 4.  This does not, and is not designed to include the cost of holding economic capital, to support the legacy interest rate guaranteed products as recognised for reporting under the Company’s supplementary reporting basis under European Embedded Value principles.

(ii)	Comprising £66 million for solvency capital and £27 million for business development.

S      Deferred acquisition costs and other intangible assets attributable to shareholders.

Significant costs are incurred in connection with acquiring new insurance business. Except for acquisition costs of with-profits contracts of the UK regulated with-profits funds, which are accounted for under the realistic FSA regime, these costs, which vary with, and are primarily related to, the production of new business, are capitalised and amortised against margins in future revenues on the related insurance policies. The recoverability of the asset is measured and the asset is deemed impaired if the projected future margins are less than the carrying value of the asset. To the extent that the future margins differ from those anticipated, then an adjustment to the carrying value of the deferred acquisition cost asset will be necessary.

The deferral and amortisation of acquisition costs is of most relevance to the Group’s results for shareholder-financed long-term business of Jackson and Asian operations. The majority of the UK shareholder-backed business are for individual and group annuity business where the incidence of acquisition costs is negligible.

In the case of Jackson for term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For interest-sensitive business, the key assumption is the long-term spread between the earned rate and the rate credited to policyholders, which is based on the annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual experience is measured by internally developed mortality studies.

 

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Variable annuity contracts written by Jackson may provide for guaranteed minimum death, income, or withdrawal benefit features. In general terms, liabilities for these benefits are accounted for under US GAAP by using estimates of future benefits and fees under best estimate assumptions. For variable annuity business the key assumption is the expected long-term level of equity market returns, which for 2008 and 2007 was 8.4 per cent per annum (net of fund management fees) determined using a mean reversion methodology. Under the mean reversion methodology, projected returns over the next five years are flexed (subject to capping) so that, combined with the actual rates of return for the current and the previous two years the 8.4 per cent rate is maintained. The projected rates of return are capped at no more than 15 per cent for each of the next five years. Further details are explained in note E(ii)(b).

These returns affect the level of future expected profits through their effects on the fee income with consequential impact on the amortisation of deferred acquisition costs as described below and the required level of provision for guaranteed minimum death benefit claims.

For traditional life insurance contracts, provisions for future policy benefits are determined under SFAS 60 using the net level premium method and assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviation.

Except to the extent of mortality experience, which primarily affects profits through variations in claim payments and the guaranteed minimum death benefit reserves, the profits of Jackson are relatively insensitive to changes in insurance risk.

The deferred acquisition costs and other intangible assets attributable to shareholders comprise:

			2008 £m				2007 £m
Deferred acquisition costs relating to insurance and investment management contracts			5,205				2,757
Present value of acquired in-force business and distribution rights			144				79
			5,349				2,836
Arising in:
UK insurance operations			134				157
US insurance operations			3,962				1,928
Asia insurance operations			1,247				745
Asset management operations			6				6
			5,349				2,836

The movement in the year comprises:

			2008 £m				2007 £m
Balance at 1 January			2,836				2,497
Additions			959				717
Amortisation to income statement			(551	)			(424	)
Exchange differences			1,035				(42	)
Change in shadow DAC (note E(ii)(b))			1,070				88
Balance at 31 December			5,349				2,836

T       Group Investments and other supplementary information

As for 2007 year-end reporting, the Company has published documents alongside the Company’s preliminary announcement for the year ended 31 December 2008, entitled ‘Group Investments – IFRS disclosures from the 2008 Annual Report’ and ‘supplementary information’. These documents include detailed analysis and explanation of the information contained the Group’s financial statements for the year ended 31 December 2008 on the Group’s investments and some additional unaudited information. The documents have been posted to the Company’s website address at www.prudential.co.uk

 

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		2008 £m
		Asia				US				UK				Total
Investment spread			38				550				143				731
Asset management fees			53				292				57				402
Net expense margin			(59	)			(192	)			(114	)			(365	)
DAC amortisation (Jackson only)			-				(450	)			-				(450	)
Net insurance margin			259				122				(12	)			369
With-profits business			30				0				395				425
Other			-				84				76				160
Total			321				406				545				1,272
			2007 £m
		Asia				US				UK				Total
Investment spread			36				533				219				788
Asset management fees			38				266				60				364
Net expense margin			(102	)			(186	)			(138	)			(426	)
DAC amortisation (Jackson only)							(286	)							(286	)
Net insurance margin			191				122				9				322
With-profits business			26				0				394				420
Other			-				(5	)			(20	)			(25	)
Total			189				444				524				1,157

 

Unaudited Supplementary Information

 

IFRS basis results - Analysis of life insurance pre-tax IFRS operating profit by driver

Notes

a) This schedule classifies the Group's pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using four broad categories:

i)

Investment spread and asset management fees - This represents profits driven by investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses and profits derived from spread, being the difference between investment income (or premium income in the case of the UK annuities new business) and amounts credited to policyholder accounts.  The table above separately identifies net spread income from net fee income.

ii)

Net expense margin - represents expenses charged to the profit and loss account (excluding those borne by the with-profits fund and those products where earnings are purely protection driven) including amounts relating to movements in deferred acquisition costs, net of any fees or premium loadings related to expenses. Jackson DAC amortisation (net of hedging effects), which is intended to be part of the expense margin, has been separately highlighted in the table above.

iii)

Insurance margin - profits derived from the insurance risks of mortality, morbidity and persistency including fees earned on variable annuity guarantees.

iv)

With-profits business - shareholders' transfer from the with-profits fund in the period.

b) Other represents a mixture of other income and expenses that are not directly allocated to the underlying drivers, including non-recurring items.

c) It has been assumed that operating assumption changes should be included within insurance margin unless another category is more suitable. In 2008 the only item included outside of insurance margin was the operating assumption changes for shareholder annuity business in the UK which was principally driven by changes to the credit default reserving methodology and hence was included within investment spread. No such allocations were made in 2007.

 

 

 

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Analysis of Group pre-tax IFRS operating profit by driver (includes life, asset management and corporate expenses)

IFRS Operating profit
		2008				2007
			£m				£m
Investment spread			731				788
Asset management fees			747				698
Net expense margin			(365	)			(426	)
DAC amortisation (Jackson only)			(450	)			(286	)
Net Insurance margin			369				322
With-profits business			425				420
Other			204				(21	)
Corporate expenses			(314	)			(294	)
Total			1,347				1,201

An analysis of Group pre-tax IFRS operating profit has also been provided and is based on the long-term insurance operations table above with the following additions:

i)

The results of Group asset management operations have been included within asset management fees.

ii)

UK GI commission of £44 million (2007: £4 million) has been included within the other income line.

iii)

Corporate expenses consist of other operating income and expenditure, UK restructuring costs and development costs.

Breakdown of Invested Assets for the Group in £bn

	Total	PAR	Policy	Shareholders
	Group	Funds	Holders
Debt securities	95.2	43.0	6.3	45.9
Equity	62.1	31.8	29.2	1.1
Property Investments	12	9.9	0.7	1.4
Commercial mortgage loans (i)	5.5	0.2	0	5.3
Other Loans	5	2	0.1	2.9
Deposits	7.3	4.8	0.9	1.6
Other Investments	6.3	3.8	0.2	2.3
Total	193.4	95.5	37.4	60.5

Note

(i) Total commercial mortgage loans includes US portfolio of £4.5bn

 

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Shareholder Exposure to Banking sector

Of the £45.9bn total shareholder debt securities, approximately £6bn is exposed to the banking sector. Exposure to Tier 1 hybrid debt amounts to £824 million (UK £366m, US£200m and Other £258m). Of the UK £366m key Tier 1 exposures to UK Banks are Barclays £64m, HSBC £50m, Lloyds Group £91m, RBS £5m and Other £156m.

 

US Commercial Mortgage Loan portfolio – £4.5bn

Breakdown by Property Type –

	%
Industrial	29.5
Multi-Family	21.2
Office	20.6
Retail	17
Hotels	9.9
Other	1.8
	100

Note:

The US commercial mortgage loan portfolio consists of collateralised commercial mortgage loans, the average loan size is £7.5m. The original portfolio is underwritten with an estimated average loan to value of 73%, being the current estimate, which provides significant cushion to withstand substantial declines in value.

Corporate Debt Portfolio

The Corporate Debt Portfolio of £16.5 billion is composed of 7% AAA and AA, 34% A, BBB 51% and BB and below 8%.

 

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RISK FACTORS

A number of factors (risk factors) affect Prudential’s operating results and financial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this report, is not updated, and any forward-looking statements are made subject to the reservations specified below under “Forward-Looking Statements”.

Prudential's businesses are inherently subject to market fluctuations and general economic conditions.

Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Uncertain or negative trends in international economic and investment climates which have adversely affected Prudential’s business and profitability could be repeated, or prolonged, or could worsen. The adverse effects of such trends, including the unprecedented market dislocation across asset classes and geographical markets witnessed since mid-2008, have been and would be felt principally through the following:

·	reduced investment returns, could impair its ability to write significant volumes of new business as a result of market volatility, which would have a negative impact on Prudential’s assets under management and profit;

 

·	higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses, as recently experienced when illiquidity and credit spreads reached all-time highs;

 

·

Prudential in the normal course of business enters into a variety of transactions, including derivative transactions, with counterparties. Failure of any of these counterparties to discharge their obligations, or where adequate collateral is not in place, could have an adverse impact on Prudential’s results; and

 

·

in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain value and estimates of value require substantial elements of judgement, assumptions and estimates (which may change over time).  Increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline.

 

In the United Kingdom, a significant part of Prudential’s shareholders’ profit is related to bonuses for policyholders declared on its with-profits products, which are broadly based on historic and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns. For all lines of business, fluctuations in financial risk factors will affect the Company’s results. In 2008, Prudential has had to operate against a challenging background of unprecedented volatility in capital and equity markets, interest rates and widespread economic uncertainty.

In the United States, fluctuations in interest rates can affect results from Jackson National Life Insurance Company (Jackson), which has a significant spread-based business and where the majority of investments are in fixed-income securities. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates. During 2008, the US financial services industry faced an unprecedented array of challenges: the S&P 500 index fell by 38.5 per cent, government interest rates fell to historic lows, and global markets experienced a significant increase in volatility. In addition, credit markets seized and global credit spreads widened to historic levels. These factors have significantly contributed to the substantial increases in Jackson’s unrealised losses. Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. There could be unforseen market circumstances where the derivatives that it enters into to hedge its market risks may not fully offset its losses, and any cost of the guarantees that remain unhedged will also affect the Company’s results.

For some non unit-linked products, in particular those written in some of the Group’s Asian operations, it may not be possible to hold assets which will provide cash flows to exactly match those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets such as Taiwan where regulated surrender values are set by regulators with reference to the interest rate environment prevailing at time of policy issue. This results in a mismatch due to the duration and uncertainty of the liability cash flows and the lack of sufficient assets of a suitable duration. This residual asset/liability mismatch risk can be managed but not eliminated. Where interest rates in these markets remain lower than interest rates used to calculate surrender values over a sustained period this could have an adverse impact on the Group’s reported profit.

 

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Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses.

Due to the geographical diversity of Prudential’s businesses, it is subject to the risk of exchange rate fluctuations. Prudential’s international operations in the United States and Asia, which represent a significant proportion of operating profit and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon translation of results into pounds sterling. The currency exposure relating to the translation of reported earnings is not separately managed. Consequently, this could impact on the Group’s gearing ratios (defined as debt over debt plus shareholders’ funds). The impact of gains or losses on currency translations is recorded as a component within the statement of changes in equity.

Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates.

Changes in government policy, legislation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. For instance, regulators in jurisdictions in which Prudential operates may change the level of capital required to be held by individual businesses. Also these changes could include possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of the recent interventions by governments in response to global economic conditions, it is widely expected that there will be a substantial increase in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure, and enhanced supervisory powers.

The current EU Insurance Groups Directive (IGD) requires European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the Group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a somewhat higher amount of regulatory capital at the Group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. In addition, changes in the local regulatory environment of countries where this is deemed equivalent to the EU could affect the calculation of the Group’s solvency position. The application of Solvency II, the new European Union solvency framework for insurers, to international groups is still unclear and there is a risk of inconsistent application in different member states which may place Prudential at a competitive disadvantage to other European and non-European financial services groups.

Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event of a failure of a market participant. As a major participant in the majority of its chosen markets, circumstances could arise where Prudential, along with other companies, may be required to make additional material contributions.

The Group's accounts are prepared in accordance with current international financial reporting standards (IFRS) applicable to the insurance industry. The International Accounting Standards Board (IASB) introduced a framework that it described as Phase I that permitted insurers to continue to use the statutory basis of accounting that existed in their jurisdictions prior to January 2005. The IASB has published proposals in its Phase II discussion paper that would introduce significant changes to the statutory reporting of insurance entities that prepare accounts according to IFRS. It is uncertain in what form the proposals in the discussion paper will be taken forward into a definitive IFRS and when such changes might take effect.

European Embedded Value (EEV) basis results are published as supplementary information. The EEV basis is a value based reporting method for Prudential's long-term business which is used by market analysts and which underpins a significant part of the key performance indicators used by the Company's management for both internal and external reporting purposes. In June 2008, in an effort to improve still further the consistency and transparency of embedded value reporting, the Chief Financial Officers’ (CFO) Forum published the initial Market Consistent Embedded Value (MCEV) Principles. The CFO Forum announced on 19 December, 2008, that it would be reviewing the Principles given the current turbulent markets.  They acknowledged that the MCEV principles were designed during a period of relatively stable market conditions and their application could, in turbulent markets, lead to misleading results.  The review may lead to changes to the published MCEV Principles or the issuance of guidance. On completion of this review, Prudential will consider its approach to them. If Prudential adopts the new Principles, this will result in a restatement of reported EEV results and change the reporting basis of future results.

 

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The resolution of several issues affecting the financial services industry could have a negative impact on Prudential’s reported results or on its reputation or on its relations with current and potential customers.

Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the United Kingdom and internationally. This could be a review of business sold in the past under previously acceptable market practices at the time such as the requirement in the United Kingdom to provide redress to certain past purchasers of pension and mortgage endowment policies, changes to the tax regime affecting products and regulatory reviews on products sold and industry practices, including in the latter case businesses it has closed.

Regulators particularly, but not exclusively, in the United States and the United Kingdom are moving towards a regime based on principles-based regulation which brings an element of uncertainty. These regulators are increasingly interested in the approach that product providers use to select third-party distributors. In some case product providers can be held responsible for the deficiencies of third-party distributors.

In the United States, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund, fixed index and variable annuity and insurance product industries. This includes new regulations in respect of the suitability of broker-dealers’ sales of certain products. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.

In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. There is a risk that new requirements are retrospectively applied to sales made prior to their introduction.

Litigation and disputes may adversely affect Prudential’s profitability and financial condition.

Prudential is, and may be in the future, subject to legal actions and disputes in the ordinary course of its insurance, investment management and other business operations. These legal actions and disputes may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provisioned in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s results of operation or cash flows.

Prudential’s businesses are conducted in highly competitive environments with developing demographic trends and Prudential’s continued profitability depends on its management’s ability to respond to these pressures and trends.

The markets for financial services in the United Kingdom, United States and Asia are highly competitive, with several factors affecting Prudential’s ability to sell its products and its continued profitability, including price and yields offered, financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance, historical bonus levels, developing demographic trends and customer appetite for certain savings products. In some of its markets Prudential faces competitors that are larger, have greater financial resources or a greater market share, offer a broader range of products or have higher bonus rates or claims-paying ratios. Further, heightened competition for talented and skilled employees with local experience, particularly in Asia, may limit the Group’s potential to grow its business as quickly as planned.

Within the United Kingdom, Prudential’s principal competitors in the life insurance market include many of the major retail financial services companies including, in particular, Aviva, Legal & General, Lloyds Banking Group and Standard Life.

Jackson’s competitors in the United States include major stock and mutual insurance companies, mutual fund organizations, banks and other financial services companies such as AIG, AXA, Hartford, Lincoln National, MetLife and TIAA-CREF.

In Asia, the Group’s main regional competitors are international financial companies, including AIG, Allianz, AXA, ING and Manulife. In a number of markets, local companies have a very significant market presence.

 

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Prudential believes competition will intensify across all regions in response to consumer demand, technological advances, the impact of consolidation, regulatory actions and other factors. Prudential’s ability to generate an appropriate return depends significantly upon its capacity to anticipate and respond appropriately to these competitive pressures.

Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and hurt its relationships with creditors or trading counterparties.

Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in most of Prudential’s products, and as a result its competitiveness. Changes in methodologies and criteria used by rating agencies could result in downgrades that do not reflect changes in the general economic conditions or Prudential’s financial condition. Downgrades in Prudential’s ratings could have an adverse effect on its ability to market products and retain current policyholders. In addition, the interest rates Prudential pays on its borrowings are affected by its debt credit ratings, which are in place to measure Prudential’s ability to meet its contractual obligations.

Prudential’s long-term senior debt is rated as A2 (stable outlook) by Moody’s, A+ (stable outlook) by Standard & Poor’s and AA– (stable outlook) by Fitch.

Prudential’s short-term debt is rated as P-1 by Moody’s, A-1 by Standard & Poor’s and F1+ by Fitch.

Prudential Assurance Company’s (PAC’s) financial strength is rated Aa1 (rating under review for possible downgrade) by Moody’s, AA+ (negative outlook) by Standard & Poor’s and AA+ (stable outlook) by Fitch.

Adverse experience in the operational risks inherent in Prudential’s business could have a negative impact on its results of operations.

Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential outsources several operations, including in the United Kingdom a significant part of its back office and customer-facing functions as well as a number of IT functions. In turn, Prudential is reliant upon the operational processing performance of its outsourcing partners.

Further, because of the long-term nature of much of Prudential’s business, accurate records have to be maintained for significant periods. Prudential’s systems and processes incorporate controls which are designed to manage and mitigate the operational risks associated with its activities. For example, any weakness in the administration systems or actuarial reserving processes could have an impact on its results of operations during the effective period. Prudential has not experienced or identified any operational risks in its systems or processes during 2008, or which have subsequently caused, or are expected to cause, a significant negative impact on its results of operations.

Adverse experience against the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations.

Prudential needs to make assumptions about a number of factors in determining the pricing of its products and for reporting the results of its long-term business operations. For example, the assumption that Prudential makes about future expected levels of mortality is particularly relevant for its United Kingdom annuity business. In exchange for a premium equal to the capital value of their accumulated pension fund, pension annuity policyholders receive a guaranteed payment, usually monthly, for as long as they are alive. Prudential conducts rigorous research into longevity risk, using data from its substantial annuitant portfolio. As part of its pension annuity pricing and reserving policy, Prudential United Kingdom assumes that current rates of mortality continuously improve over time at levels based on adjusted data from the Continuous Mortality Investigations (CMI) medium cohort table projections (as published by the Institute and Faculty of Actuaries). If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.

A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its United Kingdom annuity business. Prudential’s persistency assumptions reflect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also reflected in the assumption. If actual levels of future persistency are significantly different from those assumed, Prudential’s results of operations could be adversely affected.

 

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In common with other industry participants, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity trends, policy surrender rates, investment performance, unit cost of administration and new business acquisition expense.

As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments.

Prudential’s insurance and investment management operations are generally conducted through direct and indirect subsidiaries. As a holding company, Prudential’s principal sources of funds are dividends from subsidiaries, shareholder-backed funds, the shareholder transfer from Prudential’s long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper. Certain of the subsidiaries are regulated and therefore have restrictions that can limit the payment of dividends, which in some circumstances could limit the Group’s ability to pay dividends to shareholders.

Prudential operates in a number of markets through joint ventures and other arrangements with third parties. These arrangements involve certain risks that Prudential does not face with respect to its consolidated subsidiaries.

Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures. Prudential’s ability to exercise management control over its joint venture operations and its investment in them depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants. Prudential may also face financial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encounters financial difficulty. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could affect Prudential’s results of operations.

Prudential’s Articles of Association contain an exclusive jurisdiction provision.

Under Prudential's Articles of Association, certain legal proceedings may only be brought in the courts of England and Wales. This applies to legal proceedings between a shareholder (in its capacity as such) against Prudential and/or its directors and/or its professional service providers. It also applies to legal proceedings between Prudential and its directors and/or Prudential and Prudential's professional service providers that arise in connection with legal proceedings between the shareholder and such professional service provider. This provision could make it difficult for US and other non-UK shareholders to enforce their shareholder rights.

 

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SIGNATURES

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Date 19 March 2009

 

	PRUDENTIAL PUBLIC LIMITED COMPANY
	By:	/s/  Jon Bunn
		Jon Bunn
		Director of Public Relations

 

 

 

 

 

 

 

 

 

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