Chief Financial
Officer's overview

'That these results have been achieved despite continued macroeconomic headwinds highlights the quality of our businesses across Asia, the US and the UK.'

Signature - Nic Nicandrou

Nic Nicandrou
Chief Financial Officer

Prudential has delivered a strong performance during the first half of 2012 and continued to make progress towards the 2013 'Growth and Cash' financial objectives. This performance was driven by Asia with good contributions from the other business operations set against a tougher macroeconomic and investment market backdrop compared to a year ago.

EEV new business profit ('new business profit') increased by 7 per cent to £1,141 million (2011: £1,069 million), IFRS operating profit based on longer-term investment returns ('IFRS operating profit') increased by 13 per cent to £1,162 million (2011: £1,028 million) and net cash remitted from the business units to the Group increased by 5 per cent to £726 million (2011: £690 million). That these results have been achieved despite continued macroeconomic headwinds highlights the quality of our businesses across Asia, the US and the UK, together with the strength of our balance sheet and our ongoing financial discipline in prioritising value over volume.

Bar chart - APE sales: Half year 2011 £1,824m - Half year 2012 £2,030m +11%

In life insurance, in the first half of 2012, APE sales were up 11 per cent to £2,030 million (2011: £1,824 million) and new business profit has increased by 7 per cent to £1,141 million (2011: £1,069 million), resulting in a new business margin of 56 per cent (2011: 59 per cent). The considerably lower interest rate environment compared to the first half of 2011, has dampened our new business margins by an estimated 6 percentage points. The effect of this on the overall new business profit was more than compensated by higher sales volumes, pricing actions and business mix. The overall new business economics remain robust as we continue to focus on the products and geographies with the most attractive returns and shortest payback periods, maintaining our proactive approach to optimising the balance between value creation and capital utilisation.

Asia delivered APE sales of £899 million (2011: £743 million) and new business profit of £547 million (2011: £465 million), up 21 per cent and 18 per cent respectively on the prior period. The growth in new business profit was driven by Indonesia (up 49 per cent) and Malaysia (up 27 per cent), while sales benefited from strong contributions in Singapore (up 37 per cent), Indonesia (up 30 per cent) and Taiwan (up 49 per cent). Our new business margin has decreased to 61 per cent (2011: 63 per cent), principally reflecting the effect of the interest rate environment on the margins.

56%
New business margin

Jackson produced APE sales of £719 million (2011: £672 million), up 7 per cent on the previous year, and new business profit of £442 million (2011: £458 million) down 3 per cent compared to the prior period. We continue to write new business at aggregate internal rates of return in excess of 20 per cent. At 61 per cent, our new business margin in the US remains above historic norms, although lower than the 68 per cent in the first half of 2011 the result of the significant declines in US Treasury yields since June last year. We remain a top three player in US variable annuities1 and continue to balance value, risk and capital. Jackson continues to adjust pricing and product features to respond to both market conditions and the competitive environment.

Bar chart - IFRS Operating profit based on longer-term investment returns: Half year 2011 £1,028m - Half year 2012 £1,162m +13%

In the UK, total APE sales were up 1 per cent to £412 million (2011: £409 million), and new business profit increased by 4 per cent to £152 million (2011: £146 million). At the retail level, strong growth in sales of individual annuities (up 22 per cent) and with-profits bonds (up 36 per cent) was offset by a decrease in corporate pensions volumes (down 29 per cent), which were exceptionally high in the first half of 2011 due to new members joining existing schemes on closure of a number of defined benefit schemes. The level of bulk annuity activity achieved in the first half of 2012 was in line with the prior year. The UK retail new business margin increased to 34 per cent (2011: 32 per cent), primarily reflecting positive mix impact from growth in higher-margin individual annuities and with-profits bonds, and lower sales of corporate pensions.

Shareholder-backed policyholder liabilities across our life insurance businesses increased to £141.8 billion in the first half of 2012 (31 December 2011: £133.5 billion), primarily reflecting £5.2 billion of net inflows, together with foreign exchange and investment-related movements. This steady growth in the size of our life insurance book of business continues to underscore our forward momentum in life IFRS operating profit.

In asset management, we have delivered £5.4 billion2 of net inflows over the first half of 2012 (2011: £2.9 billion2), with the strong momentum earlier in the year continuing into the second quarter, despite increased volatility in investment markets towards the end of the period. At 30 June 2012, our total funds under management were £363 billion (31 December 2011: £351 billion), of which £114.3 billion (31 December 2011: £111.2 billion) are external assets.

'Our Asia long-term business continues to deliver good levels of growth, with IFRS operating profit of £409 million, up 26 per cent.'

M&G produced £4.9 billion (2011: £2.9 billion) of net inflows in the period (£4.3 billion retail, £0.6 billion institutional), an excellent result given the market backdrop. M&G has ranked number 1 in the UK retail market for gross and net sales over the last 14 consecutive quarters based on data to the end of March 20123, and has recently taken over as the largest player in the UK retail market as measured by funds under management4. At 30 June 2012, M&G had external funds under management of £94.6 billion, 3 per cent higher than at the end of 2011. External funds comprise £48.3 billion (31 December 2011: £44.2 billion) of retail and £46.3 billion (31 December 2011: £47.7 billion) of institutional assets. Adding these funds to internal amounts, M&G's total funds under management were £204 billion. Eastspring Investments reported retail and institutional net inflows of £426 million2 in the first half of 2012 (2011: £nil). At 30 June 2012, Eastspring Investments had £53.8 billion of funds under management (31 December 2011: £50.3 billion), of which £19.6 billion (31 December 2011: £19.2 billion) were external assets.

Notes

  1. Sources: Morningstar Annuity Research Center (MARC) First Quarter 2012 Sales Report© and Fourth Quarter 2011 Sales Report©. © Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
  2. Excludes Asia Money Market Fund (MMF).
  3. Source: Fundscape. (Q1 issue, May 2012). The Pridham Report. Fundscape LLP.
  4. Source: IMA (June 2012, data as at May 2012).
  5. The Group has adopted altered US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied, as described in note B to the IFRS financial statements.

'The strength of the UK with-profits funds, which currently have a surplus estate of £6.1 billion, offers strong policyholder protection and assists in generating positive returns for both policyholders and shareholders.'

Group IFRS operating profit increased by 13 per cent to £1,162 million in the first half of 2012 (2011: £1,028 million), driven by strong growth in Asia and the US and a robust performance in the UK and M&G. Group EEV operating profit based on longer-term investment returns ('EEV operating profit') decreased by 2 per cent to £2,109 million (2011: £2,147 million), as the negative low interest rate effect on our life in-force profitability was largely compensated by the positive effect of new business flows. The contribution to these metrics from each business operation and each source remains well balanced, preserving both the quality and the resilience of the Group's earnings.

Our Asia long-term business continues to deliver good levels of growth, with IFRS operating profit of £409 million (2011: £324 million) up 26 per cent. The strong performance has been driven by significantly increased contributions from Indonesia, Singapore and Hong Kong, which together with Malaysia account for approximately 80 per cent of the Asia total. We continue to see attractive opportunities to build our industry-leading distribution capability across South-east Asia while maintaining good penetration of high margin health and protection insurance. Asia's long-term EEV operating profit, a measure of the economic value creation in the year, grew by 13 per cent in the first half of 2012 to £872 million (2011: £774 million) further underlining the creation of sustainable value across these operations.

In the US, long-term business IFRS operating profit was up 30 per cent in the first half of 2012 to £442 million (2011: £340 million). This increase primarily reflects higher fee income and the expected non-recurring impact of accelerated deferred acquisition cost (DAC) amortisation of £66 million in 2011, the benefit of which was partly offset by the adverse effect on spread income of lower bond yields. Fee income increased by 25 per cent to £408 million in the first half of 2012 (2011: £327 million) as a result of growth in separate account asset balances which stood at £44 billion at 30 June 2012 (31 December 2011: £38 billion). Spread income (including the expected return on shareholders' assets) was £384 million in the first half of 2012 (2011: £416 million), with lower yields reducing the average spread margin that we earned on general account liabilities from 262 basis points in the first half of 2011 to 238 basis points in the first half of 2012. The general account closed the period with policyholder liabilities of £32 billion (31 December 2011: £31 billion). Jackson's long-term EEV operating profit decreased by 3 per cent to £805 million (2011: £831 million) driven by lower new and in-force business profits due to the decline in interest rates and a lower contribution from operating experience variances. The recently announced acquisition of REALIC will complete after 30 June and is therefore not included in the first half results. However, as previously disclosed, we expect the transaction to be accretive to IFRS and EEV earnings immediately, with accretion to Jackson's IFRS pre-tax profit estimated at £100 million in the first year.

In the UK, long-term business IFRS operating profit was also higher at £336 million (2011: £332 million) including £190 million from the shareholder-backed business. The strength of the with-profits funds, which currently have a surplus estate of £6.1 billion, offers strong policyholder protection and assists in generating positive returns for both policyholders and shareholders. EEV long-term operating earnings reduced by 9 per cent in the first half of 2012 to £490 million (2011: £537 million), principally due to the impact of lower interest rates on the recognition of in-force profits.

The asset management business generated IFRS operating profit of £250 million in the first half of 2012 (2011: £259 million). M&G (including Prudential Capital) IFRS operating profit at £199 million, was in line with the prior year, with the positive impact of additional inflows muted by lower average market levels in the first half of 2012. Eastspring Investments IFRS operating profit of £34 million (2011: £43 million) was also impacted by lower average margins on funds under management following a shift in business mix together with increased staff costs as the business continues to invest in growth opportunities.

'In the first half of 2012 we have continued to produce significant amounts of free capital, which we measure as free surplus generated.'

We continue to promote disciplined use of our capital resources across the Group, and focus on allocating capital to the growth opportunities that offer the most attractive returns with the shortest payback periods. We have taken several important steps over the last few years to improve the efficiency and effectiveness of the capital allocation process, which has improved not only our returns on capital invested but also our capital strength and capital fungibility. In the first half of 2012, we have continued to produce significant amounts of free capital, which we measure as free surplus generated.

In the first six months of 2012, we generated £1,403 million of underlying free surplus (before reinvestment in new business) from our life in-force and asset management businesses. This is slightly higher than the £1,390 million generated in the first half of 2011, which benefited from a one-off credit of £33 million arising from a reduction in the liabilities of the Group's pension schemes following the UK government's decision to change the basis of indexation from Retail Price Index (RPI) to Commercial Price Index (CPI) for future statutory increases to pension payments. We reinvested £364 million of the free surplus generated in the period into writing new business (2011: £297 million). This represents a capital reinvestment rate of 26 per cent which is trending back towards the 2010 norms. A favourable business mix, together with other one-off factors, meant that 2011 had a lower reinvestment rate of 21 per cent.

'Despite the challenging investment market conditions our liquidity capital generation and solvency have continued to show resilience due to our on-going capital discipline, the effectiveness of our hedging activities, our low direct Eurozone exposure, the minimal level of impairments and our comparatively low interest rate sensitivity.'

Asia accounted for £162 million of this reinvestment. In the US, new business investment has increased to £180 million from £135 million in the first half of 2011, which primarily reflects the higher level of new business written, changes in business mix, and the impact on regulatory reserving requirements for new business from the low interest rate environment. In the UK, our capital efficient product focus on annuities and with-profits bonds means we invested just £22 million yet generated higher new business profit than last year. The IRRs on this invested capital were more than 20 per cent in Asia, the US, and the UK; with payback periods of four years, two years and three years respectively.

Of the remaining free surplus generated after reinvestment in new business, £726 million was remitted from the business units to Group. This cash was used to meet central costs of £101 million, service net interest payments of £136 million and meet dividend payments of £440 million. The total free surplus balance deployed across our life and asset management operations increased slightly from £3,421 million at the beginning of the period to £3,449 million at the end of the period.

'It is testament to the quality of Jackson's post-financial crisis expansion in variable annuities that it has remitted cash of £247 million while continuing to grow the business.'

The following discussion contains forward-looking statements that involve inherent risks and uncertainties. Prudential's actual future financial condition or performance or other indicated results may differ materially from those indicated in any such forward-looking statement due to a number of important factors (including those discussed under the heading 'Risk factors' in this document). See the discussion under the heading 'Forward-looking statements' at the end of this report.

At our 2010 investor conference entitled 'Growth and Cash' we announced new financial objectives demonstrating our confidence in continued rapid growth in Asia, and increasing levels of cash remittances from all of our businesses. These objectives were defined as follows:

  1. Asia growth and profitability objectives1:

    To double the 2009 value of IFRS life and asset management pre-tax operating profit in 2013 (2009: £465 million); and

    To double the 2009 value of new business profits in 2013 (2009: £713 million).

  2. Business unit cash remittance objectives1:

    Asia to deliver £300 million of net cash remittance to the Group in 2013 (2009: £40 million);

    Jackson to deliver £200 million of net cash remittance to the Group in 2013 (2009: £39 million); and

    UK to deliver £350 million of net cash remittance to the Group in 2013 (2009: £284 million2).

  3. Cumulative net cash remittances1:

    All business units in aggregate to deliver cumulative net cash remittances of at least £3.8 billion over the period 2010 to end-2013. These net remittances are to be underpinned by a targeted level of cumulative underlying free surplus generation of £6.5 billion over the same period.

As mentioned in the Group Chief Executive's report we remain focused on these objectives and are on track to achieve them. Below we set out in more detail our progress towards these objectives based on our results in the first six months of 2012.

Asia profitability objectives

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Actual (as originally reported) Objective
2009
£m
2010
£m
2011
£m
Half year
2012
£m
Change
(since half year 2011)
%
Change
(since 2009)
%
2013
£m
Value of new business              
Full year 713 901 1,076     51 1,426
Half year 277 395 465 547 18 97  
IFRS operating profit*              
Full year 465 604 784     69 930
Half year 228 295 367 440 20 93  

Business unit net remittance objectives

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Actual Objective
2009
£m
2010
£m
2011
£m
Half year
2012
£m
    2013
£m
Asia 40 233 206 126     300
Jackson 39 80 322 247     200
UK§ 434 420 297 230     350
M&G 175 202 280 123      
Full year 688 935 1,105        
Half year 375 460 690 726      

Objectives for cumulative period 1 January 2010 to 31 December 2013

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Actual Objective Percentage achieved
1 Jan 2010
to 30 Jun
2012
£m
1 Jan 2010
to 31 Dec
2013
£m
At 30 Jun
2012
%
Cumulative net cash remittances from 2010 onwards 2,766 3,800 73
Cumulative underlying Group free surplus generation (which is net of investment in new business) 4,736 6,500 73
 

In the first half of 2012, cash remitted to the Group increased by 5 per cent to £726 million (2011: £690 million), with considerable amounts of cash remitted from all our business operations highlighting the improving balance of contributions from across the Group. Asia's remittances increased 20 per cent to £126 million (2011: £105 million), demonstrating its ongoing transition into a highly cash generative business as a result of significant growth and its focus on health and protection products. It is testament to the quality of Jackson's post-financial crisis expansion in variable annuities that it has remitted cash of £247 million while continuing to grow the business. The REALIC acquisition will be financed by Jackson's internal resources and the positive impact of this financially attractive acquisition will enable Jackson to increase its net remittance objective for Group from £200 million to £260 million in 2013 and beyond. The UK life operations have continued to make sizeable remittances at £230 million (2011: £265 million). M&G (including Prudential Capital) delivered net remittances of £123 million, reflecting their 'capital-lite' business model that facilitates a high dividend payout ratio from earnings.

Against the cumulative 2010 to 2013 net remittance objective of £3.8 billion, by 30 June 2012 over £2.7 billion has been remitted by business operations. We remain confident of achieving this target. Our confidence is underpinned by the strong underlying free surplus generation of our businesses which, by 30 June 2012, had generated a total of £4.7 billion against our 2010 to 2013 cumulative objective of £6.5 billion.

Notes

  1. The objectives assume current exchange rates and a normalised economic environment consistent with the economic assumptions made by Prudential in calculating the EEV basis supplementary information for the half year ended 30 June 2010. They have been prepared using current solvency rules and do not pre-judge the outcome of Solvency II, which remains uncertain.
  2. Representing the underlying remittances excluding the £150 million impact of proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis.
  • * Total Asia operating profit from long-term business and Eastspring Investments after development costs. The comparatives represent results as reported in the respective periods and excludes adjustment for altered US GAAP requirements for deferred acquisition costs as described in note B to the IFRS financial statements.
  • † Net remittances from Asia in 2010 included a one-off remittance of £130 million, representing the accumulation of historic distributable reserves.
  • ‡ Net remittances from Jackson in 2011 included releases of excess surplus to Group.
  • § In 2009, the net remittances from the UK included the £150 million arising from the proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis. The 2010 net remittances included an amount of £120 million representing the releases of surplus and net financing payments.
  • ¶ Including Prudential Capital.

'The Group has maintained a strong capital position. At 30 June 2012, our IGD surplus is estimated at £4.2 billion, generating very strong coverage of 2.7 times the requirement.'

Despite the challenging investment market conditions, our liquidity, capital generation and solvency have continued to show resilience due to our ongoing capital discipline, the effectiveness of our hedging activities, our low direct Eurozone exposure, the minimal level of impairments and our comparatively low interest rate sensitivity.

The Group has maintained a strong capital position. At 30 June 2012, our IGD surplus is estimated at £4.2 billion (31 December 2011: £4.0 billion), generating very strong coverage of 2.7 times the requirement. All of our subsidiaries continue to hold strong capital positions at the local regulatory level. In particular, at 30 June 2012, the value of the estate of our UK with-profit funds is estimated at £6.1 billion (31 December 2011: £6.1 billion).

Furthermore, on a statutory (Pillar 1) basis the total credit default reserve for the UK shareholder annuity funds also contributes to protecting our capital position in excess of the IGD surplus. Notwithstanding the absence of defaults in the period, at 30 June 2012 we have maintained our credit default reserves at £2.1 billion, representing 35 per cent of the portfolio spread over swaps, compared with 33 per cent at 31 December 2011.

Solvency II, which is currently anticipated to be effective from 1 January 2014, represents a major overhaul of the capital adequacy regime for European insurers. We are supportive in principle of the development of a more risk-based approach to capital, but we have concerns as to the potential consequences of some aspects of the Solvency II regime under consideration. With the continued delays to policy development, the final outcome of Solvency II remains uncertain. Despite this uncertainty we remain focused on preparing for implementation of the new regime.

Our financing and liquidity position remained strong throughout the period. The next call on external financing is in relation to the US$750 million of Perpetual Subordinated Capital Securities, where the option to redeem early is exercisable from December 2014. Our central cash resources amounted to £1.2 billion at 30 June 2012, a strong position.

We continue to engage with rating agencies in order to provide insurance financial strength ratings for the Group's insurance operations. Prudential's senior debt is currently rated A+ by Standard & Poor's, A2 by Moody's and A by Fitch.

During the first six months of 2012, investment markets experienced considerable volatility with flat to moderate positive movements in global equity market indices over the period and further falls in long-term interest rates in the US, the UK and a number of Asian countries, most notably Hong Kong. Despite these effects the Group's EEV shareholders' funds increased by 5 per cent during the first half of 2012 to £20.6 billion (31 December 2011: £19.6 billion). On a per share basis EEV at the end of 30 June 2012 stood at 806 pence, up from 771 pence at 31 December 2011. IFRS shareholders' funds were 8 per cent higher at £9.3 billion (31 December 2011: £8.6 billion).

The increases in shareholders' funds on both reporting bases are the result of the Group's strong performance, partially offset by the relatively muted effect of the investment markets on the business, reflecting both the quality of the asset portfolio and the effectiveness of our proactive approach to risk management.

 
 

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