14 Nov 2012

Prudential plc Third Quarter 2012 Interim Management Statement

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Prudential plc Third Quarter 2012 Interim Management Statement

PRUDENTIAL PLC THIRD QUARTER 2012 INTERIM MANAGEMENT STATEMENT

• PRUDENTIAL DELIVERS STRONG PERFORMANCE WITH YEAR-TO-DATE NEW BUSINESS PROFIT UP 13 PER CENT TO £1.7 BILLION AND SALES UP 14 PER CENT TO £3.1 BILLION IN A CHALLENGING ENVIRONMENT
• ASIA YEAR-TO-DATE NEW BUSINESS PROFIT UP 15 PER CENT TO £828 MILLION DRIVEN BY SOUTH-EAST ASIA
• US YEAR-TO-DATE NEW BUSINESS PROFIT UP 10 PER CENT TO £683 MILLION WITH CONTINUED FOCUS ON PRICING DISCIPLINE
• UK YEAR-TO-DATE NEW BUSINESS PROFIT UP 17 PER CENT TO £227 MILLION REFLECTING PRODUCT MIX
• ASSET MANAGEMENT YEAR-TO-DATE NET INFLOWS AT £12.3 BILLION LED BY A RECORD PERFORMANCE FROM M&G
• RESILIENT BALANCE SHEET; IGD SURPLUS ESTIMATED AT £4.1 BILLION

Tidjane Thiam, Group Chief Executive, said:

“Prudential has continued to perform strongly in the third quarter of 2012 in a global macroeconomic environment that remains turbulent.

“We are in the right markets, with the right business models and continue to make good progress across our businesses and chosen markets. We have increased new business profit, our preferred growth metric, for 13 consecutive quarters year-on-year since the third quarter of 2009. In the third quarter, Group new business profit grew by 28 per cent year-on-year with Group APE sales increasing by 19 per cent, with all businesses contributing to this performance.

"In Asia, year-to-date new business profit increased by 15 per cent and 23 per cent on a ‘like-for-like’5 basis and APE sales grew by 16 per cent. In the discrete third quarter, new business profit grew by 11 per cent (16 per cent on a ‘like-for-like’ basis5) while APE grew by 6 per cent. We took a number of initiatives in the third quarter to manage our business mix proactively, giving up volume for value. In North Asia (Korea, Taiwan) we have taken decisive action not to provide capital-intensive guaranteed products, driving down APE by 26 per cent. In Malaysia, we have refocused the business on higher-value, lower-volume protection business, driving a 20 per cent fall in APE. Outside these three markets, APE growth in the discrete third quarter was strong at 19 per cent.

"We have seen these trends continue in October with 16 per cent APE growth for Asia. Overall, our powerful multi-channel distribution platform, our continued focus on health and protection products and our geographic diversification position us well to continue to grow profitably and with discipline in the most attractive Asian markets.

"In the US we continue to balance cash and capital generation, sales volumes, risk and earnings to deliver value and maintain internal rates of return in excess of our hurdle rates. In the first nine months, Jackson has achieved a 10 per cent increase in new business profit to £683 million, with APE up 15 per cent to £1,133 million.

"In the third quarter, we have seen very strong variable annuity sales levels as a result of high consumer demand, moving us close to our annual risk appetite earlier than expected. Therefore, we have taken proactive steps to limit sales of guaranteed variable annuities and we expect total sales of these products to be between $18 billion and $18.5 billion for 2012. This will ensure we achieve adequate diversification by vintage, which enables us to perform well across economic and market cycles. We continue to see robust sales growth in our non-guaranteed Elite Access product for which we have a strong appetite, given its characteristics.

“In the UK we delivered new business profit of £227 million in the first nine months of 2012, up 17 per cent. We have delivered year-to-date growth in retail sales, with new business profits up 11 per cent. In our chosen markets in the UK, we generate internal rates of return that are commensurate with those that we are achieving in the other parts of the Group.

"Asset management has recorded net inflows of £12.3 billion, led by M&G. This is our best-ever performance at the nine-month stage, surpassing the historically high level of net inflows achieved in 2009. M&G has benefited from its strong investment performance and broad range of attractive funds across asset classes as retail investors, particularly those in continental Europe, are starting to invest again after a period of extreme risk aversion observed in 2011.

"Our balance sheet and capital position continue to be strong, with our estimated IGD surplus at the end of the third quarter at £4.1 billion.

“The global macroeconomic environment remains challenging, with persistently low government bond yields and recently we have also seen the IMF downgrade global growth forecasts6. Although we remain defensively positioned, we are focused on the long-term profitable growth opportunities available to us, particularly in South-east Asia.

"The recently announced acquisition of Thanachart Life and 15-year exclusive bancassurance agreement with Thanachart Bank in Thailand builds scale in a key target market for us with access to 865 branches across all our partnerships, making this the fourth-largest branch network in a country of 65 million people. This highlights our confidence in the longer-term profitable growth prospects in Asia.

"We are making progress towards the ‘Growth and Cash’ objectives we set ourselves for 2013 and remain on track to achieve these objectives, despite the considerable macroeconomic headwinds we face. We are well positioned to grow profitably over the long term and to create value for our shareholders.”

1. Q3 2012 Business Unit financial highlights

1.1 Asia Insurance operations

Profitable growth prospects for Asia’s life insurance markets remain compelling given the sustained expansion of the middle classes in the region and the low penetration rates for long-term savings and protection products. However, we anticipate that industry growth rates may fluctuate in the short-term as the outlook for global economic growth softened during the third quarter driven by contracting economic activity in Europe and more modest growth than expected in the United States. This impacts some of Asia’s economies to a degree in terms of trade opportunities and can undermine household confidence particularly in savings and investments that are directly linked to volatile markets. These negative trends are mitigated by the emphasis put by a number of governments on growing their domestic demand, reducing the dependency of their economies on external markets and making them more resilient across the global economic cycle.

Our strategy of expanding quality, multichannel distribution with an emphasis on regular premium policies and a focus on covering the health and protection needs of the emerging middle class across the region positions us to continue to grow profitably, well into the future.

Despite the challenge of low interest rates, new business profits for the nine months of 2012 (calculated using active assumptions) grew to £828 million which equates to a margin of 62 per cent, 1 percentage point lower year-on-year. The net impact of active assumptions, which reflect lower government bond yields as at 30 September 2012, was to reduce new business profits by £53 million compared to the end of September 2011, with this fall being mostly offset by a focus on higher margin products and a favourable geographic mix. The reported new business profit growth of 15 per cent in the nine month period equates to 23 per cent on a ‘like for like’11 basis.

Our geographic diversification remains a key strength, enabling us to deliver continued profitable growth from the region as a whole. Year-to-date APE of £1,328 million has increased by 16 per cent relative to last year mainly led by strong growth in the South Asian markets of Indonesia, Singapore and Hong Kong. Prudential’s third quarter APE of £429 million was 6 per cent higher than the third quarter last year as continuing strong growth in Indonesia (up 20 per cent), Singapore (up 27 per cent) and Hong Kong (up 23 per cent) was partially offset by our decision not to provide low margin guaranteed products in Taiwan (down 33 per cent) and Korea (down 15 per cent) and to refocus Malaysia (down 20 per cent) on protection business which is lower premium but higher value. Excluding those three markets where we deliberately and proactively gave up volume for value, our APE growth for the discrete third quarter was 19 per cent. We have seen continued momentum in October with APE up 16 per cent for Asia.

The APE growth for South-east Asian markets in the first nine months of 2012 has been achieved profitably. In Indonesia, Hong Kong and Singapore, new business profit grew by 19 per cent in aggregate year-to-date and by 37 per cent in our nascent markets of Thailand, Vietnam and the Philippines. In the discrete third quarter new business profits for these six South-east Asian markets grew by 21 per cent.

Prudential is a leading regional life insurer with both material agency and bank distribution. During this year we have seen a strong increase in new business volumes from our bank partners as we continue to deepen our long-term relationships with partners that include United Overseas Bank (UOB) and Standard Chartered Bank (SCB). The proportion of APE from this channel has increased to 35 per cent year-to-date in 2012 compared to 30 per cent for the prior period. In our agency channel, we continue to focus on enhancing activity levels and agent productivity. The number of average active agents, excluding India, has increased by 13 per cent year-on-year with 59 per cent of APE being derived from this channel. India’s agency force continues to be restructured following the regulatory changes that came into effect on 1 September 2010.

Regular premium policies generated 92 per cent of APE during the first nine months of 2012 compared to 90 per cent during the same period last year. APE from health and protection products grew by 19 per cent to £410 million in the year-to-date as we focussed on these higher value products. The product mix for the nine month period was protection at 31 per cent, participating business at 34 per cent and unit-linked at 29 per cent (2011: 30 per cent, 33 per cent and 32 per cent respectively).

Net insurance flows for Asia (excluding India) remain strongly positive for both the third quarter and the year-to-date driven by new business flows and the continued growth of the in-force book. Third quarter outflows arising from surrenders and partial withdrawals relating to shareholder-backed business are at a similar run-rate to both the first half of 2012 and the equivalent quarter last year, when expressed as a percentage of opening liabilities.

Indonesia is becoming one of Asia’s largest and fastest growing economies and Prudential continues to be a leader in the Indonesian life insurance market. We are continuing to deliver record levels of new business with year-to-date growth of 27 per cent primarily driven by the expansion and productivity improvements in our agency force. Our recruiting, training and licensing process continues to be effective and has driven a 26 per cent increase in average active manpower over the year. We are also seeing excellent results from our rapidly developing bank channel where APE is up 74 per cent over the prior year.

Hong Kong has delivered a strong performance year-to-date with APE up 19 per cent. Prudential remains the only leading player in Hong Kong to have material agency and bank distribution channels and both have made positive contributions. The insurance specialists working with SCB have delivered increased referrals and higher case sizes and we have also grown the size of our tied agency and increased average case sizes.

Singapore continues to perform well. The bancassurance channel is growing at a faster rate than agency as each of our major and exclusive partners (SCB, UOB, Singpost and Maybank) delivered growth rates in excess of 40 per cent. Our agency channel continues to grow with sales up 9 per cent principally driven by improvements in agent productivity.

In Malaysia we have taken the decision to de-emphasise high premium, but lower value, top-ups to linked polices and endowment products and to increase focus on protection. The proportion of year-to-date sales of protection business has increased by 13 percentage points over 2011. This focus on higher margin products is already bearing fruit with new business profits up 10 per cent year-to-date offsetting the impact of falling volumes. Although currently small relative to agency, our bank distribution in Malaysia is growing strongly, up 68 per cent compared to last year.

Prudential’s other operations comprise the Philippines, Thailand and Vietnam with new business APE sales increasing by 27 per cent in the first nine months of 2012. The Philippines and Thailand have grown strongly, while Vietnam’s performance has been broadly flat as the economy faces challenges. The recently announced acquisition and a fifteen year exclusive bancassurance agreement with Thanachart in Thailand enables us to double our market share and significantly enhances our growth opportunities in the country. The transaction is expected to complete in the first quarter of 2013.

The life insurance market in China remains challenging due to macroeconomic pressures and regulatory changes implemented earlier this year that impacted the bank channel. However, we have seen some signs of stabilisation and the APE for the third quarter of £13 million is 18 per cent higher than the third quarter last year.

In India, the economic environment has become more challenging and the volatile equity markets have not been conducive to higher agency activity levels. The marked depreciation of the Indian rupee relative to the pound has also depressed the reported results; on a local currency basis year-to-date APE growth is 17 per cent, while APE in the discrete third quarter is in line with the prior period. Sales of regular premium products remain robust with year-to-date APE on a constant currency basis up 32 per cent on 2011. Regular premium APE increased to 93 per cent of APE in 2012 (2011: 84 per cent).

Our business in Korea continues to concentrate on high-quality proprietary distribution and regular premium unit-linked business. We have chosen not to compete in the market for capital-intensive guaranteed return products, particularly in the bank channel. Agency production has remained in line with the prior period with the effect of increased manpower being offset by the average case sizes which have declined due to the current economic climate.

Taiwan is now successfully focused on bank distribution principally with partners E.Sun and Standard Chartered Bank. New business APE in the third quarter declined sharply relative to prior year (down 33 per cent) given our decision not to compete in the market for low margin interest rate sensitive products.

1.2 US operations

Insurance operations

Jackson continues to focus on managing the balance between earnings, sales, capital efficiency, balance sheet strength through strict pricing discipline for both variable and fixed annuities. Thanks to its financial stability and innovative products, Jackson continues to enhance its reputation as a high-quality and reliable business partner, with more advisers recognising the benefits of working with Jackson.

Jackson delivered APE retail sales of £1,105 million in the first nine months of 2012, representing a 14 per cent increase over the same period in 2011. In addition, with modest institutional sales in 2012, total APE sales were £1,133 million. Jackson has achieved these sales levels while maintaining its pricing discipline, as it continued to write new business at aggregate internal rates of return in excess of its hurdle rates.

New business profit, our preferred growth metric, was £683 million in the first nine months of 2012, 10 per cent higher than the same period in 2011 driven by higher sales volumes. The overall margin was 60 per cent for the first nine months of 2012, compared to 63 per cent for the same period in 2011. The combination of a reduction in the 10 year Treasury yields and spread compression has caused a 6 point drag on the margin relative to the same period in 2011. Pricing actions and proactive management of the business mix have partially mitigated this reduction. Notwithstanding the negative impact of lower interest rates, the overall profitability remains robust. Variable annuity margins, although lower, remain high relative to historical levels at 65 per cent for 2012 (2011: 67 per cent).

Total retail annuity net flows were £7.0 billion for the first nine months of 2012, reflecting a £1.3 billion increase over the same period in 2011. Annuity net flows in 2012 benefited from net flows of £400 million from Elite Access, a variable annuity product launched in March 2012, which has no guaranteed benefits and provides tax efficient access to alternative investments. At the end of the period Jackson’s separate account assets totalled £47.2 billion and general account assets totalled £38.7 billion; these amounts exclude separate and general account assets relating to the acquisition of Reassure America Life Insurance Company (REALIC).

In the third quarter, we have seen very strong variable annuity sales levels as a result of high consumer demand, moving us close to our annual risk appetite earlier than expected. Therefore, we have taken proactive steps to limit sales of guaranteed variable annuities and we expect total sales of these products to be between $18 billion and $18.5 billion for 2012. This will ensure we achieve adequate diversification by vintage which enables us to perform well across economic and market cycles. We continue to see strong sales growth in our non-guaranteed Elite Access product for which we have a strong appetite, given its characteristics.

Jackson’s hedging programme continues to perform well, mitigating the impact of the significant macroeconomic challenges and supporting our capital position on both an economic and a regulatory basis. Policyholder behaviour in the first nine months of 2012 continued to trend in line with our expectations. We continue to have strong regulatory capital levels.

On 4 September 2012, Jackson completed the acquisition of SRLC America Holding Corp (SRLC) from Swiss Re. SRLC was the U.S. holding company of REALIC. The acquisition helps diversify Jackson’s sources of earnings by increasing the amount of income generated from underwriting activities. REALIC was closed to new business and, therefore this transaction has no impact on APE or new business profit. Jackson has begun integrating REALIC’s book of business and the transaction will be immediately accretive to its pre-tax earnings.

Variable annuity APE sales of £970 million in the first nine months of 2012 were higher than the same period in 2011, with £40 million of the increase in APE relating to sales of Elite Access, our no guaranteed benefit variable annuity. Excluding sales of Elite Access, variable annuity sales increased 7 per cent compared to the same period in 2011 on a constant currency basis. Jackson implemented various product and pricing initiatives in the second half of 2012 to further optimise the balance of value and risk and to ensure that sales of variable annuity with discretionary guarantees do not exceed the upper end of our risk appetite limits for the calendar year.

Fixed index annuity APE sales of £79 million in the first nine months of 2012 increased 16 per cent from the same period of 2011. Jackson ranked 8th in sales of fixed index annuities through the first half of 2012, with a market share of 4.7 per cent, and was also 8th for the full year 2011 with a market share of 4.6 per cent12.

Fixed annuity APE sales of £45 million in the first nine months of 2012 were 4 per cent of total APE sales and 36 per cent higher than the historically low level of fixed annuity sales in the same period in 2011. Jackson ranked 8th in sales of traditional deferred fixed annuities through the first half of 2012, with a market share of 3.6 per cent, compared to 13th and a market share of 2.1 per cent for the full year 201113.

Asset management operations

Curian Capital, a specialised asset management company that provides innovative fee-based separately managed accounts, continued to generate positive net flows during the nine-month period, which increased total assets under management to £6.4 billion at the end of September 2012 compared with £4.7 billion at the end of 2011.

1.3 UK insurance operations

Prudential competes selectively in the UK’s retirement savings and income market, with a focus on writing profitable new business combined with sustainable cash generation and capital preservation, rather than pursuing top-line sales growth.

Total APE sales of £617 million were 8 per cent higher than during the first nine months of 2011, principally due to higher sales of individual annuities, with-profits bonds and bulk annuities which were partly offset by lower sales of corporate pensions. APE sales for the standalone quarter of £205 million were up 28 per cent, mainly due to higher sales of individual annuities, with-profits bonds and a bulk annuity sale. We have improved our new business profitability in the first nine months of 2012, despite the challenging economic environment and current competitive conditions in the UK marketplace.

New business profit was £227 million for the first nine months of 2012, an increase of 17 per cent over 2011 driven by higher sales and a more favourable product mix. Retail new business profit increased by 11 per cent over 2011. The new business margin, including bulk annuities, of 37 per cent achieved in the first nine months of 2012 was up 3 percentage points on the same period last year. The retail new business margin of 33 per cent was up 1 percentage point compared to 2011. The negative impact on product margins of lower interest rates was more than offset by a more favourable business mix, with lower sales of corporate pensions and higher sales of individual annuities, with-profits bonds and bulk annuities (which have a higher margin).

APE sales of individual annuities of £166 million were 25 per cent higher than for the first nine months of 2011. Sales from internal vestings of £104 million, were 18 per cent higher, due to a combination of two factors – a higher number of customers retiring and higher average fund values. Sales of external annuities of APE £62 million were 41 per cent higher, reflecting continued demand for our with-profits Income Choice Annuity which offers customers security with a potential for income growth.

Onshore bonds sales of APE £161 million in the first nine months of the year were up 27 per cent on the same period in 2011, including with-profits bond sales of APE £152 million, which increased by 36 per cent. Our PruFund range made up 76 per cent of with-profits bond sales. Against the first nine months of 2011, PruFund sales were 41 per cent higher. The continued popularity of PruFund is a result of consumer appetite for its range of optional guarantees, which offer a degree of security against potential market falls but may also be Retail Distribution Review (RDR) related. Although the demand for guarantees remains high, the growth in PruFund sales has been mainly in the form of non-guaranteed business so is more capital efficient.

The RDR, one of a number of current reforms to the UK regulatory framework, is due to be implemented on 1 January 2013. From that point onwards, independent financial advisers will no longer be able to accept commissions from product providers on advised sales of investment and savings products. Distributors are therefore adjusting their business models ahead of the implementation of the new regulatory framework. This is likely to lead to some short-term dislocation in the market. While our business is on track to be ready for the onset of RDR, we expect investment bond sales, in particular, to be impacted in the latter part of 2012 and into 2013 as distributors adapt to the new regulatory environment.

Corporate pensions sales of APE £148 million in the first nine months of the year were 22 per cent lower than the same period last year. Sales in 2011 were particularly high due to new defined contribution members joining our schemes following closure of a number of defined benefit schemes operated by existing clients. We continue to focus on securing new members and incremental business rather than new Corporate Pensions schemes. Prudential UK remains the largest provider of Additional Voluntary Contribution plans within the public sector where we now provide schemes for 68 of the 99 public sector authorities in the UK.

Sales of other products, principally individual pensions, PruProtect, PruHealth and offshore bonds of £101 million were 11 per cent higher than the first nine months of 2011. Individual pensions sales (including income drawdown) of APE £59 million were 9 per cent higher, reflecting the continued popularity of PruFund.

In the Wholesale market, Prudential UK’s aim is to continue to participate selectively in bulk and back-book buyouts using our financial strength, superior investment track record, annuitant mortality risk assessment and servicing capabilities. In line with this opportunistic approach, we signed a further bulk annuity buy-in insurance agreement in the third quarter of 2012 of APE £14 million, in addition to the agreement signed in the first half of 2012, bringing the total for the nine months to APE £41 million (2011: single deal APE £28 million). We will continue to maintain our focus on value and only participate in capital-efficient transactions that meet our return on capital and payback requirements.

1.4 M&G

Persistent volatility of the world’s markets has continued to dampen investors’ appetite for risk. The third quarter saw a slight improvement in sentiment but equity markets remain subdued and there are no clear trends in investor behaviour beyond a general pursuit of safety and yield.

Despite this unsupportive backdrop, M&G has delivered a record level of net inflows in the third quarter of £6.4 billion as retail investors, particularly in mainland Europe, returned to the market after a period of extreme risk aversion last year (third quarter of 2011: net outflows of £0.3 billion). Total net inflows year-to-date have been £11.3 billion, more than four times higher than the £2.6 billion of asset flows in the previous year.

M&G’s success can be attributed to continued strong long-term investment performance and a consistent programme of business diversification – by product, by distribution channel and by country. The benefits of diversification are most evident in the European retail funds market where M&G now ranks second for net sales among cross-border providers16.

Retail net fund sales remain robust; £1.9 billion of new inflows during the third quarter took the total for the year-to-date to £6.1 billion, more than double their level this time last year. As expected, net fund sales in the UK slowed in the three months to the end of September to £0.5 billion, mainly as a result of our deliberate decision in July to slow the inflow of new money into two market-leading UK corporate bond funds. Quarterly net inflows for the first half of 2012 averaged £1.4 billion.

In the UK, M&G has ranked first for gross fund sales for 16 consecutive quarters based on data at 30 September17. Over the first nine months of the year, M&G had a 10.8 per cent market share according to a measure of gross sales as defined by the Investment Management Association (IMA). It is also the UK’s largest retail fund manager with funds under management of £41.4 billion as at 30 September 201218.

In mainland Europe, M&G continues to attract strong flows from investors, with net retail fund sales for the quarter of £1.4 billion. European distribution has accounted for more than half of net retail inflows since the start of the year at a total of £3.5 billion, reflecting consistently strong fund returns and considerable investment in the M&G brand in these newer markets. Funds under management with European clients now exceed £12.2 billion, a 56 per cent increase on funds under management of £7.8 billion this time last year.

Underpinning the retail business is strong long-term investment performance. Twenty-three retail funds accounting for 72 per cent of funds under management have delivered top or upper quartile returns over the three years to 30 September 2012. A high proportion of investor contributions continue to flow into conservatively positioned funds, most notably the M&G Optimal Income Fund, a flexible bond fund which ranked fourth among European funds for net sales in the 12 months to the end of August 201219. No fewer than 11 M&G funds, representing all of the main asset classes, have each attracted net sales of £20 million or more during the three quarters.

The £6.8 billion of net retail inflows in the UK and Europe have been partially offset by £0.7 billion net outflow from funds managed by M&G’s associate entity in South Africa. These redemptions were entirely from the PPM South Africa Dividend Income Fund, which was closed on 31 March 2012 ahead of the implementation of new tax legislation on 1 April 2012 which would have had a materially adverse impact on the treatment of the distributions made by the Fund to the Fund’s investors. Fund flows into other retail funds of the South African business, while outweighed by the Dividend Income Fund outflows, are in fact at record positive levels.

The consistency and quality of retail fund performance has resulted in M&G being awarded the prestigious 2012 Morningstar OBSR20 Outstanding Investment House Award. Shared this year with First State Investments, M&G has won this award for three consecutive years. Total external retail funds under management at the end of September were £52.0 billion (30 September 2011: £41.4 billion).

In the nine months to 30 September 2012, net inflows in the Institutional Business were £5.2 billion across M&G’s range of diverse fixed income, property and alternative investment strategies. This represents a record level of year-to-date net sales, with a single fixed income mandate amounting to £4.4 billion accounting for a significant proportion of this total. However, redemptions from this short-dated mandate are expected during the course of 2013 and 2014.

In addition to record quarterly inflows, the Institutional Business has a strong pipeline of new business which has been won but which has not yet been funded. Investment performance remains extremely strong with 100 per cent of actively managed fixed income funds delivering returns ahead of their benchmarks in the three years to 30 September 2012. Total external institutional funds under management at the end of September 2012 were £52.2 billion (30 September 2011: £45.9 billion).

M&G’s Institutional Business has also been recognised for its investment performance with multiple awards, including the UK Pensions Awards 2012 Fixed Income Manager of the Year award. Indeed, M&G’s flagship institutional UK corporate bond fund, with assets of over £4.2 billion at 30 September 2012, has outperformed its benchmark21 by 1.622 percentage points a year over the five year period to 30 September 2012.

Total funds under management across M&G were £216.9 billion at the end of the third quarter, a 12 per cent increase on 30 September 2011. External funds now represent 48 per cent of the total, standing at a record level of £104.2 billion, a 19 per cent improvement year-on-year.

Looking to the future, we expect growth in retail fund sales to be strongest in mainland Europe following a substantial investment in distribution there. In the UK, however, net retail fund sales are likely to slow further as a result of our decision to limit new inflows into our two market-leading UK corporate bond funds.

1.5 Eastspring Investments

Net third party year-to-date inflows of £1,033 million were driven by inflows to new funds in India and Taiwan, as well as net inflows in Japan and China which benefitted from higher equity flows. Specifically, strong fund raising was seen in India for its fixed maturity plan range, while the Taiwanese business saw a successful launch of the Emerging Asian Local Fixed Income Fund. In addition Taiwan’s existing range of onshore and offshore fixed income funds have attracted significant net inflows year-to-date. The positive net flows were partially offset by redemptions from institutional business in Korea. Third quarter net inflows in 2012 were 22 per cent lower than the same period in 2011 mainly due to redemptions in September 2012 from an institutional mandate. At 30 September 2012, 67 per cent of funds were outperforming their benchmarks over a rolling three year period.

September marked the opening of Eastspring Investments’ first office in the US, as it aims to capture the increasing interest in Asia for investment opportunities within the US institutional market.

Total funds under management of £56.0 billion were 13 per cent higher than a year ago, driven by the net inflows and positive market movements. In September a survey conducted by Asia Asset Management25 ranked Eastspring Investments as the leading retail asset manager in Asia (based on assets sourced from Asia ex-Japan) as at 30 June 2012.

2. Financial Management

The Group remains focused on managing proactively its balance sheet and risk profile. We continue to impose stringent stress testing on our key capital measures, ensuring we could withstand significant market shocks both in the short and medium term.

2.1 Capital Management

A strong balance sheet is at the heart of our strategy and is a key consideration for our customers when they choose our products. That strength gives confidence to our customers that we will be there to serve them in the long term. Strict and proactive management and allocation of capital remain a core focus for our Group.

Our capital position remains resilient. We have continued to focus on maintaining the Group’s financial strength through optimising the balance between writing profitable new business, conserving capital and generating cash. We estimate that our Insurance Groups Directive (IGD) capital surplus was £4.1 billion at 30 September 2012 (after taking into account the 2012 interim dividend of £0.2 billion). This compares to £4.2 billion at 30 June 2012 (before taking into account the 2012 interim dividend) and £4.0 billion at 31 December 2011 (before taking into account the 2011 final dividend of £0.4 billion).

As at 30 September 2012 stress testing of our IGD capital position to various events has the following results:

• An instantaneous 20 per cent fall in equity markets from 30 September 2012 levels would reduce the IGD surplus by £400 million;
  
  
• A 40 per cent fall in equity markets (comprising an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four week period) would reduce the IGD surplus by £900 million;
  
  
• A 100 bps reduction (subject to a floor of zero) in interest rates would reduce the IGD surplus by £800 million;
  
  
• Credit defaults of ten times the expected level would reduce IGD surplus by £650 million.

In addition to our strong capital position, on a statutory basis the total credit reserve for the UK shareholder annuity funds also contributes to protecting our capital position in excess of the IGD surplus. This credit reserve as at 30 September 2012 was £2.1 billion, equivalent to 7.9 per cent of the assets backing annuity liabilities. This represents 40 per cent of the portfolio spread over swaps, compared to 33 per cent at 31 December 2011 and 35 per cent at 30 September 2011.

The surplus of the UK with-profits fund, which represents a substantial source of capital from both a solvency and economic perspective, is excluded from the IGD calculation. At 30 September 2012, the UK with-profits fund inherited estate was estimated at £6.7 billion. The value of shareholders’ interest in future transfers from the UK with-profits fund is valued at £2.2 billion.

2.2 Credit

The Group’s estimated total debt securities portfolio on an IFRS basis (excluding holdings attributable to external unit holders of consolidated unit trusts) comprised the following as at 30 September 2012:

* Jackson’s variable annuity separate account assets comprise equity securities and portfolio holdings in unit trusts (including mutual funds), the majority of which are equity based.
** Including the debt securities of REALIC acquired on 4 September 2012.

Shareholders are not directly exposed to value movements on assets backing with-profits or unit-linked operations, with sensitivity mainly related to shareholder-backed business. In the UK, of the £26.6 million of debt securities backing shareholder business and other non-linked business, 74 per cent is rated AAA to A, 21 per cent BBB and 5 per cent non-investment grade. No defaults were reported in the third quarter of 2012 for UK and Asia shareholder-backed businesses.

The most significant area of exposure to credit risk for the shareholder is in the US. The US insurance operation’s fixed income portfolio at 30 September is estimated at £33.4 billion. Net unrealised gains on available-for-sale securities were £2.9 billion at 30 September 2012 (30 June 2012: £2.5 billion).

Gross unrealised losses on securities priced below 80 per cent of book value were £0.1 billion at 30 September 2012 (30 June 2012: £0.1 billion).

For US insurance operations, total amounts charged to profits relating to debt securities as a result of impairments and sales of impaired and deteriorating bonds in the third quarter of 2012 were £39 million (third quarter 2011: £16 million), nine months ended 30 September 2012: £72 million (nine months of 2011: £29 million). In the third quarter of 2012, Jackson’s total defaults were £nil (third quarter 2011: £nil).

Group shareholder sovereign debt exposure

Sovereign debt of shareholder-backed business represented 16 per cent or £10.6 billion of the Group’s debt portfolio backing shareholder business at 30 September 2012. 38 per cent of this was rated AAA and 93 per cent investment grade.

Of the Group’s holdings in Continental Europe of £582 million, 80 per cent was AAA rated. Prudential’s direct exposure to the eurozone countries continues to be small in the context of our overall balance sheet. Shareholder exposure to the eurozone sovereigns of Italy and Spain is £49 million. The Group does not have any direct sovereign debt exposure to Greece, Portugal or Ireland.

The exposure of the Group’s shareholder funds to sovereign debt (including credit default swaps that are referenced to sovereign debt) at 30 September 2012 is as follows.

Exposure to bank debt securities

Prudential expects that any second order sovereign credit exposures would most likely be concentrated in the banking sector. The Group's bank exposure is a function of its core investment business, as well as of the hedging and other activity undertaken to manage its various financial risks. Prudential relies on publicly available information to identify banks with large concentrations of indirect exposure.

Prudential has a range of controls and processes to manage credit exposure. In addition to the control frameworks that cover shareholder and policyholder credit risk within each Business Unit, the Group Credit Risk Committee oversees shareholder credit risk across the Group. The Committee receives comprehensive management information, including details of counterparty and invested credit exposure (including structured credit and loans), secured and unsecured cash balances, top 30 credit exposures, and an analysis of shareholder exposure by industry/country and rating. The Group Risk function also continually monitors the portfolio for emerging credit risks through various tools and processes.

Prudential actively mitigates the level of Group-wide credit risk (invested credit and counterparty) through a comprehensive system of hard limits, collateralisation agreements and centrally managed ‘watch lists’.

In terms of shareholder exposure to the bank debts of Portugal, Ireland, Italy and Spain, the Group held £270 million at 30 September 2012. There was no direct exposure to Greek banks.

The exposure of the Group’s shareholder funds to bank debt securities at 30 September 2012 comprises the following:

Bank debt securities - shareholder-backed business

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Footnotes
¹ Unless otherwise stated all growth rates are on a sterling basis. Growth rates on constant currency are presented in schedule 1B of the Interim Management Statement
² The assumptions used to calculate new business profit are presented in schedule 5 to the Interim Management Statement
³ Investment net flows excluding Eastspring Money Market Funds and percentage change is based on unrounded numbers
⁴ Represents estimated IGD surplus after deducting the 2012 interim dividend of £0.2 billion
⁵ The ‘like-for-like’ basis growth figures shown above have been determined by applying economic assumptions based on government bond yields as of 30 September 2011
⁶ IMF Global Growth Outlook, October, 2012
⁷ New business profit is calculated using end-of-period economic assumptions. These are presented in schedules 5 of the Interim Management Statement. The fall in long-term interest yields between September 2011 and September 2012, have reduced the year-to-date September 2012 new business profit by £134 million.
⁸ Gross and net investment inflows excluding Eastspring Money Market Funds
⁹ Percentages based on unrounded numbers
¹⁰ Funds under management includes all external and internal funds
¹¹ The ‘like-for-like’ basis growth figures shown above have been determined by applying economic assumptions based on government bond yields as of 30 September 2011.
¹² Source: AnnuitySpecs/The Advantage Compendium
¹³ Source: LIMRA
¹⁴ From 1 January 2012, Prudential Portfolio Managers South Africa (Pty) Limited was no longer a subsidiary of M&G following the restructuring transaction whereby M&G’s ownership has been diluted following the equitisation of the staff incentive scheme and reduced further by the sale of an additional 10 per cent equity stake to an empowerment company as encouraged under Broad Based Black Economic Empowerment legislation. Consequently, 47.2 per cent of funds under management and flows from the South African associate company has been included in M&G’s 2012 results in this announcement whereas 100 per cent had been included up to the end of 2011.
¹⁵ Percentages based on unrounded numbers.
¹⁶ Source: Lipper FMI. (October 2012, data as at August 2012). SalesWatch. Thomson Reuters
¹⁷ Source: Fundscape (Q3 issue, November 2012). The Pridham Report. Fundscape LLP
¹⁸ Source: Investment Management Association
¹⁹ Source: Lipper FMI. (October 2012, data as at August 2012). SalesWatch. Thomson Reuters
²⁰ Morningstar Old Broad Street Research Limited 2012 Outstanding Investment House Award.
²¹ The benchmark for the Fund is the iBoxx Sterling Non Gilts Index
²² Returns are gross estimates on an offer to offer basis
²³ Investment flows exclude Eastspring Money Market Funds gross and net inflows. Year-to-date net outflows were £217 million (year-to-date net outflows 2011: £267 million). External funds under management exclude Money Market Funds of £4.1 billion (third quarter 2011: £4.5 billion).
²⁴ Percentages based on unrounded numbers.
²⁵ Source: September 2012, Asia Asset Management magazine