08 Nov 2011

Prudential plc Third Quarter 2011 Interim Management Statement

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Prudential plc Third Quarter 2011 Interim Management Statement - News Release

PRUDENTIAL PLC THIRD QUARTER 2011 INTERIM MANAGEMENT STATEMENT

• PRUDENTIAL DELIVERS ANOTHER STRONG QUARTER WITH BOTH NEW BUSINESS PROFITS AND SALES GROWTH
• ASIA YEAR TO DATE NEW BUSINESS PROFIT UP 16 PER CENT TO £719 MILLION AND 20 PER CENT EXC. INDIA LED BY KEY MARKETS OF HONG KONG, INDONESIA, MALAYSIA AND SINGAPORE
• US YEAR TO DATE NEW BUSINESS PROFIT UP 17 PER CENT TO £622 MILLION - GROWTH ACHIEVED WHILE MAINTAINING FINANCIAL DISCIPLINE
• UK CONTINUES TO PERFORM IN LINE WITH CASH GENERATIVE, VALUE OVER VOLUME STRATEGY; YEAR TO DATE NEW BUSINESS PROFIT UP ONE PER CENT
• GROUP-WIDE YEAR TO DATE NEW BUSINESS PROFIT UP 14 PER CENT TO £1,535 MILLION: SALES UP 10 PER CENT TO £2,704 MILLION AND 15 PER CENT EXC. INDIA
• RESILIENT BALANCE SHEET; IGD SURPLUS ESTIMATED AT £3.9 BILLION; MINIMAL SHAREHOLDER EXPOSURE TO EUROZONE CHALLENGES
• GROUP ASSET MANAGEMENT YEAR TO DATE NET INFLOWS REMAIN POSITIVE AT £3.4 BILLION

Tidjane Thiam, Group Chief Executive, said:

“Prudential has delivered strong results in the third quarter in a volatile and challenging environment. Our strong balance sheet, proactive risk management and our leading position in Asia have allowed us to continue to grow profitably.

In the first nine months of the year the Group delivered new business profits of £1,535 million, an increase of 14 per cent over the same period in 2010 (2010: £1,345 million), with total insurance sales increasing 10 per cent to £2,704 million (2010: £2,464 million). Our emphasis on writing profitable, capital-efficient business has allowed us to achieve an increased margin of 57 per cent across our insurance operations.

In volatile times, capital, balance sheet and risk management are more important than ever. The Group’s balance sheet remains strong and our capital position is robust. Our prudent and proactive approach to capital and risk management has led us to retain a defensive stance since the 2008 financial crisis. Our estimated IGD capital surplus at the end of the third quarter was £3.9 billion. That capital buffer, coupled with our proactive stance in managing our key exposures, means that we can withstand significant further deterioration in market and economic conditions. We also keep a close eye on our Group liquidity position which remains comfortable.

Going back to our business performance, in Asia our operations continue to perform well. In the first nine months of the year new business profit grew 16 per cent to £719 million (2010: £621million) and our sales grew eight per cent to £1,147 million (2010: £1,066 million). Excluding India, where the market has been impacted by regulatory reform, new business profit grew 20 per cent and our sales grew 19 per cent in the first nine months. This level of profitable growth was driven by a particularly strong performance in our four leading markets, with sales in Singapore up 38 per cent, Indonesia up 27 per cent, Hong Kong up 17 per cent and Malaysia up 16 per cent. Our new business margins remain strong, year-to-date at 63 per cent. These results confirm the value of our strategic focus on the fast-growing and highly profitable markets of South-East Asia. The momentum seen earlier in the year in our Asia business has continued during the third quarter with our highest ever third quarter of new business sales. Excluding India, third quarter sales growth was 24 per cent, compared to 17 per cent in the first two quarters of the year.

In the US, Jackson’s strong performance in the first half has continued into the third quarter, despite the increased volatility of US financial markets in that period. New business profit year-to-date is up 17 per cent to £622 million (2010: £532 million) and APE sales are £988 million, up 16 per cent (2010: £850 million) over the same period. This performance, against a challenging macro-economic environment, reflects Jackson’s financial strength ratings and a disciplined approach to writing new business. The mix of annuity sales continues to reflect customer concerns regarding the macro-economic environment. Our variable annuity APE sales of £851 million were up 25 per cent in the first nine months compared to the same period last year (2010: £683 million).

The UK continues to perform in line with our strategy. Compared to the same period last year new business profit is up one per cent to £194 million (2010: £192 million) and sales increased four per cent to £569 million (2010: £548 million). We remain focused on our strengths in the individual annuities and with-profits segments. Our strategy of putting value over volume and our unique combination of competitive advantages allow us to continue to deliver market-leading returns on capital employed.

Turning to our asset management operations, the Group’s net flows year to date totalled £3.4 billion. M&G has recorded year-to-date net inflows of £2.6 billion. Inflows have remained strong particularly in the UK however we are seeing outflows on M&G’s European funds, reflecting the difficulties within the eurozone. M&G’s total external funds under management are now £87.3 billion, five per cent higher than at the end of September 2010.

During the third quarter of 2011 global financial markets experienced significant volatility brought on by concerns over European and US sovereign debt, as well as concerns about a general slowing of global demand reflecting an increasing lack of confidence among consumers, corporates and governments. If sustained, this environment is likely to have a negative impact on our sector over time.

However, our sizeable and unique presence in the growing and developing markets of Asia; our product, geographic and channel diversification; our risk management discipline across the Group; and the strength of our balance sheet position us well to continue to outperform over the medium term”.

1. Q3 2011 Business Unit financial highlights

1.1 Asia Insurance operations

The long term prospects of the region’s life insurance sector remain very attractive driven by strong economic growth, a fast growing middle class, high savings rates and low penetration of insurance products. Prudential’s strategic focus continues to be on expanding quality, multichannel distribution with an emphasis on products that meet customers’ needs while providing good returns to shareholders. Typically this means a high proportion of regular premium policies and a focus on covering the health and protection needs of our customers.

This strategy continues to deliver excellent results with new business profits growing at a much faster rate than new business APE sales. Year to date new business profit growth was 16 per cent at £719 million, principally due to the strong sales performance in our higher margin businesses of Hong Kong, Singapore, Malaysia and Indonesia and the lower proportion of new business from India in the mix. New business profit margins excluding India were higher at 66 per cent. The improved margin is a result of business mix, partially offset by a two per cent reduction as a result of the economic environment.

Third quarter 2011 new business APE of £404 million has risen by 14 per cent over the same quarter last year (24 per cent excluding India) demonstrating the strong momentum in the business. Year to date new business APE has increased by eight per cent to £1,147 million (19 per cent excluding India).

One of Prudential’s core strengths in the region is our success in delivering profitable growth from both agency and bank partnerships; excluding India, agency average headcount increased to 185,000, up from 154,000 in the corresponding period last year. Equally important and underscoring our focus on quality is the growth in the number of active agents, which improved by nine per cent in the first nine months of this year compared to last year and also productivity (APE per agent) which improved six per cent. As a result, overall agency sales increased by 15 per cent in the first nine months of 2011. Sales from the bank channel increased by 34 per cent reflecting strong performances from our major partners. Our exclusive regional deal with UOB, signed in the first quarter last year and extended this year to include Malaysia and most recently China, is developing successfully. Standard Chartered Bank with whom we have a leading regional partnership covering ten countries and recently extended to an eleventh, the Philippines, has continued to deliver excellent results.

The priority accorded to regular premium policies is reflected by these being 91 per cent of APE, in line with prior year and the product mix, excluding India, also remains in line with prior years with unit-linked and protection both at 31 per cent of total APE and PAR business at 35 per cent.

Net insurance flows (excluding India) for Asia remain strongly positive for both the third quarter and the year to date. Third quarter outflows arising from surrenders and partial withdrawals relating to shareholder-backed business are at a lower run-rate than both the first half of 2011 and the equivalent quarter last year, when expressed as a percentage of opening liabilities.

Looking at developments of our sales in each major market:

In China, Prudential’s share of new business volumes for the first nine months of 2011, from our 50 per cent ownership of the CITIC-Prudential joint venture, is £46 million up 10 per cent on the same period in 2010. The growth in agency sales is principally driven by productivity improvements which demonstrate that CITIC-Prudential’s disciplined approach to building a high quality agency force in China continues to be effective. Sales through our bank partners have been impacted by the introduction of new regulations earlier this year prohibiting sales through non-bank staff.

Hong Kong delivered a record third quarter performance with new business APE higher by 20 per cent at £78 million. Year to date APE of £229 million represents growth of 17 per cent over the comparable period. Our continued success in this market is underpinned by both the quality of our distribution and products.

Agency APE increased by 11 per cent. Our agency numbers continue to increase principally through organic recruitment initiatives and the year to date average agency headcount was over 5,000. Agency productivity has improved by 14 per cent.

Bancassurance sales, principally through Standard Chartered Bank, have increased by 31 per cent and now account for 43 per cent of total sales (2010: 39 per cent).

In India, the insurance industry continues to adjust to the new regulations which became effective in the third quarter of 2010. ICICI Prudential continues to be amongst the top private sector players and is managing through a significant change in its strategy around distribution and products. ICICI Prudential has significantly diversified away from linked to conventional products with the latter contributing to around 40 per cent of incremental new business from around five per cent previously. The company maintains a balanced distribution mix at around 50:50 between agency and alternate channels.

Growth in Indonesia continues at a strong pace with the third quarter 2011 of £81 million up 37 per cent over the third quarter 2010. Year to date growth is 27 per cent.

The key to Prudential’s ongoing success in Indonesia to date is our ability to efficiently recruit, train and activate new agents. Year to date average agent numbers of 108,000 are up 33 per cent on the same period last year.

Although agency remains the dominant distribution channel at 93 per cent of APE, we are also having some real success with our bank partners up 139 per cent over the prior year.

Our business in Korea has extensively restructured over the past two years to concentrate on high quality distribution and regular premium unit-linked business, given our unwillingness to compete in the low margin, high capital intensive guaranteed products that are prevalent in the mass market.

Encouragingly new business APE at £81 million year to date is up 17 per cent over the same period last year driven mainly by increasing productivity of our own focussed and highly professional tied agency force. We are also participating selectively in the bancassurance sector focusing on regular premium unit-linked products.

Malaysia continues to perform very strongly producing a record third quarter with new business APE of £59 million up 13 per cent over the same period last year driven by higher agent numbers (year to date up by 11 per cent). Sales mix consists predominantly of regular premium unit-linked with protection. Takaful accounts for around 15 per cent of the mix.

Bancassurance remains small relative to agency but is now growing very strongly, up 183 per cent over the prior year period. Part of this growth has been driven by the strength of our new relationship with UOB; which was launched in May 2011. UOB has already contributed around 40 per cent of total partnership sales this year.

Singapore had an excellent third quarter with new business of £60 million up 40 per cent over last year. Year to date new business APE of £163 million is 38 per cent higher than prior year.

Agency continues to perform very well with increases in productivity. In addition, the bancassurance performance has been outstanding with sales APE of £70 million up 106 per cent over the prior year. We have four exclusive partnerships, SCB, Maybank, Singpost and UOB that was added last year. Each of these partners have made a significant contribution to sales this year.

Taiwan is now successfully focused on bank distribution principally with partners E.Sun and Standard Chartered Bank. We had a relatively slow start to the year as we introduced new products, but new business volumes increased strongly in the third quarter with APE of £36 million up 44 per cent over the same period last year.

Although year to date sales are flat relative to last year, the volume of protection business in the mix has increased to 20 per cent (2010: 16 per cent).

Prudential’s other operations, Philippines, Thailand and Vietnam all continue to perform well. Vietnam’s year to date growth rate, when translated to sterling was flat due to the depreciation of the local currency relative to sterling. In local currency terms growing the agency and improving agent productivity resulted in a record year to date new business APE with growth of 16 per cent over the same period last year. In the Philippines year to date new business APE is up 38 per cent over prior year driven by improved agency activity and higher sales through our bancassurance partners. We have also recently extended our distribution agreements with Standard Chartered Bank to include the Philippines. In Thailand, we have sustained our 2010 sales momentum which was boosted by the UOB distribution.

Japan
We announced at the start of 2010 that PCA Life Japan ceased writing new business sales with effect from 15 February 2010. New Business sales for Japan in 2010 amounted to £7 million. In order to more accurately reflect the results of our ongoing Asian operations, all of the headline financial metrics included in this announcement exclude the contribution from Japan.

1.2 US operations

Insurance operations

High volatility returned to the US equity markets in the third quarter, along with further declines in interest rates. Overall, the US equity markets rose during the first half of 2011, but then declined during the third quarter, with the S&P 500 index ending the third quarter down ten per cent for the year. Volatility in the third quarter was more than double compared to earlier in the year, or 2010. Rates on 10-year Treasuries reached near all time lows during the quarter, declining to below two per cent, while AA corporate spreads increased from year-end 2010 levels.

Jackson manages equity and interest rate exposure on an aggregate basis in order to ensure that total economic risk is hedged effectively within established policy limits. Jackson continues to adapt its hedging programme to market conditions in order to ensure continued effective risk management. Despite the historically low interest rates, falling equity markets and the high level of volatility in the third quarter of 2011, Jackson’s hedging programme continued to perform well, mitigating the impact of the macroeconomic challenges and supporting our robust capital position on both an economic and regulatory basis. Jackson’s approach to pricing and hedging has always been to adopt a conservative stance and we believe that this positions Jackson to perform well during periods of market dislocation.

Policyholder behaviour in the quarter continued to trend in line with our expectations. Jackson believes that this uncertain environment continues to provide an advantage to companies with good financial strength ratings and a track record of financial discipline. Companies that were hardest hit by the market disruptions over the last few years still have to work to regain market share as customers and distributors seek product providers that offer consistency, stability and financial strength. Jackson continues to benefit significantly from this flight to quality and heightened risk aversion.

Due to its financial stability and innovative products, Jackson continues to enhance its reputation as a high-quality and reliable business partner, with sales increasing as more advisers have recognised the benefits of working with Jackson. A significant part of Jackson’s growth continues to come from an increase in its distribution penetration with sales through distributors who either did not previously sell Jackson’s products or simply did not sell variable annuities.

Jackson’s strategy continues to focus on balancing value, volume, capital efficiency, balance sheet strength and strict pricing discipline for both variable and fixed annuities. Fixed annuity sales have slowed as a result of the current interest rate environment and as capital is directed to support higher-margin variable annuity sales.

Jackson delivered strong APE retail sales of £968 million in the first nine months of 2011, representing a 14 per cent increase over the same period in 2010. With the addition of modest institutional sales in 2011, total APE sales were £988 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 (IRR) in excess of 20 per cent.

New business profits were 17 per cent higher at £622 million, reflecting Jackson’s strong pricing discipline and a larger percentage of higher margin variable annuity sales. Overall margins were 63 per cent for the first nine months of 2011 (2010: 63 per cent). The overall margins have remained relatively stable, though this is the result of offsetting changes. The adverse impact of lower yields has been offset by the beneficial effect of business mix and product re-pricing. Variable annuity margins have remained high at 67 per cent for the first three quarters (2010: 67 per cent) despite a 60 basis point reduction in yields compared to 30 September 2010, reflecting the beneficial effect of the pricing changes implemented in the last 12 months.

Total retail annuity net flows of £5.8 billion for the first nine months of 2011, increased 13 per cent from the same period in 2010, reflecting the impact of increased sales and continued low levels of surrender activity. In the third quarter, retail annuity net flows equalled £1.7 billion and Jackson’s separate account and general account assets at the end of the quarter totalled £65.4 billion. Jackson remained the third largest seller of individual annuities during the first half of 2011, with a market share of 8.6 per cent, up from a market share of 8.0 per cent for the full year 20109.

Jackson anticipates a more modest rate of sales over the remainder of the year, due to the impact of the recent volatility in the S&P500 and various product initiatives that we implemented during the third quarter. These initiatives were taken in order to optimise the balance between growth, capital consumption and profitability.

Variable annuity (VA) APE sales of £851 million in the first nine months of 2011 were 25 per cent higher than the same period in 2010 as Jackson continued to benefit from its customers’ and distributors’ flight to quality. Although we do not target volume or market share, these market conditions allowed Jackson’s ranking to remain at third in variable annuity sales in the first half of 2011 (latest information available), while increasing its market share to 12.2 per cent from 10.7 per cent for the full year 201010. Jackson ranks first among VA providers for advisor loyalty11. Jackson also earned the top ranking for both external and internal wholesaler support11.

Fixed index annuity (FIA) APE sales of £68 million through the first nine months of 2011 were down 19 per cent from the same period of 2010 as Jackson continued to focus its marketing efforts on higher margin VA products. Jackson ranked 9th in sales of FIAs in the first half of 2011, with a market share of 4.4 per cent, down from 6th and a market share of 5.2 per cent for the full year 201012.

Jackson’s strategy of proactively managing fixed annuity (FA) volumes resulted in 2011 APE sales of £33 million, 49 per cent lower than the same period in 2010. Jackson ranked 12th in sales of traditional deferred fixed annuities in the first half of 2011, with a market share of 1.9 per cent, compared to 8th and a market share of 3.4 per cent for the full year 20109.

Asset management operations

Curian Capital, a specialised asset management company that provides innovative fee-based separately managed accounts, had total assets under management of £4.3 billion at the end of September 2011 compared with £3.5 billion at the end of 2010. Curian generated record deposits of £1.4 billion in the first nine months of 2011.

1.3 UK insurance operations

In the UK, Prudential competes selectively in the retirement savings and income market with a clear focus on balancing the writing of new business with sustainable cash generation and capital preservation. Despite the competitive UK market conditions, the business continues to succeed in this objective by deploying capital to opportunities that play to its core strengths and which generate the best returns.

The business remains a market leader in both individual annuities and with-profits and has a unique combination of competitive advantages including experience and expertise in managing longevity risk, multi-asset investment capabilities, a strong brand and financial strength.

Total APE sales of £569 million were up four per cent on the first nine months of 2010, including a bulk annuity of APE £28 million in the first half of 2011. The total margin was 34 per cent for the period, one per cent lower than in the same period in 2010.

Retail sales of APE £541 million were down one per cent on the same period last year, a reflection of Prudential’s strategy to allocate capital to opportunities that play to the core strengths of the business rather than pursuing top-line sales growth. In the same period, the retail new business margin reduced to 32 per cent, three per cent down on 2010. This was primarily driven by a changing business mix of lower shareholder-backed annuity sales and higher sales of corporate pensions, partly offset by the higher margin on non-profit annuity business due to relatively strong investment performance in the first half of the year. The individual annuity margin has reduced in the third quarter compared to the half year as we have taken a more cautious approach to investment mix in the current economic climate.

Sales of individual annuities of APE £133 million were 17 per cent lower than for the first nine months of 2010 as Prudential UK continues proactively to manage the flow of external conventional new business to control capital consumption. Sales of external annuities of APE £44 million were down 34 per cent on the same period last year, mainly due to the end of a partnership agreement in the second half of 2010. Internal vestings sales of APE £88 million, were five per cent lower than 2010 as the 2010 sales had received a temporary boost from the effects of the change in the minimum retirement age from 50 to 55 in April 2010. In effect there was a spike in sales to the 50 to 55 age group immediately prior to the change in 2010 (creating therefore an unusually high comparative for 2010) and fewer early retirees in the first half of 2011. The proportion of with-profits annuity sales continues to increase, from 22 per cent in the first nine months of 2010 to 25 per cent over the same period in 2011.

Sales of onshore bonds of APE £127 million were 15 per cent up on the same period in 2010, including with-profits bonds sales of APE £112 million, which increased by 16 per cent. PruFund comprised 74 per cent of with-profits bond sales, driven by customer demand for products offering smoothed investment returns and optional capital guarantees.

Unit-linked bond sales of APE £15 million were 11 per cent up on the first nine months of 2010, helped by the success of PruDynamic, Prudential’s risk-graded portfolio funds. Sales into the PruDynamic Funds have totalled over £180 million in 2011, including collectives, and at 30 September 2011 total funds under management were in excess of £300 million.

Corporate pensions sales of APE £190 million were 12 per cent higher than the same period last year, with strong sales to new members of existing private sector schemes in the first half of the year due in part to an existing customer transferring members from their defined benefit scheme to the defined contribution scheme. While continuing to focus on growing existing schemes, we are working with our corporate clients to develop their auto-enrolment strategies in time for its introduction in 2012. For many clients, we will facilitate the use of the National Employment Savings Trust (NEST) to provide a flexible, portable solution for short-term workers. Prudential UK also continues to write profitable sales through the provision of Additional Voluntary Contribution (AVC) arrangements within the public sector. Prudential has been the sole provider of Teachers AVCs for more than 20 years, is one of two providers for the National Health Service and remains the largest provider of Local Government Administering Authorities AVCs, with 67 of the 99 schemes in the UK.

Sales of other products of APE £91 million were 14 per cent below the same period of 2010. Individual pensions sales (including income drawdown) of APE £54 million were one per cent above the same period last year. PruHealth’s sales of APE £6 million were 36 per cent below the same period last year, reflecting difficult trading conditions for the private medical insurance market and Prudential UK’s reduced share, from 50 per cent to 25 per cent, of the expanded business following PruHealth’s acquisition of Standard Life Healthcare. PruProtect’s sales were up 22 per cent compared with 2010 on a like-for like basis, with record sales achieved in the third quarter of 2011.

Wholesale APE of £28 million relates to a bulk annuity buy-in insurance agreement written in the second quarter.

1.4 M&G

M&G is the UK and European fund manager of the Prudential Group with responsibility for investments on behalf of both internal and external clients. M&G is an investment-led business whose aim is to generate superior long-term returns for its third party investors and the internal funds of the Prudential Group. This is achieved by creating an environment that is attractive to investment talent. Over the three years to 30 September 2011, 64 per cent of M&G’s Retail funds delivered first and second quartile investment performance. The performance of our actively managed external institutional fixed income mandates also remains very strong with all of mandates meeting or outperforming their benchmarks over the three years to 30 September 2011.

With considerable uncertainty over sovereign debts on both sides of the Atlantic and concerns over the lack of global economic growth, the third quarter of 2011 saw the FTSE 100 suffer its worst quarter for nine years, falling 14 per cent from 5,946 to 5,128. M&G’s funds under management (‘FUM’) proved resilient in the face of such significant declines falling only four per cent from £202.2 billion as at 30 June 2011 to £194.4 billion as at the end of September 2011. External funds now represent 45 per cent of the FUM, an increase of five per cent from 30 September 2010.

Over the third quarter, gross inflows totalled £6.4 billion representing an increase of 14 per cent on third quarter 2010 levels. At the net level, however, we recorded an outflow of £288 million over the quarter, a clear indicator of the increasing risk aversion of retail investors particularly across Continental Europe. Market data reports show that long-term retail funds across the European industry suffered redemptions of €53.8 billion13 in August (excluding money market funds); the worst month since October 2008.

The sales performance of our Retail business relative to the market remains strong due to the robustness of our UK business. In our core UK market, gross inflows of £2.9 billion generated over the third quarter were 13 per cent higher than the same quarter in 2010. We have also continued to generate resilient net inflows in the UK despite the market environment with £1.1 billion being received in the quarter. This performance from our UK distribution channels has helped to offset the difficult conditions encountered in mainland Europe, where risk-averse investors have been withdrawing money from funds. Overall, this resulted in modest total net retail outflows of £172 million over the quarter.

M&G’s Retail business in the UK has been number one for gross and net retail sales over eleven consecutive quarters based on data to the end of June 201114. The consistency and quality of our performance resulted in M&G being awarded the prestigious 2011 OBSR Outstanding Investment House Award for the second year running.

Outside the UK, we have continued to develop our distribution capabilities. To this end, registration of our OEIC range in Norway, Denmark and Finland will be completed over the fourth quarter of 2011. M&G-managed retail FUM sourced outside of the UK now stand at £7.8 billion at the end of September 2011, equivalent to 19 per cent of the total retail external funds managed by M&G.

Net flows from the Institutional business were also in negative territory over the third quarter by £116 million. This outflow partly reflects the contractual return of £407 million in capital to investors in mature closed-ended debt structures. On the positive side, M&G’s Institutional Public Debt Business continued to attract net inflows which largely offset these contractual outflows. M&G’s flagship institutional UK corporate bond fund, with over £3.4 billion of FUM at the end of September, has outperformed its benchmark15 by 1.616 per cent a year since September 2008, the eve of the credit crisis. The excellence of M&G’s performance in the institutional fixed income market is evidenced by the recent win of the Fixed Income Manager of the Year Award at the Financial News Awards for Excellence in Institutional Asset Management.

Gross year-to-date sales for the total M&G business stand at £19.8 billion, while net sales remain resilient at £2.6 billion to the end of September. With a broadly neutral result from our Institutional Business over this period, retail fund flows have driven this growth.

1.5 Asia Asset Management

Prudential’s asset management business in Asia has three components; internal life funds, retail funds and institutional funds. Market conditions continue to be challenging in line with the rest of the world.

Year to date net inflows for the third party retail and institutional fund management non money market funds of £0.8 billion are 56 per cent lower than last year. This was mainly driven by Japan where we recorded net outflows from equity and bond funds following the March 2011 earthquake, and where high net inflows from a white-labelled equity fund in 2010 did not recur. These net outflows were partially mitigated by robust net inflows into Korea from institutional clients. Including money market funds, year to date total third party net inflows were positive at £0.5 billion compared to negative £32 million in 2010.

Total Funds under Management (FUM) at 30 September amounted to £49.5 billion in line with the prior year as gains since then have effectively been negated by recent market movements.

Investment performance across life, institutional and retail portfolios remains stable with the blended performance score of funds that either outperform their benchmark or have peer rankings in the top two quartiles at 61 per cent at the end of September 2011.

2. Financial Management

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

2.1 Capital Management

A strong balance sheet is at the heart of our strategy and is a key buying factor for our customers, who have a long-term relationship with us in all our key markets. That strength gives confidence to our customers that we will be there to serve them in the long-term, and allows us to grow strongly and write large amounts of new business without putting our customers at risk. 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 £3.9 billion at 30 September 2011 (after taking into account the 2011 interim dividend of £0.2 billion). This compares to £4.1 billion at 30 June 2011 (before taking into account the 2011 interim dividend) and £4.3 billion at 31 December 2010 (before taking into account the 2010 final dividend of £0.4 billion). The adverse effect of the equity market falls and reduction in long-term yields in the third quarter of 2011, have been broadly offset by strong operating earnings and favourable foreign exchange movements.

The proceeds of the $550 million hybrid debt raised in January 2011 are intended to finance the repayments of the Euro 500 million Tier 2 subordinated notes in December 2011. The reported IGD surplus positions at 30 June and 30 September 2011 already factor the repayment of this instrument.

We continue to have a number of options to manage both available and required capital. These could take the form of increasing our available capital (for example, through financial reinsurance) or reducing required capital (for example, through the mix and level of new business) and the use of other risk mitigation measures such as hedging and reinsurance.

As at 30 September 2011 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 2011 levels would reduce the IGD surplus by £350 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 100bps reduction (subject to a floor of zero) in interest rates would reduce the IGD surplus by £650 million;
• Credit defaults of ten times the expected level would reduce IGD surplus by £600 million.

In addition to our strong capital position, on a statutory (Pillar 1) 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 2011 was £2.0 billion, equivalent to 8.6 per cent of the fixed income assets backing annuity liabilities. This represents 35 per cent of the portfolio spread over swaps, compared to 45 per cent at 30 June 2011 and 43 per cent at 30 September 2010.

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 2011, the UK with-profits fund inherited estate was valued at £6.4 billion.

2.2 Credit

The Group’s total debt portfolio on an IFRS basis is estimated at £113.1 billion at 30 September 2011 excluding holdings attributable to external unit holders of consolidated unit trusts. Of this total, £75.0 billion is in the UK, including £45.9 billion within the UK with-profits fund. Shareholders have limited risk exposure to the with-profits fund as its solvency is protected by the inherited estate. Outside the with-profits fund there is £5.9 billion in unit-linked funds where the shareholder risk is limited, with the remaining £23.2 billion backing the shareholder annuity business and other non-linked business (of which 79 per cent is rated AAA to A, 19 per cent BBB and two per cent non-investment grade). No defaults were reported in the third quarter of 2011 for UK shareholder backed business.

Asia’s debt portfolio totals £9.5 billion, of which £5.4 billion is invested in unit-linked and with-profits funds with minimal shareholder risk and £4.1 billion held by shareholder backed non-linked business. No defaults were reported in the third quarter of 2011.

The most significant area of exposure to credit risk for the shareholder is in the US. Jackson’s fixed income portfolio at 30 September is estimated at £26.8 billion. Jackson’s net unrealised gains on available-for-sale securities were £1.9 billion at 30 September 2011 (30 June 2011: £1.4 billion).

Gross unrealised losses on securities priced below 80 per cent of book value were £0.2 billion at 30 September 2011 (30 June 2011: £0.2 billion).

In Jackson, total amounts charged to profits relating to debt securities in the third quarter were £16 million (2010: £23 million). This is net of recoveries and reversals recognised in the quarter of £24 million (2010: £3 million). This compares to net write downs of £13 million for the first half of 2011. The total charged for the first nine months of 2011 was therefore £29 million (first nine months of 2010: £184 million). In the third quarter of 2011, Jackson’s total defaults were £nil (2010: £nil). IFRS write-downs excluding defaults for the third quarter were £40 million compared to £26 million in the equivalent period in 2010.

The Group’s shareholder exposures to sovereign debt were £2.7 billion to the US, £3.1 billion to the UK, £0.7 billion to Continental Europe and £2.8 billion to the rest of the world, predominantly Asia. Of the £0.7 billion exposure to Continental Europe, 93 per cent were AAA rated, the exposure in respect of Germany was £631 million, Italy was £48 million and Spain was £1 million whilst there was no sovereign exposure to Greece, Portugal, Ireland or France.

In terms of shareholder exposures to the bank debt of Portugal, Ireland, Italy, Greece and Spain (PIIGS), we held £381 million at 30 September 2011 (£25 million to Portugal, £14 million to Ireland, £117 million to Italy and £225 million to Spain). This comprised £39 million senior debt, £15 million Tier 1 debt, £215 million Tier 2 debt and £112 million of covered bonds. There was no exposure to Greece in respect of bank debt. In addition exposure to French banks was £188 million at 30 September 2011.

Of the £55.9 billion of debt securities backing shareholder business (excluding holdings attributable to external holders of consolidated unit trusts), five per cent (£2.5 billion) was in Tier 1 and Tier 2 hybrid bank debt. In addition to the Tier 1 and Tier 2 PIIGS and French bank exposures set out above we had £454 million exposure to the US, of which £30 million was Tier 1, £703 million exposure to the UK, of which £74 million was Tier 1, and £980 million of other exposures, of which £267 million was Tier 1.

ENDS

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Notes:

Footnotes

¹ Asia 2010 comparative APE new business sales and new business profit exclude the Japanese insurance operations which ceased writing new business from 15 February 2010
² Unless otherwise stated all growth rates are on a sterling basis. Growth rates on constant currency are presented on schedule 1B of the Interim Management Statement
³ The assumptions underlying new business profit are presented in schedule 5 to the Interim Management Statement
⁴ Investment flows excluding Asia Money Market Fund (MMF) year-to-date net outflows of £0.3 billion (2010: net outflows of £1.8 billion)
⁵ The assumptions underlying new business profit are presented in schedule 5 to the Interim Management Statement
⁶ Asia 2010 comparative APE new business sales and new business profit exclude the Japanese insurance operations which ceased writing new business from 15 February 2010
⁷ Gross Investment flows excluding Asia Money Market Funds (MMF) outflows
⁸ Percentages based on unrounded numbers
⁹ Source: LIMRA
¹⁰ Source: Morningstar Annuity Research Center (‘MARC’)
¹¹ Source: Cogent Research Advisor BrandscapeTM 2011. Rankings based upon an online survey of a representative cross section of 1,643 registered financial advisors conducted between April 15 and May 9, 2011.
¹² Source: Annuity Specs
¹³ Source: Lipper FMI Fund Flash Report (October 2011)
¹⁴ Source: Fundscape Pridham Report (August 2011)
¹⁵ The benchmark for the fund is the iBoxx Sterling Non Gilts Index
¹⁶ Returns are gross estimates on an offer to offer basis