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ACHIEVED PROFIT REPORTING Philip Broadley & Andrew Crossley 2 May 2002

ACHIEVED PROFIT REPORTING Philip Broadley & Andrew Crossley 2 May 2002.

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ACHIEVED PROFIT REPORTING Philip Broadley & Andrew Crossley 2 May 2002

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  1. ACHIEVED PROFIT REPORTING Philip Broadley & Andrew Crossley 2 May 2002

  2. This presentation may contain certain “forward-looking statements” with respect to certain of Prudential’s plans and its current goals and expectations relating to its future financial condition, performance and results. By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events and circumstances which are beyond Prudential’s control including among other things, UK domestic and global economic and business conditions, market related risks such as fluctuations in interest rates and exchange rates, the policies and actions of regulatory authorities, the impact of competition, inflation, deflation, the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries, as well as the impact of tax and other legislation and other regulations in the jurisdictions in which Prudential and its affiliates operate. As a result, Prudential’s actual future financial condition, performance and results may differ materially from the plans, goals and expectations set forth in Prudential’s forward-looking statements.

  3. AGENDA • Purpose of presentation • Why was Achieved Profit reporting developed? • Alternative insights provided by Achieved Profits method • Achieved Profits methodology • Assumption setting process • Issues raised by Achieved Profits method • Economic assumptions used in 2001 results • Prudential’s Achieved Profits results • International Accounting Standard

  4. WHY WAS ACHIEVED PROFITS REPORTING DEVELOPED? • Need for companies to demonstrate fair value of in-force business • Limitations of Modified Statutory Basis (MSB) in the UK • With-profits business profit profile directly related to policyholder bonus profile with large terminal bonus - does not reflect when risk borne or work is done • MSB profit emergence gives little information on current management performance in managing the inforce book or profitability of new business

  5. ALTERNATIVE INSIGHTS PROVIDED BY ACHIEVED PROFITS METHOD • Value added system based on projected statutory cashflows • Profitability of new business reported as it is written - allows trends in margin and mix to be assessed • Allows success of ongoing management of the inforce book to be determined - analyses the effect of changes in unit costs, persistency, mortality & spread as they happen • Differences between actual and assumed experience reflected if/when variance occurs • Internally, value reporting provides greater focus on future impact of current management actions • Used as a valuation tool for M&A activity

  6. ACHIEVED PROFIT METHODOLOGY • Achieved profits based on change in balance sheet values • Profit deferral built into method: - based on statutory reserves - discounting of future cashflows - allowance made for cost of holding solvency capital • AP result analysed into profit arising from new business sales, discount unwind, actual experience differing from expected and impact of changes in underlying assumptions • Sensitivities of result to key economic assumptions disclosed • Methodology and disclosure requirements are described in ABI guidance note dated December 2001 • Method, assumptions & results are subject to external audit

  7. OPERATING ASSUMPTIONS • Assumptions not locked-in • Operating assumptions reflect recent actual experience • Reassessed annually against emerging experience • Expected favourable changes in operating experience are not anticipated • Future changes in operating experience are reflected in assumptions where they have an adverse impact on value (eg mortality improvements on immediate annuity business) • Assumptions made for all main items (expenses, mortality, lapses, withdrawals, pension vestings etc)

  8. ECONOMIC ASSUMPTIONS • Economic assumptions reflect a (deterministic) view of the future external environment (earned rate, discount rate, inflation, tax) for each territory • Assumed bonus rates are a function of the assumed earned rate • The earned rate reflects asset allocation and expected asset returns • The new ABI guidance is based on an “active” approach to economic assumption setting (eg based on appropriate bond yields at the balance sheet date with appropriate equity & risk premiums)

  9. ISSUES RAISED BY ACHIEVED PROFITS METHOD • Reliability of operating assumptions - substantial volume of experience over many years - modelled over large number of individual policies • Volatility of results - largely arises through economic variances - variances can be separately identified • Long term investment return assumptions do not take account of short term volatility • Choice of appropriate risk discount rate • Consistency with competitors - for UK companies, new ABI guidance gives greater consistency

  10. ACHIEVED PROFITS - ECONOMIC ASSUMPTIONS 2001 Prudential Aviva (CGNU) L&G UK operations • Pre-tax return on UK equities 7.5 7.5 7.6 • Pre-tax return on fixed interest gilts 5.0 5.0 5.0 • Pre-tax return on corporate bonds 6.0 n/a 5.4 - 6.3 • Risk discount rate (post-tax) 7.7 7.7 7.5 US operations (Jackson National Life) • Expected spread between earned and 1.75 n/a n/a credited rates • Risk discount rate 7.7 n/a 7.6 Asian operations • Weighted investment return 7.3 n/a n/a • Weighted risk discount rate 10.1 n/a n/a

  11. PRUDENTIAL - NEW BUSINESS ACHIEVED PROFITS Pre-tax New Business Achieved Profit* New Business Margins** 2001 2000 1999 2001 2000 1999 £m £m £m % % % UK 243 230 308 30 31 32 US 167 221 198 35 44 46 Asia 255 153 90 59 60 73 Europe 8 9 7 31 39 33 Group total673 613 603 38 40 39 * after cost of capital ** Margin = pre-tax NBAP as percentage of Annual Premium Equivalent (APE) sales

  12. PRUDENTIAL - IN FORCE ACHIEVED PROFITS 2001 2000 1999 £m £m £m UK - unwind of discount 384 429 384 all operating variances (6) 19 (7) change of operating assumptions (1) 30 0 Total UK 377 478 327 US - unwind of discount 200 218 201 average realised gains (74) 19 37 return on surplus assets 44 34 26 spread (12) 39 32 persistency (7) (24) (38) expenses (16) (37) (8) mortality & other variances 14 7 27 change of operating assumptions (13) (258) 0 Total US 136 (2) 277 Asia - unwind of discount 78 58 43 all operating variances 16 2 (8) change of operating assumptions 66 0 0 Total Asia 160 60 35 Europe - unwind of discount 9 8 6 all operating variances (9) 0 0 Total Europe 0 8 6

  13. PRUDENTIAL - ACHIEVED PROFITS - OPERATING PROFIT 2001 2000 1999 £m £m £m New business - group total 673 613 603 In force - UK 377 478 327 US 136 (2) 277 Asia 160 60 35 Europe 0 8 6 Other - Non long term businesses 82 10 (8) Other income and costs (242) (138) (142) Total group operating profit 1,186 1,029 1,098

  14. PRUDENTIAL - ACHIEVED PROFITS - TOTAL PROFIT 2001 2000 1999 £m £m £m Operating profit - group total 1,186 1,029 1,098 Short term fluctuation in investment returns (1,402) (440) 637 Effect of change in economic assumptions (482) - - Other 243 139 (54) Pre-tax profit (loss) on ordinary activities - group total (455) 728 1,681

  15. PRUDENTIAL - ACHIEVED PROFITS - BALANCE SHEET 2001 2000 1999 £m £m £m UK 3,656 4,227 4,127 US 2,683 2,671 2,409 Asia 1,089 793 593 Europe 90 82 68 Centrally held 632 1,003 1,145 Group total 8,150 8,776 8,342

  16. PRUDENTIAL - ACHIEVED PROFITS - SENSITIVITIES £m £m New Business Achieved Profit - Group Total 673 New Business Achieved Profit - Group Total 673 1% decrease in long-term investment return (99) 1% increase in long-term investment return 105 1% decrease in risk discount rate 83 1% increase in risk discount rate (72) AP Shareholder Funds - Group Total 8,150 AP Shareholder Funds - Group Total 8,150 1% decrease in long-term investment return (779) 1% increase in long-term investment return 824 1% decrease in risk discount rate 592 1% increase in risk discount rate (494)

  17. INTERNATIONAL ACCOUNTING STANDARD • IAS - will replace MSB reporting - probably asset/liability model - may reflect fair value of liabilities - not all insurance contracts within scope - will not be value based • Achieved Profits reporting will have a continuing role in providing additional useful information

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