Financial Overview

Garth Jones

For the next couple of days, we will be going into more detail about various aspects of the business. These are the four main messages I will have for this financial overview section. We have a track record of consistent delivery over many years. Diversity is one of our core strengths, across the dimensions of products, distribution and geography. We have regional scale, and this is a major advantage. This isn't just scale in one market, this is scale in a number of markets. And lastly, and most importantly, in all that we do our strong focus is on volume creation.

I'm sure to all of you this is a familiar slide and I will not spend a great amount of time on the details. Key point is that we first started using this slide back in 2000 and we've been rolling it forward ever since. For every year since 2000 this chart has shown an impressive historic track record. You will see similar growth rates to the high CAGR's there, the previous charts.

Last time some of you where in Asia, the theme was: best is yet to come. I'm sure you all remember that. Since then you can see that our Life business has been delivering high compound rates, mainly through organic growth. Our Mutual Fund business is also growing rapidly to a business of substance that complements and enhances our overall proposition. You can see our margins have reduced slightly, that's principally due to a changing mix. But they have been maintained at very attractive levels and they have picked up in the first half of 2004. Over the next couple of days we will be showing you that there is still a tremendous amount of growth potential here in Asia. For obvious reasons we didn't reuse the theme of the last Asia visit of 'the best is yet to come'. (Over the sentiment does underpin?), the theme of this time: 'seizing the opportunity'. And I look forward to presenting a similar slide to this in a few years time, which shows a continued record of delivery.

Mark mentioned earlier our successful diversification and I will illustrate this over the next three slides. We believe that this diversity across the critical dimensions of geography - distribution - product is one of our core strengths and differentiators. Looking first at geography, you can see that back in 1994 all our business came from what we call our 3 established markets; that's Singapore, Malaysia and Hong Kong. Now you can see our geographic diversity today, with PCA's established markets contributing 40% of sales. We have a balanced spread of operations that make a significant contribution to sales, clear competitive advantage.

Diversity lightness enables us to successfully smooth out the inevitable ups and downs and other one-off issues that arise in any particular country. You can also see the great success we've had with our newer markets: China, India and Vietnam, which were all green field start-ups 4 or 5 years ago.

Moving on from geography you can see how we have successfully diversified our distribution net. In 1994 we were pretty much all agency. Now you can see that while agency remains our largest channel, we had great success with partnership distribution, which includes bank assurance, direct and telemarketing and some brokers. Together these now constitute around a quarter of sales. We were one of the earliest companies to recognise the potential of bank assurance distribution. Those of you who 've been around in this region for a long time will remember that 5 or 10 years ago there was very little bank assurance in this region. We anticipated that growth, proactively, by establishing these channels at an early date and you will remember our pioneering deal with Standard Chartered several years ago.

We do not see Partnership Distribution as a substitution for Agency; rather the growth in partnership distribution has enabled us to successfully reach new customers and increase sales, above the sales that we would have from Agency. We offer a true multi-channel distribution in the same country, under the same brand. I believe we are the only regional player that truly embraces the multi-channel model in this way. With true multi-channel distribution under the same brand, in a single country. Again, I believe that the ability to manage the business successfully in this way provides a competitive advantage as markets develop over time.

The last aspect of diversity I want to talk about is how we have maintained a good, well diversified product portfolio, in spite entering new markets and adding new distribution capabilities.

Looks pretty similar. And you know all we're saying: well, so what? Great slide. What this shows is that we've done a great job in actively managing our new business achieved profit margins and we've done this through carefully managing our product mix to retain a balance of product sales.

The last three slides have illustrated the breath and diversity of our business across the key 3 dimensions: geography, product and distribution. We believe this diversity is a real competitive advantage, not only because it reduces volatility and improves risk management, but also since it allows attractive opportunities to be seized wherever they occur, and our resources to be leveraged quickly to good effect. It can also transfer successful ideas in one market to another very quickly.

I'll be talking to you about products and margins later on today, however, here are a couple of summary slides. This slide provides greater insight into the current drivers of NBAP in aggregate for Prudential Corporation Asia. By looking at the sales volume and margin variation by country and product. Sales volume is on the x-axis, while new business is on the y-axis; size of the bullet is illustrative of the resulting absolute levels of NBAP. Looking at products at the left hand side first. You see that the 3 regular premium bubbles that is the A&H business, Linked Regular Premium and Traditional Regular Premium contribute the majority of PCA's new business achieved profits and provide progressively increasing scale. Single Premium supplements Regular Premium Business, but are less profitable, particularly Traditional Single Premium business. We are therefore very clear in our strategy to avoid cannibalisation of Regular Premium sales by Single Premium products. Turning to geography on the right hand side, top-5 countries by NBAP is the same list as for weighted sales. Taiwan's profitability has improved significantly in the last few years with the introduction of Unit Link business, having a dramatic effect. And we've seen margins in Taiwan increase from a level of 34% in 2001 to 57% in 2004. Hong Kong on the other hand has a greater proportion of Traditional business and hence margins are lower. But I should stress that they still remain at very attractive levels.

Margins have been managed within a fairly tight range in recent years, averaging 55%. And standard deviation of this is about 5%. We currently see no reason for this picture to change dramatically in the near term.

One comment that I've heard is that PCA's growth has been principally through acquisition. This slide illustrates that the business has grown organically at a fast rate. The established markets, Singapore, Malaysia and Hong Kong, where we've been operating for a number of years, have grown steadily and strongly at a Compound Annual Growth Rate of 19%. We've acquired and "prudentialised" a number of businesses over the years in Indonesia, Thailand and Taiwan, with Japan and Korea added in 2001. Since 2001 we've driven volume growth by increasing sales in these businesses post acquisition with a compound growth rate of 25%. Of green field start-ups, Vietnam, India, China and Philippines have grown very rapidly at a 69% growth rate to quickly attain significant size. As you can see, strong organic growth across all three types of businesses has been successfully achieved in the past and we expect continued organic growth in the future.

This is a key slide to show how real scale is being built by Prudential Corporation Asia. This scale is being built progressively and quickly by a core of growing Regular Premium business that combined with good persistency produces Renewal Premium growth. This is supplemented by Single Premium sales.

Renewal Premium produces steady increase in cash-flow that continues to grow with each successive year's new Regular Premium business. With increased sale, the business becomes more efficient, as the fixed costs base becomes spread over a larger enforced business, thereby improving profitability and accelerating cash-flow generation. In 2003 revenue premiums from Regular Premium business where over £1.5 billion. So even if we sold no more new business we would be collecting substantial sum each year going forward. We therefore have a stable and growing foundation from which to continue to build further scale.

Premium New business flows are more volatile from year to year, particularly where these are sourced through partnership distribution. We take a view that Single Premiums are supplemental to Regular Premium sales and as a result we are far less susceptible to this volatility than some competitors. And we have more stable cash inflows.

Our Mutual Funds business shows a similar picture of progressive organic growth. The inception of the business was in India in 1998, which is growing steadily and strongly. We rapidly doubled funds in Management in Taiwan after acquisition and we have grown our Mutual Funds business elsewhere in the region. (Atjeh?) will talk about this in much more detail later on, but the point I want to make here is that we have grown a material Mutual Fund business organically, with strategic acquisitions to start the business in certain countries where this made sense.

Not surprisingly, this chart of total funds under management of the Life and Mutual Funds sourced in Asia, mirrors the previous charts. But nevertheless, I thought it was important the show how this quickly is growing and point out that funds under management have grown at a tremendous rate. They will soon reach £15 billion. This growth in scale enables us to attract the best talent to manage these assets, and build the Funds business of breath and depth of capability in the region; again, a key competitive advantage.

Now, let's look at how all of this comes together, as value is being created. Over the next few slides I'd like to show how our strategy is being translated into embedded value translation by looking at the breakdown of the chance in AP shareholder funds over the last three years. Firstly, looking at the growth on a like-for-like or long-term basis, AP shareholder funds, have grown to close to £2 billion or by more than 2.5 times with the vast majority of this growth coming from the growth in operations, rather than net new capital for acquisitions and working capital.
Interest rates have declined and we have widened the differential between risk-free and assumed discount rates. These changes in economic assumptions have impacted values adversely, leaving a net embedded value, added a constant exchange rate of £609 million. This represents an after-tax return on equity of around 17% per annum.
PCA's businesses are predominantly based in currencies that are correlated to the US Dollar. As a result, embedded value in Sterling terms has been impacted by £233 million over the last 3 years, as the strength of the US Dollar has waned. Exchange rates have remained constant. Closing AP funds would have been £1.6 billion, rather than £1.4 billion or 16% higher.

The next slide that I'll show analyses the operating achieve profits, a component of £873 million that is shown in red on this chart. Main driver of operating achieved profits is new business achieved profits, as is expected in a dynamic growing business that is Prudential Corporation Asia. This realises the importance of our focus on the growth in New Business achieved profits, which is the principal component of our variable bonuses. However, as the Amforce continues to grow steadily, so does the Unwind. And over the 3-year period, this would significant at close to £300 million. Quite rightly people do get concerned about assumption changes and experience variances. But I think this chart puts both of these into context. Both operating assumption changes and variances have added positively to the tune of over £100 million, whilst variances have been reduced and they are small in relation to gross operating profits of £1.25 billion over the period.

I've already shown that achieved profit variances are small. However, I know that these are a concern of yours when assessing the creditability of our AP assumptions, and hence I'll cover them in more detail. Variances continue to reduced and when viewed as a percentage of Opening Achieved Shareholders Funds, the reduction is dramatic. Further, as each of the businesses attain larger scale, we have seen greater stability of experience. This further increases our confidence in our assumptions, or indicates where they need to change either positively or negatively.

Breaking the variances down into more detail- we are prudent when setting claims assumptions and closely monitor our underwriting and claims positions very carefully. Consistent positive variances have therefore, not surprising, although this is particularly important in very fine or higher margins on ANH business, which is protection related.

Expenses are our largest adverse variance, reflecting the relative youth of some of our businesses, where our (Enforce book?) has not yet attained long-term scale. You will however recall from my earlier slide on Revenue Premiums that scale is increasing quickly, and you'll see that expense variances are reducing. Persistency experience can vary. Here you can see that we've had two years with small positives, and last year was negative. Over time, we expect Persistency variances to balance out and I'll show you this on the next slide.

Some of you may recall that I've used this slide back in March 2002. Then, as now, over several years Persistency variances tend to average out at pretty close to 0.

Having looked at the achieved profits and value, the next few slides will focus on capital and how PCA is moving towards, what I call a 'sweetspot', where sales are growing strongly; at the same time the capital is being remitted. To do this I use an illustration.

This is a little complicated, so I ask you to listen carefully and take a swig of coffee. The following charts are based on the expected cash-flows from the total of Prudential Corporation's new business that was written in 2003. This is in isolation of the inforce business, development costs, and so on, that are overlaid to produce our overall cash-flow. The charts here do not therefore include cash-flows from Inforce business, before 2003, development costs, and so on. I think, however, they are an important illustration. Cash-flows are per 1 million of sales in year 1, and the scale is in 100,000's. So 5 on the scale is 500,000.

The red bar in year 1 is the new business strain of 215,000 of sales in year 1 of 1 million, which represents an average new business strain PCA of 21.5% in 2003. (The stills where sales in year 1?). For this illustration I have assumed that new business grows at a rate of 20% per annum and sales in year 2 are 1.2 million and so on.

The resulting charts in the next few slides, show how the aggregate cash flows from all years of business then build up as we have progressive growth. Cash-flows in the illustration have been built up by combining the cash-flows over subsequent multiple years of new business, not only year 1.

Firstly, looking at new business strain. This grows in line with sales growth of 20% per annum. We now look at the combination of increasing new business strain in red, and positive cash-flows from earlier sales in green. We can see that the net cash-flow from the Portfolio is increasing. In earlier years, external capital support is required, since the positive cash-flows from a small book of inforce business are insufficient to fund the capital strain and new sales. Cumulative cash-flow figures for the portfolio as a whole are therefore negative.

As the inforce business gains greater scale over time, the cash-flow from inforce business eventually exceeds the increasing new business strain. Cash-flow turns positive in year 3, and thereafter cumulative cash-flow improves. After year 5 retain losses are exhausted and the business provides surplus capital for remittance dividends.

Looking at cash-flows year by year, rather than on a cumulative basis, you can see that cash surplus for remittance is increasing year by year, despite continued growth of new business. This is what I call the 'sweetspot' for a Life Insurance business, with both substantial growth, and increasing levels of cash remittance. So once again, we have growing new business strain, early capital support, as the business grows, the inforce grows, scale is leveraged, we have capital remittances, and the business continues to grow. A similar picture will result with different businesses, however, the key factor is that the return on capital invested in new business strain, or IRR, should exceed the rate of growth of new business. Pete Lloyd will talk about this further in a later session, however, currently for PCA in aggregate, we have aimed to achieve an IRR of at least 20%, whilst our current business has an IRR that exceeds 30%.

This slide is a very representation of where our businesses are today and how they move to becoming cash generators over the next few years. The time it takes to generate surplus cash depends on the size of the inforce book relative to new business volumes, the IRR on new business, and the rate of new business growth. This chart shows on one axis the profitability and size of the inforce, with our established businesses topmost, and businesses that are growing strongly but have still have to attain long-term scale in Japan and Thailand at the low-end. The other axis shows the ability to (fund?) growth internally, which is higher in our Funds business, Indonesia and Malaysia, all of which require little additional capital to support high growth; whilst, China, India and Japan will require more capital to fund their growth.

The previous slides translated to our capital flows to and from Group, and support our expectation that PCA will be a net cash contributor to the Group by 2006. I want to stress here that that expectation is not driven by the fact that we have stopped growing, or stopped investing for growth. But simply, it is a factor of our highly profitable sales and increase in scale.

Throughout the next couple of days, we will be going to more detail about various aspects of the business and you will be hearing from me again. However, at the outset, these are the main messages I have for this financial overview section: firstly, we deliver. You've seen that track record. Secondly, diversity is one of our core strengths, and one that is difficult to replicate. Thirdly, our regional scale is a major advantage that we are leveraging actively. Fourthly, underpinning all of that we do is our strong focus on long-term volume creation. PCA is approaching the sweetspot of both growth and capital repatriation going forward. With that I'll pass over to Mark, who is going to facilitate the Q&A.

Close this window