United Kingdom

Introduction

During the first half of 2008, Prudential UK continued to focus on the increasing need for retirement solutions through competing selectively in areas of the market where it can generate attractive returns. With an ageing population and the concentration of UK wealth in the mass affluent and high net worth sectors, the retirement and near-retirement segment is set to be the fastest-growing market. Low savings rates and high levels of consumer debt, combined with a shift in responsibility for providing income during retirement from Government and employers towards individuals, have resulted in individuals being inadequately provided for during increasingly long periods of retirement.

Prudential UK has a unique combination of competitive advantages including its significant longevity experience, multi-asset investment capabilities and its brand and financial strength which put it in a strong position to pursue its value driven strategy in its two principal businesses: Retail and Wholesale.

Prudential UK's Retail business is focusing on savings and income for those customers nearing or in retirement and aims to continue to drive profitable growth in its core annuities operation, grow its presence in the equity release market and maximise the opportunities in retirement savings on the back of its strong multi-asset performance record.

The significant 25-year pipeline of internal vestings annuity business from maturing individual and corporate pension policies, where Prudential UK offers a competitive proposition for its internal vestings customers, is enhanced by strategic partnerships with third parties where Prudential UK is the recommended annuity provider for customers vesting their pension at retirement. Prudential UK, with approximately 1.5 million annuities in payment, is the largest provider in the UK market.

Investing in property has been an increasingly important component for many people saving for their retirement. With an estimated £725 billion owned by pensioners in property in the UK, pensioners can consider options such as equity release to help deliver an adequate income in retirement. This is likely to become increasingly important as people live longer and the cost of living continues to rise.

Prudential UK's total retail with-profits business has performed very strongly across a range of products. This demonstrates clearly that with-profits, when invested in an actively managed, well-run and financially strong fund, can produce good returns for the cautious investor. Prudential's with-profits products offer a medium- to long-term, medium risk investment, with exposure to a diverse range of assets, skilled management of those assets and smoothed returns, all of which are particularly important to many customers against the backdrop of market volatility.

Prudential UK continues to be a market leader in the corporate pensions market where it is a provider to over 20 per cent of FTSE 350 companies and the largest provider of pension schemes to the UK public sector. Prudential UK now administers corporate pensions to over 640,000 members.

Our joint venture with Discovery to provide Health and Protection insurance based on rewarding healthy lifestyles with lower premiums continues to grow rapidly. At the end of June, PruHealth covered approximately 175,000 lives.

Prudential UK's strategy in Wholesale is to participate selectively in bulk annuity and back-book buyouts. Prudential UK will maintain a strict focus on value, only participating in transactions that generate an acceptable rate of return.

Financial performance

In an environment of volatile capital and equity markets, a decline in the housing market and general economic uncertainty, Prudential UK has delivered a strong set of figures. Total UK APE sales in the first half of the year grew by 18 per cent to £430 million and new business profit increased 19 per cent to £129 million. Sales in the second quarter were 33 per cent higher than the same period last year. The average new business margin for the half year was maintained at 30 per cent.

UK APE sales £m

UK new business profits £m

Retail sales of £398 million were 11 per cent higher than 2007. Individual annuities continued to deliver substantial sales volume. Sales growth was driven by strong performances in with-profits bonds and offshore products, supplemented by good sales of corporate pensions and encouraging growth in its equity release range. Prudential UK also completed a bulk annuity reinsurance contract with Goldman Sachs for the reinsurance of £30 million APE of Rothesay Life's non-profit annuity business. Prudential and Goldman Sachs will consider opportunities for future cooperation to provide joint solutions in selected situations in the defined benefit scheme risk management market.

Individual annuity sales at the half year of £141 million were in line with those achieved in the first half of 2007, with the second quarter sales up four per cent on the same period last year. This good performance in the second quarter was underpinned by a continued focus on the strong internal vestings pipeline which contributed more than 50 per cent of total individual annuity sales.

Prudential UK is now the market leader in the lifetime mortgage market, with over a 25 per cent share in the second quarter of 2008, based on new business advances. Sales in the second quarter were 40 per cent higher than in the first quarter of 2008. Total half-year sales of £12 million were 71 per cent higher than the first half of 2007. Prudential UK is now seeing strong contributions from the intermediary and direct markets as well as steadily increasing drawdowns from existing customers.

Prudential UK's total retail with-profits business has performed very strongly across a range of products, with total sales of £183 million up 32 per cent on the first half of 2007. Sales of with-profits bonds of £48 million were up 182 per cent on the first half of 2007, reflecting the strength of Prudential's with-profits fund performance and an increasing demand for this type of product.

Offshore sales of £34 million were up 48 per cent on the first half of 2007, driven by strong sales in the UK, which have been reinforced with the launch of our new open architecture Portfolio Account in March 2008.

Half-year corporate pensions sales of £126 million were two per cent higher than those achieved in the same period last year. Existing accounts in the public sector performed strongly and we also secured Nationwide's deposit based Additional Voluntary Contribution (AVC) business, affirming our status as a leading provider in this market. However, sales within Prudential UK's shareholder-backed business, where pricing is extremely competitive and where it maintained its strict pricing discipline rather than matching competitor pricing, fell by 11 per cent.

Total new business profits of £129 million were 19 per cent higher than the same period in 2007. Retail new business profits grew by 10 per cent to £124 million. The Wholesale new business profit of £5 million reflects the bulk annuity contract completed with Goldman Sachs, which met our target return criteria and was inclusive of the costs of the Wholesale operation. This performance demonstrates the continuing benefits of selectively participating in product lines that deliver sustained sales growth while at the same time maintaining a pricing discipline that ensures attractive returns. An average new business margin of 30 per cent was achieved in the first half of 2008, consistent with the same period last year.

UK EEV basis operating profit £m

EEV basis operating profit based on longer-term investment returns of £504 million, before restructuring costs of £5 million, was up nine per cent on the first half of 2007. The in-force operating profit of £375 million was up six per cent on the first half of 2007, although 2007 benefited from the £67 million positive operating assumption change reflecting the change in the long-term tax rate assumption from 30 per cent to 28 per cent.

Prudential UK continues to manage actively the retention of its in-force book. During 2008, experience at an aggregate level has been in line with our long-term assumptions.

IFRS operating profit increased 14 per cent to £286 million before restructuring costs of £4 million. This included £198 million of profits attributable to the with-profits business, reflecting strong long-term investment performance and its impact on terminal bonuses.

Prudential UK writes with-profits annuity, with-profits bond and with-profits corporate pension business in its life fund, with other products backed by shareholder capital. There were no defaults in Prudential Retirement Income Limited (PRIL) in the first half of 2008 and PRIL has no direct exposure to the US sub-prime market.

The weighted average post-tax IRR on the shareholder capital allocated to new business growth in the UK was 15 per cent.

The agreement announced in 2007 with Capita to outsource a large proportion of Prudential UK's in-force and new business policy administration commenced in April 2008. This agreement will deliver £60 million per annum of savings to Prudential UK and is an important element in achieving its total cost savings target of £195 million by the end of 2010. This contract also provides a significant reduction in long-term expense risk by providing certainty on per-policy costs as the number of policies in the mature life and pensions book decreases over the coming years. Unit costs per policy are expected to reduce by over 30 per cent by 2011.

Financial strength of the UK long-term fund

The PAC's long-term fund remains very strong. On a realistic valuation basis, with liabilities recorded on a market consistent basis, the free assets are valued at approximately £7.7 billion at 30 June 2008, before a deduction for the risk capital margin. The financial strength of PAC is rated AA+ (stable outlook) by Standard & Poor's, Aa1 (negative outlook) by Moody's and AA+ (stable outlook) by Fitch Ratings.

In the first half of the year, Prudential's with-profits life fund has been impacted by the difficult conditions in financial markets, with negative returns from its holdings in equities, property and bonds. The fund returned negative 6.8 per cent gross in the first half of the year.

In the light of the significantly wider level of credit spreads in major markets, the decision was taken earlier in the year to progressively close the hedge on the fund's credit exposure that had been taken out in 2007 at a profit.

In anticipation of much higher volatility in financial markets, the decision was also taken to reduce Prudential's equity exposure, for tactical purposes in that part of the fund attributed to the estate, which was beneficial.

Although market conditions remain extremely testing, they provide some value opportunities for investors with a long-term investment horizon.