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									Principles & Practices
of Financial Management
(Applicable to With-Profits business issued
by the Prudential Group to UK policyholders)
Index


 Introduction                                                                                                             6

A      Purpose of the PPFM (PPFM)                                                                                         6

B      Principles and Practices                                                                                           6

C      Structure of Prudential Group                                                                                      7

       C1       Company Structure                                                                                         7

       C2       Structure of PAC                                                                                          8

                C2.1    With-Profits Sub-Fund (WPSF)                                                                      9

                C2.2    Scottish Amicable Insurance Fund (SAIF)                                                           9

                C2.3    Defined Charge Participating Sub-Fund (DCPSF)                                                    11

                C2.4    Non-Profit Sub-Fund (NPSF)                                                                       12

       C3       Information about relevant Companies (other than PAC)                                                    12

                C3.1    Scottish Amicable Life plc (SAL)                                                                 12

                C3.2    Prudential (AN) Limited (PANL)                                                                   12

                C3.3    Prudential International Assurance plc (PIA)                                                     12

D      Risk Management of PAC                                                                                           12

E      Governance arrangements for with-profits business                                                                13

 Principles and Practices of Financial Management                                                                       14

1.     Determining With-Profits Policy Values                                                                           14

       1.1      Introduction                                                                                             14

       1.2      Principles                                                                                               14

       1.3      Practices                                                                                                15

                1.3.1   Pay-out values                                                                                   15

                1.3.2   Regular Bonus Rates                                                                              15

                1.3.3   Final Bonus Rates                                                                                16

                1.3.4   Smoothing of Maturity and Death Benefits                                                         16

                1.3.5   Target ranges for Maturity Benefits                                                              17

                1.3.6   Surrender Values and Market Value Reductions (MVRs)                                              17

                        1.3.6.1 Accumulating with-profits policies                                                       17

                        1.3.6.2 Conventional with-profits policies                                                       18

                        1.3.6.3 Target ranges for surrender benefits                                                     18
                                                                              Principles & Practices of Financial Management 3
                    1.3.7      Asset share approach                                                              18

                               1.3.7.1 Overview                                                                  18

                               1.3.7.2 Investment Return                                                         18

                               1.3.7.3 Tax                                                                       18

                               1.3.7.4 Guarantees and Smoothing                                                  19

                               1.3.7.5 Mortality and Morbidity                                                   19

                               1.3.7.6 Shareholder Profit                                                        19

                               1.3.7.7 Miscellaneous Profits and Losses                                          19

                               1.3.7.8 Expenses and Commission                                                   20

                    1.3.8      Significant variations in practice for specific types of PAC policy               20

                               1.3.8.1 Business originally issued by Scottish Amicable Life plc (SAL)            20

                               1.3.8.2 With-Profits Annuities (issued by PAC)                                    20

                               1.3.8.3 Defined Charge Participating Sub-Fund (DCPSF) business (non ELAS)         21

                               1.3.8.4 Defined Charge Participating Sub-Fund (DCPSF) business (ELAS)             21

                               1.3.8.5 PruFund Range of Funds                                                    22

                               1.3.8.6 Income Choice Annuity                                                     23

                    1.3.9      New bonus series                                                                  24

          1.4       Variations for Scottish Amicable Insurance Fund (SAIF) and Scottish Amicable Account (SAA)
                    with-profits policies                                                                        24

2.        Investment strategy                                                                                    25

          2.1       Introduction                                                                                 25

          2.2       Principles                                                                                   26

          2.3       Practices                                                                                    26




4 Principles & Practices of Financial Management
3.     Business Risks                                                                                                      28

       3.1    Introduction                                                                                                  28

       3.2    Principles                                                                                                    28

       3.3    Practices                                                                                                     28

4.     Charges and Expenses                                                                                                30

       4.1    Introduction                                                                                                  30

       4.2    Principles                                                                                                    30

       4.3    Practices                                                                                                     30

5.     Management of the Inherited Estate                                                                                  30

       5.1    Introduction                                                                                                  30

       5.2    Principles                                                                                                    31

       5.3    Practices                                                                                                     31

6.     Volumes of new business and arrangements for stopping new business                                                  33

       6.1    Introduction                                                                                                  33

       6.2    Principles                                                                                                    33

       6.3    Practices                                                                                                     33

7.     Equity between with-profits policyholders and shareholders                                                          33

       7.1    Introduction                                                                                                  33

       7.2    Principles                                                                                                    33

       7.3    Practices                                                                                                     33


 Appendix A – SAIF Principles of Financial Management                                                                      34


 Appendix B – ELAS With-Profits Annuities – Principles of Financial Management                                             37


 Appendix C – Summary of Abbreviations                                                                                     47




                                                                                 Principles & Practices of Financial Management 5
 Introduction                                      The PPFM covers all with-profits policies    recommendation to policyholders or
                                                   issued in the UK by:                         potential policyholders or their advisers
A – Purpose of the PPFM                                                                         in relation to effecting or maintaining
All firms that carry out with-profits
                                                   >   companies in the Prudential Group
                                                                                                a with-profits policy. Accordingly,
                                                       (i.e. by The Prudential Assurance
business are required to define, and                                                            any person considering whether to
                                                       Company Limited (PAC), Scottish
make publicly available, the Principles                                                         effect or maintain a with-profits policy
                                                       Amicable Life plc which were
and Practices of Financial Management                                                           with any member of the Prudential
                                                       transferred to PAC with effect from
(PPFM) that are applied in the                                                                  Group should seek financial advice.
                                                       31 December 2002, Prudential (AN)
management of their with-profits funds.
                                                       Limited which were transferred to        None of the contents of this document
Prudential is committed to providing
                                                       PAC with effect from 31 October          forms part of, or varies, the terms or
open and honest communications and
                                                       2010 and Prudential International        conditions of any policy issued by any
we believe that the PPFM will help with
                                                       Assurance plc), and                      member of the Prudential Group. In the
that aim.
                                                                                                event of any inconsistency between
In managing with-profits business, firms
                                                   >   Scottish Amicable Life Assurance
                                                                                                the contents of this document and any
                                                       Society which were transferred to
rely on their ability to use discretion,                                                        policy, the terms and conditions of the
                                                       PAC with effect from 30 September
particularly in relation to the investment                                                      policy prevail.
                                                       1997.
strategy adopted, and the smoothing and
bonus policies used. The purpose of                                                             B – Principles and Practices
                                                   The PPFM also covers the With-Profits
Prudential’s PPFM is therefore to:                 Annuity business transferred by              In the PPFM we define the Principles
                                                   The Equitable Life Assurance Society         and Practices used in managing the
>   explain the nature and extent of the
                                                   (ELAS) to PAC with effect from               with-profits business of The Prudential
    discretion available;                                                                       Assurance Company Limited (PAC),
                                                   31 December 2007. For this purpose,
                                                                                                which includes business acquired by or
>   show how competing or conflicting              the definition of business transferred
                                                                                                reinsured into the company (see section
    interests or expectations of                   includes any business which was
                                                   excluded from the transfer, but which        C below).
    − different groups and generations             was reassured from ELAS to PAC on the
      of policyholders, and                                                                     >   The Principles define the overarching
                                                   basis that it would be dealt with as if it       standards adopted in managing PAC’s
    − policyholders and shareholders,              had been transferred.                            with-profits business to maintain the
                                                   To fully understand the risks and rewards        long-term solvency of the fund for
    are managed so that policyholders                                                               current and future policyholders and
        and shareholders are treated               of effecting or holding a Prudential with-
                                                   profits policy, the reader should read           describe the approach used:
        fairly; and
                                                   the whole PPFM and not just selected             − in meeting our duty to with-profits
>   give a knowledgeable                           sections. In particular, Principles should         policyholders, and
    observer (e.g. a financial adviser)            be read with their associated Practices
    an understanding of the material               (see Section B below). However,                  − in responding to longer-term
    risks and rewards from starting                the PPFM is not a comprehensive                    changes in the business and
    and continuing an investment in a              explanation either of the management               economic environment.
    with-profits policy with Prudential.           of the with-profits business of the
                                                   Prudential Group or of every matter
                                                                                                >   The Practices describe the
                                                                                                    approach used:
                                                   which may affect that business.
                                                                                                    − in managing PAC’s with-profits
                                                   Statements within the PPFM are by their
                                                                                                      business, and
                                                   nature forward-looking statements that
                                                   are subject to a variety of uncertainties;       − responding to changes in
                                                   this document should be read in that               the business and economic
                                                   context. In addition, no part of the               environment in the shorter-term.
                                                   document should be read as a
6 Principles & Practices of Financial Management
The contents of the PPFM may be                Principles. However, there may be            The most important aspects of the PPFM
amended in the future, either as the           circumstances when changes will be           have been summarised in customer
circumstances of the Prudential Group          made without notice with the agreement       friendly form called a CFPPFM. We have
change or business or economic                 of the Financial Services Authority.         a small number of different versions,
environments alter, or to reflect                                                           each appropriate to particular products.
                                               We expect our Practices to be revised
new product launches, or to reflect                                                         All with-profits UK policyholders who
                                               from time to time as both circumstances
changes in the management of the                                                            received an annual statement following
                                               and the business environment change.
with-profits business.                                                                      the February 2006 bonus declaration,
                                               We will notify affected policyholders in a
                                                                                            and all new policyholders from 1 January
In normal circumstances we would expect        reasonable period after the effective date
                                                                                            2006, received or will receive a CFPPFM.
to give affected policyholders written         of any such change, generally in their
                                                                                            Policyholders will be notified of any
notice at least 3 months in advance of         next annual statement.
                                                                                            significant changes we subsequently
the effective date of any change to the
                                                                                            make to the relevant CFPPFM.

C – Structure of Prudential Group

C1 Company Structure
Prudential plc owns, directly or indirectly, all or most of the shares of a number of insurance companies which are shown below,
as well as a number of other types of company which are not shown.


                                                    Prudential plc

                                                                    USA: Jackson National Life
                                                                    Asia:   Various Insurance Operations**

                          The Prudential Assurance Company Limited (PAC)
                              Shareholders Fund               Long-Term Fund


      UK:     Prudential Retirement Income Limited (PRIL)
              Prudential Pensions Limited (PPL)
              Prudential Health Limited *
              Prudential Health Insurance Limited *                            UK:    Prudential Annuities Limited (PAL)
              Prudential Holborn Life Limited (PHL)
                                                                               EU:    Prudential International Assurance plc (PIA)


  * Partly Owned
  ** Some Partly Owned
  Companies shown in bold type are referred to in the PPFM.


Prudential plc also owns, directly or indirectly, various investment management companies including M&G, PruPIM, Prudential Asset
Management Singapore and PPM America. A large part of PAC’s assets are managed by these companies.




                                                                                              Principles & Practices of Financial Management 7
C2 Structure of PAC                                                                         PAC’s life and pensions business is
PAC is a proprietary company, the shares of which are wholly owned by Prudential plc.       transacted mainly in the UK and is
PAC’s principal activity is life and pensions insurance business which is written in the    predominantly with-profits.
long-term fund; it also conducts some general insurance business outside of the long-
                                                                                            The UK with-profits business consists
term fund. The long-term fund is divided into four sub-funds which are described in
                                                                                            of business:
paragraphs C2.1 to C2.4.
                                                                                            >   written directly in PAC,

                                                                                            >   transferred into PAC from the Scottish
               The Prudential Assurance Company Limited (PAC)
                                                                                                Amicable Life Assurance Society
      Shareholders Fund                               Long-Term Fund                            (SALAS) on 30 September 1997 and
                                                                                                from Scottish Amicable Life plc (SAL)
                                                                                                on 31 December 2002,
     General           Other        With-Profits    Scottish     Defined       Non-Profit
    Insurance                       Sub-Fund       Amicable      Charge        Sub-Fund
                                                                                            >   transferred into PAC from Equitable
      Fund                                         Insurance   Participating                    Life Assurance Society (ELAS) on
                                       (WPSF)        Fund       Sub-Fund        (NPSF)          31 December 2007, and
                                       “90:10”                                  “0:100”
                                                      (SAIF)    (DCPSF)                     >   transferred into PAC from Prudential
                                                     “100:0”     “100:0”                        (AN) Limited on 31 October 2010.

                                                                                            PAC also contains with-profits business
                                                                                            written outside the UK, comprising
                                                                                            business:
                                  Prudential                     Prudential International
                               Annuities Ltd (PAL)                 Assurance plc (PIA)      >   written by branches of PAC in Hong
                                                                                                Kong, France and Malta,

                                                                                            >   reassured into PAC by
 This diagram does not indicate relative sizes.
                                                                                                – other insurance subsidiaries of
                                                                                                  Prudential plc, such as Prudential
                                                                                                  International Assurance plc (PIA),
                                                                                                  or

                                                                                                – Canada Life Assurance (Europe)
                                                                                                  Ltd, and

                                                                                            >   written by branches of ELAS and
                                                                                                transferred into PAC from ELAS on
                                                                                                31 December 2007.




8 Principles & Practices of Financial Management
With-profits business consists of with-             − the unitised with-profits               >    the investment content of SALAS’s
profits policies which share in the divisible         life business, other than its                unitised with-profits life business.
profit of PAC as determined each year in              investment content which
                                                                                              The balance of SALAS’s business was
accordance with the company’s Articles                was transferred to the Scottish
                                                                                              transferred to the WPSF and is allocated
of Association. The constituents of                   Amicable Insurance Fund
                                                                                              to the Scottish Amicable Account (SAA).
the divisible profit and the proportion               (see paragraph C2.2 below),
                                                                                              As the with-profits investment element
attributable to policyholders may vary by
                                                    − the non-profit life business, and       of SAA policies (i.e. the accumulation
product type; the proportion attributable
                                                                                              of premiums less charges) is invested in
to policyholders in the With-Profits Sub-           − the unit-linked life business.          SAIF, it is managed with all other SAIF
Fund (see paragraph C2.1 below) may
                                                The WPSF contains the PAC inherited           with-profits policies.
be varied by the company over time.
The PAC long-term fund is divided               estate, which consists of assets in the       SAIF also contains the SAIF inherited
into four sub-funds to facilitate the           fund over and above the amounts that          estate. This inherited estate consists of
management of the various risk-                 we would expect to pay out over time          assets in the fund over and above the
bearing and profit-sharing                      to existing policyholders as claim values     amounts that we would normally expect
arrangements that apply.                        (see PPFM paragraph 5.1.2).                   to pay out over time, if the fund had
                                                Divisible profit arising in the WPSF,         remained open to new business, to SAIF
The profits available to policyholders
                                                including profit that arises on the non-      and SAA policyholders as claim values
(if any) vary between the different
                                                profit business in the WPSF, is divided       (see PPFM paragraph 5.1.2). Under the
sub-funds as described below.
                                                between with-profits policyholders and        terms of the SALAS Scheme, the SAIF
C2.1 With-Profits Sub-Fund (WPSF)               shareholders. The Articles of Association     inherited estate will be distributed to
The With-Profits Sub-Fund (WPSF)                permit up to 5% of the divisible profit to    with-profits policyholders as an addition
consists mainly of with-profits business,       be transferred to a contingency fund          to the with-profits benefits arising in SAIF,
which is written by:                            before the balance is divided between         including those relating to SAA policies.
                                                policyholders and shareholders.               SAIF is provided with financial support
>   PAC, both Ordinary Branch (including
                                                The proportion of divisible profit
    Hong Kong and Malta) and Industrial                                                       from the WPSF by means of the Scottish
                                                attributable to with-profits policyholders    Amicable Capital Fund (SACF), in return
    Branch,
                                                in the WPSF is defined by the Articles        for an annual charge. SACF is treated as
>   SAL, and transferred into PAC, and          of Association as being at least 90%,         part of the free assets of SAIF for the
                                                with the balance attributable to              purposes of setting SAIF’s bonus and
>   PANL, and transferred into PAC.             shareholders. For virtually all business,     investment policy. However, SACF
The WPSF also contains a small amount           the policyholders’ proportion is currently    remains in the WPSF and does not
of non-profit business, which consists of:      90%. Thus the WPSF is a “90:10” fund.         form part of the SAIF inherited estate.
                                                C2.2 Scottish Amicable Insurance              SACF cannot exceed 15 per cent of
>   the non-profit (including unit-linked
                                                Fund (SAIF)                                   the with-profits fund in SAIF and will
    business) written by PAC that is not
                                                The Scottish Amicable Insurance Fund          reduce in size as the SAIF fund reduces
    allocated by the Directors to the Non-
                                                (SAIF) is a closed sub-fund that contains     as a result of policyholder payouts.
    Profit Sub-Fund (see paragraph C2.4
                                                the bulk of the business originally written   SACF would be used to fund any deficit
    below), and
                                                by the Scottish Amicable Life Assurance       in the smoothing account in accordance
>   certain types of business originally        Society (SALAS) and acquired by PAC           with the SAIF Principles of Financial
    written by the Scottish Amicable Life       on 30 September 1997. It contains:            Management (PFM) set out in the
    Assurance Society and now contained                                                       Scheme that transferred SALAS into
    in the Scottish Amicable Account,           >   SALAS’s pensions and annuity              PAC. These Principles are set out in
                                                    business (with-profits and non-profit),   Appendix A.
    which are:
                                                >   SALAS’s conventional with-profits life
                                                    business, and

                                                                                                  Principles & Practices of Financial Management 9
Elements of SAIF and the WPSF that are relevant to SALAS business are shown in the diagram below:


                                  WPSF                                                       SAIF

    Non-Profit Liabilities                                        Ex-SALAS Liabilities
                                                                  (with-profits and non-profit)
    Ex-SALAS business in the Scottish Amicable Account (SAA)
                                                                  >   Pensions business
    >   Unitised with-profits life (excl. investment content)
                                                                      – with-profits
    >   Non-profit life
                                                                      – non-profit
    >   Unit-linked life                                              – unit-linked

                                                                  >   Life business
                                                                      – conventional with-profits
                                                                      – unitised with-profits (investment content only)




    PAC Inherited Estate
                                                                  SAF Inherited Estate
    Scottish Amicable Capital Fund

  This diagram does not indicate relative sizes.




10 Principles & Practices of Financial Management
The Scheme which transferred SALAS           >   reassured into PAC from Prudential       For this business, the charges taken are
into PAC states that the Scottish                International Assurance plc (PIA) or     defined within the Scheme of transfer.
Amicable Funds (i.e. SAIF and SACF)              other companies, or                      There is a 1% per annum deduction from
must be managed in accordance with                                                        the gross investment return credited to
specified SAIF Principles of Financial       >   written through PAC’s French
                                                                                          asset shares. This charge accrues to the
                                                 branch (between 1 January 2001
Management (PFM). These are set out                                                       NPSF, which bears all expenses; hence
                                                 and 31 December 2003).
in Appendix A. These Principles:                                                          the shareholders receive any profits
                                             This business is defined as with-profits     or losses arising from the difference
>   include the over-arching provision
                                             business on which policyholders incur        between this charge and the expenses
    that the Scottish Amicable Funds
                                             only the charges stated explicitly in        (including the capital charge from the
    should be managed in a sound and
                                             the policy (which include an annual          NPSF to the WPSF) on this business.
    prudent fashion,
                                             management charge on the assets held         In addition, there is a maximum
>   provide a framework for setting          within the DCPSF). These charges accrue      deduction of 0.5% per annum from
    bonus and investment policy for the      to the Non-Profit Sub-Fund (NPSF),           the gross investment return per annum
    Scottish Amicable Funds on a basis       which bears all expenses; hence the          for the expected cost of guarantees.
    that is fair to both SAIF and SAA        shareholders receive any profits or losses   This charge accrues to the inherited
    policyholders and other PAC              arising from the difference between the      estate within the WPSF, which bears the
    policyholders, and                       charges and expenses on this business.       cost of guarantees; hence the inherited
                                                                                          estate within the WPSF receives any
>   require that the SAIF inherited          A bonus smoothing account for this           profits or losses arising from the
    estate be distributed over time to       business is maintained in the inherited      difference between this charge and
    with-profits policyholders in SAIF       estate within the WPSF. The bonus            the actual cost of guarantees.
    and SAA.                                 smoothing account is credited or debited
                                             as appropriate with any difference           A separate bonus smoothing account
The whole of the profit arising in           between claim payments made from             for this business is maintained in the
SAIF, including profits or losses on its     the DCPSF and the relevant policies’         inherited estate within the WPSF. It is
non-profit business, will be allocated to    underlying asset shares. For International   intended that transfers to and from this
with-profits policyholders in SAIF and       Prudence Bond business invested in the       account should generate no net gain or
SAA i.e. SAIF is a “100:0” fund.             PruFund Range of Funds (as defined in        loss to either the WPSF or DCPSF over
                                             section 1.3.8.5), the smoothing account      the long term. Further information on
C2.3 Defined Charge Participating
Sub-Fund (DCPSF)                             is credited or debited as appropriate with   the operation of the bonus smoothing
The Defined Charge Participating             any difference between the unit price and    account is included in Section 1.3.8.4.
Sub-Fund (DCPSF) consists of two             the net asset value per unit when units
                                                                                          The profits allocated to the transferring
types of business.                           are created or cancelled as a result of
                                                                                          ELAS annuities arise from the investment
                                             premiums being received or claims being
The first type of business is the                                                         returns earned on the underlying asset
                                             paid. It is intended that these smoothing
accumulated investment content of                                                         shares (less the charges described above).
                                             transfers should generate no net gain to
premiums paid (i.e. the accumulation of      either sub-fund over the long term.          The profit in the DCPSF arises solely from
premiums less explicit charges) in respect                                                investment performance and is entirely
of the Defined Charge Participating          The second type of business in the
                                                                                          attributable to DCPSF policyholders
business, which is either:                   DCPSF is the With-Profits annuities
                                                                                          i.e. the DCPSF is a “100:0” fund.
                                             business transferred from ELAS on
                                             31 December 2007.




                                                                                          Principles & Practices of Financial Management 11
C2.4 Non-Profit Sub-Fund (NPSF)                     C3 Information about relevant                   C3.3 Prudential International
The Non-Profit Sub-Fund (NPSF) consists             Companies (other than PAC)                      Assurance plc (PIA)
of such non-profit and unit-linked                  C3.1 Scottish Amicable Life plc (SAL)           PIA is a wholly owned subsidiary of
business as has been explicitly allocated           SAL is a wholly owned subsidiary of PAC         Prudential plc which has transacted
to this sub-fund by the Directors.                  which wrote unit-linked, non-profit and         Defined Charge Participating business
                                                    with-profits business from 1 October            since March 2002. PIA is owned by the
It also includes all Defined Charge                 1997 until 31 December 2002.                    PAC Non-Profit Sub-Fund. All of PIA’s
Participating business, apart from the              At 31 December 2002, its business               with-profits policies (including those
business which was transferred from                 was transferred into the Non-Profit             written in Germany which were
ELAS. The investment content of the                 Sub-Fund (NPSF) with the with-profits           transferred to Canada Life Assurance
Defined Charge Participating business               element allocated to the With-Profits           (Europe) Ltd with effect from 1 January
held in the NPSF is allocated to the                Sub-Fund (WPSF). All references in this         2003) are reinsured into PAC.
DCPSF. All charges for the Defined                  PPFM to WPSF with-profits business              The investment content of the reassured
Charge Participating business held                  apply to SAL with-profits business              business is invested in the DCPSF and
in the NPSF are credited to the NPSF                unless there is a specific reference            the balance of the reassurance premiums
which bears all expenses of this business.          to SAL business.                                (and the annual management charge
                                                                                                    on the investment content) is credited
For the business transferred from ELAS              C3.2 Prudential (AN) Limited (PANL)             to the NPSF, which bears all expenses.
(and which is allocated to the DCPSF),              PANL is a wholly owned subsidiary of            The NPSF pays an annual charge to the
the NPSF is credited with the value of a            Prudential plc. PANL wrote new with-            PAC inherited estate within the WPSF
1% per annum arithmetic deduction from              profits life business from 10 December          for the use of the economic capital.
the gross investment return credited to             2002 to 11 August 2004 and unit-linked
the ELAS asset shares and bears all the             pensions business from 10 December              D – Risk Management of PAC
expenses of this business. The NPSF                 2002 until 31 October 2010. At 31               In managing risk, the PAC Board is
pays an annual charge to the PAC                    October 2010 its with-profits business          responsible for:
inherited estate within the WPSF                    was transferred into the WPSF and its
for the use of the economic capital                 non-profit business transferred into the        >   determining the company’s risk
supporting the business transferred                 NPSF. Prior to the transfer, its with-profits       appetite which, in conjunction
from ELAS. This charge is calculated                business was wholly reassured to the                with the available working capital,
as 0.14% per annum of asset shares.                 WPSF and its policies shared in the                 determines the company’s risk
                                                    divisible profits of the WPSF alongside             capacity from time to time, and
All the profit of the NPSF is attributable
                                                    PAC policies. All references in this PPFM
to shareholders i.e. the NPSF is a                                                                  >   managing the overall risk level of the
“0:100” fund.                                       for WPSF business also apply to the                 company and the long-term fund,
                                                    transferred PANL with-profits business.             including its four sub-funds, having
The shareholders’ profit from the long-
                                                                                                        regard to that risk capacity.
term fund consists of the total of their
share of the divisible profit of each of                                                            Decisions taken by the PAC Board
the sub-funds.                                                                                      regarding its overall risk appetite, risk
                                                                                                    capacity and risk level may affect all
                                                                                                    with-profits policyholders. With-profits
                                                                                                    policyholders may also be exposed
                                                                                                    to a differing range of business and
                                                                                                    investment risks specific to the type
                                                                                                    of product held; further details are
                                                                                                    provided in various sections of the
                                                                                                    PPFM as follows:



12 Principles & Practices of Financial Management
>   The overall risk level of the long-term   E – Governance arrangements for             The company prepares an annual report
    fund reflects both investment risk and    with-profits business                       to with-profits policyholders setting out
    business risks, which are described in    In addition to its other responsibilities   how it has complied with the PPFM.
    SECTION 2 and SECTION 3                   the PAC Board is responsible for the        This report, which is available on request,
    respectively.                             management of the company’s with-           includes details of how discretion has
                                              profits business, including investment      been exercised, how any conflicts of
>   The level of investment-related risk
                                                                                          interest between different groups or
                                              and bonus distribution policy. However,
    for all business depends primarily on
                                              the SALAS Scheme established the            generations of policyholders, and
    the extent to which the future asset
                                              Scottish Amicable Board to be               between policyholders and shareholders,
    and liability cash flows may differ.
                                              responsible for the management              have been addressed and a report from
    For with-profits business, this risk is
                                              (including investment and bonus             the With-Profits Actuary which states
    closely inter-related with the bonus
                                              policy) of the Scottish Amicable Funds.     whether he or she considers that the
    distribution policy which is described
                                              The SALAS Scheme also requires that         report and the discretion exercised
    in SECTION 1.
                                              a Monitoring Actuary be appointed in        by the company in the year may be
>   The risk capacity of the long-term        order to advise the Scottish Amicable       regarded as taking policyholders’
    fund depends on the amount of             Board as to the proper operation of the     interests into account in a reasonable
    working capital available, which          Scottish Amicable Funds in order to         and proportionate manner.
    is provided primarily by the PAC          safeguard the interests and reasonable
                                                                                          The With-Profits Committee has the
    inherited estate as described in          expectations of policyholders invested in
                                                                                          duty to report to the Board, providing
    SECTION 5, supported only when            the Scottish Amicable Insurance Fund.
                                                                                          an assessment of compliance with the
    necessary by the shareholders’ funds.
                                              Industry-wide regulatory requirements       PPFM and how any conflicting rights
>   The amount of working capital             changed with effect from 31 December        have been addressed. If the Committee
    required is affected by the type          2004. As a consequence, the PAC             wishes to make a statement to with-
    and volume of new business written,       Board appointed:                            profits policyholders in addition to
    as described in SECTION 6.                                                            the company’s report described above,
                                              >   an Actuarial Function Holder who        the company will make that report
The key risk for the long-term fund               provides the PAC Board with all         available. In addition, under the Scheme
results from holding a high proportion            actuarial advice,                       that transferred ELAS business to PAC,
of real assets (e.g. equities and property)                                               the Committee has responsibility for
to back smoothed liabilities which            >   a With-Profits Actuary with the
                                                                                          the application of some elements of
                                                  specific duty to advise them on the
incorporate guarantees (mainly in the                                                     discretion as defined by the Scheme.
                                                  reasonableness of how discretion has
form of basic sums assured and the
                                                  been exercised in applying the PPFM
accumulated regular bonus additions).
                                                  and how any conflicting interests
                                                  have been addressed, and

                                              >   a With-Profits Committee of
                                                  independent individuals.




                                                                                          Principles & Practices of Financial Management 13
Principles and Practices of Financial Management


 Section 1 – Determining                            guaranteed annuity. For this business             − policies in the Defined Charge
 With-Profits Policy values                         the rates do not vary according to the              Participating Sub-Fund (DCPSF)
                                                    period in which the policy commenced.
                                                                                                      − policies invested in the PruFund
1.1 Introduction                                    It may be necessary, in adverse market
                                                                                                        Range of Funds, and
1.1.1. The amount of profit available               conditions, to reduce the non guaranteed
for distribution among with-profits                 annuity.                                          − Income Choice Annuity.
policyholders and shareholders, the
                                                    The bonus rates applied to the Income         Significantly different practices are
divisible profit, is determined annually
                                                    Choice Annuity, as described in section       summarised in paragraph 1.4 for SAIF
by the Directors of PAC in accordance
                                                    1.3.8.6, consist of an increase in the        and SAA policies, and in paragraph 1.3.8
with its Articles of Association.
                                                    guaranteed income (the Secured Level)         for other with-profits policies.
Policyholders receive their distribution
                                                    and a Smooth Return that is used to
of profits by means of bonuses, or other
                                                    determine the non-guaranteed income.          1.2 Principles
methods as specified in the relevant
                                                                                                  1.2.1. The company seeks to treat all
policy documentation.                               1.1.3. A bonus becomes a contractual
                                                                                                  with-profits policyholders fairly. We aim
                                                    right only when it has been added to
1.1.2. Accumulating with-profits (i.e.                                                            to provide:
                                                    a policy but it remains subject to the
unitised and cash accumulation) and
                                                    Principles and Practices set out below        >   pay-out values on death or maturity
conventional with-profits policyholders
                                                    (see in particular paragraph 1.3.6).              that are fair between different policy
receive their share of the divisible profit
                                                    1.1.4. This section sets out the Principles       types and different generations of
by way of bonuses which are declared,
                                                    and Practices we use to work out the              policyholder, and
generally yearly, in the following form:
                                                    pay-out values including:
>   a regular bonus (also known as an                                                             >   pay-out values on surrender, transfer
                                                    >   the methods we use to work out                or retirement (other than at the
    annual or reversionary bonus) which
                                                        the amount to pay with-profits                selected retirement date) that are
    may be added during the lifetime of
                                                        policyholders,                                also fair between those policyholders
    a policy, so gradually increasing the
                                                                                                      leaving and those remaining in the
    guaranteed benefits, for example
                                                    >   the approach we take when we set              fund.
    the benefit payable on death, and                   regular bonus rates, and
                                                                                                  1.2.2. Pay-out values are managed
>   a final bonus (also known as a                  >   the approach we take when we set
                                                                                                  through the bonus declaration process
    terminal or additional bonus) which                 final bonus rates.
                                                                                                  (or alternative profit distribution
    may be added to policies when a
                                                    1.1.5. The practices set out in               mechanisms as described in the policy
    claim is paid in a specified period.
                                                    paragraphs 1.3.1 to 1.3.8 below               document), with adjustments for
The rates of regular and final bonus                cover the majority of with-profits            surrender and transfer values being
declared are generally different for each           policies. There are some differences          made through Market Value Reductions
type of policy. Final bonus rates for each          in approach for:                              (MVRs) or the surrender value bases,
type of policy generally vary by reference                                                        as appropriate.
to the period, usually a year, in which             >   Scottish Amicable Insurance Fund
                                                        (SAIF) with-profits policies,             The main objectives of the company’s
the policy commenced or each premium
                                                                                                  bonus distribution policy are:
was paid.                                           >   Scottish Amicable Account (SAA)

The bonus rates applied to the with-
                                                        with-profits policies, and                >   to give each with-profits
                                                                                                      policyholder a return on the
profits annuities transferred from ELAS             >   some other types of with-profits
                                                                                                      premiums paid reflecting the
consist of a regular bonus which is used                policy, namely:
                                                                                                      return on the underlying investments
to increase the guaranteed annuity and a
                                                        − policies originally issued by               over the time the policyholder has
combination of an Overall Rate of Return
                                                          Scottish Amicable Life plc (SAL),           held the policy, smoothing the
(ORR) and an Interim Rate of Return
                                                                                                      peaks and troughs of investment
(IRR) which is used to determine the non                − with-profits annuities,
                                                                                                      performance, and
14 Principles & Practices of Financial Management
>   to ensure that with-profits             applied investment returns, charges,         over the lifetime of the policy (allowing
    policyholders in each sub-fund          or allocations of miscellaneous surplus),    for the effect of tax on the investment
    receive a fair share of the profits     will be made as and when they are            returns and of tax relief on expenses
    distributed from that sub-fund by way   considered to be appropriate and             for life business), making appropriate
    of bonus additions to their policies.   compatible with treating customers           allowance for miscellaneous profits
                                            fairly, and only with the approval of the    and losses.
1.2.3. To retain flexibility in our
                                            Directors. Any change in respect of SAIF
investment policy and to protect the                                                     1.3.1.3 When the Ordinary Branch
                                            or SAA policies would also be approved
fund, for most types of with-profits                                                     (OB) assets and the Industrial Branch
                                            by the Scottish Amicable Board and,
product we aim to keep a substantial                                                     (IB) assets were merged in 1988,
                                            in addition, court approval may be
proportion of pay-out values in non-                                                     the company undertook to link IB policy
                                            required if the SAIF Principles of
guaranteed form (i.e. payable as final                                                   bonuses to OB policy bonuses as follows:
                                            Financial Management need to be
bonus) and determine regular bonus
                                            changed. Certain changes in respect of       >   for IB policies issued before July
rates accordingly.
                                            the with-profit annuities transferred from       1988, total bonus additions will
1.2.4. We set pay-out values by             ELAS would require review and approval           not be less than 90% of those on
reference to the earnings of the            by the With-Profits Committee, and in            corresponding OB policies; and
underlying investments, except where        certain circumstances court approval
guaranteed minimum benefits increase        may be needed.                               >   for IB policies issued from July 1988,
the total amount payable.                                                                    total bonus additions will be 100% of
                                            1.3 Practices                                    those on corresponding OB policies.
1.2.5. Final bonus rates are set so that    1.3.1. Pay-out values
in normal investment conditions pay-out                                                  Hence IB pay-out values depend on the
                                            1.3.1.1 To meet our objectives for pay-
values change only gradually over time                                                   corresponding OB pay-out values and do
                                            out values, we target them on the asset
i.e. we provide smoothed benefits.                                                       not reflect the IB asset shares, unless the
                                            shares (see paragraph 1.3.7) of sample
Our approach to smoothing is not                                                         IB value would produce a higher amount
                                            policies or groups of sample policies.
dependent on the type of claim except                                                    for business issued before July 1988.
                                            In general, and where appropriate,
when an MVR is applied or a change in                                                    The relationship between IB and OB
                                            each sample policy represents only those
surrender bases is made.                                                                 asset shares is reviewed annually.
                                            policies which share a common rate of
                                            final bonus i.e. policies of a particular    1.3.2. Regular Bonus Rates
1.2.6. Our intention is that smoothing
                                            type which were either issued in the         1.3.2.1 Rates of regular bonus are
profits and losses should balance out
                                            same year or for which a premium was         determined for each type of policy
over time, so that in the long run with-
                                            paid in that year. However where such        primarily by targeting them at a
profits policyholders in each sub-fund,
                                            sample policies would each represent a       prudent proportion of the long-term
or within a product group with a specific
                                            comparatively small number of policies,      expected future investment return
smoothing account, neither gain nor
                                            we produce scales of final bonus rates       on the underlying assets. The expected
lose as a result of our smoothing policy.
                                            that are targeted on the aggregate asset     future investment return is reduced
The accumulative cost of smoothing and
                                            shares across groups of sample policies.     as appropriate for each type of policy
guarantees is monitored. The short-term
                                            Asset shares are calculated for all          to allow for items such as expenses,
cost of smoothing is constrained only by
                                            significant blocks of business.              charges, tax and shareholders’ transfers.
the impact that smoothing costs have on
the risk level of the fund and hence the                                                 However, the rates declared may differ
                                            1.3.1.2 The asset share of a sample
security of continuing policyholders.                                                    by product type, or by date of payment
                                            policy is a fair value of the assets
                                                                                         of the premiums or date of issue of the
                                            backing the policy, and is calculated
1.2.7. Any change to the objectives                                                      policy, if the accumulated annual bonuses
                                            by accumulating the premiums paid
and the methods used to achieve them,                                                    are particularly high or low relative to a
                                            (less allowance for expenses and
or any material change to the historical                                                 prudent proportion of the achieved
                                            charges) at the actual rates of investment
assumptions or parameters relevant to                                                    investment return.
                                            return earned on the underlying assets
those methods (for example, previously

                                                                                         Principles & Practices of Financial Management 15
When target bonus levels change, the                declared which is intended to give credit    1.3.3.3 In general the same final bonus
PAC Board has regard to the overall                 for the expected investment return after     scale applies to maturity, death and
financial strength of the long-term                 the end of the calendar year until the       surrender claims except that:
fund when determining the length of                 next policy anniversary.
time over which it will seek to achieve
                                                                                                 >   the total surrender value may be
                                                    For WPSF cash accumulation products,             impacted by the application of an
the amended prudent target bonus level.
                                                    the regular bonus rates declared,                MVR (for accumulating with-profits
Regular bonuses were gradually reduced
                                                    normally in February, apply for the year         business) and is affected by the
between 1991 and 2004 to reflect the fall
                                                    ending on the scheme revision date               surrender bases (for conventional
in investment returns associated with
                                                    which falls in the next bonus year.              with-profits business), and
inflation rates that were generally lower
than had been experienced in the 1970s              1.3.2.3 In normal investment conditions,     >   for SAIF and SAA policies, and
and 1980s.                                          we expect changes to regular bonus rates         policies transferred from SAL,
                                                    to be gradual over time and changes are          the final bonus rates applicable
1.3.2.2 Regular bonus rates are
                                                    not expected to exceed 1% p.a. over any          on surrender may be adjusted to
declared, normally in February, for the
                                                    year. However, the Directors retain the          reflect expected future bonus rates.
forthcoming bonus declaration year for:
                                                    discretion whether or not to declare a       Further details are given in paragraphs
>   all WPSF and DCPSF unitised                     regular bonus each year, and there is no     1.3.6 and 1.3.8.1 below.
    with-profits products, and                      limit on the amount by which regular
                                                    bonus rates can change.                      1.3.3.4 There may be an additional
>   SAIF unitised with-profits pension                                                           bonus on retirement for certain
    products.                                       1.3.3. Final Bonus Rates                     conventional with-profits deferred
                                                    1.3.3.1 A final bonus, which is normally     annuity contracts. The rate of additional
These bonuses are added daily to each
                                                    declared yearly, may be added when a         bonus for future retirements may be
policy but the rates of future accrual may
                                                    claim is paid, or when units of a unitised   varied at any time.
be changed at any time during the bonus
                                                    product are realised.
declaration year.                                                                                1.3.4. Smoothing of Maturity and
                                                    >   Final bonus scales for WPSF and          Death Benefits
Regular bonus rates are declared,
                                                        DCPSF unitised with-profits products     1.3.4.1 The smoothing approach differs
normally in February, in respect of
                                                        and all SAIF and SAA products may        between accumulating and conventional
the previous calendar year for:
                                                        be varied at any time.                   with-profits policies as follows:
>   WPSF conventional with-profits
                                                    >   Final bonus scales for WPSF              For accumulating with-profits policies
    products,                                                                                    (i.e. unitised and cash accumulation
                                                        conventional with-profits products are
                                                                                                 with-profits policies):
>   SAA unitised life with-profits                      declared for policies becoming claims
    products,                                           in the forthcoming bonus period,         >   Pay-out values are smoothed primarily
                                                        usually a year.                              by looking at the change in the pay-
>   SAIF conventional with-profits                                                                   out value on sample policies from one
    products and                                    1.3.3.2 The rates of final bonus usually
                                                                                                     year to the next. However, we may
                                                    vary by type of policy and by reference to
>   With-profit annuities transferred                                                                also consider the change in pay-out
                                                    the period, usually a year, in which the
    from ELAS                                                                                        values on sample policies of the same
                                                    policy commenced or each premium
                                                                                                     duration from one year to the next.
For these products (except those with-              was paid. These rates of final bonus are
profit annuities transferred from ELAS)             determined by reference to the asset         >   For some policies we base bonuses
                                                    shares for the sample policies or groups         in each of the first 5 years on the
an interim bonus rate is also declared
                                                    of sample policies described in paragraph        expected average return over the first
for claims arising after the end of the
                                                    1.3.1.1, but subject to the smoothing            5 years. This helps to reduce volatility
calendar year but prior to the declaration
                                                    approach described in paragraphs                 in the early years.
for that year. For annuities transferred
from ELAS, an Interim Rate of Return is             1.3.4.1, and 1.3.4.2.


16 Principles & Practices of Financial Management
For conventional with-profits policies:      In certain circumstances it is not                − a policy is surrendered
                                             reasonable to determine payouts based               (partly or wholly),
>   Pay-out values are smoothed primarily
                                             on asset shares (e.g. for IB policies,
    by looking, for sample policies, at                                                        − benefits are taken from a pension
                                             see paragraph 1.3.1.3).
    the change from one year to the                                                              policy either before or after the
    next in the maturity values of           1.3.5.3 In setting target ranges, we use            selected retirement date, or
    corresponding policies of the same       sample policies for all product types.
                                                                                               − an investment is switched out of
    duration. However, we may also           This approach is consistent with the
                                                                                                 a with-profits fund into another
    consider the change in the pay-out       approach outlined in 1.3.1. We do not
                                                                                                 fund (including the conversion of
    value on sample policies from one        expect the range of maturity benefits
                                                                                                 a With-Profits Annuity (issued by
    year to the next year and, for           relative to asset shares to be materially
                                                                                                 PAC) to a non-profit annuity).
    deferred annuity policies, in the        different from the range that would apply
    pension payable at vesting.              if all policies were considered.              >   The amount of any MVR on a policy
                                                                                               will vary as the value of the Fund’s
1.3.4.2 In normal circumstances we           1.3.5.4 1.3.5.4 Bonus declarations
                                                                                               assets changes.
do not expect most pay-out values on         are normally made with the intention that
policies of the same duration to change      at least 90% of maturity payments are         >   It is not our practice to apply MVRs
by more than 10% up or down from one         expected to fall within the target range          which reduce surrender values below
year to the next, although some larger       in the period covered by the declaration.         an amount fairly reflecting the value
changes may occur to balance pay-out         However any substantial movement in               of the assets underlying the policy.
values between different policies.           the market value of the assets of the
Greater flexibility may be required in       relevant with-profits fund may take a         >   On some policies, the impact of any
certain circumstances, for example           significant proportion of pay-out values          MVR is reduced as policies approach
following a significant rise or fall in      outside the target ranges. This may               maturity with the aim of surrender
market values (either sudden or over         lead to a mid-year bonus declaration to           values progressing smoothly into
a period of years), and in such situations   bring more pay-out values within the              maturity values. Typically, this is done
the PAC Board may decide to vary             target range.                                     over the last 5 years of the policy
the standard bonus smoothing limits
to protect the overall interests of
                                             1.3.6. Surrender Values and Market            >   All accumulating with-profits policies
                                             Value Reductions (MVRs)                           provide some specific guarantees at
policyholders. Such a situation arose in
                                             The approach to surrender values differs          certain times – for example on death,
February 2003 when pay-out values on
                                             between accumulating and conventional             terminal illness or the pre-selected
most equivalent policies were reduced by
                                             with-profits policies.                            retirement date. At these times no
amounts greater than 10% i.e. outside of
                                                                                               MVR can apply.
the normal limits.                           1.3.6.1 Accumulating with-profits policies
                                                                                           >   Partial withdrawals are normally
1.3.5. Target ranges for Maturity            >   Surrender values are generally                subject to an MVR; however, regular
Benefits                                         the pay-out values described in               automatic withdrawals may have been
1.3.5.1 We set a target range for the            paragraph 1.3.4, less any                     set up with a guarantee that no MVR
maturity payments that we shall make on          discontinuance charge (also known             will apply. On a partial withdrawal,
our with-profits policies, expressed as a        as an early cash-in charge) applicable        the asset share of the remaining part
percentage of asset shares. The target           in accordance with the policy                 of the policy is not adjusted to reflect
range we have set is 80% – 120%.                 provisions. However, we may                   any difference between the surrender
                                                 then apply an MVR to ensure that              value and the asset share of the part
1.3.5.2 For all policies where it is
                                                 neither the security of the fund nor          surrendered i.e. the asset share is
reasonable to determine payouts based
                                                 the return to continuing policyholders        reduced by the proportion that the
on asset shares we manage our business
                                                 is affected by paying surrender values        withdrawal amount bears to the
with the aim of ensuring that maturity
                                                 significantly in excess of the value of       policy value before any MVR
payments for at least 90% of with-profits
                                                 the underlying assets. An MVR may             deduction.
policies fall within the target range.
                                                 apply if:
                                                                                           Principles & Practices of Financial Management 17
1.3.6.2 Conventional with-profits policies          1.3.6.3 Target ranges for surrender benefits
                                                    The target ranges for surrender benefits are the same as those applicable for maturity
>   Surrender values are derived by way
                                                    benefits, which are set out in paragraph 1.3.5.1. At the time of each surrender value
    of a formula, the parameters of which
                                                    review payouts are normally set such that, when expressed as a proportion of the asset
    are set to broadly target a proportion
                                                    share at the expected date of claim, payouts for over 90% of the sample policies are
    of asset shares considered in the
                                                    expected to fall in the range 80%-120% of asset share.
    aggregate. The formula is based on
    the sum assured, regular bonus and              Any substantial fall in the market value of the assets of a with-profits fund would lead
    final bonus that would be payable               to immediate changes in the application of MVRs to accumulating with-profits policies,
    on death or maturity. The parameters            firstly, to increase the size of MVRs already being applied and, secondly, to extend the
    in the formula differ by product and            range of policies to which an MVR is applied.
    can be varied at any time; they are
    designed to avoid any detriment                 1.3.7. Asset share approach
    to continuing policyholders,                    1.3.7.1 Overview
    while minimising the frequency
    of changes in bases, and to achieve                                        Premiums
                                                     Income comprises
    both objectives, the parameters are                                        Investment return (including unrealised gains)
                                                     credits for:
    targeted to provide a small overall
                                                                               Miscellaneous profits
    profit to the sub-fund (currently
    around 5% of the surrender value).               Outgo comprises           Tax, including an allowance for tax on unrealised gains
    However, in setting surrender bases,             charges for:              Guarantees and smoothing
    we aim to ensure surrender values                                          Mortality and morbidity
    progress smoothly to maturity values.
                                                                               Shareholders’ profit transfers
    Typically, this is done over the last
    5 years of the policy.                                                     Miscellaneous losses
                                                                               Expenses and commission (net of any tax relief)
>   The surrender bases are normally
    reviewed each year, although the                Asset shares are calculated as the accumulation of all items of income and outgo that
    level of surrender values is monitored          are relevant to each policy type:
    more frequently to ensure they
    remain reasonable. Any changes to               Variations in asset share calculations for specific policy types are set out in paragraphs
    the surrender bases are designed                1.3.8 for PAC and ex-ELAS policies and 1.4 for SAIF and SAA policies.
    primarily to reflect the changes in             Sample asset shares are generally calculated for an average policy size assuming that the
    underlying asset values                         policies commenced, and cash flows occur, in the middle of each bonus or scheme year.
                                                    Final bonus rates are based on asset shares projected to the middle of the bonus or
                                                    scheme year.

                                                    1.3.7.2 Investment Return
                                                    The asset shares for all the with-profits policies that are in a particular asset pool
                                                    are credited with the investment return (including unrealised capital appreciation or
                                                    depreciation) earned on the pool over each year, expressed as a single annual rate.
                                                    Hence, asset shares are not credited with any part of the investment return earned on
                                                    the inherited estate. The range of asset pools is described in paragraphs 2.1 and 2.3.3.

                                                    1.3.7.3 Tax
                                                    For life assurance business, tax is payable on investment income and realised capital
                                                    gains (after allowing for indexation relief) but is partially offset by tax relief on relevant
                                                    expenses. Tax is charged to asset shares for life assurance product lines in the same way.


18 Principles & Practices of Financial Management
For approved pensions business,               On policies other than with-profits             For the business transferred from ELAS
investment income and gains are not           annuity, Income Choice Annuity or those         and allocated to the DCPSF, a deduction
subject to taxation and likewise expenses     invested in the PruFund Range of Funds,         of up to 0.5% p.a. is made from the
are not relieved (except to the extent that   the total deduction over the lifetime of        investment return credited to asset
they form part of the shareholders’ profit    each policy is not currently more than 2%       shares. This charge is transferred from
on that business). Hence, no tax is           of any payment made from the Fund,              the DCPSF to the WPSF. The WPSF
charged to asset shares for approved          with the deduction building up to this          meets the cost of guarantees.
pensions business product lines.              level over the first few years of the policy.   This charge is kept under review
                                                                                              and may be amended but cannot
PAC is assessed for tax as a single           For with-profits annuity contracts
                                                                                              exceed 0.5% p.a.
shareholder-owned entity and the              provided by PAC a deduction is made
tax apportioned to sub-funds fairly,          from the investment return credited to          1.3.7.5 Mortality and Morbidity
subject to a requirement that the amount      asset shares each year. This deduction          For WPSF, SAIF and SAA business,
charged to SAIF is the amount that SAIF       is derived so that in aggregate its value       a mortality charge is deducted in
would pay if it were taxed as a mutual        is expected to cover the costs of               calculating asset shares. This charge is
life assurance company. In effect any         guarantees and smoothing over the               calculated by applying a mortality rate
difference between the tax otherwise          lifetime of the portfolio of this business.     to the excess of the benefit on death
fairly apportionable to SAIF and the                                                          over the current value of the policy.
                                              For Income Choice Annuity a deduction
amount charged to SAIF falls to the                                                           Any difference between the aggregate
                                              is made from the investment return
PAC inherited estate.                                                                         mortality charge and the cost of
                                              credited to asset shares each year and an
                                                                                              death claims each year accrues to the
Any difference between the tax charged        adjustment may also be made to the level
                                                                                              appropriate inherited estate. A similar
to asset shares in each sub-fund and the      of starting income. This adjustment may
                                                                                              approach applies for morbidity costs.
overall amount of tax charged to that sub-    be positive or negative. The deduction
fund falls into the PAC inherited estate or   from the investment return and the              For the business transferred from ELAS,
the SAIF inherited estate as appropriate.     adjustments to starting income levels           to the extent that actual payments of
                                              are derived so that, in aggregate, their        income are less or more than expected
The tax rates assumed in calculating
                                              value is expected to cover the cost of          in any calendar year because of heavier
asset shares are amended when tax
                                              guarantees over the lifetime of the policy.     or lighter mortality than expected, the
rates change. They are also reviewed
                                                                                              profit or loss will accrue to the WPSF.
periodically and may be retrospectively       The deductions made to cover the cost
                                                                                              Should Prudential adopt a different
adjusted to reflect any significant           of smoothing and guarantees for new
                                                                                              mortality basis for this business,
cumulative difference between the             business are regularly reviewed and may
                                                                                              the effect of this change on the asset
tax charged to asset shares and the           be adjusted, for example in line with
                                                                                              shares is subject to certain limits which
total tax paid in respect of the              market conditions, changes in asset
                                                                                              are described in Appendix B.
corresponding policies.                       allocation and/or changes in business
                                              mix. The level of these charges can rise        1.3.7.6 Shareholder Profit
1.3.7.4 Guarantees and Smoothing
                                              or fall as a result of these reviews.           For a WPSF with-profits policy,
For WPSF business the expected cost of
                                                                                              the amount transferred to shareholders
smoothing and guarantees for each type        The company keeps the level of charges
                                                                                              in respect of the bonuses credited to
of product is determined by considering       under review and may alter these if
                                                                                              the policy is deducted in calculating
the results of stochastic analysis.           necessary to protect the fund.
                                                                                              asset shares. The basis of determining
This amount is deducted in calculating
                                              For investments in the PruFund Range of         the amount to be transferred is described
asset shares and credited to the PAC
                                              Funds, see 1.3.8.5 for further information.     in paragraph 7.3.1. There is no such
inherited estate, which bears the
                                                                                              charge to the asset share of a DCPSF,
costs of smoothing and guarantees
                                                                                              SAIF or SAA policy.
as they emerge.




                                                                                              Principles & Practices of Financial Management 19
Additional tax is payable as a                          except the PruFund Range of Funds,        >   the only relevant items of income and
consequence of the transfer of                          unless the Directors have decided             outgo are premiums, investment
shareholder profits out of the WPSF.                    that specific losses should be                return, charges for tax, guarantees
This has always been charged to the PAC                 borne by the PAC inherited                    and smoothing, mortality and
inherited estate and it is expected that                estate (see paragraph 3.3.4).                 morbidity, and the explicit charges
this will continue (see paragraph 5.3.2.1).                                                           for expenses and profit specified on
                                                    1.3.7.8 Expenses and Commission                   similar unit-linked policies; and
1.3.7.7 Miscellaneous Profits and Losses            As described in paragraph 3.3.4, certain
For WPSF business, miscellaneous profits            costs allocated to the WPSF are charged       >   credit for miscellaneous profit will
and losses are reflected in asset shares            to the PAC inherited estate and not to            be given only if the asset shares
as follows:                                         asset shares.                                     calculated using explicit charges
                                                                                                      with no allowance for miscellaneous
>   Profits and losses from non-profit              All other expenses, including                     profit are less than the asset shares
    business written in the WPSF, and               commission, allocated to the WPSF are             calculated using actual expenses
    from annuity business written in                split into acquisition and administration         with allowance for miscellaneous
    Prudential Annuities Limited (PAL)              expenses, and expressed as some or all            profit and the distribution of profit
    between 1 January 2000 and 30 June              of a rate per policy, a rate per cent of          to PAC shareholders.
    2004 (excluding annuities set up in             premium, a rate per cent of sum assured
    respect of vesting Prudential Personal          and as a reduction in the investment          If the difference between the charges
    Retirement Plan (PPRP) policies),               return. The relevant combination of           deducted and the expenses incurred is
    are allocated each year over all                these expense rates is normally deducted      less than the actual shareholder transfer,
    with-profits product lines except               in calculating asset shares. However,         then this deficit accrues to the PAC
    the PruFund Range of Funds, as an               certain amounts have been charged             inherited estate.
    addition or deduction in the                    to the inherited estate so that the net
                                                                                                  The final bonus rates for surrenders
    calculation of asset shares.                    impact of the charges to asset shares for
                                                                                                  may differ from those for death or
                                                    expenses and for items 1.3.7.5 to 1.3.7.7
>   Aggregate profits, or losses, on
                                                    above is limited as follows:
                                                                                                  maturity claims to reflect expected
    discontinuance of with-profits policies                                                       future bonus rates.
    (other than profits or losses from              >   for all new business since 1997, the
                                                                                                  1.3.8.2 With-Profits Annuities issued
    smoothing) are calculated each year                 aggregate projected deductions equals
                                                                                                  by PAC
    for appropriate product groups and                  the aggregate projected policy-specific
                                                                                                  In calculating asset shares, allowance is
    credited to surviving policies in the               charges used when illustrating benefits
                                                                                                  made for any difference between the
    calculation of asset shares for that                at point of sale, while
                                                                                                  mortality levels underlying the pricing
    product group. This aggregate profit
    or loss is the difference, in respect of        >   for many pensions contracts, the net      basis at inception and the then current
                                                        impact of these deductions has been       mortality assumptions and a deduction is
    discontinuing policies, between the
                                                        limited to 1% p.a. since April 2001;      made for unsmoothed annuity payments.
    asset share allowing for the expenses
                                                        this level of charge is not guaranteed    The unsmoothed annuity represents
    incurred in running the business and
                                                        to apply in future.                       the annuity that would be paid before
    the asset share allowing for the
                                                                                                  smoothing is applied and without
    charges taken to cover these                    1.3.8. Significant variations in practice     allowance for any minimum income
    expenses. These expenses                        for specific types of PAC policy
                                                                                                  guarantee that might apply.
    include the actual cost of                      1.3.8.1 Business originally issued by
    shareholder transfers.                          Scottish Amicable Life plc (SAL)

>   Aggregate profits, or losses, that may          In calculating asset shares:
    emerge from any other business risk
    will be credited each year to asset
    shares across all product lines


20 Principles & Practices of Financial Management
The regular bonus declared each year           1.3.8.3 Defined Charge Participating           returns (net of charges, including those
has a permanent effect on the income           Sub-Fund (DCPSF) business                      taken to cover the cost of guarantees).
received. This income will increase if         (non ELAS business)                            This amount will be further adjusted
the bonus declared is higher than the          In calculating asset shares, the only          by deducting unsmoothed annuity
anticipated bonus rate selected by the         relevant items of income and outgo             payments, any uplifts or reductions
policyholder or (subject to the minimum        are premiums, investment return,               applied as a result of the longevity
income guarantee) decrease if the bonus        the charges for tax, guarantees and            risk mechanism and the respreading of
declared is lower than the anticipated rate.   smoothing and the explicit charges             mortality surplus each year (based on the
                                               for expenses and profit specified by           expected mortality experience for the
An additional bonus may be declared
                                               the policy.                                    period under review). The unsmoothed
each year which increases the income
                                                                                              annuity is calculated as the annuity that is
received for 12 months only. Additional        The detail of the PruFund Range of Funds
                                                                                              expected to exhaust the asset share over
bonuses can be amended at any time,            for International Prudence Bond is covered
                                                                                              the remaining lifetime of the annuities.
but any additional income that is being        separately in section 1.3.8.5 below.
paid will not be reduced before the next                                                      Under the longevity risk mechanism,
                                               1.3.8.4 Defined Charge Participating
policy anniversary.                                                                           mortality profits and losses are fed
                                               Sub-Fund (DCPSF) (business transferred
                                                                                              back into asset shares to the extent that
The regular and additional bonuses             from ELAS)
                                                                                              expected mortality across the ex-ELAS
declared each year affect the income
                                               The Scheme which transferred the               annuities is different from that expected
from the annuity policy anniversary
                                               ELAS with-profits annuities to PAC states      at the date of transfer. The amount of any
which falls within the next bonus year.
                                               that this business must be managed             loss or profit charged/credited to asset
The smoothing approach seeks to ensure         in accordance with the Principles of           shares is limited to the equivalent of 0.5%
that annuity income does not:                  Financial Management (PFM) contained           of asset shares per annum. Any mortality
                                               in that Scheme. The PFM is included            profits or losses not charged to asset
>   fall by more than the selected
                                               in Appendix B, and this details the            shares fall into the Inherited Estate, as do
    anticipated bonus rate in a year,                                                         differences between actual and expected
                                               management of this business.
                                               This section summarises the                    mortality costs each year.
>   rise by more than 11% a year, less the
    selected anticipated bonus rate, or        important aspects.
                                                                                              (iii) Bonuses
                                               (i) Investment Returns                         A new bonus series has been set up for
>   fall on the first policy anniversary.
                                                                                              the with-profits annuities transferred from
                                               The investment return that is credited
Larger changes may, however, be required       to asset shares will be determined by          ELAS. No other with-profits business will
to balance pay-out values between              reference to the investment return             share in the new bonus series.
different policies. Greater flexibility may    which, before deduction of charges
                                                                                              An ex-ELAS with-profits annuity has two
also be required in certain circumstances,     and adjustments for any tax liability or
                                                                                              elements that are tracked separately.
for example following a significant fall in    credit in accordance with applicable tax
                                                                                              The guaranteed income and the non-
market values (either sudden or over a         legislation, but net of unrecoverable tax,
                                                                                              guaranteed income (Total Annuity)
period of years). In such situations the       is the same as the rate of investment
                                                                                              and the policyholder receives the
PAC Board could decide to vary the             return earned by the WPSF (net of
                                                                                              larger of the two. Each element
bonus smoothing limits to protect the          unrecoverable tax).
                                                                                              changes as described below.
overall interests of policyholders.
                                               (ii) Asset Shares
                                                                                              Any regular (reversionary) bonus
A with-profits annuity cannot be               The asset shares will be calculated by
                                                                                              declared applies for the year starting
surrendered but it can be converted            means of a retrospective accumulation of
                                                                                              on 1 April following the declaration.
to a non-profit annuity at certain dates.      the “initial asset share” transferred to PAC
                                                                                              Any such bonus would have a permanent
The amount of the non-profit annuity           by ELAS, allowing for actual investment
                                                                                              effect on the guaranteed income.
will depend on the then current
                                                                                              The guaranteed income will increase
alteration basis.
                                                                                              from the previous year if the bonus

                                                                                              Principles & Practices of Financial Management 21
declared is higher than the anticipated             (iv) Smoothing                               In addition we will apply smoothing
bonus rate selected by the policyholder,            In calculating the amount to be              to ensure the objective of gradual,
or decrease if the bonus declared is                transferred to the smoothing account,        rather than erratic, changes in income.
lower than the anticipated rate. The level          it is necessary firstly to determine the
                                                                                                 If, under the provisions of the Scheme,
of regular bonus declared is expected to            cost of guarantee. The cost of guarantee
                                                                                                 PAC opts to terminate the scheme, any
be zero for the foreseeable future. Some            is calculated as being the guaranteed
                                                                                                 positive amount remaining in the bonus
policies have a Guaranteed Investment               annuity less the unsmoothed annuity
                                                                                                 smoothing account will be distributed
Return (GIR) which has been anticipated             (referred to above) and is subject to a
                                                                                                 amongst the then remaining annuity
within the guaranteed income, and the               minimum of zero.
                                                                                                 policies by way of an enhancement
level of regular bonus declared (if any)
                                                    The smoothing cost is then calculated        to non-guaranteed income in a way
could differ for different levels of GIR.
                                                    as the annuity paid to the policyholder      considered fair by the With-Profits
The amount of Total Annuity is adjusted             less the guarantee cost and the              Committee.
at annuity anniversaries by the Overall             unsmoothed annuity.
                                                                                                 (v) Miscellaneous Profits and Losses
Rate of Return (ORR) and Interim Rate
                                                    In normal circumstances, the smoothing       No adjustments are made for any
of Return (IRR) applicable at that time.
                                                    approach seeks to ensure that annuity        miscellaneous profits and losses for
The ORR generally reflects the earnings             income does not:                             this business.
on the fund over the calendar year
ending 31 December prior to the                     >   Fall by more than the combined effect    1.3.8.5 PruFund Range of Funds
                                                        of the selected anticipated bonus rate   The PruFund Range of Funds consists
announcement of the ORR each
                                                        and any guaranteed investment            of the funds listed below. The products
February. It is applied to the Total Annuity
                                                        return, in any year.                     that can invest in these funds are shown
at the annuity anniversaries in the
                                                                                                 in brackets:
12 month period following the 1 April               >   Rise by more than the smoothing
each year. The IRR generally reflects the               cap, less the combined effect of the     >   PruFund Growth Pension Fund
expected earnings, expressed as an                      selected anticipated bonus rate and          (Prudential Flexible Retirement Plan,
annual rate, on the fund since the end                  any guaranteed investment return,            Trustee Investment Plan)
of the last calendar year for which an                  in any year. The smoothing cap is
ORR has started to become effective.                    currently 11% and may be reviewed        >   PruFund Cautious Pension Fund
A proportion of the IRR, depending on                                                                (Prudential Flexible Retirement Plan,
                                                        at any time by the PAC Board
the period between the end of the                                                                    Trustee Investment Plan)
                                                        subject to approval by the
calendar year for the effective ORR and                 With-Profits Committee.
the annuity anniversary, is applied to the
                                                                                                 >   PruFund Growth Fund
                                                                                                     (PruFund Investment Plan,
Total Annuity. When the IRR is applied,             Greater flexibility may be required in
                                                                                                     Prudential Investment Plan,
the proportion of the IRR that was                  certain circumstances, for example
                                                                                                     Flexible Investment Plan)
applied to the Total Annuity at the                 following a significant fall in market
previous annuity anniversary is removed.            values (either sudden or over a period       >   PruFund Growth & Income Fund
                                                    of years). In such situations the PAC            (PruFund Investment Plan)
Although the IRR can be changed at any              Board could decide to vary the bonus
time through the year to keep it in line            smoothing limits to protect the overall      >   PruFund Cautious Fund
with the return expected on the fund in             interests of policyholders, subject to           (Flexible Investment Plan,
that year, it is the IRR that was effective         review, where appropriate, by the                Prudential Investment Plan)
on the annuity anniversary that is used             With-Profits Committee.
in the calculation of the Total Annuity.                                                         >   PruFund Growth (Sterling) Fund
                                                    The bonus smoothing account will be              (International Prudence Bond)
The bonuses applied to with-profits                 managed with the ongoing aim that it
purchased life annuities transferred from           should always tend to zero subject to
                                                                                                 >   PruFund Cautious (Sterling) Fund
ELAS will be the same as those applied to                                                            (International Prudence Bond)
                                                    the need for short-term smoothing.
pensions annuities.

22 Principles & Practices of Financial Management
>   PruFund Growth (Euro) Fund                >   Between quarter dates, the net asset      >   PruFund Growth Pension Fund
    (International Prudence Bond)                 value per unit is averaged over the           (Prudential Flexible Retirement Plan,
                                                  previous 5 working days to give the           Trustee Investment Plan)
>   PruFund Cautious (Euro) Fund                  average net asset value per unit.
    (International Prudence Bond)                 If the net asset value per unit and       >   PruFund Cautious Pension Fund
                                                  the average net asset value per unit          (Prudential Flexible Retirement Plan,
>   PruFund Growth (US Dollar) Fund
                                                                                                Trustee Investment Plan)
    (International Prudence Bond)                 are both 10% (or more) above/below
                                                  the unit price, the unit price will be
                                                                                            >   PruFund Growth Fund (PruFund
>   PruFund Cautious (US Dollar) Fund             increased/decreased so that it is             Investment Plan, Prudential Investment
    (International Prudence Bond)                 2.5% below/above the net asset                Plan, Flexible Investment Plan)
                                                  value per unit.
For all policies invested in the PruFund
Range of Funds an Annual Management
                                                                                            >   PruFund Growth & Income Fund
                                              For each of the PruFund Range of Funds,
                                                                                                (PruFund Investment Plan)
Charge (AMC) is applied by explicit unit      except those Funds available under
deduction. Part of this AMC is allocated      International Prudence Bond, a smoothing      >   PruFund Cautious Fund
to cover the expected costs of smoothing      account maintained within the WPSF is             (Flexible Investment Plan,
and guarantees incurred by these Funds        credited or debited with any difference           Prudential Investment Plan)
over the long term.                           between the unit price and the net asset
                                              value per unit when units are created or      >   PruFund Growth (Sterling) Fund
Note that each Fund has an associated                                                           (International Prudence Bond)
                                              cancelled as a result of premiums being
Protected Fund on which an investment
                                              received or claims being paid.                >   PruFund Cautious (Sterling) Fund
guarantee applies. For the majority of
business, this guarantee applies for a                                                          (International Prudence Bond)
                                              Funds from the PruFund Range of
period of 5 years. For those policies         Funds available under International
choosing to invest in a Protected Fund
                                                                                            >   PruFund Growth (Euro) Fund
                                              Prudence Bond are written in the DCPSF.           (International Prudence Bond)
an explicit charge for the investment         For this business a smoothing account is
guarantee is made by unit deduction.          maintained within the inherited estate of     >   PruFund Cautious (Euro) Fund
                                              the WPSF that is credited or debited as           (International Prudence Bond)
Where policies are invested in one of the
                                              appropriate with any difference between
PruFund Range of Funds, they participate
                                              the unit price and the net asset value per
                                                                                            >   PruFund Growth (US Dollar) Fund
in profits by means of an increase in the                                                       (International Prudence Bond)
unit price of the selected investment fund.   unit when units are created or cancelled
                                              as a result of premiums being received or     >   PruFund Cautious (US Dollar) Fund
The unit price increases at the relevant      claims being paid.                                (International Prudence Bond)
expected growth rate (which is published
on each quarter date) unless the unit         If aggregate net flows of business into or    1.3.8.6 Income Choice Annuity
price moves outside specified limits,         out of an investment fund exceed limits
                                                                                            (i) Plan Features
which are set out below:                      specified within the policy provisions, the
                                                                                            The Income Choice Annuity is an
                                              company may suspend the smoothing of
>   On a quarter date, if the net asset                                                     annuity where the income paid to the
                                              the unit price, in which event the unit
    value per unit is more than 5%                                                          policyholder has two elements that are
                                              price will be the net asset value per unit.
    above/below the unit price, the unit                                                    calculated separately for each policy year
                                              The company may also suspend the
    price is repeatedly adjusted by half                                                    – the guaranteed income (the Secure
                                              smoothing of the unit price if required
    the difference between the unit price                                                   Level) and the non-guaranteed income.
                                              to protect our with-profits funds.
    and the net asset value per unit until                                                  The policyholder receives the higher of
    the net asset value per unit is within    For the purposes of suspension of             the two.
    5% above/below unit price. The net        smoothing, the PruFund Range of
    asset value per unit is calculated by     Funds are split such that smoothing can
    Prudential in accordance with the         be suspended on each class of business
    policy provisions.                        independently of the others. The split is:

                                                                                            Principles & Practices of Financial Management 23
At policy commencement the                          income payable in the year leading          Larger changes may, however, be
policyholder can choose a level                     up to the current policy anniversary.       required to balance pay-out values
of starting non-guaranteed income                   The Secure Level can never go down.         between different policies. Greater
from within a range that we calculate.                                                          flexibility may also be required in certain
                                                    (ii) Option to change the non-
Associated with this choice will be a                                                           circumstances, for example following
                                                    guaranteed income
Required Smoothed Return. This is the                                                           a significant fall in market values
                                                    At the second and subsequent policy
Smoothed Return required each year to                                                           (either sudden or over a period of years).
                                                    anniversaries the policyholder will be
maintain the non-guaranteed income                                                              In such situations the PAC Board could
                                                    given the opportunity to change the
selected by the policyholder throughout                                                         decide to vary the bonus smoothing
                                                    level of their non-guaranteed income by
their remaining lifetime. The starting                                                          limits to protect the overall interests of
                                                    selecting from a range that we calculate
Secure Level is set equal to the bottom                                                         policyholders and hence the Smoothed
                                                    at the time. The lower level of the range
of the non-guaranteed income range.                                                             Return could be negative.
                                                    will never be less then the Secure Level.
A Smoothed Return is declared each                  If the policyholder decided to select a     (v) Conversion to a non-profit annuity
year and varies by bonus year of issue.             new level then their Required Smoothed      An Income Choice Annuity cannot be
It is calculated using a similar approach           Return will change. There is no change to   surrendered but it can be converted
to that used when calculating Final                 their Secure Level. Once a policyholder     to a non-profit annuity at certain dates.
Bonus on other contracts. In particular,            has elected to make a change the option     The terms offered on conversion will
the Smoothed Return is calculated                   to make further changes is suspended        depend on the alteration basis in-force
to target payouts on asset share                    until the second policy anniversary         at the time.
(as described in 1.3.1). The asset share            following the change.
                                                                                                The fund available for conversion to a
is calculated using the approach in 1.3.7
                                                    We can withdraw the option for a            non-profit annuity is the current value
subject to the variations in (iii) below.
                                                    policyholder to change their non-           of expected future payments under the
The non-guaranteed income is adjusted               guaranteed income if this is necessary      Income Choice Annuity. The value of
at annuity anniversaries with the new               to protect the fund.                        this fund may be reduced to ensure that
level of non-guaranteed income                                                                  neither the security of the Fund nor the
                                                    (iii) Asset Shares
calculated as follows:                                                                          return to continuing policyholders is
                                                    In calculating asset shares, allowance is
                                                                                                affected by using a conversion value
Previous non-guaranteed income x                    made for any difference between the
                                                                                                significantly in excess of the underlying
(1 + Smoothed Return) / (1 + Required               mortality levels underlying the pricing
                                                                                                assets. Any reduction will vary as the
Smoothed Return).                                   basis at inception and the current
                                                                                                value of the Fund’s assets changes.
                                                    pricing basis and a deduction is made
Hence the non-guaranteed income will
                                                    for unsmoothed annuity payments.            1.3.9. New bonus series
increase if the Smoothed Return is higher
                                                    The unsmoothed annuity represents           Any new type of product generally
than the Required Smooth Return and will
                                                    the non-guaranteed income before            constitutes a new bonus series i.e. it has
decrease if the Smoothed Return is lower
                                                    smoothing is applied (see (iv)).            rates of regular and final bonus that are
than the Required Smoothed Return.
                                                                                                appropriate to that type of product.
                                                    (iv) Smoothing
The Smoothed Return can be amended
                                                    The smoothing approach seeks to ensure      We would introduce a new bonus
at any time, but will not impact what is
                                                    that policyholder income (before the        series for an existing type of product if
paid to the policyholder until the next
                                                    reduction due to the effect of the          we did not expect to be able to fairly
policy anniversary.
                                                    Required Smooth Return) does not            accommodate the difference between
The Secure Level increases at a policy                                                          the experience of the old and new
                                                    >   rise by less than 1% a year,
                                                                                                business by using the flexibility in
anniversary by 50% of any positive
difference between the new non-                     >   rise by more than 12% a year, or        our bonus structure. This might arise
guaranteed income and the actual                                                                from a difference in the investment mix,
                                                    >   fall on the first policy anniversary.   a change in the investment environment,


24 Principles & Practices of Financial Management
or a difference in the exposure              circumstances pay-out values on policies         introduce significant unfairness
to business or insurance risk.               of the same duration may go up or down           between policyholders if the cost
The introduction of a new series             by a maximum of 15% for single premium           of guarantees were to change
would limit the impact of the experience     policies and up or down by 7% about the          significantly in future. They therefore
of the business written under either         long-term trend for annual premium               decided that from 2003:
bonus series on the bonus rates of the       policies. Greater flexibility may be
                                                                                              − an annual deduction of up to
other series.                                required in certain circumstances,
                                                                                                0.25% would be levied on asset
                                             for example following a significant rise
1.4. Variations for Scottish Amicable                                                           shares to meet guaranteed
                                             or fall in market values (either sudden
Insurance Fund (SAIF) and Scottish                                                              annuity rate costs, and
Amicable Account (SAA) with-profits          or over a period of years), and in such
policies                                     situations the Scottish Amicable Board           − any additional cost would be
1.4.1. The Scheme which transferred the      may decide to vary the standard bonus              met from the SAIF inherited
business of the Scottish Amicable Life       smoothing limits to protect the overall            estate and reflected in the claims
Assurance Society (SALAS) to PAC             interests of policyholders. Such a                 enhancement factor for all SAIF
included the Principles of Financial         situation arose in February 2003 when              and SAA with-profits policies.
Management (PFM) by which the                pay-out values on most equivalent
Scottish Amicable Funds must be              policies were reduced by amounts             >   There is no explicit allowance for
managed. The bonus policy agreed             greater than the normal limits.                  other guarantees. Any deficit accrues
by the Scottish Amicable Board is            In addition, all pay-out values for              in the fund and affects the level of the
consistent with the PFM.                     SAIF and SAA policies must move at               SAIF inherited estate and therefore
                                             least one-third of the way towards asset         the claims enhancement factor.
In general, SAIF and SAA policies are        share when moving downwards and
managed in the same way as WPSF              at least one-quarter of the way towards
                                                                                          >   The accumulation of smoothing
policies. The following paragraphs set out                                                    profits and losses is regulated by a
                                             the asset share when moving upwards.
any significant differences in Practices.                                                     yearly percentage deduction from,
                                             1.4.4. The calculation of asset shares           or addition to, asset shares which
1.4.2. In targeting pay-out values, asset    for SAIF and SAA with-profits business           is credited or debited to a bonus
shares for SAIF and SAA policies are         differs from that for WPSF with-profits          smoothing account. The smoothing
increased by a claims enhancement            business in the following ways.                  charge/credit, which is subject to
factor. The factor is applied to asset                                                        a maximum charge of 0.4% p.a.,
shares with the aim of distributing the      >   Asset shares are calculated for sample       is reassessed at least every three
SAIF inherited estate, but not the assets        policies using Scottish Amicable’s           years with the intention of
in the Scottish Amicable Capital Fund            approach at 31 December 1996, and            eliminating any deficit or surplus
(SACF), over the remaining lifetime of           are accumulated by reference to the          on the smoothing account over
the with-profits policies in SAIF and SAA.       subsequent investment performance,           the remaining life of the policies.
                                                 expense and taxation experience
The claims enhancement factor is                 of SAIF.                                 >   There is no shareholder profit transfer
reassessed at least every three years                                                         associated with bonuses declared on
and is expressed as a percentage             >   The SACF support charge, equivalent          SAIF and SAA with-profits policies.
increase to the asset shares. It is a            to 1% p.a. of the mean value of SACF,
uniform percentage for business that             is deducted from asset shares.           >   The accumulation of asset shares
has been in force for 10 years or more,                                                       includes an allocation of 0.25% p.a.
with a proportionately lower percentage      >   Prior to 2003 the cost of meeting            in respect of miscellaneous surplus
                                                 annuity rate guarantees was charged          from non-profit and unit-linked
at shorter durations.
                                                 to asset shares in the year in which         business. The extent to which the
1.4.3. The approach to smoothing for             it arose. The Scottish Amicable              actual miscellaneous surplus differs
maturity and death benefits for SAIF             Board decided that this may                  from 0.25% p.a. is reflected in the
and SAA policies is similar to that for                                                       claims enhancement factor.
WPSF policies, except that in normal

                                                                                          Principles & Practices of Financial Management 25
>   The level of expenses charged to                policies for each asset pool that are           2.2.5. No investment strategy relies on
    SAIF until the end of 2007 reflected            compatible with the overall strategy            assets outside of the asset pool unless
    the fixed fees per policy agreed under          and with maintenance of the ongoing             their utilisation has been formally agreed
    the tariff agreement set out in the             solvency of the long-term fund.                 by the Board.
    SALAS Scheme. Thereafter the                    The overall risk management
                                                                                                    2.2.6. All assets of the WPSF, the
    charges reverted to cost, on a basis            procedure is described in section D
                                                                                                    Scottish Amicable Insurance Fund (SAIF)
    equivalent to that being charged for            of the Introduction to the PPFM.
                                                                                                    and the Defined Charge Participating
    the WPSF business subject to the
                                                    2.2.2. The company’s investment                 Sub-Fund (DCPSF), other than any
    resulting costs for SAIF policies being
                                                    strategy is to seek to secure the highest       investments identified in paragraph 2.3.6,
    no greater than those applicable to                                                             would normally be available to be traded.
    corresponding policies sold by PAC.             total return (allowing for the effect of
                                                    taxation and investment expenses)
                                                                                                    2.3 Practices
>   Asset shares for unitised with-profits          whilst:
                                                                                                    2.3.1. The company’s investment
    life business and all conventional
    with-profits business reflect the actual        >   maintaining an acceptable overall risk      practices are mainly set out in a number
                                                        level (having regard to the currency,       of Investment Management Agreements
    level of expenses incurred by the
                                                        nature and outstanding duration of          all of which are reviewed at least annually
    fund. In accordance with the SALAS
                                                        the liabilities) for the long-term fund,    by the PAC Board and, for the Scottish
    Scheme, asset shares for unitised
                                                                                                    Amicable Funds, the Scottish Amicable
    with-profits pensions business reflect
                                                    >   maintaining an appropriate and broad        Board. These Agreements include:
    the specific policy charges on similar              mix of suitable investments, and
    unit-linked policies rather than the                                                            >   a list of approved types of investment
                                                    >   protecting appropriately the relative           (including types of derivatives),
    actual level of expenses incurred.
                                                        interests of all groups of policyholders.   >   benchmark asset mixes for each
                                                                                                        asset pool,
 Section 2 – Investment strategy                    2.2.3. The company’s investment
                                                    strategy permits the use of any                 >   permitted variations (typically 5% of
2.1 Introduction                                    investment instrument, including                    the asset pool) in asset mix as a result
                                                    derivatives, provided the type has been             of tactical asset allocation decisions
In this section we describe the significant
                                                    approved by the Board as recorded in                i.e. if it is expected that investment
aspects of our investment strategy,
                                                    the Investment Management Agreements                returns over the shorter term are
including the use of asset pools which
                                                    between the company and its investment              likely to differ significantly from
may consist either of physically separate
                                                    managers applicable from time to time.              the expected long-term returns,
assets or of notionally separate assets
(also known as “hypothecated” asset                 2.2.4. The company seeks to include all
                                                                                                    >   limitations on credit risk, and
pools) consisting of a different mix of             with-profits policies in a common asset         >   limitations on counterparty exposures.
the classes of assets held in a sub-fund.           pool wherever it is appropriate for them        The limits are set in accordance with
                                                    to share a common investment policy.            the fund’s risk appetite as agreed by the
Recent and historical information on
                                                    For the majority of products a single           Board. The risk appetite is determined
the asset mix of the with-profits funds
                                                    common asset pool is appropriate but the        on the assumption that the with-profits
is available from our website
                                                    Board may decide that certain products          funds are managed on a stand-alone
www.pru.co.uk.
                                                    require a separate pool, for example:           basis and do not rely on shareholder
                                                                                                    resources with the exception of the
2.2 Principles                                      >   to generate a different asset mix,
                                                                                                    specific circumstances described in
2.2.1. The PAC Board is responsible for
                                                    >   to support a specific product feature,      paragraph 5.3.2.2.
setting the investment strategy of the
company, and manages this strategy as                                                               Increases in the proportion of fixed
                                                    >   to support a product expressed in a
                                                                                                    interest stocks and cash, up to a
part of the management of the overall                   different currency, or
                                                                                                    combined proportion of 100% of the fund,
risk level of the company and the long-
                                                    >   where required by legislation.              may be necessary in extreme investment
term fund. It determines investment
                                                                                                    conditions or to protect the fund.

26 Principles & Practices of Financial Management
Derivatives are used only for the purposes          − certain shorter term investment        Some asset pools held within the WPSF
of Efficient Portfolio Management or                  products, which are designed           are what are known as "hypothecated".
reduction in investment risk. The main                and promoted to offer bonuses          This means that rather than actually
use is of exchange traded futures to                  reflecting the investment              holding separate assets in respect of this
implement changes in asset mix, including             income on short term deposits          pool, the assets are still part of the main
tactical deviations from the strategic asset          e.g. Prudential Personal Pension       WPSF asset pool. The reason why we
mix, and of currency forwards to reduce               Deposit Fund,                          may use hypothecated asset pools is that
the exchange rate exposure arising from                                                      where an asset pool is relatively small,
                                                    − Scottish Amicable Capital Fund
holding overseas assets.                                                                     the difficulties in obtaining a suitably
                                                      (SACF), which has an asset mix
                                                                                             diversified portfolio of actual assets,
Investment in any appropriate new or                  as close as possible to that of the
                                                                                             and the proportionately high costs of
novel investment instruments, or in any               Scottish Amicable Insurance Fund       administering a separate pool, mean that
new country, which is proposed by the                 (SAIF), and                            it is beneficial to hypothecate these assets
investment managers, requires Board                 − non-profit liabilities within the      as part of the main WPSF pool rather
approval prior to implementation.                     WPSF, which are backed by a            than hold them separately. However,
                                                      combination of government              investment returns for a hypothecated
2.3.2. Formal reviews of all aspects of
                                                      and corporate bonds of                 asset pool are calculated based on the
the investment policy occur at least once
                                                      approximately the same overall         asset mix that would apply if these assets
a year.
                                                      duration as the liabilities.           were actually a separate pool.
2.3.3. A separate asset pool will                                                            Currently, only the Prudence Bond
                                                >   For SAIF policies, most assets are
be established when there is a legal                                                         Optimum Bonus Fund, the PruFund
                                                    held within the main SAIF asset pool.
requirement or when the company                                                              Growth & Income Fund and the
                                                    The benchmark asset mix for SAIF’s
identifies policies for which achievement                                                    PruFund Cautious Funds have
                                                    main pool differs from that of the
of its overall acceptable risk level requires                                                hypothecated asset pools.
                                                    WPSF’s main pool to reflect the
a significantly different asset mix.
                                                    relative strength of the two sub-        2.3.4. A stochastic asset/liability model
Separate asset pools are usually                    funds. A separate asset pool is          is used to identify the range of asset
maintained for each sub-fund. Within                operated for non-profit liabilities,     mixes for each with-profits asset pool
each sub-fund separate asset pools are              which are backed by a combination        that would be consistent with the risk
held as appropriate to the different                of government and corporate bonds        appetite of the fund (see section D of
nature of the liabilities (e.g. with-profits,       of approximately the same overall        the Introduction to the PPFM) which has
non-profit, unit-linked) and, usually,              duration as the liabilities.             been set by the PAC Board and, where
for liabilities in each different currency.                                                  appropriate, by the Scottish Amicable
                                                >   For the non ELAS business in the
                                                                                             Board. The company selects from that
>   For most WPSF policies assets are               Defined Contribution Participating
                                                                                             range an appropriate strategic asset mix
    held within the main WPSF asset                 Sub-Fund (DCPSF), there are three
                                                                                             for the pool, consisting of a diversified
    pool; however separate asset pools              asset pools relating to liabilities
                                                                                             portfolio of assets which is intended
    are operated for:                               denominated in Sterling, the Euro
                                                                                             to maximise the expected long-run
                                                    and the US Dollar. For the business
    − certain with-profits products                                                          investment return, subject to the risk
                                                    transferred from ELAS in the DCPSF,      level and liquidity needs of the asset
      which have a more cautious
                                                    the asset pool backing these policies    pool. The model allows for all types of
      investment policy than the main
                                                    is identical to that of the main asset   investment risk, including mis-matching
      WPSF asset policy e.g. Optimum
                                                    pool of the WPSF.                        risk, market risk and credit risk.
      Bonus Prudence Bond, which is
      promoted to offer a higher regular        Any with-profits policyholder whose          2.3.5. The investment policy for with-
      bonus rate, and business written          policy is not backed by the main WPSF        profits business is to invest in a highly
      in the PruFund Growth & Income            asset pool has been informed of the          diversified portfolio of UK and overseas
      Fund and PruFund Cautious Funds           asset pool backing the policy, either as     assets. This policy aims to avoid
      from the PruFund Range of Funds.          part of the sales process or on the          large losses connected with default or
                                                demutualisation of SALAS.
                                                                                             bankruptcy of an individual company and
                                                                                             Principles & Practices of Financial Management 27
also generates country diversification.             >   the investment policies for SAIF rely    3.2.2. The Board seeks to ensure that:
These assets may include any available                  on the solvency support provided by
assets which enhance the risk/return                    SACF to pursue an investment policy      >   all material or significant risks are
                                                        appropriate to an open fund i.e.             identified,
balance; they will consist mainly of
exchange-traded equity and bond                         higher real assets (i.e. equity and      >   an appropriate charge is made for all
investments, but may also include                       property) than would otherwise be            significant risks, and
less liquid investments such as direct                  appropriate for a closed fund.
property or private equity and debt.
                                                                                                 >   the sub-fund bearing a particular
                                                                                                     business risk receives such charges
The mix of assets held also takes                    Section 3 – Business Risks                      and any profits or losses arising from
account of the need to maintain adequate
                                                                                                     that business risk.
liquidity within the funds. Liquidity is            3.1 Introduction
monitored on an ongoing basis to ensure                                                          3.2.3. For products which are exposed to
                                                    The long-term fund is exposed to
the cash-flow requirements of the funds                                                          business risks, allowance will be made for
                                                    business risk, which is defined as all
are met. The investments will not contain                                                        all relevant profits and losses arising from
                                                    risks (and rewards) of the long-term
shares in Prudential plc, but may contain                                                        business risks when determining pay-out
                                                    business other than those connected to
shares in subsidiary companies.                                                                  values unless the Directors have decided
                                                    investment returns (which are addressed
                                                                                                 that specific losses will be borne by the
2.3.6. The only asset of the WPSF which             in SECTION 2).
                                                                                                 inherited estate.
would not normally be traded is Prudential
                                                    In this section we describe how we
Annuities Limited (PAL), a subsidiary                                                            3.3. Practices
                                                    manage and control such business risks,
company which was set up to enable                                                               3.3.1. With-profits policyholders are not
                                                    both to protect the security of the fund
greater focus on the management                                                                  exposed to risks arising from general
                                                    and to limit any adverse impact on with-
and profitability of pensions annuity                                                            insurance business, which is written
                                                    profits policies.
business. The size of PAL is limited by the                                                      outside the long-term fund.
constraints implied by the management               Business risks may arise from a range
of the overall risk level of PAC and this           of factors, including product design         3.3.2. With-profits policies normally
contributed to the decision to close it to          (for example the provision of guarantees     share in the profits or losses from
new business from 1 July 2004. PAL has              to policyholders), selling and marketing     business risks arising within the long-
no significant impact on the investment             practices and demographic changes.           term fund as part of the allowance for
freedom of the WPSF. Profits and losses             There can be no certainty that all           miscellaneous surplus or through the
from PAL are reflected in asset shares as           potential risks have been identified.        allowance for expenses included in the
described in paragraph 1.3.7.7. There are           The extent to which with-profits policies    calculation of asset shares. However,
no assets of SAIF or the DCPSF which                are exposed to these risks will inevitably   under the terms of their policy conditions
would not normally be traded.                       change over time.                            some with-profits policies, in particular
                                                                                                 Defined Charge Participating Sub-Fund
2.3.7. In setting the investment                    3.2. Principles                              (DCPSF) policies and policies invested in
policies for the with-profits asset pools,                                                       the PruFund Range of Funds, are not
                                                    3.2.1. The PAC Board is responsible for
the directors do not rely on assets held                                                         exposed to certain specified risks.
                                                    the control of business risks within the
outside the pool except that:
                                                    management of the overall risk level of
                                                                                                 For with-profits annuities transferred from
>   the investment policy for the WPSF              the company and for the maintenance of
                                                                                                 ELAS, the Scheme of transfer requires
    with-profits pools have regard to the           the ongoing solvency of the long-term
                                                                                                 that these policies are not exposed to,
    availability of shareholder resources           fund. The overall risk management
                                                                                                 and will not incur any adjustments for,
    as described in paragraph 5.3.2.2.              procedure is described in section D
                                                                                                 profits or losses arising from, PAC’s other
                                                    of the Introduction to the PPFM.
>   the DCPSF investment policy relies                                                           policies, experience or business activities.
    on an appropriate proportion of the                                                          However, these policies will be exposed
    PAC inherited estate, and                                                                    in extreme circumstances if PAC were
                                                                                                 unable to meet or reserve for its
                                                                                                 guaranteed liabilities.
28 Principles & Practices of Financial Management
3.3.3. Profits and losses on business risks   >   WPSF accumulating and conventional            − a minimal exposure to guaranteed
are dealt with as follows:                        with-profits policies are exposed               annuity rates, and
                                                  to the level of expenses incurred,
>   those in respect of the WPSF will             and such risks may be increased
                                                                                                − a modest exposure to guaranteed
    accrue to all WPSF accumulating                                                               minimum bonus rates on some
                                                  by poor persistency. The level of
    and conventional with-profits                                                                 group cash accumulation business
                                                  expenses is controlled as part of the
    policyholders as part of the                                                                  at various rates:
                                                  budgetary process. Expenses are
    miscellaneous profits or losses               charged to asset shares, except as        >   4.75% p.a. on premiums paid
    credited to their asset shares                described in paragraphs 5.3.2.1               in scheme years ending before
    (see paragraph 1.3.7.7), except to            and 5.3.2.2.                                  15 March 1997 and
    the extent that the Board may decide
    that specific losses should accrue to     >   Smoothing profits and losses arising      >   2.5% p.a. on premiums paid in
    the PAC inherited estate;                     from surrenders are controlled                scheme years ending between
                                                  by managing the Market Value                  15 March 1997 and 30 December
>   those in respect of the Scottish              Reduction (MVR) policy and                    2003 (inclusive), and
    Amicable Insurance Fund (SAIF)                surrender bases of accumulating
    will accrue to SAIF and Scottish                                                        >   0.01% p.a. on premiums paid in
                                                  and conventional with-profits                 scheme years commencing on or
    Amicable Account (SAA) with-profits           policies respectively. Any differences        after 31 December 2002.
    policyholders; therefore they are             between the surrender value paid and
    very unlikely to have an impact on            the underlying asset share accrue:
                                                                                            >   WPSF with-profits policies other
    policyholders in the other sub-funds.                                                       than policies invested in the PruFund
                                                  − for WPSF business other than                Range of Funds and policies
The risk that results from holding a high           business in the PruFund Range               transferred from SAL are exposed
proportion of real assets (e.g. equities            of Funds, to the PAC inherited              to all profits or losses from non-
and property) to back smoothed liabilities          estate, and                                 profit business within the WPSF
which incorporate guarantees is managed                                                         (mainly immediate annuities and term
by keeping the annual bonus rates                 − for Defined Charge Participating            assurance, but also some whole life,
as a prudent proportion of the long-                Sub-Fund (DCPSF) business and               endowment assurance and deferred
term expected investment return                     business within the PruFund                 annuity business). They are also
(see paragraph 1.3.2.1). The cost of                Range of Funds (see paragraph               exposed to profits and losses from
such guarantees and smoothing falls                 C2.3 of the introduction to the             the sub-fund’s annuity subsidiary
to the PAC and SAIF inherited estate                PPFM and paragraph 1.3.8.5 of               Prudential Annuities Limited (PAL).
as appropriate (see paragraphs 1.3.7.4              the PPFM), to the relevant bonus            The main risks from non-profit
and 1.4.4).                                         smoothing account held within               annuity business are:
                                                    the PAC inherited estate
Profits and losses from business risks are                                                      − a higher than anticipated increase
                                                                                                  in life expectancy for annuitants,
not expected to be large because of the       >   Mortality risks for WPSF with-profits
                                                  business are managed through                    or
company’s approach to risk exposure,
with the possible exception of the                regular investigations of mortality           − a higher than anticipated default
exposure to guaranteed annuity rates              trends. Profits and losses arising from         rate on the associated assets
and guaranteed minimum rates of return            any difference between the amount               (mainly bonds).
within SAIF (see paragraph 3.3.5).                charged to asset shares for mortality
                                                  risks and the actual mortality cost           − a widening of credit spreads on
3.3.4. For with-profits business,                 incurred for with-profits business              the associated assets
other than that in SAIF and SAA,                  accrue to the PAC inherited estate.       Profits and losses for such risks are
specific aspects of business risk are
                                              >   Any charges for, or costs of,             reflected in asset shares through the
managed as follows:
                                                  guarantees accrue to the PAC              adjustment for miscellaneous surplus,
                                                  inherited estate. Consequently            as described in paragraph 1.3.7.7.
                                                  WPSF policies currently have:

                                                                                            Principles & Practices of Financial Management 29
>   WPSF policies other than policies               Mis-selling costs in respect of with-profits   4.3.2. Paragraphs 1.3.7.8, 1.3.8, 1.4.4,
    invested in the PruFund Range of                business sold by the Scottish Amicable         5.3.2.1 and 5.3.2.2 set out how (if at all)
    Funds are exposed to operational                Life Assurance Society (SALAS) are             charges for expenses affect asset shares
    risks, including product mis-selling            charged to the SAIF inherited estate           and thus affect the benefits payable on
    or the issue of misleading literature;          and therefore affect pay-outs to SAIF          with-profits policies.
    any consequential customer                      and SAA policyholders.
                                                                                                   4.3.3. All but a small volume of services
    compensation would normally be
                                                                                                   are provided under formal intra-group
    paid from the WPSF as an expense.
                                                      Section 4 – Charges and Expenses             or contractual third party outsourcing
    However, as described in paragraph
                                                                                                   arrangements. External arrangements are
    5.3.2.2, the PAC Board decided that                                                            provided at market prices. Intra-group
                                                    4.1 Introduction
    all expenses and compensation for                                                              arrangements are provided at cost,
                                                    In this section we describe the way in
    the mis-selling of PAC with-profits                                                            or subject to a profit margin or target
                                                    which we allocate expenses and apply
    pension policies should be charged                                                             profit level that is appropriate for the risks
                                                    charges to our with-profits business.
    to the PAC inherited estate.                                                                   taken by, and the capital requirements of,
3.3.5. SAIF and SAA with-profits policies           4.2. Principles                                the service provider. Fees for investment
are exposed to corresponding business               4.2.1. The overall aim of the expense          management services include a profit
risks on all business in SAIF and are               charging and allocation methodology            margin. All other intra-group service
treated in a similar way. They have                 is to seek to ensure that all expense          arrangements are charged to the with-
                                                    allocations are fair between policyholders     profits funds at cost. Intra-group
exposure to:
                                                    and shareholders, between different            reassurance arrangements have no
>   a significant volume of guaranteed              sub-funds and between different groups         material impact on expense allocations.
    annuity rates, although derivatives             of policyholders.
                                                                                                   4.3.4. All outsourcing arrangements,
    have been purchased to reduce the
                                                    4.2.2. The principle underlying the            whether intra-group or with third
    impact of any substantial reduction in
                                                    company’s expense allocation methods is        parties, are reviewed regularly to confirm
    fixed interest yields on the cost, and
                                                    that all expenses should be allocated on a     that they remain appropriate and are
>   a guarantee on certain SAIF                     consistent basis according to the nature       operating in accordance with the relevant
    accumulating with-profits pension               of the activity or where the resulting         agreement between PAC and the service
    business that the minimum rate of               benefit is expected to arise.                  provider. Fees are re-negotiated when
    regular bonus will be 4% p.a. on all                                                           appropriate. The two most significant
                                                    4.2.3. Any significant change to our           intra-group arrangements (for investment
    units purchased, and
                                                    bases and methods of expense allocation        management and policy administration)
>   a guarantee on certain SAIF                     and apportionment, or of exercising            can be terminated at 3 and 6 months
    accumulating with-profits pension               discretion to apply expenses to particular     notice respectively.
    business that the minimum rate of               categories of business, would be made
    regular bonus will be 4% p.a. on all            only if consistent with the above              4.3.5. The Actuarial Function Holder
    units purchased before 1 January                Principles.                                    and the With-Profits Actuary review
    2006 and 0.1% p.a. on all units                                                                each year the fairness to each category
                                                    4.3. Practices                                 of with-profits policy of the expense
    purchased subsequently, and
                                                    4.3.1. Total PAC costs are allocated to        allocation and associated practices,
>   a guarantee on certain SAIF                     sub-funds and product groups using             including intra-group and external
    accumulating with-profits pension               methods that ensure that each sub-fund         servicing and reassurance agreements.
    business that the minimum rate of               and product group receives all its direct      This review also considers the fairness
    regular bonus will be 4% p.a. on all            expenses and an appropriate share of           to with-profits policyholders of any
    units purchased before 1 January                all other expenses, including overhead         intra-group asset transfers (e.g. of
    2006 only.                                      expenses. Any significant change to our        infrastructure) and the exercise of
                                                    expense allocation methods would be            discretion to apply expenses to
The costs of guarantees are reflected in
                                                    approved by the Actuarial Function             particular categories of policy.
asset shares and the claims enhancement
                                                    Holder and the Finance Director.
factor, as described in paragraph 1.4.4.

30 Principles & Practices of Financial Management
 Section 5 – Management of the               After extensive assessment Prudential         5.3. Practices
 inherited estate                            decided in June 2008 that it would not        5.3.1. The PAC inherited estate currently
                                             proceed with a reattribution as it believes   supports the with-profits business in the
5.1 Introduction                             the current operating model for the           WPSF by:
5.1.1. This section defines the inherited    With-Profits Fund is in the best long-term
estate and describes how it is managed       interests of both current and future          >   providing the benefits associated with
                                             policyholders and shareholders.                   smoothing and guarantees,
and the uses to which it may be put.

                                             5.1.4. The inherited estate in SAIF will be
                                                                                           >   permitting investment flexibility for
5.1.2. An inherited estate is the amount
                                                                                               the fund’s assets,
of money in the long-term fund in excess     distributed to SAIF and Scottish Amicable
of the amounts that the company expects      Account (SAA) with-profits policyholders      >   meeting the regulatory capital
to pay out to meet its obligations to        in accordance with the SAIF Principles of         requirements, which demonstrate
existing policyholders. These latter         Financial Management which are part of            solvency.
amounts are equal to the with-profits        the Scheme approved by the court which        Transfers to or from the PAC inherited
policyholders’ accumulated asset shares,     transferred the Scottish Amicable Life        estate occur every year as part of the
plus any additional payments that may        Assurance Society (SALAS) into PAC.           normal process of smoothing pay-out
be required by way of smoothing or to                                                      values and as a consequence of the tax
                                             5.2. Principles
meet guarantees.                                                                           basis applicable to SAIF (see paragraph
                                             5.2.1. The company seeks to manage the
                                                                                           1.3.7.3); larger transfers from the
There are two inherited estates in           PAC inherited estate held in the WPSF
                                                                                           inherited estate may occur as a result
Prudential’s long-term fund, the PAC         so that it continues to provide adequate
                                                                                           of meeting guarantees in adverse
inherited estate and the Scottish            working capital for the future security and
                                                                                           investment conditions.
Amicable Insurance Fund (SAIF)               ongoing solvency of the long-term fund.
inherited estate.                                                                          It is also used to support business
                                             5.2.2. The PAC Board manages the
                                                                                           in other sub-funds in return for an
5.1.3. The PAC inherited estate              overall business having regard to the size
                                                                                           appropriate charge; for example it
represents the major part of the working     of the PAC inherited estate. This reflects
                                                                                           supports SAIF and the Defined Charge
capital of Prudential’s long-term fund       the inherited estate’s role as the working
                                                                                           Participating Sub-Fund (DCPSF) in return
which is available to support both current   capital of the long-term fund which
                                                                                           for a yearly charge.
and future business. It has arisen over      largely determines the risk capacity of the
many years from a number of sources          fund. The inherited estate absorbs, at        5.3.2. The PAC inherited estate may
and, like the whole of the with-profits      least in the short term, the impact of any    also be used for any other purposes as
funds, belongs to the company.               substantial changes affecting the long-       considered appropriate by the Directors.
                                             term fund. There is no specific target for    This may include absorbing the costs of
The Directors decide how the                 the size of the PAC inherited estate.         significant events, such as fundamental
PAC inherited estate is used to
                                                                                           change in its long-term business and
support the with-profits business.           5.2.3. The Scottish Amicable Board
                                                                                           the cost of providing redress for past
Neither policyholders nor shareholders       manages the overall risk level for SAIF
                                                                                           mis-selling, without affecting the bonus
can have any expectation that they will      in a similar way, having regard to the
                                                                                           and investment policies of existing
receive any distribution of the inherited    existence of Scottish Amicable Capital
                                                                                           policyholders. The costs of fundamental
estate in the normal course of events,       Fund (SACF), the size of the SAIF
                                                                                           change may include investment in
other than through the normal process        inherited estate as a proportion of SAIF
                                                                                           new technology, redundancy and
of smoothing and meeting guarantees in       and the requirement to distribute the
                                                                                           restructuring costs, cost overruns on new
adverse investment conditions.               inherited estate equitably as an addition
                                                                                           and existing business, regulatory and
                                             to with-profits benefits.
In March 2007 Prudential announced                                                         legal change and the funding of other
that it was exploring the possibility of a                                                 appropriate activities related to long-term
reattribution of the PAC inherited estate.                                                 insurance, including acquisitions.



                                                                                           Principles & Practices of Financial Management 31
5.3.2.1 Currently, the PAC inherited                on 30 June 2002 and consequently the          maintain regulatory solvency in adverse
estate bears the following costs:                   assurance has not applied to new WPSF         market conditions. The asset mix of
                                                    business issued since 1 January 2004.         the PAC inherited estate is regularly
>   the additional tax payable by the               New business in this context consists of      reviewed to ensure it remains appropriate.
    long-term fund as a result of the               new policies, new members to existing
    distribution to shareholders of their                                                         5.3.4. The investment strategy for the
                                                    pension schemes plus regular and single
    part of the WPSF divisible profit                                                             SAIF inherited estate is determined in
                                                    premium top-ups, transfers and switches
    (see paragraph 1.3.7.6),                                                                      accordance with the overall investment
                                                    to existing arrangements.
                                                                                                  strategy (see Section 2) and the SAIF
>   expenses written-off since 1997
                                                    The assurance will continue to apply          Principles of Financial Management
    (see paragraph 1.3.7.8), and
                                                    to any WPSF policy in force as at             (see Appendix A). The SAIF inherited
>   in respect of business issued by                31 December 2003, both for premiums           estate currently has a different asset mix
    Scottish Amicable Life plc, any cost            paid before 1 January 2004 and for            to that of the assets backing with-profits
    of shareholder transfer in excess of            subsequent regular premiums (including        policies. The ability to have a different
    the difference between the level                future fixed, retail price index or salary-   investment mix allows the flexibility
    of charge deducted and level of                 related increases and Department for          required in order to help meet guarantees,
    expenses incurred.                              Work and Pensions rebates).                   maintain regulatory solvency and ensure
These items will continue to be charged                                                           the fund is managed in a sound and
                                                    The maximum amount of capital                 prudent fashion, which is particularly
to the PAC inherited estate only for                support available under the terms of
as long as the security of the fund                                                               important during adverse market
                                                    the assurance will reduce over time as        conditions. The asset mix of the SAIF
remains satisfactory.                               the company pays claims on the policies       inherited estate is regularly reviewed
5.3.2.2 The PAC Board decided that                  covered by the assurance. It reduces to       to ensure it remains appropriate.
the costs associated with the PAC                   the extent that the current asset share
personal pensions mis-selling review                value of such policies remaining in force     5.3.5. If the size of the inherited estate
were abnormal and so should not impact              falls below the asset share value, at         relative to the liabilities of the long-term
on asset shares, and that they should be            31 December 2003, of all policies then        fund became significantly smaller or
met from the PAC inherited estate.                  covered by the assurance adjusted for         significantly larger, the Board would
                                                    the net investment return earned on the       take the appropriate action at that time.
So that the resulting reduction in the              asset shares since that date.                 There is no specific target for the size of
inherited estate would have no adverse                                                            the PAC inherited estate.
impact on policyholder pay-out values,              The bonus and investment policy for
Prudential stated in 1998 that deducting            each type of WPSF with-profits policy         5.3.6. A significant reduction in the PAC
personal pensions mis-selling costs from            is currently the same irrespective of         inherited estate as a proportion of the
the inherited estate would not impact the           whether or not the assurance applies.         WPSF would be likely to lead to changes
company’s bonus or investment policy                Hence removal of the assurance for            in the investment and bonus policies
for WPSF policies. The company gave an              new business has had no impact on             for the affected with-profits business,
assurance that if this unlikely event were          policyholder returns and this is expected     such that the overall risk level of the
to occur, it would make available support           to continue for the foreseeable future.       company was substantially unaltered.
to the long-term fund from shareholder              5.3.3. The investment strategies for          5.3.7. In accordance with the SALAS
resources for as long as the situation              the PAC inherited estate, excluding           Scheme, the SAIF inherited estate will
continued, so as to ensure that WPSF                any assets which would not normally           be distributed progressively to SAIF and
policyholders were not disadvantaged.               be traded (see paragraph 2.3.6),              SAA with-profits policyholders as they
The assurance was designed to protect               is determined in accordance with the          become claims. When SAIF is eventually
both existing WPSF policyholders at the             overall investment strategy (see Section      merged into the WPSF in accordance
date it was announced, and policyholders            2). The PAC inherited estate currently        with the SAIF Principles of Financial
who subsequently purchased policies                 has a different asset mix to that of the      Management, the balance of the SAIF
while the pension mis-selling review was            assets backing with-profits policies.         inherited estate will be attributed to the
continuing. This review was completed               This is to help meet guarantees and           asset shares of the remaining SAIF and
                                                                                                  SAA with-profits policyholders.
32 Principles & Practices of Financial Management
 Section 6 – Volumes of new                     6.3 Practices                                 7.2 Principles
 business and arrangements on                   6.3.1. The PAC Board manages the types        7.2.1. The company seeks to
 stopping new business                          and maximum volumes of new business           treat all customers fairly at all times,
                                                accepted by the company and its               balancing any conflicting interests that
6.1 Introduction                                subsidiaries Prudential Annuities Limited     arise between the various groups and
In this section we describe the way in          (PAL) and Prudential International            generations of policyholders or between
which we review limits on the quantity          Assurance (PIA) having regard to              policyholders and shareholders.
and type of new business accepted               the risk appetite of the company.
                                                                                              7.2.2. The proportion, or minimum
and the actions we would take if we
                                                6.3.2. There is no immediate prospect of      proportion, of the relevant divisible profit
ceased to take on a significant amount
                                                the company closing the WPSF to new           (as defined in paragraph 1.1.1) to be
of new business.
                                                with-profits business. Although it is not     allocated to each type of with-profits
The Scottish Amicable Insurance Fund            easy to predict the circumstances under       policy is specified via the sub-fund
(SAIF) is closed to new business except         which such a decision would become            structure, as described in section C
for a small volume of contractual               appropriate, it might occur if the volume     of the Introduction to the PPFM.
increases to existing arrangements.             of new business declined to a negligible      The actual proportion applicable in the
The operation of SAIF, as a closed fund,        level and there was no apparent prospect      WPSF may be varied from year to year,
is defined by the SAIF Principles of            of the volume recovering. However,            any substantial overall reduction in the
Financial Management.                           if the fund were to close to new with-        policyholders’ proportion being subject
                                                profits business, it is unlikely that there   to specific regulatory requirements.
6.2 Principles                                  would be any immediate reduction in the
6.2.1. The PAC Board manages the types          requirement to maintain the inherited         7.3 Practices
and volumes of new business accepted            estate as it would still be needed for use    7.3.1 Bonuses and pay-out values are
as part of its management of the overall        as working capital.                           determined as set out in section 1 and
risk level of the company and for the                                                         the divisible profits are calculated, after
maintenance of the ongoing solvency                                                           any transfer to a contingency fund, as
of the long-term fund.                           Section 7 – Equity between                   an amount equal to the cost of bonuses
                                                 with-profits policyholders and               on the regulatory reporting basis plus
6.2.2. In the event that the fund became         shareholders                                 the associated shareholder transfer.
closed to with-profits business or the
                                                                                              For this purpose:
volume of new with-profits business             7.1 Introduction
became negligible, it would be necessary        In this section we describe how we            >   the cost of regular bonuses is the
to review the position and put in place a       balance the interests in the WPSF                 amount added to policyholders'
plan for the management of the inherited        of with-profits policyholders and                 accounts, or in the case of
estate over the long term. Any proposal         shareholders.                                     conventional with-profits business,
for the reattribution, or the ultimate                                                            the change in liability on the statutory
distribution, of any part of the inherited      As set out in the Introduction to the
                                                                                                  reporting basis as a result of the
estate between policyholders and                PPFM, profits of the Scottish Amicable
                                                                                                  bonus addition, reduced by the cost
shareholders would need to take into            Insurance Fund (SAIF) and the Defined
                                                                                                  of guaranteed bonuses on Group
account all the relevant factors and claims     Charge Participating Sub-Fund (DCPSF)
                                                                                                  Cash Accumulation business,
on the estate. It is likely that any proposal   are attributable wholly to policyholders,
to reattribute or distribute would need to      and profits of the Non-Profit Sub-Fund        >   the cost of final bonuses is generally
                                                (NPSF) are wholly attributable to                 the amount paid on claims, net of any
be sanctioned by the court to ensure that
                                                shareholders. Therefore, issues of equity         market value reduction, and
the competing interests of all classes of
policyholders and of shareholders are           between policyholders and shareholders
properly considered and reflected.              are largely confined to the equity of the
                                                expense apportionment (see section 4)
                                                for these sub-funds.


                                                                                              Principles & Practices of Financial Management 33
>   the cost of bonus is adjusted for any           >   any transfer of assets or business out      Appendix A
    difference between the actual cost                  of the long-term fund or between
    and the expected cost of the previous               sub-funds which might affect with-         Scottish Amicable Insurance
    year’s bonuses, including the amount                profits policyholders must be at fair      Funds – Principles of Financial
    of final bonus allowed for in paid-up               value i.e. on market related terms;        Management (PFM)
    policy, surrender and transfer values                                                          This appendix reproduces the Principles
    after the application of any Market
                                                    >   it will consider the suitability for the
                                                        long-term fund of any investment           of Financial Management defined in
    Value Reduction (MVR).                                                                         1997. The terminology used relates to
                                                        proposed for the benefit of the
Taxation on all long-term fund assets is                company as a whole and only                documentation agreed as part of the
provided for (and in due course paid                    accept into the long-term fund:            Scheme of Transfer of SALAS business
from) the appropriate sub-fund before                                                              and therefore differs from that used
                                                        − investments which, by the nature
determination of the divisible profit.                                                             in the Principles and Practices of
                                                          of the asset, could be a natural
The additional tax payable by the long-                                                            Financial Management.
                                                          part of the investment portfolio
term fund as a result of the distribution
                                                          (e.g. an initial investment in a new     1. The affairs of the Scottish Amicable
to shareholders of their part of the WPSF
                                                          unit trust); these investments are          Funds shall be conducted in a sound
divisible profit is paid from the PAC
                                                          made subject to any additional              and prudent fashion.
inherited estate (see paragraph 1.3.7.6).
                                                          costs or risks being compensated
                                                                                                   2. The investment and bonus policies for
7.3.2 If the Financial Services Authority                 for appropriately, or
                                                                                                      the Scottish Amicable Insurance Fund
changes the statutory reporting basis,
                                                        − investment in a subsidiary where            shall have regard to the interests and
which is used to calculate the cost of
                                                          the underlying business has                 expectations (as modified by this
bonus, the impact on the allocation
                                                          similar risks to insurance business         Scheme) of the holders of Policies
between policyholders and shareholders
                                                          which the long-term fund might              allocated to the Scottish Amicable
cannot be assessed until any such new
                                                          write directly, such as Prudential          Insurance Fund, Excluded Policies
method has been published. A change
                                                          Annuities Limited (PAL) which               which would have been so allocated
in the basis for calculating the cost of
                                                          was set up to enable greater                if they were Transferred Policies and
bonus would not normally lead to
                                                          focus on the management and                 Unitised With Profits Policies referred
any change in the division of profits
                                                          profitability of pensions annuity           to in Paragraph 27.1 (Relevant
between policyholders and shareholders;
                                                          business; the aggregate size of             Policies) and shall be determined
however, the allocation would be
                                                          such subsidiaries is limited by             as if the Scottish Amicable Capital
reviewed on any major change in
                                                          the constraints implied by the              Fund represented free assets of the
the valuation approach.
                                                          management of the overall risk              Scottish Amicable Insurance Fund.
7.3.3 As part of treating with-profits                    level of PAC. No new business has           Such investment and bonus policies
customers fairly the PAC Board has                        been written in PAL since 1 July            shall not be constrained in any way
determined that:-                                         2004. Profits (or losses) on PAL            other than by the financial position of
                                                          business issued prior to 1 January          the Scottish Amicable Funds and in
>   it may change the allocation of new                   2000 accrue to the PAC inherited            accordance with the principles
    non-profit business between the                       estate, while profits (or losses)           specified in this Schedule.
    WPSF and the NPSF; any such                           on business issued subsequently
    amendments will not adversely                                                                  3. The investment policy for the
                                                          are credited to WPSF asset shares
    affect the rights of WPSF with-profits                                                            Scottish Amicable Funds:
                                                          as part of the miscellaneous
    policyholders at the time of the                      surplus (see paragraphs 1.3.7.7             (a) shall be substantially the same as
    amendment to share in the profits                     and 3.3.3)                                      the investment policy followed for
    from existing non-profit business
                                                                                                          business in the Other Long Term
    then within the WPSF;
                                                                                                          PAC Funds as appropriate to the
                                                                                                          nature of the liabilities, shall follow
                                                                                                          similar investment principles,

34 Principles & Practices of Financial Management
       in terms of asset allocations,             in the Scottish Amicable Capital              operating the smoothing policy
       to the Other Long Term PAC                 Fund) over the remaining life of              of the Scottish Amicable
       Funds and shall be conducted               the Relevant Policies;                        Insurance Fund as described
       with a view to ensuring so far                                                           in Paragraph 9 below.
                                               (b) shall aim to distribute the surplus
       as reasonably practicable the
                                                   assets in the Scottish Amicable       5. Asset Share records shall be
       same returns for policyholders
                                                   Insurance Fund in excess of those        maintained and referred to in
       of Relevant Policies by asset class
                                                   already earmarked for distribution       setting bonus rates in order to
       as for policyholders of the Other           to policyholders under Scottish          ensure equity between different
       Long Term PAC Funds;                        Amicable's current bonus policy          groups of policyholders.
   (b) shall have regard to any statement          so as to provide a uniform
                                                                                            Asset Shares shall be determined as
                                                   percentage enhancement
       of intent on investment in equities                                                  at the Effective Date using Scottish
                                                   (reassessed from time to time
       made in the Circular; and                                                            Amicable's approach at 31 December
                                                   in accordance with Paragraph 6
                                                                                            1996 and shall be accumulated in the
   (c) shall provide for maintaining the           below) to projected claim values,
                                                                                            future using a consistent approach,
       maximum equity backing ratio                subject to adjustment for policies
                                                                                            by reference to the investment
       possible subject to such constraints        which have been in force for less
                                                                                            performance, expense and taxation
       as may be necessary to reduce               than ten years;
                                                                                            experience of the Scottish Amicable
       the risk of statutory insolvency
                                               (c) shall smooth payouts in a manner         Insurance Fund.
       to a similar level as for the Other         consistent with the selected
       Long Term PAC Funds. The risk                                                        The future accumulation of Asset
                                                   equity-oriented investment
       of statutory insolvency shall                                                        Shares shall include an allocation
                                                   policy of the Scottish Amicable
       be determined on bases and                                                           of 0.25% per annum in respect of
                                                   Insurance Fund, and the need
       assumptions which are no more                                                        miscellaneous surplus from non-profit
                                                   to reduce to acceptable levels
       cautious than those applied to the                                                   and unit-linked business, and an
                                                   (determined on bases and
       Other Long Term PAC Funds but                                                        allocation or deduction of a
                                                   assumptions which are no more
       the Scottish Amicable Capital                                                        smoothing credit or charge
                                                   cautious than those applied to
       Fund shall be ignored to the extent                                                  determined in accordance with
                                                   the Other Long Term PAC Funds),
       that taking it into account would                                                    the principles referred to in
                                                   the expected cost of operating
                                                                                            Paragraph 8 below.
       otherwise permit a higher equity            the smoothing policy of the
       backing ratio than the greater of (a)       Scottish Amicable Insurance           6. Payouts at maturity shall be targeted
       that of the Other Long Term PAC             Fund as described in Paragraph 9         on 100% of Asset Shares with the
       Funds and (b) 85%.                          below; and                               addition of an enhancement to reflect
                                                                                            the distribution or surplus assets
4. The bonus policy for Relevant Policies:     (d) shall be such as to provide an
                                                                                            referred to in Paragraph 4(b) above.
                                                   attractive amount of guaranteed
   (a) shall be determined by reference            bonus for holders of Relevant            The level of enhancement shall be
       to the financial position,                  Policies consistent with the             set at the Effective Date, and shall
       performance and experience of               selected equity-oriented                 be reassessed at least triennially,
       the Scottish Amicable Insurance             investment policy and the                to provide a uniform percentage
       Fund as if the Scottish Amicable            need to reduce to acceptable             enhancement to the projected
       Capital Fund represented free               levels (determined on bases and          claim values of all Relevant Policies
       assets of the Scottish Amicable             assumptions which are no more            remaining in force at the time.
       Insurance Fund, and in such a               cautious than those applied to           The enhancement shall be
       manner as to distribute equitably           the Other Long Term PAC Funds),          determined by the Appointed
       all the assets of the Scottish              the risk of statutory insolvency         Actuary (since 1 January 2005,
       Amicable Insurance Fund                     as described in Paragraph 3(c)           the Actuarial Function Holder – see
       (including all future surplus arising       above and the expected cost of           section E of the Introduction) and
       in the fund but excluding assets
                                                                                            approved by the Monitoring Actuary

                                                                                         Principles & Practices of Financial Management 35
    using the best estimate at the time,               (a) the present value of 75% of the     (a) the enhancement referred to
    on realistic assumptions, of the                       fees payable by the Scottish            in Paragraph 6 above relating to
    projected claim values and the                         Amicable Insurance Fund to the          the remaining Relevant Policies
    value of future miscellaneous surplus                  Other Long Term PAC Funds in            shall be reassessed so that the
    (including any surrender surplus),                     respect of the Scottish Amicable        remaining assets of the Scottish
    and shall exclude any deficit or                       Capital Fund, less the expected         Amicable Insurance Fund plus
    surplus on the smoothing account                       cost to the Other Long Term PAC         the amount of any deficit in the
    referred to in Paragraph 7 below.                      Funds of any restrictions on            smoothing account together
                                                           investment freedom resulting            with the value of future surplus
7. A smoothing account shall be                            from the provision of capital           projected to arise in the Scottish
   maintained to which shall be                            support to the Scottish Amicable        Amicable Insurance Fund shall
   credited the difference between                         Insurance Fund by means of the          be distributed to the remaining
   claim payments (excluding the                           Scottish Amicable Capital Fund;
   enhancement described in Paragraph                                                              Relevant Policies as a uniform
                                                           and                                     enhancement to expected
   6 above) on Relevant Policies, and
   Asset Shares. A smoothing charge                    (b) the present value of 35% of the         claim values by means of an
   or allocation may be levied against,                    fees payable by the Scottish            enhancement to asset shares
   or credited to, Asset Shares, and the                   Amicable Insurance Fund to the          (such enhancement to be
   amount of such charge or allocation                     Other PAC Funds in respect of the       determined by the Appointed
   shall be credited to, or deducted                       Scottish Amicable Capital Fund,         Actuary and agreed by the
   from, the smoothing account.                                                                    Monitoring Actuary); and
                                                          calculated assuming that the
8. Subject to Paragraph 9 below, the                      maximum permitted amount of          (b) thereafter, the bonuses payable
   intention at all times shall be to aim                 the Scottish Amicable Capital            on the remaining Relevant Policies
   for neither surplus nor deficit in the                 Fund is outstanding at all times.        shall be determined by reference
   smoothing account, and the level                                                                to the enhanced Asset Shares,
                                                    10. The maximum smoothing charge shall         accumulated at the rate of
   of the charge or allocation referred
                                                        be agreed by the Appointed Actuary         investment return with additions
   to in Paragraph 7 above shall be
                                                        of PAC and the Appointed Actuary           for premiums and with deductions
   determined as the percentage per
                                                        of Scottish Amicable prior to the          for expenses, taxation and risk
   annum of Asset Shares, which is
                                                        Effective Date, and in the event of        benefits which reflect the
   expected to eliminate any deficit or
                                                        agreement not being reached by the
   surplus on the smoothing account                                                                performance and experience of
                                                        Effective Date shall be referred for
   over the remaining life of the policies,                                                        the whole of the Long Term Fund
                                                        final determination to an Umpire
   after allowing for smoothing costs                                                              and subject to the smoothing
                                                        appointed in accordance with
   which may be expected to arise as a                                                             policy applied to other With-
                                                        Schedule 10.
   result of guarantees or underlying                                                              Profits Policies in the Long Term
   trends in claim values. The charge                  The level of smoothing charge or            Fund. Any further smoothing
   or allocation shall be reassessed at                allocation determined from time to          charges which may be levied
   least triennially, but in any event any             time shall be determined (subject to        against Asset Shares shall not
   charge shall not exceed the amount                  the maximum referred to in Paragraph        exceed the maximum charge
   set out in Paragraph 9 below.                       9 above) by the Appointed Actuary           referred to in Paragraph 9 above.
                                                       and shall be subject to approval by         For the avoidance of doubt,
9. The maximum charge shall be set
                                                       the Monitoring Actuary.                     no deductions shall be made in
   prior to the Effective Date so that the
   expected cost to the Other Long Term                                                            respect of shareholder transfers or
                                                       11. Upon the merger of the Scottish
   PAC Funds of smoothing in relation to                                                           shareholder tax, and no further
                                                           Amicable Insurance Fund with the        allocations shall be made in
   the Scottish Amicable Insurance Fund                    Other Long Term PAC Funds in
   is equal to the greater of:                                                                     respect of miscellaneous surplus
                                                           accordance with Paragraph 32 of         or otherwise, other than the
                                                           the Scheme:                             0.25% allocation referred to in
                                                                                                   Paragraph 5 above.
36 Principles & Practices of Financial Management
 Appendix B                                     (b) each Transferring Policy will have     4. Exhaustion of Aggregate Asset
                                                    a level of Post-Smoothing Non-            Share over the lifetime of the
                                                    Guaranteed Income equal to the            Transferring Policies
ELAS With-Profits Annuities –
Principles of Financial                             level of Post-Smoothing Non-              (a) The Transferee will determine the
Management                                          Guaranteed Income in respect                  amounts of Pre-Smoothing Non-
                                                    thereof immediately prior to the              Guaranteed Income in respect
This appendix reproduces the Principles
                                                    Effective Date; and                           of the Transferring Policies in a
of Financial Management agreed as
                                                                                                  manner calculated to exhaust the
part of the Scheme of Transfer of ELAS          (c) until a new bonus rate is                     Aggregate Asset Shares (including
business to PAC. The terminology used               announced by the Transferee with              any adjustment of the Aggregate
relates to documentation agreed as part             respect to the Transferring Policies
                                                                                                  Asset Share as a result of the
of the Scheme of Transfer of ELAS                   on or after the Effective Date, any
                                                                                                  Aggregate Augmentation
business and therefore differs from that            bonus rate, interim or otherwise,
                                                                                                  Amount) of the Transferring
used in the Principles and Practices of             which is applicable to the policy
                                                                                                  Policies over the lifetime of the
Financial Management. The Scheme is                 immediately prior to the Effective
                                                                                                  Transferring Policies, allowing for
available on request.                               Date will continue to apply.
                                                                                                  the Transferee's expectations of
1. The Transferring Policies                    2.2 The rates from time to time                   future mortality, in line with the
   Bonus Series                                 determined by the Transferee as the               Transferee PPFM from time to
   On the Effective Date, the Transferee        rates of Non-Guaranteed Bonus to be               time. The Transferee will allow for
   will create a new bonus series (the          applied to the Transferring Policies              its expectations of future mortality
   "Transferring Policies Bonus Series")        will be applied in determining the                by using a mortality basis which
   and the Transferring Policies                Post-Smoothing Non-Guaranteed                     the Transferee With-Profits
   will be allocated to and form the            Income in respect of each                         Committee confirms at the start
   Transferring Policies Bonus Series.          Transferring Policy in accordance                 of each calendar year to be a best
   The Transferring Policies Bonus Series       with the established practice for the             estimate basis for the Transferring
   will not be merged or amalgamated            calculation thereof (being initially the          Policies (without any known
   with any other bonus series and no           established practice of the Transferor            margins for prudence) for
   other policies, in whole or in part,         but subject to changes from time
                                                                                                  expected mortality during the
                                                to time made by the Transferee
   will be allocated to the Transferring                                                          remaining lifetimes of the
                                                consistently with applicable law and
   Policies Bonus Series. None of                                                                 Transferring Policies.
                                                regulation and with the consent of the
   the Transferring Policies will be
                                                Transferee With-Profits Committee).           (b) Bonuses announced and paid on
   transferred from the Transferring
   Policies Bonus Series at any time                                                              the Transferring Policies will be
                                             3. Maintenance of separate Asset
   after the Effective Date.                    Shares for the Transferring Policies              calculated with the aim of fully
                                                The Individual Asset Shares attaching             distributing the achieved returns
2. Income after the Effective date                                                                on the underlying investments
                                                to the Transferring Policies shall be
   2.1 Immediately following the                maintained separately from the asset              over the time the Transferring
   Effective Date (and, for the avoidance       shares of all other policies of the               Policies are in force, allowing for
   of doubt, this reference to Effective        Transferee. The Transferring Policies             smoothing of the peaks
   Date shall refer to the time and date        shall have no exposure to, and shall              and troughs of investment
   in the definition of "Effective Date"):      incur no adjustment for, profits and              performance in accordance
                                                losses arising from the Transferee's              with paragraph 7 (Smoothing)
   (a) each Transferring Policy will have
                                                other policies, experience or business            of these Principles of Financial
       the same level of Guaranteed
                                                activities (save to the extent of                 Management and other factors
       Income as it had immediately
                                                unavoidable indirect exposure as a                more fully described below.
       prior to the Effective Date;
                                                result of the effects of such profits
                                                and losses on the Transferee's overall
                                                financial position).

                                                                                           Principles & Practices of Financial Management 37
    (c) The Aggregate Asset Share held                 earned by the Transferee on the          (f) Asset pools other than the
        in the Transferee DCPSF will only              Transferee WPSF Asset Pool                   Transferee WPSF Asset Pool,
        fund such part of any payment                  (net of unrecoverable tax)                   with asset mixes different to
        made under a Transferring Policy               (the "Gross Rate of Investment               the Transferee WPSF Asset Pool,
        as constitutes the Pre-Smoothing               Return"), and the Individual Asset           may operate within the Transferee
        Non-Guaranteed Income in                       Share of each Transferring Policy            WPSF for certain specific
        respect of such payment, and not               shall be credited accordingly.               categories of business but the
        any additional amount by which                                                              Transferring Policies will not
                                                    (c) In determining the investment
        the Guaranteed Income in respect                                                            participate in the investment
                                                        return to be credited to the
        of such payment exceeds the                                                                 return of such asset pools.
                                                        Individual Asset Share of
        Pre-Smoothing Non-Guaranteed
                                                        any Transferring Policy, the         6. Mortality experience
        Income in respect of such
                                                        Transferee may adjust the               (a) To the extent that actual payments
        payment.
                                                        Gross Rate of Investment                    of income on the Transferring
    (d) For any Transferring Policy an                  Return for any tax liability or             Policies are less or more than
        Incurred Cost of Guarantee                      credit of the Transferee arising            expected in any calendar year
        may occur whenever a payment                    out of or in consequence of that            because of heavier or lighter
        is made under the policy.                       Transferring Policy in accordance           mortality than expected, the profit
        The Incurred Cost of Guarantee                  with applicable tax legislation             or loss shall be for the account of
        in respect of any payment is the                which is properly allocable to              the Transferee WPSF, and such
        Guaranteed Income in respect                    such Transferring Policy.                   transfers shall be made between
        of that payment less the                                                                    the Transferee DCPSF and the
                                                    (d) In determining the Gross Rate of
        Pre-Smoothing Non-Guaranteed                                                                Transferee WPSF as are necessary
                                                        Investment Return, the Transferee
        Income in respect of that payment,                                                          to achieve this.
                                                        will not treat the Transferring
        subject to a minimum of zero.
                                                        Policies less favourably than it        (b) For the purposes of determining
        The Transferee WPSF shall pay
                                                        treats other policies for which             what annuity payments on
        the Incurred Cost of Guarantee
                                                        the crediting of investment return          the Transferring Policies are
        in respect of all payments under
                                                        to asset shares is determined               "expected" to be made in any
        Transferring Policies.
                                                        by reference to the investment              period for the purposes of
5. Investment return of the WPSF                        return of the Transferee WPSF               paragraph 6(a), the Transferee
   Asset Pool to be credited to the                     Asset Pool and will not make                shall use the mortality basis or a
   Transferring Policies
                                                        adjustments for miscellaneous               combination of mortality bases
    (a) The asset mix backing the                       profits or losses or on account             which the Transferee With-Profits
        Transferring Policies will be                   of smoothing.                               Committee has confirmed in
        identical to the asset mix of the
                                                                                                    advance of and for purposes of
        Transferee WPSF Asset Pool.                 (e) Except as required by paragraph 8
                                                                                                    that period to be a best estimate
                                                        of these Principles of Financial
    (b) The Aggregate Asset Share will                                                              basis or best estimate bases for
                                                        Management, the Transferee will
        be credited in each year by a                                                               the Transferring Policies (without
                                                        not apply different rates of Non-
        rate of investment return which                                                             any known margins for prudence)
                                                        Guaranteed Bonus to different
        (before deduction of charges and                                                            for expected mortality during
                                                        Transferring Policies and will
        adjustments for any tax liability                                                           the remaining lifetimes of the
                                                        not apply different rates of
        or credit in accordance with                                                                Transferring Policies, and for this
                                                        Guaranteed Bonus to different
        applicable tax legislation, but net                                                         purpose the Transferee will ensure
                                                        Transferring Policies having the
        of unrecoverable tax) is the same                                                           that the Transferee With-Profits
                                                        same GIR.
        as the rate of investment return                                                            Committee gives such a




38 Principles & Practices of Financial Management
   confirmation for an appropriate          (e) The Transferee may only adopt             (g) The Estimated Mortality Change
   period not less than once per year           a different mortality basis for its           shall be calculated, being the
   and that, in so far as they relate           management of the Transferring                amount given by:
   to the same period, the mortality            Policies if the Transferee
                                                                                              (i) the Aggregate Policy Value
   basis confirmed is the same as the           With-Profits Committee has
                                                                                                  at the time of the change in
   mortality basis confirmed by the             given its consent, which the
                                                                                                  mortality basis, calculated
   With-Profits Committee for                   Transferee With-Profits
                                                                                                  using the Core Reserving
   purposes of paragraph 4(a)                   Committee will only give if:
                                                                                                  Basis, including the mortality
(c) At the end of each calendar year,       (i) it is satisfied that the new                      basis included in the Core
    the Transferee shall adjust the             mortality basis to be adopted                     Reserving Basis;
    Individual Asset Shares of all the          by the Transferee is fair to both         Minus
    Transferring Policies which remain          the Transferring Policies and the
    in force at that time in a manner           Transferee WPSF and represents            (ii) the Aggregate Policy Value at the
    which redistributes amongst those           a best estimate basis for the                  time of the change in mortality
    remaining policies, in a manner             expected future mortality                      basis, calculated using the Core
    which is fair to all holders of those       experience of the Transferring                 Reserving Basis but with the
    remaining policies having regard            Policies;                                      mortality basis therein replaced
    to these Principles of Financial                                                           by the new mortality basis.
                                            (ii) in forming its assessment
    Management, the amount of the                                                         (h) Where the Estimated Mortality
                                                 for adopting a different basis
    Individual Asset Shares that would                                                        Change is positive, the Mortality
                                                 (including for the purposes of
    have been released or reduced if                                                          Impact shall be calculated as the
                                                 paragraph (i) above), it has taken
    the actual incidence of deaths of                                                         percentage rate which, if applied
                                                 into account the historic mortality
    Transferring Annuitants during                                                            on a compound basis as an annual
                                                 experience of the Transferring
    such calendar year had exactly                                                            increase to Post-Smoothing Non-
                                                 Policies as well as the expected
    matched the expectations                                                                  Guaranteed Income from the time
                                                 future mortality experience of the           of the change in mortality basis
    included in the mortality basis
                                                 Transferring Policies.                       onwards, would produce an
    or mortality bases used for
    expected mortality in that              (f) Where the Transferee adopts a                 increase in the Aggregate Policy
    calendar year in accordance with                                                          Value equal to the Estimated
                                                different mortality basis for its
    paragraph 6(b) of these Principles                                                        Mortality Change (this valuation
                                                management of the Transferring
    of Financial Management.                                                                  to be carried out using the Core
                                                Policies, the following provisions
                                                                                              Reserving Basis, but with the
                                                may require a payment to be
(d) Subject to paragraph (e),                                                                 mortality basis therein replaced
                                                made from the Transferee WPSF
    the Transferee may from time to                                                           by the new mortality basis).
                                                to the Transferee DCPSF or from
    time adopt a different mortality
                                                the Transferee DCPSF to the
    basis for its management of the
                                                Transferee WPSF. On each
    Transferring Policies representing
                                                occasion when the Transferee
    its changed expectations of future
                                                adopts a different mortality
    mortality and the lifetime of
                                                basis for its management of
    Transferring Policies over which
                                                the Transferring Policies,
    Individual Asset Shares are
                                                the Transferee With-Profits
    expected to be distributed in
                                                Committee shall consider whether
    the form of Pre-Smoothing
                                                the following provisions apply.
    Non-Guaranteed Income.




                                                                                       Principles & Practices of Financial Management 39
    (i) Where the Estimated Mortality                  (ii) if the Non-Chargeable                     basis onwards or, where the
        Change is negative, the Mortality                   Mortality Transfer Amount                 Estimated Mortality Change
        Impact shall be calculated as the                   is positive, the Transferee               is negative, that an annual
        percentage rate which, if applied                   DCPSF will pay to the                     compound reduction of
        on a compound basis as an annual                    Transferee WPSF an amount                 0.5% per annum is applied
        reduction to Post-Smoothing Non-                    equal to the Non-Chargeable               to the Post-Smoothing Non-
        Guaranteed Income from the time                     Mortality Transfer Amount,                Guaranteed Income from the
        of the change in mortality basis                    and the Aggregate Asset                   time of the change in mortality
        onwards, would produce a                            Share shall be reduced by                 basis onwards.
        reduction in the Aggregate Policy                   the Non-Chargeable Mortality
        Value equal to the absolute value                                                      (m)Whenever a change is made to
                                                            Transfer Amount and the
        of the Estimated Mortality Change                                                         the mortality basis, the Mortality
                                                            Individual Asset Share of
        (this valuation to be carried out                                                         Impact shall be recalculated;
                                                            each Transferring Policy shall
        using the Core Reserving Basis,                                                           the new Mortality Impact shall
                                                            be reduced proportionately.
        but with the mortality basis                                                              replace, not add to, any previous
        therein replaced by the new                 (l) The Non-Chargeable Mortality              Mortality Impact, save that the
        mortality basis).                               Transfer Amount will be zero if           previous Mortality Impact shall be
    (j) If the first such Mortality Impact              the Mortality Impact is less than         used as described in paragraph
        is less than or equal to 0.50% per              or equal to 0.50% per annum.              6(n)(i) below.
        annum then the Non-Chargeable                   Otherwise, the Non-Chargeable
                                                                                               (n) In the event that there has been a
        Mortality Transfer Amount will be               Mortality Transfer Amount will be
                                                                                                   change in mortality basis which
        zero and no payment shall be due                calculated as the amount given by:
                                                                                                   resulted in a Non-Chargeable
        in respect of it from the Transferee           (i) the Aggregate Policy Value              Mortality Transfer Amount which
        WPSF or the Transferee DCPSF.                      at the time of the change in            was not zero and the mortality
    (k) If the first such Mortality Impact                 mortality basis calculated              basis is subsequently changed
        is greater than 0.50% per annum                    using the Core Reserving                again, the following will be
        then the Non-Chargeable                            Basis, including the mortality          calculated at the time of that
        Mortality Transfer Amount will                     basis included in the Core              subsequent change to the
        be calculated in accordance with                   Reserving Basis;                        mortality basis:
        paragraph 6(l) of these Principles             Minus                                      (i) the Non-Chargeable Mortality
        of Financial Management, and:                                                                 Transfer Amount that would
                                                       (ii) the Aggregate Policy Value
        (i) if the Non-Chargeable                                                                     apply for a change of the
                                                            at the time of the change in
            Mortality Transfer Amount is                                                              mortality basis from the
                                                            mortality basis calculated using
            negative, the Transferee WPSF                                                             mortality basis included in the
                                                            the Core Reserving Basis but
            will pay to the Transferee                                                                Core Reserving Basis to the
                                                            with the mortality basis therein
            DCPSF an amount equal to                                                                  then current mortality basis as
                                                            replaced by the new mortality
            the absolute value of the Non-                                                            though it were the first and
                                                            basis and assuming, where the
            Chargeable Mortality Transfer                                                             only change in mortality basis
                                                            Estimated Mortality Change
            Amount, and the Aggregate                                                                 since the Effective Date,
                                                            is positive, that an annual
            Asset Share shall be increased                                                            but based on the Mortality
                                                            compound increase of 0.5%
            by the absolute value of the                                                              Impact calculated at the
                                                            per annum is applied to
            Non-Chargeable Mortality                                                                  time of the previous change
                                                            the Post-Smoothing Non-
            Transfer Amount and the                                                                   ("NCMTACurrent"); and
                                                            Guaranteed Income from the
            Individual Asset Share of each                  time of the change in mortality
            Transferring Policy shall be
            increased proportionately; and

40 Principles & Practices of Financial Management
(ii) the Non-Chargeable Mortality            and the Aggregate Asset Share
     Transfer Amount that would
     apply for a change of the
     mortality basis from the
                                             shall be reduced by the amount
                                             of the payment and the Individual
                                             Asset Share of each Transferring
                                                                                     100% x 1 –
                                                                                                [               1
                                                                                                      (1 + ABR) x (1 + GIR)   ]
     mortality basis included in             Policy shall be reduced               where:
     the Core Reserving Basis to             proportionately.
     the new mortality basis as                                                                "ABR" means the anticipated
                                             This process will be repeated                     bonus rate applicable under
     though it were the first and
                                             every time there is a change in                   that Transferring Policy,
     only change in mortality basis
                                             the mortality basis used by the                   expressed as a decimal; and
     since the Effective Date
                                             Transferee for its management
     ("NCMTANew").                                                                             "GIR" means the guaranteed
                                             of the Transferring Policies
If NCMTACurrent is greater than                                                                interest rate applicable under
                                      7. Smoothing                                             that Transferring Policy,
or equal to NCMTANew then a
payment shall be made to the          7.1 Under normal circumstances,                          expressed as a decimal; or
Transferee DCPSF from the             smoothing shall be applied in respect
                                                                                               (2) rise above its then
Transferee WPSF in an amount          of the Transferring Policies according to
                                                                                                   current amount from time
given by:                             the following principles:
                                                                                                   to time in any year by a
(1) NCMTACurrent;                        (a) Smoothing will operate to                             percentage exceeding
                                             ensure that the amount of Post-                       the percentage given by:
Minus                                        Smoothing Non-Guaranteed

(2) NCMTANew,

and the Aggregate Asset Share
                                             Income in respect of a
                                             Transferring Policy, before
                                             allowing for the impact of the
                                                                                    100% x
                                                                                              {[          (1+SC)
                                                                                                   (1 + ABR) x (1 + GIR)  ] }
                                                                                                                         –1


shall be increased by the amount             Guaranteed Income, shall not:
                                                                                   where:
of the payment, and the Individual
                                             (i) in the case of Low Start
Asset Share of each Transferring                                                               SC" means the Smoothing
                                                 Annuity Policies:
Policy shall be increased                                                                      Cap, expressed as a decimal;
proportionately.                                 (1) fall below its then current               and "ABR" and "GIR" have the
                                                     amount from time to time;                 meanings given in paragraph
If NCMTACurrent is less than
                                                     or                                        7.1(a)(ii)(1).
NCMTANew then a payment
shall be made from the Transferee                (2) rise above its then                    (b) The Smoothing Cap, which
DCPSF to the Transferee WPSF in                      current amount from time                   shall be capable of alteration
an amount equal to the absolute                      to time in any year by a                   by the Transferee with the
value of the amount given by                         percentage greater than                    approval of the Transferee
                                                     the Smoothing Cap;                         With-Profits Committee, will
(3) NCMTANew;
                                                                                                initially be 11%. The level of
                                             (ii) in the case of Transferring
Minus                                                                                           the Smoothing Cap will be
                                                  Policies other than Low Start
                                                                                                stated as a practice in the
(4) NCMTACurrent,                                 Annuity Policies:
                                                                                                Transferee's PPFM.
                                                 (1) fall below its then
                                                                                            (c) Smoothing will also be applied
                                                     current amount from time
                                                                                                as necessary to ensure the
                                                     to time in any year by a
                                                                                                objective of gradual, rather
                                                     percentage exceeding the
                                                                                                than erratic, changes in
                                                     percentage given by:
                                                                                                bonus rates.


                                                                                   Principles & Practices of Financial Management 41
7.2 Greater flexibility in smoothing than              (ii) where the Pre-Smoothing Non-             that payment. If the Pre-Smoothing
is permitted by paragraph 7.1 of these                      Guaranteed Income in respect of          Payment Amount is not equal to the
Principles of Financial Management may                      the Transferring Policies is less        Post-Smoothing Payment Amount
be required in certain circumstances,                       than the Post-Smoothing Non-             there shall be a Smoothing Cost
for example following a significant fall or                 Guaranteed Income in respect             associated with the application of
rise in market values (either sudden or                     of the Transferring Policies,            smoothing in relation to that
over a period of years). In such situations,                the balance of the Transferring          payment.
the Transferee may decide to vary the                       Policies Smoothing Account
                                                                                                  (e) Where there is a Smoothing Cost
bonus smoothing limits referred to in                       will decrease by the amount
                                                                                                      associated with the application of
paragraph 7.1 to protect the overall                        determined in accordance
                                                                                                      smoothing in relation to a payment
interests of all policyholders of the                       with paragraph 7.3(e) or 7.3(f)
                                                                                                      and the Guaranteed Income in
Transferee. When determining whether                        of these Principles of Financial
                                                                                                      respect of that payment is less than
smoothing rules and limits for the                          Management, as applicable.
                                                                                                      the Pre-Smoothing Non-Guaranteed
Transferring Policies should be changed,
                                                    (c) Except as provided in paragraph               Income in respect of that payment,
the Transferee will apply the same
                                                        7.3(h) of these Principles of Financial       the Smoothing Cost shall be equal to:
principles as it would for other with-
                                                        Management, the amount held in
profits business as stated in the                                                                    (i) the greater of the Guaranteed
                                                        the Transferring Policies Smoothing
Transferee PPFM from time to time,                                                                       Income in respect of that payment
                                                        Account will change if and only if
taking account of the balance of the                                                                     and the Post-Smoothing Non-
                                                        the application of smoothing changes
Transferring Policies Smoothing Account.                                                                 Guaranteed Income in respect
                                                        a payment actually made under a
                                                                                                         of that payment;
7.3 The Transferee shall follow the                     Transferring Policy from the amount
following practices in respect of the                   that it would have been if smoothing      Less
Transferring Policies:                                  had not been applied – by comparing
                                                        (i) the higher of the Guaranteed             (ii) the Pre-Smoothing Non-
(a) The Transferring Policies Smoothing                                                                   Guaranteed Income in respect
                                                        Income and the Post-Smoothing
    Account will be held within the                                                                       of that payment.
                                                        Non-Guaranteed Income in respect
    Transferee WPSF and will contain
                                                        of the Transferring Policies with (ii)
    a nominal balance denominated in                                                              (f) Where there is a Smoothing Cost
                                                        the higher of the Guaranteed
    pounds sterling at all times (which                                                               associated with the application of
                                                        Income and the Pre-Smoothing
    balance may be positive or negative).                                                             smoothing in relation to a payment
                                                        Non-Guaranteed Income in respect
                                                                                                      and the Guaranteed Income in
(b) Subject to paragraph 7.3(c) of these                of the Transferring Policies.
                                                                                                      respect of that payment is greater
    Principles of Financial Management:                                                               than the Pre-Smoothing Non-
                                                    (d) For any Transferring Policy at any
                                                        time where a payment is made                  Guaranteed Income in respect of that
    (i) where the Pre-Smoothing Non-
                                                        which is affected by the application          payment, the Smoothing Cost shall
        Guaranteed Income in respect
                                                        of smoothing, the Pre-Smoothing               be equal to:
        of the Transferring Policies
        exceeds the Post-Smoothing                      Payment Amount shall be equal to the
                                                                                                     (i) the Post-Smoothing Non-
        Non-Guaranteed Income in                        higher of the Guaranteed Income in
                                                                                                         Guaranteed Income in respect
        respect of the Transferring                     respect of that payment and the Pre-
                                                                                                         of that payment;
        Policies, the balance of the                    Smoothing Non-Guaranteed Income
        Transferring Policies Smoothing                 in respect of that payment. The Post-        Less
        Account will increase by the                    Smoothing Payment Amount shall be
                                                                                                     (ii) the Guaranteed Income in respect
        amount determined in accordance                 equal to the higher of the Guaranteed
                                                                                                          of that payment subject to a
        with paragraph 7.3(e) or 7.3(f)                 Income in respect of that payment
                                                                                                          minimum Smoothing Cost of zero.
        of these Principles of Financial                and the Post-Smoothing Non-
        Management, as applicable; and                  Guaranteed Income in respect of



42 Principles & Practices of Financial Management
(g) Any Smoothing Cost, positive or           (a) by way of arithmetic deduction from       9.2 These charges may be applied
    negative, shall be DEDUCTED                   the gross investment return that          irrespective of whether the Guaranteed
    from the balance of the Transferring          would otherwise be credited to the        Income in respect of the Transferring
    Policies Smoothing Account (so that           Individual Asset Share of such            Policy exceeds the Pre-Smoothing Non-
    the balance of the account is reduced         Transferring Policy:                      Guaranteed Income in respect of the
    where the Smoothing Cost is positive                                                    Transferring Policy.
                                                 (i) 1.0% per annum of the Individual
    and increased where the Smoothing
                                                     Asset Share throughout the             9.3 Subject to paragraphs 9.4 and 9.5,
    Cost is negative).
                                                     lifetime of the policy for expenses,   no other charges will be imposed on
(h) The Transferring Policies Smoothing              to be credited to the Transferee       any Transferring Policy (whether by
    Account will itself be adjusted by the           NPSF; and                              deduction from the Individual Asset
    Gross Rate of Investment Return and                                                     Shares or the Aggregate Asset Share or
                                                 (ii) a maximum of 0.5% per annum
    adjusted for any other tax liability or                                                 from the Transferring Policies Smoothing
                                                      of the Individual Asset Share
    credit of the Transferee arising out of                                                 Account or from bonuses or from
                                                      throughout the lifetime of the
    or in consequence of the Transferring                                                   gross investment return or otherwise),
                                                      policy for the expected cost of
    Policies in accordance with applicable                                                  including without limitation in respect
                                                      guarantees, to be credited to the
    tax legislation, and reduced by                                                         of investment management, transaction
                                                      Transferee WPSF; and
    charges as provided in paragraph                                                        expenses arising from the transfer of the
    9.1(b) of these Principles of Financial   (b) by way of arithmetic deduction            Transferring Policies to the Transferee,
    Management.                                   from the gross investment return          capital support provided for the benefit
                                                  that would otherwise be applied to        of such policies, whether from the
(i) The Transferring Policies Smoothing
                                                  the Transferring Policies Smoothing       Transferee WPSF or otherwise, or
    Account will have a value of zero
                                                  Account of:                               mortality (but without prejudice to any
    at the Effective Date, and shall be
                                                                                            requirement for the Transferee DCPSF
    managed with the ongoing aim that it         (i) 1.0% per annum of the balance          to make payment to the Transferee WPSF
    should always tend to zero, subject to           of the Transferring Policies           in accordance with paragraph 6 of these
    the need for short-term smoothing.               Smoothing Account for expenses,        Principles of Financial Management).
                                                     to be credited to the Transferee
8. Deferred Cost Policies
                                                     NPSF (or debited to the                9.4 Paragraph 9.3 shall not prevent the
The Transferee will make deductions                                                         Transferee from determining the gross
                                                     Transferee NPSF where the
from bonuses on Deferred Cost Policies                                                      investment return for the Transferring
                                                     balance of the Transferring
of 0.5 per cent per annum for 2008,                                                         Policies in the same manner as it
                                                     Policies Smoothing Account is
2009 and 2010 (consistently with the                                                        determines the gross investment return
                                                     negative); and
practice of the Transferor prior to the                                                     for other policies for which the crediting
Effective Date).                                 (ii) a maximum of 0.5% per annum           of investment return to asset shares
                                                      of the balance of the Transferring    is determined by reference to the
9. Charges
                                                      Policies Smoothing Account for        investment return of the Transferee
9.1 Notwithstanding any provisions
                                                      the expected cost of guarantees,      WPSF Asset Pool, provided that in
contained in the policy conditions
                                                      to be credited to the Transferee      determining the gross investment
of the Transferring Policies and
                                                      WPSF (or debited to the               return for the Transferring Policies the
any representations, warranties or
                                                      Transferee WPSF where the             Transferee shall make no deduction in
undertakings made before the Effective
                                                      balance of the Transferring           respect of investment management,
Date in relation to the Transferring
                                                      Policies Smoothing Account            transaction expenses arising from the
Policies by any person other than the
                                                      is negative).                         transfer of the Transferring Policies to the
Transferee, the Transferee may impose
                                                                                            Transferee, capital support provided for
charges on each Transferring Policy on
the basis set out below:



                                                                                            Principles & Practices of Financial Management 43
the benefit of such policies, whether               10. Changes in charges for guarantees             a percentage which is an integral
from the Transferee WPSF or otherwise,              (a) Reduction                                     multiple of 5) either in a single step or
or mortality (but without prejudice to any                                                            a series of steps then the increase will
requirement for the Transferee DCPSF                   If, at any time after the Effective Date,      be notified to the Transferee With-
to make payment to the Transferee WPSF                 the Target Equity Backing Ratio is             Profits Committee. The Transferee
in accordance with paragraph 6 of these                reduced by a material amount (being            will produce recommendations
Principles of Financial Management).                   a reduction of the Target Equity               as to whether there should be an
                                                       Backing Ratio below a percentage               increase in the on-going charges
9.5 Notwithstanding this paragraph 9,                  which is an integral multiple of 5)            for guarantees for the Transferring
the Transferee may make deductions                     either in a single step or series of           Policies, and by how much they
from the Aggregate Asset Share or from                 steps then the reduction will be               should be increased, and the
the gross investment income that would                 notified to the Transferee With-Profits        Transferee With-Profits Committee
otherwise be credited there to:                        Committee. The Transferee will                 will review the Transferee’s
                                                       produce recommendations as to                  recommendations and consider
(a) in accordance with paragraph 16.7
                                                       whether there should be a reduction            whether the on-going charges for
    of the Scheme; or
                                                       in the on-going charges for                    guarantees should be increased.
(b) where it has suffered a loss in                    guarantees for the Transferring                Any resulting increase shall be
    connection with the transfer to it of              Policies, and by how much they                 applied on a consistent basis as
    the WPA Business in respect of which               should be reduced, and the                     between the Transferring Policies
    it has a claim against the Transferor              Transferee With-Profits Committee              and the Transferee's other with-profits
    and, in the opinion of the Transferee              will review the Transferee’s                   policies, save that the increase of
    With-Profits Committee, it is proper               recommendations and consider                   the on-going charges for guarantees
    for all or part of such loss to be                 whether the on-going charges for               applied to the Transferring Policies
    absorbed by the Transferring Policies              guarantees should be reduced.                  will not be such as to increase these
    because they would otherwise retain                Any resulting reduction shall                  charges above the maximum level
    an improper benefit as a result of                 be applied on a consistent basis               of 0.5% per annum permitted by
    the circumstances which gave rise to               as between the Transferring                    paragraph 9 (Charges) of these
    the loss.                                          Policies and the Transferee's                  Principles of Financial Management.
                                                       other with-profits policies.
9.6 Without prejudice to future crediting                                                          (c) Review of guarantee charges
to the Transferee NPSF of charges                   (b) Increase
deducted under paragraph 9.1(a)(i) or                                                                 Any review of the on-going charges
                                                       If the ongoing charges for guarantees          for guarantees which is applied to
9.1(b)(i) of these Principles of Financial
                                                       applied to the Transferring Policies           any of the Transferee's with-profits
Management, any crediting of charges
                                                       have been reduced below the                    policies will also include, on a
from the Transferee NPSF to the
                                                       maximum level of 0.5% per annum                consistent basis, a review of the
Transferee WPSF in accordance with
                                                       pursuant to paragraph 10(a) of these           on-going charges for guarantees
paragraph 9.1(b)(i) will not give rise to
                                                       Principles of Financial Management             applied to the Transferring Policies,
any requirement for subsequent
                                                       and subsequently the Target Equity             in each case taking into account the
reimbursement to the Transferee NPSF.
                                                       Backing Ratio is increased by a                amount of any up-front guarantee
                                                       material amount (being an increase of          charge (including, in the case of
                                                       the Target Equity Backing Ratio above




44 Principles & Practices of Financial Management
   the Transferring Policies, the Post-          be replaced by references to any           13. Interim arrangements
   Augmentation Up-front Guarantee               other funds or sub-funds of the            These Principles of Financial
   Charge). The Transferee will produce          Transferee, and provided that              Management are subject, in respect
   recommendations as to whether there           the effect of this Schedule is not         of the first year following the Effective
   should be an increase or a reduction          changed to the material detriment          Date, to the Interim Arrangements.
   in the on-going charges for                   of the Transferring Policies;
   guarantees for the Transferring                                                          14. Application of Uplift
                                              (b) at any time after 2009 provided              (a) On the Income Uplift Date,
   Policies, and by how much they
                                                  that paragraphs 4, 5, 6, 8, 9 and                the Aggregate Asset Share of
   should be increased or reduced,
                                                  10 of these Principles of Financial              the Transferring Policies will be
   and the Transferee With-Profits
                                                  Management are not amended,                      amended in accordance with
   Committee will review the
                                                  save that references to the Transferee           paragraph 16.3(b) or paragraph
   Transferee’s recommendations
                                                  WPSF and the Transferee NPSF may                 16.4 of the Scheme, as applicable.
   and consider whether the on-going
                                                  be replaced by references to any
   charges for guarantees should be                                                            (b) Where the Aggregate
                                                  other funds or sub-funds of the
   increased or reduced. Any resulting                                                             Augmentation Amount is positive,
                                                  Transferee, and provided that the
   increase or reduction in those charges                                                          the bonuses announced by the
                                                  effect of these Principles of Financial
   as a result of such a review will be                                                            Transferee in respect of the
                                                  Management is not changed to the
   applied on a consistent basis as                                                                Transferring Policies in 2009
                                                  material detriment of the Transferring
   between the Transferring Policies                                                               shall be increased to distribute
                                                  Policies; or
   and the Transferee's other with-profits                                                         an amount corresponding to the
   policies, save that any increase in the    (c) to the extent required in order to               full amount of the benefit received
   on-going charges for guarantees                enable the Transferee to comply                  by the Transferee by reason of
   applied to the Transferring Policies           with applicable law and regulation.              having received the Transferring
   will not be such as to increase these                                                           Assets on the Effective Date but
   charges above the maximum level               Any such amendment will require                   not having uplifted the Post-
   of 0.5% per annum permitted by                the approval of the Transferee                    Smoothing Non-Guaranteed
   paragraph 9 (Charges) of these                With-Profits Committee and will                   Income in respect thereof until
   Principles of Financial Management.           be notified to the FSA in advance                 the Income Uplift Date.
                                                 of the amendment taking effect.
11. Amendment of terms of                                                                      (c) Where the Aggregate
    management of the                         12. Application to Excluded Policies                 Augmentation Amount is
    Transferring Policies                                                                          negative, paragraph 16 of
                                              These Principles of Financial Management
The terms on which the Transferee will        shall apply mutatis mutandis to the                  the Scheme will not result in a
be permitted to manage the Transferring       manner in which the Transferee is                    change in Post-Smoothing Non-
Policies may be amended in any of the         required to carry out its obligations in             Guaranteed Income. Accordingly,
following circumstances:                      respect of the Excluded Policies under               in the absence of this paragraph
                                              the Excluded Policies Reassurance                    14(c), the Post-Smoothing Non-
(a) to the extent required to facilitate
                                              Agreement and, except to the extent that             Guaranteed Income in respect of
    a restructuring of the long-term
                                              the context otherwise requires, each                 the Transferring Policies would
    insurance fund of the Transferee
                                              reference in these Principles of Financial           exceed the amounts that the
    provided that paragraphs 4, 5, 6, 8, 9
                                              Management to the "Transferring Policies"            Aggregate Asset Share would
    and 10 of these Principles of Financial
                                              shall be treated as being a reference to             normally have supported in
    Management are not amended, save          both the Transferring Policies and the               accordance with these Principles
    that references to the Transferee         Excluded Policies.                                   of Financial Management.
    WPSF and the Transferee NPSF may
                                                                                                   The amount of any resulting
                                                                                                   overpayments of income may be
                                                                                                   recovered by the Transferee by:


                                                                                            Principles & Practices of Financial Management 45
    (i) reducing future bonuses of the              (b) Where the Transferee elects that the
        Transferring Policies; and/or                   Scheme shall cease to apply under
                                                        paragraph 15(a) of these Principles of
    (ii) with the approval of the
                                                        Financial Management, any positive
         Transferee With-Profits
                                                        amount allocated to the Transferring
         Committee, reducing the Post-
                                                        Policies Smoothing Account will be
         Smoothing Non-Guaranteed
                                                        distributed amongst the Transferring
         Income in respect of the
                                                        Policies by way of an enhancement to
         Transferring Policies at any time
                                                        the Post-Smoothing Non-Guaranteed
         on or after the Income Uplift Date.
                                                        Income in respect thereof in a manner
15. Relaxation of the Scheme                            considered to be fair in all the
(a) Other than paragraph 6 of this                      circumstances by the Transferee
    Scheme, paragraph 9 (Charges)                       With-Profits Committee.
    of these Principles of Financial                16. Interest in the inherited estate of
    Management, paragraph 14 of this                the Transferee WPSF
    Scheme (to the extent necessary to              The Transferring Policies will have no
    cause paragraph 9 (Charges) of these            interest in any possible future distribution
    Principles of Financial Management to           or reattribution of the inherited estate of
    continue to apply) and any provision            the Transferee WPSF.
    required for the interpretation of the
    foregoing paragraphs, all of which
    shall continue to apply until all of the
    Transferring Policies have terminated,
    the Scheme shall, at the election of
    the Transferee, cease to apply at any
    time after the realistic liabilities of the
    Transferring Policies have fallen below
    the Minimum Threshold Amount.




46 Principles & Practices of Financial Management
Summary of Abbreviations

 Abbreviation    Full Text

 DCPSF           Defined Charge Participating Sub-Fund

 ELAS            Equitable Life Assurance Society

 IB              Industrial Branch

 MVR             Market Value Reduction

 NPSF            Non-Profit Sub-Fund

 OB              Ordinary Branch

 PAC             The Prudential Assurance Company Limited

 PAL             Prudential Annuities Limited

 PANL            Prudential (AN) Limited

 PFM             Principles of Financial Management (for SAIF)

 PIA             Prudential International Assurance plc

 PPFM            Principles and Practices of Financial Management

 SAA             Scottish Amicable Account

 SACF            Scottish Amicable Capital Fund

 SAIF            Scottish Amicable Insurance Fund

 SAL             Scottish Amicable Life plc

 SALAS           Scottish Amicable Life Assurance Society

 WPSF            With-Profits Sub-Fund




                                                                    Principles & Practices of Financial Management 47
                                                                                                                                                                           WPGB0014 02/2011




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"Prudential" is a trading name of The Prudential Assurance Company Limited, which is registered in England and Wales. This name is also used by other companies within
the Prudential Group, which between them provide a range of financial products including life assurance, pensions, savings and investment products. Registered Office at
Laurence Pountney Hill, London EC4R 0HH. Registered number 15454. Authorised and regulated by the Financial Services Authority.

								
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