Additional information 466 Risk factors 471 Glossary 476 Shareholder information 478 How to contact us
First, our life insurance business in Asia1 is now the biggest contributor to Group IFRS operating profit2, making it our largest business on both IFRS and EEV profitability measures. Since 2008, we have made considerable progress in translating the promise of our Asian life insurance franchise into a solid business, delivering significant growth in sales but also IFRS operating profit and cash. Asia offers some of the most attractive opportunities within the global insurance market and the potential for long-term profitable growth for Prudential in the region is clear. Our focus on Asia is simply a consequence of our approach to shareholder value and capital allocation that prioritises our investment towards the markets, products and channels that offer the most profitable returns and the most attractive payback periods.
Third, we take a proactive approach to managing risk across the cycle. We have transformed the capital position of the Group since 2008 with an estimated £4.0 billion of Insurance Groups Directive (IGD) capital surplus against £1.5 billion at the end of 2008. We are continuously improving our risk management process and systems to ensure that our key risks are tracked and managed both locally and centrally.
Solvency II, which is currently anticipated to be implemented from 1 January 2014, represents a major overhaul of the capital adequacy regime for European insurers. We are supportive in principle of the development of a more risk-based approach to capital but we have concerns about the potential consequences of some aspects of the Solvency II regime under consideration. With the continued delays to policy development, the final outcome of Solvency II remains uncertain. We are continuing to engage directly with our peers, policymakers and regulators so that the industry ultimately operates under a fair, effective and reasonable capital adequacy regime. Lack of certainty over the policy content and timetable continues to impede the industry’s ability to prepare fully for the new regime.
The Group’s results are a clear sign of the success of our strategy of focusing our energies and capital on the most attractive opportunities and we are in a strong position to continue to deliver relative outperformance in the medium term. We have made a positive start to 2012 and over the course of the year we expect to continue to make progress towards our 2013 ‘Growth and Cash’ objectives.
United States • Deliver £200 million of net cash remittance to the Group
2 Payback: expected period over which future undiscounted free surplus generation from shareholder-backed business recoups initial new business investment.
Profitability Group IFRS operating profit increased by 7 per cent to £2,070 million (2010: £1,941 million) and Group EEV operating profit based on longer-term investment returns (‘EEV operating profit’) by 8 per cent to £3,978 million (2010: £3,696 million), equivalent to an annualised return on embedded value of 16 per cent. The contribution to these metrics from each business operation and each source is more balanced than at any previous time in the Group’s history, greatly enhancing both the quality and the resilience of the Group’s earnings.
Against the cumulative 2010 to 2013 target of £3.8 billion, by the end of 2011 a total of £2,040 million has been remitted by business operations. We remain confident of achieving this target. Our confidence is underpinned by the strong underlying free surplus generation of our businesses which, by the end of 2011, had generated a total of £3.7 billion against our 2010 to 2013 cumulative target of £6.5 billion.
Prudential has a diverse range of successful bank distribution partnerships across the region that includes regional relationships with international banks such as Standard Chartered and local ones such as E.Sun in Taiwan. We are also successful in working with multiple partners in one market. Key drivers of this success are a long-term commitment to creating value for ourselves and our partners, expertise in developing, training and motivating bank sales teams and committed marketing support.
Protecting the value of the in-force book is also a core priority for Prudential. Technology, such as iPad-based customer and agent services, drives operational efficiencies. Persistency drivers are actively monitored and achieving persistency targets forms part of compensation calculations for staff and agents. We have a robust claims platform with technical expertise and a disciplined approach to monitoring claims and re-pricing as necessary.
Prudential’s focus on customer service and delivery is reflected through the number of awards received by its operations, that include in China, ‘The Brand with Greatest Potential in the Insurance Industry’, in India, ‘Insurance Company of the Year’, in Indonesia, ‘Best Life Insurance Company’, ‘Best Islamic Insurance Company’, ‘Best Life Insurer in Achieving Total Customer Satisfaction’, and in Vietnam, a Labour Medal from the President’s Office, a first for a foreign insurance company in that country.
Thanks to our financial stability and innovative products, we continue to enhance our reputation as a high-quality and reliable business partner, with sales increasing as more advisers have recognised the benefits of working with Jackson. A significant part of Jackson’s growth continues to come from an increase in its distribution penetration with sales through distributors who either did not previously sell Jackson’s products or simply did not sell variable annuities. In the second half of 2011, Jackson entered into another wirehouse distribution agreement further extending Jackson’s ability to reach all major wirehouse firms in the US on attractive terms.
Further enhance operational efficiency We continue to invest in our back office staffing and systems to provide world class customer service in an efficient and cost effective manner. In 2011, for the sixth consecutive year, Jackson was rated as a ‘World Class’ service provider by Service Quality Measurement Group. Jackson was able to provide this level of service in 2011 while processing record retail sales, and decreasing its ratio of statutory general expenses to average assets (one measure of efficiency) to 42 basis points, compared to the 2010 level of 44 basis points.
At 31 December 2011, Jackson had £37.8 billion in separate account assets, an increase of 21 per cent compared to £31.2 billion in 2010. The increase in separate account assets primarily reflects the impact of substantial positive net flows. This growth resulted in variable annuity separate account fee income of £680 million in 2011, up 34 per cent over the £506 million achieved in 2010.
With-profits performance The strength and performance track record of Prudential UK’s With-Profits Fund is widely recognised. Despite extreme market volatility in 2011 the Fund continues to provide customers with solid returns over medium to long-term time horizons. Over 10 years the Fund has delivered investment returns of 92.7 per cent, which compares favourably with other with-profits funds and the FTSE All-Share Index (total return) of 59.5 per cent over the same period. This strong medium to long-term performance has shown that with-profits, when invested in an actively managed and financially strong fund like Prudential’s, continues to be a very attractive medium to long-term investment, offering strong annualised returns compared with other investment options. Prudential’s with-profits customers benefit from the security offered by Prudential’s large inherited estate, with the free assets of the with-profits fund valued at approximately £6.1 billion at the year end, valued on the regulatory realistic basis.
Institutional The strength of M&G’s performance in the institutional market is evidenced by the award of Fixed Income Manager of the Year 2011 at the Financial News Awards for Excellence in Institutional Asset Management.
Operating profit based on longer-term investment returns* 3,978 3,696 Short-term fluctuations in investment returns (907) (30) Mark to market value movements on core borrowings (14) (164) Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes 23 (11) Effect of changes in economic assumptions (158) (10) Costs of terminated AIA transaction – (377) Gain on dilution of Group holdings – 3
Operating earnings per share* (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests)(i) 115.7p 106.9p
Dividends per share declared and paid in reporting period 25.19p 20.17p Dividends per share relating to reporting period 25.19p 23.85p Funds under management £351bn £340bn Insurance Groups Directive capital surplus (as adjusted)* £4.0bn £4.3bn
excludes in 2010 an exceptional tax credit of £158 million which primarily relates to the impact of a settlement agreed with the UK tax authorities.
The £33 million increase in the charge for other income and expenditure from £450 million in 2010 to £483 million in 2011 primarily reflects an increase in interest payable on core structural borrowings, following additional debt raised in January 2011 to repay debt in December 2011.
A total of £55 million of Solvency II implementation costs were incurred in 2011 (2010: £45 million) as we move closer to the implementation of the new regime.
M&G’s asset management fee margin increased from 34 bps in 2010 to 36 bps in 2011. This reflected a shift in funds under management mix towards external business which at 31 December 2011 represented 46 per cent of total funds under management (2010: 45 per cent). M&G continues to focus on cost control and the efficiencies created as the scale of the business grows. The benefit of this operational leverage is evident in the reduction in the cost/income ratio from 63 per cent in 2010 to 60 per cent in 2011.
Short-term fluctuations for other operations were negative £120 million representing unrealised losses on investments, principally on centrally held swaps to manage foreign exchange and certain macroeconomic exposures of the Group.
US life in-force profit was lower at £616 million (2010: £697 million). Jackson’s focused approach to managing the in-force portfolio coupled with the benefits of scale, have enabled the business to outperform its expected return in both years, albeit to a lower extent in 2011. The contribution to profits from experience and operating assumption changes totalled £183 million in 2011, compared to £246 million last year. Within these amounts, swap transactions undertaken to more closely match the overall asset and liability duration in 2010 and 2011, contributed to spread gains of £152 million (2010: £158 million).
During 2011 Prudential generated total free surplus from the retained businesses of £1,452 million (2010: £1,620 million). Underlying free surplus generated from the in-force book in 2011 increased by 8 per cent to £2,536 million (2010: £2,359 million), as a result of increased expected returns from the growing insurance book. Changes in operating assumptions and variances comprise £168 million for our life business (2010: £220 million) and a £33 million credit arising from a reduction in the liabilities of the Group’s defined benefit pension schemes following the UK government’s decision to change the basis of indexation from RPI to CPI. The life business variances comprise positive £52 million in Asia (2010: positive £3 million), negative £38 million in the UK (2010: positive £26 million), and positive £154 million in the US (2010: positive £191 million), principally reflecting favourable spread experience.
New business sales (APE) 1,660 1,660 1,275 746 New business margins (% APE) 65% 65% 64% 35% Internal rate of return* >20% >20% >20% >20%
Overall, the Group wrote £3,681 million of sales on an APE basis in 2011 (2010: £3,485 million1) generating a post-tax new business contribution to embedded value of £1,536 million (2010: £1,433 million1). To support these sales, we invested £553 million of capital (2010: £643 million1). By focusing on sales of products and in geographies which are less capital intensive, the Group has increased the amount of post-tax new business profit contribution to embedded value per £1 million of free surplus invested by 27 per cent to £2.8 million (2010: £2.2 million). We estimate the Group’s overall internal rate of return for the year ended 31 December 2011 to be greater than 20 per cent. The amount of capital invested covers both new business strain, including commissions, of £147 million (2010: £182 million1) and the required capital of £406 million (2010: £461 million1). Management will continue to focus on capital preservation and investment in those areas which add most value to the Group.
Cash remittances to the Group from business units As previously highlighted, the Group focuses on the generation of free surplus by each of the Group’s business units and then determines the use of this surplus, balancing between financing new business growth, retaining surplus capital in operations to absorb the effect of market shocks and remitting funds to the Group to cover central outgoings, including the shareholder dividend.
In the course of 2009 and 2010, the Group raised certain financing contingent on future profits of the UK and Hong Kong life insurance operations which increased the cash remitted by business units by £245 million in aggregate. This was done in order to increase the financial flexibility of the Group during the investment market crisis.
Total policyholder liabilities including unallocated surplus at 31 December 236,290 224,980
Perpetual subordinated Capital securities (Innovative Tier 1) 1,823 (10) 1,813 1,463 28 1,491 Subordinated notes (Lower Tier 2) 829 120 949 1,255 117 1,372
Debt securities 57.2 8.9 58.4 124.5 116.4 Equity 26.0 59.9 1.4 87.3 86.6 Property investments 8.5 0.7 1.6 10.8 11.2 Mortgage loans 1.0 – 4.7 5.7 5.0 Other loans 1.7 – 2.3 4.0 4.3 Deposits 7.2 1.5 2.0 10.7 10.0 Other investments 4.5 0.1 3.0 7.6 5.8
In terms of shareholder exposures to the bank debt of PIIGS, we held £328 million at 31 December 2011. This comprised £107 million of covered bonds, £59 million senior debt, £16 million Tier 1 debt and £146 million Tier 2 debt. There was no direct exposure to Greek banks.
The Group held the following direct exposures to banks’ debt securities of shareholder-backed business at 31 December 2011: Bank debt securities – shareholder-backed business
Notes (i) The majority of Asia insurance operations loans are commercial loans held by the Malaysian operation that are rated investment grade by two local rating agencies. (ii) All commercial mortgage loans held by US insurance operations are collateralised by properties. The US commercial mortgage loan portfolio does not include any single-family residential mortgage loans and therefore is not exposed to the risk of defaults associated with residential sub-prime mortgage loans. Jackson incurred impairments of £28 million on its commercial mortgage book (2010: £12 million). Other loans represents policy loans.
3. The environment Increasing the efficiency of our business by reducing the direct impact of the properties we occupy and the properties we manage as part of our investment portfolio.
Morningstar European Fund Awards 2011, Graham French – ‘Best Manager – Global Equity’
Particularly in the emerging markets of South-East Asia, the demand for savings and protection products continues to grow as people seek greater financial security and peace of mind. We continue to broaden our offering to help meet our customers’ goals.
We strive to live up to our brand promise in the region of always listening, always understanding, and regularly monitor our customers’ trust in us. In 2011 our customer retention rates across the region were maintained at 93 per cent1, and 42 per cent of new business was derived from existing customers.
In 2011, a new Customer Relationship Team was established to provide support directly to those customers seeking further information to help them with this important decision.
The complexities and challenges surrounding ageing populations have significant policy implications in many countries around the world. Through our partnership with the Washington DC-based think tank, the Center for Strategic and International Studies (CSIS) we have continued to contribute to the debate during 2011, through events and seminars with policymakers promoting the Global Aging Preparedness Index.
Reducing our impact: property investment portfolio PRUPIM believes that taking a lead in its approach to responsible property investment protects and enhances returns for its clients.
A number of financial education projects are supported through the Chairman’s Challenge, our Group-wide volunteering programme. This includes our financial literacy projects with Junior Achievement – the worldwide charity focused on building young people’s financial skills – in the US and Asia, as well as our partnership with Plan International in Thailand. These six-year partnerships have benefited approximately 90,000 young people.
3,000+ employees signed up as Chairman’s Challenge volunteers, +14% on 2010
The review was carried out by an external evaluator, Dr Tracy Long of Boardroom Review, in consultation with the Chairman, the Senior Independent Director and the Group Chief Executive. Boardroom Review has no other connection with the Company. The findings of the review will be discussed by the Board in March and an action plan will be implemented during the year.
Executive directors may accept external directorships and retain any fees earned from those directorships subject to prior discussion with the Group Chief Executive and always provided this does not lead to any conflicts of interest. In line with the UK Code, executive directors would be expected to hold no more than one non-executive directorship, nor the chairmanship, of a FTSE 100 company. Some of our executive directors hold directorships or trustee positions of unquoted companies or institutions. Details of any fees retained are included in the Directors’ remuneration report on page 146 and major commitments of our executive directors are detailed in their biographies on pages 108 and 109.
The Board has determined that Ann Godbehere and Kathleen O’Donovan have recent and relevant financial experience in respect of the financial reporting period under review and for the purposes of the UK Code and the Hong Kong Listing Rules. In March 2011, the Board designated Ann Godbehere as its audit committee financial expert for Sarbanes-Oxley Act purposes. This will be reviewed during 2012 in conjunction with the publication of Form 20-F.
Meetings The Committee meets at least five times a year and gives consideration to the financial statements of the Group and the Group’s system of internal control, as well as its internal and external audit providers.
The Committee also reviews the conflicts of interest or potential conflicts of interest raised by directors between Board meetings or for prospective new Board members. In cases where there might be an actual or potential conflict of interest the Committee has powers to authorise any such actual or potential conflict situation on behalf of the Board, imposing any terms and conditions it deems appropriate, or to make recommendations to the Board as to whether the conflict or potential conflict should be authorised and on what terms.
• Considering and, where necessary, authorising any actual or potential situational conflicts, upon such terms and conditions as the Committee considered appropriate, arising out of a proposed new appointment, the changed circumstances of an existing appointment or that of a director’s connected person.
The effectiveness of the Committee was reviewed as part of the externally facilitated review of the Board and its committees. The findings will be discussed by the Board in March 2012.
Independent assurance (3rd LoD): Group Audit Committee: The committee, supported by Group-wide Internal Audit, provides independent assurance and oversight of the effectiveness of the Group’s system of internal control and risk management.
Reporting The Group’s economic capital position and overall position against risk limits is reviewed regularly by the Group Executive Risk Committee. Key economic capital metrics, as well as risk-adjusted profitability information, are included in business plans, which are reviewed by the Group Executive Committee and approved by the Board.
Remuneration The report on the responsibilities and activities of the Remuneration Committee can be found in the Directors’ Remuneration Report, which is set out on pages 134 to 157.
The members of the Committee during 2011 are listed below. All are independent non-executive directors: • Lord Turnbull KCB CVO (Chairman from 14 June 2011) • Keki Dadiseth • Michael Garrett • Bridget Macaskill (until 14 June 2011) • Paul Manduca
April 2011 • Review of the reward implications of M&G’s business model and KPIs; • Approve the performance measures to be used for annual bonuses and long-term incentive awards.
Base salary No executive director was awarded a salary increase effective in 2011: Director Role 2010 Base salary Percentage increase 2011 Base salary
Limits on award sizes The rules of the GPSP and BUPP set a limit on the value of shares which may be awarded to an executive in a financial year. The combined value of shares awarded under the two plans may not exceed a maximum of 550 per cent of salary although the awards made in a particular year are often significantly below this limit. On a change in control of Prudential, vesting of awards made under these arrangements would be prorated for performance and to reflect the elapsed portion of the performance period.
On 31 December 2011, the performance periods for the 2008 awards under the JNL long-term incentive plans (which began on 1 January 2008) came to an end. Over the period the shareholder value of the US business grew by 18.1 per cent per annum (on a compound basis) and 94.7 per cent over the performance period. This resulted in vesting of 150 per cent of Mike Wells’ 2008 JNL US Performance Share Plan award and 95 per cent of his 2008 cash-settled JNL Long-Term Incentive Plan award.
Notes 1 Keki Dadiseth and Michael Garrett were reappointed in 2011 for one year. The Board will consider a further renewal term in May 2012. 2 For Alistair Johnston and Kaikhushru Nargolwala, the table assumes initial election by shareholders at the 2012 AGM. 3 Bridget Macaskill retired from the Board on 30 September 2011. 4 Kathleen O’Donovan will step down from the Board on 31 March 2012.
Chairman Harvey McGrath 500 – – – 43 – 543 – Executive directors Rob Devey(note 1) 550 496 331 827 43 154 1,574 – Michael McLintock 350 1,052 552 1,604 53 87 2,094 3,312 Nic Nicandrou (note 2) 550 512 341 853 43 161 1,607 – Barry Stowe(note 3) 666 625 417 1,042 285 167 2,160 937 Tidjane Thiam 900 – 1,570 1,570 64 225 2,759 2,099
Operating earnings per share after related tax and non-controlling interests (excluding 2010 exceptional tax credit) EEV note 12 415 115.7p 106.9p
Other non-investment and non-cash assets: Property, plant and equipment H6 748 554 Reinsurers’ share of insurance contract liabilities H3 1,647 1,344 Deferred tax assets H4 2,276 2,188 Current tax recoverable H4 546 555 Accrued investment income G1,H5 2,710 2,668 Other debtors G1,H5 987 903
Cash flows from investing activities Purchases of property, plant and equipment (124) (93) Proceeds from disposal of property, plant and equipment 10 4 Acquisition of subsidiaries, net of cash balance note (iii) I1 (53) (145)
Jackson For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For interest-sensitive business, the key assumption is the long-term spread between the earned rate and the rate credited to policyholders, which is based on the annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of Jackson’s actual industry experience and future expectations. A detailed analysis of actual experience is measured by internally developed mortality studies. For variable annuity business, the key assumption is the expected long-term level of equity market returns as described above. The level of acquisition costs carried in the statement of financial position is also sensitive to unrealised valuation movements on debt securities held to back the liabilities and solvency capital. Further details are explained in notes D3(g) and H1.
Financial liabilities designated at fair value through profit and loss Consistent with the Group’s risk management and investment strategy and the nature of the products concerned, the Group has designated under IAS 39 classification certain financial liabilities at fair value through profit and loss as these instruments are managed and their performance evaluated on a fair value basis. These instruments include liabilities related to consolidated collateralised debt obligations and net assets attributable to unit holders of consolidated unit trusts and similar funds.
UK regulated with-profits funds Prudential’s long-term business written in the UK comprises predominantly life insurance policies with discretionary participating features under which the policyholders are entitled to participate in the returns of the funds supporting these policies. Business similar to this type is also written in certain of the Group’s Asian operations subject to local market and regulatory conditions. Such policies are called with-profits policies. Prudential maintains with-profits funds within the Group’s long-term business funds, which segregate the assets and liabilities and accumulate the returns related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and final, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profits with respect to bonuses declared on with-profits business correspond to the shareholders’ share of the cost of bonuses as declared by the Board of directors. The shareholders’ share currently represents one-ninth of the cost of bonuses declared for with-profits policies. Annual bonuses are declared and credited each year to with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account in the year declared. Final bonuses are declared each year and accrued for all policies scheduled to mature and for death benefits expected to be paid during the next financial year. Final bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or final bonus declarations. The policyholders’ liabilities of the regulated with-profits funds are accounted for under FRS 27. Under FRS 27 for the UK with-profits funds: • no deferred acquisition costs and related deferred tax are recognised, and • adjusted realistic basis liabilities instead of MSB liabilities are recognised.
The Group utilises the projected unit credit method to calculate the defined benefit obligation. Estimated future cash flows are then discounted at a high-quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine its present value. These calculations are performed by independent actuaries. The plan assets of the Group’s pension schemes exclude several insurance contracts that have been issued by the Group. These assets are excluded from plan assets in determining the pension obligation recognised in the consolidated statement of financial position. The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of discount on liabilities at the start of the period, less the expected investment return on scheme assets at the start of the period, is charged to the income statement. Actuarial gains and losses as a result of changes in assumptions or experience variances are also charged or credited to the income statement. Contributions to the Group’s defined contribution schemes are expensed when due. Once paid, the Group has no further payment obligations. Any prepayments are reflected as an asset on the statement of financial position.
US insurance operations The short-term fluctuations in investment returns for US insurance operations comprise the following items: Short-term fluctuations relating to debt securities: Charges in the year Defaults – – Losses on sales of impaired and deteriorating bonds (32) (99) Bond write downs (62) (124)
UK Insurance operations The short-term fluctuations gain for UK insurance operations of £159 million (2010: £116 million) principally reflect net investment gains arising in the period on fixed income assets backing the capital of the shareholder-backed annuity business.
Other gains and losses Movement in the provision for deficit funding of PSPS (4) – Less: amount attributable to the PAC with-profits sub-fund 3 –
Borrowings attributable to with-profits operationsG1,H13 972 – – – – – 972 1,522 Deferred tax liabilitiesH4 1,215 33 2,707 5 251 – 4,211 4,224 Other non-insurance liabilities 6,667 1,631 7,277 5,913 739 (6,231) 15,996 15,325
o f resu lts c Reconciliation of movement in investments A reconciliation of the Group’s directly held investments from the beginning of the year to the end of the year is as follows: Insurance operations Total insurance operations £m
At 31 December 2009/1 January 2010 Total investments (including derivative assets) 132,690 49,576 23,390 205,656 2,890 176 208,722 Less: investments held by consolidated investment funds (1,835) – (718) (2,553) – – (2,553)
Movement in the year of directly held investments, net of derivative liabilities 9,576 13,591 7,456 30,623 363 (45) 30,941
Notes (i) UK insurance operations The UK insurance operations’ exposure to asset-backed securities at 31 December 2011 comprises: Shareholder-backed business (2011: 38% AAA, 18% AA)(i) 1,358 1,181 With-profits operations (2011: 58% AAA, 9% AA)(ii) 5,351 5,237
(iv) Other operations Other operations’ exposure to asset-backed securities at 31 December 2011 is held by Prudential Capital and comprises: RMBS: Prime (2011: 91% AAA, 9% AA) 340 197 CMBS (2011: 27% AAA, 16% AA) 146 184 CDO funds and other ABS - all without sub-prime exposure (2011: 98% AAA) 108 56
ii Ceded business The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group of liability to its policyholders, the Group participates in such agreements for the purpose of managing its loss exposure. The Group evaluates the financial condition of its reinsurers and monitors concentration of credit risk from similar geographic regions, activities or economic characteristics of the reinsurers to minimise its exposure from reinsurer insolvencies. Reinsurance recoverable insurance assets are not a significant component of the Group’s statement of financial position and accordingly, exposure to concentrations of reinsurance risk is not significant to the Group. At 31 December 2011, 91 per cent (2010: 97 per cent) of the reinsurance recoverable insurance assets were ceded by the Group’s UK and US operations, of which 94 per cent (2010: 90 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above.
Market and credit risk a UK insurance operations (i) With-profits business UK business of PAC with-profits fund Shareholder results of UK with-profits business are sensitive to market risk only through the indirect effect of investment performance on declared policyholder bonuses. The investment assets of the PAC with-profits fund are subject to market risk. However, changes in their carrying value, net of related changes to asset-share liabilities of with-profit contracts, affect the level of unallocated surplus of the fund. As unallocated surplus is accounted for as a liability under IFRS, movements in its value do not affect shareholders’ profit or equity. The shareholder results of the UK with-profits fund correspond to the shareholders’ share of the cost of bonuses declared on the with-profits business. This currently corresponds to one-ninth of the cost of bonuses declared. Investment performance is a key driver of bonuses, and hence the shareholders’ share of cost of bonuses. Due to the ‘smoothed’ basis of bonus declaration the sensitivity to investment performance in a single year is low relative to the movements in the period to period performance. However, over multiple periods it is important.
Invested assets covering liabilities (other than the separate accounts) and related capital comprise principally debt securities classified as available-for-sale. Value movements for these securities are reflected as movements in shareholders’ equity through the statement of comprehensive income. Other invested assets and derivatives are carried at fair value with the value movements reflected in the income statement. By contrast, the IFRS insurance liabilities for business written by Jackson, by the application of ‘grandfathered’ GAAP under IFRS 4, are measured on US GAAP bases which, with the exception of certain items covered by the equity hedging programme, are generally insensitive to temporary changes in market conditions or the short-term returns on the attaching asset portfolios. These differences in carrying value of debt securities, other invested assets, derivatives and insurance liabilities give rise to potentially significant volatility in the IFRS income statement and shareholders’ equity. As with other shareholder-backed business the profit or loss for Jackson is presented by distinguishing the result for the year between an operating result based on longer-term investment returns and short-term fluctuations in investment returns. In this way the most significant direct effect of market changes that have taken place to the Jackson result are separately identified. Excluding these short-term effects, the factors that most significantly affect the Jackson IFRS operating result based on long-term investment returns are: • Variable annuity business – effect of market risk arising from the variability of asset management fees, • Fixed annuity and fixed index annuity business – the spread differential between the earned rate and the rate credited to policyholders, and • Amortisation of deferred acquisition costs.
Properties held for sale – – – – – – – – 254 Cash and cash equivalents 112 1,636 191 1,827 666 360 1,026 2,965 2,839
(ii) SAIF is a separate sub-fund within the PAC long-term business fund. (iii) Wholly-owned subsidiary of the PAC WPSF that writes annuity business. The closing liabilities are significantly lower than in 2010 due to a recapture of business by the PAC WPSF. (iv) Excluding policyholder liabilities of the Hong Kong branch of PAC.
† Other loans held by the PAC WPSF are all commercial loans and comprise mainly syndicated loans. (vi) Other investments comprise: Derivative assets* 1,461 926 Partnerships in investment pools and other† 3,107 3,072 * In the UK, Prudential uses derivatives to reduce equity and credit risk, interest rate and currency exposures, and to facilitate efficient portfolio management. After derivative liabilities of £1,298 million (2010: £792 million), which are also included in the statement of financial position, the overall derivative position was a net asset of £163 million (2010: £134 million).
D2: UK insurance operations continued b Reconciliation of movement in investments A reconciliation of the total investments of UK insurance operations from the beginning of the year to the end of the year is as follows: PAC with-profits sub-fund Other funds and subsidiaries
S&P – AAA 578 4,292 585 4,877 699 3,302 472 9,928 18,833 S&P – AA+ to AA- 554 3,323 645 3,968 792 3,008 325 8,647 6,885 S&P – A+ to A- 1,104 10,257 1,318 11,575 1,444 6,525 826 21,474 21,508 S&P – BBB+ to BBB- 1,014 9,551 541 10,092 917 3,186 537 15,746 12,848 S&P – Other 311 2,461 62 2,523 142 174 25 3,175 3,403
AM92 minus 4 years 84% to 96% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2009 mortality model, with a long-term improvement rate of 1.25%.
In deferment 102% to 126% PNMA00 (C = 2000) with medium cohort improvement table with a minimum annual improvement of 2.25% up to age 90, tapering to zero at age 120.
iv Shareholder exposure to interest rate risk and other market risk By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK insurance operations are, except for pension annuity business, not generally exposed to interest rate risk. At 31 December 2011, pension annuity liabilities accounted for 98 per cent (2010: 98 per cent) of UK shareholder-backed business liabilities. For pension annuity business, liabilities are exposed to interest rate risk. However, the net exposure to the PAC WPSF (for PAL) and shareholders (for annuity liabilities of PRIL and the non-profit sub-fund) is very substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mismatching profits or losses to arise.
More than 10 years (28) (49) Mortgage-backed and other debt securities (183) (268)
D3: US insurance operations continued j Sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The estimated sensitivity of Jackson’s profit and shareholders’ equity to equity and interest rate risks provided below is net of the related changes in amortisation of DAC. The effect on the related changes in amortisation of DAC provided is based on the current ‘grandfathered’ US GAAP DAC basis but does not include any effect from an acceleration or deceleration of amortisation of DAC. Note A5 provides explanation of the new US GAAP DAC basis intended to be adopted by the Company from 1 January 2012. Note D3(g) above provides an explanation of the dynamics that affect the amortisation charge and an indicative sensitivity for the 2012 results on the new US GAAP DAC basis.
Related effect on amortisation of DAC (1,144) (646) 646 1,144 (1,174) (641) 641 1,174
(iii) Asian insurance operations The loans of the Group’s Asian insurance operations comprise: Mortgage loans* 31 25 Policy loans* 572 528 Other loans† 630 787
Total Asia insurance operations loans 1,233 1,340 * The mortgage and policy loans are secured by properties and life insurance policies respectively. † The majority of the other loans are commercial loans held by the Malaysian operation and which are all investment graded by two local rating agencies.
Comprising: – Policyholder liabilities 12,593 12,015 6,254 30,862 – Unallocated surplus of with-profits funds 50 – – 50 * Adjusted for transactions in the period and excluding the unallocated surplus of with-profits funds.
• Interest rate guarantees It is common in Asia for regulations or market-driven demand and competition to provide some form of capital value protection and minimum crediting interest rate guarantees. This would be reflected within the guaranteed maturity and surrender values. The guarantees are borne by shareholders for non-participating and investment-linked (non-investment guarantees only) products. Participating product guarantees are predominantly supported by the segregated life funds and their estates.
D5: Capital position statement for life assurance businesses continued 2010 £m
E1: Income statement for asset management operations continued b M&G operating profit based on longer-term investment returns: Asset management fee income 702 612 Other income 4 3 Staff costs (285) (263) Other costs (141) (123)
Operating profit (loss) based on longer-term investment returns 719 833 532 284 22 72 2,462 (521) 1,941
Variance from expected tax chargenote v(ii) 110 – 110 381 – 381 Actual tax (charge) credit (449) 17 (432) (25) (611) (636)
Actual tax rate (excluding exceptional tax credit*): Operating profit based on longer-term investment returns 11% 30% 25% 83% 19%
Increase in policyholder liabilities (3,824) (11,075) (8,490) (23,389) Movement in unallocated surplus of with-profits funds(note) (315) – 70 (245)
Non-linked shareholder-backed Loans – 279 – 279 Equity securities and portfolio holdings in unit trusts 1,175 176 61 1,412 Debt securities 11,753 46,401 251 58,405 Other investments (including derivative assets) 30 2,237 706 2,973 Derivative liabilities (78) (1,408) (218) (1,704)
Non-linked shareholder-backed Equity securities and portfolio holdings in unit trusts 179 43 5 30 (95) – 2 (3) 161 Debt securities 1,068 49 72 46 (213) (27) 61 (713) 343 Other investments (including derivative
Assessment of whether goodwill may be impaired Goodwill is tested for impairment by comparing the CGUs carrying amount, including any goodwill, with its recoverable amount. With the exception of M&G, the goodwill attributable to shareholders in the statement of financial position mainly relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the business as determined using the EEV methodology, as described in note D1. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report. In particular at 31 December 2011, the EEV of the CGU containing the UOB Life Assurance goodwill (being the Singapore insurance operations) materially exceeded its IFRS net asset value and so no impairment was deemed to arise.
H2: Intangible assets attributable to with-profits funds a Goodwill in respect of acquired investment subsidiaries for venture fund and other investment purposes
Investment properties of £3,439 million (2010: £3,435 million) are held under finance leases. A reconciliation between the total of future minimum lease payments at the statement of financial position date, and their present value is shown below: Future minimum lease payments at 31 December 1,071 1,107 Future finance charges on finance leases (944) (972)
Associates accounted for using the equity method A summary of the movements in investments in associates accounted for using the equity method in 2011 and 2010 is set out below: Share of capital £m
There are several minor service agreements in place between the joint ventures and the Group. During 2011, the aggregate amount of the transactions was £33 million (2010: £29.7 million) and the balance outstanding as at 31 December 2011 was £74.2 million (2010: £69.5 million). The joint ventures have no significant contingent liabilities or capital commitments to which the Group is exposed nor does the Group have any significant contingent liabilities or capital commitments in relation to its interest in the joint ventures.
Notes (i) The €500 million 5.75 per cent borrowings had been swapped into borrowings of £333 million with interest payable at six month £LIBOR plus 0.962 per cent. The borrowings were repaid in December 2011.
Non-recourse borrowings of US operations Investment subsidiariesnote (i) 20 20 Piedmont and CDO fundsnote (i), (ii) 1 60
(iii) Other borrowings include mainly amounts whose repayment to the lender is contingent upon future surpluses emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on the contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall. Further, the Group has chosen to designate as a fair value hedge under IAS 39 certain fixed to floating rate swaps which hedge the fair value exposures to interest rate movements of these borrowings.
Of the other provisions balance of £300 million (2010: £282 million), £159 million (2010 £141 million) is expected to be settled within one year. Employer contributions expected to be paid into defined benefit pension schemes within one year are shown in note I3.
Other matters Inherited estate of the PAC long-term fund The assets of the with-profits sub-fund (WPSF) within the long-term insurance fund of The Prudential Assurance Company Limited (PAC) comprise the amounts that it expects to pay out to meet its obligations to existing policyholders and an additional amount used as working capital. The amount payable over time to policyholders from the WPSF is equal to the policyholders’ accumulated asset shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of the WPSF is called the ‘inherited estate’ and has accumulated over many years from various sources. The inherited estate, as working capital, enables PAC to support with-profits business by providing the benefits associated with smoothing and guarantees, by providing investment flexibility for the fund’s assets, by meeting the regulatory capital requirements that demonstrate solvency and by absorbing the costs of certain significant events or fundamental changes in its long-term business without affecting the bonus and investment policies. The size of the inherited estate fluctuates from year to year depending on the investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events.
As a result of this dilution in holding and the consequential loss of control, PruHealth was reclassified from a joint venture to an associate, and the entity was no longer proportionally consolidated from the date of the transaction. In accordance with IAS 31 ‘Interests in joint ventures’, a gain of £30 million arose in 2010 upon the dilution, representing the difference between the fair value of the enlarged 25 per cent investment still held and the book value of the original 50 per cent investment holding.
The Group also operates two smaller defined benefit schemes for UK employees in respect of Scottish Amicable and M&G. For all three schemes the projected unit method was used for the most recent full actuarial valuations. There is also a small defined benefit scheme in Taiwan, but as part of the sale of the Taiwan agency business completed in June 2009, the Group settled the majority of the obligations under the scheme as a significant number of employees transferred out. Defined benefit schemes in the UK are generally required to be subject to full actuarial valuation every three years in order to assess the appropriate level of funding for schemes in relation to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. The last completed actuarial valuation of PSPS was as at 5 April 2008 by C G Singer, Fellow of the Institute of Actuaries, of Towers Watson Limited (previously Watson Wyatt Limited). This valuation demonstrated the scheme to be 106 per cent funded by reference to the Scheme Solvency Target that forms the basis of the scheme’s statutory funding objective. No formal deficit plan was required. However, in recognition of the fall in value of the Scheme’s investments between 5 April 2008 and the completion of the actuarial valuation in 2009, an additional funding akin to deficit funding was agreed by the Trustees. The total contributions being currently made by the Group into the scheme, representing the annual accrual cost and additional funding, are £50 million per annum. Deficit funding for PSPS is apportioned in the ratio of 70/30 between the PAC with-profits fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant to current activity. The current contributions will continue to be made until the next valuation as at 5 April 2011 is finalised later in 2012. In 2011, total contributions paid in the year including expenses and augmentations were £54 million (2010: £55 million). The market value of PSPS scheme assets as at the 5 April 2008 valuation was £4,759 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the 2008 valuation were as follows: Rate of increase in salaries Nil Rate of inflation 3.5% Rate of increase of pensions in payment for inflation: Guaranteed (maximum 5%) 3.5% Guaranteed (maximum 2.5%) 2.5% Discretionary Nil Expected returns on plan assets 4.55%
Under the IAS 19 valuation basis, the Group applies IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ Under IFRIC 14, for PSPS, where the Group does not have unconditional right of refund to any surplus in the scheme, the surplus is not recognised. Additionally, the Group has to recognise a liability for committed deficit funding obligation to PSPS. Accordingly, at 31 December 2011, the Group has not recognised the underlying PSPS surplus of £1,588 million gross of deferred tax (2010: £485 million) and has recognised a liability for deficit funding to 30 June 2012 for PSPS of £19 million, gross of deferred tax (2010: £47 million). The asset and liabilities of PSPS are unaffected by the impact of the application of IFRIC 14. PSPS is managed on an economic basis for the longer-term benefit of its current and deferred pensioners and active members. The surplus in PSPS is available to absorb future adverse asset value movements and, if required, strengthening in mortality assumptions. As at 31 December 2011, after the effect of the application of IFRIC 14, the shareholders’ share of the pension liability for PSPS deficit funding obligation and the deficits of the defined benefit pension schemes amounted to a £17 million liability net of related tax relief (2010: £83 million). These amounts are determined after including amounts invested by the M&G scheme in Prudential policies as explained later in this note. On the economic basis (including investments of the M&G scheme in Prudential policies as assets), for 2011, a £18 million pre-tax shareholder credit (2010: £27 million charge) to operating results based on longer-term returns arises. The £18 million credit in 2011 included a £42 million credit for the RPI to CPI inflation measure change as described later. In addition, outside the operating result but included in total profits is a pre-tax shareholder gain of £21 million (2010: £10 million loss) for shareholders’ share of actuarial and other gains and losses. In addition, also on the economic basis, the PAC with-profits sub-fund was credited £9 million (2010: charge of £18 million) for its share of the pension credit/charge of PSPS and Scottish Amicable, and credited with £15 million (2010: charge of £5 million) for its share of net actuarial and other losses on the scheme assets and liabilities. The £9 million credit in 2011 included a £24 million credit for the PAC with-profit funds share of accounting benefit from the RPI to CPI inflation-measure charge as described later. As shareholder profits for the PAC with-profits sub-fund reflects the surplus for distribution, these amounts are effectively absorbed by an increased credit in the income statement for the transfer to the liability for unallocated surplus. At 31 December 2011, after the effect of the application of IFRIC 14, the total share of the liability for deficit funding on PSPS and the deficit on the smaller Scottish Amicable Scheme attributable to the PAC with-profits fund amounted to a liability of £38 million (2010: £99 million) net of related tax relief.
Prudential insurance policies: Attributable to the PAC with-profits fund (ie absorbed by the liability for unallocated surplus) (41) (106) Attributable to shareholder-backed operations (ie shareholders’ equity) (23) (114)
With the effect of IFRIC 14 (Deficit) surplus (220) 27 36 93 (64) Less: amount attributable to PAC with-profits fund 106 (9) (15) (41) 41
Fair value of plan assets, beginning of year 376 187 563 563 Present value of benefit obligation, beginning of year
The Group maintains 10 main share award and share option plans relating to Prudential plc shares, which are described below. The Group Performance Share Plan (GPSP) is the incentive plan in which all executive directors and other senior executives within the Group can participate. This scheme was established as a replacement for the Restricted Share Plan (RSP) under which no further awards could be made after March 2006. Awards are granted either in the form of a nil cost option, conditional right over shares, or such other form that shall confer to the participant an equivalent economic benefit, with a vesting period of three years. The performance measure for the awards is that Prudential’s Total Shareholder Return (TSR) outperforms an index comprising of peer companies. Vesting of the awards between each performance point is on a straight-line sliding-scale basis. Participants are entitled to the value of reinvested dividends that would have accrued on the shares that vest. Beginning in 2010, newly issued shares have been used in settling the awards that vest and are released. The RSP was, until March 2006, the Group’s long-term incentive plan for executive directors and other senior executives designed to provide rewards linked to shareholder return. Each year participants were granted a conditional option to receive a number of shares. There was a deferment period of three years, at the end of which the award vested to an extent that depended on the performance of the Group’s shares including notional reinvested dividends and on the Group’s underlying financial performance. After vesting, the option may be exercised at zero cost at any time, subject to closed period rules, in the balance of a 10-year period. Shares are purchased in the open market by a trust for the benefit of qualifying employees. The Business Unit Performance Plan (BUPP) is an incentive plan created to provide a common framework under which awards would be made to senior employees in the UK, Jackson and Asia, including the chief executive officers. Awards under this plan were based on growth in shareholder capital value on the European Embedded Value (EEV) basis with performance measured over three years. Upon vesting of awards made up to 2008, half of the awards were released as shares and the other half released in cash. Since the year ended 31 December 2009, all awards made will be settled in shares after vesting. Participants are entitled to receive the value of reinvested dividends over the performance period for those shares that vest. The growth parameters for the awards are relevant to each region, and vesting of the awards between each performance point is on a straight-line sliding-scale basis. Beginning in 2010, newly issued shares will be used in settling the awards that vest and are released. During 2009, the Remuneration Committee decided that future BUPP awards for the UK business unit would be based on the same relative TSR measure applied to GPSP awards. As a result, awards made under the UK BUPP reflect those TSR conditions applied to GPSP awards. In 2011, the Remuneration Committee decided to cancel two-thirds of the number of shares comprising the 2008 share awards and one-third of the 2009 share awards to most UK BUPP participants with the vesting of the remaining one-third and two-thirds, respectively, of awards then being dependent on the achievement of the TSR condition. The change in awards was not applicable to executive directors. Upon the cancellation, Prudential recognised as expense the full amount of the one-third and two-thirds awards that would have been accrued for the remainder of the respective vesting periods in accordance with IFRS 2, ‘Share-based Payment’.
The PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, made acquisitions during the period. These were acquisitions for a 100 per cent interest of Earth & Wind Energias Renovables SL, a company which invests in solar panel parks, in March 2011 and a 100 per cent interest of Alticom Holdings BV, a company investing in telecommunication towers, in June 2011. The Earth & Wind portfolio of solar panel parks was further expanded with the acquisition of a 100 per cent interest in Promociones Fotovoltaicas Betula SL, Promociones Fotovoltaicas Castanea SL, Promociones Fotovoltaicas Corylus SL and Promociones Fotovoltaicas Fagus SL in July 2011, and a 50 per cent controlling interest in Sarinena Solar SL in October 2011. As these transactions are within the with-profits fund, they have no impact on shareholders’ profit or equity for the year ended 31 December 2011. The impact on the Group’s consolidated revenue, including investment returns, is not material. Had the acquisitions been effected at 1 January 2011, the revenue and profit of the Group for the year ended 31 December 2011 would not have been materially different.
Future minimum lease payments for non-cancellable operating leases fall due during the following periods: Not later than 1 year 66 70 Later than 1 year and not later than 5 years 173 236 Later than 5 years 72 120
Derivatives Derivative financial instruments are held to manage interest rate and currency profiles. Derivative financial instruments are carried at fair value with changes in fair value included in the profit and loss account. Under FRS 26, ‘Financial Instruments: Recognition and Measurement’, hedge accounting is permissible only if certain criteria are met regarding the establishment of documentation and continued measurement of hedge effectiveness. For derivative financial instruments designated as fair value hedges, the movements in the fair value are recorded in the profit and loss account with the accompanying change in fair value of the hedged item attributable to the hedged risk.
Share-based payments The Group offers share award and option plans for certain key employees and a SAYE plan for all UK and certain overseas employees. The share-based payment plans operated by the Group are mainly equity-settled plans with a few cash-settled plans. Under FRS 20, where the Company, as the parent company, has the obligation to settle the options or awards of its equity instruments to employees of its subsidiary undertakings, and such share-based payments are accounted for as equity-settled in the Group financial statements, the Company records an increase in the investment in the subsidiary undertakings for the value of the share options and awards granted with a corresponding credit entry recognised directly in equity. The value of the share options and awards granted is based upon the fair value of the options and awards at the grant date, the vesting period and the vesting conditions.
At 1 January 9,410 849 Transfer of investment in subsidiary undertaking (115) – Additional investment in subsidiary undertakings 1,607 – Loan advance – 339 Foreign exchange movement – 12
The transfer of investment in subsidiary undertaking relates to the sale of shares in a central subsidiary to another such company. The additional investment in subsidiary undertakings consists of £1,600 million in respect of a new central subsidiary, created as part of an internal restructuring, and £7 million in respect of share-based payments reflecting the value of payments settled by the Company for employees of its subsidiary undertakings in 2011.
Core structural borrowings: ¤500m 5.75% Subordinated Notes 2021note (i) – 428 – – – 428 £300m 6.875% Bonds 2023 300 300 – – 300 300 ¤20m Medium-Term Subordinated
Fair value of Scheme assets, at 1 January 5,351 4,949 Expected return on Scheme assets 267 287 Employee contributions 1 1 Employer contributions* 54 55 Actuarial gains 973 275 Benefit payments (214) (216)
in a n cia l state m e n ts Financial statements | Statement of directors’ responsibilities
UK insurance operations: Net assets of operations 7 6,058 29 6,087 5,970 33 6,003 M&G: Net assets of operations – 229 229 – 254 254 Acquired goodwill – 1,153 1,153 – 1,153 1,153
Other operations: Holding company net borrowings at market value 9 – (2,188) (2,188) – (2,212) (2,212) Other net assets – 128 128 – 149 149
Total EEV basis shareholders’ equity (excluding non-controlling interests) 7,10 19,637 18,207 * Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.
The EEV basis results have been prepared in accordance with the EEV Principles issued by the European Insurance CFO Forum in May 2004 and expanded by the Additional Guidance on EEV disclosures published in October 2005. Where appropriate, the EEV basis results include the effects of adoption of International Financial Reporting Standards (IFRS). The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles.
• locked-in required capital, and • shareholders’ net worth in excess of required capital (free surplus).
(ii) In determining the EEV basis value of new business, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out for statutory basis reporting.
Notes Analysis by business unit (i) Asian operations £m 2010 note (j)
Notes (a) The increase in unwind of discount and other expected returns to £613 million in 2011 from £573 million in 2010 mainly arises from the growth in the opening value of the in-force book, partially offset by the effect of the reduction in interest rates. (b) The credit of £126 million in 2011 for mortality and morbidity assumption changes arises as follows: 2011 £m
(2) The charge in India of £(21) million reflects lower persistency assumptions for paid-up policies for unit-linked business. The charge of £(75) million for 2010 for the effect of changes in persistency and withdrawals assumptions mainly arises in Indonesia of £(33) million, Malaysia of £(26) million and India of £(24) million partly offset by a credit in Hong Kong of £16 million. The charge in Indonesia of £(33) million primarily relates to Shariah and single premium policies for which lower renewal rates had been experienced. The charge in Malaysia of £(26) million reflects altered premium holiday and other lapse assumptions and the charge in India of £(24) million represents changes in persistency assumptions on linked business.
(e) The credit of £13 million in 2011 for other operating assumptions principally represents the combined effect of a favourable change in assumed asset management margins, a reduction in investment expenses for Indonesia resulting from a growth in the asset portfolio, a decrease in policyholder bonuses in the Philippines, partly offset by the effect of altered profit sharing arrangements in relation to participating business in Vietnam.
(d) The charge of £(36) million for 2011 for updated mortality assumptions primarily arises on variable annuity business to reflect recent mortality experience. The credit of £10 million for 2010 represents a credit of £29 million for business other than variable annuity, reflecting recent experience, partially offset by a negative effect on variable annuity business of £(19) million for a change in the modelling of mortality rates.
Notes (i) EEV basis holding company borrowings comprise: Perpetual subordinated capital securities (Innovative Tier 1) 1,813 1,491 Subordinated debt (Lower Tier 2) 949 1,372 Senior debt 626 581
UK general insurance commission – – – – 40 40 M&G – – – – 357 357 Eastspring Investments – – – – 80 80 US broker-dealer and asset management – – – – 24 24 Other income and expenditure – – – – (536) (536) RPI to CPI inflation measure change on defined benefit pension schemes – – 27 27 18 45 Solvency II implementation costs – (4) (8) (12) (44) (56)
Tax on short-term fluctuations in investment returns 10 157 35 202 8 210 Tax on shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes – – (5) (5) (1) (6)
Financial statements | European Embedded Value (EEV) basis supplementary information 10 Reconciliation of movement in shareholders’ equity (excluding non-controlling interests) continued
Adjustment for net of tax asset management projected profits of covered business (15) (3) (22) (40)
Average number of shares (millions) 2,533 2,524 * The 2010 tax charge attributable to shareholders’ profit included an exceptional tax credit of £158 million which primarily related to the impact of a settlement agreed with the UK tax authorities.
(vii) The value of in-force business includes the value of future margins from current in-force business less the cost of holding required capital and represents: Asian operations
Interest rates – 1% increase (7) 34 (8) 19 Interest rates – 1% decrease (20) (40) 8 (52) Equity/property yields – 1% rise 41 63 12 116 Long-term expected defaults – 5 bps increase – – (13) (13) Liquidity premium – 10 bps increase – – 26 26
(iii) The risk discount rates for new business and business in force for UK insurance operations other than shareholder-backed annuities reflect weighted rates based on the type of business.
(b) 52 basis points for fixed annuities and 47 basis points for inflation-linked annuities in respect of additional provisions which comprise a credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults.
Group total 18,889 18,177 1,792 1,667 3,681 3,485 27,741 25,907 Group total – excluding India 18,754 18,092 1,704 1,487 3,580 3,297 27,275 25,325
Prudential plc Annual Report 2011Prudential plc Annual Report 2011Prudential plc Annual Report 2011
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 433, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Scope of the audit of the supplementary information An audit involves obtaining evidence about the amounts and disclosures in the supplementary information sufficient to give reasonable assurance that the supplementary information is free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s circumstances and have been consistently applied and adequately disclosed; and the reasonableness of significant accounting estimates made by the directors. In view of the purpose for which the supplementary information has been prepared, however, we did not assess the overall presentation of the supplementary information which would have been required if we were to express an audit opinion under International Standards on Auditing (UK and Ireland).
Total operating profit based on longer-term investment returns 784 718 1,080 (512) 2,070 * Including restructuring and Solvency II implementation costs.
‡ Following the reduction in 2010 of the Group’s interest in the PruHealth and PruProtect businesses from 50 per cent to 25 per cent, the profits of these businesses have been shown as a single line in the insurance margin line consistent with associate accounting principles. The UK's 2010 analysis has been amended in light of this change.
Notes (i) Analysis of operating profit between new and in-force business The result for insurance operations comprises amounts in respect of new business and business in-force as follows: New business strain (excluding Japan) (54) (56) Japan – (1)
Profit before tax attributable to shareholders (including actual investment returns) 1,943 (115) 1,828 1,164 (50) 1,114 1,461 (190) 1,271
Available-for-sale securities US operations classified as available-for-sale 811 – 811 237 – 237 1,221 – 1,221 Related change in amortisation of deferred income and acquisition costs (331) 56 (275) (97) 26 (71) (496) 86 (410)
Expected transfer of value of in-force (VIF) and required capital business to free surplus The tables below show how the VIF generated by the in-force long-term business and the associated required capital is modelled as emerging into free surplus over the next 40 years. Although a small amount (1 per cent) of the Group’s embedded value emerges after this date, analysis of cash flows emerging in the early years is considered most meaningful. The modelled cash flows use the same methodology underpinning the Group’s embedded-value reporting, and so are subject to the same assumptions and sensitivities. In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in-force business at 31 December 2011, the tables also present the expected future free surplus to be generated from the investment made in new business during 2011 over the same 40-year period.
The undiscounted expected free surplus generation from all in-force business at 31 December 2011 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2010 as follows.
Group £m £m £m £m £m £m Other £m Total £m 2010 expected free surplus generation for years 2011 to 2050 1,923 1,551 1,579 1,449 1,446 1,367 26,538 35,853
Add: Expected free surplus to be generated in year 2051* – – – – – – 192 192
US operations: New business 815 734 Business in force 616 672
End of period 20 Apr 2006 5.65 01 Jun 2011 30 Nov 2011 820 – – – – – 820 28 Sep 2006 4.75 01 Dec 2011 31 May 2012 709 – – – – – 709 26 Apr 2007 5.72 01 Jun 2010 30 Nov 2010 88,610 – – – 854 87,756 – 26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 17,847 – – – – – 17,847 27 Sep 2007 5.52 01 Dec 2010 31 May 2011 40,465 – 9,891 4,185 – 4,204 22,185 25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 27,068 – 16,323 822 256 739 8,928 25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 4,192 – – – – – 4,192 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 236,700 – 24,571 15,989 251 – 195,889 25 Sep 2008 4.38 01 Dec 2013 31 May 2014 6,951 – – – – – 6,951 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 1,906,105 – 8,966 111,432 44,927 – 1,740,780 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 90,029 – – – 8,811 – 81,218 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 132,837 – 979 16,508 4,928 – 110,422 25 Sep 2009 4.25 01 Dec 2014 31 May 2015 2,682 – – – – – 2,682 28 Sep 2010 4.61 01 Dec 2013 31 May 2014 175,050 – – 16,735 1,208 – 157,107 28 Sep 2010 4.61 01 Dec 2015 31 May 2016 6,501 – – 371 – – 6,130 16 Sep 2011 4.66 01 Dec 2014 31 May 2015 – 422,073 – 9,386 1,931 – 410,756 16 Sep 2011 4.66 01 Dec 2016 31 May 2017 – 25,739 – – – – 25,739
d d itio n a l in fo rm atio n 466 Risk factors 471 Glossary 476 Shareholder information 478 How to contact us
As a holding company, Prudential’s principal sources of funds are remittances from subsidiaries, shareholder-backed funds, the shareholder transfer from long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper. Certain of the subsidiaries are restricted by applicable insurance, foreign exchange and tax laws, rules and regulations that can limit the payment of dividends, which in some circumstances could limit the ability to pay dividends to shareholders, or to make available funds held in certain subsidiaries to cover operating expenses of other members of the Group.
International Financial Reporting Standards (IFRS) Accounting standards that all publicly listed groups in the European Union are required to apply in preparing consolidated financial statements.
Electronic communications Shareholders are encouraged to elect to receive shareholder documents electronically by registering with Shareview at www.shareview.co.uk This will save on printing and distribution costs, and create environmental benefits. Shareholders who have registered will be sent an email notification whenever shareholder documents are available on the Company’s website, and a link will be provided to that information. When registering, shareholders will need their shareholder reference number which can be found on their share certificate or proxy form. The option to receive shareholder documents electronically is not available to shareholders holding shares through The Central Depository (Pte) Limited (CDP). Please contact Equiniti if you require any assistance or further information.
Any forward-looking statements contained in this document speak only as of the date on which they are made. Prudential expressly disclaims any obligation to update the forward-looking statements contained in this report or any other forward-Iooking statements it may make, whether as a result of future events, new information or otherwise except as required pursuant to the UK Prospectus Rules, the UK Listing Rules, the UK Disclosure and Transparency Rules, the Hong Kong listing Rules, the SGX-ST listing rules or other applicable laws and regulations.