UNITED KINGDOM & EUROPE www.mandg.co.uk 7m customers customers through M&G Investments2,700 employees employees 1 Excludes Japan, which ceased writing new business in 2010.
Our strategy and the disciplined implementation of our operating principles have produced excellent results.
Note 1 Excluding Japan, which ceased writing new business in 2010.
We have strengthened our risk management practices by forming a Group Risk Committee headed by Howard Davies reporting directly to the Board. We also appointed a new Chief Risk Officer (CRO), John Foley, and have elevated the CRO position to board level.
• Focus on regular premium products with comprehensive suite of protection riders
• Continue to drive positive net retail flows • Innovate around our key variable annuity product • Further enhance operational efficiency
On our capital metric of net underlying free surplus generation we improved 21 per cent to £1,714 million (2009: £1,414 million). Prudential’s ability to deliver on all of these metrics is testament to the quality of our businesses and marks us out among our peers. Our ongoing focus on driving value over volume coupled with our advantaged product and geographic business footprint and the financial discipline that is ingrained within all of our businesses has resulted in the Group delivering excellent performance in the year and gives us confidence as we look into 2011 and beyond.
Solvency II, which is expected to be implemented from 1 January 2013, represents a complete overhaul of the capital adequacy regime for European insurers. We welcome the risk-based focus of the Solvency II regime but, along with our European peers, we do have concerns about the degree of prudence built in within the proposed calibrations for the standard formula. We are engaging directly with our peers, politicians and regulators to ensure a fair and reasonable outcome before the regime becomes law.
Household savings rates in Asia have historically been multiples of those in the UK and US and in markets where little exists in the way of state backed social security benefits or welfare support, the need to save in case of an unplanned life changing event such as a medical incident involving hospitalisation is real and strong. As households have become wealthier the quantum of these emergency funds has increased materially, resulting in significant amounts of undeployed or under-deployed capital waiting to be brought into the formal economy as they migrate to insurance companies’ and banks’ balance sheets. Life insurance companies are ideally placed to provide some financial protection and security to household balance sheets.
Competition is primarily around securing distribution. With insurance penetration rates being generally low, growth is less constrained by the size of the market than by companies’ ability to further expand it by adding distribution and making their products available to parts of the population who have never used them. A large proportion of sales in markets with low penetration are to consumers who have never bought a policy before, thus expanding the market itself.
Prudential’s product mix continues its emphasis on regular premium policies and protection riders. The high proportion of health and protection, standalone and riders, at 27 per cent of new business premiums in 2010, supports the new business profit margins and reflects the higher proportion of risk based products in our book than some competitors who focus on single premium investment orientated policies.
CITIC-Prudential remains one of the leading foreign joint ventures and we continue to pursue our strategy of quality sales and sustainable value creation rather than trying to achieve short-term sales volume growth.
Following our exit of the agency channel in 2009, Taiwan is now successfully focused on bank distribution principally with partners E.Sun and SCB. New business volumes of £120 million for the year are up 12 per cent on prior year and Taiwan remains a material contributor to Asia’s results.
Jackson delivered record retail APE sales of £1,164 million in 2010, representing a 28 per cent increase over 2009. With no institutional sales in 2010, total APE sales were also £1,164 million, the highest total in the company’s history. This achievement further demonstrates the resilience of Jackson’s business model, as well as stability of our high-quality product offerings, exceptional wholesaling support and consistency demonstrated throughout the economic downturn.
“ Prudential UK’s expertise in areas such as longevity risk management and multi-asset investment, together with its financial strength and strong brand, mean that the business is strongly positioned in the retirement planning space.”
In the Wholesale market, Prudential UK’s aim is to continue to participate very selectively in bulk and back-book buyouts using its financial strength, superior investment track record and annuitant mortality risk assessment and servicing capabilities. In line with this approach, in the fourth quarter of 2010, Prudential UK signed a bulk annuity buy-in insurance agreement of £88 million APE.
Gross fund inflows for the full year rose six per cent to £26.4 billion. This set a new record for the M&G business, surpassing the £24.9 billion achieved in 2009. Maintaining this strong sales performance over 2010, and in some highly volatile markets, demonstrates M&G’s strength in depth across all the main asset classes and distribution channels.
M&G’s Retail business in the UK has been number one for gross and net retail sales over nine consecutive quarters based on data to the end of December 20101. As already highlighted, it was sales of M&G’s top-performing fixed income funds that accounted for the lion’s share of net inflows in 2009 with 68 per cent of the net retail flows. During 2010, fixed income products continued to sell extremely well, accounting for 43 per cent of flows, but, with market sentiment turning more bullish, investor appetite for our equity and property funds increased. Net inflows into equity funds have increased in share from 26 per cent in 2009 to 48 per cent of total net retail sales in 2010. Over the same period, property funds’ share of total net sales trebled to nine per cent.
Retail and institutional business net inflows 1,838 556 231 569 223 Money Market Funds net (outflows)/ inflows (MMF) (2,053) 1,443 (242) 1,550 (232) Funds under management 51.9bn 42.4bn 22 47.2bn 10
NPH continues to grow the business and revenue per representative. By utilising high-quality, state-of-the-art technology, we provide NPH’s advisers with the tools they need to operate their practices more efficiently. At the same time, through its relationship with NPH, Jackson continues to benefit from an important retail distribution outlet, as well as receive valuable insights into the needs of financial advisers and their clients.
Exchange translation – Actual Exchange Rate (AER) and Constant Exchange Rate (CER) The comparative results have been prepared using previously reported exchange rates (AER basis) except where otherwise stated.
TOTAL IFRS BASIS OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNSnote i 1,941 1,564 24 1,609 21
M&G’s operating profit for 2010 was £284 million, an increase of 19 per cent from £238 million in 2009, primarily reflecting the continuation of exceptionally strong net inflows, including increased sales of higher margin equity products and higher equity market levels. In 2010 M&G had net inflows of £9.1 billion, the second highest annual level of flows after 2009.
Margin on revenues principally comprises amounts deducted from premiums to cover acquisition costs and administration expenses and has increased by 19 per cent from £1,041 million in 2009 to £1,241 million in 2010. This is driven by the growth of the business in Asia.
ii Margin represents the operating return earned in the period as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. Opening and closing policyholder liabilities have been used to derive an average balance for the period.
* Operating income is net of commissions and includes performance related fees. † Margin represents operating income as a proportion of the related funds under management (FUM). Opening and closing FUM have been used to derive the average. ‡ Cost/income ratio is calculated as cost as a percentage of income excluding performance-related fees.
OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNS 1,941 1,564 Short-term fluctuations in investment returns:note i Insurance operations (148) 7 IGD hedge costs – (235)
In our US business, economic assumption changes were negative £1 million, with the fall in the separate account return being offset by the beneficial effect arising from the decrease in the risk discount rate following a reduction of 0.6 per cent in the US 10-year Treasury rate during the period.
FREE SURPLUS GENERATED IN THE PERIOD FROM RETAINED BUSINESSES 1,620 1,216 Effect of disposal and trading results of Taiwan agency business – 987 Net cash remitted by the business units (935) (688) Other movements and timing differencesnote 1 122 157
positive effects of exchange movements of £0.7 billion offset by the dividend payments of £0.5 billion.
Pre-tax new business profit for the year 725 (12) 713 664 230 1,619 1,607
In the UK, investment in new business decreased by 37 per cent from £103 million in 2009 to £65 million in 2010. This decrease compares with a 13 per cent increase in APE new business sales in the period. For each £1 million of free surplus invested we generated £4.1 million of post-tax new business contribution to embedded value (2009: £1.6 million). This increase reflects the UK’s disciplined approach to pricing which has led to higher retail margins across the product range in 2010. It is also improved by the large bulk annuity transaction undertaken in 2010, the size of which may not be repeated in future years. The average free surplus undiscounted payback period for shareholder-backed business written in the 12 months to 31 December 2010 was four years (2009: five years).
The above amounts can be reconciled to the new 2010 business amounts as follows: 2010 New business
US NET 80 39 Asia paid to Group Long-term business 330 181 Other operations 33 46 363 227 Group invested in Asia Long-term business (63) (101) Other operations (67) (86)
OPERATING HOLDING COMPANY* CASH FLOW BEFORE DIVIDEND 709 382 Dividend paid net of scrip (449) (344)
Remittance ratio analysis The holding company received £935 million of net cash remittances from the business units in 2010, an increase of £247 million from 2009. Overall net remittances as a percentage of net underlying free surplus increased from 49 per cent in 2009 to 55 per cent in 2010. In line with the Group’s strategy the highest remittance ratios are from the UK businesses. The UK insurance operations remitted £420 million in 2010 (2009: £434 million), equivalent to 85 per cent of net underlying free surplus. Contributions from UK with-profits were lower, reflecting the bonus reductions effected at the start of 2009, resulting in a lower share for shareholders in that year and lower remittances in 2010. Net remittances from our shareholderbacked businesses were £218 million, an increase of £68 million from 2009. M&G and PruCap collectively remitted £202 million in 2010 (2009: £175 million) equivalent to 98 per cent of net underlying free surplus.
Share capital and premium 1,983 1,970 IFRS basis shareholders’ reserves 6,048 4,301
If the liabilities were remeasured to fair value them using IAS 39 and FAS 157 principles, but with the removal of the fee capping feature, so as to include the full value of future expected fees for guarantees, the change in liability from the IFRS accounting value would be favourable by some £100 million. After offsetting related adjustments to DAC amortisation on the respective GMDB and GMWB components of the change, and for deferred tax, the net effect would be an increase in shareholders’ equity, which is also estimated to be approximately £100 million.
We use a two-tier approach to apply the limits at business unit level. Firstly, we calculate business unit risk limits. These ensure that, provided each business unit keeps within its limits, the Group risk position will remain within the Group limits. Secondly, the impact on the risk position is considered as part of Group Risk’s scrutiny of large transactions or departures from plan proposed by individual business units.
In our variable annuity sales activities, we focus on meeting the needs of conservative and risk averse customers who are seeking reliable income in retirement, and who display little tendency to arbitrage their guarantees. These customers generally select conservative investment options. We are able to meet the needs of these customers because our unique and market-leading operational platform allows us to tailor more than 3,400 product combinations.
The US corporate and government debt portfolio of £20.2 billion is comprised of £17.8 billion of corporate debt and £2.4 billion of government debt. Of the £17.8 billion of corporate debt 95 per cent is investment grade. Concentration risk within the corporate debt portfolio is low, with the top ten holdings accounting for approximately eight per cent of the portfolio. Our largest sector exposures in the investment grade corporate debt portfolio are Utilities and Energy at 16 per cent and 15 per cent respectively. We actively manage the portfolio and will sell exposures as events dictate.
The CMBS portfolio of £2.4 billion is performing strongly, with 36 per cent of the portfolio rated AAA and one per cent rated below investment grade. The entire portfolio has an average credit enhancement level of 30 per cent. This level provides significant protection, since it means the bond has to incur a 30 per cent loss, net of recoveries, before we are at risk.
Of the £7.1 billion held by shareholder-backed operations, the Asian insurance operations held £0.5 billion of other loans, the majority of which are commercial loans held by the Malaysian operation that are rated investment grade by two local rating agencies. The US insurance operations held £4.2 billion of loans, comprising £3.6 billion of commercial mortgage loans, all of which are collateralised by properties, and £0.5 billion of policy loans. 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. The UK insurance operations held £1.0 billion of loans, the majority of which are mortgage loans collateralised by properties.
We continue to have further options available to us to manage available and required capital. These could take the form of increasing available capital (for example, through financial reinsurance) or reducing required capital (for example, through the mix and level of new business) and the use of other risk mitigation measures such as hedging and reinsurance.
Stress Testing As at 31 December 2010, stress testing of our IGD capital position to various events has the following results: • An instantaneous 20 per cent fall in equity markets from 31 December 2010 levels would reduce the IGD surplus by £200 million; • A 40 per cent fall in equity markets (comprising an instantaneous 20 per cent fall followed by a further 20 per cent fall over a fourweek period) would reduce the IGD surplus by £650 million; • A 150 bps reduction (subject to a floor of zero) in interest rates would reduce the IGD surplus by £500 million; and
However, we also recognise the importance of ensuring good governance and achieving consistent standards across the Company, which is why the Group is accountable for developing the overarching framework, principles and policies for each of our CR priorities, and for reporting progress to the Board and external stakeholders.
Like the US, many people in the UK are insufficiently prepared for increasingly long periods of retirement. Prudential UK is one of the largest annuity providers in the country, paying an income to more than one million customers every year. In addition, our with-profits offering is among the strongest in the industry, consistently outperforming the market for our long-term investors and providing them with attractive returns compared with many other investment options. The with-profits offering also protects investors from the full impact of volatile market conditions while giving them the comfort of knowing that their savings are invested in a financially strong and well managed fund.
Despite improvements in consumer confidence and market gains in 2009, some scores in the ABI Customer Impact Scheme fell sharply across the industry in the 2009/10 study, especially for return on investment and industry reputation. Our scores came within the industry average. While this demonstrates that we have achieved a solid performance in very challenging market conditions, we are taking action. This includes providing more information about how our with-profits fund is performing and what impact this may have on a policy. We are also improving our service to our annuity customers. We have revised our annuity quotes to make them clearer, and we are providing interactive online tools which explain the effects of different annuity choices.
We work in an extremely competitive marketplace that demands we attract the most talented people. It is important that we continue to create an environment that appeals to the right individuals – those who are committed and able to deliver top performance for our customers and shareholders.
We fully recognise the value that a diverse workforce brings to our organisation and believe Prudential should reflect the diversity of the markets in which we operate. It is Group policy to give full and fair consideration and encouragement to the employment of applicants with suitable aptitudes and abilities. It is our policy to recruit and develop talented people, regardless of their disability status, and to continue employing people who become disabled.
Chairman and Chief Executive The roles of Chairman and Group Chief Executive are separate and clearly defined. The scope of these roles is approved and kept under regular review by the Board so that no individual has unfettered decision-making powers.
The report on the findings of the review was discussed by the Board at its meeting in February 2011 and an action plan will be implemented during the year.
Notes 1 The Audit Committee held eight scheduled meetings during the year and nine unscheduled meetings to discuss extraordinary business. 2 Ceased to be a director with effect from 1 January 2011. 3 Appointed as a director and Chairman of Risk Committee on 15 October 2010 and member of the Audit Committee on 9 November 2010. 4 Appointed as a director on 15 October 2010, as a member of the Audit and Remuneration Committee on 9 November 2010 and as a member of the Nomination Committee on 1 January 2011.
Directors may hold directorships or other significant interests with companies outside of the Group which may have business relationships with the Group.
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 Combined Code 2008, executive directors would be expected to hold no more than one non-executive directorship 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 135 and major commitments of our executive directors are detailed in their biographies on pages 100 to 103.
Role of the Committee The Committee’s principal responsibilities for 2010 consisted of oversight over financial reporting, internal controls and risk management, and monitoring auditor independence. Its duties include gaining assurance on the control over financial processes and the integrity of the Group’s financial reports, monitoring the performance, objectivity and independence of the external auditor, and reviewing the work of the internal auditor. With the establishment of the Risk Committee, the oversight of risk management has transferred to that Committee with effect from 2011.
The Committee recognises the need to meet without the presence of executive management. Such sessions were held with the external and internal auditors in February and October 2010. At all other times management and auditors have open access to the Chairman.
Confidential reporting One of the standing agenda items of the Committee is to review a report on the use of the confidential reporting procedures, which are available to employees to enable them to communicate confidentially, and anonymously if they so wish, on matters of concern and actions taken in response to these communications. No material control implications were raised through these procedures during the year.
Details of Committee members’ attendance at meetings are set out on page 107.
The Business Review provides further detail on Prudential’s risk appetite and exposures on pages 80 to 86 and corporate responsibility activities on pages 91 to 98.
Internal business unit routine reporting requirements vary according to the nature of the business. Each business unit is responsible for ensuring that its risk reporting framework meets both the needs of the business unit (for example, reporting to the business unit risk and audit committees) and the minimum standards set by the Group (for example, to meet Group-level reporting requirements).
• Overseeing the remuneration of the Group Leadership Team (comprising around 100 senior individuals including the Group Executive Committee) and of employees with remuneration over £1 million per annum.
Consideration is also given to remuneration arrangements and levels offered to other Prudential employees.
All-employee share plans Offer all employees an opportunity to participate in the success of the Company.
M&G Executive Long-Term Incentive Plan Under the M&G Executive Long-Term Incentive Plan, an annual award of phantom shares is made with a notional starting share price of £1. The phantom share price at vesting is determined by the increase or decrease in M&G’s profitability over the three-year performance period with a profit and investment performance adjustment also applied. The adjustments are described below.
Pensions and long-term savings For executive directors in the UK and Asia hired externally after 30 June 2003, it is the Company’s policy to provide a supplement in lieu of pension of 25 per cent of base salary. This includes, where relevant, any Company contributions to the staff defined contribution pension, which UK executive directors may choose to join. This plan has no salary cap. This approach applies to Rob Devey, Nic Nicandrou, Barry Stowe and Tidjane Thiam, and these executives are provided with life assurance cover of up to four times salary. All these executive directors, except Barry Stowe, have opted to become members of the staff defined contribution pension plan.
Executive directors’ service contracts and letters of appointment The normal notice of termination that the Company is required to give executive directors is 12 months. Accordingly, in normal circumstances, a director whose contract is terminated would be entitled to one year’s salary and benefits in respect of their notice period. Additionally, outstanding awards under annual and long-term incentive plans may vest depending on the circumstances and according to the rules of the plans. When considering the termination of any service contract, the Remuneration Committee will have regard to the specific circumstances of each case, including the director’s obligation to mitigate his loss. Payments are phased over the notice period.
Deferred 2007 annual incentive award 2008 43,777 1,562 45,339 31 Dec 10 635
Profit after tax attributable to equity holders of the Company IFRS income statement 153 £1,431m £676m Basic earnings per share IFRS income statement 153 56.7p 27.0p Dividends per share declared and paid in reporting period IFRS note B3 188 20.17p 19.20p Shareholders’ equity, excluding non-controlling interest IFRS statement of financial position 158 £8,031m £6,271m
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)* 2,072 1,564 Tax charge attributable to policyholders’ returns (611) (818)
Change in non-controlling interests arising principally from purchase and sale of property partnerships of the PAC withprofits fund and other consolidated investment funds – – – – – – (24) (24)
CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, plant and equipment H6 (93) (91) Proceeds from disposal of property, plant and equipment 4 54 Completion adjustment for previously disposed business I10 – (20) Disposal of Taiwan agency business I2(b) – (497) Acquisition of subsidiaries, net of cash balancenote (ii) I1 (145) –
a Financial instruments other than financial instruments classified as long-term business contracts Investment classification Under IAS 39, subject to specific criteria, financial instruments should be accounted for under one of the following categories: financial investments at fair value through profit and loss, financial investments held on an available-for-sale basis, financial investments held-tomaturity or loans and receivables. Upon initial recognition, financial investments are measured at fair value plus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. These IAS 39 classifications have been changed by IFRS 9 ‘Financial Investments: Classification and Measurement’ which is not required to be adopted until 2013 and is still subject to EU endorsement. This standard has not been adopted by the Group in 2010. The Group holds financial investments on the following bases: i Financial assets and liabilities at fair value through profit and loss – this comprises assets and liabilities designated by management as fair value through profit and loss on inception and derivatives that are held for trading. These investments are measured at fair value with all changes thereon being recognised in investment income.
The WPBR is primarily based on the retrospective calculation of accumulated asset shares but is adjusted to reflect future policyholder benefits and other outgoings. The FPRL must include a market consistent valuation of costs of guarantees, options and smoothing, less any related charges, and this amount is determined using either a stochastic approach, hedging costs or a series of deterministic projections with attributed probabilities. The assumptions used in the stochastic models are calibrated to produce risk-free returns on each asset class. Volatilities of, and correlations between, investment returns from different asset classes are as determined by the Group’s Portfolio Management Group on a market consistent basis. The cost of guarantees, options and smoothing is very sensitive to the bonus, market value reduction (MVR) and investment policies the Group employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that the Group retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with management’s policy for with-profits funds and the disclosures made in the publicly available Principles and Practices of Financial Management. The realistic basis liabilities representing the Peak 2 basis realistic liabilities for with-profits business included in Form 19 of the FSA regulatory returns include the element for the shareholders’ share of the future bonuses. For accounting purposes under FRS 27, this latter item is reversed because, consistent with the current basis of financial reporting, shareholder transfers are recognised only on declaration.
Prudential Capital has been incorporated into the M&G operating segment for the purposes of segment reporting. The Group’s operating segments are also its reportable segments. The performance measure of operating segments utilised by the Company is IFRS operating profit attributable to shareholders based on longer-term investment returns. This measure excludes the recurrent items of short-term fluctuations in investment returns and the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes. In addition, for 2010 this measure excluded costs associated with the terminated AIA transaction and gain arising upon the dilution of the Group’s holding in PruHealth. For 2009 it excluded the non-recurrent cost of hedging the Group IGD capital surplus included within short-term fluctuations in investment returns and the loss on sale and the results of the Taiwan agency business during the period of ownership. In 2010 the Company amended its presentation of operating profit for its US insurance operations to exclude the net equity hedge accounting effect previously included relating principally to its variable annuity business as explained below in note A4(d). These amounts are included in short-term fluctuations in investment returns. Prior year comparatives have been amended accordingly. There is no change to total profit for continuing operations before tax attributable to shareholders arising from this altered treatment. Operating earnings per share is based on operating profit based on longer-term investment returns, after tax and non-controlling interests. Further details on the determination of the performance measure of ‘operating profit based on longer-term investment returns’ is provided below in note A4 (d). Segment results that are reported to the GEC include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items are mainly in relation to the Group Head Office and Asia Regional Head Office.
Asian insurance operations The fluctuations for Asian insurance operations in 2010 of £114 million primarily reflect unrealised gains on the debt securities held by shareholders’ funds, as well as a £30 million unrealised gain on the Group’s 8.66 per cent stake in China Life Insurance Company of Taiwan. For 2009, the gain of £31 million primarily relate to strong market performance in Taiwan and Japan partially offset by the fall in the Vietnamese bond markets.
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (74) 21 – (53) (2.1p) (2.1p)
Note (1) The Group has amended the presentation of IFRS operating profit for its US operations to remove net equity hedge accounting effect
Deferred tax assetsH4 214 1,391 98 1,703 123 362 – 2,188 Other non-investment and non-cash assetsH3-H6 4,633 1,241 811 6,685 999 4,159 (5,761) 6,082 Investment of long-term business and other operations: Investment properties 11,212 26 9 11,247 – – – 11,247 Investments accounted for using the equity
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 2008/1 JANUARY 2009 Total investments (including derivative assets) 121,862 46,171 21,809 189,842 3,303 289 193,434 Less: investments held by consolidated investment funds (609) – (1,101) (1,710) – – (1,710)
Directly held investments, net of derivative liabilities 117,852 45,308 20,676 183,836 3,011 45 186,892
AT 31 DECEMBER 2010 Total investments (including derivative assets) 141,426 63,505 30,943 235,874 3,282 141 239,297 Less: investments held by consolidated investment funds (912) – (739) (1,651) – – (1,651)
ii US insurance operations The US insurance operations’ exposure to asset-backed securities at 31 December 2010 comprises: RMBS*: Sub-prime (2010: 40% AAA, 11% AA) 224 194
The Group manages its actual risk profile against its tolerance of risk. To do this, the Group maintains risk registers that include details of the identified risks and of the controls and mitigating actions employed in managing them. Any mitigation strategies involving large transactions, such as a material derivative transaction, are subject to scrutiny at Group level before implementation. The Group uses a range of risk management and mitigation strategies. The most important of these include: adjusting asset portfolios to reduce investment risks (such as duration mismatches or overweight counterparty exposures); using derivatives to hedge market risks; implementing reinsurance programmes to limit insurance risk; implementing corporate insurance programmes to limit the impact of operational risks; and revising business plans where appropriate.
iii Impact of diversification on risk exposure The Group enjoys significant diversification benefits. This arises because not all risk scenarios will happen at the same time and across all geographic regions. The Group tests the sensitivities of results to different correlation factors such as: Correlation across geographic regions • Financial risk factors • Non-financial risk factor
Investments of long-term business and other operations: Investment propertiesnote viii 673 7,589 731 8,320 745 1,474 2,219 11,212 10,861 Investments accounted for using the
vi Other investments comprise: Derivative assets*(note G3) 926 910 Partnerships in investment pools and other† 3,072 2,720 * 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 £792 million (2009: £709 million), which are also included in the statement of financial position, the overall derivative position was a net asset of £134 million (2009: £201 million).
Net cash inflow (outflow) from operating activities (762) (838) (21) (859) 1,000 1,950 1,329 Realised gains in the year 368 1,502 73 1,575 267 23 2,233 Unrealised gains and losses and exchange movements
AT 31 DECEMBER 2010 91,773 21,671 22,273 135,717 Comprising: – Policyholder liabilities 81,586 21,671 22,273 125,530 – Unallocated surplus of with-profits funds 10,187 – – 10,187
e Products and guarantees Prudential’s long-term products in the UK consist of life insurance, pension products and pension annuities. These products are written primarily in: • One of three separate sub-funds of the PAC long-term fund, namely the with-profits sub-fund, SAIF, and the non-profit sub-fund; • Prudential Annuities Limited, which is owned by the PAC with-profits sub-fund; • Prudential Retirement Income Limited, a shareholder-owned subsidiary; or • Other shareholder-backed subsidiaries writing mainly non-profit unit-linked business.
Net income of the fund: Investment return 8,815 10,461 Claims incurred (6,390) (6,253) Movement in policyholder liabilities (4,301) (3,692) Add back policyholder bonuses for the year (as shown below) 2,019 1,827 Claims incurred and movement in policyholder liabilities (including charge for provision for asset shares and excluding policyholder bonuses) (8,672) (8,118) Earned premiums, net of reinsurance 3,148 3,063 Other income 9 (2) Acquisition costs and other expenditure (600) (842) Tax (charge) (528) (640)
Net income of the fund before movement in unallocated surplus 2,172 3,922 Movement in unallocated surplus 70 (1,893)
The tables and range of percentages used are set out in the following tables: PAL PRIL
a Summary results and statement of financial position i Results and movements in shareholders’ equity
Total Book value* 25,115 22,664 Net unrealised gain (loss) 1,210 1,221 (15) 4
ASSETS Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets – 3,543 3,543 3,092
Residential mortgage-backed securities 2,784 3,316 Commercial mortgage-backed securities 2,375 2,104 Other debt securities 976 956
f Intra-group arrangements in respect of SAIF Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency. Due to the quality and diversity of the assets in SAIF and the ability of SAIF to revise guaranteed benefits in the event of an asset shortfall, the directors believe that the probability of either the PAC long-term fund or the Group’s shareholders’ funds, under their obligation to maintain the capital position of long-term funds generally, having to contribute to SAIF is remote.
i Currency translation Consistent with the Group’s accounting policies, the profits of the Asia and PPM America asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2010, the rates for the most significant operations are given in note B4. A 10 per cent increase in the relevant Asian exchange rates would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Asia and PPM America asset management operations, by £9 million (2009: £5 million) and £28 million (2009: £23 million) respectively.
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (5) – – (5) – – (10) – (10)
Notes i The acquisition costs as shown on the table above relate to policy acquisition costs. Acquisition costs from business combinations are included within other expenditure. Acquisition costs in 2010 comprise amounts related to insurance contracts of £941 million (2009: £871 million), and investment contracts and asset management contracts of £165 million (2009: £162 million).
Actual tax rate (excluding exceptional tax credit):* Operating profit based on longer-term investment returns 11% 30% 25% 83% 19%
FINANCIAL LIABILITIES Core structural borrowings of shareholder-financed operationsnotes i,H13 – 3,676 – 3,676 3,866 Operational borrowings attributable to shareholder-financed operationsH13 – 3,004 – 3,004 2,991 Borrowings attributable to with-profits fundsH13 82 1,440 – 1,522 1,524 Obligations under funding, securities lending and sale and repurchase agreements – 4,199 – 4,199 4,236 Net asset value attributable to unit holders of consolidated unit trust and similar funds 3,372 – – 3,372 3,372 Investment contracts with discretionary participation featuresnote iv – – 25,732 25,732 – Investment contracts without discretionary participation features 15,822 1,882 – 17,704 17,652
Total financial investments, net of derivative liabilities 33 2 1 16 – (8) – (4) 40 Net asset value attributable to unit holders of consolidated unit trusts and similar funds – – – (1) – – (1) – (2)
Transfers between level 1 and level 2 During 2010, transfers from level 1 to level 2 amounted to £354 million in respect of certain investment funds held by the Group’s participating funds which arose to reflect the change in the observability of the inputs used in valuing these funds. There were no significant transfers between level 1 and level 2 during 2009.
M&G The recoverable amount for the M&G CGU has been determined by calculating its value in use. This has been calculated by aggregating the present value of future cash flows expected to be derived from the M&G operating segment (based upon management projections).
AT 1 JANUARY Gross amount 162 148 Accumulated amortisation (55) (40)
Future minimum lease payments are due as follows: Less than 1 year 7 9
* The 2010 amounts include the Group’s share of PruHealth’s revenue and profit and loss for the five months ended 31 December 2010. Prior to August 2010, PruHealth was accounted for as a joint venture (see note I2 and the note below).
Associates carried at fair value through profit and loss The Group’s associates that are carried at fair value through profit and loss comprise investments in OEICs, unit trusts, funds holding collateralised debt obligations, property unit trusts, and venture capital investments of the PAC with-profits fund where the Group has significant influence. These investments are incorporated both in the UK and overseas, and some have year ends which are noncoterminous with that of the Group. In these instances, the investments are recorded at fair value at 31 December 2010 based on valuations or pricing information at that specific date. The aggregate fair value of associates carried at fair value through profit and loss where there are published price quotations is approximately £5 billion (2009: £6 billion) at 31 December 2010. The aggregate assets of these associates are approximately £6 billion (2009: £9 billion). Aggregate liabilities, excluding liabilities to unit holders and shareholders for unit trusts and OEICs, are approximately £1 billion (2009: £2 billion). Fund revenues, with revenue arising in unit trusts and OEICs deemed to constitute the investment return for these vehicles, were approximately £0.4 billion (2009: £0.8 billion) and net loss in the year, excluding unit trusts and OEICs where all investment returns accrue to unit holders or shareholders respectively, was approximately £0.1 billion (2009: profit of £0.2 billion).
Issued shares of 5p each fully paid: Shares issued under share option schemes 605,721 – 3 Shares issued in lieu of cash dividends 34,674,062 2 136 Reserve movements in respect of shares issued in lieu of cash dividends – – (136)
Notes B6, D2c, D3c and D4c provide further analysis of the movement in the year of the Group’s policyholder liabilities and unallocated surplus of the with-profits funds.
Provision after elimination of investments in Prudential insurance policies and matching policyholder liability from Group statement of financial position 447 437 Other provisions (see below) 282 206
Analysis of other provisions: Charged to income statement: Additional provisions 182 148 Unused amounts released (10) (13) Used during the year (106) (75) Exchange differences 10 (9)
Legal provisions Of the legal provisions of £20 million (2009: £15 million), £19 million (2009: £11 million) relates to Jackson. Jackson has been named in civil proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers in the US, alleging misconduct in the sale of insurance products. During 2010 and 2009, £1 million and £9 million was paid respectively. In 2010, Jackson established an additional £9 million reserve for potential litigation. We expect the provision balance to be utilised over the next six years.
(ii) the allocation of any such altered future deficit funding between the PAC life fund and shareholder-backed operations would be in a 70/30 ratio. This ratio was determined following detailed consideration in 2005 of the source of previous contributions and has been applied from then when deficit funding has been required.
The valuation of the Scottish Amicable Pension Scheme as at 31 March 2008 demonstrated the scheme to be 91 per cent funded, with a shortfall of actuarially determined liabilities of nine per cent, representing a deficit of £38 million. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a seven year period were made from July 2009 of £7.3 million per annum. Since the valuation date, there has been deterioration in the funding level. During 2010, the Group agreed to pay additional funding of £5.8 million per annum from October 2010 until conclusion of the next formal valuation, or until the funding level reaches 90 per cent, whichever is the earlier. The IAS 19 deficit of the Scottish Amicable Pension Scheme at 31 December 2010 of £146 million (2009: £139 million) has been allocated approximately 50 per cent to the PAC with-profits fund and 50 per cent to the shareholders’ fund. The valuation of the M&G Pension Scheme as at 31 December 2008 was finalised in January 2010 and demonstrated the scheme to be 76 per cent funded. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a five year period are being made from January 2010 of £14.1 million per annum for the first two years and £9.3 million per annum for the subsequent three years. The IAS 19 deficit of the M&G Pension Scheme on an economic basis at 31 December 2010 was £27 million (2009: £36 million) and is wholly attributable to shareholders. The next triennial valuations for the PSPS, Scottish Amicable and M&G pension schemes are scheduled to take place by 5 April 2011, 31 March 2011 and 31 December 2011. 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. At 31 December 2010, the Group has not recognised the underlying PSPS surplus of £485 million gross of deferred tax (2009: £513 million) and has recognised a liability for deficit funding to 30 June 2012 for PSPS of £47 million, gross of deferred tax (2009: £75 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 2010, 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 £83 million liability net of related tax relief (2009: £92 million). These amounts are determined after including amounts invested by the M&G scheme in Prudential policies as explained later in this note.
WITH THE EFFECT OF IFRIC 14 Surplus (deficit) (149) (48) (155) 85 17 (250) Less: amount attributable to PAC with-profits fund 67 16 81 (42) – 122
Notes i The PSPS has entered into a derivatives based strategy to match the duration and inflation profile of its liabilities. This involved a reallocation from other investments to cash-like investments with an interest and inflation swap overlay. In broad terms, the scheme is committed to making a series of payments related to LIBOR on a nominal amount and in return the scheme receives a series of fixed and inflation-linked payments which match a proportion of its liabilities. As at 31 December 2010, the nominal value of the interest and inflation-linked swaps amounted to £1.1 billion (2009: £1.1 billion) and £1.8 billion (2009: £1.9 billion) respectively.
Net periodic pension cost (included within acquisition and other operating expenditure in the income statement) (84) (195)
The weighted average share price of Prudential plc for the year ended 31 December 2010 was £5.68 compared to £4.17 for the year ended 31 December 2009.
iii Acquisition and disposal of subsidiaries During 2010, the Group acquired a 100 per cent interest in United Overseas Bank Life Assurance Limited (UOB) in Singapore. Further details are set out in note I1. On 1 October 2010, the PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, acquired control of Meterserve (North West) Limited and Meterserve (North East) Limited (together referred to as ‘Meterserve’), increasing its 50 per cent stake to 100 per cent. As this transaction is within the with-profits fund it has no impact on shareholders’ profit or equity for the period ended 31 December 2010. The impact on the Group’s consolidated revenue, including investment returns, is not material. Had the acquisition been effected at 1 January 2010, the revenue and profit of the Group from continuing operations for the year ended 31 December 2010 would not have been materially different. A summary of the consideration, goodwill and net assets acquired relating to Meterserve is provided in the table below: 2010 £m
As of and for the Year Ended 31 December 2010 £bn 2009 £bn 2008 £bn 2007 £bn 2006 £bn
In addition, for EEV basis results, operating profit excludes the effect of changes in economic assumptions and the market value movement on core borrowings.
This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: i Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to policyholder accounts. It excludes the longer-term investment return on assets in excess of those covering shareholder-backed policyholder liabilities, which has been separately disclosed as expected return on shareholder assets.
iv Insurance margin primarily represents profits derived from the insurance risks of mortality, morbidity and persistency.
DAC adjustments 518 614 205 Expected return on shareholder assets 242 248 213 Non-recurrent release of reserve for Malaysia Life – 63 –
DAC adjustments 517 467 – Expected return on shareholder assets 125 98 89
• Fee income has increased by 11 per cent to £60 million broadly in line with the value of unit-linked liabilities following the improvement in equity markets.
Operating profit based on longer-term investment returns 228 52 58 7 345
ii The 2009 operating profit of Asian long-term operations excludes the results of the Taiwan agency business for which the sale process was completed in June 2009.
The total number of securities available for issue under the scheme is 6,649,860, which represents 0.261 per cent of the issued share capital at 31 December 2010.
Pensions The Company assumes a portion of the pension surplus or deficit of the Group’s largest pension scheme, the Prudential Staff Pension Scheme (PSPS) and applied the requirements of FRS 17 (as amended in December 2006) to its interest in the PSPS surplus or deficit. Further details are disclosed in note 9.
Total value of assets 5,351 100.0 4,949 100.0 4,803 100.0 4,889 100.0 4,748 100.0 Present value of Scheme liabilities 4,866 4,436 4,075 4,361 4,607
At 31 December 2010, there were options to subscribe for 12,802,482 (2009: 12,230,833) shares at prices ranging from 288 pence to 572 pence (2009: 266 pence to 572 pence) and exercisable by the year 2016 (2009: 2016). Further information on the Group’s employee share options is given in note I4 ‘Share-based payments’ of the notes on the financial statements of the Group.
Long-term business 1,450 1,105 Asset management 72 55 Development expenses (4) (6)
OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNS 3,696 3,090 Short-term fluctuations in investment returns 4 (30) 351 Mark to market value movements on core borrowings 9 (164) (795) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (11) (84) Effect of changes in economic assumptions 5 (10) (910) Costs of terminated AIA transaction 6 (377) – Gain on dilution of holding in PruHealth 18 3 – Profit on sale and results for Taiwan agency business 19 – 91
Total IFRS basis shareholders’ equity 7 8,031 6,271 Additional EEV basis retained profit 7 10,176 9,002
In addition, for 2010, the Company incurred costs associated with the terminated AIA transaction and the Group’s holding in PruHealth was diluted. The effect of both of these items has been shown separately from operating profits based on longer-term investment returns.
iv Unwind of discount and other expected returns The unwind of discount and other expected returns is determined by reference to the value of in-force business, required capital and surplus assets at the start of the period as adjusted for the effect of changes in economic and operating assumptions reflected in the current period.
b The credit of £89 million (2009: £26 million) for mortality and morbidity assumption changes mainly arises in Indonesia of £72 million comprising £36 million for relaxation of morbidity assumptions and £36 million to reflect recent experience in relation to protection benefits provided by unit-linked policies. The favourable effect of £26 million in 2009 primarily arises in Indonesia of £24 million reflecting recent experience.
The charge of £(76) million in 2009 relating to negative persistency experience arises across the region with the largest impacts in Korea (£(29) million), India (£(11) million) and Japan (£(9) million).
Unwind of discount and other expected returnsa 550 588 Effect of changes in operating assumptions: Updated mortality assumptions, net of release of marginsb (40) – Expensec 37 – (3) – Effect of change in UK corporate tax rated 41 – Other itemse (17) 52
c This item arises due to the market returns, net of related hedging activity, being higher or lower than the assumed longer-term rate of return. This gives rise to higher or lower than expected period end values of variable annuity assets under management with a resulting effect on the projected value of future account values and hence future profitability from altered fees. For 2010 the US equity market returns were 14.5 per cent compared to the assumed longer-term rate of 6.8 per cent for the period which was more than offset by the impact of hedging activity. For 2009 the US equity market returns were approximately 24 per cent compared to the assumed longer-term rate of 7.4 per cent for the period.
The following costs were incurred in relation to the proposed and subsequently terminated transaction, to purchase AIA Group Limited and related rights issue.
(2009: £158 million)note 9) 4,799 4,122 Broker-dealer and asset management operationsnote i
M&G:note i Net assets of operations 254 173 Acquired goodwill 1,153 1,153
Notes i With the exception of the share of the Prudential Staff Pension Scheme (PSPS) deficit attributable to the PAC with-profits fund, which is included in ‘Other operations’ net assets (liabilities), these amounts have been determined on the statutory IFRS basis. The overall pension scheme deficit, net of tax, attributable to shareholders relating to PSPS is determined as shown below: IFRS basis deficit (relating to shareholder-backed operations) (10) (16) Additional EEV deficit (relating to shareholders’ 10 per cent share of the IFRS basis deficit attributable to the PAC with-profits fund) (3) (5)
NET MOVEMENT IN FREE SURPLUS 683 124 807 Balance at 1 January 2010 2,065 466 2,531
Beginning of year 30 (821) Change: Income statement 164 795 Foreign exchange effects (4) 56
Reserve movements in respect of share-based payments – – – – 37 37 Acquisition of UOB Lifenotes iv and 17 79 – – 79 (79) – Investment in operationsnote v 103 – 21 124 (124) – Other transfersnote vi (8) (16) (21) (45) 45 – Movement in own shares held in respect of share-based payment plans – – – – (4) (4) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – – – 3 3 New share capital subscribed – – – – 75 75 Mark to market value movements on Jackson assets backing surplus and required capital (net of related tax of £37 million)note 13 – 68 – 68 – 68
The discounted value of in-force business and required capital can be reconciled to the 2010 and 2009 totals in the tables below for the emergence of free surplus as follows: Required capitalnote 13 3,415 2,994 Value of in-force (VIF)note 13 12,051 10,283 Add back: deduction for cost of time value of guaranteesnote 13 369 260 Other itemsnote (845) (865)
For 2009 the ‘active’ basis was applied in preparing the EEV results for Japan, Korea and US dollar denominated business written in Hong Kong, as described in note 1(b).
iv The risk discount rate for Malaysia reflects both the Malaysia life and Takaful operations. v The mean equity return assumptions for the most significant equity holdings in the Asian operations were: To obtain the mean, an average over all simulations of the accumulated return at the end of the projection period is calculated. The annual average return is then calculated by taking the root of the average accumulated return minus 1.
Prudential’s long-term senior debt is rated as A2 (negative outlook) by Moody’s, A+ by Standard & Poor’s and A by Fitch; Prudential’s short-term debt is rated as P-1 by Moody’s, A-1 by Standard & Poor’s and F1 by Fitch; The Prudential Assurance Company Limited long-term fund is rated Aa2 (negative outlook) by Moody’s, AA by Standard & Poor’s and AA by Fitch; Jackson’s financial strength is rated AA by Standard & Poor’s and Fitch, A1 (negative outlook) by Moody’s, and A+ by AM Best.
In common with other industry participants, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity trends, policy surrender rates, investment performance and impairments, unit cost of administration and new business acquisition expense.
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