Indonesia and Korea • Voted most trusted brand in Malaysia, Singapore and
• Ranked third for net UK retail sales for the whole of 2008 • Named Global Group of the Year by Investment Week and by TrustNet in 2008, as well as winning the Lipper Large Group of the Year 2009
All our businesses are well positioned to take advantage of the biggest demographic wave in history as people move out of the workforce and into retirement. To harness the power of this wave we have a clear and consistent retirement-led strategy with the right focus on the main growth regions, importantly Asia, and a relentless focus on the most profitable product lines.
‘As well as reaffirming our strategy, these results also reflect the operational expertise and excellence that our operating divisions around the world bring to bear, and fully justify our commitment to nurturing the financial strength of the Group through prudent management of capital resources.’
• Through prudent and proactive management the Group’s Insurance Groups Directive (IGD) surplus is estimated at £1.7 billion
‘In 2009, we will focus on balancing new business with cash generation and capital preservation. We will continue, in a volatile environment, to manage risk in a prudent but proactive manner.’
Prudential achieved a strong performance in 2008, despite extremely challenging global economic and financial markets. The results, as summarised below, show that we have delivered solid growth in sales and operating profits, maintained a robust capital position, and met the target we set ourselves of generating a positive Group holding company cash flow in 2008.
We expect markets to remain challenging for some while. However, our long-term growth and profitability potential remains intact and we are well positioned to take advantage of the opportunities existing in the pre and post-retirement market in our chosen geographies. In 2009, we will focus on balancing new business with cash generation and capital preservation. We will continue, in a volatile environment, to manage risk in a prudent but proactive manner.
In our Asian business, economic assumption changes were negative £34 million. This mainly comprises a negative charge in Taiwan of £239 million as a result of extending the phased bond yield progression period out by five years from 31 December 2013 to 31 December 2018, offset by the positive changes in other territories, mainly reflecting the reduction in risk discount rates.
The £535 million charge for debt securities reflects the levels of defaults, losses on sale, and writedowns in excess of the allowance for longer-term defaults included in the operating result. The main constituent of the £439 million charge is £369 million for freestanding derivatives held to manage the fixed annuity and other general account business. There is also a charge of £70 million in respect of Guaranteed Minimum Withdrawal Benefit and other embedded derivative liabilities for the difference between the effect of applying year-end AA corporate bond rate and equity volatility curves in the total result rather than longer-term levels, as applied in determining the operating result.
Operating profit from continuing operations based on longer-term investment returns after restructuring costs 1,347 1,201 12
Discontinued operations (net of tax) 0 241 Minority interests (5) (3)
Instead, adding embedded value reporting to the IFRS accounting and specific additional disclosures, particularly on capital and cash flow, provides investors with a better sense of underlying profitability of our Group’s long-term businesses. Embedded value reporting is a valuable supplement to statutory accounts.
Our risk appetite framework forms an integral part of our annual business planning cycle. Throughout the year, our Group Risk function monitors the Group’s risk profile against the agreed limits. Using submissions from business units, Group Risk calculates our position (allowing for diversification effects between business units) relative to the limits implied by the risk appetite statements.
We take a macro approach to hedging that covers market risk in the US business, including all exposure to GMDB and GMWB guarantees. Within this macro approach we make use of the natural offsets that exist between the variable annuity guarantees and the fixed-indexed annuity book, and then use a combination of Over The Counter (OTC) options and futures to hedge the residual risk, allowing for significant market shocks and limiting the amount of capital we are putting at risk. The hedging programme covers both the in-force book and new business for the ‘greeks’ – i.e. changes in equity market levels, the rate of change in market levels and equity market volatility, as well as interest rate movements. In addition we hedge the fees on variable annuity guarantees.
Credit risk The risk of loss if another party fails to meet its obligations, or fails to do so in a timely fashion
Partnership Our bank distribution strategy is heavily influenced by our agency competencies, since we do not simply rely on bank counter staff to promote insurance products, but also deploy a highly-trained and specialised sales force sitting in the bank branches. These Financial Service Consultants (FSCs) are managed in a very similar way to the agency force; they are accountable for high standards of quality and productivity and they are rewarded for results. There were 8,900 FSCs at 31 December 2008 up 11 per cent on prior year and during 2008 FSCs generated 81 per cent of the region’s bank new business.
Each operation has a target for IRR on new business of at least 10 percentage points above the relevant country risk discount rate, which varies across Asia from three per cent to 17 per cent. Our aggregate IRR in Asia remained in excess of 20 per cent in 2008.
Financial performance Jackson delivered record total APE sales of £716 million in 2008, representing a seven per cent increase over 2007, during a year when the industry faced numerous challenges. While admittedly aided by exchange rate movements during the year, APE retail sales in 2008 were £596 million, the highest level in the company’s history. This achievement continues to demonstrate the resilience of Jackson’s business model and the importance of diversification within our product portfolio.
IFRS operating profit for the long-term business was £406 million in 2008, down by nine per cent from £444 million in 2007. This decline was primarily due to accelerated DAC amortisation in the declining equity market, which was partially offset by equity hedging gains.
The aggregate IRR in new business at 18 per cent declined slightly due to a shift in product mix with variable annuities accounting for 50 per cent of total sales in 2008 against 70 per cent in 2007.
Jackson recorded impairment write-downs and credit related losses of £624 million in 2008. Gross unrealised losses moved from £439 million at 31 December 2007 to £3,178 million at 31 December 2008. This is discussed in greater detail in the Risk and Capital Management section on page 37.
Through a disciplined focus on competing selectively in areas of the retirement savings and income markets where it can generate attractive returns, Prudential UK generates significant value for the Group and remains a leader in the individual annuities, corporate pensions and emerging equity release markets.
In the final quarter of 2008, Prudential UK – working in conjunction with Hannover Re – launched an enhanced annuity, for which the longevity risk is shared, and which uses Hannover Re’s efficient market underwriting model. The current market for enhanced annuities is estimated to exceed £1 billion.
M&G is an investment-led business which aims to deliver superior investment performance and maximise risk-adjusted returns in a variety of macro-economic environments. Through M&G we seek to add value to our Group by generating attractive returns on internal funds as well as growing profits from the management of third-party assets. Such external funds now represent a third of M&G’s total funds under management (FUM).
Our overall strategy at M&G is to focus first and foremost on investment performance, by recruiting, developing and retaining market-leading investment talent, and by providing the environment and infrastructure this talent needs to perform to its full potential.
Our asset management businesses are well placed to capitalise on their leading market positions and strong track records in investment performance. These advantages enable us to deliver positive net flows and profit growth, as well as strategically diversifying the Group’s investment propositions in retail financial services (RFS) markets worldwide. The fact that these markets are increasingly favouring greater product transparency, greater cross-border opportunities and more open-architecture investment platforms also plays to our strengths.
IFRS profit from fund management was £52 million, a fall of 28 per cent, driven by decreasing funds under management and performance related fees as a result of the current market situation.
As at 31 December 2008, after the effect of the adoption of IFRIC 14, the shareholders’ share of the pension liability for PSPS’ deficit funding obligation and the other schemes’ deficits amounted to a £61 million liability net of related tax relief. The total share attributable to the PAC with-profits fund amounted to a liability of £60 million net of related tax relief in respect of the PAC with-profits fund’s share of the liability for deficit funding to 5 April 2010 on PSPS and the deficit on the smaller Scottish Amicable scheme.
In 2008, Jackson donated US$297,000 and more than US$25,000 as in-kind donations to a range of charities focused on the needs of elderly people and children. The volunteering programme for employees – Jackson in Action – saw Jackson employees volunteer more than 3,900 hours, a 62 per cent increase on the previous year. Volunteering activities included teaching financial literacy programmes to high-school children. Jackson also matched employee donations with more than US$400,000 to organisations on the Jackson National Community Fund list for 2008.
A further key part of our efforts to grow our talent pipeline is the Momentum Programme. Launched in 2007, this aims to identify high-potential individuals early in their careers and provide them with opportunities to develop the skills needed to manage an international business. Momentum has a strong diversity focus and is open to people both within and outside Prudential. In 2008 it continued to attract a wide diversity of applicants from across the world.
Under this framework, seven CR priorities have been developed as a basis for guiding and planning our activities.
Bridget Macaskill Independent non-executive director, Chairman of the Remuneration Committee and member of the Nomination Committee Bridget Macaskill has been an independent non-executive director of Prudential since September 2003. Bridget rejoined the Board of Prudential having previously resigned due to a potential conflict of interest in 2001. She has been a member of the Remuneration Committee since 2003 and became Chairman of the Remuneration Committee in May 2006. Bridget joined Arnhold and S. Bleichroeder Advisers, LLC, a US based investment management firm, as President and Chief Operating Officer in February 2009. She is also a trustee of the TIAA-CREF funds and was previously a non-executive director of Fannie Mae (2005-2008), Scottish & Newcastle PLC (2004-2008) and J Sainsbury Plc (2002-2006). Prior to that she spent 18 years at OppenheimerFunds Inc, a major New York based investment management company, the final 10 years of which she was Chief Executive Officer.
Governance, internal control and risk management The Board is responsible for establishing a system of internal control, and for reviewing its effectiveness. To achieve this, the Board has established frameworks for internal governance, risk and corporate responsibility. This system is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable and not absolute assurance against material misstatement or loss.
Details of shares issued during 2007 and 2008 are given in Note H11. No shares were issued in 2006 disapplying pre-emption rights, and the total number of shares issued disapplying pre-emption rights over the last three years amounted to less than 7.5 per cent.
US corporate governance and regulations As a result of the listing of its securities on the New York Stock Exchange, the Company is required to comply with the relevant provisions of the Sarbanes-Oxley Act 2002 as they apply to foreign private issuers, and has adopted procedures to ensure this is the case.
• Group Compliance: Verify compliance with regulatory standards and inform the Group’s senior management and the Board on key regulatory issues affecting the Group.
d Communication: Communicate the Group risk, capital and profitability position to internal and external stakeholders and rating agencies.
The directors are further required to confirm that the directors’ report includes a fair review of the development and performance of the business, with a description of the principal risks and uncertainties. Such confirmation is included in the statement of directors’ responsibilities on page 316.
The Business Review includes, on pages 34 to 41, a description of the Group’s risk and capital management, which includes a description of the Group’s liquidity position. These risks are also discussed in Note C to the financial statements. The Group has considerable internal and external financial resources and the directors believe that the Group is well placed to manage its business risks successfully despite the current uncertain economic outlook.
In overall terms, the Committee considers the current remuneration architecture for the executive directors is appropriate because of its simplicity and transparency and its alignment with shareholders’ interests.
Compensation information on reward for executive directors in the relevant markets provides the background for compensation decisions by the Committee. Consideration is also given to remuneration arrangements and levels for the other Prudential employees in the relevant market.
Scope of role and market position, as well as individual’s contribution and experience, taking into account total remuneration, market movement of salaries in comparator organisations and salary increases for employees generally in the company.
This represents a substantial increase in deferral. The deferral of any award made for 2010 onwards will be 30% of total bonus; and
It is the Company’s policy to provide efficient pension vehicles to allow executive directors to save for their retirement and to make appropriate contributions to their retirement savings plans. The level of company contribution is related to competitive practice in the executive directors’ employment markets.
Tidjane Thiam’s remuneration arrangements after he becomes Group Chief Executive on 1 October 2009 are set out on page 114.
4 This maximum annual bonus will apply on a pro-rated basis for 2009 (see section on Tidjane Thiam’s arrangements on page 114). 5 Mark Tucker’s 2009 annual bonus will be pro-rated based on his period of employment during the year. No 2009 long-term incentive award will be made (his 2008 Group Performance Share Plan award was 200% of basic salary).
Vesting of awards For any Group PSP award to vest, the Remuneration Committee must also be satisfied that the quality of the Company’s underlying financial performance justifies the level of award delivered at the end of the performance period and may adjust the vesting level accordingly at its discretion.
Mark Tucker will continue to receive his basic salary, pension contribution and other benefits under the terms of his contract until 30 September 2009. His annual bonus for 2008 has been paid fully in cash and he will receive a pro-rated bonus for 2009 (9/12ths) based on his length of service during the year. He will receive no LTIP award in 2009.
A comparison with the 2007 results, using constant exchange rates, is set out in the following table.
Michael McLintock annual incentive awardnote 1 2006 86,874 2,580 89,454 1 31 Dec 08 89,454 31 Dec 08 715.5 416.5
Deferred 2007 annual incentive awardnote 1 2008 49,898 1,482 51,3801,5 31 Dec 10
Basic (loss) earnings per share EEV earnings per share 319 (54.1)p 121.2p Shareholders’ equity, excluding minority interests EEV balance sheet 321 £15.0bn £14.6bn *The Company has adopted the principles of IFRIC 14 in accounting for pension schemes in the current year, giving rise to consequential changes to the comparative results for 2007 (see note I1 to the Group financial statements and note 20 to the EEV basis supplementary information).
(Loss) profit from continuing operations after tax (391) 709 Discontinued operations (net of tax) I9 – 241
Treasury shares Movement in own shares in respect of share-based payment plans 3 3 3 Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS (25) (25) (25)
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes H2(a) 174 192 Deferred acquisition costs and other intangible assets H2(b) 126 19
In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company (Jackson). The Group also has operations in Hong Kong, Malaysia, Singapore, Taiwan and other Asian countries. On 20 February 2009, the Company announced that it had entered into agreement, subject to regulatory approval to sell the assets and liabilities of its agency distribution business and its agency force in Taiwan. See note I10 for further details.
Unrealised losses that are considered to be primarily the result of market conditions, such as interest rates movements, unusual market volatility, or industry-related events, and where the Group also believes there is a reasonable expectation for recovery and, furthermore, it has the intent and ability to hold the investment until maturity or the market recovers, are usually determined to be temporary. The Group’s review of fair value involves several criteria, including economic conditions, credit loss experience, other issuer-specific developments and future cash flows. These assessments are based on the best available information at the time. Factors such as market liquidity, the widening of bid/ask spreads and a change in cash flow assumptions can contribute to future price volatility. If actual experience differs negatively from the assumptions and other considerations used in the consolidated financial statements, unrealised losses currently in equity may be recognised in the income statement in future periods. The preceding note in this section provides explanation on how fair value is determined when the markets for the financial investments are not active. Further, additional details on the impairments of the available-for-sale securities of Jackson are described in notes D3 and G5.
Deferred tax Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all the available evidence, it can be regarded as more likely than not that there will be suitable taxable profits against which the losses can be relieved. The UK taxation regime applies separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a capital or trading nature may affect the recognition of deferred tax assets. The judgements made, and uncertainties considered, in arriving at deferred tax balances in the financial statements are discussed in note H4.
For Jackson an extensive derivative programme is maintained. Value movements on the derivatives held can be very significant in their effect on shareholder results. The Group has chosen generally not to seek to construct the Jackson derivative programme so as to facilitate hedge accounting where theoretically possible, under IAS 39. Further details on this aspect of the Group’s financial reporting are described in note A3.
Reinsurance In the normal course of business, the Group seeks to reduce loss exposure by reinsuring certain levels of risk in various areas of exposure with other insurance companies or reinsurers. An asset or liability is recognised in the consolidated balance sheet representing premiums due to or payments due from reinsurers and the share of benefits and claims recoverable from reinsurers. The measurement of reinsurance assets is consistent with the measurement of the underlying direct insurance contracts.
Less: risk margin charge included in operating profit based on longer-term investment returns 54 48
Actuarial gains and losses Actual less expected return on scheme assets (97) 4 Experience gains (losses) on scheme liabilities 18 (4) Gains (losses) on changes of assumptions for scheme liabilities 71 (7)
Shareholders’ share of actuarial gains and losses on defined benefit pension schemes (1) 1 – 0 0.0p 0.0p
As a result of shares issued in lieu of dividends of £157 million (2007: £176 million), dividends paid in cash, as set out in the consolidated cash flow statement, were £297 million (2007: £255 million).
Prudential needs to make assumptions about a number of factors in determining the pricing of its products and for reporting the results of its long-term business operations. In common with other industry participants, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity trends, voluntary discontinuance rates, investment performance, unit cost of administration and new business acquisition expenses.
• Prudential Corporation Asia – minor amounts for a number of small categories of business.
As part of the risk management framework, the Group regularly monitors concentration of risk using a variety of risk monitoring tools. Scenario testing and sensitivity analysis for the Group capital and profitability metrics involving IGD, Group economic capital, EEV and IFRS help identify concentrations of risks by risk types, products and business units, as well as the benefits of diversification of risks.
UK insurance operations (see also section D2(j)) With-profits business Net neutral direct exposure (Indirect exposure only) Investment performance Persistency risk to
Invested assets covering liabilities for these types of business and related capital comprise principally debt securities classified as available-for-sale. Value movements for these securities are reflected as movements in shareholders’ equity. Other invested assets and derivatives are carried at fair value with the value movements reflected in the income statement.
f Duration of liabilities Under the terms of the Group’s contracts, as for life assurance contracts generally, the contractual maturity date is the earlier of the end of the contract term, death, other insurable events or surrender. The Group has therefore chosen to provide details of liability duration that reflect the actuarially determined best estimate of the likely incidence of these factors on contract duration. Details are shown in sections D2(k), D3(k) and D4(k).
Credit risk allowance Long-term expected defaultsnote ii 15 – 15 Long-term credit risk premiumnote iii 11 – 11 Short-term allowance for credit risknote iv 54 (25) 29
The close matching by the Group of assets of appropriate duration to annuity liabilities is based on maintaining economic and regulatory capital. The measurement of liabilities under capital reporting requirements and IFRS is not the same as detailed in note D2(g)(iii), with contingency reserves and some other margins for prudence within the assumptions required under the FSA regulatory solvency basis not included for IFRS reporting purposes. As a result IFRS equity is higher than regulatory capital and therefore more sensitive to interest rate risk.
In addition to the policyholder liabilities above, Jackson has entered into a programme of funding arrangements under contracts which, in substance, are almost identical to GICs. The liabilities under these funding arrangements totalled £3,233 million (2007: £2,607 million) and are included in ‘other non-insurance liabilities’ in the balance sheet above.
Moody’s – Aaa 458 549 Moody’s – Aa1 to Aa3 100 118 Moody’s – A1 to A3 111 47 Moody’s – Baa1 to Baa3 100 79 Moody’s – Other 95 78
Jackson defines its exposure to sub-prime mortgages as investments in residential mortgage-backed securities in which the underlying borrowers have a US Fair Isaac Credit Organisation (FICO) credit score of 659 or lower. With an average FICO score of 610-620, Jackson’s sub-prime collateral could be categorised as ‘near prime’ with a score close to a prime score of 660.
The following table shows the fair value of the debt securities in a gross unrealised loss position for various percentages of book value and by maturity of security at 31 December 2008: Fair Unrealised Fair Unrealised Fair value of securities as a percentage of book value value loss value loss
Fixed indexed annuities Fixed indexed annuities accounted for eight per cent (2007: seven per cent) of Jackson’s policy and contract liabilities at 31 December 2008. Fixed indexed annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of an equity-linked return (based on participation rates and caps) but provide a guaranteed minimum return. These guaranteed minimum rates are generally set at three per cent.
D3: US insurance operations continued i Assumptions used to measure insurance assets and liabilities a Measurement basis for embedded derivatives of variable annuity business There were no changes of assumptions that had a material effect on the Jackson results. However, there has been a significant change of estimation technique for two aspects of the basis of measuring ‘embedded derivatives’ for Guaranteed Minimum Withdrawal Benefit (GMWB) features of Jackson’s variable annuity products and the reinsurance of the Guaranteed Minimum Income Benefit (GMIB). The two aspects are for the application of: i Implied current equity volatility levels rather than historic long-term average levels, which had been applied previously, and ii The reference basis for determining the discount rate to apply to future cash flows in the projection of the effect of the guarantees.
The change is to apply AA corporate bond rates based off appropriate Merrill Lynch indices, rather than LIBOR based swap rates that, in 2008, had become both anomalously low and distorted by comparison to US Treasury bond curve rates. In broad terms, corporate AA rates were approximately 400 basis points higher than the LIBOR based swap rates at the end of 2008. Similarly, at the beginning of 2008 corporate AA rates were approximately 100 basis points higher than the LIBOR based swap rate.
j Sensitivity of IFRS basis profit and equity to market and other risks i Currency fluctuations Consistent with the Group’s accounting policies, the profits of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2008, the rates were US$1.85 (2007: US$2.00) and US$1.44 (2007: US$1.99) to £1 sterling, respectively. A 10 per cent increase or decrease in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows: A 10% increase in A 10% decrease in exchange rates exchange rates
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 832 322 – 1,154 506
Notes i The balance sheet for with-profits business comprises the with-profits assets and liabilities of the Hong Kong, Malaysia and Singapore with-profits operations. Assets and liabilities of other participating business are included in the column for ‘other business’. ii The loans of the Group’s Asian insurance operations of £1,705 million (2007: £1,087 million) comprise mortgage loans of £238 million (2007: £132 million), policy loans of £675 million (2007: £430 million) and other loans of £792 million (2007: £525 million). 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.
Total Asian operations 21,045 17,167 b Reconciliation of movement in investments A reconciliation of the total investments of Asian insurance operations from the beginning of the year to the end of the year is as follows: Asian Unit-linked insurance
Less: Investments held by consolidated investment funds (705) (153) (243) (1,101) Less: Derivative liabilitiesnote G3 – – (32) (32)
The increase in holdings of debt securities for Asian operations was principally due to exchange rate movements, a rise in the number of unit trusts and similar funds requiring consolidation, and portfolio change for equities to bonds.
Product guarantees in Asia can be broadly classified into four main categories, namely premium rate, cash value and interest rate guarantees, policy renewability, and convertibility options.
As noted in section D2(g)(ii), PAC has discretion in its management actions in the case of adverse investment conditions. Management actions encompass, but are not confined to, investment allocation decisions, levels of reversionary bonuses, crediting rates and total claim values. To illustrate the flexibility of management actions, rates of regular bonus are determined for each type of policy primarily by targeting them at a prudent proportion of the long-term expected future investment return on the underlying assets. The expected future investment return is reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers. However, the rates declared may differ by product type, or by date of payment of the premiums or date of issue of the policy, if the accumulated annual bonuses are particularly high or low relative to a prudent proportion of the achieved investment return.
iii Asian operations The available capital shown above of £1,410 million (2007: £874 million) represents the excess of local regulatory basis assets over liabilities before deduction of required capital of £407 million (2007: £265 million). These amounts have been determined applying the local regulations in each of the operations.
D5: Capital position statement for life assurance businesses continued c Movements in total available capital Total available capital for the Group’s life assurance operations has changed during 2008 as follows: 2008 £m
Asset management in the US is undertaken through PPM America which manages assets for the Group’s US, UK and Asian affiliates plus also provides investment services to other affiliated and unaffiliated institutional clients including CDOs, private investment funds, institutional accounts and mutual funds. In addition, broker-dealer activities are undertaken in the US where trades in securities are carried out for both third-party customers and for its own account.
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 64 59 Present value of future profits of acquired investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 1 4
Other debtors Premiums receivable: From policyholders 194 154 From intermediaries 17 13 From reinsurers 253 104
Investments in joint ventures Joint ventures represent activities over which the Group exercises joint control through contractual agreement with one or more parties. The Group’s significant joint ventures, which are accounted for using proportionate consolidation, comprise various joint ventures relating to property investments where the Group has a 50 per cent interest as well as the following interests: Investment % held Principal activity Country
The summarised financial data for the Group’s share of investments in joint ventures is as follows: Financial position Current assets 250 1,277 Non-current assets 1,212 173
Restructuring provisions Restructuring provisions of £21 million (2007: £35 million) relate to restructuring activities of UK insurance operations.
Shareholders’ equity at the end of the year 5,233 (175) 5,058 6,201 (139) 6,062
Estimated pension scheme deficit attributable to shareholder operations – economic basis Movements on the pension scheme deficit (determined on the ‘economic basis’), to the extent attributable to shareholder operations are as follows: 2008 £m
Charge to operating results Actuarial (based on and other longer-term gains (losses) Contributions investment attributable to paid by
Since shareholder profits in respect of the PAC with-profits fund are a function of the actuarially determined surplus for distribution, the overall income statement result is not directly affected by the level of pension cost or other expenses attributable to the fund.
Fair value of plan assets, beginning of year 401 172 573 573 Present value of benefit obligation, beginning of year (654) (654) Provision for deficit funding for PSPS (102) (102)
Effect of the change in accounting policy for pension schemes: Derecognition of PSPS’ surplus (728) (528) (141) – – Set up obligation for deficit funding for PSPS until 5 April 2010 (65) (102) (143) – – Adjustment in respect of investment of PSPS in Prudential policies 103 140 126 – –
Percentage of scheme liabilities at 31 December 3.10% 0.28% (0.35)% (0.02)% 0.35% Experience adjustments on scheme assets (IAS 19 basis) (277) (7) 140 527 112 Percentage of scheme assets at 31 December (5.48)% (0.14)% 2.81% 11.42% 2.74%
The expected volatility is measured as the standard deviation of expected share price returns based on statistical analysis of daily share prices over a period up to the grant date equal to the expected life of options. Risk-free interest rates are UK gilt rates with projections for three, five and seven year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over the year of grant and expected dividends are not incorporated into the measurement of fair value. For the GPSP, volatility and correlation between Prudential and an index constructed from a simple average of the TSR growth of 11 companies is required. For grants in 2008, an average index volatility and correlation of 26 per cent and 82 per cent respectively, were used.
Total key management remuneration amounts to £18,122,000 (2007: £15,670,000). This comprises salaries and short-term benefits of £10,425,000 (2007: £9,496,000), post-employment benefits of £1,003,000 (2007: £967,000), leaving benefits of £507,000 (2007: £nil) and share-based payments of £6,187,000 (2007: £5,207,000).
Aggregate goodwill of £313 million was recognised for the excess of the cost over the Group’s interest in the net fair value of the entities’ assets, liabilities, and contingent liabilities acquired.
Fixed assets Investments: Shares in subsidiary undertakings 4 7,193 7,170 Loans to subsidiary undertakings 4 3,212 2,809
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19. The Company has chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
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.
For the purpose of preparing consolidated financial statements, the Group applies IFRS basis accounting including IAS 19, ‘Employee Benefits’. However, the individual accounts of the Company continue to follow UK GAAP. In 2006, the Company early adopted the amendment to FRS 17 issued in December 2006 which aligned the FRS 17 disclosures with IAS 19. In 2008, the Group adopted IFRIC 14, an interpretation guidance to IAS 19 with the effect of derecognising the Group’s interest in PSPS surplus and recognising an additional liability for the deficit funding for PSPS to 5 April 2010 in the Group financial statements. Further details are described in note I1 ‘Staff and pension plans’ of the notes on the financial statements of the Group.
The profit after tax of the Company for the year was £486 million (2007: loss of £17 million). After dividends of £453 million (2007: £426 million), actuarial gains (losses) net of tax in respect of the pension scheme of £(103) million (2007: gain of £66 million), share based payment reserve movement of £9 million (2007: £5 million) and a transfer from the share premium account of £156 million (2007: £175 million) in respect of shares issued in lieu of cash dividends, retained profit at 31 December 2008 amounted to £1,280 million (2007: £1,185 million).
In addition, the Company paid fees for other services of £0.2 million (2007: £0.2 million). e In certain instances the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
Under that law the directors are required to prepare the Group financial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and applicable law and have elected to prepare the parent company financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice).
In preparing each of the Group and parent company financial statements, the directors are required to: • Select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • for the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; • for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and
The directors of Prudential plc, whose names and positions are set out on pages 80 to 82 confirm that to the best of their knowledge: • The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and
European Embedded Value (EEV) basis supplementary information Year ended 31 December 2008
(Loss) profit from continuing operations for the financial year after tax before minority interests (1,335) 2,743 Discontinued operations (net of tax) – 241
Other operations: Holding company net borrowings at market value 15 (818) (873) Other net liabilities (501) (143)
Except for UK shareholder-backed annuity business, a constant margin of 50 basis points (2007: 50 basis points) has been added to the risk margin derived for market risk to cover the non-diversifiable non-market risks associated with the business. For UK shareholder-backed annuity business, a margin of 100 basis points was used (2007: 100 basis points).
2 Methodology continued f Pension costs The Group operates three defined benefit schemes in the UK. The principal scheme is the Prudential Staff Pension Scheme (PSPS). The other two, much smaller, schemes are the Scottish Amicable and M&G schemes. There is also a small scheme in Taiwan.
f Taxation and other legislation Current taxation and other legislation have been assumed to continue unaltered except where changes have been announced and the relevant legislation passed.
For the purposes of determining the long-term returns for debt securities of shareholder-backed operations, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of risk-free rates and equity risk premium. For US variable annuity separate account business, operating profit reflects the expected longer-term rate of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
iv The table above for full year 2008 and 2007 reflect the inclusion of the Group’s UK health insurance joint venture operation, PruHealth.
New business margins are shown on two bases, namely the margins by reference to Annual Premium and Contribution Equivalents (APE) and the Present Value of New Business Premiums (PVNBP).
3 The favourable effect of the change in persistency assumptions of £36 million in 2008 predominately arises in Singapore of £90 million, Hong Kong of £28 million and Malaysia of £21 million which reflect altered lapse rates, arising from recent experience, offset by charges in Taiwan of £(45) million and Korea of £(44) million mainly relating to premium holidays. The charge of £(51) million for the effect of changes in persistency assumptions in 2007 mainly arise in Singapore (£(29) million) as a result of changes in a number of product related features and updated maturity assumptions in Taiwan (£(15) million) from an increase in lapse rates, reflecting recent experience.
IFRS basis 89 86 Less: projected asset management result in respect of covered business incorporated in opening
Restructuring costs have been incurred as follows: UK insurance operations 14 8 Unallocated corporate 18 12
The charge of £32 million (2007: £20 million) comprises £28 million (2007: £19 million) recognised on the IFRS basis and an additional £4 million (2007: £1 million) recognised on the EEV basis for the shareholders’ share of costs incurred by the PAC with-profits fund.
For 2007, the short-term fluctuations in investment returns for Asian operations of £226 million arose mainly from favourable equity investment performance in most territories, principally in Hong Kong of £102 million, Vietnam of £66 million and Singapore of £38 million offset by a negative fluctuation in Taiwan of £(26) million principally due to a £(30) million value reduction for an investment in a CDO fund.
With-profitsnote a (2,083) Shareholder-backed annuitynote b (213) Unit-linked and othernote c (111)
iv Other operations Short-term fluctuations in investment returns of other operations arises from: £m
Asian asset management operations 52 52 US broker-dealer and asset management 10 10
Tax on short-term fluctuations in investment returns 167 492 683 1,342 69 1,411 Tax on shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 1 1 2 3 Tax on effect of changes in economic assumptions and time value of cost of options and guarantees (14) (97) 233 122 – 122
Analysed as: Statutory IFRS basis shareholders’ equity 2,056 1,698 1,655 5,409 (351) 5,058 Additional retained profit on an EEV basis 3,208 2,641 3,264 9,113 785 9,898
Asian operations 273 204 US operations 19 12 UK insurance operations 117 133 vii Other transfers from net worth
17 Reconciliation of net worth and value of in-force business continued b Group analysis of underlying business activity The following analysis shows the movement in embedded value arising from the Group’s underlying business activity and the effects of the current extraordinary market conditions.
iii Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements, as described in note 2b.
360 Risk factors 364 Shareholder information 366 How to contact us
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates. Changes in government policy, legislation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. For instance, regulators in jurisdictions in which Prudential operates may change the level of capital required to be held by individual businesses. Also these changes could include possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of the recent interventions by governments in response to global economic conditions, it is widely expected that there will be a substantial increase in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure, and enhanced supervisory powers.
The current EU Insurance Groups Directive (IGD) requires European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the Group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a somewhat higher amount of regulatory capital at the Group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, shortterm movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. In addition, changes in the local regulatory environment of countries where this is deemed equivalent to the EU could affect the calculation of the Group’s solvency position. The application of Solvency II, the new European Union solvency framework for insurers, to international groups is still unclear and there is a risk of inconsistent application in different member states which may place Prudential at a competitive disadvantage to other European and non-European financial services groups.
Prudential is, and may be in the future, subject to legal actions and disputes in the ordinary course of its insurance, investment management and other business operations. These legal actions and disputes may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provisioned in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s results of operation or cash flows.
Financial calendar 2008 final dividend – deadline for scrip dividend mandates (Irish shareholders) 30 April 2009 2008 final dividend – deadline for scrip dividend mandates (UK shareholders) 1 May 2009