Note *2011 comparative adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Wherever we operate in the world, we strive to make a strong contribution to the communities we serve, not just through our business activities, but by helping to address the needs of the disadvantaged in those societies. Each of our businesses has a community investment programme in place which provides support to charitable organisations, both through long-term funding and the experience and expertise of our employees.
Having looked at the strength and sustainability of the results we have generated, the Board has decided to rebase our dividend upwards for the second time in three years. This decision refl ects the Board’s confi dence in the Group’s ability to continue to deliver strong, sustainable fi nancial performance.
Beyond Asia, there has been continued progress towards our other cash objectives. The US remitted £249 million in 2012 (2011: £322 million including exceptional release of surplus), on track to meet its 2013 cash objective raised from £200 million to £260 million earlier this year. The UK made remittances to the Group of £313 million in 2012, on track to meet its 2013 objective of £350 million.
Geographically, Asia is a vast and diverse region. Our primary area of focus is on what we call our ‘sweet-spot’ – Indonesia, Hong Kong, Singapore, Malaysia, the Philippines, Thailand and Vietnam. All these markets have attractive long-term characteristics. We are in a strong position to capture profi tably the growing demand for our products and services in these selected markets. We continuously invest in these markets to grow our distribution and to ensure we are well positioned in terms of people, systems and capabilities. We will continue to innovate to meet the evolving needs of our customers and maintain our focus on regular premium savings and protection products.
Our performance in 2012 has been strong in a diffi cult market, which has been impacted by signifi cant UK and EU regulatory change. This includes the implementation of the Retail Distribution Review (RDR), auto-enrolment for company pension schemes and gender neutral pricing.
Of the remaining free surplus generated after reinvestment in new business, £1,200 million was remitted from the business units to Group. This cash was used to meet central costs of £205 million, service net interest payments of £278 million and meet dividend payments of £655 million. The total free surplus balance deployed across our life and asset management operations at the end of the year was £3,689 million (2011: £3,421 million).
Our fi nancing and liquidity position remained strong throughout the period. The issue of US$700 million (£0.4 billion) of subordinated debt (perpetual tier 1 notes) in January 2013 further supports the fi nancial fl exibility of the Group, while taking advantage of very favourable market conditions. Our central cash resources amounted to £1.4 billion at 31 December 2012, up from £1.2 billion at 31 December 2011, and we retain a further £2.1 billion of untapped committed liquidity facilities.
B u sin ess rev iew 21Prudential plc Annual Report 2012Insurance operations: Asia
These new regulations represent major changes to the way business is conducted in a number of areas of the markets in which we operate in the UK, and impact not only insurance and investments providers, but also distributors and consumers. It is inevitable that regulatory change of this scale and scope creates a period of uncertainty before the shape of the new long-term competitive landscape becomes evident.
Prudential UK’s longevity experience, multi-asset investment capabilities, long-standing trusted brand and fi nancial strength mean that we are favourably positioned to help consumers translate their accumulated wealth into dependable retirement income through our range of market leading with-profi ts and annuity products.
Business performance Net third-party infl ows (excluding Money Market Funds) of £1,626 million were driven by net infl ows in India, Taiwan and China. Specifi cally, strong fund-raising was seen in India for our fi xed maturity plan range and open-ended bond funds, while the Taiwan business saw a successful launch of the Emerging Asian Local Fixed Income Fund in the fi rst half of the year and the Global Aggregate Strategy High Yield Bond Fund in the second half. In addition, Taiwan’s existing range of onshore and offshore bond funds also generated signifi cant net infl ows in 2012. In China, both the CSI 500 Index Fund and the Tianjin Split Bond Fund launched in the second half of the year attracted positive fl ows. The positive net fl ows were partially offset by redemptions from an institutional client in Singapore and another in Korea.
Operating earnings per share*(refl ecting operating profi t based on longer-term investment returns after related tax and non-controlling interests) 76.8p 62.8p
Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes 50 21 Gain on dilution of Group holdings 42 – Amortisation of acquisition accounting adjustments arising on the purchase of REALIC (19) –
Mark to market value movements on core borrowings (380) (14) Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes 62 23 Effect of changes in economic assumptions (16) (158) Gain on dilution of Group holdings 42 – Gain on acquisition of REALIC 453 –
In the US, short-term fl uctuations in investment returns were negative £254 million (2011: negative £491 million). This includes the net value movements on derivatives held to manage the Group’s equity and interest rate exposures offset by the positive impact of equity market increases on the expected level of future fee income from the variable annuity separate accounts.
Free surplus and holding company cash fl ow continued During 2012 Prudential generated underlying free surplus from the in-force book of £2,700 million (2011: £2,536 million) despite lower investment return conditions, refl ecting the progress we have made in growing the portfolio of business and our focus on managing the in-force book for value. Changes in operating assumptions and experience variances were £295 million in 2012 compared with £168 million in 2011. These variances included positive £80 million from Asia (2011: positive £52 million), which in 2012 included £51 million from the sale of the Group’s share-holding in China Life Insurance Company of Taiwan. The US continued to record strong positive variances of £219 million (2011: positive £154 million), which included a signifi cant level of favourable spread experience. These variances also included a reduced negative £4 million from the UK (2011: negative £38 million). 2011 also benefi ted from a one-off credit of £33 million arising from a reduction in the liabilities of the Group’s defi ned benefi t pension schemes following the UK Government’s decision to change the basis of indexation from RPI to CPI, which did not reoccur in 2012.
Underlying free surplus generated from in-force business has been used by our life businesses to invest in new business. Investment in new business has increased by 12 per cent to £618 million in 2012. This compares to a 14 per cent increase in sales and a 14 per cent increase in new business profi t.
New business sales (APE) 1,897 1,462 836 Internal rate of returnnote >20% >20% >20%
Net worth invested in new business (200) 30 23 (147) Value of in-force created by new business 1,011 500 172 1,683
Pre-tax new business profi t for the year 1,076 815 260 2,151
Post-tax new business profi t for the year 804 536 195 1,535 Tax 261 289 65 615
Operating holding company cash fl ow for 2012 before the shareholder dividend was £911 million, £102 million higher than 2011. After deducting the shareholder dividend the operating holding company cash fl ow was £256 million (2011: £167 million).
Holding company total 3,126 536 3,662 3,201 187 3,388 Prudential Capital 275 – 275 250 – 250 Jackson surplus notes (Lower Tier 2) 153 43 196 160 17 177
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 of the strength of our operational platform.
In the UK, the investment policy for the shareholder-backed annuity business is to match the annuity payments with the cash fl ows from investments. As a result, assets and liabilities are closely matched by duration. The impact on profi t of any residual cash fl ow mismatching can be adversely affected by changes in interest rates; therefore the mismatching position is regularly monitored. The guarantees of the with-profi t business give rise to some interest rate discounting risk as falling rates may result in an increase in the cost of guarantees. Except for severe stress scenarios where shareholders’ support may be required, this risk is borne by the with-profi ts fund.
vi Counterparty credit risk (Audited) The Group enters into a variety of exchange traded and over-the-counter derivative fi nancial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.
Offset by: AAAAAAAAAAAAA Negative impact arising from market movements estimated at £0.2 billion; AAAAAAAAAAAAA Final 2011 dividend of £0.5 billion and interim 2012 dividend of £0.2 billion; AAAAAAAAAAAAA External fi nancing costs and other central costs, net of tax, of £0.4 billion; and
At Prudential, we aim to be sustainable in the broadest sense – fi nancially, socially and environmentally. Sustainability is integral to the way we do business. Our commitments to our customers and our employees, as well as our support for communities and our responsibility towards the environment, are rooted in our aim of continuing to deliver strong fi nancial performance sustainably.
The insurance industry plays a unique role in society by helping people manage uncertainty and gain security. Prudential has been meeting customers’ needs for 165 years and we are always looking for new ways to ensure that we understand our customers’ long-term fi nancial goals and provide them with the right products to help them plan for the future. We do not underestimate how important these decisions are for our customers, nor do we take for granted the trust they place in us to deliver for them over the long term. Our customers have made a choice to purchase from us, and we value highly their decision and their loyalty.
In line with our federal operating model, we believe that corporate responsibility is best managed by those closest to our customers and stakeholders. Underpinning this approach are our four guiding principles. These provide clarity to our businesses on where they should focus their eff orts and resources.
US Founded over 50 years ago, Jackson National Life is one of the largest life insurance companies in the United States, providing retirement savings and income solutions, with approximately 4 million customers.
Valuing our people We aim to create an environment that enables our people to fi nd value and meaning in their work, and to deliver outstanding performance for our customers, shareholders and communities. This is essential to our continued success, and is performed through our focus on four key areas – diversity and inclusion, talent development, employee engagement, and performance and reward.
In Asia, we operate two SAYE schemes, similar to those in the UK. Participation in these schemes continues to grow strongly among our employees and agents.
Political donations It is the Group’s policy not to make donations to political parties, nor to incur political expenditure, within the meaning of those expressions as defi ned in the Political Parties, Elections and Referendums Act 2000. The Group did not make any such donations or incur any such expenditure in 2012.
Michael Garrett worked for Nestlé from 1961, becoming Head of Japan from 1990 to 1993, and then Zone Director and Member of the Executive Board, responsible for Asia and Oceania. In 1996 his responsibilities were expanded to include Africa and the Middle East. Michael retired as Executive Vice President of Nestlé in 2005. He served the Government of Australia as Chairman of the Food Industry Council and as a Member of the Industry Council of Australia, and was also a member of the Advisory Committee for an APEC (AsiaPacifi c Economic Cooperation) Food System, a Member of The Turkish Prime Minister’s Advisory Group and the WTO (World Trade Organization) Business Advisory Council in Switzerland.
Lord Turnbull entered the House of Lords as a Life Peer in 2005. In 2002 he became Secretary of the Cabinet and Head of the Home Civil Service until he retired in 2005. Prior to that he held a number of positions in the Civil Service, including Permanent Secretary at HM Treasury; Permanent Secretary at the Department of the Environment (later Environment, Transport and the Regions); Private Secretary (Economics) to the Prime Minister; and Principal Private Secretary to Margaret Thatcher and then John Major. He joined HM Treasury in 1970.
The Board has delegated authority to a number of Board committees which assist the Board in delivering its responsibilities and ensuring that there is appropriate independent oversight of internal control and risk management. Each of these committees has established terms of reference and is comprised of independent non-executive directors, with the exception of the Nomination Committee which, in keeping with the provisions of UK Code, is chaired by the Chairman.
The Board was satisfi ed that during 2012 the Chairman’s external commitments did not hinder the day-to-day performance of his duties for Prudential and that he had the commitment and capability to make himself available under unforeseen circumstances. The major commitments of the Chairman, including changes during the year where applicable, are detailed in his biography on page 88.
Where a director was unable to attend board meetings, their views were canvassed by the Chairman prior to the meeting.
Terms of appointment for non-executive directors Non-executive directors are usually appointed for an initial three-year term commencing with their election by shareholders at the fi rst Annual General Meeting following their appointment by the Board and are subject to annual re-election by shareholders. Each appointment is reviewed towards the end of the three-year term against performance and the requirements of the Group’s businesses. The terms and conditions of all directors’ appointments are available for inspection at the Company’s registered offi ce during normal business hours and at the Annual General Meeting.
Meetings The Committee meets at least fi ve times a year and gives consideration to the fi nancial statements of the Group and the Group’s system of internal control, as well as its internal and external audit providers. The Chairman of the Committee is a member of the Risk Committee and works closely with that committee in fulfi lling the Audit Committee’s responsibilities.
AAAAAAAAAAAAA review the eff ectiveness of the business unit audit committees.
Confi dential reporting A standing agenda item of the Committee is to review a report on the use of the confi dential reporting procedures, which are available to employees to enable them to communicate confi dentially, and anonymously if they so wish, on matters of concern and actions taken in response to these communications.
Fees payable to the auditor For the year ended 31 December 2012 the Committee approved fees payable of £14.3 million to its auditor, KPMG Audit Plc. Within this total, the Committee approved fees payable of £2.6 million to KPMG for services not related to audit work which accounted for 18 per cent of total fees payable to the external auditor in the year. In accordance with the Group’s Auditor
Membership The Nomination Committee (the Committee) is comprised of the Chairman and the independent non-executive directors as set out below: AAAAAAAAAAAAA Harvey McGrath (Chairman to 2 July 2012)
As part of the process for appointing any new director, the Committee gives consideration to the balance of skills, experience and knowledge on the Board and, in light of this evaluation, prepares a description of the role and capabilities required for a particular appointment, as well as the expected time commitment. Appointments are made based on merit, against objective criteria set by the Committee.
The Committee provides leadership, direction and oversight in relation to the Group’s overall risk appetite and tolerance and the risk management framework. Oversight of the framework includes reviewing the Group’s risk policies and standards, supporting risk limits, methodologies adopted and the processes and controls in place for assessing the Group’s risks. During the year the Committee carried out an in depth review of a number of policies and other components forming part of the overall Group Risk Framework and recommended improvements to the Board, providing eff ective oversight with regard to the Group’s risk appetite, tolerance and risk management framework. The Committee also provides oversight in respect of the Group Chief Risk Offi cer’s responsibilities.
Culture: to foster a risk management culture, providing quality assurance and facilitating the sharing of best practice.
As at 12 March 2013, Trustees held 0.34 per cent of the issued share capital of the Company under the various plans in operation.
Authority to issue shares The directors require authority from shareholders in relation to the issue of shares by the Company. Whenever shares are issued the Company has to offer the shares to existing shareholders pro rata to their holdings unless it has been given authority by shareholders to issue shares without offering them fi rst to existing shareholders. The Company seeks authority from its shareholders on an annual basis to issue shares up to a maximum amount and to issue up to 5 per cent of its issued share capital without observing pre-emption rights, in line with relevant regulations and best practice. Dis-application of statutory pre-emption procedures is also sought for rights issues. The Company’s existing authorities to issue shares and to do so without observing pre-emption rights are due to expire at the end of this year’s Annual General Meeting. An ordinary resolution and a special resolution to approve the renewal of these authorities respectively will be put to shareholders at the Annual General Meeting on 16 May 2013.
TSR will be measured against a revised peer group and assessed against peers on a ranked (rather than an index) basis.
The guidelines continue to be expressed as a percentage of salary.
No changes were proposed to the structure or the performance conditions, of the annual bonus for 2013.
25 per cent of the award will vest for median performance increasing on a straight-line basis to full vesting for TSR at or above the upper quartile.
The President & CEO, Jackson, participates in Jackson’s Defi ned Contribution Retirement Plan on the same basis as other JNL employees.
Base salary Executive directors’ salaries were reviewed in 2012 with changes effective from 1 January 2013. In determining 2013 salaries, the Committee considered the performance, experience and internal relativities of each director, as well as the performance of the Group and the salary increases awarded to other employees. To provide context for this review, information was drawn from the following market reference points: Director Role Benchmark(s) used to assess remuneration
For any GPSP award to vest, the Committee must be satisfi ed that the quality of the Company’s underlying fi nancial performance justifi es the level of reward delivered at the end of the performance period. To ensure close alignment with our shareholders’ long-term interests, participants receive the value of reinvested dividends over the performance period for those shares which ultimately vest. If performance measures are not achieved in full, the unvested portion of any award lapses and performance cannot be retested.
Outstanding awards made to Mike Wells before his appointment as an executive director remain subject to the original performance conditions and vesting schedule. No further awards will be made to Mike Wells under these plans.
On 31 December 2012, the performance periods for the 2009 awards under the JNL long-term incentive plans (which began on 1 January 2009) came to an end. Over the period the shareholder value of the US business grew by 22.68 per cent per annum (on a compound basis) and by 126.51 per cent over the performance period. This resulted in vesting of 150 per cent of Mike Wells’ 2009 JNL US Performance Share Plan award and of 126.51 per cent of his 2009 cash-settled JNL Long-Term Incentive Plan award (for reference 150 per cent of Mike Wells’ 2008 to 2011 JNL US Performance Share Plan award and 95 per cent of his 2008 to 2011 cash-settled JNL Long-Term Incentive Plan award vested).
Note The contract for Mike Wells is a renewable one-year fi xed term contract. The contract is renewable automatically upon the same terms and conditions unless the Company or the director gives at least 90 days’ notice prior to the end of the relevant term.
Other comprehensive income for the year, net of related tax 171 244
Liabilities Policyholder liabilities and unallocated surplus of with-profi ts funds: Insurance contract liabilities H12 208,584 180,363 171,291 Investment contract liabilities with discretionary participation features G1 33,812 29,745 25,732 Investment contract liabilities without discretionary participation features G1 18,378 16,967 17,704 Unallocated surplus of with-profi ts funds H12 10,589 9,215 10,253
Issue of subordinated debt, net of costs – 340 Redemption of senior debt – (333) Bank loan 25 – Interest paid (270) (286) With-profi ts operations:note (v)
(iii) The acquisition of REALIC in 2012, as explained further in note I1, resulted in a net cash outfl ow of £224 million. The acquisition of subsidiaries in 2011 related to the PAC with-profi ts fund’s purchase of Earth & Wind and Alticom venture investments with an outfl ow of £53 million. (iv) Structural borrowings of shareholder-fi nanced operations comprise the core debt of the parent company, a PruCap bank loan and Jackson surplus notes.
Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international fi nancial services group with its principal operations in Asia, the US and the UK. Prudential offers a wide range of retail fi nancial products and services and asset management services throughout these territories. The retail fi nancial products and services principally include life insurance, pensions and annuities as well as collective investment schemes.
Prudential’s long-term business written in the UK comprises predominantly life insurance policies with discretionary participating features under which the policyholders are entitled to participate in the returns of the funds supporting these policies. Business similar to this type is also written in certain of the Group’s Asian operations subject to local market and regulatory conditions. Such policies are called with-profi ts policies. Prudential maintains with-profi ts funds within the Group’s long-term business funds, which segregate the assets and liabilities and accumulate the returns related to that with-profi ts business. The amounts accumulated in these with-profi ts funds are available to provide for future policyholder benefi t provisions and for bonuses to be distributed to with-profi ts policyholders. The bonuses, both annual and fi nal, refl ect the right of the with-profi ts policyholders to participate in the fi nancial performance of the with-profi ts funds. Shareholders’ profi ts with respect to bonuses declared on with-profi ts business correspond to the shareholders’ share of the cost of bonuses as declared by the Board of directors. The shareholders’ share currently represents one-ninth of the cost to the with-profi ts fund of bonuses declared for with-profi ts policies.
Jackson accounts for the majority of its investment portfolio on an available-for-sale basis (see investment policies above) whereby unrealised gains and losses are recognised in other comprehensive income. As permitted by IFRS 4, Jackson has used shadow accounting. Under shadow accounting, to the extent that recognition of unrealised gains or losses on available-for-sale securities causes adjustments to the carrying value and amortisation patterns of deferred acquisition costs (DAC) and deferred income, these adjustments are recognised in other comprehensive income to be consistent with the treatment of the gains or losses on the securities. More precisely, shadow DAC adjustments refl ect the change in DAC that would have arisen if the assets held in the statement of fi nancial position had been sold, crystallising unrealised gains or losses, and the proceeds reinvested at the yields currently available in the market.
For investment contracts with discretionary participation features, the accounting basis is consistent with the accounting for similar with-profi ts insurance contracts. Other investment contracts are accounted for on a basis that refl ects the hybrid nature of the arrangements whereby part is accounted for as a fi nancial instrument under IAS 39 and the investment management service component is accounted for under IAS 18, ‘Revenue’.
For UK with-profi ts funds the derivative programme derivatives are used for the purposes of effi cient portfolio management or reduction in investment risk.
Leases of investment property where the Group has substantially all the risks and rewards of ownership are classifi ed as fi nance leases (leasehold property). Finance leases are capitalised at the lease’s inception at the lower of the fair value of the leased property and the present value of the minimum lease payments.
Insurance operations principally comprise of products that contain both signifi cant and insignifi cant elements of insurance risk. The products are managed together and there is no distinction between these two categories other than for accounting purposes. This segment also includes the commission earned on general insurance business and investment subsidiaries held to support the Group’s insurance operations.
AAAAAAAAAAAAAAAA The fi nancial condition and prospects of the issuer or other observable conditions that indicate the investment may be impaired.
attributable to policyholders’ returns 378 – 378 (17) – (17) Tax charge attributable to shareholders’ returns (661) 48 (613) (449) 40 (409)
Assets Deferred acquisition costs and other intangible assets attributable to shareholders 5,173 (906) 4,267 5,069 (835) 4,234 Total other assets 305,986 – 305,986 268,511 – 268,511
Equity Shareholders’ equity 10,962 (603) 10,359 9,117 (553) 8,564 Non-controlling interests 5 – 5 43 – 43
IFRS 9, ‘Financial instruments: Classifi cation and measurement’ The new standard, effective on or after 1 January 2015, will automatically replace IAS 39, ‘Financial Instruments – Recognition and measurement’. Under the new requirements the classifi cation and hence measurement of fi nancial assets would be on two bases, either amortised cost or fair value through profi t or loss, rather than the existing four bases of classifi cation. These requirements maintain the existing amortised cost measurement for most liabilities but will require changes in fair value due to changes in the entity’s own credit risk to be recognised in the other comprehensive income (OCI) section of the comprehensive income statement, rather than within profi t or loss for liabilities measured at fair value. On 28 November 2012, the IASB released an Exposure Draft proposing amendments to IAS 9. The proposed changes would introduce a fair value through other comprehensive income (FVOCI) category which would include certain fi nancial assets that contain contractual cash fl ows that are solely payments of principal and interest and are held in a business model in which assets are managed both in order to collect contractual cash fl ows and for sale. The Group is still assessing the full impact of this standard.
The determination of the operating segments and performance measure of the operating segments of the Group are as detailed in note A3(2)(d). Further segmentation of the income statement is provided in note F1 of these fi nancial statements.
Consistent with the basis of measurement of insurance assets and liabilities for Jackson’s IFRS results, the charges and credits to operating profi ts based on longer-term investment returns are partially off set by related changes to amortisation of deferred acquisition costs.
Based on profi t for the year 1,828 (409) (4) 1,415 55.8p 55.7p * The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Dividend per share Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders. The fi nal dividend for the year ended 31 December 2011 of 17.24 pence per ordinary share was paid to eligible shareholders on 24 May 2012 and the 2012 interim dividend of 8.4 pence per ordinary share was paid to eligible shareholders on 27 September 2012.
Asia operations (87) (28) US operations (187) 35 Unallocated to a segment (central funds) 60 (44)
Assets Intangible assets attributable to shareholders: Goodwill – – 239 239 1,230 – – 1,469 Deferred acquisition costs and other intangible assets 105 3,222 908 4,235 14 18 – 4,267
Properties held for sale H9 – 3 – 3 – – – 3 Cash and cash equivalents H10 2,965 271 1,977 5,213 1,735 309 – 7,257 * The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Borrowings attributable to with-profi ts operations 972 – – 972 – – – 972
Total policyholder liabilities and unallocated surplus of with-profi ts funds 108,384 85,523 77,456 – – – 271,363 236,290
Comprising: Policyholder liabilities 133,912 92,261 34,601 260,774 Unallocated surplus of with-profi ts funds 10,526 – 63 10,589 Average policyholder liability balances*
With-profi ts operations: UK insurance operations (2012: 60% AAA, 9% AA) note (i) 5,850 5,351 Asia insurance operations note (ii) 241 454
Disclosures concerning the Group’s risk framework and the management of the risk attached to the Group’s fi nancial instruments and insurance liabilities, together with the inter-relationship with the management of capital have been included in the audited sections of the Risk and capital management disclosure in the Business review. Additional disclosures are shown in section D1.
Contracts of the Group, which are classifi ed as investment contracts that do not contain discretionary participation features, can be summarised as: AAAAAAAAAAAAAAAA UK – certain unit-linked savings and similar contracts; AAAAAAAAAAAAAAAA Jackson – Guaranteed Investment Contracts (GICs) and funding agreements – minor amounts of ‘annuity certain’ contracts; and
b Concentration of risk i Business accepted The Group’s exposure to life assurance risks is well diversifi ed. This is achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types.
Interest rates for those operations where the basis of insurance liabilities is sensitive to current market movements .
197Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
D2: UK insurance operations continued d 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: AAAAAAAAAAAAAAAA One of three separate sub-funds of the PAC long-term fund, namely the with-profi ts sub-fund (WPSF), SAIF, and the non-profi t sub-fund; AAAAAAAAAAAAAAAA Prudential Annuities Limited (PAL), which is owned by the PAC with-profi ts sub-fund; AAAAAAAAAAAAAAAA Prudential Retirement Income Limited (PRIL), a shareholder-owned subsidiary; or AAAAAAAAAAAAAAAA Other shareholder-backed subsidiaries writing mainly non-profi t unit-linked business.
AAAAAAAAAAAAAAAAA Determining at what level to set bonuses to ensure that they are competitive: The overall return to policyholders is an important competitive measure for attracting new business.
Prudential’s fi xed-increase annuities incorporate automatic increases in annuity payments by fi xed amounts over the policyholder’s life. The RPI annuities that Prudential offers provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK RPI.
The process for determining policyholder bonuses of SAIF with-profi ts policies, which constitute the vast majority of obligations of the funds, is similar to that for the with-profi ts policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefi ts ie in excess of those based on asset share.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £371 million was held in SAIF at 31 December 2012 (2011: £370 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefi t of policyholders of SAIF, this provision has no impact on the fi nancial position of the Group’s shareholders’ equity.
Total allowance for credit risk at 31 December 2011 66 42 Credit rating changes 3 2 Asset trading 1 1 New business and other (5) (3)
AM92 minus 4 years 89% – 101% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2011 mortality model, with a long-term improvement rate of 1.50%.
† Translated at the average rate of US$1.5849: £1.00 ‡ Debt securities for US operations included in the statement of fi nancial position at 31 December 2012 comprise: Available-for-sale 32,825 27,016 Fair value through profi t and loss: Securities of consolidated investment funds – 6 Securities held to back liabilities for funds withheld under reinsurance arrangement 168 –
217Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
Total US debt securities 32,993 27,022 * A 1990 SEC rule that facilitates the resale of privately placed securities that are without SEC registration to qualifi ed institutional investors. The rule was designed to develop a more liquid and effi cient institutional resale market for unregistered securities.
: L ife assu ran ce b u sin ess f Reinsurance The reinsurance asset for business ceded outside the Group was £6,076 million (2011: £907 million). The increase from 2011 is due to the acquisition of REALIC as described in note I1, whereby certain former REALIC business was retained by Swiss Re through 100 per cent reinsurance agreements. Apart from the reinsurance acquired through the purchase of REALIC, the principal reinsurance ceded by Jackson outside the Group is on term life insurance, direct and assumed accident and health business and GMIB variable annuity guarantees. In 2012, the premiums for such ceded business amounted to £193 million (2011: £72 million). Net commissions received on ceded business and claims incurred ceded to external reinsurers totalled £24 million and £123 million respectively during 2012 (2011: £9 million and £84 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2012 or 2011.
As noted above, Jackson is exposed to equity risk through the options embedded in the fi xed indexed liabilities and GMDB and GMWB guarantees included in certain VA benefi ts. This risk is managed using an equity hedging programme to minimise the risk of a signifi cant economic impact as a result of increases or decreases in equity market levels while taking advantage of naturally offsetting exposures in Jackson’s operations. Jackson purchases external futures and options that hedge the risks inherent in these products, while also considering the impact of rising and falling separate account fees.
A 10 or 20 per cent increase in their value is estimated to have an approximately equal and opposite effect on profi t and shareholders’ equity to the sensitivities shown above.
Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2012, the policyholder liabilities net of reinsurance of £175 million (2011: £151 million) and unallocated surplus for Asia operations of £34.5 billion (2011: £30.8 billion) comprised the following: Singapore 10,731 9,323 Hong Kong 8,610 8,279 Malaysia 3,336 2,829 Indonesia 2,110 1,809 Korea 2,131 1,852 Taiwan 1,931 1,429 Other countries 5,640 5,240
The terms and conditions of the contracts written by the Asia operations and, in particular, the products’ options and guarantees, vary from territory to territory depending upon local market circumstances.
Subject to local market circumstances and regulatory requirements, the guarantee features described in note D2(d) in respect of UK business broadly apply to similar types of participating contracts written in the Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements.
Similar principles to those explained for UK with-profi ts business apply to profi t emergence for the Asia with-profi ts business. Correspondingly, the profi t emergence refl ects bonus declaration and is relatively insensitive to period by period fl uctuations in insurance risk or interest rate movements.
Total available capital resources of life assurance businesses on local regulatory bases – 6,139 6,139 1,937 2,527 1,493 12,096 * The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes (i) WPSF unallocated surplus includes amounts related to the Hong Kong branch. Policyholder liabilities of the Hong Kong branch are included in the amounts of Asia life assurance subsidiaries.
Assets, liabilities and shareholders’ equity included in the Group consolidated statement of fi nancial position in respect of asset management operations are as follows: M&G note (iii)
Assets Intangible assets: Goodwill 1,153 16 61 1,230 1,230 Deferred acquisition costs and other intangibles assets 10 2 2 14 16
Other operations consist of unallocated corporate activities relating to Group Head Offi ce and the Asia regional head offi ce, with net expenditure for the year of £498 million (2011: £483 million) as detailed in note B1. An analysis of the assets and liabilities of other operations is shown in note B5.
Profi t (loss) from continuing operations before tax attributable to shareholders 900 484 612 332 24 80 2,432 (604) 1,828
Unrealised gains and losses on investments (91) 129 Balances relating to investment and insurance contracts 467 148 Short-term timing differences (226) 66 Capital allowances – 2 Unused tax losses (334) 5
Profi t before tax attributable to shareholders 2,810 1,828 Tax attributable to shareholders’ profi ts: Tax charge (991) (392) Less: tax attributable to policyholders’ returns 378 (17)
in an cial statem en ts F: In co m e statem en t n o tes 2011† £m (except for tax rates)
Group total Loans – 226 1,842* 2,068 Equity securities and portfolio holdings in unit trusts 96,698 2,692 568 99,958 Debt securities 33,474 105,839 790 140,103 Other investments (including derivative assets) 186 4,059 3,655 7,900 Derivative liabilities (77) (2,557) (195) (2,829)
Total fi nancial investments, net of derivative liabilities 12,880 47,685 800 61,365 Percentage of total 21% 78% 1% 100%
Financial assets Deposits 1,021 11,445 187 12,653 Debt securities 131,732 7,851 520 140,103 Loans 8,992 2,809 20 11,821 Other investments (including derivatives) 1,896 1,126 4,878 7,900
277Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
Note All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts: 31 December
H2: Intangible assets attributable to with-profi ts funds a Goodwill in respect of acquired investment subsidiaries for venture fund and other investment purposes
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 available evidence, it can be regarded as more likely than not that there will be suitable taxable profi ts from which the future reversal of the underlying temporary differences can be deducted.
The taxation regimes applicable across the Group often apply separate rules to trading and capital profi ts and losses. The distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of deferred tax assets. Accordingly, for the 2012 results and fi nancial position at 31 December 2012 the possible tax benefi t of approximately £158 million (31 December 2011: £158 million), which may arise from capital losses valued at approximately £0.8 billion (31 December 2011: £0.7 billion), is suffi ciently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £122 million (31 December 2011: £147 million), which may arise from trading tax losses and other potential temporary differences totalling £0.5 billion (31 December 2011: £0.6 billion) is suffi ciently uncertain that it has not been recognised. Of these, losses of £105 million will expire within the next seven years. The remaining losses have no expiry date. Until the end of 2012, for the Group’s UK life insurance companies, shareholders’ profi ts were calculated using regulatory surplus as a starting point, with appropriate deferred tax adjustments for IFRS. Beginning in 2013, under new UK life tax rules, shareholders’ profi ts will be calculated using accounting profi t or loss as a starting point. As the 2012 Finance Act had been enacted at the balance sheet date, the effects of these changes are refl ected in the fi nancial statements for the year ended 31 December 2012 but with no material impact on the Group’s net assets.
Capital expenditure: property, plant and equipment by segment The capital expenditure of £135 million (2011: £124 million) arose as follows: £80 million in UK, £24 million in US and £20 million in Asia in insurance operations with the remaining balance of £11 million arising from asset management operations and unallocated corporate expenditure (2011: £69 million in UK, £20 million in US, £21 million in Asia insurance operations and £14 million in other).
The investments noted in the table above have the same accounting year end as the Group, except for ICICI Prudential Life Insurance Company Limited and ICICI Prudential Asset Management Company Limited. Although these investments have reporting periods ending 31 March, 12 months of fi nancial information up to 31 December is recorded. Accordingly, the information covers the same period as that of the Group. Joint ventures contributed £98 million (31 December 2011: £54 million) to profi t after tax attributable to equity holders during the period. The year-on-year movement in these contributions refl ect the growth in their operating profi t based on longer-term investment returns and the increase in short-term fl uctuations in investment returns by these joint ventures. Further, in June 2012, the PAC with-profi ts fund, via its venture fund holdings and as part of its investment portfolio, entered into a joint venture to acquire control of Veolia Water RegCo (now renamed Affi nity Water), the UK regulated water business of Veolia Environnement S.A. This joint venture investment is carried at fair value through profi t and loss in the Group’s fi nancial statements, as allowed under IAS 28. The results of this operation are refl ected in the movement in the unallocated surplus of the PAC with-profi ts fund and therefore do not affect shareholders’ results. The summarised fi nancial data for the Group’s share of investments in joint ventures is as follows: Financial position Current assets 442 706 Non-current assets 3,504 2,757
289Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
(ii) The US$250 million 6.75 per cent borrowings, the US$300 million 6.5 per cent borrowings and the US$550 million 7.75 per cent borrowings can be converted, in whole or in part, at the Company’s option and subject to certain conditions, on any interest payment date, into one or more series of Prudential preference shares.
291Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
The provision balance is expected to be paid out within the next fi ve years.
293Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
At 31 December 2012, Jackson has unfunded commitments of £325 million (2011: £341 million) related to its investments in limited partnerships and of £86 million (2011: £77 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
The provisional fair value of the acquired assets and liabilities are shown in the table below.
b Acquisition of Thanachart Life Assurance Company Limited On 5 November 2012, Prudential plc, through its subsidiary Prudential Life Assurance (Thailand) Public Company Limited (Prudential Thailand) entered into an agreement to acquire 100 per cent of Thanachart Life Assurance Company Limited (Thanachart Life), a wholly-owned life insurance subsidiary of Thanachart Bank Public Company limited (Thanachart Bank). The consideration for Thanachart Life is THB 17.5 billion (£352 million at the year end exchange rate) settled in cash on completion, with a further payment of THB 0.5 billion (£10 million) payable 12 months after completion, subject to a post-completion adjustment to refl ect the net asset value as at the completion date. The transaction is subject to regulatory approval and is expected to close in the fi rst half of 2013. Upon completion of the transaction, Thanachart Life will become a wholly-owned subsidiary of Prudential Thailand.
2011: The PAC with-profi ts fund, via its venture fund holdings and as part of its investment portfolio, made acquisitions during the period. These were acquisitions for a 100 per cent interest of Earth & Wind Energias Renovables SL, a company which invests in solar panel parks, in March 2011 and a 100 per cent interest of Alticom Holdings BV, a company investing in telecommunication towers, in June 2011. The Earth & Wind portfolio of solar panel parks was further expanded with the acquisition of a 100 per cent interest in Promociones Fotovoltaicas Betula SL, Promociones Fotovoltaicas Castanea SL, Promociones Fotovoltaicas Corylus SL and Promociones Fotovoltaicas Fagus SL in July 2011 and a 50 per cent controlling interest in Sarinena Solar SL in October 2011.
This section illustrates the fi nancial position of the Group’s defi ned benefi t pension schemes on an economic basis and the IAS 19 basis. The underlying position on an economic basis refl ects the assets (including investments in Prudential policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. At 31 December 2012, the investments in Prudential insurance policies comprise £123 million (2011: £112 million) for PSPS and £169 million (2011: £165 million) for the M&G scheme.
Present value of unfunded obligations (M&G scheme)† – – (254) (223) (180)
The 2012 actuarial and other gains refl ects the positive impact of infl ation rate movements in the period, off set by lower discount rates as interest rate falls, and partial recognition of actuarial surplus in PSPS described above.
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts 2.0 2.1 Fees payable to the Company’s auditor and its associates for other services: Audit of subsidiaries pursuant to legislation 6.5 6.1 Audit-related assurance services 3.2 2.6 Tax compliance services 0.5 0.6 Other assurance services 0.5 0.5 Services relating to corporate fi nance transactions 0.4 0.5 All other services 1.2 0.3
I8: Subsidiary undertakings i Principal subsidiaries The principal subsidiary undertakings of the Company at 31 December 2012, all wholly owned were: Main activity Country of incorporation
In January 2013, the Company issued US$700 million 5.25 per cent Tier 1 perpetual subordinated capital securities. The proceeds, net of costs, were US$689 million. The Company also repaid on maturity, the £250 million Medium-Term Notes 2013, included within operational borrowings in note H13 in January 2013.
The Company has not prepared a cash fl ow statement on the basis that its cash fl ow is included within the cash fl ow statement in the consolidated fi nancial statements. The Company has also taken advantage of the exemption within FRS 29, ‘Financial Instruments: Disclosures’, from the requirements of this standard on the basis that the Company’s results are included in the publicly available consolidated fi nancial statements of the Group that include disclosures that comply with IFRS 7, ‘Financial Instruments: Disclosures’, which is equivalent to FRS 29.
The assets and liabilities of the defi ned benefi t pension schemes of the Prudential Group are subject to a full triennial actuarial valuation using the projected unit method. Estimated future cash fl ows are then discounted at a high quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine its present value. These calculations are performed by independent actuaries.
Shareholders’ equity of the Company in accordance with IFRS 6,536 7,313 Share in the IFRS net equity of the Group† 3,823 1,251
Shareholders' equity of the Group in accordance with IFRS 10,359 8,564 * ‘IFRS adjustment’ in the above tables represent the diff erence in the accounting treatment for pension schemes between UK GAAP and IFRS. † The ‘shares in the IFRS result and net equity of the Group’ lines represent the Company’s equity in the earnings and net assets of its subsidiaries and associates.
Actual less expected return on Scheme assets (1% (2011: 15%) (2010: 5%) (2009: 2%) (2008: 5%) of assets) (45) 973 275 85 (259)
The directors are responsible for preparing the Annual Report and the Group and parent company fi nancial statements in accordance with applicable law and regulations.
in an cial statem en ts European Embedded Value (EEV) basis results Prudential plc Annual Report 2012
The defi nition of long-term business operations is consistent with previous practice and comprises those contracts falling under the defi nition for regulatory purposes together with, for US operations, contracts that are in substance the same as guaranteed investment contracts (GICs) but do not fall within the technical defi nition.
The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in note 1(c)(iv)) no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profi t before tax. Separately, the analysis of profi t is delineated between operating profi t based on longer-term investment returns and other constituent items (as explained in note 1(c)(i)).
(v) Debt capital Core structural debt liabilities are carried at market value. As the liabilities are generally held to maturity or for the long term, no deferred tax asset or liability has been established on the difference, compared to the IFRS carrying value. Accordingly, no deferred tax credit or charge is recorded in the results for the reporting period in respect of the mark to market value adjustment.
Non-operating results comprise the recurrent items of short-term fl uctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes, the mark to market value movements on core borrowings and the effect of changes in economic assumptions.
Movements on the shareholders’ share of surpluses (to the extent not restricted by IFRIC 14) and defi cits of the Group’s defi ned benefi t pension schemes adjusted for contributions paid in the year are recorded within the income statement. Consistent with the basis of distribution of bonuses and the treatment of the estate described in notes 1(b)(i) and (iv), the shareholders’ share incorporates 10 per cent of the proportion of the fi nancial position attributable to the PAC with-profi ts fund. The fi nancial position is determined by applying the requirements of IAS 19.
(viii) Taxation The profi t for the year for covered business is in most cases calculated initially at the post-tax level. The post-tax profi t for covered business is then grossed up for presentation purposes at the rates of tax applicable to the countries and periods concerned. In the UK, the rate applied for 2012 is 23 per cent (2011: 25 per cent). For Jackson, the US federal tax rate of 35 per cent is applied to gross up movements on the value of in-force business. The overall tax rate includes the impact of tax effects determined on a local regulatory basis. For Asia, similar principles apply subject to the availability of taxable profi ts. Tax payments and receipts included in the projected cash fl ows to determine the value of in-force business are calculated using rates that have been substantively enacted by the end of the reporting period. Possible future changes of rate are not anticipated. See note 17(ix) for further details.
(c) The charge of £(140) million for 2011 principally arose in Malaysia for partial withdrawals. The 2012 charge refl ects a number of off setting items including further adjustments to partial withdrawals in Malaysia.
Embedded value of acquired businessnote (i) 823 Total purchase consideration (370)
V b asis su p p lem en tary in fo rm atio n 7 Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes
For 2011, the eff ect of £(93) million for the increase in the risk margin allowance within the risk discount rate for credit risk represented a 50 basis points increase for spread business and 10 basis points increase for VA business.
Profi t aft er tax from long-term business 1,364 543 1,907 2,198 4,105 Exchange movements on foreign operations and net
Profi t aft er tax from long-term business 593 135 728 1,027 1,755 Exchange movements on foreign operations and net
V b asis su p p lem en tary in fo rm atio n 15 Expected transfer of value of in-force business to free surplus
(b) Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2012 (31 December 2011) and the new business contribution after the effect of required capital for 2012 and 2011 to: AAAAAAAAAAAAAAAAAAA 10 per cent proportionate decrease in maintenance expenses (a 10 per cent sensitivity on a base assumption of £10 per annum would represent an expense assumption of £9 per annum); AAAAAAAAAAAAAAAAAAA 10 per cent proportionate decrease in lapse rates (a 10 per cent sensitivity on a base assumption of 5 per cent would represent a lapse rate of 4.5 per cent per annum); and
In the event that long-term default levels are higher, then unlike for UK annuity business where policyholder benefi ts are not changeable, Jackson has some discretion to adjust crediting rates, subject to contract guarantee levels and general market competition considerations.
in an cial statem en ts Independent auditor’s report/ Additional unaudited fi nancial information Prudential plc Annual Report 2012
Benefi ts and claims and movement in unallocated surplus of with-profi ts funds, net of reinsurance (45,953) (29,289) (40,518) (41,195) 10,824
Acquisition costs and other expenditure (6,055) (5,120) (4,989) (4,756) (2,457) Finance costs: interest on core structural borrowings of shareholder-fi nanced operations (280) (286) (257) (209) (172) Loss on sale of Taiwan agency business – – – (559) –
Funds under management note (4) 405 351 340 290 249 EEV shareholders’ equity, excluding non-controlling interests 22.4 19.6 18.2 15.3 15.0 Insurance Groups Directive capital surplus (as adjusted) note (5) 5.1 4.0 4.3 3.4 1.5
AAAAAAAAAAAAAAAAAAA Margin on revenues represents premiums charges for expenses and other sundry net income received by the UK. 2012 income was £216 million (2011: £226 million).
Business area: Asia operations 38.9 32.6 US operations 91.4 71.9 UK operations 153.3 146.3
The equivalent discounted amounts of the undiscounted totals shown previously are outlined below: 2012 £m
Changes in tax legislation may result in adverse tax consequences Tax rules, including those relating to the insurance industry, and their interpretation, may change, possibly with retrospective effect, in any of the jurisdictions in which Prudential operates. Signifi cant tax disputes with tax authorities, and any change in the tax status of any member of the Group or in taxation legislation or its scope or interpretation could affect Prudential’s fi nancial condition and results of operations.
Currency risk The risk that asset or liability values, cash fl ows, income or expenses will be affected by changes in exchange rates. Also referred to as foreign exchange risk.
Discretionary participation features or DPF A contractual right to receive, as a supplement to guaranteed benefi ts, additional benefi ts: AAAAAAAAAAAAA That are likely to be a signifi cant portion of the total contractual benefi ts; AAAAAAAAAAAAA Whose amount or timing is contractually at the discretion of the issuer; and
Net worth Regulatory basis net assets for EEV reporting purposes, these net assets are sometimes subject to minor adjustment to achieve consistency with the IFRS treatment of certain items.
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