(iv) Other US shareholder-financed business Debt securities Jackson is the shareholder-backed operation for which the distinction between impairment losses and interest-related realised gains and losses is in practice relevant to a significant extent. Jackson has used the ratings by Nationally Recognised Statistical Ratings Organisations (NRSRO) or ratings resulting from the regulatory ratings detail issued by the National Association of Insurance Commissioners (NAIC) developed by external third parties such as PIMCO or BlackRock Solutions to determine the average annual risk margin reserve to apply to debt securities held to back general account business. Debt securities held to back separate account and reinsurance funds withheld are not subject to risk margin reserve charge. Further details of the risk margin reserve charge, as well as the amortisation of interest-related realised gains and losses, for Jackson are shown in note B1.2.
arn in gs p erfo rm an ce 149 Prudential plc Annual Report 2014
Equity-type securities As at 31 December 2014, the equity-type securities for US insurance non-separate account operations amounted to £1,094 million (2013: £1,118 million). For these operations, the longer-term rates of return for income and capital applied in 2014 and 2013, which reflect the combination of the average risk free rates over the period and appropriate risk premiums are as follows: Equity-type securities such as common and preferred stock and portfolio holdings in mutual funds 6.2% to 6.7% 5.7% to 6.8% Other equity-type securities such as investments in limited partnerships and private equity funds 8.2% to 8.7% 7.7% to 9.0%
d UK Insurance operations (i) Shareholder-backed annuity business For this business, policyholder liabilities are determined by reference to current interest rates. The value movements of the assets covering liabilities are closely correlated with the related change in liabilities. Accordingly, asset value movements are recorded within the operating results based on longer-term investment returns. Policyholder liabilities include a margin for credit risk. Variations between actual and best estimate expected impairments are recorded as a component of short-term fluctuations in investment returns.
The operating results based on longer-term investment returns reflects the impact of value movements on policyholder liabilities for annuity business in PRIL and the PAC non-profit sub-fund after adjustments to allocate the following elements of the movement to the category of short-term fluctuations in investment returns: — The impact on credit risk provisioning of actual upgrades and downgrades during the period; — Credit experience compared to assumptions; and — Short-term value movements on assets backing the capital of the business.
e Fund management and other non-insurance businesses For these businesses, the particular features applicable for life assurance noted above do not apply. For these businesses it is inappropriate to include returns in the operating result on the basis described above. Instead, it is appropriate to generally include realised gains and losses in the operating result with temporary unrealised gains and losses being included in short-term fluctuations. In some instances, it may also be appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time period that reflects the underlying economic substance of the arrangements.
Earned premiums, net of reinsurance 10,882 15,389 5,762 – – – 32,033 – 32,033
Total revenue, net of reinsurance 14,819 20,825 22,449 1,395 806 310 60,604 (478) 60,126
Benefits and claims and movements in unallocated surplus of with-profits funds, net of reinsurance (11,247) (19,761) (19,161) – – – (50,169) – (50,169)
Acquisition costs and other operating expenditureB3 (2,367) (795) (1,660) (920) (794) (249) (6,785) 33 (6,752)
Remeasurement of carrying value of Japan life business classified as held for sale (13) – – – – – (13) – (13)
Share of profit from joint ventures and associates, net of related tax 133 – 128 13 – 29 303 – 303
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns)note (i) 1,325 257 1,756 471 12 90 3,911 (757) 3,154
The segmental analysis of profit (loss) before tax attributable to shareholders as represented in note B1.1 is analysed below: Insurance operations Asset management Unallocated to a segment (central operations)Asia US UK M&G US
Short-term fluctuations in investment returns on shareholder-backed business 178 (1,103) 464 (17) – – (478) (96) (574)
Insurance operations Asset management Unallocated to a segment (central operations) note (iii)
Finance costs: interest on core structural borrowings of shareholder-financed operations – (13) – (17) – – (30) (275) (305)
Notes (i) This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. (ii) Investment return principally comprises: – Interest and dividends; – Realised and unrealised gains and losses on securities and derivatives classified as fair value through profit or loss under IAS 39; and – Realised gains and losses, including impairment losses, on securities classified as available-for-sale under IAS 39. (iii) In addition to the results of the central operations, unallocated to a segment includes intra-group eliminations. In 2014, this column includes the elimination of the intra-group reinsurance contract entered into during the year between the UK with-profits and Asia with-profits operations.
Long-term business premiums Insurance contract premiums 29,973 28,339 Investment contracts with discretionary participation feature premiums 2,637 1,877 Inwards reinsurance premiums 222 286 Less: reinsurance premiums ceded (799) (658)
Insurance operations Asset management operations Unallocated to a segment (central operations)Asia US UK M&G US
Revenue from external customers: Total revenue from external customers 9,719 16,111 8,509 – 34,339 9,066 16,150 6,812 – 32,028 * Eliminated on consolidation.
Revenue from external customers of Asia, US and UK insurance operations shown above are net of outwards reinsurance premiums of £311 million, £265 million, and £223 million respectively (2013: £190 million, £278 million and £190 million respectively). In Asia, revenue from external customers from no individual country exceeds 10 per cent of the Group total. The largest country is Hong Kong with a total revenue from external customers of £2,554 million (2013: Hong Kong £2,243 million).
Revenue (excluding NPH broker-dealer fees) 1,395 303 310 2,008 1,914 NPH broker-dealer feesnote (i) – 503 – 503 504
Charges (excluding NPH broker-dealer fees) (937) (291) (249) (1,477) (1,353) NPH broker-dealer feesnote (i) – (503) – (503) (504)
Notes (i) NPH broker-dealer fees represent commissions received that are then paid on to the writing brokers on sales of investment products. To reflect their commercial nature the amounts are also wholly reflected as charges within the income statement. After allowing for these charges, there is no effect on profit from this item. The presentation in the table above shows separately the amounts attributable to this item so that the underlying revenue and charges can be seen.
The revenue shown above for M&G of £987 million (2013: £888 million), comprising asset management fee income, other income and performance-related fees, is different to the amount of £1,395 million shown in the main table of this note primarily due to the inclusion of the revenue of Prudential Capital of £104 million (2013: £144 million) in the latter. In addition, the £987 million (2013: £888 million) is after deducting commissions which would have been included as charges in the main table. The difference in the presentation of commission is aligned with how management reviews the business.
Total acquisition costs and other expenditure includes: (a) Total depreciation and amortisation expense of £(159) million (2013: £(510) million) relates primarily to amortisation of deferred acquisition costs of insurance contracts and asset management contracts. The segmental analysis of total depreciation and amortisation expense is analysed below; (b) The charge for non-deferred acquisition costs and the amortisation of those costs that are deferred, was £(1,752) million (2013: £(1,987) million). These amounts comprise £(1,714) million and £(38) million for insurance and investment contracts respectively (2013: £(1,953) million and £(34) million, respectively); (c) Interest expense, excluding interest on core structural borrowings of shareholder-financed operations, amounted to £(128) million (2013: £(120) million) and is included as part of investment management expenses. The segmental interest expense is analysed below; (d) Finance costs of £(341) million (2013: £(305)million) comprises £(312) million (2013: £(275) million) interest on core debt of the parent company, £(12) million (2013: £(13) million) of interest on US insurance operations’ surplus notes and £(17) million (2013: £(17) million) on PruCap’s bank loan; (e) Movements in amounts attributable to external unit holders are in respect of those OEICS and unit trusts which are required to be consolidated and comprises a charge of £(258) million (2013: £(583) million) for UK insurance operations and a charge of £(256) million (2013: a credit of £12 million) for Asia insurance operations; (f) Analysis of depreciation and amortisation expense, and interest expense: £m
B3.1 Staff and employment costs The average number of staff employed by the Group during the year was: Business operations: Asia operations 13,957 12,239 US operations 4,494 4,414 UK operations 5,464 5,533
Eligible Jackson employees were previously granted share awards under a long-term incentive plan which rewarded the achievement of shareholder value targets. These awards were in the form of a contingent right to receive shares or a conditional allocation of shares. These share awards have vesting periods of four years and are at nil cost to the employee. Award holders do not have any right to dividends or voting rights attaching to the shares. The shares are held in the employee share trust in the form of American Depository Receipts which are tradable on the New York Stock Exchange. The final awards under this arrangement were made in 2012.
Employees and eligible agents in a number of geographies are eligible for plans similar to the HMRC approved Save As You Earn (SAYE) share option scheme in the UK. Eligible employees participate in the International savings-related share option scheme, while eligible agents based in Hong Kong and Malaysia can participate in the non-employee savings-related share option scheme.
The weighted average share price of Prudential plc for the year ended 31 December 2014 was £13.75 compared to £11.14 for the year ended 31 December 2013.
Risk-free interest rates are taken from government bond spot rates with projections for two-year, three-year and five-year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over a period of 12 months up to and including the date of grant. For the Prudential LTIP (TSR), volatility and correlation between Prudential and a basket of 18 competitor companies is required. For grants in 2014, the average volatility for the basket of competitors was 23.4 per cent. Correlations for the basket are calculated for each pairing from the log of daily TSR returns between April 2011 and the valuation date. Market implied volatilities are used for both Prudential and the components of the index. Changes to the subjective input assumptions could materially affect the fair value estimate.
arn in gs p erfo rm an ce 157 Prudential plc Annual Report 2014 d Share-based payment expense charged to the income statement Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows: Share-based compensation expense 99 83 Amount accounted for as equity-settled 93 63 Carrying value at 31 December of liabilities arising from share-based payment transactions 16 23 Intrinsic value of above liabilities for which rights had vested at 31 December 9 17
Total key management remuneration includes total directors’ remuneration of £50.5 million (2013: £48.9 million) less LTIP releases of £28.4 million (2013: £26.4 million) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report. Further information on directors’ remuneration is given in the directors’ remuneration report.
The following features are of particular relevance to the determination of the 2014 results: a Asia insurance operations In 2014, the IFRS operating profit based on longer-term investment returns for Asia insurance operations included a profit of £49 million (2013: £44 million) representing a number of non-recurring items, none of which are individually significant.
The weighted components of the bond spread over swap rates for shareholder-backed fixed and linked annuity business for PRIL, based on the asset mix at these dates are shown below.
The reserves for credit risk allowance at 31 December 2014 for the UK shareholder annuity fund were as follows: Pillar 1 regulatory
Other assumption changes For the shareholder-backed business, the net effect of other assumption changes and modelling adjustments was a credit of £28 million (2013: a credit of £20 million).
B5: Tax charge a Total tax charge by nature of expense The total tax charge in the income statement is as follows: Tax charge Current
Deferred tax arising from: Origination and reversal of temporary differences 163 (392) Impact of changes in local statutory tax rates 1 55 Expense in respect of a previously unrecognised tax loss, tax credit or temporary difference from a prior period 6 –
The current tax charge of £1,108 million includes £37 million (2013: £18 million) in respect of the tax charge for the Hong Kong operation. The Hong Kong current tax charge is calculated as 16.5 per cent for all periods on either (i) 5 per cent of the net insurance premium or (ii) the estimated assessable profits, depending on the nature of the business written.
The total tax charge comprises tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders as shown below: Tax charge Current
b Reconciliation of effective tax rate For the purposes of explaining the relationship between tax expense and accounting profit, it is appropriate to consider the sources of profit and tax by reference to those that are attributable to shareholders and policyholders. A reconciliation of tax charge on profit attributable to shareholders is provided below.
Taxation charge: Variance from expected tax charge 196 – 196 140 – 140 * For the column entitled ‘Attributable to policyholders’, the profit before tax represents income before tax attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. This income has been determined after deduction of charges for policyholder benefits and movements on unallocated surplus which are determined net of tax. Hence, the pre-tax results attributable to policyholders is the inverse of the tax charge attributable to policyholders.
arn in gs p erfo rm an ce 161 Prudential plc Annual Report 2014
Reconciliation of tax charge on profit attributable to shareholders 2014 £m (except for tax rates)
Profit (loss) before tax attributable to shareholders 1,220 257 1,321 (184) 2,614
Tax charge (credit) at the expected tax rate 268 90 277 (41) 594 Effects of: Adjustment to tax charge in relation to prior years (2) (1) 3 (7) (7) Movements in provisions for open tax matters 7 – – (26) (19) Income not taxable or taxable at concessionary rates (17) (82) – (2) (101) Deductions not allowable for tax purposes 13 – 7 9 29 Effect of different basis of tax in local jurisdiction (44) – – – (44) Impact of changes in local statutory tax rates (1) – 2 – 1
Analysed into: Tax charge (credit) on operating profit (loss) based on longer-term investment returns 171 419 168 (34) 724 Tax charge (credit) on non-operating profit (loss) 1 (411) 103 (19) (326)
Actual tax rate: Operating profit based on longer-term investment returns 16% 29% 22% 48% 23%
* The expected tax rates shown in the table above (rounded to the nearest whole percentage) reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations, the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
Tax charge (credit) at the expected tax rate 144 194 103 (12) 429 Effects of: Adjustment to tax charge in relation to prior years (3) – 4 (7) (6) Movements in provisions for open tax matters 5 – – (12) (7) Income not taxable or taxable at concessionary rates (45) (88) – (10) (143) Deductions not allowable for tax purposes 61 – – 5 66 Impact of changes in local statutory tax rates (9) – (51) 5 (55) Deferred tax adjustments (4) – – (8) (12) Effect of results of joint ventures and associates (10) – – (8) (18) Irrecoverable withholding taxes – – – 20 20
Actual tax rate: Operating profit based on longer-term investment returns 17% 28% 18% 40% 22%
* The expected tax rates shown in the table above reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations, the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for Other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
Costs of domestication of Hong Kong branch D2 (5) 1 (4) (0.2)p (0.2)p
Based on profit for the year 2,614 (398) 2,216 86.9p 86.8p
Loss attaching to held for sale Japan life business (102) – (102) (4.0)p (4.0)p Costs of domestication of Hong Kong branch D2 (35) 7 (28) (1.1)p (1.1)p
In order to facilitate comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the results attributable to the held for sale Japan life business are included separately within the supplementary analysis of profit as shown above.
Weighted average number of shares for calculation of: Basic earnings per share 2,549 2,548 Shares under option at end of year 9 10 Number of shares that would have been issued at fair value on assumed option price (6) (6)
Dividends relating to reporting year: Dividends declared and paid in reporting year: Current year interim dividend 11.19p 285 9.73p 249
Shareholders on the principal register and Irish branch register will be able to participate in a Dividend Reinvestment Plan.
alan ce sh eet n o tes 165 Prudential plc Annual Report 2014
To explain the assets, liabilities and capital of the Group’s businesses more comprehensively, it is appropriate to provide analyses of the Group’s statement of financial position by operating segment and type of business.
C1.1 Group statement of financial position – analysis by segment a Position as at 31 December 2014
Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method D6 374 – 536 910 107 – – 1,017
Assets held for sale D1(b) 819 – 5 824 – – – 824 Cash and cash equivalents note (iii) 1,684 904 2,457 5,045 1,044 320 – 6,409
Borrowings attributable to with-profits operations C6.2 – – 1,093 1,093 – – – 1,093
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – 1,156 1,191 2,347 – – – 2,347
alan ce sh eet n o tes 167 Prudential plc Annual Report 2014 b Position as at 31 December 2013
Intangible assets attributable to with-profits funds: Goodwill in respect of acquired subsidiaries for venture fund and other investment purposes C5.2(a) – – 177 177 – – – 177
Deferred acquisition costs and other intangible assets C5.2(b) 66 – 6 72 – – – 72
Operational borrowings attributable to shareholder-financed operations C6.2 – 142 74 216 3 1,933 – 2,152
Borrowings attributable to with-profits operations C6.2 – – 895 895 – – – 895
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – 794 1,280 2,074 – – – 2,074
alan ce sh eet n o tes 169 Prudential plc Annual Report 2014
Of the other £4,519 million (2013: £4,355 million) of accrued investment income and other debtors, £381 million (2013: £350 million) is expected to be settled after one year or more.
(iv) Other liabilities comprise: Creditors arising from direct insurance and reinsurance operations 1,431 1,159 Interest payable 59 56 Other items* 2,615 2,521 * Of the £2,615 million (2013: £2,521 million) other items as at 31 December 2014, £2,201 million (2013: £2,051 million) related to liabilities for funds withheld under reinsurance arrangement of the REALIC business.
Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method 536 – 374 107 – – 1,017 809
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) 105,589 118,915 85,035 – – – 309,539 273,953
Operational borrowings attributable to shareholder-financed operations C6.2 – 4 249 6 2,004 – 2,263 2,152
Liabilities held for sale D1(b) – 281 489 – – – 770 868
Deferred tax assets – – 84 84 55 Other non-investment and non-cash assets 1,943 168 1,000 3,111 1,073 Investments of long-term business and other operations: Investment properties – – – – 1 Investments in joint ventures and associates accounted for using the equity method – – 374 374 268 Financial investments: Equity securities and portfolio holdings in unit trusts 6,974 11,294 932 19,200 14,383
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) 17,873 13,874 8,321 40,068 31,910
(ii) On 1 January 2014, the Hong Kong branch of PAC was transferred to separate subsidiaries established in Hong Kong. From this date, the unallocated surplus of the Hong Kong with-profits business is reported within the Asia insurance segment. Up until 31 December 2013, for the purpose of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance was reported within the unallocated surplus of the PAC with-profits sub-fund of the UK insurance operations.
alan ce sh eet n o tes 173 Prudential plc Annual Report 2014
Financial investments: Equity securities and portfolio holdings in unit trusts note (iii) 81,741 340 82,081 66,008
Equity and liabilities Equity Shareholders’ equity note (vi) – 4,067 4,067 3,446
† Partnerships in investment pools and other comprise primarily investments in limited partnerships. These include interests in the PPM America Private Equity Fund and diversified investments in 164 (2013: 166) other partnerships by independent money managers that generally invest in various equities and fixed-income loans and securities.
Total unrealised valuation movements 956 (2,089) Related amortisation of deferred acquisition costs C5.1(b) (87) 498 Related tax (304) 557
Total comprehensive income (loss) for the year 1,049 (614) Dividends, interest payments to central companies and other movements (428) (283)
Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets – – – 86 86 86 90
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes – 186 – – – 186 177 Deferred acquisition costs – 7 – – – 7 6
Properties held for sale – – 5 – 5 5 – Cash and cash equivalents 84 1,336 534 503 1,037 2,457 2,586
Operational borrowings attributable to shareholder-financed operations – – 4 70 74 74 74
Borrowings attributable to with-profits funds 11 1,082 – – – 1,093 895
(ii) The fund is solely for the benefit of policyholders of SAIF. Shareholders have no interest in the profits of this fund although they are entitled to asset management fees on this business. SAIF is a separate sub-fund within the PAC long-term business fund.
(iii) Other investments comprise: Derivative assets* 2,344 1,472 Partnerships in investment pools and other† 3,438 3,131 * After including derivative liabilities of £1,381 million (2013: £804 million), which are also included in the statement of financial position, the overall derivative position was a net asset of £963 million (2013: £668 million).
Assets Intangible assets: Deferred acquisition costs and other intangible assets 18 2 1 21 20
C3.1 Group assets and liabilities – Classification The classification of the Group’s assets and liabilities, and its corresponding accounting carrying values reflect the requirements of IFRS. For financial investments the basis of valuation reflects the Group’s application of IAS 39 ‘Financial Instruments: Recognition and Measurement’ as described further below. Where assets and liabilities have been valued at fair value or measured on a different basis but fair value is disclosed, the Group has followed the principles under IFRS 13 ‘Fair Value Measurement’. The basis applied is summarised below: 2014 £m
Other non-investment and non-cash assets: Property, plant and equipment – – 978 978 Reinsurers’ share of insurance contract liabilities – – 7,167 7,167 Deferred tax assets – – 2,765 2,765 Current tax recoverable – – 117 117 Accrued investment income – – 2,667 2,667 2,667 Other debtors – – 1,852 1,852 1,852
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities – – 250,038 250,038 Investment contract liabilities with discretionary participation features note (iii) – – 39,277 39,277 Investment contract liabilities without discretionary participation features 17,554 – 2,670 20,224 20,211 Unallocated surplus of with-profits funds – – 12,450 12,450
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – – 2,347 2,347 2,361 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 7,357 – – 7,357 7,357 Deferred tax liabilities – – 4,291 4,291 Current tax liabilities – – 617 617 Accruals and deferred income – – 947 947 Other creditors 327 – 3,935 4,262 4,262 Provisions – – 724 724 Derivative liabilities 2,323 – – 2,323 2,323 Other liabilities note (vii) 2,201 – 1,904 4,105 4,105
Assets held for sale note (vii) 916 – – 916 916 Cash and cash equivalents – – 6,785 6,785 6,785
alan ce sh eet n o tes 181 Prudential plc Annual Report 2014 2013 £m
Core structural borrowings of shareholder-financed operations – – 4,636 4,636 5,066 Other borrowings: Operational borrowings attributable to shareholder-
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – – 2,074 2,074 2,085 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,278 – – 5,278 5,278 Deferred tax liabilities – – 3,778 3,778 Current tax liabilities – – 395 395 Accruals and deferred income – – 824 824 Other creditors 263 – 3,044 3,307 3,307 Provisions – – 635 635 Derivative liabilities 1,689 – – 1,689 1,689 Other liabilities note (vii) 2,051 – 1,685 3,736 3,736
C3.2 Group assets and liabilities – Measurement The section provides detail of the designation and valuation of the Group’s financial assets and liabilities shown under following categories: a Determination of fair value The fair values of the assets and liabilities of the Group as shown in this note have been determined on the following bases.
The fair value of investment properties is based on market values as assessed by professionally qualified external valuers or by the Group’s qualified surveyors.
The fair value of financial liabilities (other than derivative financial instruments) is determined using discounted cash flows of the amounts expected to be paid.
b Fair value measurement hierarchy of Group assets and liabilities Assets and liabilities carried at fair value on the statement of financial position The table below shows the assets and liabilities carried at fair value analysed by level of the IFRS 13 ‘Fair Value Measurement’ defined fair value hierarchy. This hierarchy is based on the inputs to the fair value measurement and reflects the lowest level input that is significant to that measurement.
Total financial investments, net of derivative liabilities 47,575 46,381 4,528 98,484
Total financial investments, net of derivative liabilities 17,109 59,764 2,692 79,565
Total financial investments, net of derivative liabilities 177,579 112,873 7,252 297,704 Investment contracts liabilities without discretionary participation features held at fair value – (17,554) – (17,554) Net asset value attributable to unit holders of consolidated unit trusts and
Other financial liabilities held at fair value – (327) (2,201) (2,528)
Total financial instruments at fair value 172,184 94,321 3,760 270,265 * Loans in the above table are those classified as fair value through profit and loss in note C3.1.
In addition to the financial instruments shown above, the assets and liabilities held for sale on the consolidated statement of financial position at 31 December 2014 in respect of Japan life business included a net financial instruments balance of £844 million, primarily for equity securities and debt securities. Of this amount, £814 million has been classified as level 1 and £30 million as level 2.
Total financial investments, net of derivative liabilities 39,771 46,142 4,003 89,916
Total financial investments, net of derivative liabilities 94,223 6,266 37 100,526
Total financial investments, net of derivative liabilities 14,269 52,406 2,723 69,398
Other financial liabilities held at fair value – (263) (2,051) (2,314)
alan ce sh eet n o tes 185 Prudential plc Annual Report 2014
Total financial instruments at fair value 3,385 565 20 428 (675) 227 (169) – 13 (34) 3,760
Total financial investments, net of derivative liabilities 6,279 534 (45) 122 (434) (67) 225 (28) 228 (51) 6,763
Total financial instruments at fair value 3,034 480 (5) 122 (432) 171 (134) (28) 228 (51) 3,385
Of the total net gains and losses in the income statement of £914 million (2013: £441 million), £851 million (2013: £410 million) relates to net unrealised gains of investment properties still held at the end of the year.
Valuation approach for level 3 fair valued assets and liabilities Financial instruments at fair value Investments valued using valuation techniques include financial investments which by their nature do not have an externally quoted price based on regular trades, and financial investments for which markets are no longer active as a result of market conditions eg market illiquidity. The valuation techniques used include comparison to recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation. These techniques may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments. When determining the inputs into the valuation techniques used priority is given to publicly available prices from independent sources when available, but overall the source of pricing is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date.
Excluding the loans and funds withheld liability under REALIC’s reinsurance arrangements as described above, which amounted to a net liability of £(176) million (2013: £(164) million), the level 3 fair valued financial assets net of financial liabilities were £3,936 million (2013: £3,549 million). Of this amount, a net asset of £11 million (2013: net liability of £(304) million) were internally valued, representing less than 0.1 per cent of the total fair valued financial assets net of financial liabilities (2013: 0.1 per cent). Internal valuations are inherently more subjective than external valuations. Included within these internally valued net asset/liability were: (a) Debt securities of £298 million (2013: £118 million), which were either valued on a discounted cash flow method with an internally developed discount rate or on external prices adjusted to reflect the specific known conditions relating to these securities (eg distressed securities or securities which were being restructured).
(b) Private equity and venture investments of £1,002 million (2013: £878 million) which were valued internally based on management information available for these investments. These investments were principally held by consolidated investment funds which are managed on behalf of third parties.
(e) Other sundry individual financial investments of £3 million (2013: £1 million).
Of the internally valued net asset referred to above of £11 million (2013: net liability of £(304) million): (a) A net liability of £(133) million (2013: net liability of £(380) million) was held by the Group’s participating funds and therefore shareholders’ profit and equity are not impacted by movements in the valuation of these financial instruments.
In addition to the debt securities shown above, the assets held for sale on the consolidated statement of financial position at 31 December 2014 in respect of Japan life business included a debt securities balance of £351 million (2013: £387 million). Of this amount, £321 million were rated as AA+ to AA- (2013: £356 million) and £30 million (2013: £29 million) were rated A+ to A-.
Fair value (as included in the footnote above in the overview table and the statement of financial position) 32,897 30,205 * Book value represents cost/amortised cost of the debt securities. † Translated at the average rate of US$1.6476: £1.00.
Below 80%: Residential mortgage-backed securities – sub-prime 4 (1) 4 (1) Commercial mortgage-backed securities 10 (3) 16 (6) Other asset-backed securities 9 (6) 9 (6) Government bonds – – 521 (188)
Further, the following table shows the age analysis as at 31 December 2014, of the securities whose fair values were below 80 per cent of the book value: Age analysis Fair value Unrealised loss Fair value Unrealised loss
M&G AAA to A- by S&P or equivalent ratings 2,056 1,690
Notes (i) Asia insurance operations The Asia insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations. Of the £228 million, 99 per cent
(iii) UK insurance operations The majority of holdings of the shareholder-backed business relates to the UK market and primarily relates to investments held by PRIL. Of the holdings of the with-profits operations, £1,333 million (2013: £1,490 million) relates to exposure to the US markets with the remaining exposure being primarily to the UK market. (iv) Other operations Asset management operations’ exposure to asset-backed securities is held by Prudential Capital with no sub-prime exposure. Of the £875 million, 89 per cent
C3: Assets and liabilities – Classification and Measurement continued f Group sovereign debt and bank debt exposure The Group exposures held by the shareholder-backed business and with-profits funds in sovereign debts and bank debt securities at 31 December 2014: Exposure to sovereign debts
The table above excludes assets held to cover linked liabilities and those of the consolidated unit trusts and similar funds. In addition, the table above excludes the proportionate share of sovereign debt holdings of the Group’s joint venture operations.
alan ce sh eet n o tes 197 Prudential plc Annual Report 2014 g Group oil and gas industries debt exposure The Group exposures held by the shareholder-backed business in debt securities issued by the oil and gas industries at 31 December 2014 are analysed as follows: 2014 £m
† The policy loans are fully secured by individual life insurance policies or annuity policies. Policy loans backing liabilities for funds withheld under reinsurance arrangements are accounted for at fair value through profit or loss. All other policy loans are accounted for at amortised cost, less any impair.
The US insurance operations’ commercial mortgage loan portfolio does not include any single-family residential mortgage loans and is therefore not exposed to the risk of defaults associated with residential sub-prime mortgage loans. The average loan size is £7.2 million (2013: £6.5 million). The portfolio has a current estimated average loan to value of 59 per cent (2013: 61 per cent).
Total UK insurance operations loans 4,254 4,173 * The mortgage loans are collateralised by properties. By carrying value, 74 per cent of the £1,585 million held for shareholder-backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 29 per cent.
Maturity analysis of investment contracts The table below shows the maturity profile for investment contracts on undiscounted cash flow projections of expected benefit payments as part of the determination of the value of in-force business when preparing EEV basis results.
Of the total loans and receivables held, £11 million (2013: £14 million) are past their due date but are not impaired. Of the total past due but not impaired, £5 million are less than one year past their due date (2013: £9 million). The Group expects full recovery of these loans and receivables.
No further analysis has been provided of the element of loans and receivables that was neither past due nor impaired for the total portfolio on the grounds of immateriality of the difference between the neither past due nor impaired elements and the total portfolio.
iii Foreign exchange risk As at 31 December 2014, the Group held 22 per cent (2013: 20 per cent) and 9 per cent (2013: 7 per cent) of its financial assets and financial liabilities respectively, in currencies, mainly US dollar and Euro, other than the functional currency of the relevant business unit.
Of these financial assets, 56 per cent (2013: 58 per cent) are held by the PAC with-profits fund, allowing the fund to obtain exposure to foreign equity markets.
The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note C3.5(b) below).
alan ce sh eet n o tes 201 Prudential plc Annual Report 2014 b Derivatives and hedging Derivatives The Group enters into a variety of exchange traded and over-the-counter derivative financial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.
Fair value hedges The Group had previously designated as a fair value hedge certain fixed to floating rate swaps which hedge the fair value exposure to interest rate movements of certain of the Group’s operational borrowings. All of these hedges were terminated by January 2013.
Movements in the fair value of the hedging instruments of a net gain of £0.3 million and the hedged items of a net loss of £0.3 million were recorded in the 2013 income statement in respect of these fair value hedges.
Net investment hedges At 31 December 2014, the Group has designated perpetual subordinated capital securities totalling US$2.8 billion (2013: US$3.55 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £1,789 million as at 31 December 2014 (2013: £2,133 million). The foreign exchange loss of £96 million (2013: gain of £46 million) on translation of the borrowings to pounds sterling at the statement of financial position date is recognised in the translation reserve in shareholders’ equity. This net investment hedge was 100 per cent effective.
At 31 December 2014, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities. The fair value of the collateral held in respect of these transactions was £12,857 million (2013: £9,931 million).
Collateral and pledges under derivative transactions At 31 December 2014, the Group had pledged £1,411 million (2013: £780 million) for liabilities and held collateral of £2,388 million (2013: £1,432 million) in respect of over-the-counter derivative transactions.
Financial assets: Derivative assets 2,136 (832) (555) (631) 118 Reverse repurchase agreements 9,931 – – (9,931) –
During the year ended 31 December 2014, net impairment reversals of £37 million (2013: £17 million) were recognised for available-for-sale securities and loans and receivables analysed as follows: Available-for-sale debt securities held by Jackson (7) (8) Loans and receivables* 44 25
Impairment recognised on available-for-sale securities amounted to £(7) million (2013: £(8) million) arising from: Residential mortgage-backed securities (2) (3)
The impairment recorded on the residential mortgage-backed securities was primarily due to reduced cash flow expectations on such securities that are collateralised by diversified pools of primarily below investment grade securities. Of the impaired losses of £7 million (2013: £8 million), the top five individual corporate issuers made up 76 per cent (2013: 57 per cent), reflecting a deteriorating business outlook of the companies concerned. The impairment losses have been recorded in ‘investment return’ in the income statement.
In 2014, the Group realised gross losses on sales of available-for-sale securities of £35 million (2013: £22 million) with 68 per cent (2013: 72 per cent) of these losses related to the disposal of fixed maturity securities of the top 10 individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £35 million (2013: £ 22 million), £5 million (2013: £5 million) relates to losses on sales of impaired and deteriorating securities.
The effect of those reasonably likely changes in the key assumptions that underpin the assessment of whether impairment has taken place depends on the factors described in note A3.1j(iii). A key indicator of whether such impairment may arise in future, and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available-for-sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned.
Comprising: Policyholder liabilities on the consolidated statement of financial position 31,501 92,261 133,912 257,674 Unallocated surplus of with-profits funds on the consolidated statement of financial position 63 – 10,526 10,589 Group's share of policyholder liabilities of joint ventures* 3,100 – – 3,100
Comprising: Policyholder liabilities on the consolidated statement of financial position 31,910 107,411 134,632 273,953 Unallocated surplus of with-profits funds on the consolidated statement of financial position 77 – 11,984 12,061 Group's share of policyholder liabilities of joint ventures* 3,159 – – 3,159
Reallocation of unallocated surplus for the domestication of the Hong Kong branch‡ 1,690 – (1,690) –
alan ce sh eet n o tes 205 Prudential plc Annual Report 2014 * The Group’s investment in joint ventures are accounted for on an equity method basis in the Group’s balance sheet. The Group’s share of the policyholder liabilities as shown above relate to the joint venture life businesses in China, India and of the Takaful business in Malaysia.
ii Analysis of movements in policyholder liabilities for shareholder-backed business 2013 £m
Reclassification of Japan life business as held for salenote (a) (1,026) – – (1,026) Net flows: Investment-related items and other movements 622 8,219 2,312 11,153 Acquisition of subsidiaries 487 – – 487 Foreign exchange translation differences (1,714) (2,704) – (4,418)
Comprising: Policyholder liabilities on the consolidated statement of financial position 18,772 107,411 50,779 176,962 Group's share of policyholder liabilities relating to joint ventures 3,159 – – 3,159 2014 £m
Comprising: Policyholder liabilities on the consolidated statement of financial position 22,195 126,746 55,009 203,950 Group's share of policyholder liabilities relating to joint ventures 4,215 – – 4,215
(b) Including net flows of the Group’s insurance joint ventures. (c) Policyholder liabilities relating to shareholder-backed business grew by £28.1 billion from £180.1 billion at 31 December 2013 to £208.2 billion at 31 December 2014 demonstrating the ongoing growth of our business. The increase reflects positive net flows (premiums net of upfront charges less surrenders, withdrawals, maturities and deaths) of £9.6 billion in 2014 (2013: £10.9 billion), driven by strong inflows of £8.3 billion in the US and £1.9 billion in Asia.
The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group from its liability to its policyholders, the Group participates in such agreements for the purpose of managing its loss exposure. The Group evaluates the financial condition of its reinsurers and monitors concentration of credit risk from similar geographic regions, activities or economic characteristics of the reinsurers to minimise its exposure from reinsurer insolvencies. Of the reinsurers’ share of insurance contract liabilities balance of £7,167 million at 31 December 2014 (2013: £6,838 million), 93 per cent (2013: 96 per cent) were ceded by the Group’s UK and US operations, of which 95 per cent (2013: 93 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above.
The reinsurance asset for Jackson as shown in the table above primarily relates to certain fully collateralised former REALIC business retained by Swiss Re through 100 per cent reinsurance agreements. Apart from the reinsurance of REALIC business, 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. Net commissions received on ceded business and claims incurred ceded to external reinsurers totalled £35 million and £265 million respectively during 2014 (2013: £37 million and £278 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2014 or 2013.
The Group’s Asia and UK businesses do not cede significant amounts of business outside the Group. In each of 2014 and 2013, the Group’s UK insurance business wrote a longevity swap on certain aspects of the UK’s annuity back-book liabilities. This resulted in a one-off benefit of £30 million (2013: £27 million) to IFRS profit before tax. The gains and losses recognised in profit and loss for the other reinsurance contracts written in the year were immaterial.
alan ce sh eet n o tes 207 Prudential plc Annual Report 2014
Comprising: Policyholder liabilities on the consolidated statement of financial position 13,388 11,969 6,144 31,501 Unallocated surplus of with-profits funds on the consolidated statement of financial position 63 – – 63 Group's share of policyholder liabilities of joint ventures* – 2,059 1,041 3,100
Reallocation of unallocated surplus for the domestication of the Hong Kong branchnote (b) 1,690 – – 1,690
Comprising: Policyholder liabilities on the consolidated statement of financial position‡ 16,510 13,874 8,321 38,705 Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,102 – – 2,102 Group's share of policyholder liabilities relating to joint ventures* – 2,335 1,880 4,215
† The £1,026 million liabilities of the Japan life operation at 1 January 2013 were removed from policyholder liabilities following its reclassification as held for sale at 31 December 2013. No further amounts are shown within the 2014 or 2013 analysis above in respect of Japan life business.
‡ The policyholder liabilities of the with-profits business of £16,510 million, shown in the table above, is after deducting the intra-group reinsurance liabilities ceded by the UK insurance operations of £1,363 million to the Hong Kong with-profits business. Including this amount the Asia with-profits policyholder liabilities are £17,873 million.
§ Averages have been based on opening and closing balances and adjusted for acquisitions and disposals in the year and exclude unallocated surplus of with-profits funds.
(d) Net flows have increased by £546 million to £3,374 million in 2014 compared with £2,828 million in 2013 reflecting increased flows from new business and growth in the in-force books.
(e) The rate of surrenders for shareholder-backed business (expressed as a percentage of opening liabilities) was 10 per cent in 2014, in line with the 10 per cent recorded in 2013 (based on opening liabilities after the removal of Japan life). Maturities/deaths have increased from £997 million in 2013 to £1,259 million in 2014, primarily as a result of an increased number of endowment products within Malaysia and Singapore reaching their maturity point.
Expected maturity: iii Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2014, the policyholder liabilities and unallocated surplus for Asia operations of £40.8 billion (2013: £32.0 billion), net of reinsurance of £488 million (2013: £251 million), excluding joint ventures, comprised the following: Hong Kong* 13,748 8,655
Notes (a) Movements in the year have been translated at an average rate of US$1.65/£1.00 (2013: US$1.56/£1.00). The closing balances have been translated at closing rate of US$1.56/£1.00 (2013: US$1.66/£1.00). Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows for the year were £8,263 million compared with £9,635 million in 2013 on an actual exchange rate basis and £9,149 million on a constant exchange rate basis, reflecting in part lower premiums into the fixed index annuity business following product changes implemented in late 2013 to ensure appropriate returns on shareholder capital.
C4.1(d) UK insurance operations i Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of UK insurance operations from the beginning of the year to the end of the year is as follows: Shareholder-backed funds and subsidiaries
Shareholders' transfers post tax (192) – – (192) Switches (195) 195 – – Investment-related items and other movements 5,695 2,017 100 7,812 Foreign exchange translation differences (117) – – (117)
Notes (a) Up until 31 December 2013, for the purposes of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance was reported within the unallocated surplus of the PAC WPSF of the UK insurance operations.
The tables above show the carrying value of the policyholder liabilities and the maturity profile of the cash flows for insurance contracts, as defined by IFRS: With-profits business Annuity business
Cash value and interest rate guarantees are of three types: Types Features
Maturity values Maturity values are guaranteed for non-participating products and on the guaranteed portion of participating products. Declared regular bonuses are also guaranteed once vested. Future bonus rates and cash dividends are not guaranteed on participating products.
Surrender values Surrender values are guaranteed for non-participating products and on the guaranteed portion of participating products. The surrender value of declared reversionary bonuses are also guaranteed once vested. Market value adjustments and surrender penalties are used for certain products and where the law permits such adjustments in cash values.
For India, Japan and Taiwan, US GAAP is applied for measuring insurance assets and liabilities. For these countries, the future policyholder benefit provisions for non-linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claims expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business.
b US Features of products and guarantees Jackson provides long-term savings and retirement products to retail and institutional customers throughout the US and offers the products discussed below: i Fixed annuities Fixed interest rate annuities At 31 December 2014, fixed interest rate annuities accounted for 9 per cent (2013: 10 per cent) of policy and contract liabilities of Jackson. Fixed interest rate annuities are primarily deferred annuity products that are used for asset accumulation in retirement planning and for providing income in retirement. They permit tax-deferred accumulation of funds and flexible payout options.
Approximately 57 per cent (2013: 50 per cent) of the fixed interest rate annuities Jackson wrote in 2014 provide for a market value adjustment (‘MVA’), that could be positive or negative, on surrenders in the surrender period of the policy. This formula-based adjustment approximates the change in value that assets supporting the product would realise as interest rates move up or down. The minimum guaranteed rate is not affected by this adjustment. While the MVA feature minimises the surrender risk associated with certain fixed annuities, Jackson still bears a portion of the surrender risk on policies without this feature, and the investment risk on all fixed interest rate annuities.
Fixed index annuities Fixed index annuities accounted for 6 per cent (2013: 7 per cent) of Jackson’s policy and contract liabilities at 31 December 2014. Fixed index 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), and provide a guaranteed minimum return. These guaranteed minimum rates are generally set at 1.0 to 3.0 per cent. At 31 December 2014, Jackson had fixed index annuities allocated to indexed funds totalling £6.3 billion (2013: £6.1 billion) in account value with minimum guaranteed rates on index accounts ranging from 1.0 per cent to 3.0 per cent and a 1.83 per cent average guaranteed rate (2013: 1.0 per cent to 3.0 per cent and a 1.85 per cent average guarantee rate). At 31 December 2014, Jackson also offers fixed interest accounts on some fixed index annuity products. At 31 December 2014, fixed interest accounts of fixed index annuities totalled £1.8 billion (2013: £1.5 billion) in account value with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 2.53 per cent average guaranteed rate (2013: 1.0 per cent to 3.0 per cent and a 2.56 per cent average guaranteed rate).
Jackson hedges the equity return risk on fixed index products using futures and options linked to the relevant index as well as through offsetting equity exposure in the variable annuity product. The cost of these hedges is taken into account in setting the index participation rates or caps. Jackson bears the investment risk and a portion of the surrender risk on these products.
iii Life insurance Life insurance products accounted for 12 per cent (2013: 14 per cent) of Jackson’s policy and contract liabilities at 31 December 2014. Jackson discontinued new sales of life insurance products effective 1 August 2012. Life products include term life and interest-sensitive life (universal life and variable universal life). Term life provides protection for a defined period and a benefit that is payable to a designated beneficiary upon death of the insured. Universal life provides permanent individual life insurance for the life of the insured and includes a savings element. Variable universal life is a type of life insurance policy that combines death benefit protection with the ability for the policyholder account to be invested in separate account funds. For certain fixed universal life plans, additional provisions are held to reflect the existence of guarantees offered in the past that are no longer supported by earnings on the existing asset portfolio, or for situations where future mortality charges are not expected to be sufficient to provide for future mortality costs.
Excluding the business that is subject to the retrocession treaties at 31 December 2014, Jackson had interest sensitive life business in force with total account value of £5.9 billion (2013: £5.7 billion), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.65 per cent average guaranteed rate (2013: 2.5 per cent to 6.0 per cent with a 4.65 per cent average guaranteed rate).
alan ce sh eet n o tes 215 Prudential plc Annual Report 2014
In accordance with US GAAP, the Guaranteed Minimum Death Benefit and the ‘for life’ portion of Guaranteed Minimum Withdrawal Benefit liabilities are determined each period end by estimating the expected value of benefits in excess of the projected account balance and recognising the excess ratably over the life of the contract based on total expected assessments. At 31 December 2014, these liabilities were valued using a series of deterministic investment performance scenarios, a mean investment return of 7.4 per cent (2013: 7.4 per cent) net of external fund management fees, and assumptions for lapse, mortality and expense that are similar to those used in amortising the capitalised acquisition costs.
The direct Guaranteed Minimum Income Benefit liability is determined by estimating the expected value of the annuitisation benefits in excess of the projected account balance at the date of annuitisation and recognising the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating the direct Guaranteed Minimum Income Benefit liability at 31 December 2014 and 2013 are consistent with those used for calculating the Guaranteed Minimum Death Benefit and ‘for life’ Guaranteed Minimum Withdrawal Benefit liabilities.
For traditional life insurance contracts, provisions for future policy benefits are determined under US GAAP using the net level premium method and assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviation.
These products are written primarily in: — One of three separate sub-funds of the PAC long-term fund, namely the with-profits sub-fund (WPSF), Scottish Amicable Insurance Funds (SAIF), and the non-profit sub-fund; — Prudential Retirement Income Limited (PRIL), a shareholder-owned subsidiary; or — Other shareholder-backed subsidiaries writing mainly non-profit unit-linked business.
i With-profits products and PAC with-profits sub-fund The WPSF mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). The WPSF’s profits are apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution is determined via the annual actuarial valuation. In October 2014, the long-term business of Prudential Annuities Limited (PAL) was transferred into the WPSF following a Part VII transfer under the Financial Services and Markets Act 2000. PAL is owned by the WPSF.
The WPSF held a provision of £50 million at 31 December 2014 (2013: £36 million) to honour guarantees on a small amount of guaranteed annuity products. SAIF’s exposure to guaranteed annuities is described below.
With-profits products provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘regular’ and ‘final’. Regular bonuses are declared once a year, and once credited, are guaranteed in accordance with the terms of the particular product. Unlike regular bonuses, final bonuses are guaranteed only until the next bonus declaration.
In general, the same final bonus scale applies to maturity, death and surrender claims except that: — The total surrender value may be impacted by the application of a Market Value Reduction for accumulating with-profits policies and by the surrender bases for conventional with-profits business; and
Application of significant judgement The application of the above method for determining bonuses requires the PAC Board to apply significant judgement in many respects, including in particular the following: — Determining what constitutes fair treatment of customers: Prudential is required by UK law and regulation to consider the fair treatment of its customers in setting bonus levels. The concept of determining what constitutes fair treatment, while established by statute, is not defined; — Smoothing of investment returns: This is an important feature of with-profits products. Determining when particular circumstances, such as a significant rise or fall in market values, warrant variations in the standard bonus smoothing limits that apply in normal circumstances requires the PAC Board of directors to exercise significant judgement; and
alan ce sh eet n o tes 217 Prudential plc Annual Report 2014
Furthermore, in accordance with industry-wide regulatory requirements, the PAC Board has appointed: — An Actuarial Function Holder who provides the PAC Board with all actuarial advice; — A With-Profits Actuary whose specific duty is to advise the PAC Board on the reasonableness and proportionality of the manner in which its discretion has been exercised in applying the Principles and Practices of Financial Management and the manner in which any conflicting interests have been addressed; and
Net income of the fund: Investment return 8,958 5,757 Claims incurred (6,115) (6,681) Movement in policyholder liabilities (4,366) (197) Add back policyholder bonuses for the year (as shown below) 1,812 1,749 Claims incurred and movement in policyholder liabilities (including charge for provision for asset shares and excluding policyholder bonuses) (8,669) (5,129) Earned premiums, net of reinsurance 3,007 3,801 Other income 72 52 Acquisition costs and other expenditure (961) (1,025) Share of profits from investment joint ventures 129 88 Tax charge (440) (308)
Surplus for distribution allocated as follows: 90% policyholders’ bonus (as shown above) 1,812 1,749
C4: Policyholder liabilities and unallocated surplus of with-profits funds continued ii Annuity business Prudential’s conventional annuities include level, fixed-increase and inflation-linked annuities, the link being to the Retail Price Index (RPI) in the majority of cases.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £549 million was held in SAIF at 31 December 2014 (2013: £328 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefit of policyholders of SAIF, this provision has no impact on the financial position of the Group’s shareholders’ equity.
For annuities in payment, the tables and range of percentages used are set out below: CMI Model, with calibration to reflect future mortality improvements
Males Females Males Females 2014 CMI 2012 For males: with a long-term improvement rate of 2.25% pa
v Effect of changes in assumptions used to measure insurance assets and liabilities Credit risk There has been no change of approach in the setting of assumption levels of credit risk in 2014 and 2013. However, changes in the portfolio have given rise to altered levels of credit risk allowance as set out in note B4(c).
C5.1 Intangible assets attributable to shareholders a Goodwill attributable to shareholders
Cost At beginning of year 1,581 1,589 Exchange differences 2 (8)
The aggregate goodwill impairment of £120 million at 31 December 2014 and 2013 relates to the goodwill held in relation to the held for sale Japan life business (see note D1), which was impaired in 2005.
Assessment of whether goodwill may be impaired Goodwill is tested for impairment by comparing the cash-generating units’ carrying amount, including any goodwill, with its recoverable amount.
With the exception of M&G, the goodwill attributable to shareholders mainly relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the business as determined using the EEV methodology, as described in note 16. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report.
The value in use is particularly sensitive to a number of key assumptions as follows: i The set of economic, market and business assumptions used to derive the three-year plan. The direct and secondary effects of recent developments, eg changes in global equity markets, are considered by management in arriving at the expectations for the financial projections for the plan; ii The assumed growth rate on forecast cash flows beyond the terminal year of the plan. A growth rate of 2.5 per cent (2013: 2.5 per cent) has been used to extrapolate beyond the plan period representing management’s best estimate view of the long-term growth rate of the business after considering the future and past growth rates and external sources of data; iii The risk discount rate. Differing discount rates have been applied in accordance with the nature of the individual component businesses. For retail and institutional business, a risk discount rate of 12 per cent (2013: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 16 per cent (2013: 18 per cent). Management have determined the risk discount rate by reference to an average implied discount rate for comparable UK listed asset managers calculated by reference to risk-free rates, equity risk premiums of 5 per cent and an average ‘beta’ factor for relative market risk of comparable UK listed asset managers. A similar approach has been applied for the other component businesses of M&G; and iv That asset management contracts continue on similar terms. Management believes that any reasonable change in the key assumptions would not cause the recoverable amount of M&G to fall below its carrying amount.
alan ce sh eet n o tes 221 Prudential plc Annual Report 2014 b Deferred acquisition costs and other intangible assets attributable to shareholders The deferred acquisition costs and other intangible assets attributable to shareholders comprise: Deferred acquisition costs related to insurance contracts as classified under IFRS 4 5,840 4,684 Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 87 96
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 (PVIF) 59 67 Distribution rights and other intangibles 1,275 448
Reclassification of Japan Life as held for sale note D1 – – – – – – (28) Additions and acquisitions of subsidiaries 209 678 8 8 865 1,768 1,251 Amortisation to the income statement: Non-operating profit – 653 – – – 653 228
Disposals and transfers – – – – (6) (6) (1) Exchange differences and other movements 16 299 – – 19 334 (187) Amortisation of DAC related to net unrealised valuation movements on Jackson's available-for-sale securities recognised within other comprehensive income – (87) – – – (87) 498 * PVIF and other intangibles includes software rights of £66 million (2013: £56 million) with additions of £34 million, amortisation of £25 million and exchange gain of £1 million.
It also includes £18 million for PVIF and other intangibles in 2014 for the acquisition of Express Life of Ghana and Shield Assurance Company Limited in Kenya.
Total DAC for US operations 5,177 4,121 * Consequent upon the positive unrealised valuation movement in 2014 of £956 million (2013: negative unrealised valuation movement of £2,089 million), there is a charge of £87 million (2013: a credit of £498 million) for altered ‘shadow’ DAC amortisation booked within other comprehensive income. These adjustments reflect movement from period to period, in the changes to the pattern of reported gross profits that would have happened if the assets reflected in the statement of financial position had been sold, crystallising the unrealised gains and losses, and the proceeds reinvested at the yields currently available in the market. At 31 December 2014, the cumulative shadow DAC balance as shown in the table above was negative £584 million (2013: negative £463 million).
Acquisition costs for Jackson’s variable annuity products are also amortised in line with the emergence of profits. The measurement of the amortisation in part reflects current period fees (including those for guaranteed minimum death, income, or withdrawal benefits) earned on assets covering liabilities to policyholders, and the historical and expected level of future gross profits which depends on the assumed level of future fees, as well as components related to mortality, lapse, expense and the long-term cost of hedging.
Mean reversion technique For variable annuity products, under US GAAP (as ‘grandfathered’ under IFRS 4) the projected gross profits, against which acquisition costs are amortised, reflect an assumed long-term level of returns on separate account investments which, as referenced in note A3, for Jackson, is 7.4 per cent (2013: 7.4 per cent) after deduction of net external fund management fees. This is applied to the period end level of separate account assets after application of a mean reversion technique that removes a portion of the effect of levels of short-term variability in current market returns.
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Deferred acquisition costs related to insurance and investment contracts attributable to shareholders Additional movement analysis of deferred acquisition costs and other intangibles attributable to shareholders The movements in deferred acquisition costs relating to insurance and investment contracts attributable to shareholders are as follows: Insurance contracts
Jackson’s securities classified as available-for-sale note (i) (87) – 498 –
Additions (including amounts arising on acquisition of subsidiaries) – 808 57 865 21 271 26 318
Comprising: Notes (i) All of the PVIF balances relate to insurance contracts. The PVIF attaching to investment contracts have been fully amortised. Amortisation is charged over the period of provision of asset management services as those profits emerge. (ii) Software is amortised over its useful economic life, which generally represents the licence period of the software acquired.
All the goodwill relates to the UK insurance operations segment. The venture fund investments consolidated by the Group relates to investments of the PAC with-profits fund which are managed by
b Deferred acquisition costs and other intangible assets Other intangible assets in the Group consolidated statement of financial position attributable to with-profits funds consist of: Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund note (i) 3 6 Distribution rights attributable to with-profits funds of the Asia insurance operations 47 60 Computer software attributable to with-profits funds 11 6
At 1 January Gross amount 91 92 Accumulated amortisation (31) (22)
alan ce sh eet n o tes 225 Prudential plc Annual Report 2014
Holding company operations: US$1,000m 6.5% Perpetual Subordinated Capital Securities 641 604 US$250m 6.75% Perpetual Subordinated Capital Securities note (vii) 160 151 US$300m 6.5% Perpetual Subordinated Capital Securities note (vii) 193 181 US$750m 11.75% Perpetual Subordinated Capital Securities note (vi) – 451 US$700m 5.25% Perpetual Subordinated Capital Securities notes (iv), (vii) 444 417 US$550m 7.75% Perpetual Subordinated Capital Securities note (vii) 351 329
Holding company total 3,869 4,211 Prudential Capital bank loan note (iii) 275 275 Jackson US$250m 8.15% Surplus Notes 2027 (Lower Tier 2) notes (i), (ix) 160 150
(viii) The €20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These have been swapped into borrowings of £14 million with interest payable at three month £LIBOR plus 1.2 per cent.
(ix) Jackson’s borrowings are unsecured and subordinated to all present and future indebtedness, policy claims and other creditor claims of Jackson.
Notes (i) In addition to the debt listed above, £200 million Floating Rate Notes were issued by Prudential plc in October 2014 which will mature in October 2015.
(ii) Other borrowings mainly include amounts whose repayment to the lender is contingent upon future surplus emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall. In addition, other borrowings include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson.
Non-recourse borrowings of consolidated investment funds 924 691 £100m 8.5% undated subordinated guaranteed bonds of Scottish Amicable Finance plc* 100 100 Other borrowings (predominantly obligations under finance leases) 69 104 * The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinated to the entitlements of the policyholders of that fund.
C6.3 Maturity analysis The following table sets out the remaining contractual maturity analysis of the Group’s borrowings on the statement of financial position: Shareholder-financed operations With-profits operations
The financial and insurance assets and liabilities on the Group’s balance sheet are, to varying degrees, subject to market and insurance risk and other changes of experience assumptions that may have a material effect on IFRS basis profit or loss and shareholders’ equity. The market and insurance risks, including how they affect Group’s operations and how they are managed are discussed in the ‘Group Chief Risk Officer’s report on the risks facing our business and our capital strength’.
Credit risk Interest rates for those operations where the basis of insurance liabilities is sensitive to current market movements
i Sensitivity to risks other than foreign exchange risk With-profits business Similar principles to those explained for UK with-profits business in C7.4 apply to profit emergence for the Asia with-profits business. Correspondingly, the profit emergence reflects bonus declaration and is relatively insensitive to period by period fluctuations in insurance risk or interest rate movements.
For the sensitivity analysis as shown in the table below, the reasonably possible interest rate movement used is one per cent for all territories but subject to a floor of zero where the bond rates are currently below 1 per cent.
In addition, the degree of sensitivity of the results shown in the table above is dependent on the interest rate level at that point of time. In 2014, the lower interest rates in certain countries have had an adverse impact on the degree of sensitivity to a decrease in interest rates.
The estimated sensitivity to a 10 per cent and 20 per cent change in equity and property prices for shareholder-backed Asia other business, which would be reflected in the short-term fluctuation component of the Group’s segmental analysis of profit before tax, at 31 December 2014 and 2013 would be as follows: Decrease
Net effect on profit and shareholders’ equity (164) (82) (90) (45)
Insurance risk Many of the territories in Asia are exposed to mortality/morbidity risk and provision is made within policyholder liabilities on a prudent regulatory basis to cover the potential exposure. If these prudent assumptions were strengthened by 5 per cent then it is estimated that post-tax profit and shareholders’ equity would be decreased by approximately £47 million (2013: £38 million). Mortality and morbidity has a symmetrical effect on the portfolio and any weakening of these assumptions would have a similar equal and opposite impact.
C7: Risk and sensitivity analysis continued ii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Asia insurance operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2014, the rates for the most significant operations are given in note A1.
A 10 per cent increase (strengthening of the pound sterling) or decrease (weakening of the pound sterling) in these rates would have reduced or increased profit before tax attributable to shareholders, profit for the year and shareholders’ equity, excluding goodwill, attributable to Asia operations respectively as follows: A 10% increase in local currency to £ exchange rates
Profit before tax attributable to shareholders (111) (63) 135 77 Profit for the year (95) (49) 117 60 Shareholders’ equity, excluding goodwill, attributable to Asia operations (315) (246) 384 300
Jackson’s main exposures are to market risk through its exposure to interest rate risk and equity risk. Approximately 94 per cent (2013: 94 per cent) of its general account investments support fixed interest rate and fixed index annuities, life business and surplus and 6 per cent (2013: 6 per cent) support institutional businesses. All of these types of business contain considerable interest rate guarantee features and, consequently, require that the assets that support them are primarily fixed income or fixed maturity.
Jackson uses free-standing derivative instruments for hedging purposes. Additionally, certain liabilities, primarily trust instruments supported by funding agreements, fixed index annuities, certain Guaranteed Minimum Withdrawal Benefit variable annuity features and reinsured Guaranteed Minimum Income Benefit variable annuity features contain embedded derivatives as defined by IAS 39, ‘Financial Instruments: Recognition and Measurement’. Jackson does not account for such derivatives as either fair value or cash flow hedges as might be permitted if the specific hedge documentation requirements of IAS 39 were followed. Financial derivatives, including derivatives embedded in certain host liabilities that have been separated for accounting and financial reporting purposes are carried at fair value.
Put-swaption contracts These contracts provide the purchaser with the right, but not the obligation, to require the writer to pay the present value of a long-duration interest rate swap at future exercise dates. Jackson purchases and writes put-swaptions with maturities up to 5 years. Put-swaptions hedge against significant movements in interest rates.
GMAB – Premium only 0% 57 – Highest specified anniversary account value minus withdrawals post-anniversary
† Ranges shown based on simple interest. The upper limits of 5 per cent, or 8 per cent simple interest are approximately equal to 4.1 per cent and 6 per cent respectively, on a compound interest basis over a typical ten year bonus period. For example 1 + 10 x 0.05 is similar to 1.041 growing at a compound rate of 4.01 per cent for a further nine years.
As noted above, Jackson is exposed to equity risk through the options embedded in the fixed index annuity liabilities and Guaranteed Minimum Death Benefit and Guaranteed Minimum Withdrawal Benefit guarantees included in certain variable annuity benefits as illustrated above. This risk is managed using an equity hedging programme to minimise the risk of a significant 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.
At 31 December 2014, the estimated sensitivity of Jackson’s profit and shareholders’ equity to immediate increases and decreases in equity markets is shown below. The sensitivities are shown net of related changes in DAC amortisation.
Pre-tax profit, net of related changes in amortisation of DAC 360 130 8 (25) 485 165 213 77
Net sensitivity of profit after tax and shareholders’ equity 234 84 5 (16) 315 107 139 50
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within the income statement. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease (subject to a floor of zero) and increase in interest rates at 31 December 2014 and 2013 is as follows: Decrease
Other comprehensive income: Direct effect on carrying value of debt securities
Total net effect on shareholders’ equity 1,027 633 (760) (1,367) 1,623 917 (994) (1,811)
Profit before tax attributable to shareholdersnote (23) (50) 29 61 Profit for the year (23) (41) 28 50 Shareholders’ equity attributable to US insurance operations (370) (313) 452 383
A decrease in assumed mortality rates of 1 per cent would decrease pre-tax profits by approximately £94 million (2013: £71 million). A decrease in credit default assumptions of five basis points would increase pre-tax profits by £190 million (2013: £151 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase pre-tax profits by £30 million (2013: £27 million). The effect on profits would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above. The net effect on profit after tax and shareholders’ equity from all the changes in assumptions as described above would be an increase of approximately £101 million (2013: £86 million).
Due to the matching of policyholder liabilities to attaching asset value movements, the UK unit-linked business is not directly affected by market or credit risk. The liabilities of the other business are also broadly insensitive to market risk. Profits from unit-linked and similar contracts primarily arise from the excess of charges to policyholders for management of assets, over expenses incurred. The former is most sensitive to the net accretion of funds under management as a function of new business and lapse and timing of death. The accounting impact of the latter is dependent upon the amortisation of acquisition costs in line with the emergence of margins (for insurance contracts) and amortisation in line with service provision (for the investment management component of investment contracts). By virtue of the design features of most of the contracts which provide low levels of mortality cover, the profits are relatively insensitive to changes in mortality experience.
The estimated sensitivity of the UK non-linked shareholder-backed business (principally annuities business) to a movement in interest rates is as follows: A decrease
Net sensitivity of profit after tax and shareholders’ equity 1,607 650 (505) (928) 862 382 (326) (618)
The deferred tax asset at 31 December 2014 and 2013 arises in the following parts of the Group: Asia insurance operations 84 55 US insurance operations 2,343 2,042 UK insurance operations
SAIF – 1 PAC with-profits fund (including non-profit annuity business) 71 82
Asia insurance operations 30 1 to 3 years 47 3 to 5 years US insurance operations 2,268 With run-off of in-force book
UK insurance operations 129 1 to 10 years – 1 to 3 years Other operations 180 1 to 10 years 15 1 to 3 years
C8.2 Current tax Of the £117 million (2013: £244 million) current tax recoverable, the majority is expected to be recovered in one year or less.
C9: Defined benefit pension schemes a Background and summary economic and IAS 19 financial positions The Group’s businesses operate a number of pension schemes. The specific features of these plans vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS). PSPS accounts for 84 per cent (2013: 84 per cent) of the underlying scheme liabilities of the Group’s defined benefit schemes.
Less: unrecognised surplus note (i) (710) – – – (710) (602) – – – (602)
Notes (i) For PSPS, the Group does not have an unconditional right of refund to any surplus of the scheme. The PSPS pension asset represents the present value of the economic benefit (impact) of the Company from the difference between future ongoing contributions to the scheme and estimated accrued cost of service. No deficit or other funding is required for PSPS. Deficit funding, where applicable, is apportioned in the ratio of 70/30 between the PAC with-profits fund and shareholder-backed operations following detailed considerations in 2005 of the sourcing of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant to current activity.
Funding level at the last valuation 111 per cent* 85 per cent 83 per cent
£13.1 million per annum until 31 December 2018. The deficit will be reviewed every three years at subsequent valuations £18.6 million per annum for two years beginning 1 January 2013; and £9.3 million for the year beginning 1 January 2015 * Funding level by reference to the Scheme Solvency Target that forms the basis of the scheme’s funding objective.
The market value of PSPS scheme assets as at the 5 April 2011 valuation was £5,255 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the 2011 valuation were as follows: %
Mortality assumptions: The tables used for PSPS pensions in payment at 5 April 2011 were: Base post-retirement mortality For current male (female) pensioners 113% (108%) of the mortality rates of the 2000 series mortality tables (PNMA00/PNFA00), published by the Continuous Mortality Investigation Bureau (CMI).
Corporate governance The Group’s UK pension schemes are regulated by ‘The Pension Regulator’ in accordance with the Pension Act 1995. Trustees have been appointed for each pension scheme and they have the ultimate responsibility to ensure that the scheme is managed in accordance with the Trust Deed & Rules. The Trustees are required by the Pension Regulator to be well conversant with the Trust Deed & Rules and to act in accordance with these Rules.
The Trustee consults the Principal Employer, the Prudential Assurance Company, on the investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustee.
The investment policies and strategies for the other two UK defined benefit schemes, (the SASPS and M&GGPS, which are both final salary schemes), follow similar principles, but have different target allocations reflecting the particular requirements of the schemes. All of the three UK schemes are closed to new entrants.
The Trustee of each of the schemes manages the investment strategy of the scheme to achieve an acceptable balance between investing in the assets that most closely match the expected benefit payments and assets that are expected to achieve a greater return in the hope of reducing the contributions required or providing additional benefits to members. When determining the investment strategy, the Trustee considers the risk that falls in asset values may not be matched by similar falls in the value of the schemes’ liabilities. It also consults the Principal Employer, in order to understand the Principal Employer’s appetite for bearing this risk and considers the Employer’s ability to make good any shortfall that may arise.
The PSPS scheme has entered into a derivatives based strategy to match the duration and inflation profile of its liabilities. This involved a reallocation from other investments to other assets with an interest and inflation swap overlay. In broad terms, the scheme is committed to making a series of payments related to LIBOR on a nominal amount and in return the scheme receives a series of fixed and inflation-linked payments which match a proportion of its liabilities. As at 31 December 2014, the nominal value of the interest and inflation-linked swaps amounted to £0.8 billion (2013: £0.8 billion) and negative £3.0 billion (2013: £2.7 billion) respectively.
Rate of increase of pensions in payment for inflation: PSPS: Other schemes 3.0 3.3 * The discount rate has been determined by reference to an ‘AA’ corporate bond index, adjusted where applicable, to allow for the difference in duration between the index and the pension liabilities.
The tables used for PSPS immediate annuities in payment at 31 December 2013 were: Male: 112.0 per cent PNMA00 with improvements in line with a custom calibration of the CMI’s 2011 mortality model, with a long-term mortality improvement rate of 1.75 per cent per annum; and
Female: 108.5 per cent PNFA00 with improvements in line with a custom calibration of the CMI’s 2011 mortality model, with a long-term mortality improvement rate of 1.25 per cent per annum.
The assumed life expectancies on retirement at age 60, based on the mortality table used was: Male Female Male Female
The mean term of the current PSPS liabilities is around 17 years. Using external actuarial advice provided by the scheme actuaries being Towers Watson for the valuation of PSPS, Xafinity Consulting for SASPS and Aon Hewitt Limited for the M&GGPS, the most recent full valuations have been updated to 31 December 2014, applying the principles prescribed by IAS 19.
alan ce sh eet n o tes 243 Prudential plc Annual Report 2014
Less: amount attributable to PAC with-profits fund (457) (4) (49) (15) (525)
Shareholders' share: Gross of tax surplus (deficit) 189 (12) 13 40 230
Less: amount attributable to PAC with-profits fund 428 18 60 – 506
Shareholders' share: Gross of tax surplus (deficit) 15 (20) (9) 40 26
Benefit payments (266) 266 – – – Employers' contributions note (iv) 55 55 55 55 Employees' contributions 2 (2) – – – Actuarial and other gains and
Benefit payments (254) 254 – – – Employers' contributions note (iv) 56 56 56 56 Employees' contributions 2 (2) – – – Actuarial and other gains and
Effect of the application of IFRIC 14 for pension schemes: Derecognition of PSPS’ surplus (710) (602) Consolidation adjustment in respect of investment of PSPS in Prudential policies 131 143
* The IAS 19 basis plan assets at 31 December 2014 of £7,804 million (2013: £6,687 million) is different from the economic basis plan assets of £8,067 million (2013: £6,944 million) as shown above due to the exclusion of investment in Prudential insurance policies, which are eliminated on consolidation of £263 million (2013: £257 million) comprising £131 million for PSPS (2013: £143 million) and £132 million for the M&G scheme (2013: £114 million).
(iv) Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2015 amounts to £45 million (2014: £56 million). These amounts are subject to reassessment when the 2014 triennial valuations are finalised.
(v) The actuarial and other gains and losses attributable to policyholders and shareholders as shown in the table above are analysed as follows: Actuarial and other gains and losses Return on the scheme assets less amount included in interest income 1,037 (366) Losses on changes in demographic assumptions (9) (22) Losses on changes in financial assumptions (939) (174) Experience losses on scheme liabilities (27) (1)
Effect of derecognition of PSPS (deficit) surplus (82) 447 Consolidation adjustment for investments in Prudential insurance policies and other adjustments (4) 1
The sensitivity of the underlying pension scheme liabilities as shown above does not directly equate to the impact on the profit or loss attributable to shareholders or shareholders’ equity due to the effect of the application of IFRIC 14 on PSPS and the allocation of a share of the interest in financial position of the PSPS and Scottish Amicable schemes to the PAC with-profits fund as described above.
Discount rate 3.5% 4.4% Decrease by 0.2% Increase in scheme liabilities by: Other schemes 5.2% 5.1%
Discount rate 3.5% 4.4% Increase by 0.2% Decrease in scheme liabilities by: Other schemes 4.9% 4.7%
Mortality rate Increase life expectancy Increase in scheme liabilities by: by 1 year PSPS 3.3% 2.7%
Issued shares of 5p each fully paid: Shares issued under share-based schemes 7,398,214 – 13 3,139,384 – 6
The Company purchased the following number of shares in respect of employee incentive plans. The shares purchased each month are as follows: 2014 share price 2013 share price
Pension liability difference between IAS 19 and regulatory basis – (47) (47) – – – (47) (55)
Other liabilities: Insurance contracts: With-profits liabilities of non-UK regulated funds note (i) – – – – – 16,292 16,292 6,744 Unit-linked, including variable annuity – 2,218 2,218 6,004 81,741 13,696 103,659 83,758
Investment contracts with discretionary participation features note (i) – – – – – 180 180 –
Investment contracts without discretionary participation features note (vi) – 25 25 17,349 2,670 218 20,262 20,176
Total policyholder liabilities shown in the consolidated statement of financial position 6,690 82,389 89,079 55,009 126,746 38,705 309,539 273,953
(ii) Excluding PAC shareholders’ equity that is included in ‘parent company and shareholders’ equity of other subsidiaries and funds’. (See note (b) below). (iii) The term shareholders’ equity held in long-term funds refers to the excess of assets over liabilities attributable to shareholders of funds which are required by law to be maintained ring-fenced with segregated assets and liabilities.
b Reconciliation to the Group total shareholders’ equity The table below reconciles shareholders’ equity held in life assurance operations as shown in the table in note (a) to the Group total shareholders’ equity as at 31 December 2014: 2014 £m
Note (i) Including PAC shareholders’ equity. The £(1,235) million includes the core structural borrowings and the elimination of the investment in subsidiaries at the parent company.
(iv) Asia life assurance subsidiaries The increase of £3,021 million in 2014 reflects an underlying increase of £2,991 million (applying the relevant 2014 year end exchange rates) and £30 million of exchange translation gain. The underlying increase of £2,991 million reflects primarily the transfer of the available capital of the Hong Kong business from the UK operations on 1 January 2014 and its increase during the year.
C11: Capital position statement continued d Basis of preparation, capital requirements and management Each of the Group’s long-term business operations is capitalised to a sufficiently strong level for its individual circumstances. Details by the Group’s major operations are shown below.
i Asia insurance operations The available capital shown above of £4,823 million (2013: £1,802 million) represents the excess of local regulatory basis assets over liabilities before deduction of required capital of £1,514 million (2013: £699 million). The 2014 available capital and required capital for Asia insurance operations include the amounts for the Hong Kong with-profits and non-participating business following its domestication as described further below.
The businesses in Asia are subject to local capital requirements in the jurisdictions in which they operate. The Hong Kong business branch of PAC was transferred to separate subsidiaries established in Hong Kong following the completion of the process of the domestication of the Hong Kong business on 1 January 2014 (see note D2). Prior to 2014, the Hong Kong business branch of PAC and its capital requirements were subsumed within those of the PAC long-term fund. From 2014, the Hong Kong business is solely regulated by the relevant regulators in Hong Kong and its local available capital and capital requirements are shown within the Asia insurance operations in this note. For material Asian operations, the details of the basis of determining regulatory capital and regulatory capital requirements are as follows: Hong Kong As mentioned above, the Hong Kong business branch of PAC was domesticated on 1 January 2014 and the resulting companies Prudential Hong Kong Limited (PHKL), for long-term business, and Prudential General Insurance Hong Kong Limited (PGHK), for General Insurance business, were established.
For non-participating business, mathematical reserves are generally calculated using a modified net premium approach with no allowance for future discontinuance. The underlying assumptions are based on a best estimate basis with prudent margins for adverse deviations. Cash flows are discounted at a valuation interest rate based on a blend between the risk-adjusted portfolio yield and the reinvestment rate.
Policy reserves for traditional business are determined on a net premium reserve basis using standard mortality and prescribed standard interest rates. For linked business, the value of the units are held together with the non-unit reserves and calculated in accordance with the local regulator’s standard actuarial methodology.
In accordance with the local risk-based capital framework, insurers are expected to maintain a level of free surplus in excess of the capital requirements.
Participating fund surplus is not allowed to be used to support a deficit (if any) and the capital requirement of the non-participating business. The capital requirement is calculated based on a prescribed series of risk charges. The local regulator has set a Supervisory Target Capital Level of 130 per cent below which supervisory actions of increasing intensity will be taken. Each insurer is also required to set its own Individual Target Capital Level to reflect its own risk profile and this is expected to be higher than the Supervisory Target Capital Level.
The available capital of Jackson shown above of £3,141 million (2013: £2,903 million) reflects US regulatory basis available capital as adjusted to exclude asset valuation reserves. The asset valuation reserve, which is reflected as available capital, is designed to provide for future credit-related losses on debt securities and losses on equity investments. Available capital includes a reduction for the effect of the interest maintenance reserve, which is designed by state regulators to defer recognition of non-credit related realised capital gains and losses and to recognise them ratably in the future.
Jackson’s Risk-Based Capital ratio is significantly in excess of regulatory requirements. At 31 December 2014, Jackson had a permitted practice in effect as granted by the local regulator allowing Jackson to carry certain interest rate swaps at book value, as if statutory hedge accounting were in place, instead of at fair value as would have been otherwise required. Jackson is required to demonstrate the effectiveness of its interest rate swap programme pursuant to the Michigan Insurance Code. The total effect of this permitted practice, net of tax, was to decrease statutory surplus by £356 million at 31 December 2014.
Michigan insurance law specifically allows value of business acquired as an admitted asset as long as certain criteria are met. US NAIC standards limit the admitted amount of goodwill/value of business acquired generally to 10 per cent of capital and surplus. At 31 December 2014, Jackson reported £242 million of statutory basis value of business acquired as a result of the REALIC acquisition, which is fully admissible under Michigan insurance law.
iii UK insurance operations In the UK, the insurers, regulated by PRA, must hold capital resources equal at least to the Minimum Capital Requirement (MCR). In addition, the rules require insurers to perform Individual Capital Assessments. Under these rules insurers must assess for themselves the amount of capital needed to back their business. If the PRA views the results of this assessment as insufficient, it may draw up its own Individual Capital Guidance for a firm, which can be superimposed as a requirement.
Other UK life assurance subsidiaries and funds The available capital of £3,297 million (2013: £2,708 million) reflects the excess of regulatory basis assets over liabilities of the subsidiaries and funds, before deduction of the capital resources requirement of £1,552 million (2013: £1,364 million).
Accordingly, the excess of assets over liabilities of the PAC long-term fund is retained within that company. The retention of the capital enables it to support with-profits and other business of the fund by, for example, providing the benefits associated with smoothing and guarantees. It also provides investment flexibility for the fund’s assets by meeting the regulatory capital requirements that demonstrate solvency and by absorbing the costs of significant events or fundamental changes in its long-term business without affecting the bonus and investment policies.
alan ce sh eet n o tes 253 Prudential plc Annual Report 2014 f Sensitivity of liabilities and total capital to changed market conditions and capital management policies Prudential manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities Prudential has in each business. As a result of the diversity of products offered by Prudential and the different regulatory requirements in which it operates, Prudential employs differing methods of asset/liability and capital management, depending on the business concerned.
For businesses that are most sensitive to equity price changes, Prudential uses stochastic modelling and scenario testing to look at the future returns on its investments under different scenarios which best reflect the large diversity in returns that equities can produce. This allows Prudential to devise an investment and with-profits policyholder bonus strategy that, based on the model assumptions, allows it to optimise returns to its policyholders and shareholders over time while maintaining appropriate financial strength. Prudential uses this methodology extensively in connection with its UK with-profits business.
Provision in respect of defined benefit pension schemes:C9 217 194 Other provisions (see below) 507 441
Capital expenditure: property, plant and equipment by segment The capital expenditure of £141 million (2013: £125 million) arose as follows: £82 million in UK, £16 million in US and £20 million in Asia in insurance operations with the remaining balance of £23 million arising from asset management operations and unallocated corporate expenditure (2013: £68 million in UK, £16 million in US, £23 million in Asia and £18 million in other operations).
alan ce sh eet n o tes 255 Prudential plc Annual Report 2014
Investment properties principally relate to the PAC with-profits fund and are carried at fair value. A reconciliation of the carrying amount of investment properties at the beginning and end of the year is set out below: Additions: Resulting from acquisitions 669 1,050 Resulting from expenditure capitalised 59 42
Net gain from fair value adjustments 914 441 Net foreign exchange differences 20 (15) Transfers (to) from held for sale assets (5) 18
Investment properties of £5,263 million (2013: £4,426 million) are held under finance leases. A reconciliation between the total of future minimum lease payments at the statement of financial position date, and their present value is shown below: Future minimum payments
The sale was completed on 14 November 2014. This transaction gave rise to a gain on disposal of £86 million. This amount is shown separately in the Group’s supplementary analysis of profit excluded from the Group’s IFRS operating profit based on longer-term investment returns. The net cash inflow arising from this sale, as shown in the consolidated statement of cash flows, of £152 million, comprised the net cash proceeds received.
The Japan life business has been classified as held for sale in these consolidated financial statements in accordance with IFRS 5, ‘Non-current assets held for sale and discontinued operations’.
The remeasurement of the carrying value of the Japan life business on classification as held for sale resulted in a charge of £(13) million (2013: £(120) million) as shown in the income statement. These amounts, together with the results of the business including short-term value movements on investments are included within ‘Loss attaching to held for sale Japan life business’ in the supplementary analysis of profit of the Group as shown in note B1.1.
As part of this transaction Prudential agreed to pay Standard Chartered Bank an initial fee of US$1.25 billion for distribution rights which is not dependent on future sales volumes. Of this total, US$850 million was settled in the first half of 2014. The remainder will be paid in two equal instalments of US$200 million each in April 2015 and April 2016.
d Acquisition of Thanachart Life Assurance Company Limited and bancassurance partnership agreement with Thanachart Bank On 3 May 2013, the agreement Prudential plc, through its subsidiary Prudential Life Assurance (Thailand) Public Company Limited (Prudential Thailand), entered into in November 2012 to establish an exclusive 15-year partnership with Thanachart Bank Public Company Limited (Thanachart Bank) to develop jointly their bancassurance business in Thailand was launched. At the same time, Prudential Thailand completed the acquisition of 100 per cent of the voting interest in Thanachart Life Assurance Company Limited (Thanachart Life), a wholly-owned life insurance subsidiary of Thanachart Bank.
: O th er n o tes 257 Prudential plc Annual Report 2014
On 1 January 2014, following consultation with policyholders of PAC and regulators and court approval, the Hong Kong branch of PAC was transferred to separate subsidiaries established in Hong Kong. On an IFRS basis, approximately £12.6 billion of assets, £12.3 billion of liabilities (including policyholder liabilities of £10.2 billion and £1.7 billion of unallocated surplus) and £0.3 billion of shareholders’ funds (for the excess assets of the transferred non-participating business) were transferred.
The costs of enabling the domestication in 2014 were £5 million (2013: £35 million). Within the Group’s supplementary analysis of profit, these costs have been presented as a separate category of items excluded from operating profit based on longer-term investment returns as shown in note B1.1.
Pension mis-selling review The pensions review by the UK insurance regulator of past sales of personal pension policies required all UK life insurance companies to review their cases of potential mis-selling and record a provision for the estimated costs. The Group met the requirement of the UK insurance regulator to issue offers to all cases by 30 June 2002.
At 31 December 2014 the pension mis-selling provision was £328 million (2013: £286 million). The pension mis-selling provision is included within the liabilities in respect of investment contracts with discretionary participation features under IFRS 4 and is stochastically determined on a discounted basis. The average discount rate in the movement in the year is 2.0 per cent (2013: 3.4 per cent).
Guaranteed annuities PAC used to sell guaranteed annuity products in the UK and at 31 December 2014 held a provision of £50 million (2013: £36 million) within the main with-profits fund within policyholder liabilities to honour guarantees on these products. The Group’s main exposure to guaranteed annuities in the UK is through SAIF and at 31 December 2014 a provision of £549 million (2013: £328 million) was held in SAIF to honour the guarantees. As SAIF is a separate sub-fund of the PAC long-term business fund, attributable to the policyholders, the movement in this provision has no impact on shareholders.
In 1997, the business of Scottish Amicable Life Assurance Society, a mutual society, was transferred to PAC with the creation of a separate sub-fund, SAIF within PAC’s long-term business fund containing all the with-profits business and all other pension business that was transferred. No new business has been or will be written in the sub-fund and it is managed to ensure that all the invested assets are distributed to SAIF policyholders over the lifetime of SAIF policies. With the exception of certain amounts in respect of the unitised with-profits life business, all future earnings arising in SAIF are retained for SAIF policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is attributable to the policyholders of the fund. Shareholders have no interest in the profits of SAIF but are entitled to the asset management fees paid on this business.
Unclaimed Property Provision Jackson has received regulatory enquiries on an industry-wide matter regarding claims settlement practices and compliance with unclaimed property laws. Concurrently, some regulators and state legislatures have required life insurance companies to take additional steps to identify unreported deceased policy and contract holders. Additionally, numerous states are contracting with independent firms to perform specific unclaimed property audits or targeted market conduct examinations covering claims settlement practices and procedures for escheating unclaimed property. Any regulatory audits, related examination activity and internal reviews may result in additional payments to beneficiaries, escheatment of funds (ie reversion of funds to the state) deemed abandoned under state laws, administrative penalties and changes in Jackson’s procedures for the identification of unreported claims and handling of escheatable property.
Jackson continually reviews active and recently terminated policies compared to vendors’ databases of known deaths. At 31 December 2014, Jackson has accrued £13 million to cover any such liability.
Guarantees and commitments Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies and are financed by payments assessed on solvent insurance companies based on location, volume and types of business. The Group estimated its reserve for future guarantee fund assessments for Jackson, included within other liabilities to be £3 million at 31 December 2014 (2013: £13 million). Similar assessments for the UK businesses were not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies.
At 31 December 2014, Jackson has unfunded commitments of £332 million (2013: £298 million) related to its investments in limited partnerships and £73 million (2013: £132 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.
Intra-group capital support arrangements Prudential and PAC have put in place intra-group arrangements to formalise circumstances in which capital support would be made available by Prudential (including in the scenarios referred to in pension mis-selling review above). While Prudential considers it unlikely that such support will be required, the arrangements are intended to provide additional comfort to PAC and its policyholders.
In addition, Prudential has put in place intra-group arrangements to formalise undertakings by Prudential to the regulators of the Hong Kong subsidiaries, which from 1 January 2014, contain the domesticated branch business from PAC as noted in note D2 regarding their solvency levels. In addition, the scheme of transfer of the Hong Kong branch includes short-term support arrangements between Prudential and PAC to underpin similar arrangements between PAC and the newly domesticated business. It is considered unlikely that support will need to be provided under these arrangements.
Completion of the sale of Japan life business On 5 February 2015, the Group announced that it had completed the sale of its closed book life insurance business in Japan, as described further in note D1(b).
Final dividend The 2014 final dividend approved by the Board of Directors after 31 December 2014 is as described in note B7.
As a consequence of adoption of IFRS 11 ‘Joint Arrangements’ from 1 January 2013, the Group’s joint ventures are accounted for by using the equity method. For these operations the net of tax results are included in the Group’s profit before tax.
PAC with-profits fund (prior to offsetting effect in movement in unallocated surplus) 129 88 – –
There is no other comprehensive income in the joint ventures and associates. There have been no unrecognised share of losses of a joint venture or associate that the Group has stopped recognising in the total income.
Future minimum lease payments for non-cancellable operating leases fall due during the following periods: Not later than 1 year 89 110 Later than 1 year and not later than 5 years 214 308 Later than 5 years 105 333
Future minimum sub-lease rentals received for non-cancellable operating leases for land and buildings 17 20 Minimum lease rental payments included in consolidated income statement 95 92
P aren t co m p an y 261 Prudential plc Annual Report 2014
Fixed assets Investments: Shares in subsidiary undertakings 5 5,373 18,216 Loans to subsidiary undertakings 5 6,329 1,497
Notes on the parent company financial statements 1 Nature of operations
The Company has not prepared a cash flow statement on the basis that its cash flow is included within the cash flow statement in the consolidated financial statements. The Company has also taken advantage of the exemption within FRS 29, ‘Financial Instruments: Disclosures’, from the requirements of this standard, because the Company’s results are included in the publicly available consolidated financial statements of the Group that include disclosures that comply with IFRS 7, ‘Financial Instruments: Disclosures’, which is equivalent to FRS 29.
Borrowings Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profit and loss account to the date of maturity, or, for subordinated debt, over the expected life of the instrument.
Pensions The Company assumes a portion of the pension surplus or deficit of the Group’s main pension scheme, the Prudential Staff Pension Scheme (‘PSPS’) and applied the requirements of FRS 17 ‘Retirement Benefits’ (as amended in December 2006) to its interest in the PSPS surplus or deficit. Further details are disclosed in note 9.
The assets and liabilities of the defined benefit pension schemes of the Prudential Group are subject to a full triennial actuarial valuation using the projected unit method. Estimated future cash flows are then discounted at a high-quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine their present value. These calculations are performed by independent actuaries.
Profit after tax Profit for the financial year of the Company in accordance with UK GAAP 1,460 1,579 IFRS adjustment* 3 16
Net equity Shareholders’ equity of the Company in accordance with UK GAAP and IFRS 7,945 7,352 Share in the IFRS net equity of the Group† 3,866 2,298
Shareholders’ equity of the Group in accordance with IFRS 11,811 9,650 * ‘IFRS adjustment’ in the above table represents the difference 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.
The profit for the financial year of the Company in accordance with UK GAAP and IFRS includes dividends declared in the year from subsidiary undertakings of £1,774 million and £2,332 million for the years ended 31 December 2014 and 2013, respectively.
Dissolution of subsidiary undertaking (12,791) 6,326 Net reduction in loans – (1,494) Other movements (52) –
Recorded in the balance sheet as: Subordinated liabilitiesnote (iv) 3,662 Debenture loans 549 549
Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. These Notes were originally issued in October 2008 and have been continually reissued upon their maturity.
Cross-currency swap 2 – 3 – Inflation-linked swap – 315 – 199
Derivative financial instruments are held to manage certain macroeconomic exposures. The change in fair value of the derivative financial instruments of the Company was a loss before tax of £115 million (2013: loss before tax of £9 million).
The majority of UK Prudential staff are members of the Group’s pension schemes. The largest scheme is the Prudential Staff Pension Scheme (the ‘Scheme’) which is primarily a closed defined benefit scheme.
The last completed triennial actuarial valuation of the Scheme was as at 5 April 2011. Further details on the results of this valuation and the total employer contributions to the Scheme for the year are provided in note C9, together with the key assumptions adopted, including mortality assumptions. The triennial valuation of the Scheme as at 5 April 2014 is currently in progress.
The assets and liabilities of the Scheme were: 31 Dec 2014 31 Dec 2013 31 Dec 2012 31 Dec 2011 31 Dec 2010
Amounts reflected in the balance sheet of the Company, net of deferred tax 31 30 38 39 41
The surplus in the Scheme recognised in the balance sheet of the Company represents the amount which is recoverable through reduced future contributions, and is net of the apportionment to the PAC with-profits fund.
The pension charge attributable to the Company is net of the apportionment to the PAC with-profits fund and is related to the surplus recognised on the balance sheet of the Company. No adjustment was made to the pension charge in 2014 or 2013 relating to the unrecognised portion of the Scheme’s surplus.
Actual less expected return on Scheme assets (14% (2013: 5%) (2012: 1%) (2011: 15%) (2010: 5%) of assets) 964 (318) (45) 973 275
Total actuarial gains (losses) (2% (2013: 7%) (2012: 6%) (2011: 17%) (2010: 2%) of the present value of Scheme liabilities) 134 (396) (297) 842 (94)
Actuarial gains (losses) attributable to the Company before tax 11 8 35 (16) (14)
P aren t co m p an y 269 Prudential plc Annual Report 2014
The total actual return on Scheme assets was a gain of £1,183 million (2013: loss of £136 million). The experience gains on Scheme liabilities in 2011 of £295 million related mainly to improvements in data consequent upon the 2011 triennial valuation of the Scheme. The actuarial gains (losses) attributable to the Company are net of the apportionment to the PAC with-profits fund and are related to the surplus recognised in the balance sheet of the Company. In 2014, the actuarial gains attributable to the Company included a charge of £29 million (2013: a credit of £127 million) for the adjustment to the unrecognised portion of surplus which has not been deducted from the pension charge.
A reconciliation of the movement in shareholders’ funds of the Company is given below: Profit for the yearnote 4 1,460 1,579
Company law requires the directors to prepare Group and parent company financial statements for each financial year. 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).
The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the parent company’s transactions, and disclose with reasonable accuracy, at any time, the financial position of the parent company, and enable them to ensure that its financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.
Under applicable law and regulations, the directors are also responsible for preparing a strategic report, directors’ report, directors’ remuneration report and corporate governance statement that comply with that law and those regulations.
Opinions and conclusions arising from our audit 1. Our opinion on the financial statements is unmodified We have audited the financial statements of Prudential plc for the year ended 31 December 2014 set out on pages 123 to 269. In our opinion: — The financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2014 and of the Group’s profit for the year then ended; — The Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union; — The parent company financial statements have been properly prepared in accordance with UK Accounting Standards; and
2. Our assessment of risks of material misstatement In arriving at our audit opinion above on the financial statements the risks of material misstatement that had the greatest effect on our audit were as follows: Investments (£337,454 million) Refer to page 81 (Audit Committee report), page 136 (accounting policy) and pages 182 to 203 (financial disclosures)
The substantial majority of the portfolio does not involve significant judgement as prices are readily available from liquid market sources.
The areas that involved significant audit effort and judgement in 2014 were the valuation of illiquid positions within the financial investment portfolio representing 2 per cent of the Group’s total assets. These included unlisted equity, unlisted debt securities, derivatives and loans such as commercial mortgage loans and bridge loans. For these positions a reliable third party price was not readily available and therefore involved the application of expert judgement in the valuations adopted.
Policyholder Liabilities (£309,539 million) Refer to page 81 (Audit Committee report), page 133 (accounting policy) and pages 204 to 219 (financial disclosures)
The risk: The Group has significant insurance liabilities representing 87 per cent of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long term policyholder liabilities. Economic assumptions, such as investment return and associated discount rates, and operating assumptions such as mortality and persistency are the key inputs used to estimate these long term liabilities. The valuation of the guarantees in the US variable annuity business is a complex exercise as it involves exercising significant judgement over the relationship between the investment return attaching to these products and the guarantees contractually provided to policyholders and the likely policyholder behaviour in response to changes in investment performance. The valuation of the insurance liabilities in relation to the UK annuity business requires the exercise of significant judgement over the setting of mortality and credit risk assumptions.
Our response: We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included: (a) Consideration of the appropriateness of the assumptions used in the stochastic models for the valuation of the US variable annuity guarantees. These included assumptions for investment mix and projected investment returns considered by reference to company specific and industry data and for future growth rates considered by reference to market trends and market volatility. We assessed assumptions of policyholder behaviour by reference to relevant company historical and industry data.
(b) Consideration of the appropriateness of the mortality and credit risk assumptions used in the valuation of the UK annuity liabilities by reference to company and industry data on historical mortality experience and expectations of future mortality. Our work on the credit risk assumptions primarily considered the appropriateness of the methodology and assumptions by reference to industry practice and our expectation derived from market experience.
The risk – DAC represents 1.6 per cent of the total assets and involves judgement in the identification of, and the extent to which, certain acquisition costs can be deferred, and assessment of recoverability of the asset. The DAC associated with the US business, which represents 87 per cent of total DAC, involves the greatest judgement in terms of measurement and recoverability. The amortisation and recoverability assessment of the US DAC asset is related to the achieved and projected future profit profile. This involves making assumptions about future investment returns and the consequential impact on fee income.
(i) evaluating the appropriateness of the Group’s deferral policy by comparing it against the requirements of relevant accounting standards; (ii) evaluating whether costs are deferred in accordance with the Group’s deferral policy; and
(iii) assessing the calculations performed including the appropriateness of the assumptions used in determining the profit profile and the extent of the associated adjustment necessary to the DAC asset. Our work in this area included assessing the reasonableness of assumptions such as the projected investment return by comparing against the Group’s investment portfolio mix and market return data.
3. Our application of materiality and an overview of the scope of our audit The materiality for the Group financial statements as a whole was set at £307 million determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 3 per cent). We consider IFRS shareholders’ equity to be the most appropriate benchmark as it represents the residual interest that can be ascribed to shareholders after policyholder assets and corresponding liabilities have been accounted for.
— Audits of account balances that correspond to the risks of material misstatement identified above in relation to Prudential Capital and the insurance operations in China, Taiwan and Thailand. The account balances audited are investments, policyholder liabilities and deferred acquisition costs. These operations covered 2 per cent of total Group revenue; 4 per cent of Group profit before tax; 2 per cent of total Group assets and 1 per cent of Group shareholders’ equity.
The remaining operations cover 6 per cent of total Group revenue, 8 per cent of Group profit before tax and 7 per cent of total Group assets, none of which individually represented more than 4 per cent of any of total Group revenue, Group profit before tax or total Group assets. For the remaining operations, we performed analysis at an aggregated Group level to re-examine our assessment that there were no significant risks of material misstatement within these operations.
The Group team in the UK covered the UK Group Head office operations. Component auditors performed the audit work in the remaining locations.
The Group audit team instructed component auditors as to the significant areas to be covered, including the relevant risks detailed above and the information to be reported back. The Group audit team approved the component materialities, which were set as £110 million for key reporting components in Asia and £140 million for all other key reporting components listed above, having regard to the size and risk profile of the Group.
in an cial statem en ts In d ep en d en t au d ito r’s rep o rt
We have nothing to report in respect of the matters on which we are required to report by exception Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading.
Scope of report and responsibilities As explained more fully in the Directors’ Responsibilities Statement set out on page 270, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/ auditscopeukco2014a which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
The European Embedded Value principles were published by the CFO Forum of major European insurers in May 2004 and subsequently supplemented by Additional Guidance issued in October 2005. The principles provide consistent definitions, a framework for setting actuarial assumptions and an approach to the underlying methodology and disclosures.
As previously announced, from 1 January 2014, the basis of presentation has been altered to be on a post-tax basis and, accordingly, all comparatives are shown on a comparable basis.
Long-term business 1,901 1,892 Eastspring Investments 78 64 Development expenses (1) (1)
Total UK insurance operations 765 854 M&G (including Prudential Capital) 386 346
Long-term business 4,175 4,250 Asset management 470 449 Other results (549) (495)
Profit for the year attributable to equity shareholders 4,343 4,358 Items taken directly to equity: Exchange movements on foreign operations and net investment hedges 737 (1,077)
Mark to market value movements on Jackson assets backing surplus and required capital 77 (97)
Net increase in shareholders’ equity 12 4,316 2,413 Shareholders’ equity at beginning of year: As previously reported 12 24,856 22,443 Effect of the domestication of Hong Kong branch on 1 January 2014 9 (11) –
Shareholders’ equity at end of year 29,357 (196) 29,161 24,844 12 24,856
Representing: Net assets excluding acquired goodwill and holding company net borrowings 29,124 1,542 30,666 24,613 1,155 25,768
Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds (314,822) (279,176) Less shareholders’ accrued interest in the long-term business 17,350 15,206
The supplementary information on pages 277 to 307 was approved by the Board of Directors on 9 March 2015.
Post-tax operating profit based on longer-term investment returns 4,096 4,204 3,933 (3)% 4%
Profit for the year attributable to shareholders 4,343 4,358 4,121 0% 5%
Asia operations(note ii) 2,237 12,331 1,162 52 9.4 US operations 1,556 15,555 694 45 4.5 UK insurance operations 857 7,471 270 32 3.6
Note The increase in new business contribution of £44 million from £2,082 million for 2013 to £2,126 million in 2014 comprises an increase on a CER basis of £187 million, offset by foreign exchange effects of £(143) million. The increase of £187 million on the CER basis comprises a contribution of £277 million reflecting higher sales volumes and the impact of pricing and product actions, offset by a £(90) million adverse effect of reductions in long-term interest rates in the year (analysed as Asia negative £(17) million, US negative £(63) million and UK negative £(10) million).
Total Asia operations 1,162 1,139 1,032 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
basis resu lts 283 Prudential plc Annual Report 2014 4 Operating profit from business in force
Unwind of discount and other expected returns 648 382 410 1,440 Effect of changes in operating assumptions 52 86 – 138 Experience variances and other items 39 366 66 471 2013* £m
Unwind of discount and other expected returns 668 395 437 1,500 Effect of changes in operating assumptions 5 76 98 179 Experience variances and other items 80 349 60 489 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
Total Asia operations 739 753 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(b) In 2014, the credit of £27 million for mortality and morbidity assumption changes reflects a number of offsetting items, including the effect of reduced projected mortality rates for Hong Kong. In 2013, the credit of £19 million mainly reflected the beneficial effect arising from the renegotiation of a reinsurance agreement in Indonesia.
(c) In 2014, the charge of £(17) million for persistency assumptions mainly reflects increased partial withdrawal assumptions on unit-linked business in Korea. For 2013, the charge of £(23) million reflected a number of offsetting items including the effect of strengthening lapse and premium holiday assumptions in Korea.
(d) In 2014, the credit of £47 million for other assumption changes reflects a number of offsetting items, including the effects of modelling improvements and those arising from asset allocation changes in Hong Kong.
(e) The favourable effect of mortality and morbidity experience in 2014 of £23 million (2013: £33 million) reflects better than expected experience in Indonesia and Hong Kong, offset by higher claims in Malaysia on medical reimbursement products.
Unwind of discount and other expected returnsnote (a) 382 395 Effect of changes in operating assumptions: Experience variances and other items: Spread experience variancenote (d) 192 217 Amortisation of interest-related realised gains and lossesnote (e) 56 58
Notes (a) The decrease in unwind of discount and other expected returns of £(13) million from £395 million for 2013 to £382 million for 2014 reflects a £(73) million adverse effect of the 90 basis points reduction in the US 10-year treasury rate and a £(19) million adverse foreign currency effect, partially offset by a £79 million effect mainly for the underlying growth in the in-force book.
(b) The credit in 2014 of £55 million (2013: £47 million) for persistency assumption changes principally relates to revised assumptions for variable annuity business to more closely reflect recent experience.
(f) The effect of £118 million in 2014 for other experience variances and other items includes the effect of favourable persistency, mortality and tax experience variances, the most significant item arising from the continued positive persistency experience for annuity business of £59 million (2013: £40 million).
Unwind of discount and other expected returnsnote (a) 410 437 Effect of change in UK corporate tax ratenote (b) – 98 Other itemsnote (c) 66 60
Investment return related experience on fixed income securitiesnote (a) 31 13 Investment return related impact due to changed expectation of profits on in-force variable annuity business in future periods based on current period separate account return, net of related hedging activitynote (b) (187) (377)
Other items including actual less long-term return on equity based investmentsnote (c) (10) 84
Notes (a) Short-term fluctuations in investment returns for shareholder-backed annuity business comprise: – Gains/(losses) on surplus assets compared to the expected long-term rate of return reflecting reductions/(increases) in corporate bond and gilt yields; – The difference between actual and expected default experience; and – The effect of mismatching for assets and liabilities of different durations and other short-term fluctuations in investment returns. (b) The short-term fluctuations in investment returns for with-profits, unit-linked and other business primarily arise from the excess of actual over expected returns for with-profits business, reflecting a total pre-tax return on the fund (including unallocated surplus) in 2014 of 9.5 per cent compared to an assumed rate of return of 5.0 per cent (2013: 8.0 per cent total return compared to assumed rate of 6.0 per cent). In addition, the amount includes the effect of a partial hedge of future shareholder transfers expected to emerge from the UK’s with-profits sub-fund taken out during 2013. This hedge reduces the risks arising from equity market declines.
Asia operationsnote (ii) (269) 255 US operationsnote (iii) (77) 242 UK insurance operationsnote (iv) (23) 132 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(ii) Asia operations The effect of changes in economic assumptions for Asia operations comprises: 2014 £m 2013* £m
The negative effect of £(269) million in 2014 principally reflected the overall impact of the reduction in fund earned rates for participating business in Hong Kong, Singapore and Taiwan, driven by the decrease in long-term interest rates. A negative effect has been reported on non-participating business in Korea (adverse £(38) million) and Thailand (adverse £(34) million) for similar reasons. These amounts were partially offset by the positive effect of valuing future health and protection profits at lower discount rates in Indonesia and Malaysia. The positive impact in 2013 of £255 million reflected the overall impact of an increase in fund earned rates for participating business, principally arising in Hong Kong, Singapore and Taiwan, mainly due to the increase in long-term interest rates. There were partial offsets arising in Indonesia and Malaysia, valuing the negative impact of future health and protection profits at a higher discount rate.
Effect of changes in 10-year treasury rates: Fixed annuity and other general account businessnote (a) 151 (244) Variable annuity businessnote (b) (228) 382 Decrease in additional allowance for credit risknote (c) – 104 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(b) In 2014, there was a 90 basis points decline in 10-year treasury rates. For variable annuity business the charge of £(228) million principally reflects the net effect of the consequent decrease in the assumed future rate of return on the underlying separate account assets, resulting in lower projected fee income and an increase in projected benefit costs, partially offset by the decrease in the risk discount rate. The credit of £382 million in 2013 reflected an increase in the risk-free rate of 130 basis points.
(c) For 2013, the £104 million effect of the decrease in the additional allowance for credit risk within the risk discount rate reflected the reduction in credit spreads (50 basis points for spread business and 10 basis points for variable annuity business).
Effect of changes in expected long-term rates of return, risk discount rates and other changes: Shareholder-backed annuity businessnote (a) 352 (56) With-profits and other businessnote (b) (375) 188 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
Notes on the EEV basis results continued 9 Domestication of the Hong Kong branch business
On 1 January 2014, following consultation with policyholders of PAC and regulators and court approval, the Hong Kong branch of PAC was transferred to separate subsidiaries established in Hong Kong. The 2014 EEV basis results includes opening adjustments arising from the transfer of capital that was previously held within the UK business in respect of the Hong Kong branch operations and additional capital requirements that arise from the newly established subsidiaries as follows: Adjustment to shareholders’ equity at 1 January 2014 Free surplus Required capital Total net worth
Holding company cash and short-term investments* (1,480) – (1,480) (2,230) – (2,230)
(i) Underlying free surplus generated The 2013 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2013 CER comparative results are translated at 2014 average exchange rates.
Asia operations Underlying free surplus generated from in-force life business 860 819 742 5% 16% Investment in new businessnotes (ii)(a), (ii)(g) (346) (310) (285) (12)% (21)%
UK insurance operations Underlying free surplus generated from in-force life business 645 680 680 (5)% (5)% Investment in new businessnote (ii)(a) (73) (29) (29) (152)% (152)%
Effects of changes in operating assumptions, operating experience variances and other operating items 314 478 457 (34)% (31)%
Notes on the EEV basis results continued 11 Analysis of movement in free surplus continued
Effects of changes in operating assumptions, operating experience variances and other operating items 314 – 314 478
Increase in EEV assumed level of required capital – – – (58) Loss attaching to held for sale Japan life businessnote 8 – – – (40) Gain on sale of PruHealth and PruProtectnotes 7, 13 130 – 130 – Other non-operating itemsnote (c) (252) (14) (266) (722)
Representing: Balance at 1 January: Notes (a) Free surplus invested in new business represents amounts set aside for required capital and acquisition costs. (b) For the purposes of this analysis, free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis post-tax earnings and shareholders’ equity.
basis resu lts 291 Prudential plc Annual Report 2014 12 Reconciliation of movement in shareholders’ equity 2014 £m
Intra-group dividends (including statutory transfers)note (ii) (410) (413) (200) (1,023) 1,023 – Investment in operationsnote (iii) 3 – – 3 (3) – External dividends – – – – (895) (895)
Representing: Statutory IFRS basis shareholders’ equity: Total IFRS basis shareholders’ equity 3,315 4,067 3,785 11,167 644 11,811 Additional retained profit (loss) on an EEV
Notes (i) For the purposes of the table above, goodwill of £233 million (2013: £231 million) related to Asia long-term operations is included in Other operations. (ii) Intra-group dividends (including statutory transfers) represent dividends that have been declared in the year and amounts accrued in respect of statutory transfers. The amounts included in note 11 for these items are as per the holding company cash flow at transaction rates. The difference primarily relates to intra-group loans, timing differences arising on statutory transfers, and other non-cash items.
(v) The additional retained loss on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of £(579) million (2013: £(392) million), as shown in note 10.
Notes on the EEV basis results continued 13 Reconciliation of movement in net worth and value of in-force for long-term business 2014 £m
New business contributionnotes (ii) and 3 (606) 453 (153) 2,279 2,126 Existing business – transfer to net worth 2,276 (316) 1,960 (1,960) – Expected return on existing businessnote 4 106 81 187 1,253 1,440 Changes in operating assumptions and experience variancesnote 4 335 36 371 238 609 Development expenses, Solvency II and restructuring costs (21) – (21) – (21)
Post-tax operating profit based on longer-term investment returns 514 151 665 1,235 1,900
Post-tax profit from long-term business 632 221 853 1,217 2,070 Exchange movements on foreign operations and net
Intra-group dividends and investment in operations (407) – (407) – (407)
Post-tax operating profit based on longer-term investment returns 1,004 58 1,062 466 1,528
Post-tax profit from long-term business 735 3 738 545 1,283 Exchange movements on foreign operations and
Post-tax new business contribution per £1 million of free surplus invested 3.4 3.7 3.7 3.5 3.7 2.4 8.2 3.3
(ii) The value of in-force business comprises the value of future margins from current in-force business less the cost of holding required capital as shown below: Asia operations
The discounted value of in-force business and required capital can be reconciled to the 2014 and 2013 totals in the tables below for the emergence of free surplus as follows: Value of in-force (VIF)note 13 20,375 17,439 Add back: deduction for cost of time value of guaranteesnote 13 575 196 Expected cash flow from sale of Japan life business (23) (25) Other itemsnote (1,382) (1,157)
Note ‘Other items’ represent amounts incorporated into VIF where there is no definitive timeframe for when the payments will be made or receipts received. In particular, other items includes the deduction of the value of the shareholders’ interest in the estate, the value of which is derived by increasing final bonus rates so as to exhaust the estate over the lifetime of the in-force with-profits business. This is an assumption to give an appropriate valuation. To be conservative, this item is excluded from the expected free surplus generation profile opposite.
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long-term business operations and include the combined effect on the value of in-force business and net assets at the balance sheet dates indicated. If the change in assumption shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year. These are for the effect of economic assumption changes and short-term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition, for Jackson, the fair value movements on assets backing surplus and required capital which are taken directly to shareholders’ equity would also be affected by changes in interest rates.
(b) Sensitivity analysis – non-economic assumptions The tables opposite show the sensitivity of the embedded value as at 31 December 2014 (31 December 2013) and the post-tax new business contribution after the effect of required capital for 2014 and 2013 to: — 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); — 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
The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in note 16(b)(iii)), no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profit. Separately, the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items (as explained in note 16(b)(i)).
The definition of long-term business operations is consistent with previous practice and comprises those contracts falling under the definition 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 definition.
A small amount of UK Group pensions business is also not modelled for EEV reporting purposes.
(ii) Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency and mortality (as described in note 17). These assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the non-diversifiable risks associated with the cash flows that are not otherwise allowed for.
For UK immediate annuity business and single premium Universal Life products in Asia, primarily in Singapore, the new business contribution is determined by applying economic assumptions reflecting point-of-sale market conditions. This is consistent with how the business is priced as crediting rates are linked to yields on specific assets and the yield is locked-in when the assets are purchased at the point-of-sale of the policy. For other business within the Group, end-of-year economic assumptions are used.
New business profitability is a key metric for the Group’s management of the development of the business. In addition, post-tax new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP). These margins are calculated as the percentage of the value of new business profit to APE and PVNBP. APE is calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts. PVNBP is calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
However, in determining the movements on the additional shareholders’ interest, the basis for calculating the Jackson EEV result acknowledges that, for debt securities backing liabilities, the aggregate EEV results reflect the fact that the value of in-force business instead incorporates the discounted value of future spread earnings. This value is not affected generally by short-term market movements on securities that broadly speaking, are held for the longer term.
The Group’s main exposure to guaranteed annuity options in the UK is through the non-covered business of SAIF. A provision on the Pillar I Peak 2 basis of £549 million was held in SAIF at 31 December 2014 (31 December 2013: £328 million) to honour the guarantees. As described in note 16(a)(i), the assets and liabilities are wholly attributable to the policyholders of the fund. Therefore the movement in the provision has no direct impact on shareholders.
The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations. Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of long-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for correlation between the various asset classes. Details of the key characteristics of each model are given in notes 17(iv),(v) and (vi).
In deriving the time value of financial options and guarantees, management actions in response to emerging investment and fund solvency conditions have been modelled. Management actions encompass, but are not confined to, investment allocation decisions, levels of reversionary and terminal bonuses and credited rates. Bonus rates are projected from current levels and varied in accordance with assumed management actions applying in the emerging investment and fund solvency conditions.
(vii) Internal asset management The new business and in-force results from long-term business include the projected value of profits or losses from asset management and service companies that support the Group’s covered insurance businesses. The results of the Group’s asset management operations include the current year profits from the management of both internal and external funds. EEV basis shareholders’ other income and expenditure is adjusted to deduct the unwind of the expected internal asset management profit margin for the year. The deduction is on a basis consistent with that used for projecting the results for covered insurance business. Group operating profit accordingly includes the variance between actual and expected profit in respect of management of the covered business assets.
(viii) Allowance for risk and risk discount rates Overview Under the EEV Principles, discount rates used to determine the present value of future cash flows are set by reference to risk-free rates plus a risk margin. The risk margin should reflect any non-diversifiable risk associated with the emergence of distributable earnings that is not allowed for elsewhere in the valuation. Prudential has selected a granular approach to better reflect differences in market risk inherent in each product group. The risk discount rate so derived does not reflect an overall Group market beta, but instead reflects the expected volatility associated with the cash flows for each product category in the embedded value model.
The risk discount rate incorporates an additional allowance for credit risk premium and short-term downgrades and defaults as shown in note 17(ii). In determining this allowance, a number of factors have been considered. These factors, in particular, include: (a) How much of the credit spread on debt securities represents an increased credit risk not reflected in the RMR long-term default assumptions, and how much is liquidity premium (which is the premium required by investors to compensate for the risk of longerterm investments which cannot be easily converted into cash, and converted at the fair market value). In assessing this effect, consideration has been given to a number of approaches to estimating the liquidity premium by considering recent statistical data; and
(b) Policyholder benefits for Jackson fixed annuity business are not fixed. It is possible, in adverse economic scenarios, to pass on a component of credit losses to policyholders (subject to guarantee features) through lower investment return rates credited to policyholders. Consequently, it is only necessary to allow for the balance of the credit risk in the risk discount rate.
Notes on the EEV basis results continued 16 Methodology and accounting presentation continued
(3) With-profits fund holdings of debt securities The UK with-profits fund holds debt securities as part of its investment portfolio backing policyholder liabilities and unallocated surplus. The assumed earned rate for with-profit holdings of corporate bonds is defined as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
Non-operating results comprise the following: — Short-term fluctuations in investment returns; — The mark to market value movements on core borrowings; — The effect of changes in economic assumptions; — The gain on sale of PruHealth and PruProtect businesses in 2014; — The costs associated with the domestication of the Hong Kong branch which became effective on 1 January 2014; and — The loss attaching to the held for sale Japan life business.
For the purpose of determining the long-term returns for debt securities of US operations for fixed annuity and other general account business, 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 end-of-period risk-free rates and equity risk premium. For US variable annuity separate account business, operating profit includes the unwind of discount on the opening value of in-force adjusted to reflect end-of-period projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
(iii) Unwind of discount and other expected returns The unwind of discount and other expected returns is determined by reference to: — The value of in-force business at the beginning of the period (adjusted for the effect of current period economic and operating assumption changes); and
In applying this general approach, the unwind of discount included in operating profit for the with-profits business of UK insurance operations is determined by reference to the opening value of in-force, as adjusted for the effects of short-term investment volatility due to market movements (ie, smoothed). In the summary statement of financial position, and for total profit reporting, asset values and investment returns are not smoothed. At 31 December 2014, the shareholders’ interest in the smoothed surplus assets used for this purpose only, were £194 million lower (31 December 2013: £136 million lower) than the surplus assets carried in the statement of financial position.
(iv) Effect of changes in operating assumptions Operating profit includes the effect of changes to operating assumptions on the value of in-force at the end of the period. For presentational purposes, the effect of change is delineated to show the effect on the opening value of in-force with the experience variance being determined by reference to the end-of-period assumptions.
The total profit that emerges over the lifetime of an individual contract, as calculated using the embedded value basis, is the same as that calculated under the IFRS basis. Since the embedded value basis reflects discounted future cash flows, under this methodology the profit emergence is advanced, thus more closely aligning the timing of the recognition of profits with the efforts and risks of current management actions, particularly with regard to business sold during the year.
Risk discount rate % 10-year government bond yield % Expected long-term inflation %New business In force 31 Dec 31 Dec 31 Dec 31 Dec
Equity risk premiums in Asia (excluding those for the held for sale Japan life business) range from 3.5 per cent to 8.7 per cent for 2014 and 2013.
Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each country’s risk discount rates by reference to the post-tax EEV basis new business result and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
January to June issues 1.5 1.2 July to December issues 1.5 1.75 Fixed index annuity business: January to June issues 2.0 1.45 July to December issues 2.0 2.0 Institutional business 0.7 0.75 Allowance for long-term defaults included in projected spreadnote 16(a)(viii) 0.25 0.25 Risk discount rate: Variable annuity: Risk discount rate 6.9 7.6 Additional allowance for credit risk included in risk discount ratenote 16(a)(viii) 0.2 0.2 Non-variable annuity: Risk discount rate 3.9 4.8 Additional allowance for credit risk included in risk discount ratenote 16(a) (viii) 1.0 1.0 Weighted average total: New business 6.7 7.4 In force 6.2 6.9 US 10-year treasury bond rate at end of year 2.2 3.1 Pre-tax expected long-term nominal rate of return for US equities 6.2 7.1 Expected long-term rate of inflation 2.8 2.6 Equity risk premium 4.0 4.0 S&P equity return volatilitynote 17 (v) 18.0 19.0 * Including the proportion of variable annuity business invested in the general account and fixed index annuity business, the assumed spread margin grades up linearly by 25 basis points to a long-term assumption over five years.
Pre-tax expected long-term nominal rate of return for shareholder-backed annuity business: New business 4.1 4.2 In forcenote (a) 3.2 4.3
Expected long-term rate of inflation 3.0 3.4 Equity risk premium 4.0 4.0
(b) Credit spread treatment: for Prudential Retirement Income Limited, which has approximately 90 per cent of UK shareholder-backed annuity business, the credit assumptions used in the underlying MCEV calculation (see note 16(a)(viii)) and the residual liquidity premium element of the bond spread over swap rates are as follows: Individual annuity new business bps
(v) US operations (Jackson) — Interest rates and equity returns are projected using a log-normal generator reflecting historical market data; — Corporate bond returns are based on Treasury yields plus a spread that reflects current market conditions; and — The volatility of equity returns ranges from 18 per cent to 27 per cent (2013: 19 per cent to 32 per cent) and the standard deviation of interest rates ranges from 2.2 per cent to 2.5 per cent for both years.
(vi) UK insurance operations — Interest rates are projected using a stochastic interest rate model calibrated to the current market yields; — Equity returns are assumed to follow a log-normal distribution; — The corporate bond return is calculated based on a risk-free bond return plus a mean-reverting spread; — Property returns are also modelled on a risk-free bond return plus a risk premium with a stochastic process reflecting total property returns; and
Expense assumptions Expense levels, including those of service companies that support the Group’s long-term business operations, are based on internal expense analysis investigations and are appropriately allocated to acquisition of new business and renewal of in-force business.
Corporate expenditure, which is included in other income and expenditure, comprises: — Expenditure for Group head office, to the extent not allocated to the PAC with-profits funds, together with Solvency II implementation and restructuring costs, which are charged to the EEV basis results as incurred; and
Asia operations: Hong Kong 16.5* Indonesia 25.0 Malaysia 2015: 25.0; From 2016: 24.0 Singapore 17.0
basis resu lts 307 Prudential plc Annual Report 2014 18 New business premiums and contributionsnote (i)
Asia insurance operations Cambodia – – 3 1 3 1 16 3 Hong Kong 419 326 603 455 645 487 3,861 2,795 Indonesia 280 303 357 445 385 477 1,619 1,943 Malaysia 117 114 189 197 201 208 1,284 1,352 Philippines 121 193 39 34 51 53 248 299 Singapore 677 571 289 304 357 361 2,683 2,588 Thailand 92 66 74 61 83 68 392 289 Vietnam 4 2 61 54 61 54 247 204
Total individual annuities 1,065 2,077 – – 106 208 1,065 2,077 Corporate pensions 92 120 138 161 147 173 592 686 Onshore bonds 2,318 1,754 – – 232 176 2,321 1,756 Other products 1,496 901 51 51 201 140 1,783 1,183 Wholesale 1,710 276 – – 171 28 1,710 276
Total UK and Europe insurance operations 6,681 5,128 189 212 857 725 7,471 5,978
resp on sibilities/In d ep en d en t au d itor’s rep ort
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities statement set out on page 308, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
d d itio n al in fo rm atio n7 312 Index to the additional unaudited financial information 338 Risk factors 344 Glossary 348 Shareholder information 351 How to contact us
IFRS operating profit based on longer-term investment returns by driver 318 b Asia operations – analysis of IFRS operating profit by territory 319 c Analysis of asset management operating profit based on longer-term investment returns
I: IFRS profit and loss information a Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets.
With-profits business represents the gross of tax shareholders’ transfer from the with-profits fund for the year.
Insurance margin primarily represents profits derived from the insurance risks of mortality and morbidity.
Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses.
Acquisition costs and administration expenses represent expenses incurred in the year attributable to shareholders. It excludes items such as restructuring costs and Solvency II costs which are not included in the segment profit for insurance as well as items that are more appropriately included in other sources of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate).
DAC adjustments comprises DAC amortisation for the year, excluding amounts related to short-term fluctuations in investment returns, net of costs deferred in respect of new business.
Analysis of pre-tax IFRS operating profit by source and Margin analysis of Group long-term insurance business The following analysis expresses certain of the Group’s sources of operating profit as a margin of policyholder liabilities or other suitable driver. Details on the calculation of the Group’s average policyholder liability balances are given in note (iii).
Margin on revenues 1,562 187 1,749 Expenses: Expected return on shareholder assets 58 24 134 216
— Expected return on shareholder assets has increased from £52 million in 2013 to £64 million in 2014, primarily due to higher income from increased shareholder assets.
Analysis of US operating profit drivers — Spread income has increased by 6 per cent at constant exchange rates (AER increased by 1 per cent) to £734 million during 2014. The reported spread margin increased to 256 basis points from 246 basis points in 2013. Spread income benefited from swap transactions previously entered into to more closely match the asset and liability duration. Excluding this effect, the spread margin would have been 182 basis points (2013 CER: 183 basis points); — Fee income has increased by 26 per cent at constant exchange rates (AER 20 per cent) to £1,402 million during 2014, primarily due to higher average separate account balances resulting from positive net cash flows from variable annuity business and overall market appreciation. Fee income margin has remained broadly consistent with the prior year at 193 basis points (2013 CER: 195 basis points and AER:196 basis points), with the decrease primarily attributable to a change in the mix of business; — Insurance margin represents operating profits from insurance risks, including variable annuity guarantees and other sundry items. Positive net flows from variable annuity business with life contingent and other guarantee fees, coupled with a benefit from repricing actions and an increased contribution from REALIC, have increased the insurance margin by 20 per cent at constant exchange rates (AER 14 per cent) to £670 million during 2014; — Acquisition costs, which are commissions and expenses incurred to acquire new business, including those that are not deferrable, have decreased slightly in absolute terms and as a percentage of APE compared to 2013. As a percentage of APE, acquisition costs have remained relatively flat in comparison to 2013; — Administration expenses increased to £693 million during 2014 compared to £636 million for 2013 at a constant exchange rate (AER £670 million), primarily as a result of higher asset-based commissions paid on the larger 2014 separate account balance subject to these trail commissions. These are paid upon policy anniversary dates and are treated as an administration expense in this analysis. Excluding these trail commissions, the resulting administration expense ratio would be lower at 36 basis points (2013: CER 44 basis points and AER 44 basis points), reflecting the benefits of operational leverage; and
Analysis of pre-tax operating profit before and after acquisition costs and DAC adjustments note (iii)
Total operating profit before acquisition costs and DAC adjustments 2,127 2,127 1,844 1,844 1,752 1,752
A d d itio n al in fo rm atio n 317 Prudential plc Annual Report 2014
Notes (i) The ratio for acquisition costs is calculated as a percentage of APE sales including with-profits sales. Acquisition costs include only those relating to shareholder-backed business. (ii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. (iii) The 2013 comparative information has been presented at AER and CER so as to eliminate the impact of exchange translation. CER results are calculated by translating prior year results using the current year foreign exchange rates. All CER profit figures have been translated at current year average rates. For Asia CER average liability calculations the policyholder liabilities have been translated using current year opening and closing exchange rates. For the US CER average liability calculations the policyholder liabilities have been translated at the current year month end closing exchange rates. See also note A1.
(v) The 2014 and 2013 analyses exclude the results of the held for sale life insurance business of Japan in both the individual profit and average liability amounts shown in the table above.
Notes (i) Analysis of operating profit between new and in-force business The result for insurance operations comprises amounts in respect of new business and business in force as follows: AER CER
New business strain* (18) (15) (18) Business in force 1,021 974 884 Non-recurrent itemsnote (ii) 49 44 41 * The IFRS new business strain corresponds to approximately 1 per cent of new business APE premiums for 2014 (2013: approximately 1 per cent of new business APE).
Operating income before performance-related fees 954 240 130 303 1,627 Performance-related fees 33 1 – – 34
Average funds under management £250.0bn £68.8bn Margin based on operating income* 38bps 35bps Cost/income ratio† 58% 59%
Operating income (net of commission)note (i) 888 216 121 362 1,587
Share of associate’s results 12 – – – 12 Group's share of tax on joint ventures' operating profit – (8) – – (8)
bps * Margin represents operating income before performance-related fees as a proportion of the related funds under management (FUM). Monthly closing internal and external funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations which are managed by third parties outside of the Prudential Group are excluded from these amounts.
Asia net remittances to the Group Asia paid to the Group: Long-term business 453 454 Other operations 60 56
Group invested in Asia: Long-term business (3) (9) Other operations (including funding of regional head office costs) (110) (101)
Net remittances to the Group from business units 1,482 1,341 Net interest paid (335) (300) Tax received 198 202 Corporate activities (193) (185) Solvency II costs (23) (32)
Operating holding company cash flow before dividend* 1,129 1,026 Dividend paid (895) (781)
Total holding company cash flow (744) 858 Cash and short-term investments at beginning of year 2,230 1,380 Foreign exchange movements (6) (8)
Business area: Asia operations 49.0 38.0 US operations 123.6 104.3 UK operations 169.0 157.3
(ii) External funds shown above as at 31 December 2014 of £154.3 billion (2013: £143.3 billion) comprise £167.2 billion (2013: £148.2 billion) of funds managed by M&G and Eastspring Investments as shown in note (b) below less £12.9 billion (2013: £4.9 billion) that are classified within Prudential Group’s funds. The £167.2 billion (2013: £148.2 billion) investment products comprise £162.4 billion (2013: £143.9 billion) plus Asia Money Market Funds of £4.8 billion (2013: £4.3 billion).
External funds under management 30.1 22.2 137.0 126.0 Internal funds under management 47.2 37.7 127.0 118.0
II: Other information continued c Development of economic capital Overview Over the last decade regulatory bodies across the European Union have been working on the development of a more risk sensitive solvency framework. Solvency II was developed with this objective in mind and following ratification of the Omnibus II Directive on 16 April 2014, it is expected to come into force on 1 January 2016. It will apply to all European based insurers including Prudential.
Notwithstanding these limitations, Prudential has been working to implement the requirements of Solvency II in time for its adoption in 2016. The section that follows provides an update on our progress towards implementation of Solvency II highlights ongoing areas of uncertainty and draws attention to aspects where our current approach may differ to the one that will be ultimately agreed with the Prudential Regulation Authority.
From our work to date and subject to these limitations, our estimated economic capital surplus, based on outputs from our Solvency II internal model, is £9.7 billion, equivalent to an economic capital ratio of 218 per cent. Further explanation of the underlying economic capital methodology and assumptions which underpin these results is set out in the sections below.
In a number of areas Prudential’s Solvency II methodology and assumptions will need to evolve in response to policy development and regulatory interpretations. A number of working assumptions have been adopted at this stage, which remain subject to policy clarifications and continuing feedback from the Prudential Regulation Authority. The calibration of the matching adjustment for UK annuity liabilities is one such example, as are a range of other calibration issues which will remain unclear until our internal model is approved by the Prudential Regulation Authority. Other areas where supervisory judgement and approval will be required include the proportion of Jackson’s excess capital that will be included in the total surplus (under the deduction and aggregation approach) and the extent to which the economic capital surplus of our Asia operations will be recognised under the Solvency II fungibility tests. Against this backdrop of uncertainty it is expected that the Solvency II outcome will result in a lower ratio than the economic capital ratio above.
— A 10 per cent increase in UK annuity credit and longevity capital requirements (reflecting adverse matching adjustment outcomes or calibration strengthening) is estimated to reduce Group surplus by £0.6 billion (-12 percentage points of cover ratio). However, in this case the impact of transitional relief would be expected to increase as an offset to these changes.
A d d itio n al in fo rm atio n 323 Prudential plc Annual Report 2014
Methodology In line with Solvency II, for the Group’s European and Asia life business, and holding companies, the available capital is the value of assets in excess of liabilities. The key components of available capital are the market value of assets, insurance technical provisions (calculated as the sum of best estimate liabilities plus a risk margin) and other liabilities. Subordinated-debt forms part of available capital, rather than being treated as a liability, since this debt is subordinated to policyholder claims.
The Economic Capital Requirement measures the potential reduction in the value of available capital over a one year time horizon, in an adverse 1-in-200 probability event, consistently with Solvency II. This allows for diversification effects between different risk-types and between entities. No restrictions on the economic value of overseas surplus have been allowed for in assessing the capital position at Group level, reflecting our view that in an economic capital assessment, haircuts for transferability restrictions are artificial.
Prudential’s US insurance entities are included in the economic capital position on a local RBC basis under the assumption of US equivalence and the assumed permitted use of the ’deduction and aggregation’ method. This is in line with our view of the most likely outcome of Solvency II given the agreement reached in the Omnibus II Directive. The contribution of US insurance entities to the Group surplus is that in excess of 250 per cent of the US RBC Company Action Level, which is in line with the level at which we measure both the Group’s IGD surplus and the Group’s reported free surplus amount. In line with Solvency II requirements under the ’deduction and aggregation’ method, no diversification benefit is allowed for between US insurance entities and other parts of the Group.
The Group calculation also includes all non-insurance entities, including asset management companies, Prudential Capital and holding companies, as follows: — Asset managers are included in line with existing sectoral capital rules, and Prudential Capital is included on a Basel basis, which follows the expected Solvency II treatment; — Defined benefit pension schemes are included using international accounting standards and, in addition, a capital requirement is derived from stressing the accounting position; and
(iii) Capital requirements for currency translation impacts, arising from overseas capital (supporting non-UK subsidiaries) being measured in sterling at potentially stressed exchange rates. This impact is not currently allowed for, reflecting our view that an economic capital exposure only arises where funds need to be transferred between entities in order to cover a negative surplus position.
Further, Solvency II outcomes remain unclear in relation to the tiering of hybrid capital instruments, although tiering limits are not currently expected to result in any restrictions.
(v) Assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert judgement.
The matching adjustment is set equal to the yield on the backing-assets in each portfolio, less deductions for credit risk, cash flow mismatch allowances and haircuts for assets assumed to be ineligible for the matching adjustment (currently around 10 per cent of shareholder-backed annuity assets). Full allowance has been made for diversification benefits between the matching adjustment portfolio and other funds, reflecting an economic treatment. These assumed deductions from the portfolio yield are summarised in the table below. However, the final Solvency II matching adjustment outcome remains subject to considerable uncertainties and may vary significantly from these assumptions.
Credit allowances deducted from asset yields UK shareholder-backed annuities 71 172
Analysis of movement in economic capital surplus1 from 1 January to 31 December 2014 £bn 2013 £bn
Economic capital surplus as at 1 January 11.3 8.8 Operating experience 1.8 2.1 Non-operating experience (including market movements) (0.9) 0.9 Other capital movements
Corporate restructuring (0.3) – Distribution deals (0.8) (0.4) Subordinated debt issuance/(redemption) (0.4) 1.1 Foreign currency translation impacts 0.1 (0.4)
During 2014 the movement in the Group economic surplus is driven by: — Operating experience: generated by in-force business, new business written in 2014, the impact of non-market assumption changes and non-market experience variances over the year. The 2013 operating experience result additionally benefited from specific de-risking actions which were not repeated given the Group’s overall economic capital strength; — Non-operating experience: mainly arising from negative market experience during 2014, principally caused by the reduction in long-term interest rates in the UK; — Other capital movements: a reduction in surplus from the repayment of subordinated debt, renewal of the bancassurance partnership agreement with Standard Chartered Bank, the negative capital effect of the domestication of the Hong Kong branch, an increase in surplus from the sale of the PruHealth and PruProtect businesses, positive foreign currency translation effects, and a reduction in surplus due to dividend payments in 2014; and
— Model changes: a negative impact to Group surplus for the estimated impact of evolving the liability discount rate for UK shareholderbacked annuity business from one based on a liquidity premium to one based on the matching adjustment, and other internal model refinements.
Notes 1 The Group Economic Capital Requirement by risk type includes capital requirements in respect of Jackson’s risk exposures, based on 250 per cent of the
The Group’s most material risk exposures are to financial markets, in particular to equities and credit, which we hold to generate a higher return on capital and a higher return for our policyholders over the long term. The Group also has material insurance risk exposures including longevity risk from UK annuities, lapse risk across a wide range of products, and mortality and morbidity risk mainly arising from protection products written in Asia. These risks diversify strongly with market risks, even after allowing for market-related policyholder behaviour, thereby increasing the return on capital which can be earned from the balanced mix of risks. A brief description of the most material risks is set out below: — The Group’s exposure to equities mainly arises from UK shareholder transfers linked to policyholder funds (partially offset by economic equity hedges) and from future fund management charges on unit-linked funds in Asia. The equity exposure arising from Jackson’s variable annuity business is mostly hedged; — The Group also has significant exposure to credit risk, mainly from the UK annuity portfolio and from Jackson’s fixed annuity credit portfolio. Credit exposures across the Group are carefully monitored and managed as part of the Group’s risk management framework; — The Group is exposed to movements in yields (interest rates); while falling interest rates increase the risks arising from policyholder guarantees in with-profits funds and variable annuities, falling interest rates also increase the value of future insurance profits; — The most material insurance risk exposures arise from UK longevity risk, and lapse, mortality and morbidity risk in Asia; and the Group is also exposed to expense and operational risk, which is closely monitored and managed through internal control processes.
Note 1 Based on outputs from the Group’s Solvency II internal model which has not been reviewed or approved by the Prudential Regulation Authority.
The key items of reconciliation are: — £1.1 billion (2013: £0.6 billion) represents the adjustment required to the Group’s shareholders’ funds in order to convert Jackson’s contribution from an IFRS basis to the local statutory valuation basis which underpins the US Risk Based Capital regime; — £3.5 billion (2013: £2.7 billion) due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £3.7 billion (2013: £3.8 billion) due to the addition of subordinated debt which is treated as available capital on an economic basis but as a liability under IFRS; — £4.7 billion (2013: £3.5 billion) due to the inclusion of a risk margin which is not required under IFRS; — £4.0 billion (2013: £4.1 billion) due to the inclusion of the value of future shareholder transfers from with-profits business on the economic balance sheet in the UK and Asia, which is excluded from the determination of the Group’s IFRS shareholders’ funds; — £9.0 billion (2013: £9.3 billion) due to differences in insurance valuation requirements between economic capital and IFRS, with available capital partially capturing the economic value of in-force business which is excluded from IFRS; and
— £0.9 billion (2013: £1.3 billion) due to the impact on the valuation of deferred tax assets and liabilities resulting from the other valuation differences noted above.
A d d itio n al in fo rm atio n 327 Prudential plc Annual Report 2014
These sensitivity results are shown before the impact of potential management actions to de-risk the exposures of shareholder funds. Even before such management actions are allowed for, the results demonstrate the resilience of the economic capital position following large falls in equity markets, sizeable reductions in yields (relative to very low starting yields) and a severe credit event.
The adverse impact of a fall in yields largely arises from a decrease in the value of future with-profits shareholder transfers and an increase in the size of risk margins. Falling yields also increases the value of the Group’s external debt, reducing the Group surplus. However, these impacts are partially offset by an increase in the value of future insurance profits and changes in the value of hedging assets.
An increase in defaults and downgrades adversely impacts on the UK annuity credit book although the business is much less sensitive to credit spreads under the matching adjustment framework. Jackson is not exposed to credit spread widening on a US RBC basis but an increase in defaults in the Jackson credit book would have a negative impact on the Group capital position and is reflected in the credit stress test above.
II: Other information continued d Reconciliation of expected transfer of value of in-force (VIF) and required capital business to free surplus The tables below show how the VIF generated by the in-force long-term business and the associated required capital is modelled as emerging into free surplus over the next 40 years. Although a small amount (less than 2 per cent) of the Group’s embedded value emerges after this date, analysis of cash flows emerging in the years shown in the tables is considered most meaningful. The modelled cash flows use the same methodology underpinning the Group’s embedded value reporting, so are subject to the same assumptions and sensitivities.
Expected transfer of value of in-force business (VIF) and required capital to free surplus 2014 £m
The above amounts can be reconciled to the new business amounts as follows: 2014 £m
† In November 2014, the Group disposed of its stake in the PruHealth and PruProtect businesses for an EEV profit of £44 million. New business profit for the year includes new business written by the businesses prior to the disposed date. For the analysis above, such profits have been excluded as the Group has realised the cash through sale in 2014.
A d d itio n al in fo rm atio n 329 Prudential plc Annual Report 2014
Add: Expected free surplus to be generated in year 2054† – – – – – – 367 367
2014 expected free surplus generation for years 2015 to 2054* – 2,513 2,336 2,228 2,141 2,179 35,745 47,142
Asia £m £m £m £m £m Other £m Total £m 2013 expected free surplus generation for years 2014 to 2053* 801 821 798 735 705 682 17,471 22,013
Less: Amounts expected to be realised in the current year (801) – – – – – – (801)
Add: Expected free surplus to be generated in year 2054† – – – – – – 324 324
£m £m £m £m £m Other £m Total £m 2013 expected free surplus generation for years 2014 to 2053* 902 817 760 709 700 666 4,834 9,388
Less: Amounts expected to be realised in the current year (902) – – – – – – (902)
Add: Expected free surplus to be generated in year 2054† – – – – – – – –
2014 expected free surplus generation for years 2015 to 2054 – 1,054 902 844 792 866 6,072 10,530 * Includes the removal of Japan life business following the sale. † Excluding 2014 new business.
£m £m £m £m £m Other £m Total £m 2013 expected free surplus generation for years 2014 to 2053 462 471 467 467 479 466 9,333 12,145
Less: Amounts expected to be realised in the current year (462) – – – – – – (462)
Add: Expected free surplus to be generated in year 2054* – – – – – – 43 43
Total discounted free surplus expected to emerge in the next 40 years 10,402 7,471 5,758 23,631 1,471 1,062 322 2,855
Discounted expected generation from all in-force business (excluding Japan) at 31 December 2014note 14 24,101 Add: Free surplus of life operations held at 31 December 2014note 13 4,193 Less: Time value of guaranteesnote 14 (575) Expected cash flow from the sale of Japan life business* 23 Other non-modelled items†note 14 1,382
Total EEV for life operations 29,124 * Upon completion of the sale of the Japan life business, £23 million of free surplus will be released. See note 8 and note 14 of the EEV basis results section for further details. † These relate to items where there is no definitive timeframe for when the payments will be made or receipts received and are, consequently, excluded from the amounts incorporated into the tables above showing the expected generation of free surplus from in-force business at 31 December 2014. In particular, it excludes the value of the shareholders’ interest in the estate.
II: Other information continued e Foreign currency source of key metrics The tables below show the Group’s key free surplus, IFRS and EEV, metrics analysis by contribution by currency group: Free surplus and IFRS 2014 results
The weighted average share price of Prudential plc for the year ended 31 December 2014 was £13.75 (2013: £11.14). Particulars of options granted to directors are included in the directors’ remuneration report on page 93. The closing price of the shares immediately before the date on which the options were granted during the current year was £14.14. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2014.
The total number of securities available for issue under the scheme is 3,434,507 which represents 0.134 per cent of the issued share capital at 31 December 2014.
The total number of securities available for issue under the scheme is 3,747,177 which represents 0.146 per cent of the issued share capital at 31 December 2014.
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (50,169) (43,154) (45,144) (28,706) (39,687)
Share of profits from joint ventures and associates, net of related tax 303 147 135 76 64
Tax (charge) credit attributable to policyholders’ returns (540) (447) (370) 7 (607)
Operating earnings per share (including 2010 exceptional tax credit) (in pence) 96.6p 90.9p 76.9p 62.7p 65.1p
Year ended 31 December 2014 £m 2013* £m 2012* £m 2011* £m 2010* £m
Core structural borrowings of shareholder-financed operations 4,304 4,636 3,554 3,611 3,676
As of and for the year ended 31 December 2014 £bn 2013 £bn 2012 £bn 2011 £bn 2010 £bn
Notes 1 This measure is the formal profit (loss) before tax measure under IFRS, but is not the result attributable to shareholders. 2 Operating profits are determined on the basis of including longer-term investment returns. EEV and IFRS operating profits are stated after excluding the effect of short-term fluctuations in investment returns against long-term assumptions, gain on dilution of the Group’s holdings, the costs arising from the domestication of the Hong Kong business, (loss) profit attaching to held-for-sale Japan life insurance business and, in 2010, costs associated with the terminated AIA transaction. Separately on the IFRS basis, operating profit also excludes amortisation of acquisition accounting adjustments. In addition, for EEV basis results, operating profit excludes the effect of changes in economic assumptions, the market value movement on core borrowings and, in 2012, the gain arising on the acquisition of REALIC.
3 Comparative APE new business sales prior to 2011 exclude the Japanese insurance operations, which ceased writing new business from 15 February 2010. 4 Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations. 5 The 2014 surplus is estimated.
APE sales 23 14 Operating profit New business contribution 11 6 Total operating profit 11 8
A number of risk factors affect Prudential’s operating results and financial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, and any forward-looking statements are made subject to the reservations specified below under ‘Forward-looking statements’.
In the future, the adverse effects of such factors would be felt principally through the following items: — Investment impairments or reduced investment returns, which could reduce Prudential’s capital and impair its ability to write significant volumes of new business, increase the potential adverse impact of product guarantees, or have a negative impact on its assets under management and profit; — Higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses; — Failure of counterparties to transactions with Prudential that could give rise to a negative impact on Prudential’s financial position and on the accessibility or recoverability of amounts due or, for derivative transactions, adequate collateral not being in place; — Estimates of the value of financial instruments being difficult because, in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain such values require substantial elements of judgement, assumptions and estimates (which may change over time); and
In the US, fluctuations in prevailing interest rates can affect results from Jackson which has a significant spread- based business, with the majority of its assets invested in fixed income securities.
Jackson hedges the guarantees on its variable annuity book on an economic basis and, thus, accepts variability in its accounting results in the short term in order to achieve the appropriate economic result. In particular, for Prudential’s Group IFRS reporting, the measurement of the Jackson variable annuity guarantees is typically less sensitive to market movements than for the corresponding hedging derivatives, which are held at market value. However, depending on the level of hedging conducted regarding a particular risk type, certain market movements can drive volatility in the economic results which may be less significant under IFRS reporting.
A significant part of the profit from Prudential’s UK insurance operations is related to bonuses for policyholders declared on with-profits products, which are broadly based on historical and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns. This profit could be lower in a sustained low interest rate environment.
A d d itio n al in fo rm atio n 339 Prudential plc Annual Report 2014 amounts of sovereign debt obligations held in its investment portfolio. In recent years, rating agencies have downgraded the sovereign debt of some countries. There is a risk of further downgrades.
Investing in sovereign debt creates exposure to the direct or indirect consequences of political, social or economic changes (including changes in governments, heads of states or monarchs) in the countries in which the issuers are located, and the creditworthiness of the sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject.