Total financial investments, net of derivative liabilities 12,880 47,685 800 61,365 Percentage of total 21% 78% 1% 100%
Total financial investments, net of derivative liabilities 11,169 43,650 866 55,685 Percentage of total 20% 78% 2% 100%
Total financial investments, net of derivative liabilities 110,138 92,245 4,573 206,956 Borrowings attributable to the with-profits fund held at fair value – (82) – (82) Investment contract liabilities without discretionary participation features held at fair value – (15,822) – (15,822) Net asset value attributable to unit holders of consolidated unit trusts and
Total financial instruments at fair value 108,039 75,447 4,194 187,680 Percentage of total 58% 40% 2% 100%
With-profits Equity securities and portfolio holdings in unit trusts 415 42 – 21 (160) – – (34) 284 Debt securities 772 50 (1) 263 (371) (19) 1 (40) 655 Other investments (including derivative
Equity securities and portfolio holdings in unit trusts – – – 30 – – – – 30
Non-linked shareholder-backed Equity securities and portfolio holdings in unit trusts 161 8 (1) 11 (118) – – – 61 Debt securities 343 (5) 6 10 (119) (2) 49 (31) 251 Other investments (including derivative
Group Total Equity securities and portfolio holdings in unit trusts 654 37 5 78 (154) – 2 (46) 576 Debt securities 2,321 (64) 93 63 (375) (79) 72 (914) 1,117 Other investments (including derivative
Interest income and expense The interest income on financial assets not at fair value through profit and loss for the year ended 31 December 2011 from continuing operations was £1,814 million (2010: £1,994 million). The interest expense on financial liabilities not at fair value through profit and loss for the year ended 31 December 2011 from continuing operations was £456 million (2010: £427 million).
Interest rate risk The following table shows an analysis of the classes of financial assets and liabilities except for cash and cash equivalents and their direct exposure to interest rate risk. Each applicable class of the Group’s financial assets or liabilities is analysed between those exposed to fair value interest rate risk, cash flow interest rate risk and those with no direct interest rate risk exposure.
Financial assets Deposits 790 9,439 479 10,708 Debt securities 117,988 5,788 722 124,498 Loans 6,424 3,091 199 9,714 Other investments (including derivatives) 1,912 1,077 4,520 7,509
Financial liabilities Core structural borrowings of shareholder-financed operations 3,362 249 – 3,611 Operational borrowings attributable to shareholder-financed operations 3,114 213 13 3,340 Borrowings attributable to with-profits funds 120 743 109 972 Obligations under funding, securities lending and sale and repurchase agreements 580 2,534 – 3,114 Investment contracts without discretionary participation features 1,011 903 15,053 16,967 Derivative liabilities 1,426 615 1,013 3,054 Other liabilities 158 142 949 1,249
Financial liabilities Core structural borrowings of shareholder-financed operationsH13 3,611 245 624 606 840 1,243 737 1,834 6,129 Operational borrowings attributable
Borrowings attributable to with-profits fundsH13 972 199 418 158 100 5 97 139 1,116
Other liabilities 1,249 842 106 5 – – – 296 1,249 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 3,840 3,840 – – – – – – 3,840
Borrowings attributable to with-profits fundsH13 1,522 155 1,051 161 2 2 121 182 1,674
Credit risk The Group’s maximum exposure to credit risk of financial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk. These assets comprise cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note G3 for derivative assets. The collateral in place in relation to derivatives is described in G4. Notes D2(a)(v), D3(a)(ii)(ii) and D4(a)(iii), describe the security for these loans held by the Group, as disclosed at the start of this note. Of the total loans and receivables held, £39 million (2010: £74 million) are past their due date but have not been impaired. Of the total past due but not impaired, £3 million is less than one year past their due date and no loans or receivables are more than six months but less than one year past their due date (2010: £26 million and £9 million respectively). The Group expects full recovery of these loans and receivables. No further analysis has been provided of the age of financial assets that are past due at the end of the reporting period but not impaired as the amounts are immaterial. No further analysis has been provided of the element of loans and receivables that was neither past due nor impaired for the total portfolio. This is on the grounds of immateriality of the difference between the neither past due nor impaired elements and the total portfolio. Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £90 million (2010: £97 million). In addition, during the year the Group took possession of £13 million (2010: £22 million) of other collateral held as security, which mainly consists of assets that could be readily convertible into cash. Further details of collateral and pledges are provided in note G4.
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. All over-the-counter derivative transactions, with the exception of some Asian transactions, are conducted under standardised ISDA (International Swaps and Derivatives Association Inc) master agreements and the Group has collateral agreements between the individual Group entities and relevant counterparties in place under each of these market master agreements. The total fair value balances of derivative assets and liabilities as at 31 December 2011 were as follows: UK insurance operations
Collateral and pledges under derivative transactions At 31 December 2011, the Group had pledged £840 million (2010: £800 million) for liabilities and held collateral of £1,953 million (2010: £804 million) in respect of over-the-counter derivative transactions. These transactions are conducted under terms that are usual and customary to collateralised transactions including, where relevant, standard securities lending and repurchase agreement.
In accordance with the Group’s accounting policy set out in note A4, impairment reviews were performed for available-for-sale securities and loans and receivables. In addition, impairment reviews were undertaken for the reinsurers’ share of insurance contract liabilities. During the year ended 31 December 2011, impairment losses of £126 million (2010: £145 million) were recognised for available-for-sale securities and loans and receivables analysed as shown in the attached table.
Available-for-sale securities held by Jackson 62 124 Loans and receivables* 64 21 * Relates to loans held by the UK with-profits fund and mortgage loans held by Jackson
Goodwill attributable to shareholders comprises: Other represents goodwill amounts allocated across cash generating units (CGUs) in Asia and US operations. Other goodwill amounts are not individually material. During 2010, £141 million (SGD313 million) of goodwill was recognised upon the acquisition of UOB Life Assurance Limited. Upon translation at the year end exchange rate, the carrying value of this UOB Life Assurance goodwill at 31 December 2011 was £155 million (31 December 2010: £156 million).
M&G The recoverable amount for the M&G CGU has been determined by calculating its value in use. This has been calculated by aggregating the present value of future cash flows expected to be derived from the M&G operating segment (based upon management projections). The discounted cash flow valuation has been based on a three-year plan prepared by M&G, and approved by management, and cash flow projections for later years. 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 (2010: 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 (2010: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 15 per cent (2010: 16 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 five 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.
Balance at 1 January 116 3,543 758 9 241 4,667 4,097 Additions 16 890 256 7 120 1,289 1,162 Acquisitions of subsidiaries – – – – – – 12 Amortisation to the income statement: Amortisation related to short-term
Exchange differences – 38 (28) – (2) 8 141 Change in shadow DAC related to movement in unrealised appreciation of Jackson's securities classified as available-for-sale* – (331) – – – (331) (496)
Dilution of Group's holdings – – – – – – (7)
Note (i) The DAC amount in respect of US insurance operations includes: Variable annuity business 3,860 2,834 Other business 886 1,229 Cumulative shadow DAC (866) (520)
Deferred acquisition costs related to insurance contracts attributable to shareholders The movement in deferred acquisition costs relating to insurance contracts attributable to shareholders is as follows: Deferred acquisition costs at 1 January 4,316 3,823 Additions 1,152 1,064 Amortisation (507) (190) Exchange differences 10 122 Change in shadow DAC related to movement in unrealised appreciation of Jackson’s securities classified as available-for-sale (331) (496) Dilution of Group's holdings – (7)
Present value of acquired in-force business of long-term business contracts attributable to shareholders The present value of acquired in-force business (PVAIF) relating to investment contracts without discretionary participation features represents the contractual right to benefit from providing these investment management services in the future. The fair value is measured as the present value of the future profits of the investment management component of these contracts. These contracts are accounted for under the provisions of IAS 18. The PVAIF balance relating to insurance contracts is accounted for under UK GAAP as permitted by IFRS 4. The present value of future profits of acquired investment management contracts which was fully amortised during 2010 related to unit-linked contracts acquired as part of the M&G acquisition in 1999. Amortisation is charged to the ‘acquisition costs and other operating expenditure’ line in the income statement over the period of provision of asset management services as those profits emerge.
Acquisition of UOB Life Assurance Ltd note I1 – – 12 –
Comprising: Cost 200 – 203 – Accumulated amortisation (136) – (133) –
At 1 January Cost 136 79 144 155 280 234 Accumulated amortisation (23) (13) (86) (107) (109) (120)
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 fundnote I8(iii) 6 13 Distribution rights attributable to with-profits funds of the Asian insurance operations 83 97
At 1 January Gross amount 108 103 Accumulated amortisation (11) (6)
Comprising amounts in respect of: UK insurance operationsnote D2 (h) 589 608 US insurance operationsnote D3 (h) 907 695 Asian insurance operationsnote D4 (h) 151 41
Unrealised losses on investments 297 449 Balances relating to investment and insurance contracts 13 11 Short-term timing differences 1,513 1,152 Capital allowances 15 16 Unused deferred tax losses 438 560
Asia 28 3 to 5 years UK long-term business 11 1 to 3 years Other 399 1 to 3 years
Liabilities The current tax liability increased to £930 million (2010: £831 million) reflecting both an increase in taxable profits in the UK insurance business, and the recent fiscal developments affecting the Indonesia life insurance industry.
Unrealised gains on investments 1,566 1,678 Balances relating to investment and insurance contracts 949 1,057 Short-term timing differences 1,687 1,477 Capital allowances 9 12
The UK government’s tax rate change to 25 per cent (from the current 26 per cent which was effective from 1 April 2011) has had the effect of reducing the UK with-profits and shareholder-backed business element of the net deferred tax balances as at 31 December 2011 by £26 million. The tax change to 25 per cent is effective from 1 April 2012 but has been enacted at 31 December 2011. The subsequent proposed phased rate changes to 23 per cent are expected to have the effect of reducing the UK with-profits and shareholder-backed business elements of the net deferred tax balances at 31 December 2011 by £45 million.
Other debtors Amounts due from: Policyholders 227 141 Intermediaries 27 28 Reinsurers 11 27 Other 722 707
Of the £3,697 million (2010: £3,571 million) of accrued investment income and other debtors, £162 million (2010: £151 million) is expected to be settled after one year or more.
Property, plant and equipment comprise Group occupied properties and tangible assets. A reconciliation of the carrying amount of these items from the beginning of the year to the end of the year is as follows: Group occupied Property £m
Year ended 31 December 2010note I1 Opening net book amount 153 166 319 Exchange differences 5 5 10 Depreciation charge (4) (52) (56) Additions 19 48 67 Arising on acquisitions of subsidiaries – 219 219 Disposals and transfers – (5) (5)
At 1 January 2011 Cost 197 764 961 Accumulated depreciation (24) (383) (407)
Year ended 31 December 2011 Opening net book amount 173 381 554 Exchange differences (2) (7) (9)
Additions 5 119 124 Arising on acquisitions of subsidiaries 69 99 168 Disposals and transfers (7) (8) (15)
Insurance operations: UK 69 23 US 20 18 Asia 21 18 Asset management operations: M&G 1 1 US 1 1 Asia 5 3
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 393 267 Resulting from expenditure capitalised 45 44 Disposals (1,439) (390) Net gain from fair value adjustments 522 636 Net foreign exchange differences (41) 38 Transfers from/(to) held for sale assets 25 (254) Transfers from owner occupied properties 5 1
The income statement includes the following items in respect of investment properties: Rental income from investment properties 606 625 Direct operating expenses (including repairs and maintenance expenses) arising from investment properties that generated rental income during the year 128 125
Further information on the investment property held by the UK insurance operations is included in note D2(a).
Investments in associates The Group had one associate at 31 December 2011 (31 December 2010: three) that was accounted for under the equity method, which is for a 25 per cent interest in PruHealth Holdings Limited. During 2011 the Group disposed of a 30 per cent interest in The Nam Khang, a Vietnamese property developer and a 30 per cent interest in Apollo Education and Training Organisation Vietnam. The Group also has investments in associates which meet the IAS 28 criteria for measurement at fair value through profit and loss in accordance with IAS 39.
Balance at 31 December 2009 5 – 5 1 6 Transfer of PruHealth to associatesnote I2 1 65 66 – 66 Acquisition/capital injection in PruHealth 9 – 9 – 9 Exchange translation and other movements (3) (1) (4) – (4) Share of loss for the year after tax – (6) (6) – (6)
Balance at 31 December 2010 12 58 70 1 71 Capital injection 4 – 4 – 4 Exchange translation and other movements (1) 1 – – – Disposals (1) – (1) – (1) Goodwill write-off – – – (1) (1) Share of loss for the year after tax – (3) (3) – (3)
* The 2010 amounts include the Group’s share of PruHealth’s revenue and profit and loss for the five months ended from 1 August to 31 December 2010. Prior to August 2010, PruHealth was accounted for as a joint venture.
CITIC Prudential Life Insurance Company Limited 50 Life assurance China CITIC-Prudential Fund Management Company Limited 49 Asset management China ICICI Prudential Asset Management Company Limited 49 Asset management India Prudential BSN Takaful Berhad 49 General and life insurance Malaysia BOCI-Prudential Asset Management Limited 36 Asset management China (Hong Kong) ICICI Prudential Life Insurance Company Limited 26 Life assurance India
Cash and cash equivalents held centrally are considered to be available for general use by the Group. These funds amount to £309 million and £523 million at 31 December 2011 and 2010, respectively. The remaining funds are considered not to be available for general use by the Group, and include funds held for the benefit of policyholders.
A summary of the ordinary shares in issue is set out below: Share capital and share premium
At 31 December 2010 2,545,594,506 127 1,856 Shares issued under share option schemes 2,444,824 – 17
Cost £m * The maximum number of shares held in 2011 was 8.1 million which was at the end of the period.
January 12,723 6.83 6.83 86,834 February 11,688 7.13 7.13 83,376 March 2,106,702 7.04 7.14 15,253,240 April 263,361 7.40 7.49 1,960,300 May 174,614 7.46 7.53 1,307,410 June 1,418,209 7.07 7.18 10,141,069 July 98,334 6.89 7.34 683,084 August 1,520,620 5.77 6.32 9,051,804 September 19,273 5.85 6.00 115,022 October 15,385 6.07 6.07 93,310 November 110,951 6.15 6.33 692,501 December 2,456,692 6.07 6.55 15,226,106
The Group has consolidated a number of authorised investment funds where it is deemed to control these funds under IFRS. Some of these funds hold shares in Prudential plc. The total number of shares held by these funds at 31 December 2011 was 8.6 million (2010: 9.8 million) and the cost of acquiring these shares of £52 million (2010: £47 million) is included in the cost of own shares. The market value of these shares as at 31 December 2011 was £54 million (2010: £65 million). During 2011, these funds made net disposals of 1,171,635 Prudential shares (2010: net disposals of 833,618) for a net increase of £4.8 million to book cost (2010: net decrease of £3 million). All share transactions were made on an exchange other than the Stock Exchange of Hong Kong. Other than set out above the Group did not purchase, sell or redeem any Prudential plc listed securities during 2011 or 2010.
Reserves The translation reserve represents cumulative foreign exchange translation differences taken directly to equity in accordance with IFRS, net of related tax. In accordance with IFRS 1, cumulative translation differences are deemed to be zero at 1 January 2004, the date of transition to IFRS. The available-for-sale reserve represents gains or losses arising from changes in the fair value of available-for-sale securities of Jackson, net of the related change in amortisation of deferred income and acquisition costs and of the related tax.
At 1 January 2010 145,713 10,019 Income and expense included in the income statement 22,412 245 Foreign exchange translation differences 3,193 (11) Dilution of Group's holdings (27) –
Central operations Subordinated debt: ¤500m 5.75% Subordinated Notes 2021note (i) – – 428 ¤20m Medium-Term Subordinated Notes 2023note (ii) 17 17 17 £435m 6.125% Subordinated Notes 2031 428 428 428 £400m 11.375% Subordinated Notes 2039 384 384 382 US$1,000m 6.5% Perpetual Subordinated Capital Securities 644 644 639 US$250m 6.75% Perpetual Subordinated Capital
Total central operations 1,823 829 549 3,201 3,267 PruCap £250m bank loannote (iv) 250 250 250 Jackson US$250m 8.15% Surplus Notes 2027 note (v) 160 160 159 * These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the FSA handbook. In January 2011, the Company issued US$550 million 7.75 per cent Tier 1 subordinated debt, primarily to retail investors. The proceeds, net of costs, were US$539 million (£340 million) and have been used to finance the repayments of the €500 million Tier 2 subordinated debt in December 2011.
(v) The Jackson borrowings are unsecured and subordinated to all present and future indebtedness, policy claims and other creditor claims of Jackson.
(vi) Maturity analysis The following table sets out the contractual maturity analysis of the Group’s core structural borrowings: Less than 1 year 115 – 1 to 2 years – 115 2 to 3 years 135 – 3 to 4 years – 135 4 to 5 years – – Over 5 years 3,361 3,426
(vii) Management analyses the net core structural borrowings position as follows: Total core structural borrowings (as above) 3,611 3,676 Less: Holding company cash and short-term investments
Other borrowings Bank loans and overdrafts 13 5 Obligations under finance leases 1 2 Other borrowingsnote (iii) 349 357
(iv) In addition to the debt listed above, £200 million Floating Rate Notes were issued by Prudential plc in October 2011 which mature in April 2012. These Notes have been wholly subscribed by a 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 reissued upon their maturity.
(v) Maturity analysis The following table sets out the contractual maturity analysis of the Group’s operational borrowings attributable to shareholder-financed operations: Less than 1 year 3,169 2,496 1 to 2 years 140 98 2 to 3 years 10 401 3 to 4 years 10 – 4 to 5 years 11 – Over 5 years – 9
Non-recourse borrowings of consolidated investment fundsnote (i) 747 1,287 £100m 8.5% undated subordinated guaranteed bonds of the Scottish Amicable Insurance Fundnote (ii) 100 100 Other borrowings (predominantly obligations under finance leases) 125 135
Notes (i) In all instances the holders of the debt instruments issued by these funds do not have recourse beyond the assets of those funds. (ii) The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinate to the entitlements of the policyholders of that fund.
Provision after elimination of investments in Prudential insurance policies and matching policyholder liability from Group statement of financial position 229 447 Other provisions (see below) 300 282
Analysis of other provisions: At 1 JanuaryI3 282 206 Charged to income statement: Additional provisions 144 182 Unused amounts released (29) (10) Used during the year (97) (106) Exchange differences – 10
At 1 January 2010 11 4 15 Charged to income statement: Additional provisions 9 – 9 Used during the year (1) (3) (4)
Restructuring provisions These primarily relate to restructuring activities of UK insurance operations. The provisions pertain to property liabilities resulting from the closure of regional sales centres and branches, staff terminations and other transformation costs to enable streamlining of operations. The movement is summarised in the table below: At 1 January 26 17 Charge to income statement: Additional provisions 5 14 Unused amounts released (5) (2) Used during the year (3) (3)
Other provisions The movement in other provisions is shown in the table below: Staff Benefits* £m
At 1 January 2010 143 27 4 174 Charge to income statement: Additional provisions 148 10 4 162 Unused amounts released (6) – – (6) Used during the year (92) (8) – (100)
Contingencies and related obligations In addition to the legal proceedings relating to Jackson mentioned under the legal provisions section above, the Group is involved in other litigation and regulatory issues. Whilst the outcome of such litigation and regulatory issues cannot be predicted with certainty, the Company believes that their ultimate outcome will not have a material adverse effect on the Group’s financial condition, results of operations, or cash flows.
The pension mis-selling provision at 31 December 2011 set out above of £362 million is stochastically determined on a discounted basis. The average discount rate implied in the movement in the year is 2.6 per cent. The undiscounted amounts at 31 December 2011 expected to be paid in each of the years ending 31 December are as follows: 2011 £m
The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling including administration costs. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased. The costs associated with the pension mis-selling review have been met from the inherited estate (see below). Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders’ payout values have been unaffected by pension mis-selling. In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment policy and it gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing.
Unclaimed property provision Jackson has received industry-wide regulatory enquiries with respect to claims settlement practices and compliance with unclaimed property laws. To date, only one state (New York) has requested a formal search for potential unreported claims. 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. Based on its current analysis, at 31 December 2011, Jackson accrued £16 million for these unreported claims. Additionally, regulators and state legislators are considering proposals that would require life insurance companies to take additional steps to identify unreported deceased policy and contract holders. Currently, there does not appear to be a consensus among state insurance regulators and state unclaimed property administrators regarding a life insurer’s obligations in connection with identifying unreported deaths of its policy and contract holders.
in a n cia l state m e n ts I: O
In addition to the amounts above, the Group incurred £2 million of acquisition-related costs (excluding integration costs). These have been excluded from the consideration transferred and were recognised as an expense during 2010, in the consolidated income statement.
Goodwill arose on the acquisition of UOB Life Assurance Limited in Singapore because the acquisition included revenue and cost synergies. These synergies could not be recognised as assets separately from goodwill because they are not capable of being separated from the Group and sold, transferred, licensed, rented or exchanged, either individually or together with any related contracts, and did not arise from contractual or other legal rights.
None of the goodwill arising on this transaction is expected to be deductible for tax purposes.
Assets acquired and liabilities assumed at the date of acquisition £m
Impact of acquisition on the results of the Group Included in the Group’s consolidated profit before tax for 2010 is £8 million attributable to UOB Life Assurance Limited in Singapore. Consolidated revenue, including investment returns, for 2010 includes £125 million in respect of UOB Life Assurance Limited in Singapore.
Had the acquisition been effected at 1 January 2010, the revenue and profit of the Group from continuing operations for the year ended 31 December 2010 would not have been materially different.
I3: Staff and pension plans a Staff and employment costs The average number of staff employed by the Group during the year was: Business operations: Asian operations 17,001 17,988 US operations 3,785 3,545 UK operations 4,628 4,459
The costs of employment were: Business operations: Wages and salaries 1,101 1,052 Social security costs 75 69 Other pension costs Defined benefit schemes* Defined benefit schemes – PSPS† 22 27 Defined benefit schemes – Other schemes* (34) 31 Defined contribution schemes Defined contribution schemes – Domestic 12 11 Defined contribution schemes – Overseas 29 26 Pension actuarial and other (gains) losses charged to income statement* (37) 26 * The derivation of these amounts is shown in note (b)(i)7. † Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of PSPS as described in note (b)(i)1 below, the other pension costs for PSPS represents the cash cost of contributions for ongoing service of active members and the unwind of discount on the opening provision for deficit funding for PSPS.
The Group business operations 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 PSPS; 86 per cent (2010: 86 per cent) of the underlying scheme liabilities of the Group defined benefit schemes are accounted for within PSPS.
Mortality assumptions The tables used for PSPS pensions in payment at 5 April 2008 were: Base post retirement mortality For current male (female) pensioners 108.6 per cent (103.4 per cent) of the mortality rates of the 2000 series mortality tables, published by the Continuous Mortality Investigation Bureau. For male (female) non-pensioners 113.4 per cent (97.4 per cent) of the 2000 series rates.
th er n o tes 3 Assumptions The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended 31 December were as follows: Discount rate* 4.7 5.45 Rate of increase in salaries 2.9 5.55 Rate of inflation:† Retail price index (RPI) 2.9 3.55 Consumer price index (CPI) 1.9 n/a Rate of increase of pensions in payment for inflation: Guaranteed (maximum 5%)‡ 2.5 3.55 Guaranteed (maximum 2.5%)‡ 2.5 2.5 Discretionary‡ 2.5 2.5 Expected returns on plan assets 5.1 5.9 * 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 rate of inflation for the year ended 31 December 2011 reflects the long-term assumption for the UK RPI or CPI, depending on the tranche of the schemes. For prior periods it reflects the long-term assumption for the UK RPI. See explanation below.
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 the Scottish Amicable scheme and Aon Hewitt Limited for the M&G scheme, the most recent full valuations have been updated to 31 December 2011, applying the principles prescribed by IAS 19. In July 2010, the UK government announced plans to use the CPI in place of the RPI in its determination of the statutory minimum pension increases for private sector occupational pension schemes. In December 2010, the government published the statutory revaluation order for 2011 which confirms the change to use CPI. Further, in December 2010, the government consulted on the impact of the switch from RPI to CPI on the private sector occupational pension schemes. In its response following the consultation published in June 2011, the government confirmed that it would not introduce legislation to override scheme rules that provide for pension increases/revaluation on a basis that is higher than the statutory minimum. For the Group’s UK defined benefit schemes, the pensions in deferment and/or pensions in payment for certain tranches of these schemes are subject to statutory increases in accordance with the schemes’ rules and were therefore affected by the government’s decision to change the indexation from RPI to CPI. Other tranches, where RPI is specified in the scheme rules, were unaffected. During 2011, the pension schemes communicated to their members the changes in basis from RPI to CPI in light of the government announcement. The impact of this change in 2011 was an accounting benefit of £42 million to the Group’s operating profit based on longer-term investment returns and profit attributable to shareholders before tax and £31 million to shareholders’ equity. There was no impact on the results for the year ended 31 December 2010.
I3: Staff and pension plans continued 4 Summary financial position The Group liability in respect of defined benefit pension schemes is as follows: Economic position: Deficit, gross of deferred tax, based on scheme assets held, including investments in
5 Group economic financial position The following tables illustrate the movement on the financial position of the Group’s defined benefit pension schemes on an economic basis. The underlying position on an economic basis reflects the assets (including investments in Prudential policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. At 31 December 2011, the investments in Prudential policies comprise £112 million (2010: £118 million) for PSPS and £165 million (2010: £227 million) for the M&G scheme. Separately, the economic financial position also includes the effect of the application of IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. For PSPS, where there are constraints in the trust deed to prevent the company access, the surplus is not recognised and a liability to additional funding is established (as previously described).
All schemes Underlying position (without the effect of IFRIC 14) Surplus 312 256 882 93 1,543 Less: amount attributable to PAC with-profits fund (264) (171) (607) (41) (1,083)
Shareholders’ share: Gross of tax surplus 48 85 275 52 460 Related tax (13) (22) (68) (14) (117)
Effect of IFRIC 14 Derecognition of surplus and set-up of additional funding obligation (532) (229) (846) – (1,607) Less: amount attributable to PAC with-profits fund 370 162 592 – 1,124
Shareholders’ share: Gross of tax surplus (deficit) 53 (18) (38) 51 48 Related tax (15) 5 11 (14) (13)
Total credit (charge) without the effect of IFRIC 14 256 (7) Effect of IFRIC 14 for pension schemes (229) (38)
scheme surplus is not recognised for accounting purposes due to the application of IFRIC 14. The £66 million for other schemes (as shown in the table below) is allocated as £24 million to PAC with-profits fund and £42 million to shareholders referred to in note B1.
(ii) The net credit (charge) to operating profit (comprising amounts attributable to the PAC with-profits fund and shareholder-backed operations) of £27 million (2010: (£45 million)) is made up of the following: Underlying IAS 19 charge for other pension schemes (17) (18) Cash costs for PSPS (20) (23) Unwind of discount on opening provision for deficit funding for PSPS (2) (4) Negative past service cost – RPI to CPI inflation measure change (note (i) to table above) 66 –
The net charge for actuarial and other gains and losses is recorded within the income statement but, within the segmental analysis of profit, the shareholders’ share of actuarial and other gains and losses ( ie net of allocation of the share to the PAC with-profits funds) is excluded from operating profit based on longer-term investment returns.
The 2011 actuarial gains of £882 million (gross of allocation of share to the PAC with-profits funds and before the application of IFRIC 14) primarily reflects the effect of the excess of market returns over long-term assumptions and experience gains on liabilities which are partially offset by the effect of changes in economic assumptions.
Total value of assets 6,432 731 7,163 100 5,351 653 6,004 100 Present value of benefit obligations (4,844) (776) (5,620)
(ii) The resulting scheme deficits arising from the excess of liabilities over assets at 31 December 2011, after application of IFRIC 14 of £64 million (2010: £220 million), comprised a deficit of £41 million (2010: £106 million) attributable to the PAC with-profits fund and deficit of £23 million (2010: £114 million) attributable to shareholder operations.
(iii) In addition to PSPS, there are two smaller schemes in the UK, the Scottish Amicable Pension Scheme and the M&G Pension Scheme, with a combined deficit at 31 December 2011 of £45 million (2010: £173 million), gross of tax. There is also a small scheme in Taiwan, with a negligible amount of deficit at 31 December 2011 and 2010.
Employer contributions 54 19 20 39 93 Actuarial gains (losses) 13 (1) 12 28 40 Benefit payments (10) (5) (15) 15 – Movement in the provision for deficit funding for PSPS (4) (4) Transfer out of investment in Prudential insurance policies 92 (92) – – Cash costs and unwind of discount on the opening provision for deficit funding for PSPS (22) (22)
Fair value of plan assets, end of year 566 165 731 731 Present value of benefit obligation, end of year (776) (776) Provision for deficit funding of PSPS (19) (19)
Fair value of plan assets, end of year 426 227 653 653 Present value of benefit obligation, end of year (826) (826) Provision for deficit funding of PSPS (47) (47)
Effect of the application of IFRIC 14 for pension schemes Derecognition of PSPS’ surplus (1,588) (485) (513) (728) (528) Set up obligation for deficit funding for PSPS (19) (47) (75) (65) (102) Adjustment in respect of investment of PSPS in
Deficit recognised in the statement of financial position (229) (447) (437) (306) (355)
* The M&G pension scheme invests in Prudential insurance policies. On Prudential Group consolidation, these assets are eliminated against liabilities in the statement of financial position of UK Insurance Operations. Up until 2011, all of the M&G scheme assets were invested in this way, thus giving rise to an unfunded status on a Prudential Group consolidated basis. At 31 December 2011, only £165 million out of the M&G scheme assets of £257 million was invested in Prudential insurance policies, thereby switching its status to a partly funded scheme.
Actuarial gains and losses – economic basis 882 (109) Less: actuarial gains on investments of scheme assets in Prudential insurance policies 17 (20)
* Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of PSPS, the effect on the net periodic pension cost for PSPS was to replace the usual IAS 19 pension charges and credits with the cash cost of contribution for ongoing services of active members, and also not to report the actuarial gains and losses.
† In determining the expected return on scheme assets for 2011, the 5.1 per cent (2010: 5.9 per cent) rate shown below has been applied to the opening assets.
Equities 336 5 610 11 917 18 875 17 1,332 26 Bonds 5,826 85 4,095 72 3,587 69 2,619 52 1,299 25 Properties 317 4 206 4 278 5 290 6 583 11 Cash-like investments 407 6 748 13 442 8 1,273 25 1,936 38
Long-term expected rates of return Equities 6.8 8.2 8.5 Bonds 3.0 4.6 5.3 Properties 5.55 6.9 6.75 Cash-like investments 2.0 4.75 4.75
The expected rates of return have been determined by reference to long-term expectations, the carrying value of the assets and equity, and other market conditions at the statement of financial position date. The actual return on scheme assets was a gain of £1,290 million (2010: £631 million) on an IAS 19 basis. None of the scheme assets included shares in Prudential plc or property occupied by the Prudential Group.
Underlying scheme assets in surplus (deficit) of benefit obligation, before the effect of IFRIC 14 1,266 (33) 50 384 135
Discount rate Decrease by 0.2% from 4.7% to 4.5% Increase in scheme liabilities by: PSPS 3.3% Other schemes 4.8% Discount rate Increase by 0.2% from 4.7% to 4.9% Decrease in scheme liabilities by: PSPS 3.1% Other schemes 4.5% Rate of inflation RPI: Decrease by 0.2% from 2.9% to 2.7%
Discount rate Decrease by 0.2% from 5.45% to 5.25% Increase in scheme liabilities by: PSPS 3.6% Other schemes 5.2% Discount rate Increase by 0.2% from 5.45% to 5.65% Decrease in scheme liabilities by: PSPS 3.5% Other schemes 4.8% Rate of inflation RPI: Decrease by 0.2% from 3.55% to 3.35%
The sensitivity of the underlying pension scheme liabilities to changes in discount, inflation and mortality rates 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. The sensitivity to the changes in the key variables as shown in the table above has no significant impact on the pension costs included in the Group’s operating results. This is due to the pension costs charged in each of the periods presented being derived largely from market conditions at the beginning of the period. After applying IFRIC 14 and to the extent attributable to shareholders, any residual impact from the changes to these variables is reflected as actuarial gains and losses on defined benefit pension schemes within the supplementary analysis of profits. The relevance of this is described further below. For PSPS, the underlying surplus of the scheme of £1,588 million (2010: £485 million) has not been recognised under IFRIC 14. Any change in the underlying scheme liabilities to the extent that it is not sufficient to alter PSPS into a liability in excess of the deficit funding provision will not have an impact on the Group’s results and financial position. Based on the underlying financial position of PSPS as at 31 December 2011, none of the changes to the underlying scheme liabilities for the changes in the variables shown in the table above have had an impact on the Group’s 2011 results and financial position. In the event that a change in the PSPS scheme liabilities results in a deficit position for the scheme which is recognisable, the deficit recognised affects the Group’s results and financial position only to the extent of the amounts attributable to shareholder operations. The amounts attributable to the PAC with-profits fund are absorbed by the liability for unallocated surplus and have no direct effect on the profit or loss attributable to shareholders or shareholders’ equity. The deficit of the Scottish Amicable pension scheme has been allocated approximately 50 per cent to the PAC with-profits fund and 50 per cent to the shareholders. Accordingly, half of the changes to its scheme liabilities, which at 31 December 2011 were £527 million (2010: £572 million), due to the changes in the variables shown in the table above would have had an impact on the Group’s shareholder results and financial position.
The Prudential Corporation Asia Long-Term Incentive Plan (PCA LTIP) is an incentive plan created in 2008 for senior employees and chief executive officers. Awards under the PCA LTIP will vest after three years subject to the employee being in employment at the time of vesting without any performance conditions. Awards will be discretionary and on a year-by-year basis determined by Prudential’s full year financial results and the employee’s contribution to the business. All awards will be in Prudential shares except for countries where share awards are not feasible due to securities and/or tax reasons, where awards will be replaced by the cash value of the shares that would otherwise have been transferred. Certain senior executives have annual incentive plans with awards paid in cash up to the target level of their plan. The portion of any award for above-target performance is made in the form of awards of shares deferred for three years, with the release of shares subject to close periods. The shares are held in the employee share trust and shares equivalent to dividends otherwise payable will accumulate for the benefit of award holders during the deferral period up to the release date. In addition, there are other share awards, including the Prudential Corporation Asia Deferred Bonus Plan (PCA DBP), Prudential Capital Deferred Bonus Plan (PruCap DBP) and other arrangements. There are no performance conditions attaching to these deferred bonus plans, and awards vest in full subject to the individual being employed by Prudential at the end of the vesting period. The other arrangements relate to various awards that have been made without performance conditions to individual employees, typically in order to secure their appointment or ensure retention.
Beginning of year: 12.8 3.4 12.2 3.2 Granted 2.1 4.66 2.2 4.61 Exercised (0.6) 3.98 (0.6) 3.15 Forfeited (0.2) 3.17 (0.2) 3.44 Cancelled (0.4) 3.56 (0.5) 3.37 Lapsed (0.4) 3.94 (0.3) 3.89
The weighted average share price of Prudential plc for the year ended 31 December 2011 was £6.86 compared to £5.68 for the year ended 31 December 2010. Movements in share awards outstanding under the Group’s share-based compensation plans relating to Prudential plc shares at 31 December 2011 and 2010 were as follows: Awards outstanding under incentive plans including conditional options
Post-employment benefits comprise the change in the transfer value of the accrued benefit relating to directors’ defined benefit pension schemes in the year and the total contributions made to directors’ other pension arrangements. The share-based payments charge is the sum of £6,571,000 (2010: £7,320,000), which is determined in accordance with IFRS 2, ‘Share-Based Payments’ (see note I4) and £3,163,000 (2010: £3,837,000) of deferred share awards. Total key management remuneration includes total directors’ emoluments of £16,212,000 (2010: £14,225,000) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report, and additional amounts in respect of pensions and share-based payments. Further information on directors’ remuneration is given in the directors’ remuneration report.
The fees for services relating to the AIA transaction in 2010 of £5.5 million were primarily comprised of the following services: • accountants’ report on historical financial information on Prudential Group, • consulting actuaries’ report on AIA EEV information, • technical accounting advice, • financial due diligence, • working capital review, • synergies review, and • extraction comfort
I8: Subsidiary undertakings i Principal subsidiaries The principal subsidiary undertakings of the Company at 31 December 2011, all wholly owned were: Main activity Country of incorporation
Net assets acquired: Property, plant and equipment 190 Other non-investment and non-cash assets 16 Cash and cash equivalents 14 Borrowings attributable to with-profits funds (114) Derivative liabilities (2) Other non-insurance liabilities (49)
The acquisition costs associated with these transactions were expensed as incurred and totalled less than £1.7 million. Goodwill represents management’s expectation of future income streams and is not allowable for tax.
The acquisition costs associated with this transaction were expensed as incurred and totalled less than £1 million. Goodwill represents management’s expectation of future income streams and is not allowable for tax. As noted above, the transaction increased the previously held stake from 50 per cent to 100 per cent. The fair value of the existing stake at the date of the transaction was £25 million. As the investment was held in the Group’s balance sheet as a financial instrument classified as at fair value through profit and loss, no gain or loss arises as a result of the transaction. Other than the above, there were no other material acquisitions or disposals of subsidiaries during 2011 or 2010.
I9: Commitments i Operating leases The Group leases various offices to conduct its business. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
The total minimum future sublease rentals to be received on non-cancellable operating leases for land and buildings for the year ended 31 December 2011 were £nil (2010: £nil). Minimum lease rental payments for the year ended 31 December 2011 of £74 million (2010: £92 million) are included in the consolidated income statement.
ii Capital commitments The Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. The contractual obligations to purchase or develop investment properties at 31 December 2011 were £9 million (2010: £28 million).
Structural borrowings of shareholder-financed operations comprise of core debt of the parent company, the PruCap bank loan and Jackson surplus notes. Core debt excludes borrowings to support short-term fixed income securities programmes, non-recourse borrowings of investment subsidiaries of shareholder-financed operations and other borrowings of shareholder-financed operations. Cash flows in respect of these borrowings are included within cash flows from operating activities. Structural borrowings of with-profits operations relate solely to the £100 million 8.5 per cent undated subordinated guaranteed bonds which contribute to the solvency base of the Scottish Amicable Insurance fund (SAIF), a ring-fenced sub-fund of the PAC with-profits fund. Cash flows in respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash flows from operating activities.
On 22 February 2012, M&G completed transactions to (i) exchange bonus share rights for equity holdings with the employees of PPM South Africa and (ii) the sale of a 10 per cent holding in the majority of the business to Thesele Group, a minority shareholder, for cash. Following these transactions M&G’s holding in the majority of the business reduced from 75 per cent to 47 per cent. Under IFRS requirements, the divestment is accounted for as the disposal of the 75 per cent holding and an acquisition of a 47 per cent holding at fair value. As a consequence of the IFRS application, the transactions give rise to a gain on dilution of approximately £40 million. This amount will be accounted for in the Group 2012 supplementary analysis of profit as a gain on dilution excluded from the Group’s IFRS operating profit based on longer-term investment returns.
Amounts owed to subsidiary undertakings (1,049) (1,084) Tax payable (198) (169) Sundry creditors (19) (19) Accruals and deferred income (46) (59)
Total net assets (excluding pension) 7,318 4,226 Pension asset (net of related deferred tax) 9 39 41
Dividends Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders.
Tax Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year, they can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company. Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19, ‘Deferred Tax’. The Company has chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered. The Group’s UK subsidiaries each file separate tax returns. In accordance with UK tax legislation, where one domestic UK company is a 75 per cent owned subsidiary of another UK company or both are 75 per cent owned subsidiaries of a common parent, the companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses arising in the same accounting period may be offset for the purposes of determining current and deferred taxes.
Shareholders’ equity of the Company in accordance with IFRS 7,313 4,216 Share in the IFRS net equity of the Group 1,804 3,815
Shareholders’ equity of the Group in accordance with IFRS 9,117 8,031
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 £4,002 million, and £1,318 million for the years ended 31 December 2011 and 2010, respectively. The ‘IFRS adjustment’ lines in the above tables represent the difference in the accounting treatment for pension schemes between UK GAAP and IFRS. Under UK GAAP, the parent company’s interest in the surplus of the Group’s main pension scheme recognised on the balance sheet represents the element which is recoverable through reduced future contributions. Under IFRS, as the terms of the relevant trust deed restrict shareholders’ access to any underlying surplus, not only is the underlying IAS 19 basis surplus not recognised, but the Company’s share of the obligation for deficit funding has also to be recognised on the balance sheet. The shares in the IFRS result and net equity of the Group represent the Company’s equity in the earnings and net assets of its subsidiaries and associates. As stated in note 1, under UK GAAP, the Company accounts for its investments in subsidiary undertakings at the lower of cost and estimated realisable value. For the purpose of this reconciliation, no adjustment is made to the Company in respect of any valuation adjustments to shares in subsidiary undertakings which would be eliminated on consolidation.
Notes 2023note (ii) 17 17 – – 17 17 £250m 5.875% Bonds 2029 249 249 – – 249 249 £435m 6.125% Subordinated Notes 2031 428 428 – – 428 428 £400m 11.375% Subordinated Notes 2039 384 382 – – 384 382 US$1,000m 6.5% Perpetual Subordinated
Capital Securitiesnote (iii) 161 160 – – 161 160 US$300m 6.5% Perpetual Subordinated
Capital Securities 477 472 – – 477 472 US$550m 7.75% Perpetual Subordinated
Notes (i) The €500 million 5.75 per cent borrowings were swapped into borrowings of £333 million with interest payable at six month £LIBOR plus 0.962 per cent. The borrowings were repaid in December 2011.
The key assumptions adopted were: Rate of inflation: Retail price index (RPI) 2.9 3.55 Consumer price index (CPI) 1.9 n/a Rate of increase in salaries 2.9 5.55 Rate of increase in pension payments for inflation: Guaranteed (maximum 5%) 2.5 3.55 Guaranteed (maximum 2.5%) 2.5 2.5 Discretionary 2.5 2.5 Rate used to discount Scheme liabilities 4.7 5.45
The assets and liabilities of the Scheme were: 31 Dec 2011 31 Dec 2010 31 Dec 2009 31 Dec 2008 31 Dec 2007
Total value of assets 6,432 100.0 5,351 100.0 4,949 100.0 4,803 100.0 4,889 100.0 Present value of Scheme
Amounts reflected in the balance sheet of the Company, net of deferred tax 39 41 37 36 117
Fair value of Scheme assets, at 31 December 6,432 5,351 * The contributions include deficit funding, ongoing service contributions, expenses and augmentations.
Pension credit (charge) and actuarial (losses) gains of the Scheme The pension credit (charge) recognised in the Company’s profit and loss account is as follows: Pension credit (charge): 2011 £m 2010 £m
Experience gains (losses) on Scheme liabilities (6% (2010: 0%) (2009: 1%) (2008: 3%) (2007: 0%) of liabilities) 295 1 59 127 (10)
Total actuarial gains (losses) (17% (2010: 2%) (2009: 5%) (2008: 2%) (2007: 7%) of the present value of Scheme liabilities) 842 (94) (230) 68 302
aren t co m p an y 10 Share capital and share premium
At 31 December 2011, there were options to subscribe for 13,329,709 (2010: 12,802,482) shares at prices ranging from 288 pence to 572 pence (2010: 288 pence to 572 pence) and exercisable by the year 2017 (2010: 2016). Further information on the Group’s employee share options is given in note I4 ‘Share-based payments’ of the Group financial statements.
Notes on the parent company financial statements continued 12 Other information a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note I5 ‘Key management remuneration’ of the Group financial statements.
b Information on transactions of the directors with the Group is given in note I7 ‘Related party transactions’ of the Group financial statements.
c The Company employs no staff. d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2010: £0.1 million).
The Company paid no fees for other services (2010: £6.0 million). e In certain instances the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
D irecto rs’ resp o n sib ilities/ au d ito r’s rep o rt
The directors are responsible for preparing the Annual Report and the Group and parent company financial statements in accordance with applicable law and regulations.
Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In preparing each of the Group and parent company financial statements, the directors are required to: • Select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • for the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; • for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and
We have audited the financial statements of Prudential plc for the year ended 31 December 2011 set out on pages 163 to 382 . The financial reporting framework that has been applied in the preparation of the Group financial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU. The financial reporting framework that has been applied in the preparation of the parent company financial statements is applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice).
• the information given in the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements.
Under the Listing Rules we are required to review: • the directors’ statement, set out on page 130, in relation to going concern; • the part of the Corporate Governance Statement set out in the Governance report relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and
Asian operations New business: Excluding Japan 2 1,076 902 Japannote (v) – (1)
UK operations New business 2 260 365 Business in force 3 593 571
Other income and expenditure Investment return and other income 22 30 Interest payable on core structural borrowings (286) (257) Corporate expenditure (219) (223) Unwind of expected asset management marginnote (ii) (53) (44)
RPI to CPI inflation measure change on defined benefit pension schemesnote (iii) 45 – Solvency II implementation costsnote (iv) (56) (46) Restructuring costsnote (iv) (19) (28)
Long-term business 4,048 3,844 Asset management 461 378 Other results (531) (526)
Notes (i) EEV basis operating profit based on longer-term investment returns excludes the recurrent items of short-term fluctuations in investment returns, the mark to market value movements on core borrowings, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, and the effect of changes in economic assumptions. In addition for 2010, operating profit excluded costs associated with the terminated AIA transaction and the gain arising upon the dilution of the Group’s holding in PruHealth. The amounts for these items are included in total EEV profit attributable to shareholders. The Company believes that operating profit, as adjusted for these items, better reflects underlying performance. Profit before tax and basic earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout this supplementary information.
(ii) The value of future profits or losses from asset management and service companies that support the Group’s covered businesses are included in the profits for new business and the in-force value of the Group’s long-term business. The results of the Group’s asset management operations include the profits from the management of internal and external funds. For EEV basis reporting, Group shareholders’ other income is adjusted to deduct the unwind of the expected margin for the year arising from the management of the assets of the covered business (as defined in note 1(a)). The deduction is on a basis consistent with that used for projecting the results for covered business. Group operating profit accordingly includes the variance between actual and expected profit in respect of covered business.
(v) For 2010, new business profits for the Group’s Japanese insurance subsidiary, which ceased writing new business with effect from 15 February 2010, have been presented separately from those of the remainder of the Group.
Operating profit based on longer-term investment returns Asian operations 1,839 1,518 US operations 1,455 1,480 UK operations: UK insurance operations 893 982 M&G 357 284 1,250 1,266
Profit before tax attributable to shareholders (including actual investment returns) 2,922 3,107 Tax attributable to shareholders’ profit 11 (776) (530)
Attributable to: Equity holders of the Company 2,142 2,573 Non-controlling interests 4 4
Based on operating profit based on longer-term investment returns, after related tax and non-controlling interests of £2,930 million (2010: £2,700 million*) 12 115.7p 106.9p
Dividends relating to reporting year: Interim dividend 7.95p 6.61p Final dividend 17.24p 17.24p
Profit for the year attributable to equity shareholders 2,142 2,573 Items taken directly to equity: Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year (90) 659 Related tax (68) 34 Dividends (642) (511) New share capital subscribed (including shares issued in lieu of cash dividends) 17 75 Reserve movements in respect of share-based payments 44 37 Treasury shares: Movement in own shares in respect of share-based payment plans (30) (4) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS (5) 3 Mark to market value movements on Jackson assets backing surplus and required capital: Mark to market value movements arising during the year 96 105 Related tax (34) (37)
Net increase in shareholders’ equity 10 1,430 2,934 Shareholders’ equity at beginning of year (excluding non-controlling interests) 7,10 18,207 15,273
Shareholders’ equity at end of year (excluding non-controlling interests) 7,10 19,637 18,207
Asian operations: Net assets of operations 8,510 211 8,721 7,445 197 7,642 Acquired goodwill 235 61 296 236 61 297
Shareholders’ equity at end of year (excluding non-controlling interests) 7 19,885 (248) 19,637 18,450 (243) 18,207
Representing: Net assets 19,650 (1,478) 18,172 18,214 (1,473) 16,741 Acquired goodwill 235 1,230 1,465 236 1,230 1,466
* Return on embedded value is based on EEV operating profit after related tax and non-controlling interests as a percentage of opening EEV basis shareholders’ equity. The 2010 return has been determined after excluding an exceptional tax credit of £158 million, which primarily related to the impact of a settlement agreed with the UK tax authorities.
Total assets less liabilities, before deduction for insurance funds 243,760 231,667 Less insurance funds:* Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds (234,643) (223,636) Less shareholders’ accrued interest in the long-term business 10,520 10,176
Share capital 127 127 Share premium 1,873 1,856 IFRS basis shareholders’ reserves 7,117 6,048
Total IFRS basis shareholders’ equity 7 9,117 8,031 Additional EEV basis retained profit 7 10,520 10,176
The supplementary information on pages 385 to 432 was approved by the Board of directors on 12 March 2012 and signed on its behalf.
Best estimate assumptions Best estimate assumptions are used for the cash flow projections, where best estimate is defined as the mean of the distribution of future possible outcomes. The assumptions are reviewed actively and changes are made when evidence exists that material changes in future experience are reasonably certain. Assumptions required in the calculation of the value of options and guarantees, for example relating to volatilities and correlations, or dynamic algorithms linking liabilities to assets, have been set equal to the best estimates and, wherever material and practical, reflect any dynamic relationships between the assumptions and the stochastic variables.
Principal economic assumptions The EEV basis results for the Group’s operations have been determined using economic assumptions where the long-term expected rates of return on investments and risk discount rates are set by reference to year end rates of return on government bonds (the ‘active’ basis). Expected returns on equity and property asset classes are derived by adding a risk premium, based on the long-term view of Prudential’s economists, to the risk-free rate. 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.
Valuation movements on investments With the exception of debt securities held by Jackson, investment gains and losses during the year (to the extent that changes in capital values do not directly match changes in liabilities) are included directly in the profit for the year and shareholders’ equity as they arise. The results for any covered business conceptually reflects the aggregate of the IFRS results and the movements on the additional shareholders’ interest recognised on the EEV basis. Thus the start point for the calculation of the EEV results for Jackson, as for other businesses, reflects the market value movements recognised on the IFRS basis. 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 are, broadly speaking, held for the longer-term. Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for Jackson securities classified as available-for-sale, movements in unrealised appreciation on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.
Financial options and guarantees Nature of options and guarantees in Prudential’s long-term business Asian operations Subject to local market circumstances and regulatory requirements, the guarantee features described below in respect of UK business broadly apply to similar types of participating contracts principally written in the PAC Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements. There are also various non-participating long-term products with guarantees. The principal guarantees are those for whole of life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions.
US operations (Jackson) The principal options and guarantees in Jackson are associated with the fixed annuity and variable annuity (VA) lines of business. Fixed annuities provide that, at Jackson’s discretion, it may reset the interest rate credited to policyholders’ accounts, subject to a guaranteed minimum. The guaranteed minimum return varies from 1.0 per cent to 5.5 per cent (2010: 1.5 per cent to 5.5 per cent), depending on the particular product, jurisdiction where issued, and date of issue. At 31 December 2011, 85 per cent (2010: 83 per cent) of the account values on fixed annuities relates to policies with guarantees of 3 per cent or less. The average guarantee rate is 2.8 per cent for 2011 (2010: 2.9 per cent). Fixed annuities also present a risk that policyholders will exercise their option to surrender their contracts in periods of rapidly rising interest rates, possibly requiring Jackson to liquidate assets at an inopportune time. Jackson issues VA contracts where it contractually guarantees to the contract holder either: a) return of no less than total deposits made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial withdrawals plus a minimum return, or c) the highest contract value on a specified anniversary date adjusted for any withdrawals following the specified contract anniversary. These guarantees include benefits that are payable at specified dates during the accumulation period (Guaranteed Minimum Withdrawal Benefit (GMWB)), as death benefits (Guaranteed Minimum Death Benefits (GMDB)) or as income benefits (Guaranteed Minimum Income Benefits (GMIB)). Jackson reinsures and hedges these risks using equity options and futures contracts. These guarantees generally protect the policyholder’s value in the event of poor equity market performance. Jackson also issues fixed index annuities that enable policyholders to obtain a portion of an equity-linked return while providing a guaranteed minimum return. The guaranteed minimum returns would be of a similar nature to those described above for fixed annuities.
(ii) Level of required capital In adopting the EEV Principles, Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements. Economic capital is assessed using internal models but, when applying the EEV Principles, Prudential does not take credit for the significant diversification benefits that exist within the Group. For with-profits business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is sufficient to meet the required capital requirements. For shareholder-backed business the following capital requirements apply: • Asian operations: the level of required capital has been set at the higher of local statutory requirements and the economic capital requirement; • US operations: the level of required capital has been set to an amount at least equal to 235 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL); and
(iii) 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 equal 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. Since financial options and guarantees are explicitly valued under the EEV methodology, discount rates under EEV are set excluding the effect of these product features. The risk margin represents the aggregate of the allowance for market risk, additional allowance for credit risk where appropriate, and allowance for non-diversifiable non-market risk. No allowance is required for non-market risks where these are assumed to be fully diversifiable. The majority of non-market and non-credit risks are considered to be diversifiable.
These allowances are initially reflected in determining best-estimate returns and through the market risk allowance described above. However, for those businesses which are largely backed by holdings of debt securities, these allowances in the projected returns and market risk allowances may not be sufficient and an additional allowance may be appropriate. The practical application of the allowance for credit risk varies depending upon the type of business as described below.
Asian operations For Asian operations, the allowance for credit risk incorporated in the projected rates of return and the market risk allowance are sufficient. Accordingly, no additional allowance for credit risk is required.
US business (Jackson) For Jackson business, the allowance for long-term defaults is reflected in the Risk Margin Reserve (RMR) charge which is deducted in determining the projected spread margin between the earned rate on the investments and the policyholder crediting rate. The risk discount rate incorporates an additional allowance for credit risk premium and short-term downgrades and defaults. In determining this allowance a number of factors have been considered. These factors, in particular, include: • 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. In assessing this effect, consideration has been given to a number of approaches to estimating the liquidity premium by considering recent statistical data; and
After taking these and related factors into account and, based on market conditions from 2009 to 2011, the risk discount rate for general account business includes an additional allowance of 200 basis points (2010: 150 basis points) for credit risk. For VA business, the additional allowance has been set at one-fifth (equivalent to 40 basis points (2010: 30 basis points)) of the non-VA business to reflect the proportion of the VA business that is allocated to holdings of general account debt securities. The level of the additional allowance is assessed at each reporting period to take account of prevailing credit conditions and as the business in force alters over time.
UK business (1) Shareholder-backed annuity business For Prudential’s UK shareholder-backed annuity business, Prudential has used a market consistent embedded value (MCEV) approach to derive an implied risk discount rate which is then applied to the projected best estimate cash flows. In the annuity MCEV calculations, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for expected long-term defaults, a credit risk premium, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults. For the purposes of presentation in the EEV results, the results on this basis are reconfigured. Under this approach the projected earned rate of return on the debt securities held is determined after allowing for expected long-term defaults and, where necessary, an additional allowance for an element of short-term downgrades and defaults to bring the allowance in the earned rate up to best estimate levels. The allowances for credit risk premium and the remaining element of short-term downgrade and default allowances are incorporated into the risk margin included in the discount rate, as shown in note 17(a).
(2) With-profit fund non-profit annuity business For UK non-profit annuity business including that written by Prudential Annuities Limited (PAL) the basis for determining the aggregate allowance for credit risk is consistent with that applied for UK shareholder-backed annuity business (as described above). The allowance for credit risk in PAL is taken into account in determining the projected cash flows to the with-profits fund, which are in turn discounted at the risk discount rate applicable to all of the projected cash flows of the fund.
Allowance for non-diversifiable non-market risks Finance theory cannot be used to determine the appropriate component of beta for non-diversifiable non-market risks since there is no observable risk premium associated with it that is akin to the equity risk premium. Recognising this, a pragmatic approach has been applied. A base level allowance of 50 basis points is applied to cover the non-diversifiable non-market risks associated with the Group’s businesses. For the Group’s US business and UK business other than shareholder-backed annuity, no additional allowance is necessary. For UK shareholder-backed annuity business a further allowance of 50 basis points is used to reflect the longevity risk which is of particular relevance. For the Group’s Asian operations in China, India, Indonesia, Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points.
(iv) Management actions 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. In all instances, the modelled actions are in accordance with approved local practice and therefore reflect the options actually available to management. For the PAC with-profits fund, the actions assumed are consistent with those set out in the Principles and Practices of Financial Management.
(vii) Debt capital Core structural debt liabilities are carried at market value. As the liabilities are generally held to maturity or for the long-term, no deferred tax asset or liability has been established on the difference, compared to the IFRS carrying value. Accordingly, no deferred tax credit or charge is recorded in the results for the reporting period in respect of the mark to market value adjustment.
(viii) Foreign currency translation Foreign currency profits and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange. The purpose of translating the profits and losses at average exchange rates, notwithstanding the fact that EEV profit represents the incremental value added on a discounted cash flow basis, is to maintain consistency with the methodology applied for IFRS basis reporting.
c Accounting presentation (i) Analysis of profit before tax To the extent applicable, the presentation of the EEV profit for the year is consistent with the basis that the Group applies for analysis of IFRS basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results including longer-term investment returns (which are determined as described in note 1(c)(ii) below) and incorporate the following: • new business contribution, as defined in note 1(b)(i), • unwind of discount on the value of in-force business and other expected returns, as described in note 1(c)(iv) below, • the impact of routine changes of estimates relating to non-economic assumptions, as described in note 1(c)(iii) below, and • non-economic experience variances, as described in note 1(c)(v) below.
(ii) Operating profit For the investment element of the assets covering the net worth of long-term insurance business, investment returns are recognised in operating results at the expected long-term rate of return. These expected returns are calculated by reference to the asset mix of the portfolio. For the purpose of calculating the longer-term investment return to be included in the operating result of the PAC with-profits fund of UK operations, where assets backing the liabilities and unallocated surplus are subject to market volatility, asset values at the beginning of the reporting period are adjusted to remove the effects of short-term market movements as explained in note 1(c)(iv) below. 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 year 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 year projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
For UK annuity business, rebalancing of the asset portfolio backing the liabilities to policyholders may, from time to time, take place to align it more closely with the internal benchmark of credit quality that management applies. Such rebalancing will result in a change in the projected yield on the asset portfolio and the allowance for default risk. The net effect of these changes is reflected in the result for the year. In general, the effect is booked in operating results.
(iii) 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.
(iv) Unwind of discount and other expected returns The unwind of discount and other expected returns is determined by reference to the value of in-force business, required capital and surplus assets at the start of the period as adjusted for the effect of changes in economic and operating assumptions reflected in the current period. For UK insurance operations the amount included within operating results based on longer-term investment returns represents the unwind of discount on the value of in-force business at the beginning of the period (adjusted for the effect of current period assumption changes), the unwind of discount on additional value representing the shareholders’ share of smoothed surplus assets retained within the PAC with-profits fund (as explained in note 1(b)(v) above), and the expected return on shareholders’ assets held in other UK long-term business operations. Surplus assets retained within the PAC with-profits fund are smoothed for this purpose to remove the effects of short-term investment volatility from operating results. In the summary statement of financial position and for total profit reporting, asset values and investment returns are not smoothed.
(vi) Pension costs Profit before tax Movements on the shareholders’ share of surpluses (to the extent not restricted by IFRIC 14) and deficits of the Group’s defined benefit pension schemes adjusted for contributions paid in the year are recorded within the income statement. Consistent with the basis of distribution of bonuses and the treatment of the estate described in note 1(b)(iv) and (v), the shareholders’ share incorporates 10 per cent of the proportion of the financial position attributable to the PAC with-profits fund. The financial position is determined by applying the requirements of IAS 19.
These items are recorded in the income statement but, consistent with the IFRS basis of presentation, are excluded from operating results based on longer-term investment returns.
(ix) Inter-company arrangements The EEV results for covered business incorporate the effect of the reinsurance arrangement of non-profit immediate pension annuity liabilities of SAIF (which is not covered business) to PRIL. In addition, the analysis of free surplus and value of in-force business takes account of the impact of contingent loan arrangements between Group companies.
(x) Foreign exchange rates Foreign currency results have been translated as discussed in note 1(b)(viii), for which the principal exchange rates are as follows: Local currency: £ Closing rate at
China 9.78 10.37 10.32 10.46 11.02 Hong Kong 12.07 12.48 12.17 12.01 12.52 India 82.53 74.80 70.01 70.66 75.15 Indonesia 14,091.80 14,049.41 14,106.51 14,033.41 15,171.52 Korea 1,790.32 1,775.98 1,776.86 1,786.23 1,880.45 Malaysia 4.93 4.90 4.83 4.97 5.53 Singapore 2.02 2.02 2.01 2.11 2.27 Taiwan 47.06 47.12 45.65 48.65 51.65 Vietnam 32,688.16 33,139.22 30,526.26 29,587.63 29,832.74 US 1.55 1.60 1.57 1.55 1.61 2 Analysis of new business contributionnote (iv)
Asian operationsnotes (v), (vi) 1,104 1,391 1,501 7,493 902 60 12.0 US operations 11,417 22 1,164 11,572 761 65 6.6 UK insurance operationsnote (vii) 5,656 254 820 6,842 365 45 5.3
Asian operations:note (v) China 46 47 Hong Kong 66 74 India 20 20 Indonesia 87 75 Korea 43 31 Taiwan 19 13 Other 76 79 Weighted average for all Asian operations 65 60
Notes (i) New business margins are shown on two bases, namely the margins by reference to Annual Premium Equivalents (APE) and the Present Value of New Business Premiums (PVNBP) and are calculated as the ratio of the value of new business profit to APE and PVNBP. APE are calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts. PVNBP are 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.
(vi) The new business contribution in 2010 of £902 million for Asian operations includes a benefit of around £5 million arising from the application of the ‘active’ basis of economic assumption setting rather than the previously applied basis of an assessment of longer-term economic conditions, as described in note 17a(v).
Unwind of discount and other expected returns 613 349 485 1,447 Effect of change in operating assumptions 10 14 79 103 Experience variances and other items 65 253 29 347 2010 £m
Unwind of discount and other expected returnsnote (a) 613 573 Effect of change in operating assumptions: Mortality and morbiditynote (b) 126 89 Expensenote (c) 11 (62) Persistency and withdrawalsnote (d) (140) (75) Other note (e) 13 25
Experience variance and other items: Mortality and morbiditynote (f) 58 45 Expensenote (g) (31) (39) Persistency and withdrawalsnote (h) 10 (48)
(c) The credit of £11 million in 2011 for expense assumption changes mainly arises from altered assumptions for maintenance expenses, reflecting recent experience, principally in Singapore of £34 million and Indonesia of £11 million, partly offset by a charge in India of £(30) million.
14 3 Experience variances and other items: Spread experience variancenote (f) 152 158 Amortisation of interest-related realised gains and lossesnote (g) 84 82 Othernote (h) 17 85
Notes (a) The decrease in unwind of discount and other expected returns from £369 million for 2010 to £349 million for 2011 mainly reflects lower unwind of discount driven by the reduction in the 10-year US treasury rate, partly offset by an increase in opening value of in-force business.
(f) The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults. The spread experience variance in 2011 of £152 million (2010: £158 million) includes the positive effect of transactions undertaken in 2010 and 2011 to more closely match the overall asset and liability duration.
(g) The amortisation of interest-related gains and losses reflects the same treatment applied to the supplementary analysis of IFRS profit. When bonds that are neither impaired nor deteriorating are sold and reinvested there will be a consequent change in the investment yield. The realised gain or loss is amortised into the result over the period when the bonds would have otherwise matured to better reflect the long-term returns included in operating profits.
Unwind of discount and other expected returnsnote (a) 485 550 Effect of change in UK corporate tax ratenote (b) 79 41 Updated mortality assumptions, net of release of marginsnote (c) – (40)
(c) In 2010 the Continuous Mortality Investigation (CMI) model and Core Projection parameters were reviewed and a custom parameterisation of the CMI model was made where some aspects of the pattern of convergence from current rates of improvements to long-term rates of improvement were altered. The assumption change shown above for 2010 of a charge of £(40) million represents the effect of the implementation of the custom parameterisation on the opening value of in-force business at 1 January 2010, offset by the effects of other mortality assumption changes and the release of margins on the base mortality assumptions.
(d) Other items of £29 million for 2011 includes £45 million for the effects of annuity portfolio rebalancing. In 2010, other items of £20 million includes a credit of £37 million for changes in operating expense assumptions relating to renewal expense assumptions on shareholder-backed annuity business.
In 2010, pre-tax costs of £377 million (post tax £284 million) were incurred in relation to the proposed, and subsequently terminated transaction, to purchase AIA Group Limited and related rights issue.
For 2010, short-term fluctuations in investment returns in Asian operations of £287 million primarily reflect the favourable performance in equity markets across the territories, primarily arising in Indonesia £55 million, Hong Kong £51 million, Taiwan £40 million, Malaysia £37 million and Singapore £16 million. Also included for 2010 is an unrealised gain of £30 million on the Group’s 8.66 per cent stake in China Life Insurance Company of Taiwan, which at 31 December 2010 was valued at £100 million.
Notes (a) The charge relating to fixed income securities comprises the following elements: – the excess of actual realised losses over the amortisation of interest related realised losses recorded in the profit and loss account, – credit loss experience (versus the longer-term assumption), and – the impact of de-risking activities within the portfolio, which accounts for the majority of the 2010 charge. (b) This item reflects the net impact of: (1) variances in projected future fees arising from the effect of market fluctuations on the growth in separate account asset values in the current reporting period, and
(b) Short-term fluctuations in investment returns for shareholder-backed annuity business comprise: (1) gains on surplus assets reflecting reductions in corporate bond and gilt yields in 2011 and 2010, and (2) the effect of mismatching for assets and liabilities of different durations and other short-term fluctuations in investment returns.
(iv) Other operations Short-term fluctuations in investment returns for other operations in 2011 of £(120) million (2010: £25 million) represent unrealised value movements on investments, principally on centrally held swaps to manage foreign exchange and certain macro-economic exposures of the Group.
The effects of changes in economic assumptions for in-force business, net of the related change in the time value of cost of options and guarantees, included within profit before tax (including actual investment returns) arise as follows: Group summary
Asian operationsnote (i) 279 (71) US operationsnote (ii) (144) (1) UK insurance operationsnote (iii) (293) 62
For fixed annuity and other general account business the effect of changes to the risk-free rate, which is defined as the 10-year treasury rate, is reflected in the risk discount rate. This discount rate is in turn applied to projected cash flows which principally reflect projected spread, which is largely insensitive to changes in the risk-free rate. Secondary effects on the cash flows also result from changes to assumed future yield and resulting policyholder behaviour. For VA business, changes to the risk-free rate are also reflected in determining the risk discount rate. However, the projected cash flows are also reassessed for altered investment returns on the underlying separate account assets from which fees are charged. For 2011, the effect of these changes resulted in an overall credit for fixed annuity and other general account business of £282 million (2010: £111 million) and a charge for VA business of £(333) million (2010: £(112) million) reflecting the reduction of 1.4 per cent (2010: a reduction of 0.6 per cent) in the risk-free rate (as shown in note 17a).
Notes on the EEV basis results continued 6 Effect of changes in economic assumptions continued
Effect of changes in expected long-term rates of return 58 (1,113) (1,055) (102) (80) (182)
Notes (a) For shareholder-backed annuity business the overall effect of changes in expected long-term rates of return and risk discount rates for the years shown above reflect the combined effects of the changes in assumptions which incorporate a default allowance for both best estimate defaults and in respect of the additional credit risk provisions, as shown in note 17a.
UK operations Insurance operations: Long-term business operations: Smoothed shareholders’ equity 6,097 5,911 Actual shareholders’ equity less smoothed shareholders’ equity (39) 59 EEV basis shareholders’ equity 6,058 5,970 Othernote (i) 29 33
Total long-term business operations 9,172 10,713 19,885 8,079 10,371 18,450 Other operationsnote (ii) (55) (193) (248) (48) (195) (243)
1,100 352 1,452 Net cash flows to parent companynote (iv) (829) (276) (1,105) Exchange movements, timing differences and other itemsnote (v) (180) (84) (264)
Representing: Asian operations 1,067 211 1,278 US operations 1,220 113 1,333 UK operations 552 258 810
Notes (i) All figures are shown net of tax. (ii) For the purposes of this analysis, free surplus for asset management operations and the UK general insurance commission is taken to be IFRS
Group’s shareholder-backed operations. (iv) Net cash flows to parent company for long-term business operations reflect the flows as included in the holding company cash flow at transaction rates.
(v) Exchange movements, timing differences and other items represent: 2011 £m
(vi) Other primarily reflects the effect of repayment of contingent loan funding, as shown in note 14(ii), together with timing differences, intragroup loans and other non-cash items.
Holding company net borrowings 2,001 187 2,188 2,035 177 2,212 Core structural borrowings –
Prudential Capitalnote (iii) 250 – 250 250 – 250 Core structural borrowings – Jackson 160 17 177 159 13 172
In January 2011, the Company issued US$550 million perpetual subordinated capital securities which has been used to finance the repayment of the €500 million subordinated debt in December 2011.
(ii) The movement in the mark to market value adjustment represents: Mark to market movement in balance sheet: 2011 £m 2010 £m
Financial statements | European Embedded Value (EEV) basis supplementary information 10 Reconciliation of movement in shareholders’ equity (excluding non-controlling interests)
Profit (loss) before tax (including actual investment returns) 1,883 788 439 3,110 (188) 2,922
Tax on effect of changes in economic assumptions (58) 50 72 64 – 64
Intragroup dividends (including statutory transfers)note (iii) (302) (330) (218) (850) 850 –
External dividends – – – – (642) (642) Reserve movements in respect of share-based payments – – – – 44 44 Investment in operationsnote (iii) 32 – 4 36 (36) – Other transfersnote (iv) (11) 1 (18) (28) 28 – Movement in own shares held in respect of share-based payment plans – – – – (30) (30) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – – – (5) (5) New share capital subscribed – – – – 17 17 Mark to market value movements on Jackson assets backing surplus and required capital: Mark to market value movements arising during the year – 96 – 96 – 96 Related tax – (34) – (34) – (34)
Notes (i) Profits are translated at average exchange rates, consistent with the method applied for statutory IFRS basis results. The amounts recorded above for exchange rate movements reflect the difference between 2011 and 2010 exchange rates as applied to shareholders’ equity at 1 January 2011 and the difference between 31 December 2011 and average rates for the year ended 31 December 2011.
(ii) For the purposes of the table above, goodwill related to Asia long-term operations (as shown in note 7) is included in Other operations. (iii) Total intragroup dividends and investment in operations represent: Asian operations £m
Total tax charge on operating profit based on longer-term investment returns, including exceptional tax credit 1,044 834
Tax credit on items not included in operating profit: Tax credit on short-term fluctuations in investment returnsnote (iii) (210) (222) Tax charge (credit) on shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 6 (2) Tax (credit) charge on effect of changes in economic assumptions (64) 13 Tax credit on costs of terminated AIA transaction – (93)
Tax charge on profit attributable to shareholders (including tax on actual investment returns) 776 530
Notes (i) Including tax relief on Asia development expenses and restructuring costs borne by UK insurance operations. (ii) The 2010 tax charge on operating profit based on longer-term investment returns of £834 million included an exceptional tax credit of £158 million which primarily related to the impact of a settlement agreed with the UK tax authorities. (iii) In 2010, the tax charge on short-term fluctuations in investment returns of £(222) million included a credit of £52 million for a net present value reduction in US deferred tax liabilities following changes to variable annuity reserving in accordance with revised statutory guidance.
b asis su p p lem en tary in fo rm atio n 12 Earnings per share (EPS)
Operating profit after tax and non-controlling interests excluding exceptional tax credit 2,930 2,700 Exceptional tax credit* – 158
Total EPS: Profit before tax 2,922 3,107 Tax (776) (530) Non-controlling interests (4) (4)
Financial statements | European Embedded Value (EEV) basis supplementary information 14 Reconciliation of net worth and value of in-force businessnote(i)
Group Shareholders’ equity at 1 January 2011 2,748 3,415 6,163 12,051 18,214 New business contributionnotes (iv), (v) (553) 406 (147) 1,683 1,536 Existing business – transfer to net worth 1,862 (339) 1,523 (1,523) – Expected return on existing business 110 84 194 880 1,074 Changes in operating assumptions and experience variances 168 (42) 126 173 299 RPI to CPI inflation measure change on defined benefit pension schemes 20 – 20 – 20 Changes in non-operating assumptions and
Profit after tax from long-term business 1,100 31 1,131 1,130 2,261 Exchange movements on foreign operations and
Representing: Asian operations Shareholders’ equity at 1 January 2011 1,045 790 1,835 5,610 7,445 New business contributionnote (v) (297) 97 (200) 1,011 811 Existing business – transfer to net worth 597 21 618 (618) – Expected return on existing business 58 – 58 424 482 Changes in operating assumptions and experience variances 52 (40) 12 52 64 Changes in non-operating assumptions and
Profit after tax from long-term business 361 75 436 997 1,433 Exchange movements on foreign operations and
Intragroup dividends (including statutory transfers) and investment in operationsnote (ii) (305) – (305) 35 (270) Other transfers from net worth (11) – (11) – (11)
Profit after tax from long-term business 316 (140) 176 332 508 Exchange movements on foreign operations and net investment hedges 8 6 14 28 42 Intragroup dividends (including statutory transfers) and investment in operations (330) – (330) – (330) Mark to market value movements on Jackson assets backing surplus and required capital 62 – 62 – 62 Other transfers to net worth 1 – 1 – 1
Notes (i) All figures are shown net of tax. (ii) The amounts shown in respect of free surplus and the value of in-force business for Asian and UK insurance operations for intragroup dividends
(iii) For US operations, changes in non-operating assumptions and experience variances for required capital reflects a release to free surplus following a reduction in the required asset risk charges arising from improvements to quality of the investment portfolio.
Financial statements | European Embedded Value (EEV) basis supplementary information 14 Reconciliation of net worth and value of in-force businessnote(i) continued
(iv) The movements arising from new business contribution are as follows: Free surplus invested in new business: Excluding Japan (553) (643) Japannote (vi) – (2) Totalnote (vi) (553) (645)
Total net worth (147) (184) Value of in-force business 1,683 1,616
(v) Free surplus invested in new business is as follows: Asian operations (excluding
Post-tax new business contribution per £1 million free surplus invested 2.7 2.6 3.6 2.8 – 2.8
Value of in-force business before deduction of cost of capital and of guarantees 6,922 3,222 4,598 14,742 Cost of capital (317) (135) (241) (693) Cost of time value of guaranteesnote (viii) (22) (596) (67) (685)
Value of in-force business before deduction of cost of capital and of guarantees 5,941 2,584 4,635 13,160 Cost of capital (321) (183) (236) (740) Cost of time value of guaranteesnote (viii) (10) (270) (89) (369)
(viii) The change in the cost of time value of guarantees for US operations from £(270) million in 2010 to £(596) million in 2011 primarily relates to VA business, mainly arising from the new business written in the year, reflecting the increase in VA sales, and the reduction in the expected long-term rate of return for US equities of 1.4 per cent, driven by the reduction in US 10-year treasury bond rate, as shown in note 17a.
15 Expected transfer of value of in-force business to free surplus
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2011 total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years
Asian operations 7,387 2,582 1,596 1,012 732 1,262 203 US operations 4,267 2,241 1,287 490 173 76 – UK insurance operations 4,628 1,864 1,166 743 453 394 8
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2010 total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years
Interest rates – 1% increase 2 81 5 88 Interest rates – 1% decrease (72) (117) (6) (195) Equity/property yields – 1% rise 50 92 11 153 Long-term expected defaults – 5 bps increase – – (8) (8) Liquidity premium – 10 bps increase – – 16 16
Notes on the EEV basis results continued 16 Sensitivity of results to alternative assumptions continued
Interest rates – 1% decrease 176 103 336 615 Equity/property yields – 1% rise 308 120 227 655 Equity/property market values – 10% fall (174) (5) (339) (518) Statutory minimum capital 104 127 5 236 Long-term expected defaults – 5 bps increase – – (87) (87) Liquidity premium – 10 bps increase – – 174 174
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, to the extent that asset value changes are included in the sensitivities, within 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.
b asis su p p lem en tary in fo rm atio n b Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2011 (31 December 2010) and the new business contribution after the effect of required capital for 2011 and 2010 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),
Effect of proposed changes in UK corporation tax rate The 2011 results include the effect of the change in the UK corporate tax rate that has been enacted to revise the rate to 25 per cent from 1 April 2012. The impact of further reductions in the UK corporate tax rate of 1 per cent per annum to 23 per cent in 2014 would be an increase in the net of tax value of in-force business of UK insurance operations at 31 December 2011 of around £60 million.
Risk discount rate: New business 10.0 3.85 13.75 11.15 – 7.1 6.4 12.2 3.9 5.0 10.1 19.6 In-force 10.0 3.7 13.75 11.15 4.7 7.1 6.5 12.2 4.65 5.0 10.1 19.6 Expected long-term
Notes (i) The weighted risk discount rates for Asian operations shown above have been determined by weighting each country’s risk discount rates by reference to the EEV basis new business result and the closing value of in-force business. The risk discount rates for individual Asian territories reflect the movement in government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
(iii) The risk discount rate for Malaysia reflects both the Malaysia life and Takaful operations.
(v) In preparing the EEV basis results for 2011 and 2010 the ‘active’ basis of economic assumption setting has been applied for all Asian operations. Previously, the EEV basis results for Japan, Korea and US dollar denominated business written in Hong Kong were determined on the
Risk discount rate:note (iv) Variable annuity 6.7 7.8 Non-variable annuity 4.6 5.6 Weighted average total:note (ii)
New business 6.5 7.6 In-force 6.0 6.9 US 10-year treasury bond rate at end of year 1.9 3.3 Pre-tax expected long-term nominal rate of return for US equities 5.9 7.3 Expected long-term rate of inflation 2.0 2.3 * including the proportion of variable annuity business invested in the general account.
Notes (i) For new business issuances in 2011, the assumed spread margin for fixed annuity business and for the proportion of variable annuity business invested in the general account is assumed to grade from 1.75 per cent to 2.0 per cent over five years. For new business issuances in 2010, the assumed spread margin for fixed annuity business and for the proportion of variable annuity business invested in the general account applies from inception.
(iii) Credit risk treatment The projected cash flows incorporate the expected long-term spread between the earned rate and the rate credited to policyholders. The projected earned rates reflect book value yields which are adjusted over time to reflect projected reinvestment rates. Positive net cash flows are assumed to be reinvested in a mix of corporate bonds, commercial mortgages and limited partnerships. The yield on those assets is assumed to grade from the current level to a yield that allows for a long-term assumed credit spread on the reinvested assets of 1.25 per cent over 10 years. The yield also reflects an allowance for a RMR, which for 2011 is 27 basis points (2010: 26 basis points) for longer-term defaults as described in note 1b(iii), which represents the allowance as at the valuation date applied in the cash flow projections of the value of the in-force business.
In the event that longer-term default levels are higher, then, unlike for UK annuity business where policyholder benefits are not changeable, Jackson has some discretion to adjust crediting rates, subject to contract guarantee levels and general market competition considerations.
(ii) For shareholder-backed annuity business, the movement in the pre-tax long-term nominal rates of return and the risk discount rates for in-force business reflect the combined effect of changes in asset yields and changes to the aggregate credit risk allowances as shown in note (iv) below.
The credit assumptions used and the residual liquidity premium element of the bond spread over swap rates is as follows: New businessnote (1) 2011 (bps) 2010 (bps)
Bond spread over swap rates 139 117 Total credit risk allowancenote (2) 35 38
(2010: 38 basis points). The reduced allowance for new business in comparison to that for the in-force book reflects the assets held and other factors that influence the necessary level of provision.
Asian operations • The same asset return models as described for UK insurance operations below, appropriately calibrated, have been used for Asian operations. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK while property holdings do not represent a significant investment asset; • The stochastic cost of guarantees is primarily only of significance for the Hong Kong, Korea, Malaysia and Singapore operations; and • The mean stochastic returns are consistent with the mean deterministic returns for each country. The expected volatility of equity returns ranges from 18 per cent to 35 per cent, and the volatility of government bond yields ranges from 0.9 per cent to 2.4 per cent for both years.
US operations (Jackson) • Interest rates are projected using a log-normal generator calibrated to historical US Treasury yield curves; • Corporate bond returns are based on Treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and • Variable annuity equity returns and bond interest rates have been stochastically generated using a log-normal model with parameters determined by reference to historical data. The volatility of equity fund returns for 2011 and 2010 ranges from 19 per cent to 32 per cent, depending on the risk class and the class of equity, and the standard deviation of interest rates ranges from 2.1 per cent to 2.4 per cent (2010: 2.0 per cent to 2.4 per cent).
c 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. Exceptional expenses are identified and reported separately. It is Prudential’s policy not to take credit for future cost reduction programmes until the savings have been delivered. For Asian life operations, the expenses comprise costs borne directly and recharged costs from the Asian regional head office, that are attributable to covered business. The assumed future expenses for these operations also include projections of these future recharges. Development expenses are charged as incurred.
• Expenditure of the Asian regional head office that is not allocated to the covered business or asset management operations, and is charged as incurred. These costs are primarily for corporate related activities and included within corporate expenditure.
d Taxation and other legislation Current taxation and other legislation have been assumed to continue unaltered except where changes have been announced and substantively enacted in the year.
SE Asian operations including Hong Kong 987 704 1,152 969 1,251 1,039 6,936 5,570 Chinanote (iv) 46 103 54 48 59 58 294 336 Korea 71 66 94 89 101 96 542 486 Taiwan 217 146 126 105 148 120 672 519
Total Asian operations – excluding Indianote (iii) 1,321 1,019 1,426 1,211 1,559 1,313 8,444 6,911 India 135 85 88 180 101 188 466 582
US insurance operations Fixed annuities 472 836 – – 47 84 472 836 Fixed index annuities 934 1,089 – – 93 109 934 1,089 Life 10 11 19 22 20 23 168 166 Variable annuities 10,909 9,481 – – 1,091 948 10,909 9,481 Wholesale 237 – – – 24 – 237 –
Notes (i) The tables shown above are provided as an indicative volume measure of transactions undertaken in the reporting period that have the potential to generate profits for shareholders. The amounts shown are not, and not intended to be, reflective of premium income recorded in the IFRS income statement.
APE are calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts and are subject to roundings. The PVNBP are 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.
(iii) New business in India is included at Prudential’s 26 per cent interest in the India life operation. (iv) New business in China is included at Prudential’s 50 per cent in the China life operation. (v) UK wholesale sales for 2010 and 2011 include amounts for a small number of bulk annuity buy-in insurance agreements with an APE of £93 million and £33 million respectively.
On 22 February 2012, M&G completed transactions to: (i) exchange bonus share rights for equity holdings with the employees of PPM South Africa, and (ii) the sale of a 10 per cent holding in the majority of the business to Thesele Group, a minority shareholder, for cash. Following these transactions M&G’s holding in the majority of the business reduced from 75 per cent to 47 per cent. Under IFRS requirements the divestment is accounted for as the disposal of the 75 per cent holding and an acquisition of a 47 per cent holding at fair value. As a consequence of the IFRS application, the transactions give rise to a gain on dilution of approximately £40 million. On an EEV basis, consistent with IFRS, this amount will be accounted for in the Group 2012 summarised consolidated income statement as a gain on dilution, excluded from the Group’s EEV operating profit based on longer-term investment returns.
resp o n sib ilities Financial statements | Statement of directors’ responsibilities
• identified and described the business covered by the EVM, • applied the EVM consistently to the covered business, • determined assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then applied them consistently,
• made estimates that are reasonable and consistent, and • described the basis on which business that is not covered business has been included in the supplementary information, including any material departures from the accounting framework applicable to the Group’s financial statements.
We have audited the EEV basis supplementary information (‘the supplementary information’) of Prudential plc (‘the Company’) for the year ended 31 December 2011 set out on pages 385 to 432. The financial reporting framework that has been applied in the preparation of the supplementary information is the European Embedded Value Principles issued in May 2004 by the European CFO Forum as supplemented by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 (together ‘the EEV Principles’) using the methodology and assumptions set out on pages 391 to 396 and 425 to 430 respectively. The supplementary information should be read in conjunction with the Group financial statements which are on pages 163 to 370.
Our responsibility is to audit, and express an opinion on, the supplementary information in accordance with the terms of our engagement and having regard to International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
Opinion on supplementary information In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2011 has been properly prepared, in all material respects, in accordance with the EEV Principles using the methodology and assumptions set out on pages 391 to 396 and 425 to 430 respectively.
operating profit based on longer term investment returns by driver 444 (b) Asian operations – analysis of IFRS operating profit by territory 445 (c) Analysis of asset management operating profit based on longer-term investment return
IV. Other information 452 (a) Reconciliation of expected transfer of fair value of in-force (VIF) and required capital business of free surplus 457 (b) Funds under management 457 (c) Effect of foreign currency rate movements on results 460 (d) Option schemes
Earned premiums, net of reinsurance 25,277 24,211 19,976 18,789 18,188 Investment return 9,360 21,769 26,889 (30,202) 12,225 Other income 1,869 1,666 1,234 1,146 2,457
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (29,289) (40,518) (41,195) 10,824 (26,785)
Acquisition costs and other expenditure (5,005) (4,799) (4,572) (2,459) (4,859) Finance costs: interest on core structural borrowings of shareholder-financed operations (286) (257) (209) (172) (168) Loss on sale of Taiwan agency business – – (559) – –
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) (1) 1,926 2,072 1,564 (2,074) 1,058
Based on profit (loss) for the year attributable to the equity holders of the Company: Basic earnings per share (in pence) 58.8p 56.7p 27.0p (16.0)p 38.7p Diluted earnings per share (in pence) 58.7p 56.6p 27.0p (16.0)p 38.6p Dividend per share declared and paid in reporting period
Operating profit based on longer-term investment returns(note 2) 2,070 1,941 1,564 1,212 1,152 Short-term fluctuations in investment returns on shareholder- backed business (148) (123) (123) (1,650) (51) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 21 (10) (74) (13) (1) Costs of terminated AIA transaction – (377) – – – Gain on dilution of Group's holdings – 30 – – – Loss on sale and results of Taiwan agency business – – (621) 1 (37)
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and excluding 2010 exceptional tax credit) (in pence) 63.9p 62.0p 47.5p 38.1p 31.3p
Operating profit based on longer-term investment returns(note 2) 3,978 3,696 3,090 2,865 2,353 Short-term fluctuations in investment returns on shareholder- backed business (907) (30) 351 (4,967) 200 Mark to market value movements on core borrowings (14) (164) (795) 656 223 Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 23 (11) (84) (14) (5) Effect of changes in economic assumptions (158) (10) (910) (398) 632 Costs of terminated AIA transaction – (377) – – – Gain on dilution of Group's holdings 3 – – – Profit on sale and results of Taiwan agency business – – 91 (248) 267
Profit (loss) from continuing operations before tax attributable to shareholders 2,922 3,107 1,743 (2,106) 3,670
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and excluding 2010 exceptional tax credit) (in pence) 115.7p 106.9p 88.8p 85.1p 69.2p
As of and for the Year Ended 31 December 2011 £m 2010 £m 2009 £m 2008 £m 2007 £m
IFRS basis results: Total assets 273,580 260,806 227,754 215,542 219,382 Total policyholder liabilities and unallocated surplus of with-profits funds 236,290 224,980 196,417 182,391 190,317 Core structural borrowings of shareholder-financed operations 3,611 3,676 3,394 2,958 2,492 Total liabilities 264,420 252,731 221,451 210,429 213,218 Total equity 9,160 8,075 6,303 5,113 6,164
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, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, transaction costs arising from business combinations in the period and costs associated with the terminated AIA transaction. In addition, for EEV basis results, operating profit excludes the effect of changes in economic assumptions and the market value movements on core borrowings.
iii With-profits business represents the shareholders’ transfer from the with-profits fund in the period.
vii DAC adjustments comprises DAC amortisation for the period, excluding amounts related to short-term fluctuations, net of costs deferred in respect of new business.
Spread income 88 730 247 – 1,065 Fee income 131 680 59 – 870 With-profits 38 – 293 – 331 Insurance margin 477 232 27 – 736 Margin on revenues 1,199 – 226 – 1,425 Expenses: Acquisition costs (766) (890) (127) – (1,783) Administration expenses (503) (412) (128) – (1,043) DAC adjustments 14 271 (5) – 280 Expected return on shareholder assets 26 83 91 – 200
Long-term business operating profit 704 694 683 – 2,081 Asset management operating profit 80 24 357 – 461 GI commission – – 40 – 40 RPI to CPI inflation measure change on defined benefit pension schemes – – – 42 42 Other income and expenditure* – – – (554) (554)
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued 2010† £m
Long-term business operating profit 532 833 673 – 2,038 Asset management operating profit 72 22 284 – 378 GI commission – – 46 – 46 Other income and expenditure* – – – (521) (521)
Total operating profit based on longer-term investment returns 604 855 1,003 (521) 1,941 * Including restructuring and Solvency II implementation costs. † Following the reduction in 2010 of the Group’s interest in the PruHealth and PruProtect businesses from 50 per cent to 25 per cent, the profits of these businesses have been shown as a single line in the insurance margin line in 2011, consistent with associate accounting principles. 2010 has been amended in light of this change.
Spread income 1,065 57,417 185 1,013 53,894 188 Fee income 870 68,298 127 688 56,822 121 With-profits 331 93,056 36 342 89,693 38 Insurance margin 736 592 Margin on revenues 1,425 1,212 Expenses: Acquisition costs† (1,783) 3,681 (48)% (1,645) 3,492 (47)%
† The ratio for acquisition costs is calculated as a percentage of APE including with-profits sales and Japan (2011: £nil; 2010: £7 million). Acquisition costs include only those relating to shareholders.
Spread income 88 5,623 157 70 4,393 159 Fee income 131 12,370 106 122 11,222 109 With-profits 38 11,775 32 32 10,135 32 Insurance margin 477 392 Margin on revenues 1,199 1,018 Expenses: Acquisition costs* (766) 1,660 (46)% (656) 1,508 (44)%
DAC adjustments 14 2 Expected return on shareholder assets 26 19 * The ratio for acquisition costs is calculated as a percentage of APE, including with-profits sales and Japan (2011: £nil; 2010: £7 million). Acquisition costs include only those relating to shareholders.
Spread income 730 28,274 258 692 28,532 243 Fee income 680 34,452 197 506 25,247 200 With-profits – – Insurance margin 232 188 Margin on revenues – – Expenses: Acquisition costs† (890) 1,275 (70)% (851) 1,164 (73)%
• Spread income remains broadly unchanged from 2010 at £247 million (2010: £251 million). The margin has fallen from 120 bps to 105 bps principally due to 2010 benefiting from higher bulk annuity sales, partly offset by the benefit of portfolio restructuring undertaken in the year and higher yields being achieved on new individual annuity business; • Insurance margin has increased from £12 million in 2010 to £27 million in 2011, principally driven by an improvement in the profitability of PruHealth and PruProtect; • Margin on revenues represents premiums charges for expenses and other sundry net income received by the UK. Higher amounts were recorded in 2011 (£226 million) compared to 2010 (£194 million), reflecting higher sundry income and an increase in premiums from shareholder-backed retail business in 2011 as compared to 2010; • Acquisition costs as a percentage of new business sales has remained constant with 2010 at 17 per cent; The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. It is therefore impacted by the level of with-profit sales in the year. Acquisition costs as a percentage of shareholder-backed new business sales were 33 per cent in 2011 (30 per cent in 2010), due in part to the beneficial effect in 2010 of the higher level of bulk annuity transactions, which had a relatively modest level of acquisition costs; • Administration expenses have increased by £15 million to £128 million in 2011 primarily as a result of increased project expenditure, resulting in a marginally higher administration expense ratio of 28 bps in 2011 (2010: 27 bps); and
• Expected return on shareholder asset has fallen from £98 million in 2010 to £91 million in 2011 following a reduction in assumed longer-term yields on assets backing shareholder capital.
China 11 5 Hong Kong 69 51 India 43 24 Indonesia 212 157 Japan 2 (6) Korea 17 12 Malaysia 104 97 Philippines 5 2 Singapore 167 129 Taiwan bancassurance business 1 (4) Thailand 4 2 Vietnam 35 43 Other 1 5 Non-recurrent itemsnote (ii) 38 19
(ii) Non-recurrent items of £38 million in 2011 (2010: £19 million) represents a small number of items that are not anticipated to reoccur in subsequent periods.
Operating profit based on longer-term investment returns 301 80 56 24 461
Change to accounting policy for deferral of acquisition costs for operations applying US GAAP measurement principles to insurance assets and liabilities from 1 January 2012 Background Under the Group’s accounting policies the measurement of insurance assets and liabilities reflects the application of UK GAAP under the Modified Statutory Basis (MSB). This has been applied from when the Company first adopted IFRS in 2005, subject to subsequent policy improvements under IFRS 4. The MSB in turn is based on the codification in the 2003 ABI Statement of Recommended Practice which, subject to various restrictions, permits the use of local bases for overseas operations. Accordingly, since 2005, the insurance assets and liabilities of the Group’s US operations have been measured using US GAAP. This basis has also been explicitly applied to those Asian operations (namely India, Japan, Taiwan and Vietnam) where the local regulatory basis is not appropriate as a starting point for deriving MSB compliant results. In October 2010, the Emerging Issues Task Force of the US Financial Accounting Standards Board issued Update No 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’. The update was issued to address perceived diversity by companies preparing financial statements in accordance with US GAAP as regards the types of acquisition costs being deferred. Under US GAAP, costs that can be deferred and amortised are those that ‘vary with and are primarily related to the acquisition of insurance contracts’. The Update requires insurers to capitalise only those incremental costs directly related to acquiring a contract for financial statements for reporting periods starting after 15 December 2011. All other indirect acquisition expenses are required to be charged to the income statement as incurred expenses. Accordingly, the main impact of the Update is to disallow insurers from deferring costs that are not directly related to successful sales. Under the Update, US insurers preparing financial statements under US GAAP can choose to make a prospective or a retrospective application. Under the prospective basis, the change is confined to the income statement from the date of adoption to incorporate the additional charge for non-deferrable expenses for the activity of the reporting period. No changes are made to the results of comparative periods. By contrast, under retrospective application, the deferred acquisition costs balances in the statement of financial position for comparative periods are reset so as to only defer those costs permitted by the Update. In the income statement, the net effect of the Update reflects: (i) as for the prospective basis, the additional charge for non deferrable expenses for the activity of the reporting period, offset by (ii) a reduced charge for DAC amortisation reflecting the lower level of expenses that could be deferred on prior period activity.
Effect of change of policy in 2012 The results impact of the policy improvement to adopt the Update in 2012 is summarised in the tables shown below.
Total 2,070 (43) 2,027 1,058 (30) 1,028 1,941 (115) 1,826 Short-term fluctuations in investment
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 21 – 21 (7) – (7) (10) – (10)
Profit after tax and non-controlling interests 1,490 (75) 1,415 861 (32) 829 1,431 (125) 1,306
Excluding, for 2010, exceptional tax credit 1,618 (28) 1,590 816 (19) 797 1,565 (76) 1,489
Operating (basic) – excluding, for 2010, exceptional tax credit (pence) 63.9p (1.1)p 62.8p 32.2p (0.8)p 31.4p 62.0p (3.0)p 59.0p
New business Acquisition costs on new contracts not able to be deferred (16) (10) (20) Business in force at beginning of period Reduction in amortisation on reduced DAC balance 16 8 10
Arising in the following insurance operations: (b) US insurance operations Year ended 31 December 2011 £m 6 months ended 30 June 2011 £m Year ended 31 December 2010 £m
New share capital and other movements (42) – (42) 32 – 32 111 – 111
Year ended 31 December 2011 £m 6 months ended 30 June 2011 £m Year ended 31 December 2010 £m
Assets Deferred acquisition costs attributable to shareholders: Insurance operations Asia 744 (50) 694 741 (52) 689 758 (52) 706 US 3,880 (785) 3,095 3,639 (717) 2,922 3,543 (714) 2,829 UK 111 – 111 115 – 115 116 – 116 Asset management 12 – 12 9 – 9 9 – 9
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds 236,290 – 236,290 232,304 – 232,304 224,980 – 224,980 Core structural borrowings of shareholder-financed operations 3,611 – 3,611 3,998 – 3,998 3,676 – 3,676 Deferred tax liabilities 4,211 (282) 3,929 4,194 (258) 3,936 4,224 (256) 3,968 Other liabilities 20,308 – 20,308 20,423 – 20,423 19,851 – 19,851
Asian operations Insurance operations: Net assets of operation 2,114 1,913 Acquired goodwill 235 236 Total 2,349 2,149 Eastspring Investments Net assets of operation 211 197 Acquired goodwill 61 61 Total 272 258
US operations Jackson (net of surplus note borrowings) 4,271 3,815 Broker-dealer and asset management operations: Net assets of operation 113 106 Acquired goodwill 16 16 Total 129 122
UK operations Insurance operations: Long-term business operations 2,552 2,115 Other 29 33 Total 2,581 2,148 M&G Net assets of operation 229 254 Acquired goodwill 1,153 1,153 Total 1,382 1,407
Closing equity shareholders’ funds £9,117m £8,031m Net asset value per share attributable to equity shareholdersnote (i) 358p 315p
Note (i) Based on the closing issued share capital as at 31 December 2011 of 2,548 million shares (2010: 2,546 million shares).
Total free surplus expected to emerge in the next 40 years 17,702 6,013 10,347 34,062 2,702 1,253 602 4,557 * The analysis excludes amounts incorporated into VIF at 31 December 2011 where there is no definitive timeframe for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the estate. It also excludes any free surplus emerging after 2051.
Discounted expected free surplus generation for years 2012 to 2051 1,091 876 247 2,214 Discounted expected free surplus generation for years 2051+ 32 – 2 34 Less: Free surplus investment in new business (297) (202) (54) (553)
Post-tax EEV new business profit 811 530 195 1,536 Tax 265 285 65 615
Pre-tax EEV new business profit 1,076 815 260 2,151 * Other items represent the impact of the time value of options and guarantees on new business, foreign exchange effects and other non-modelled items. Foreign exchange effects arise as EEV new business profit amounts are translated at average exchange rates and expected free surplus generation uses year end closing rates.
Less: Amounts expected to be realised in the current year (1,923) – – – – – – (1,923)
New business – 369 247 239 126 213 3,363 4,557 Operating movements – 16 19 18 – 3 Non-operating and other movements – (148) (198) (139) (51) (73) (3,986) (4,539)
Less: Amounts expected to be realised in the current year (635) – – – – – – (635)
Non-operating and other movements – (14) (35) (26) (20) (23) (2,187) (2,344)
Add: Expected free surplus to be generated in year 2051* – – – – – – – –
2011 expected free surplus generation for years 2012 to 2051 – 680 485 450 480 484 3,434 6,013
Add: Expected free surplus to be generated in year 2051* – – – – – – 38 38
At 31 December 2011, the total free surplus expected to be generated over the next five years (years 2012-2016 inclusive), using the same assumptions and methodology as underpin our embedded-value reporting was £8.0 billion, an increase of £0.6 billion from the £7.4 billion expected over the same period at the end of 2010. This increase reflected the new business written in 2011, which is expected to generate £1,194 million of free surplus over the next five years. Operating movements were positive £56 million, less than 1 per cent of our 2012 to 2016 free surplus expectation at the end of 2010. Market effects and foreign exchange movements reduced expected free surplus generation for the next five years by £609 million and £52 million respectively. Market movements in Asia include the effect of lower fund-earned rates in Indonesia, Singapore and Hong Kong where government yields have fallen by 165 bps, 110 bps and 140 bps respectively. In the US, lower US treasury bond yields have led to a reduction in the assumed variable annuity separate return, which has had a consequential negative impact on the level of projected future fees. Market movements in the UK primarily reflect the adverse effect on with-profits bonus rates of lower assumed investment returns. At 31 December 2011, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £34 billion. Notwithstanding the drag on future earnings caused by the market effects on fee and with-profits business referred to above, the expected free surplus generation over the next 40 years has increased. This reflects both our ability to write new business on very attractive economics and the robust management of the in-force book. Actual underlying free surplus generated in 2011 from life business in-force at the end of 2010 was £2.2 billion, inclusive of £0.2 billion of changes in operating assumption and experience variances. This compares with the expected 2011 realisation at the end of 2010 of £1.9 billion. This can be analysed further as follows: Asia £m
Underlying free surplus generated from in-force life business in 2011 707 950 503 2,160 2011 free surplus expected to be generated at 31 December 2010 635 852 436 1,923
IV(a): Reconciliation of expected transfer of fair value of in-force (VIF) and required capital business of free surplus continued
The equivalent discounted amounts of the undiscounted totals shown previously are outlined below: 2011 £m
Internal funds under management 250.8 239.7 External fundsnote (i) 99.8 100.4
Asian operations US operations UK operations Total 2011 £bn 2010 £bn 2011 £bn £bn 2011 £bn £bn 2011 £bn 2010 £bn
Investment propertiesnote (i) – – – 0.1 10.7 11.5 10.7 11.6 Equity securities 12.0 14.5 38.1 31.5 37.3 40.7 87.4 86.7 Debt securities 17.7 14.1 27.1 26.4 79.8 75.9 124.6 116.4 Loans and receivables 2.4 1.3 4.3 4.2 13.7 3.8 20.4 9.3 Other investments 0.5 1.0 2.4 1.4 4.8 13.3 7.7 15.7
Total Asian insurance operations after development costs 704 529 Eastspring Investments 80 73
The Group maintains four share option schemes satisfied by the issue of new shares. UK-based executive directors are eligible to participate in the UK Savings Related Share Option Scheme, and Asia-based executives can participate in the International Savings Related Share Option Scheme. Dublin-based employees are eligible to participate in the Prudential International Assurance Sharesave Plan, and Hong Kong-based agents can participate in the Non-employee Savings Related Share Option Scheme. Further details of the schemes and accounting policies are detailed in Note I4 of the IFRS basis condensed consolidated financial statements. All options were granted at £nil consideration. No options have been granted to substantial shareholders, suppliers of goods or services (excluding options granted to agents under the Non-employee Savings Related Share Option Scheme) or in excess of the individual limit for the relevant scheme.
The weighted average share price of Prudential plc for the year ended 31 December 2011 was £6.86 (2010: £5.68). Particulars of options granted to directors are included in the Directors’ Remuneration Report on page 134. The closing price of the shares immediately before the date on which the options were granted during the current period was £5.99. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2011.
End of period 01 Oct 2003 3.62 01 Dec 2010 31 May 2011 2,775 – 1,850 – – 925 – 15 Apr 2004 3.46 01 Jun 2011 30 Nov 2011 17,946 – 17,946 – – – – 30 Sep 2004 3.43 01 Dec 2011 31 May 2012 8,430 – 4,522 – – 56 3,852 12 Apr 2005 3.87 01 Jun 2012 30 Nov 2012 12,222 – 3,321 – – 373 8,528 29 Sep 2005 4.07 01 Dec 2010 31 May 2011 10,597 – 10,597 – – – – 29 Sep 2005 4.07 01 Dec 2012 31 May 2013 9,492 – 237 – – 183 9,072 20 Apr 2006 5.65 01 Jun 2011 30 Nov 2011 13,884 – 13,771 – – 113 – 20 Apr 2006 5.65 01 Jun 2013 30 Nov 2013 7,564 – 114 – – 128 7,322 28 Sep 2006 4.75 01 Dec 2011 31 May 2012 48,003 – 35,810 – – 1,164 11,029 28 Sep 2006 4.75 01 Dec 2013 31 May 2014 13,325 – – – – – 13,325 26 Apr 2007 5.72 01 Jun 2010 30 Nov 2010 3,558 – 495 – – 198 2,865 26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 8,337 – – – – 1,146 7,191 26 Apr 2007 5.72 01 Jun 2014 30 Nov 2014 503 – – – – – 503 27 Sep 2007 5.52 01 Dec 2010 31 May 2011 25,033 – 21,910 – – 3,123 – 27 Sep 2007 5.52 01 Dec 2012 31 May 2013 17,870 – 86 121 – 399 17,264 27 Sep 2007 5.52 01 Dec 2014 31 May 2015 1,668 – – – – – 1,668 25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 50,952 – 45,633 682 – 4,637 – 25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 28,220 – 168 – – 953 27,099 25 Apr 2008 5.51 01 Jun 2015 30 Nov 2015 1,670 – 73 – – 53 1,544 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 153,998 – 103,089 2,628 5,525 2,139 40,617 25 Sep 2008 4.38 01 Dec 2013 31 May 2014 49,036 – 401 – 765 517 47,353 25 Sep 2008 4.38 01 Dec 2015 31 May 2016 14,857 – 709 1,660 – 1,117 11,371 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 3,138,322 – 185,439 24,356 60,965 99,908 2,767,654 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 1,993,530 – 61,175 17,362 26,585 98,560 1,789,848 27 Apr 2009 2.88 01 Jun 2016 30 Nov 2016 202,734 – 4,560 7,960 1,137 10,109 178,968 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 264,812 – 13,167 14,601 2,348 10,401 224,295 25 Sep 2009 4.25 01 Dec 2014 31 May 2015 101,327 – 955 5,928 731 2,848 90,865 28 Sep 2010 4.61 01 Dec 2013 31 May 2014 314,557 – 2,996 12,636 11,310 15,646 271,969 28 Sep 2010 4.61 01 Dec 2015 31 May 2016 134,638 – – 334 – – 134,304 16 Sep 2011 4.66 01 Dec 2014 31 May 2015 – 491,329 – 4,828 1,081 – 485,420 16 Sep 2011 4.66 01 Dec 2016 31 May 2017 – 202,210 – 4,573 – – 197,637
The total number of securities available for issue under the scheme is 40,004, which represents 0.002 per cent of the issued share capital at 31 December 2011. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £7.10.
The total number of securities available for issue under the scheme is 4,145,787, which represents 0.163 per cent of the issued share capital at 31 December 2011. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £6.58. The fair values of options granted under the Plan in the period was £2.63.
Global financial markets have experienced, and continue to experience, significant volatility brought on, in particular, by concerns over European and US sovereign debt, as well as concerns about a general slowing of global demand reflecting an increasing lack of confidence among consumers, companies and governments. Upheavals in the financial markets may affect general levels of economic activity, employment and customer behaviour. For example, insurers may experience an elevated incidence of claims, lapses, or surrenders of policies, and some policyholders may choose to defer or stop paying insurance premiums. The demand for insurance products may also be adversely affected. If sustained, this environment is likely to have a negative impact on the insurance sector over time and may consequently have a negative impact on Prudential’s business and profitability. New challenges related to market fluctuations and general economic conditions may continue to emerge.
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. In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates.
Declines in spread from these products or other spread businesses that Jackson conducts could have a material impact on its businesses or results of operations. Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. There could be market circumstances where the derivatives that it enters into to hedge its market risks may not fully offset its losses, and any cost of the guarantees that remain unhedged will also affect Prudential’s results.
European Embedded Value (‘EEV’) basis results are published as supplementary information by Prudential using principles issued by the European CFO (Chief Financial Officers) Forum. The EEV basis is a value-based reporting method for Prudential’s long-term business which is used by market analysts, and which underpins a significant part of the key performance indicators used by Prudential’s management for both internal and external reporting purposes.
The resolution of several issues affecting the financial services industry could have a negative impact on Prudential’s reported results or on its relations with current and potential customers Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the UK and internationally. These actions could involve a review of business sold in the past under acceptable market practices at the time, such as the requirement in the UK to provide redress to certain past purchasers of pension and mortgage endowment policies, changes to the tax regime affecting products and regulatory reviews on products sold and industry practices, including, in the latter case, businesses it has closed.
Regulators particularly, but not exclusively, in the US and the UK are moving towards a regime based on principles-based regulation which brings an element of uncertainty. These regulators are increasingly interested in the approach that product providers use to select third party distributors and to monitor the appropriateness of sales made by them. In some cases, product providers can be held responsible for the deficiencies of third-party distributors.
Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential is, and may be in the future, subject to legal actions, disputes and regulatory investigations in the ordinary course of its insurance, investment management and other business operations. These legal actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations (including tax) or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provided in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s results of operations or cash flows.
Adverse experience in the operational risks inherent in Prudential’s business could have a negative impact on its results of operations Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential outsources several operations, including a significant part of its UK back office and customer-facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments. The Group’s insurance and investment management operations are generally conducted through direct and indirect subsidiaries.
Annuity A contract providing for periodic payments to an annuitant for a specified period of time, often until the annuitant’s death.
Cede When an insurer reinsures its risk with another insurer, it ‘cedes’ business.
Claim An occurrence that is the basis for submission and/or payment of a benefit under an insurance policy. Depending on the terms of the insurance policy, a claim may be covered, limited or excluded from coverage.
Collateralised debt obligation fund (CDO fund) An asset backed security and structured credit product. CDOs gain exposure to the credit of a portfolio of assets and divide the credit risk among different tranches, with any losses initially applied to the most junior tranches and moving up to the more senior tranches should these be exhausted.
Commission A fee paid to an agent or broker by an insurance company for services rendered in connection with the sale or maintenance of an insurance product.
Constant exchange rate (CER) Constant exchange rate – Prudential plc reports its results at both actual exchange rates (AER) to reflect actual results and also constant exchange rates, so as to eliminate the impact from exchange translation.
Deferred acquisition costs or DAC Acquisition costs are expenses of an insurer which are incurred in connection with the acquisition of new insurance contracts, or the renewal of existing insurance policies. They include commissions and other variable sales inducements and the direct costs of issuing the policy, such as underwriting and other policy issue expenses. Typically, under IFRS, an element of acquisition costs is deferred ie not expensed in the year incurred, and instead, amortised in the income statement in line with the emergence of surpluses on the related contracts.
Defined benefit pension scheme An occupational scheme where the benefits paid to the annuitant depend on the number of years in service and the salary at the time of retirement. Also known as a final salary scheme in the UK.
• whose amount or timing is contractually at the discretion of the issuer, and
• that are contractually based on asset, fund, company or other entity performance as discussed in IFRS 4.
Earnings per share (EPS) Total earnings divided by the number of shares outstanding. Basic EPS uses a weighted average number of shares outstanding during the year. For diluted earnings per share, the weighted average number of shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares.
Economic assumptions Assumptions about economic variables such as interest rates, economic growth and inflation.
European Embedded Value or EEV Financial results prepared in accordance with a set of Principles issued by the Chief Financial Officers Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance of EEV Disclosures published in October 2005.
Fair value The price that a reasonable buyer would be willing to pay and a reasonable seller would be willing to accept for a product on the open market.
Generally accepted accounting principles (GAAP) A widely accepted set of rules, conventions, standards and procedures for reporting financial information of a national standard setter.
d d itio n a l in fo rm atio n
Group free surplus Group free surplus at the end of the period comprises free surplus for the insurance businesses, representing the excess of the net worth over the required capital included in the EEV results, and IFRS net assets for the asset management businesses excluding goodwill. The free surplus generated during the period comprises the movement in this balance excluding foreign exchange, capital movements and other reserve movements. Specifically, it includes amounts maturing from the in-force operations during the period less the investment in new business, the effect of market movements and other one-off items.
Holding company cash flow The cash flow of Prudential plc, the ultimate parent company, and its central finance subsidiaries.
IGD surplus The Prudential Group’s solvency surplus, measured in accordance with the EU Insurance Groups Directive.
Internal rate of return (IRR) The IRR is equivalent to the discount rate at which the present EEV value of the post-tax cash flows expected to be earned over the life time of the business written in shareholder-backed life funds is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is equal to the amount required to pay acquisition costs and set up reserves less premiums received, plus encumbered capital. The impact of the time value of options and guarantees is included in the calculation.
Loans Policy loans, mortgage loans on residential and commercial real estate and other loans outside of Prudential Group.
Money Market Fund (MMF) A MMF is an open-ended mutual fund that invests in short-term debt securities such as US treasury bills and commercial paper. The purpose of an MMF is to provide investors with a safe place to invest easily accessible cash-equivalent assets characterised as a low-risk, low-return investment.
Mortality rate Rate of death, varying by such parameters as age, gender and health, used in pricing and computing liabilities for future policyholders of life and annuity products, which contain mortality risks.
Net premiums Life insurance premiums net of reinsurance premiums ceded to third party reinsurers.
Operating profits based on longer-term investment returns • IFRS basis – operating profits based on longer-term investment returns are IFRS profit before tax attributable to shareholders, which, inter alia, excludes short-term fluctuations in investment returns, the shareholders’ share of actuarial gains and losses on defined benefit pension schemes, profits and losses on the sale or dilution of the Group’s businesses and other significant non-operational items included in the total profit.
Reinsurance The practice whereby an insurer, in consideration of a premium paid to it, agrees to indemnify another party for part or all of the liabilities assumed by the reinsured party under an insurance contract, which the reinsured party has issued.
Subordinated debt A fixed interest issue or debt that ranks below other debt in order of priority for repayment if the issuer is liquidated. Holders are compensated for the added risk through higher rates of interest. Under EU insurance regulation, subordinated debt is not treated as a liability and counts towards the coverage of the required minimum margin of solvency, with limitations.
Surrender The termination of a life insurance policy or annuity contract at the request of the policyholder, after which the policyholder receives the cash surrender value, if any, of the contract.
Total shareholder return (TSR) TSR represents the growth in the value of a share, plus the value of dividends paid, assuming that the dividends are reinvested in the Company’s shares on the ex-divided date.
Underwriting The process of examining, accepting or rejecting insurance risks, and classifying those accepted, in order to charge an appropriate premium for each accepted risk.
Unit-linked products or unit-linked contracts See ‘investment-linked products or investment-linked contracts’ above.
Universal life An insurance product where the customer pays flexible premiums, subject to specified limits, that are accumulated in an account and are credited with interest (at a rate either set by the insurer or reflecting returns on a pool of matching assets). The customer may vary the death benefit and the contract may permit the customer to withdraw the account balance, typically subject to a surrender charge.
Whole of life A type of life insurance policy that provides lifetime protection, premiums must usually be paid for life. The sum assured is paid out whenever death occurs. Commonly used for estate planning purposes.
Payment date 24 May 2012 24 May 2012 On or about
Cash dividend alternative The Company operates a Dividend Re-investment Plan (DRIP). Shareholders who have elected for the DRIP will automatically receive shares for all future dividends in respect of which a DRIP alternative is offered. The election may be cancelled at any time by the shareholder. Further details of the DRIP and the timetable are available on the Company’s website at www.prudential.co.uk/prudential-plc/investors
For enquiries about shareholdings, including dividends and lost share certificates, please contact the Company’s registrars: By post Equiniti Limited Aspect House Spencer Road Lancing West Sussex BN99 6DA
Calls to 0871 numbers are charged at 8 pence per minute from a BT landline. Lines are open from 8.30 am to 5.30 pm (UK), Monday to Friday. Other telephone providers’ costs may vary.
Share dealing services The Company’s Registrar, Equiniti, offer a postal dealing facility for buying and selling Prudential plc ordinary shares, please see the Equiniti address on page 476 or telephone 0871 384 2248. They also offer a telephone and internet dealing service, Shareview, which provides a simple and convenient way of selling Prudential plc shares. For telephone sales call 0871 384 2020 between 8.30am and 4.30pm, Monday to Friday, and for internet sales log on to www.shareview.co.uk/dealing
ShareGift Shareholders who have a small number of shares the value of which makes them uneconomic to sell them may wish to consider donating them to ShareGift (Registered Charity 1052686). The relevant share transfer form may be downloaded from our website www.prudential.co.uk/prudential-plc/investors/shareholder_ services/forms or from Equiniti. Further information about ShareGift may be obtained on +44 (0)20 7930 3737 or from www.ShareGift.org. There are no implications for capital gains tax purposes (no gain or loss) on gifts of shares to charity and it is also possible to obtain income tax relief.
Irish branch register The Company operates a branch register for shareholders in Ireland. All enquiries regarding Irish branch register accounts should be directed to Capita Registrars (Ireland) Limited, Unit 5, Manor Street Business Park, Manor Street, Dublin 7. Telephone: +353 1 810 2400
American Depositary Receipts (ADRs) The Company’s ordinary shares are listed on the New York Stock Exchange in the form of American Depositary Shares, evidenced by ADRs and traded under the symbol PUK. Each American Depositary Share represents two ordinary shares. All enquiries regarding ADR holder accounts should be directed to JP Morgan, the authorised depositary bank, at JP Morgan Chase & Co, PO Box 64504, St. Paul, MN 55164-0504, USA. Telephone +1 800 990 1135 or from outside the US +1 651 453 2128 or log on to www.adr.com
Singapore shareholder enquiries Shareholders who have shares standing to the credit of their securities accounts with CDP in Singapore, may refer queries to CDP at 4 Shenton Way, #02-01, SGX Centre 2, Singapore 068807. Telephone +65 6535 7511. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker.
Forward-looking statements This document may contain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations, are forward-looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward-looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future financial condition or performance or other indicated results to differ materially from those indicated in any forward-looking statement. Such factors include, but are not limited to, future market conditions, fluctuations in interest rates and exchange rates, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives related to the financial crisis and the effect of the European Union’s ‘Solvency II’
requirements on Prudential’s capital maintenance requirements; the impact of competition, inflation, and deflation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards or accounting standards, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate; and the impact of legal actions and disputes. These and other important factors may, for example, result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefits. Further discussion of these and other important factors that could cause Prudential’s actual future financial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the ‘Risk factors’ heading of this document and the ‘Risk factors’ heading of Prudential’s most recent annual report on Form 20-F filed with the US Securities and Exchange Commission, as well as under the ‘Risk factors’ heading of any subsequent Prudential Half Year Financial Report. Prudential’s most recent Annual Report, Form 20-F and any subsequent Half Year Financial Report are/will be available on the Company’s website at www.prudential.co.uk
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