During 2017 the Committee considered the results of a Group‑wide risk culture assessment which built on the previous work of the Committee in this area. The assessment was intended to compare the Group’s risk culture against best practice behaviours, identify any areas which need improvement and provide high‑level industry benchmarking and peer comparison.
I meet the Material Subsidiary risk committee chairs to facilitate escalation of important matters and reporting of material issues to the Committee.
Since the year end, we welcomed Alice Schroeder as a member of the Committee with effect from 1 March 2018. Her biography is set out on page 87.
Liquidity Risk Management Plan, Systemic Risk Management Plan and Recovery Plan
Risk appetite The Risk Committee is responsible for recommending the Group’s overall risk appetite and tolerance to the Board.
The Committee approved the Group Risk Appetite Statement, which sets aggregate risk limits in respect of capital requirements, earnings volatility and liquidity as well as maintaining the existing tolerance levels associated with each of these limits.
The Risk Committee considered the results of a number of ‘deep dive’ reviews undertaken during 2017. These focused on risks embedded within the existing portfolio of products in our US, Asia and UK businesses.
The Cyber Strategy and Cyber Defence Plan articulates the strategic outcomes and key deliverables relating to our cyber resilience. The Group Cyber Risk Strategy was reviewed by the Risk Committee in mid‑2017. The Committee also reviewed the Cyber Defence Plan and were provided further detail around the implementation of the Cyber Strategy at the end of 2017.
Group top risks The Committee evaluated the Group’s top risks, considering recommendations for promoting additional risks, expanding the scope of existing risks, and removing those risks no longer requiring particular focus from the Committee. The Committee received regular reporting on the top risks and mitigating actions over the course of the year.
The Committee reviewed the methodology and annual calibration of the Solvency II internal model. The 2017 Major Model Change application was closely overseen by the Committee throughout the year and we approved the model changes as part of the submission of the application to the regulator.
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Reverse Stress Testing Stress and scenario testing is a key risk measurement and management tool for the Group. The Reverse Stress Test exercise was carried out to confirm the Group’s position as being significantly resilient to certain business failure scenarios. The report related to the Group’s year end 2017 position and was submitted to the PRA.
Company law requires the Directors to prepare financial statements for each financial year that give a true and fair view of the financial affairs of the Company and of the Group. The criteria applied in the preparation of the financial statements are set out in the statement of Directors’ responsibilities on pages 314 and 360. Company law also requires the Board to approve the Strategic report. In addition, the UK Code requires the Directors’ statement to state that they consider the Annual Report and financial statements, taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.
The Directors are further required to confirm that the Strategic report includes a fair review of the development and performance of the business, with a description of the principal risks and uncertainties. Such confirmation is included in the statement of Directors’ responsibilities on pages 314 and 360.
The Strategic report provides, on pages 43 and 44, a description of the Group’s capital position, financing and liquidity. The risks facing the Group’s business and how these are managed are discussed in the Report on the risks facing our business on pages 48 to 63.
Significant agreements impacted by a change of control Governance report 121
Structure of share capital, including changes during the year and restrictions on the transfer of securities, voting rights and significant shareholders
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Our Executive Directors’ remuneration at a glance 126 Summary of the current Directors’ remuneration policy 128 Annual report on remuneration 132 Supplementary information 154
This report has been prepared to comply with Schedule 8 of The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, as well as the Companies Act 2006 and other related regulations.
By way of preface, I would like to share the context for the key decisions the Committee took during 2017, in particular, how we rewarded the performance achieved in 2017 and the decisions relating to remuneration arrangements in 2018. I am also delighted to welcome Thomas Watjen, who joined the Committee in July 2017.
Implementing the Directors’ remuneration policy During 2017, the Committee operated all elements of remuneration in line with the Directors’ remuneration policy, which received the support of 90.7 per cent of shareholders at the AGM in May 2017. As you may recall, the new policy simplified pay arrangements by reducing the number of annual bonus measures and by offering the Chief Executive of M&G awards under a single long‑term incentive plan rather than two. The policy also introduced a two‑year holding period on long‑term incentive awards and increased share ownership guidelines.
As set out in the Business review section earlier in this Annual Report, the Group delivered sustained growth in profit and cash in 2017.
Performance against business unit remittances and IFRS operating profit exceeded, or were closely aligned to, the stretching targets established by the Board. EEV new business profit delivered double digit growth, a strong result in the light of the challenges outlined in the business performance review and delivered a result approaching the Board approved targets. The Group achieved these results while maintaining appropriate levels of capital and operating within the Group’s risk framework and appetites. The Committee believes that the bonuses it awarded to Executive Directors for 2017 (between 89 per cent and 100 per cent of executives’ maximum opportunities) appropriately reflect this performance.
Performance in 2017 built on the momentum achieved in recent years. The Group delivered total IFRS operating profits of £12,924 million in 2015, 2016 and 2017 financial years. I am pleased to say that the continued impressive financial performance has translated into significant returns to the Company’s shareholders, with £100 invested on 1 January 2015 being worth £139 on 31 December 2017.
UK gender pay gap The UK business entities have recently reported their 2017 UK gender pay gap data and details can be found on www.prudential.co.uk. We have a policy and carry out procedures to ensure that, where men and women perform similar roles, they are paid equally. However, the gender pay gaps demonstrate the demographic profile of the business (and the financial services sector more widely): there is a greater proportion of males in more senior and front‑office roles and a greater proportion of females in more junior, support and back‑office non‑finance roles. All the Group’s businesses are working on initiatives to increase the proportion of women in senior management and operating roles as part of the Group’s strategic focus on diversity and inclusion as described in the Diversity and Inclusion Statement on our website. This important priority is reflected in the Group’s reward structure as a result of the diversity measure attached to PLTIP awards granted from 2017 onwards.
I trust that you will find this report a clear account of the way in which the Committee has implemented the Directors’ remuneration policy during 2017.
CAGR4 (excluding Korea and UK bulk annuity new business profits): +15%
Stretching IFRS profit ranges set with reference to business plans approved by the Board
Salary increase of 2% in 2017Broadly aligned with pay budget for other employees
The Group Chief Executive has a maximum bonus opportunity of 200% of salary. For other Executive Directors the maximum is 180% of salary or less 2017 bonuses were paid based on financial performance or functional measures as well as personal objectives
For other Executive Directors, awards vest based on TSR, Group IFRS operating profit and balanced scorecard measures
Significant share ownership guidelines for all Executive Directors as follows: — 400% of salary for the Group Chief Executive — 250% of salary for other Executive Directors
Key Fixed pay Short‑term variable pay Long‑term variable pay Share ownership guidelines
Notes 1 The Chief Executive, NABU also receives a 10% share of the Jackson bonus pool. 2 The Chief Executive, M&G retains separate bonus arrangements.
In particular, the long‑term incentives awarded to Executive Directors in 2015 had stretching performance conditions attached to vesting and were denominated in shares or ADRs. The value generated for shareholders through share price growth and dividends paid over the last three years is reflected in the value of the LTIP releases.
The value of these performance‑related elements of remuneration is added to the fixed packages provided to Executive Directors to calculate the 2017 ‘single figure’ of total remuneration. The total 2017 ‘single figure’ for the Group Chief Executive is higher than the total 2016 ‘single figure’, which is chiefly a result of the higher value of the 2015 PLTIP release. The values for the current Executive Directors who were Directors during the year are outlined in the table below: Executive Director Role
Mark FitzPatrick1 Chief Financial Officer £335,000 £102,000 £1,197,000 – £1,634,000 N/A John Foley Chief Executive,
Nic Nicandrou2 Chief Executive, PCA3 £869,000 £521,000 £1,414,000 £2,016,000 £4,820,000 £4,184,000
Barry Stowe Chairman & CEO, NABU4 £880,000 £279,000 £5,354,000 £3,109,000 £9,622,000 £7,679,000 Mike Wells Group Chief Executive £1,103,000 £769,000 £2,072,000 £4,758,000 £8,702,000 £7,370,000
Chief Executive, Prudential Corporation Asia. 3 PCA is an abbreviation of Prudential Corporation Asia. 4 NABU is an abbreviation of North American Business Unit which includes Jackson National Life and PPM America.
Mark FitzPatrick Chief Financial Officer £745,000 175% 40% 250% John Foley Chief Executive, M&G Prudential £781,000 180% 40% 250% Nic Nicandrou Chief Executive, PCA HK$10,710,000 180% 40% 250% Anne Richards1 Chief Executive, M&G £408,000 600% 40% 450% Barry Stowe2 Chairman & CEO, NABU US$1,157,000 160% 40% 460% Mike Wells Group Chief Executive £1,126,000 200% 40% 400%
Notes 1 The bonus opportunity for the Chief Executive, M&G remains the lower of 0.75 per cent of M&G’s IFRS operating profit or six times salary. 2 The Chairman & CEO, NABU will also continue to have a 10 per cent share of the Jackson bonus pool. 40 per cent of this is deferred in shares. 3 The PLTIP award is subject to a three‑year performance period and a further two‑year holding period.
The Company’s Directors’ remuneration policy was approved by shareholders at the 2017 AGM. This policy came into effect following the AGM on 18 May 2017 and is expected to apply until the 2020 AGM, when shareholders will be asked to approve a revised Directors’ remuneration policy.
Salary The Committee reviews salaries annually, considering factors such as: — Salary increases for other employees across the Group; — The performance and experience of the executive; — The size and scope of the role; — Group and/or business unit financial performance; — Internal relativities; and
Annual salary increases for Executive Directors will normally be in line with the increases for other employees across our business units. However, there is no prescribed maximum annual increase.
Benefits Executive Directors are offered benefits which reflect their individual circumstances and are competitive within their local market, including: — Health and wellness benefits; — Protection and security benefits; — Transport benefits; — Family and education benefits; — All employee share plans and savings plans; — Relocation and expatriate benefits; and
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Annual bonus Currently all Executive Directors participate in the Annual Incentive Plan (AIP).
AIP awards for all Executive Directors, other than the Group Chief Risk Officer, are subject to the achievement of financial and personal objectives. The Group Chief Risk Officer’s performance measures are entirely based on a combination of functional and personal measures.
The financial measures used for the annual bonus will typically include profit and cash flow targets and payments depend on the achievement of minimum capital thresholds. Jackson’s profitability and other key financial measures determine the value of the Jackson Senior Management Bonus Pool.
The Chief Executive, M&G has a bonus opportunity of the lower of six times salary or 0.75 per cent of M&G’s IFRS profit. For other Executive Directors the maximum AIP opportunity is up to 200 per cent of salary. Annual awards are disclosed in the relevant Annual report on remuneration.
In addition to the AIP, the Chairman and CEO, NABU receives a 10 per cent share of the Jackson Senior Management Bonus Pool.
The full policy sets out the Committee’s powers in respect of Executive Directors joining or leaving the Board, where a change in performance conditions is appropriate or in the case of corporate transactions (such as a takeover, merger or rights issue). The policy also describes legacy long‑term incentive plans under which some Executive Directors continue to hold awards.
John Foley Mark FitzPatrick Anne Richards Barry Stowe Nic Nicandrou Mike Wells
Note The scenarios in the chart above have been calculated on the following assumptions: Minimum In line with expectations Maximum
Travel and expenses for Non‑executive Directors are incurred in the normal course of business, for example, in relation to attendance at Board and Committee meetings. The costs associated with these are all met by the Company.
Non‑executive Directors are expected to attain this level of share ownership within three years of their appointment.
The Chairman receives an annual fee for the performance of the role. On appointment, the fee may be fixed for a specified period of time. Fees will otherwise be reviewed annually with any changes effective from 1 July.
The Chairman is not eligible to participate in annual bonus plans or long‑term incentive plans.
The Chairman may be offered benefits including: — Health and wellness benefits; — Protection and security benefits; — Transport benefits; — Reimbursement of business expenses (and any associated tax liabilities) incurred when travelling overseas in performance of duties; and
The Board has established Audit, Remuneration, Risk and Nomination & Governance Committees as principal standing committees of the Board. These committees form a key element of the Group governance framework.
The operation of the Remuneration Committee Members Anthony Nightingale (the Chair of the Committee) Kai Nargolwala Philip Remnant Thomas Watjen (member since 11 July 2017)
The principal responsibilities of the Committee are: — Determining and recommending to the Board for approval, the framework and policy for the remuneration of the Chairman, Executive Directors and other members of the Group Executive Committee; — Approving the design of performance‑related pay schemes operated for the Executive Directors and other members of the Group Executive Committee, and determining the targets and individual payouts under such schemes; — Reviewing the design and development of all share plans requiring approval by the Board and/or the Company’s shareholders; — Approving the share ownership guidelines for the Chairman and Executive Directors and other members of the Group Executive Committee, and monitoring compliance; — Reviewing and approving individual packages for the Executive Directors and other members of the Group Executive Committee, and the fees of the Chairman and the Non‑executive Directors of the Group’s material subsidiaries; — Reviewing and approving packages to be offered to newly recruited Executive Directors and other members of the Group Executive Committee; — Reviewing and approving the structure and quantum of any severance package for Executive Directors and other members of the Group Executive Committee; — Ensuring the process for establishing remuneration policy is transparent and consistent with the Group’s risk framework and appetites, encouraging strong risk management and solvency management practices and taking account of remuneration practices across the Group; — Monitoring the remuneration and risk management implications of remuneration of senior executives across the Group, other selected roles and those with an opportunity to earn in excess of £1 million in a particular year; and
May 2017 Approve remuneration arrangements for a new Executive Director and an Executive Director whose role changed and separation arrangements for an Executive Director who stepped down from the Board.
September 2017 Review proposed 2018 remuneration arrangements ahead of consultation with shareholders; approve the Solvency II Remuneration Policy Statement; and review the Remuneration Committee’s terms of reference.
During 2017, Deloitte LLP was the independent adviser to the Committee. Deloitte was appointed by the Committee in 2011 following a competitive tender process. As part of this process, the Committee considered the services that Deloitte provided to Prudential and its competitors, as well as other potential conflicts of interest. Deloitte is a member of the Remuneration Consultants’ Group and voluntarily operates under their code of conduct when providing advice on executive remuneration in the UK. Deloitte regularly meet with the Chair of the Committee without management present. The Committee is comfortable that the Deloitte engagement partner and team providing remuneration advice to the Committee do not have connections with Prudential that may impair their independence and objectivity. The total fees paid to Deloitte for the provision of independent advice to the Committee in 2017 were £56,000 charged on a time and materials basis. During 2017, Deloitte gave Prudential management advice on remuneration, as well as providing guidance on capital optimisation, digital and technology, taxation, internal audit, real estate, global mobility and other financial, risk and regulatory matters. Remuneration advice is provided by an entirely separate team within Deloitte.
* Benefits include (where provided) the cost of providing the use of a car and driver, medical insurance, security arrangements and relocation/expatriate benefits. † The deferred part of the bonus is subject to malus and clawback in accordance with the malus and clawback policies but no further conditions. ‡ In line with the regulations, the estimated value of PLTIP releases in 2017 has been calculated based on the average share/ADR price over the last three months of 2017 (£18.52/$49.12).
The actual value of PLTIPs, based on the share price on the date awards are released, will be shown in the 2018 report. § 2017 pension benefits include cash supplements for pension purposes and contributions into DC schemes as outlined on page 142. ¶ Each remuneration element is rounded to the nearest £1,000 and totals are the sum of these rounded figures. Total remuneration is calculated using the methodology prescribed by
4 To facilitate her appointment as Chief Executive, M&G, in 2016 Anne Richards’s benefits include travel costs from Anne’s home in Edinburgh to London of £15,000. 5 Barry Stowe’s bonus figure excludes a contribution of £16,200 from a profit sharing plan which has been made into a 401(k) retirement plan in respect of his role as Chairman & CEO,
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Notes 1 John Foley was appointed to the Board on 19 January 2016. The remuneration above was paid in respect of his service as an Executive Director, other than the LTIP releases which related to his previous role. 2 Michael McLintock stepped down from the Board on 6 June 2016. The remuneration above was paid in respect of his service as an Executive Director.
Remuneration in respect of performance in 2017 Base salary Executive Directors’ salaries were reviewed in 2016 with changes effective from 1 January 2017. When the Committee took these decisions it considered: — The salary increases awarded to other employees, which vary across our business units, reflecting local market conditions; — The performance and experience of each Executive Director; — The relative size of each Executive Director’s role; and
Anne Richards Chief Executive, M&G — McLagan UK Investment Management Survey
Barry Stowe Chairman & CEO, NABU — Towers Watson US Financial Services Survey
Notes 1 Mark FitzPatrick was appointed Chief Financial Officer on 17 July 2017. The annualised 2017 salary above was paid in respect of his service as Chief Financial Officer. 2 John Foley was appointed Chief Executive, UK and Europe on 19 January 2016. The annualised 2016 salary above was paid in respect of his service as Chief Executive, UK and Europe. 3 Penny James stepped down from the Board on 30 September 2017.
Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017. The maximum bonus opportunity shown represents his annual opportunity as an Executive Director. This was not pro‑rated for the portion of the year for which he was an Executive Director, as Mark did not receive a 2017 bonus from his previous employer. 2 Penny James stepped down from the Board on 30 September 2017. The maximum bonus opportunity shown represents her annual opportunity as an Executive Director but no bonus was paid.
2017 AIP performance measures and achievement Target-setting process For the financial AIP metrics, the performance ranges are set by the Remuneration Committee prior to, or at the beginning of, the performance period based on the annual business plans approved by the Board. These reflect the ambitions of the Group and business units, in the context of anticipated market conditions.
The level of performance required for threshold, plan and maximum payment against the Group’s 2017 Annual Incentive Plan financial measures and the results achieved are set out below.
— Specific goals related to the business or function for which they are responsible and progress on major projects.
At its meeting in March 2018, the Committee concluded that there had been a high level of performance against these 2017 objectives, as summarised below: Business Overview of objectives 2017 highlights
— Highly commended in the 2017 Building Public Trust in Corporate Reporting Awards in the category for tax reporting; — Developed executive bench strength and succession and emerging talent to leverage high potential talent across the Group as demonstrated by the appointment of the former Group Chief Financial Officer as Chief Executive, Prudential Corporation Asia; and
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Objectives included leveraging digital opportunities, developing our product range and focusing on core business areas
— Launched Jackson’s The Financial Freedom Studio which aims to make retirement and investment choices easier to understand; — Introduced ‘Retire on Purpose’, a new platform with a focus on thoughtful life planning as a crucial first step towards creating a comprehensive financial plan; — Launched Perspective Advisory II and Elite Access Advisory to serve advisers and distributors with a preference for advisory products, and launched Private Wealth Shield, entering the Private Wealth and Trust Market; and
2017 Annual Incentive Plan payments On the basis of the strong performance of the Group and its business units, and the Committee’s assessment of each Executive Director’s personal performance, the Committee determined the following 2017 AIP payments: Executive Director Role 2017 salary1 Maximum 2017 AIP
Chief Executive, PCA HK$10,500,000 180% 90% £1,414,000 Anne Richards Chief Executive, M&G £400,000 600% 100% £2,400,000 Barry Stowe4 Chairman & CEO, NABU US$1,134,000 160% 94% £5,354,000 Mike Wells Group Chief Executive £1,103,000 200% 94% £2,072,000 Tony Wilkey5 Chief Executive, PCA HK$9,070,000 180% 89% £787,000
Notes 1 At 31 December 2017 or on stepping down from the Board if earlier. 2 As Mark FitzPatrick did not receive a bonus from his previous employer for 2017, his bonus was not pro‑rated. 3 Penny James stepped down from the Board on 30 September 2017 and no bonus was paid. 4 In addition to the Annual Incentive Plan, Barry Stowe also participates in the Jackson bonus pool (see below). 5 Tony Wilkey stepped down from the Board on 17 July 2017. The AIP shown above was paid in respect of his service as an Executive Director.
Disclosure of targets and achievement for the 2016 Annual Incentive Plan The level of performance required for threshold, plan and maximum payment against the Group’s 2016 Annual Incentive Plan financial measures and the results achieved are set out below.
Operating free surplus generated 25% 2,719 3,244 3,394 3,566 Group Solvency II surplus 7.5% 9,400 11,900 12,900 12,483
Prudential’s Group IFRS operating profit performance between 1 January 2016 to 31 December 2017 was 5 per cent above the stretch target established for 2016 PLTIP awards. The Group’s IFRS achievement between 1 January 2017 and 31 December 2017 was 2 per cent above the stretch target adopted for 2017 PLTIP award.
— Conduct measure During 2017, there were no significant conduct/culture/governance issues that resulted in significant capital add‑ons or material fines.
Under the Group TSR measure, 25 per cent of the award vests for TSR at the median of the peer group increasing to full vesting for performance within the upper quartile. TSR is measured on a local currency basis since this has the benefit of simplicity and directness of comparison. The peer group for the 2015 awards is: Aegon Aflac AIA AIG Allianz Aviva AXA Generali Legal & General Manulife MetLife Munich Re Old Mutual Prudential Financial Standard Life Sun Life Financial Swiss Re Zurich Insurance Group
Under the IFRS measure, 25 per cent of the award vests for meeting the threshold IFRS profit set at the start of the performance period increasing to full vesting for performance at or above the stretch level. The table below illustrates the cumulative performance achieved over 2015 to 2017 compared to the Group targets set in 2015: Group 2015-17 cumulative targets 2015-17 cumulative achievement Overall vestingThreshold Plan Maximum
The Committee determined that the cumulative IFRS operating profit target established for the PLTIP should be expressed using exchange rates consistent with the reported disclosures. All the individual business units exceeded their stretch performance target and achieved 100 per cent vesting, other than Asia which exceeded plan performance, but not the stretch target, and therefore vested at 87 per cent.
Details of business unit IFRS targets have not been disclosed as the Committee considers that these are commercially sensitive and disclosure of targets at such a granular level would put the Company at a disadvantage compared to its competitors. The Committee will keep this disclosure policy under review based on whether, in its view, disclosure would compromise the Company’s competitive position.
LTIP vesting The Committee considered a report from the interim Group Chief Risk Officer which had been approved by the Group Risk Committee. This report confirmed that the financial results were achieved within the Group’s and business units’ risk framework and appetite. On the basis of this report, and the performance of the Group and its business units described above, the Committee determined the vesting of each Executive Director’s LTIP awards as set out below.
Notes 1 The share price used to calculate the value of the LTIP awards with performance periods which ended on 31 December 2017 and vest in 2018 was the average share price/ADR price for the three months up to 31 December 2017, being £18.52/$49.12.
Tony Wilkey/Nic Nicandrou Pension supplement in lieu of pension of 25 per cent of salary and a HK$18,000 payment to the Hong Kong Mandatory Provident Fund.
UK‑based executives Pension contribution to defined contribution plan and/or pension supplement in lieu of pension of 25 per cent of salary.
John Foley previously participated in a non‑contributory defined benefit scheme that was open at the time he joined the Company. The scheme provided an accrual of 1/60ths of final pensionable earnings for each year of pensionable service. The normal retirement date is 60 years of age and during 2017 John elected to commence payment of his pension. John took a tax free cash sum of £103,551.06 and from March 2017 received pension payments equivalent to £15,533 per annum, which increased to £15,636 per annum from 1 April 2017, in line with the Consumer Prices Index. The pension will continue to be subject to statutory increases in line with the Consumer Prices Index.
Prudential TSR vs. FTSE 100 and peer group average – total return per cent over nine years to December 2017
Note The peer group average represents the average TSR performance of the peer group used for 2017 PLTIP awards (excluding companies not listed at the start of the period).
The information in the table below shows the total remuneration for the Group Chief Executive over the same period: Group Chief Executive M Tucker1 T Thiam T Thiam T Thiam T Thiam T Thiam T Thiam T Thiam2 M Wells M Wells M Wells
Group Chief Executive 2% (44.8)% (3.7)% All UK employees 3% 3.3% 6.3%
Relative importance of spend on pay The table below sets out the amounts payable in respect of 2016 and 2017 on all employee pay and dividends: Percentage change
Long-term incentives awarded in 2017 2017 share-based long-term incentive awards As detailed in the Directors’ remuneration policy, approved by shareholders at the 2017 AGM, all long‑term incentive awards made to Executive Directors in 2017 were granted under the PLTIP. The vesting of these awards will depend on: — Relative TSR (25 per cent of award); — Group or business unit IFRS operating profit (50 per cent of award); and
Conduct measure: Through appropriate management action, ensure there are no significant conduct/culture/governance issues that result in significant capital add‑ons or material fines.
Vesting basis: 100 per cent for achieving the Group’s expectations, otherwise 0 per cent vesting.
Diversity measure: Percentage of the Leadership Team that is female at the end of 2019. The target for this metric will be based on progress towards the goal that the Company set when it signed the Women in Finance Charter, specifically that 30 per cent of our Leadership Team will be female by the end of 2021. For this portion of PLTIP awards made in 2017 to vest, at least 27 per cent of our Leadership Team must be female by the end of 2019.
Vesting basis: 100 per cent vesting for achieving the target, otherwise 0 per cent vesting.
* Awards over shares were awarded to all Executive Directors other than Barry Stowe whose awards were over ADRs. † Awards for Executive Directors are calculated based on the average share price over the three dealing days prior to the grant date, being £16.75 and an ADR price of $42.12 for all
Executive Directors other than Mark FitzPatrick and £18.005 for Mark FitzPatrick. ‡ The 2017 balanced scorecard is assessed on a binary basis. The percentage of awards released for achieving maximum targets is 100 per cent.
This buy‑out award was made under rule 9.4.2 of the UKLA Listing Rules as the award could not be effected under any of the Company’s existing incentive plans. Anne is the sole participant in this arrangement and no further awards will be made to Anne under the arrangement.
Basic fee 95,000 97,000 Additional fees: Audit Committee Chair 75,000 75,000 Audit Committee member 27,500 27,500 Remuneration Committee Chair 60,000 60,000 Remuneration Committee member 27,500 27,500 Risk Committee Chair 75,000 75,000 Risk Committee member 27,500 27,500 Nomination Committee member 10,000 10,000 Senior Independent Director 50,000 50,000
2 Kai Nargolwala also received an annual fee of £250,000 (payable in HK$) in respect of his non‑executive chairmanship of Prudential Corporation Asia Limited with effect from 3 Philip Remnant also received an annual fee of £250,000 in respect of his non‑executive chairmanship of M&G Group Limited with effect from 1 April 2016. 4 Thomas Watjen joined the Board on 11 July 2017.
Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017. Total interest in shares is shown from this date. 2 Penny James stepped down from the Board on 30 September 2017. Total interest in shares is shown as at this date. 3 For the 1 January 2017 figure, Barry Stowe’s beneficial interest in shares is made up of 132,939 ADRs (representing 265,878 ordinary shares), (8,513.73 of these ADRs are held within an investment account which secures premium financing for a life assurance policy). For the 31 December 2017 figure the beneficial interest in shares is made up of 141,173 ADRs (representing 282,346 ordinary shares).
4 For the 1 January 2017 figure, Mike Wells’ beneficial interest in shares is made up of 218,576 ADRs (representing 437,152 ordinary shares) and 107,382 ordinary shares. For the 31 December 2017 figure his beneficial interest in shares is made up of 249,811 ADRs (representing 499,622 ordinary shares) and 163,001 ordinary shares.
5 Tony Wilkey stepped down from the Board on 17 July 2017. Total interest in shares is shown as at this date. 6 Ann Godbehere stepped down from the Board on 18 May 2017. Total interest in shares is shown as at this date. 7 For the 1 January 2017 and 31 December 2017 figure, Alice Schroeder’s beneficial interest in shares is made up of 4,250 ADRs (representing 8,500 ordinary shares). 8 Tom Watjen was appointed to the Board on 11 July 2017. Total interest in shares is shown from this date. For the 31 December 2017 figure, Tom Watjen’s beneficial interest in shares is made up of 2,750 ADRs (representing 5,500 ordinary shares). 9 James Turner, who joined the Board as Group Chief Risk Officer on 1 March 2018, has a total beneficial interest in 9,701 shares, awards over 82,976 shares subject to performance conditions and an option over 1,237 shares in the UK Prudential Savings‑Related Share Option Scheme. There was no change in his share interests between 1 and 13 March 2018.
Share ownership guideline as % of salary Beneficial interest as % of salary
John Foley Mark FitzPatrick Anne Richards Barry Stowe Mike Wells Nic Nicandrou
Outstanding share options The following table sets out the share options held by the Executive Directors in the UK Savings‑Related Share Option Scheme (SAYE) as at the end of the period. Anne Richards holds options under her buy‑out arrangement, details of which were set out on page 146.
Mark FitzPatrick 21 Sep 17 1,455 1,905.5 01 Dec 22 31 May 23 – 2,061 – – – – 2,061 John Foley 23 Sep 14 1,155 1,905.5 01 Dec 17 31 May 18 779 – 779 – – – – John Foley 21 Sep 16 1,104 1,905.5 01 Dec 19 31 May 20 815 – – – – – 815 John Foley 21 Sep 17 1,455 1,905.5 01 Dec 20 31 May 21 – 618 – – – – 618 Penny James 22 Sep 15 1,111 1,905.5 01 Dec 18 31 May 19 1,620 – – – – – 1,620 Nic Nicandrou 23 Sep 14 1,155 1,905.5 01 Dec 19 31 May 20 1,311 – – – – – 1,311 Nic Nicandrou 21 Sep 16 1,104 1,905.5 01 Dec 21 31 May 22 1,358 – – – – – 1,358 Anne Richards 21 Sep 16 1,104 1,905.5 01 Dec 19 31 May 20 1,630 – – – – – 1,630 Mike Wells 22 Sep 15 1,111 1,905.5 01 Dec 18 31 May 19 1,620 – – – – – 1,620
Subject to the Group Chief Executive’s or the Chairman’s approval, Executive Directors are able to accept external appointments as non‑executive directors of other organisations. Fees payable are retained by the Executive Directors.
Chairman Paul Manduca1 15 October 2010 AGM 2011 12 months AGM 2018 Non-executive Directors Philip Remnant 1 January 2013 AGM 2013 6 months AGM 2019 Howard Davies 15 October 2010 AGM 2011 6 months AGM 2018 Ann Godbehere2 2 August 2007 AGM 2008 6 months N/A David Law 15 September 2015 AGM 2016 6 months AGM 2019 Kai Nargolwala 1 January 2012 AGM 2012 6 months AGM 2018 Anthony Nightingale 1 June 2013 AGM 2014 6 months AGM 2020 Alice Schroeder 10 June 2013 AGM 2014 6 months AGM 2020 Lord Turner 15 September 2015 AGM 2016 6 months AGM 2019 Thomas Watjen3 11 July 2017 AGM 2018 6 months AGM 2018
Notes 1 Paul Manduca was appointed as Chairman on 2 July 2012. 2 Ann Godbehere retired from the Board at the 2017 AGM. 3 Thomas Watjen joined the Board on 11 July 2017.
Recruitment arrangements In making decisions about the remuneration arrangements for those joining the Board, the Committee worked within the Directors’ remuneration policy approved by shareholders and was mindful of: — The skills, knowledge and experience that each new Executive Director brought to the Board; — The need to support the relocation of executives to enable them to assume their roles; and
Mark FitzPatrick joined the Board during the year. As Mark did not need to relocate to enable him to assume his role and he had no awards from his previous employer to replace, there were no specific arrangements required for his recruitment.
Tony’s employment with the Group will end on 17 July 2018 and between 18 July 2017 and 31 December 2017 he received £1,345,308 in respect of salary, benefits and pension in accordance with his contract of employment. Tony did not receive a loss of office payment.
Notes 1 The number of shares vesting include accrued dividend shares. 2 The share price used to calculate the value was the average share price for the three months up to 31 December 2017, being £18.52.
Michael McLintock Michael McLintock’s employment with the Group ended on 31 July 2016. The 2016 Directors’ remuneration report provided details of the remuneration arrangements that would apply to Michael after he left the Board. During the year, tax was paid by the Company in 2017 on certain non‑payroll benefits received by Michael in 2016 (and reported in the Annual report on remuneration for 2016), which amounted to £7,496.
Michael holds a PLTIP award granted in 2015 and as set out in the section ‘Remuneration in respect of performance in 2017’ the performance condition attached to Michael’s 2015 PLTIP awards was partially met and 91.67 per cent of these awards will be released in 2018. These awards were pro‑rated for service (16 of 36 months) and the details of the release are set out below.
Additionally, Michael holds phantom share awards granted under the 2015 M&G Executive Long‑Term Incentive. The share price of those awards is determined by the increase or decrease in M&G’s profitability over the three‑year performance period with adjustments for the investment performance of its funds. These awards were pro‑rated for service (578 of 1,096 days) and M&G’s performance and the resulting phantom share price are shown below: Award Three-year profit growth of M&G
www.prudential.co.uk Annual Report 2017 Prudential plc 153 01 G roup overview 02 Strategic report 03 G
Statement of voting at general meeting At the 2017 Annual General Meeting, shareholders were asked to vote on the new Directors’ remuneration policy and the 2016 Directors’ remuneration report. Each of these resolutions received a significant vote in favour by shareholders and the Committee is grateful for this support and endorsement by our shareholders. The votes received were: Resolution Votes for % of votes cast Votes against % of votes cast Total votes cast Votes withheld
To approve the Directors’ remuneration report (2017 AGM) 1,754,440,188 88.86 219,921,823 11.14 1,974,362,011 26,736,043
— Performance against the balanced scorecard measures in the scorecard used for the 2018 PLTIP awards will be assessed on a vesting scale of threshold, target and maximum performance over a three‑year period rather than using the binary, meet/fail, approach used for the 2017 PLTIP awards.
On 1 March 2018, the Company announced that James Turner had joined the Board as Group Chief Risk Officer. James’s basic salary will be £625,000 per annum. He will have a maximum bonus opportunity of 160 per cent of base salary under the Annual Incentive Plan. In accordance with the Solvency II remuneration requirements, James’s bonus will be assessed solely on functional and personal objectives. Forty per cent of any bonus will be deferred into the Company’s shares for three years. Long‑term incentive awards, granted under the Prudential LTIP, will have a face value on grant of 250 per cent of base salary. In accordance with the Solvency II remuneration requirements, the vesting of James’s PLTIP awards will depend on TSR (50 per cent of award), Group IFRS operating profit (20 per cent of award) and the sustainability scorecard (30 per cent of award). James’s service contract contains a notice provision under which either party may terminate upon 12 months’ notice.
Chairman and Non-executive Directors Fees for the Chairman and Non‑executive Directors were reviewed in 2017 with changes effective from 1 July 2017, as set out on page 147. The next review will be effective 1 July 2018.
Notes 1 The awards for Barry Stowe were made in ADRs (1 ADR = 2 ordinary shares). The figures in the table are represented in terms of ordinary shares. 2 The awards in 2014 and 2015 for Mike Wells were made in ADRs (1 ADR = 2 ordinary shares). The awards in 2016 and 2017 were made in ordinary shares. The figures in the table are represented in terms of ordinary shares.
Face value of conditional share awards outstanding at 1 January 2017
Note Under the M&G Executive LTIP, the value of each unit at award is £1. The value of units changes based on M&G’s profit growth and investment performance over the performance period.
www.prudential.co.uk Annual Report 2017 Prudential plc 155 01 G roup overview 02 Strategic report 03 G
Conditional share awards outstanding at 1 Jan 2017 (number of shares)
Deferred 2013 annual incentive award 2014 32,950 32,950 – 31 Dec 16 03 Apr 17 1,317 1,653
Deferred 2014 annual incentive award 2015 29,046 754 29,800 31 Dec 17 1,672
Deferred 2015 annual incentive award 2016 111,618 2,900 114,518 31 Dec 18 1,279
Deferred 2014 annual incentive award 2015 120,686 3,136 123,822 31 Dec 17 1,672
Deferred 2016 annual incentive award 2017 51,371 1,332 52,703 31 Dec 19 1,672
All-employee share plans It is important that all employees are offered the opportunity to own shares in Prudential, connecting them both to the success of the Company and to the interests of other shareholders. Executive Directors are invited to participate in these plans on the same basis as other staff in their location.
Save As You Earn (SAYE) schemes UK‑based Executive Directors are eligible to participate in the HM Revenue and Customs (HMRC) approved Prudential Savings‑Related Share Option Scheme. This scheme allows all eligible employees to save towards the exercise of options over Prudential plc shares with the option price set at the beginning of the savings period at a discount of up to 20 per cent of the market price.
Cash-settled long-term incentive awards This information has been prepared in line with the reporting requirements of the Hong Kong Stock Exchange and sets out Executive Directors’ outstanding share awards and share options. For details of the cash‑settled long‑term incentive awards held by some Executive Directors, please see our Annual report on remuneration.
www.prudential.co.uk Annual Report 2017 Prudential plc 159 01 G roup overview 02 Strategic report 03 G
Index to Group IFRS financial statements 160 Parent company financial statements 305 Notes on the parent company financial statements 307 Statement of Directors’ responsibilities 314 Independent auditor’s report to Prudential plc 315
Primary statements Consolidated income statement 161 Consolidated statement of comprehensive income 162 Consolidated statement of changes in equity: 2017 163
B1.4 Segmental income statement 186 B1.5 Other investment return 188 B1.6 Additional analysis of performance by segment components B1.6(a) Asia 188 B1.6(b) US 189 B1.6(c) UK and Europe
B4 Tax charge 196 B5 Earnings per share 201 B6 Dividends 202
C Balance sheet notes C1 Analysis of Group statement of financial 203 position by segment C2 Analysis of segment statement of financial position by business type C2.1 Asia 206 C2.2 US 207 C2.3 UK and Europe 208
C3.1 Group assets and liabilities 209 C3.2 Debt securities 217 C3.3 Loans portfolio 223 C3.4 Financial instruments – additional information C3.4(a) Financial risk 225 C3.4(b) Derivatives and hedging 227 C3.4(c) Derecognition, collateral and offsetting 228
C4 Policyholder liabilities and unallocated C4.1 Movement and duration of liabilities C4.1(a) Group overview 230 C4.1(b) Asia insurance operations 233 C4.1(c) US insurance operations 235 C4.1(d) UK and Europe insurance operations 237 C4.2 Products and determining contract liabilities C4.2(a) Asia 239 C4.2(b) US 242 C4.2(c) UK and Europe 248
C7 Risk and sensitivity analysis C7.1 Group overview 259 C7.2 Asia insurance operations 261 C7.3 US insurance operations 262 C7.4 UK and Europe insurance operations 267 C7.5 Asset management and other operations 269
C9 Defined benefit pension schemes 271 C10 Share capital, share premium and own shares 277 C11 Provisions 278 C12 Capital
C12(b) Local capital regulations 279 C12(c) Transferability of available capital 281
www.prudential.co.uk Annual Report 2017 Prudential plc 161 01 G roup overview 02 Strategic report 03 G
Total charges, net of reinsurance and gain (loss) on disposal of businesses B1.4 (82,894) (68,812)
Share of profits from joint ventures and associates, net of related tax D6 302 182
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)* 3,970 3,212 Less tax charge attributable to policyholders' returns (674) (937)
Profit before tax attributable to shareholders B1.1 3,296 2,275 Total tax charge attributable to policyholders and shareholders B4 (1,580) (1,291) Adjustment to remove tax charge attributable to policyholders' returns 674 937 Tax charge attributable to shareholders' returns B4 (906) (354)
Other comprehensive income: Items that may be reclassified subsequently to profit or loss Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year A1 (404) 1,148 Cumulative exchange gain of sold Korea life business recycled through profit or loss (61) – Related tax (5) 13
Net unrealised valuation movements on securities of US insurance operations classified as available‑for‑sale: Net unrealised holding gains arising during the year 591 241 Net gains (losses) included in the income statement on disposal and impairment 26 (269)
Related change in amortisation of deferred acquisition costs C5 (b) (76) 76 Related tax C8 (55) (17)
Attributable to: Equity holders of the Company 2,494 3,020 Non‑controlling interests 1 –
www.prudential.co.uk Annual Report 2017 Prudential plc 163 01 G roup overview 02 Strategic report 03 G
Shareholders’ share of actuarial gains and losses on defined benefit pension schemes, net of related tax – – 89 – – 89 – 89
Reserve movements in respect of share‑based payments – – 89 – – 89 – 89 Change in non‑controlling interests* – 5 5
Net increase (decrease) in equity – 21 1,384 (470) 486 1,421 6 1,427 * Arising from the acquisition of the majority stake in Zenith Life of Nigeria in 2017.
Reserves Profit for the year – – 1,921 – – 1,921 – 1,921 Other comprehensive income: Exchange movements on foreign operations and net investment hedges, net of related tax – – – 1,161 – 1,161 – 1,161
Treasury shares Movement in own shares in respect of share‑based payment plans – – 2 – – 2 – 2 Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – (6) – – (6) – (6)
Equity securities and portfolio holdings in unit trusts 223,391 198,552 Debt securities C3.2 171,374 170,458 Derivative assets C3.4 4,801 3,936 Other investments 5,622 5,465
Liabilities Insurance contract liabilities C4.1 328,172 316,436 Investment contract liabilities with discretionary participation features C4.1 62,677 52,837 Investment contract liabilities without discretionary participation features C4.1 20,394 19,723 Unallocated surplus of with‑profits funds C4.1 16,951 14,317 Core structural borrowings of shareholder‑financed operations C6.1 6,280 6,798 Operational borrowings attributable to shareholder‑financed operations C6.2 1,791 2,317 Borrowings attributable to with‑profits operations C6.2 3,716 1,349 Obligations under funding, securities lending and sale and repurchase agreements 5,662 5,031 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 8,889 8,687 Deferred tax liabilities C8.1 4,715 5,370 Current tax liabilities C8.2 537 649 Accruals, deferred income and other liabilities 14,185 13,825
The consolidated financial statements on pages 161 to 304 were approved by the Board of Directors on 14 March 2018. They were signed on its behalf.
Cash flows from investing activities Purchases of property, plant and equipment C13 (134) (348) Proceeds from disposal of property, plant and equipment – 102 Acquisition of subsidiaries and intangiblesnote (v) (351) (303) Sale of businessesnote (v) 1,301 –
Cash flows from financing activities Structural borrowings of the Group: Shareholder‑financed operations:note (ii) C6.1
Net increase in cash and cash equivalents 734 1,281 Cash and cash equivalents at beginning of year 10,065 7,782 Effect of exchange rate changes on cash and cash equivalents (109) 1,002
Notes (i) This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders. (ii) Structural borrowings of shareholder‑financed operations exclude 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.
(iv) Tax paid includes £298 million (2016: £226 million) paid on profits taxable at policyholder rather than shareholder rates. (v) Net cash flows for corporate transactions are for distribution rights and acquisition and disposal of businesses (including private equity and other subsidiaries acquired by with‑profits funds for investment purposes).
www.prudential.co.uk Annual Report 2017 Prudential plc 167 01 G roup overview 02 Strategic report 03 G
The exchange movement arising during 2017 recognised in other comprehensive income is: Asia operations* (295) 785 US operations (477) 853 Unallocated to a segment (other funds)† 307 (490)
* 2017 included the recycling of the cumulative exchange gain of the sold Korea life business of £61 million to the income statement. † The exchange rate movement unallocated to a segment mainly reflects the translation of currency borrowings, issued by group holding companies, that have been designated as a net investment hedge against the currency risk of the Group’s investment in Jackson.
The preparation of these financial statements requires Prudential to make estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. Prudential evaluates its estimates, including those related to long‑term business provisioning and the fair value of assets. Below are set out those critical accounting policies the application of which requires the Group to make critical estimates and judgements. Also set out are further critical accounting policies affecting the presentation of the Group’s results and other items that require the application of critical estimates and judgements.
IFRS 4 requires contracts written by insurers to be classified as either ‘insurance’ contracts or ‘investment’ contracts. The classification of the contract determines its accounting. Judgement is applied in considering whether the material features of a contract gives rise to the transfer of significant insurance risk.
UK and Europe — With‑profits contracts — Bulk and individual annuity business
www.prudential.co.uk Annual Report 2017 Prudential plc 169 01 G roup overview 02 Strategic report 03 G
Measurement of insurance contract liabilities and investment contracts liabilities with discretionary participation features.
For those investment contracts in the US with fixed and guaranteed terms, the Group uses the amortised cost model to measure the liability. The US has no investment contracts with discretionary participation features.
The sensitivity of US insurance operations to variations in key estimates and assumptions, including policyholder behaviour, is discussed in note C7.3.
The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefits are based on published mortality tables adjusted to reflect actual experience.
Incremental, directly attributable acquisition costs relating to the investment management element of these contracts are capitalised and amortised in line with the related revenue. If the contracts involve up‑front charges, this income is also deferred and amortised through the income statement in line with contractual service provision in accordance with IAS 18.
www.prudential.co.uk Annual Report 2017 Prudential plc 171 01 G roup overview 02 Strategic report 03 G
£18,533 million of US income statement investment return arises from such derivatives and debt securities.
The Group has decided that, except for occasional circumstances, applying hedge accounting using IAS 39 to derivative instruments held by Jackson would not improve the relevance or reliability of the financial statements to such an extent that would justify the difficulty and cost of applying these provisions. As a result of this decision, the total income statement results are more volatile as the movements in the fair value of Jackson’s derivatives are reflected within it. This volatility is reflected in the level of short‑term fluctuations in investment returns, as shown in notes B1.1 and B1.2.
Under IAS 39, unless carried at amortised cost (subject to impairment provisions where appropriate) under the held‑to‑maturity category, debt securities are also carried at fair value. The Group has chosen not to classify any financial assets as held‑to‑maturity. Debt securities of Jackson are designated as available‑for‑sale with value movements, unless impaired, being recorded as movements within other comprehensive income. Impairments are recorded in the income statement.
Profit before tax attributable to shareholders is £3,296 million and compares to profit before tax of £3,970 million.
The Group uses operating profit based on longer‑term investment returns as the segmental measure of its results.
For shareholder‑backed business, with the exception of debt securities held by Jackson and assets classified as loans and receivables at amortised cost, all financial investments and investment property are designated as assets at fair value through profit or loss. Short‑term fluctuations in fair value affect the result for the year and the Group provides additional analysis of results before and after the effects of short‑term fluctuations in investment returns, together with other items that are of a short‑term, volatile or one‑off nature. The effects of short‑term fluctuations include asymmetric impacts where the measurement bases of the liabilities and associated derivatives used to manage the Jackson annuity business differ as described in note B1.2.
Short‑term fluctuations in investment returns on assets held by with‑profits funds in the UK, Hong Kong, Malaysia and Singapore, do not affect directly reported shareholder results. This is because (i) the unallocated surplus of with‑profits funds is accounted for as a liability and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from policyholder liabilities (including the unallocated surplus).
The Group applies judgement in determining qualifying costs that should be capitalised (ie those costs of acquiring new insurance business that meet the criteria under the Group’s accounting policy for deferred acquisition costs). It makes estimates in projecting future profits/ margins to assess whether adjustments to the carrying value or amortisation profile of deferred acquisition cost assets are necessary.
Except for acquisition costs of with‑profits contracts of the UK regulated with‑profits funds, which are accounted for under FRS 27, costs of acquiring new insurance business are accounted for in a way that is consistent with the principles of the ABI SORP with deferral and amortisation against margins in future revenues on the related insurance policies. In general, this deferral is shown by an explicit carrying value in the balance sheet. However, in some Asia operations the deferral is implicit through the reserving methodology. The recoverability of the deferred acquisition costs is measured and is deemed impaired if the projected margins (which are estimated based on a number of assumptions similar to those underlying policyholder liabilities) are less than the carrying value. To the extent that the future margins differ from those anticipated, then an adjustment to the carrying value will be necessary.
Asia insurance operations For those business units applying US GAAP to insurance assets and liabilities, as permitted by the ABI SORP, principles similar to those set out in the US insurance operations paragraph below are applied to the deferral and amortisation of acquisition costs. For other territories in Asia, the general principles of the ABI SORP are applied with, as described above, deferral of acquisition costs being either explicit or implicit through the reserving basis.
For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest‑sensitive life business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For fixed and fixed index annuity and interest‑sensitive life business, the key assumption is the long‑term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of Jackson’s actual experience, industry experience and future expectations. A detailed analysis of actual mortality, lapse and expenses experience is performed using internally developed experience studies.
Jackson makes certain adjustments to the deferred acquisition costs which are recognised directly in other comprehensive income (‘shadow accounting’). If the recognition of unrealised gains or losses on available‑for‑sale securities causes adjustments to the carrying value and amortisation patterns of deferred acquisition costs and deferred income, these adjustments are recognised in other comprehensive income consistent with the gains or losses on the securities. More precisely, shadow deferred acquisition costs adjustments reflect the change in deferred acquisition costs that would have arisen if the assets held in the statement of financial position had been sold, crystallising unrealised gains or losses, and the proceeds reinvested at the yields currently available in the market.
Determination of fair value The Group uses current bid prices to value its investments having quoted prices. Actively traded investments without quoted prices are valued using prices provided by third parties as described further in note C3.1. Financial investments measured at fair value are classified into a three‑level hierarchy as described in note C3.1(b).
The Group applies judgement as to whether evidence of an impairment in value exists for financial investments classified as ‘available‑for‑sale’ or ‘at amortised cost’.
Assets held at amortised cost Assets held at amortised cost are subject to impairment testing where appropriate under IFRS requirements by comparing estimated future cash flows to the carrying value of the asset. In estimating future cash flows, the Group looks at the expected cash flows of the assets and applies historical loss experience of assets with similar credit risks that has been adjusted for conditions in the historical loss experience which no longer exist, or for conditions that are expected to arise. The estimated future cash flows are discounted using the financial asset’s original or variable effective interest rate and exclude credit losses that have not yet been incurred.
Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contractual agreement with the bank partner. Distribution rights impairment testing is conducted when there is an indication of impairment.
As a result, IFRS 15 in the context of Prudential’s business, applies to the Group’s asset management contracts and the measurement of the Group’s investment contracts that do not contain discretionary participating features where the contracts include provision for investment management services. The IFRS 15 impact assessment performed included the review of the recognition of asset management and performance fees of these contracts. The adoption of this standard in 2018 is not expected to result in a restatement of the Group’s profit for the year or shareholders’ equity.
In September 2016, the IASB published Amendments to IFRS 4, ‘Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts’ to address the temporary consequences of the different effective dates of IFRS 9 and IFRS 17, ‘Insurance Contracts’. The amendments include an optional temporary exemption from applying IFRS 9 and the associated amendments until IFRS 17 comes into effect in 2021. This temporary exemption is available to companies whose predominant activity is to issue insurance contracts based on meeting the eligibility criteria as at 31 December 2015 as set out in the amendments. The Group met the eligibility criteria and will defer the adoption of IFRS 9 to 1 January 2021.
The existing IAS 39 amortised cost measurement for financial liabilities is largely maintained under IFRS 9 but for financial liabilities designated at FVTPL, changes in fair value due to changes in entity’s own credit risk, required by IFRS 13, are to be recognised in other comprehensive income.
— The calculation of the impairment charge relevant for financial assets held at amortised cost or FVOCI A new impairment model based on an expected credit loss approach replaces the existing IAS 39 incurred loss impairment model, resulting in earlier recognition of credit losses compared to IAS 39. The impairment charge recognition under the new model is in three stages: – Stage 1 – at initial recognition, and for each subsequent reporting period when there has been no significant increase in credit risk since initial recognition, recognise 12 month expected credit losses; – Stage 2 – recognise lifetime expected credit losses if there has been a significant increase in credit risk since initial recognition; or – Stage 3 – recognise incurred losses for credit‑impaired assets, similar to IAS 39.
This aspect is the most complex area of IFRS 9 to implement and will involve significant judgements and estimate processes. — The hedge accounting requirements which are more closely aligned with the risk management activities of the Company. No significant change to the Group’s hedge accounting is currently anticipated, but this remains under review.
Accounting pronouncements not yet endorsed by the EU IFRS 17, ‘Insurance Contracts’ In May 2017, the IASB issued IFRS 17 ‘Insurance Contracts’ to replace the existing IFRS 4 ‘Insurance Contracts’. The standard, which is subject to endorsement in the EU and other territories, applies to annual periods beginning on or after 1 January 2021. Early application is permitted; provided the entity also applies IFRS 9 and IFRS 15 on or before the date it first applies IFRS 17. The Group intends to adopt the new standard on its mandatory effective date in 2021, alongside the adoption of IFRS 9 (see above).
IFRS 17 provides an adaptation of the measurement model designed to account for certain contracts with participating features, such as UK style with‑profits contracts and unit‑linked or similar contracts, in which the policyholder will be paid a substantial share of the fair value returns of a specified group of items and the return to the insurer effectively reflects a variable management fee. This adaptation – the Variable Fee Approach (VFA) – allows the CSM to be adjusted for changes in economic experience and assumptions which reflect a change in the overall future fee the insurer expects to receive as a result of managing the participating pool of assets.
IFRS 17 introduces a new measure of insurance revenue, based on the delivery of services to policyholders and excluding any premiums related to the investment elements of policies, which will be significantly different from existing premium revenue measures, currently reported in the income statement.
Retrospective application of the standard is required for determining the CSM for the opening balance sheet. However, if full retrospective application for a group of insurance contracts is impracticable, then the entity is required to choose either a modified retrospective approach or a fair value approach. Choosing the appropriate approach and hence determining the opening balance sheet is one of the most critical activities in implementing the new standard, as the approach adopted will have a significant impact on the entity’s results both on the initial impact on shareholders’ funds at IFRS 17 adoption and on the future profits to be earned on the in‑force business at the date of transition.
The requirements of IFRS 17 are complex and will have the effect of introducing fundamental changes to the existing IFRS 4 insurance accounting and require the application of significant judgement and new estimation techniques. As previously highlighted IFRS 9 could require reclassification of investments and the introduction of new and complex impairment models. The effect of changes required to the Group’s accounting policies as a result of implementing these standards are currently uncertain, but these changes can be expected to, among other things, alter the timing of IFRS profit recognition. The implementation of this standard is also likely to involve significant enhancements to IT, actuarial and finance systems of the Group, and so will have an impact on the Group’s expenses.
The key responsibilities of the programme include setting a framework for Group‑wide accounting policies, determining additional data requirements, assessing the level of IT and finance system changes as well as establishing an appropriate work plan for determining the opening balance sheet. The work is at an early stage.
Total UK and Europe insurance operations 878 828 828 6% 6% UK and Europe asset managementnote (vi) 500 425 425 18% 18%
* The 2016 comparative results have been re‑presented from those previously published following the reassessment of the Group’s operating segments as described in note B1.3.
Underlying profit before performance‑related fees 432 379 Share of associate results 15 13 Performance‑related fees 53 33
(vii) Tax charges have been reflected as operating and non‑operating in the same way as for pre‑tax items. In 2017 a significant US tax reform package was enacted, and the effects of which in the income statement have been treated as non‑operating. Further details are provided in note B4.
US note (i) (1,568) (1,455) UK and Europe note (ii) (14) 206 Other operations note (iii) 20 (204)
Notes (i) US operations The short‑term fluctuations in investment returns for US insurance operations are reported net of related credit for amortisation of deferred acquisition costs of £462 million as shown in note C5(b) (2016: £565 million) and comprise amounts in respect of the following items: Net equity hedge result note (a) (1,490) (1,587) Other than equity‑related derivatives note (b) (36) (126) Debt securities note (c) (73) 201 Equity‑type investments: actual less longer‑term return 12 35 Other items 19 22
The net equity hedge result therefore includes significant accounting mismatches and other factors that detract from the presentation of an economic result. These other factors include: – The variable annuity guarantees and fixed index annuity embedded options being only partially fair valued under ‘grandfathered’ US GAAP as described in note B1.3 (c); – The interest rate exposure being managed through the other than equity‑related derivative programme explained in note (b) below; and – Jackson’s management of its economic exposures for a number of other factors that are treated differently in the accounting frameworks such as future fees and assumed volatility levels.
The free‑standing, other than equity‑related derivatives, are held to manage interest rate exposures and durations within the general account and the variable annuity guarantees and fixed index annuity embedded options described in note (a) above. Accounting mismatches arise because of differences between the measurement basis and presentation of the derivatives, which are fair valued with movements recorded in the income statement, and the exposures they are intended to manage.
Short‑term fluctuations relating to debt securities (Charges) credits in the year: Losses on sales of impaired and deteriorating bonds (3) (94) Defaults – (4) Bond write‑downs (2) (35) Recoveries/reversals 10 15
Note The debt securities of Jackson are held in the general account of the business. Realised gains and losses are recorded in the income statement with normalised returns included in operating profit with variations from year to year included in the short‑term fluctuations category. The risk margin reserve charge for longer‑term credit‑related losses included in operating profit based on longer‑term investment returns of Jackson for 2017 is based on an average annual risk margin reserve of 21 basis points (2016: 21 basis points) on average book values of US$55.3 billion (2016: US$56.4 billion) as shown below: Moody’s rating category (or equivalent under NAIC ratings of mortgage-backed securities)
Risk margin reserve charge to operating profit for longer‑term credit‑related losses (91) (71) (97) (72)
B1.3 Determining operating segments and performance measure of operating segments Operating segments The Group’s operating segments for financial reporting are defined and presented in accordance with IFRS 8, ‘Operating Segments’ on the basis of the management reporting structure and its financial management information. Following the combination during the year of the Group’s UK insurance business and M&G to form M&G Prudential, the Group has reassessed its operating segments.
In the prior year, the operating segments of the Group were each of the insurance operations in Asia, US and UK, and the asset management operations of Asia, US, M&G and Prudential Capital.
Operations which do not form part of any business unit are reported as ‘Unallocated to a segment’. These include Group Head Office and Asia Regional Head Office costs. Following the formation of M&G Prudential certain minor operations which were previously reported as ‘Unallocated to a segment’ are now included in the UK and Europe segment, reflecting the revised structure. Prudential Capital and Africa operations do not form part of any operating segment under the revised structure, and their assets and liabilities and loss before tax are not material to the overall financial position of the Group. Prudential Capital and Africa operations are therefore reported as ‘Unallocated to a segment’.
Performance measure The performance measure of operating segments utilised by the Company is IFRS operating profit attributable to shareholders based on longer‑term investment returns, as described below. This measurement basis distinguishes operating profit based on long‑term investment returns from other constituents of the total profit as follows: — Short‑term fluctuations in investment returns on shareholder‑backed business. This includes the impact of short‑term market effects on the carrying value of Jackson’s guarantee liabilities and related derivatives as explained below.
— Profit/loss attaching to businesses that have been sold in the year including, where relevant, the recycling of the cumulative translation gain or loss in respect of sold businesses.
Determination of operating profit based on longer-term investment returns for investment and liability movements: (a) General principles (i) UK style with-profits business The operating profit based on longer‑term returns reflects the statutory transfer gross of attributable tax. Value movements in the underlying assets of the with‑profits funds do not affect directly the determination of operating profit.
However, movements in liabilities for some types of business do require bifurcation to ensure that at the net level (ie after allocated investment return and charge for policyholder benefits) the operating result reflects longer‑term market returns.
Examples of where such bifurcation is necessary are in Hong Kong and for UK shareholder‑backed annuity business, as explained in sections b(i) and d(i), respectively. For other types of Asia’s non‑participating business, expected longer‑term investment returns are used to determine the movement in policyholder liabilities for determining operating results.
(v) Other shareholder-financed business The measurement of operating profit based on longer‑term investment returns reflects the particular features of long‑term insurance business where assets and liabilities are held for the long term and for which the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying performance of life businesses exclusive of the effects of short‑ term fluctuations in market conditions. In determining the profit on this basis, the following key elements are applied to the results of the Group’s shareholder‑financed operations.
Except in the case of assets backing liabilities which are directly matched (such as unit‑linked business) or closely correlated with value movements (as discussed below) operating profit based on longer‑term investment returns for shareholder‑financed business is determined on the basis of expected longer‑term investment returns. Longer‑term investment returns comprise actual income receivable for the period (interest/dividend income) and for both debt and equity‑type securities longer‑term capital returns.
— The amortisation of interest‑related realised gains and losses to operating results based on longer‑term investment returns to the date when sold bonds would have otherwise matured.
At 31 December 2017, the level of unamortised interest‑related realised gains and losses related to previously sold bonds for the Group was a net gain of £855 million (2016: £969 million).
Derivative value movements Generally, derivative value movements are excluded from operating results based on longer‑term investment returns (unless those derivative value movements broadly offset changes in the accounting value of other assets and liabilities included in operating profit). The principal example of derivatives whose value movements are excluded from operating profit arises in Jackson, as discussed below in section (c).
(b) Asia insurance operations (i) Business where policyholder liabilities are sensitive to market conditions For certain Asia non‑participating business, for example in Hong Kong, the economic features are more akin to asset management products with policyholder liabilities reflecting asset shares over the contract term. For these products, the charge for policyholder benefits in the operating results should reflect the asset share feature rather than volatile movements that would otherwise be reflected if the local regulatory basis (also applied for IFRS basis) was used.
Equity-type securities For Asia insurance operations, investments in equity securities held for non‑linked shareholder‑backed operations amounted to £1,759 million as at 31 December 2017 (2016: £1,405 million). The rates of return applied in 2017 ranged from 4.3 per cent to 17.2 per cent (2016: 3.2 per cent to 13.9 per cent) with the rates applied varying by business unit. These rates are broadly stable from period to period but may be different between countries reflecting, for example, differing expectations of inflation in each business unit. The assumptions are for the returns expected to apply in equilibrium conditions. The assumed rates of return do not reflect any cyclical variability in economic performance and are not set by reference to prevailing asset valuations.
(c) US insurance operations (i) Separate account business For such business the policyholder unit liabilities are directly reflective of the asset value movements. Accordingly, the operating results based on longer‑term investment returns reflect the current period value movements in unit liabilities and the backing assets.
Embedded derivatives for the ‘not for life’ portion of GMWB and fixed index annuity business The ‘not for life’ portion of GMWB embedded derivative liabilities is measured under the US GAAP basis applied for IFRS in a manner consistent with IAS 39 under which the projected future growth rate of the account balance is based on current swap rates (rather than expected rates of return) with only a portion of the expected future guarantee fees included. Reserve value movements on these liabilities are sensitive to changes to levels of equity markets, implied volatility and interest rates.
Embedded derivatives for variable annuity guarantee minimum income benefit The GMIB liability, which is substantially fully reinsured, subject to a deductible and annual claim limits, is accounted for in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Subtopic 944‑80 Financial Services – Insurance – Separate Accounts (formerly SOP 03‑1) under IFRS using ‘grandfathered’ US GAAP. This accounting basis substantially does not recognise the effects of market movements. As the corresponding reinsurance asset is net settled, it is considered to be a derivative under IAS 39, ‘Financial Instruments: Recognition and Measurement’, and the asset is therefore recognised at fair value. As the GMIB is economically reinsured, the mark to market element of the reinsurance asset is included as a component of short‑term fluctuations in investment returns.
(iv) Other US shareholder-financed business Debt securities Jackson is the shareholder‑backed operation for which the distinction between impairment losses and interest‑related realised gains and losses is in practice relevant to a significant extent. Jackson has used the ratings by Nationally Recognised Statistical Ratings Organisations (NRSRO) or ratings resulting from the regulatory ratings detail issued by the National Association of Insurance Commissioners (NAIC) developed by external third parties such as BlackRock Solutions to determine the average annual risk margin reserve to apply to debt securities held to back general account business. Debt securities held to back separate account and reinsurance funds withheld are not subject to risk margin reserve charge. Further details of the risk margin reserve charge, as well as the amortisation of interest‑related realised gains and losses for Jackson are shown in note B1.2.
Equity-type securities As at 31 December 2017, the equity‑type securities for US insurance non‑separate account operations amounted to £946 million (2016: £1,323 million). For these operations, the longer‑term rates of return for income and capital applied in the years indicated, which reflect the combination of the average risk‑free rates over the year and appropriate risk premiums are as follows: Equity‑type securities such as common and preferred stock and portfolio holdings in mutual funds 6.1% to 6.5% 5.5% to 6.5% Other equity‑type securities such as investments in limited partnerships and private equity funds 8.1% to 8.5% 7.5% to 8.5%
The operating result based on longer‑term investment returns reflects the impact of value movements on policyholder liabilities for shareholder‑backed annuity business within The Prudential Assurance Company Limited (PAC) after adjustments to allocate the following elements of the movement to the category of ‘short‑term fluctuations in investment returns’: — The impact on credit risk provisioning of actual upgrades and downgrades during the period; — Credit experience compared with assumptions; and — Short‑term value movements on assets backing the capital of the business.
Credit experience reflects the impact of defaults and other similar experience, such as asset exchanges arising from debt restructuring by issuers that include effectively an element of permanent impairment of the security held. Positive or negative experience compared with assumptions is included within short‑term fluctuations in investment returns without further adjustment. The effects of other changes to credit risk provisioning are included in the operating result, as is the net effect of changes to the valuation rate of interest due to portfolio rebalancing to align more closely with management benchmark.
(ii) Non-linked shareholder-financed business For debt securities backing non‑linked shareholder‑financed business of the UK and Europe insurance operations (other than the annuity business) the realised gains and losses are principally interest related. Accordingly, all realised gains and losses to date for these operations are being amortised over the period to the date those securities would otherwise have matured, with no explicit risk margin reserve charge.
(e) Fund management and other non-insurance businesses For these businesses, the particular features applicable for life assurance noted above do not apply. For these businesses, it is inappropriate to include returns in the operating result on the basis described above. Instead, it is appropriate to generally include realised gains and losses in the operating result with temporary unrealised gains and losses being included in short‑term fluctuations. In some instances, it may also be appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time period that reflects the underlying economic substance of the arrangements.
Earned premiums, net of reinsurance 15,032 14,812 12,076 41,920 23 41,943 Other income from external customers note (ii) 307 669 1,406 2,382 48 2,430
Total revenue, net of reinsurance 24,374 34,078 28,071 86,523 39 86,562
Benefits and claims and movements in unallocated surplus of with‑profits funds, net of reinsurance (18,291) (31,205) (23,025) (72,521) (11) (72,532)
Acquisition costs and other operating expenditureB2 (4,052) (2,257) (3,379) (9,688) (477) (10,165)
Interest on core structural borrowings – (16) – (16) (409) (425) Disposal of Korea life businessD1
Cumulative exchange gain on the sold Korea life business recycled from other comprehensive incomeD1 61 – – 61 – 61
Total charges, net of reinsurance and gain (loss) on disposal of businesses (22,277) (33,316) (26,404) (81,997) (897) (82,894)
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) note (i) 2,278 762 1,788 4,828 (858) 3,970
Total revenue from external customers note (v) 13,611 15,002 10,631 39,244 87 39,331
Total revenue, net of reinsurance 16,555 22,667 32,730 71,952 (110) 71,842
Acquisition costs and other operating expenditureB2 (3,684) (1,913) (2,813) (8,410) (438) (8,848)
Interest on core structural borrowings – (15) – (15) (345) (360) Remeasurement of carrying value of Korea life business classified as held for saleD1 (238) – – (238) – (238)
Share of profit from joint ventures and associates, net of related tax 148 – 34 182 – 182
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) note (i) 1,339 525 2,241 4,105 (893) 3,212
Tax charge attributable to policyholders’ returns (155) – (782) (937) – (937)
Notes (i) This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. (ii) Other income from external customers includes £7 million (2016: £8 million) relating to financial instruments that are not held at fair value through profit or loss. These fees primarily related to prepayment fees, late fees and syndication fees.
(iii) Unallocated to a segment includes central operations (Group and Asia Regional Head Offices and Group borrowings), Prudential Capital and Africa operations. In addition, this column includes intra‑group eliminations, including the elimination of the intra‑group reinsurance contract between the UK with‑profits and Asia with‑profits operations. (iv) Interest income includes £3 million (2016: £3 million) accrued in respect of impaired securities. (v) In Asia, revenue from external customers from no individual market exceeds 10 per cent of the Group total except for Hong Kong in 2017 (2016: no individual market exceeded 10 per cent except for Hong Kong). Total revenue from external customers of Hong Kong is £7,269 million (2016: £6,313 million). (vi) Due to the nature of the business of the Group, there is no reliance on any major customers.
Realised and unrealised gains on securities at fair value through profit or loss 33,121 28,489 Realised and unrealised (losses) on derivatives at fair value through profit or loss (1,624) (7,050) Realised (losses) gains on available‑for‑sale securities, previously recognised in other comprehensive
Realised gains and losses on the Group’s investments for 2017 recognised in the income statement amounted to a net gain of £5.7 billion (2016: a net loss of £1.6 billion).
B1.6 Additional analysis of performance by segment components B1.6(a) Asia 2017 £m 2016* £m
Cumulative exchange gain recycled from other comprehensive income 61 – – 61 –
Total charges, net of reinsurance and gain (loss) on disposal of businesses (22,136) (249) 108 (22,277) (15,364)
Share of profit from joint ventures and associates, net of related tax 121 60 – 181 148
Analysis of operating profit Operating profit based on longer‑term investment returns 1,799 176 – 1,975 1,644 Short‑term fluctuations in investment returns on shareholder‑
Amortisation of acquisition accounting adjustments (7) – – (7) (8) Loss attaching to disposal of businesses – – – – (227) Cumulative exchange gain on the sold Korea life business D1 61 – – 61 –
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Benefits and claims (31,205) – – (31,205) (20,214) Interest on core structural borrowings (16) – – (16) (15) Acquisition costs and other operating expenditureB2 (1,538) (770) 51 (2,257) (1,913) Gain on disposal of businessesD1 – 162 – 162 –
Analysis of operating profit Operating profit based on longer‑term investment returns 2,214 10 – 2,224 2,048 Short‑term fluctuations in investment returns on shareholder‑
Amortisation of acquisition accounting adjustments (56) – – (56) (68) Profit attaching to the disposal of businesses – 162 – 162 –
Earned premiums, net of reinsurance 12,076 – – 12,076 9,285 Other income from external customers 241 1,165 – 1,406 1,346
Benefits and claims and movements in unallocated surplus of with‑profits funds, net of reinsurance (23,025) – – (23,025) (27,710)
Share of profit from joint ventures and associates, net of related tax 106 15 – 121 34
related fees shown in note B1.1(vi), is different to the amount of £1,444 million shown in the table above. This is because the £1,087 million (2016: £956 million) is after deducting commissions which would have been included as charges in the table above. The difference in the presentation of commission is aligned with how management reviews the business. For further information see note B1.1.
Acquisition costs incurred for insurance policies (3,712) (3,687) Acquisition costs deferred less amortisation of acquisition costs 911 923 Administration costs and other expenditure (6,380) (5,522) Movements in amounts attributable to external unit holders of consolidated investment funds (984) (562)
Total acquisition costs and other expenditure includes: (a) Total depreciation and amortisation expense of £(288) million (2016: £(242) million) is included in ‘Administration costs and other expenditure’ and relates primarily to amortisation of deferred acquisition costs of insurance contracts and asset management contracts.
(b) The charge for non‑deferred acquisition costs and the amortisation of those costs that are deferred was £(2,801) million (2016: £(2,764) million).These amounts comprise £(2,772) million and £(29) million for insurance and investment contracts respectively (2016: £(2,734) million and £(30) million respectively).
(c) Movements in amounts attributable to external unit holders are in respect of those OEICs and unit trusts which are required to be consolidated and comprise a charge of £(719) million (2016: £(485) million) for UK and Europe insurance operations and a charge of £(265) million (2016: £(77) million) for Asia insurance operations.
* The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3.
UK and Europe* 7,110 6,381 * The UK and Europe staff numbers include staff from central operations and Africa which are unallocated to a segment.
Pension costs: Defined benefit schemes* (3) 213 Defined contribution schemes 85 79 * The (credit) charge incorporates the effect of actuarial gains and losses.
B2.2 Share-based payment (a) Description of the plans The Group operates a number of share award and share option plans that provides Prudential plc shares to participants upon vesting. The plans in operation include the Prudential Long Term Incentive Plan (PLTIP), Annual Incentive Plan (AIP), savings‑related share option schemes, share purchase plans and deferred bonus plans. Some of these plans are participated in by Executive Directors, the details of which are described in the Directors’ remuneration report. In addition, the following information is provided.
Certain agents in Asia are eligible to be granted awards under the Prudential Agency Long‑Term Incentive Plan. These awards are structured in a similar way to the PCA LTIP described above.
(b) Outstanding options and awards The following table shows movement in outstanding options and awards under the Group’s share‑based compensation plans at 31 December 2017 and 2016: Options outstanding under SAYE schemes
Expected option life (years) – 3.49 – – 3.70 – Weighted average exercise price (£) – 14.55 – – 11.04 – Weighted average share price at grant date (£) 16.80 17.74 – 12.82 13.94 – Weighted average fair value at grant date (£) 8.30 3.29 16.12 4.41 3.05 12.57
B2.3 Key management remuneration Key management constitutes the directors of Prudential plc as they have authority and responsibility for planning, directing and controlling the activities of the Group.
Total key management remuneration is analysed in the following table: Salaries and short‑term benefits 17.9 20.7 Post‑employment benefits 1.3 1.3 Share‑based payments 14.1 18.7
The share‑based payments charge comprises £8.3 million (2016: £12.9 million), which is determined in accordance with IFRS 2, ‘Share‑based Payment’ (see note B2.2) and £5.8 million (2016: £5.8 million) of deferred share awards.
Total key management remuneration includes total Directors’ remuneration of £40.2 million (2016: £37.9 million) less LTIP releases of £15.2 million (2016: £10.1 million) as shown in the Directors’ remuneration table and related footnotes in the Directors’ remuneration report. Further information on Directors’ remuneration is given in the Directors’ remuneration report.
In addition, there were fees incurred by pension schemes of £0.1 million (2016: £0.1 million) for audit services and £nil million (2016: £0.1 million) for other assurance services.
The following matters are relevant to the determination of the 2017 results: (a) Asia insurance operations In 2017, the IFRS operating profit based on longer‑term investment returns for Asia insurance operations included a net credit of £75 million (2016: £67 million) representing a small number of individually minor items.
Longevity reinsurance and other management actions A number of management actions were taken in 2017 to improve the solvency position of the UK and Europe insurance operations and further mitigate market risk, which have generated combined profits of £276 million. Similar actions were also taken in 2016 and 2015.
At 31 December 2017, longevity reinsurance covered £14.4 billion of IFRS annuity liabilities equivalent to 44 per cent of total annuity liabilities (2016: £14.4 billion, 42 per cent).
With-profits sub-fund For the with‑profits sub‑fund, the aggregate effect of assumption changes in 2017 was a net charge to unallocated surplus of £58 million (2016: net charge of £78 million).
(a) Total tax charge by nature of expense The total tax charge in the income statement is as follows: Tax charge
The reduction in the corporation tax expense from £1,464 million in 2016 to £746 million in 2017 principally relates to US operations where a higher tax deduction arises in 2017 as compared to 2016 in respect of derivative losses.
The 2017 impact of changes in local statutory tax rates relates to the remeasurement of US deferred tax balances following US tax reform attributable to both shareholders and policyholders.
The movement in the short‑term temporary differences from a credit in 2016 of £573 million to a charge in 2017 of £526 million principally relates to the US operations due to the combination of the £445 million charge relating to the remeasurement of the deferred tax balances following the US tax reform changes and a £695 million deferred tax charge relating to the amortisation of US operations derivative losses, which are spread across three years for tax purposes. The unrealised gains and losses on investments charge is after including the £92 million benefit from remeasurement of deferred tax balances on unrealised gains of US investments in the with‑profits funds of UK and Europe operations.
In 2017, a tax charge of £75 million (2016: credit of £10 million) attributable to shareholders has been taken through other comprehensive income. The 2017 charge includes a £190 million deferred tax charge primarily on unrealised gains on bonds held in the US operations partly offset by £134 million benefit relating to the remeasurement of US net deferred tax liabilities on the bonds.
(b) Reconciliation of shareholder effective tax rate In the reconciliation below, the expected tax rates reflect the corporation tax rates that are expected to apply to the taxable profit of the relevant business. Where there are profits of more than one jurisdiction the expected tax rates reflect the corporation tax rates weighted by reference to the amount of profit contributing to the aggregate business result.
Effects of non‑recurring tax reconciliation items: Adjustments to tax charge in relation to
Analysed into: Tax on operating profit based on longer‑term investment returns 276 548 268 (121) 971
Effects of results of joint ventures and associates The £55 million reconciling item arises from the accounting requirement for inclusion in the profit before tax of Prudential’s share of the profits after tax from the joint ventures and associates, with no equivalent item included in Prudential’s tax charge.
Movements in provisions for open tax matters The complexity of the tax laws and regulations that relate to our businesses means that from time to time we may disagree with tax authorities on the technical interpretation of a particular area of tax law. This uncertainty means that in the normal course of business the Group will have matters whereupon ultimate resolution of the uncertainty, the amount of profit subject to tax may be greater than the amounts reflected in the Group’s submitted tax returns. The statement of financial position contains the following provisions in relation to open tax matters: £m
* Other movements include interest arising on open tax matters and amounts included in the Group’s share of profits from joint ventures and associates, net of related tax.
Operating profit (loss) based on longer‑term investment returns 1,644 2,048 1,253 (689) 4,256
Tax at the expected rate 260 184 292 (179) 557 24.4% Effects of recurring tax reconciliation items: Income not taxable or taxable at concessionary rates (31) (18) (13) (5) (67) (2.9%)
Deductions not allowable for tax purposes 20 8 10 22 60 2.6% Items related to taxation of life insurance
Excluding non‑recurring tax * Other operations include restructuring costs. † The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3.
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Based on operating profit based on longer‑term investment returns 4,699 (971) (1) 3,727 145.2p 145.1p
Amortisation of acquisition accounting adjustments (63) 20 – (43) (1.7)p (1.7)p
Based on operating profit based on longer‑term investment returns 4,256 (894) – 3,362 131.3p 131.2p
Short‑term fluctuations in investment returns on shareholder‑backed business B1.2 (1,678) 519 – (1,159) (45.3)p (45.2)p
Loss attaching to held for sale Korea life business D1 (227) (4) – (231) (9.0)p (9.0)p
Based on profit for the year 2,275 (354) – 1,921 75.0p 75.0p
Earnings per share are calculated based on earnings attributable to ordinary shareholders, after related tax and non‑controlling interests. The weighted average number of shares for calculating earnings per share, which excludes those held in employee share trusts and consolidated unit trusts and OEICs, is set out as below: millions millions
Dividend per share For the year ended 31 December 2016 the second interim ordinary dividend of 30.57 pence per ordinary share was paid to eligible shareholders on 19 May 2017. The 2017 first interim ordinary dividend of 14.50 pence per ordinary share was paid to eligible shareholders on 28 September 2017.
Reinsurers’ share of insurance contract liabilities 1,960 6,424 2,521 3 (1,235) 9,673
Investment in joint ventures and associates accounted for using the equity method D6 912 – 504 – – 1,416
Assets held for sale – – 38 – – 38 Cash and cash equivalents note (ii) 1,934 1,658 5,808 1,290 – 10,690
Investment in joint ventures and associates accounted for using the equity method D6 825 – 448 – – 1,273
Assets held for sale D1 3,863 – 726 – – 4,589 Cash and cash equivalents note (ii) 2,157 1,135 5,064 1,709 – 10,065
Unallocated surplus of with‑profits funds C4.1 2,667 – 11,650 – – 14,317 Core structural borrowings of shareholder‑financed
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 3,093 – 5,594 – – 8,687
Accruals, deferred income and other liabilities note (iii) 5,916 4,920 6,688 1,611 (5,310) 13,825
Liabilities held for sale D1 3,758 – 535 – – 4,293 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3.
Analysed as: Expected to be settled within one year 4,957 5,548 Expected to be settled after one year 682 624
Analysed as: Held centrally and available for general use by the Group 328 247 Other funds not available for general use by the Group, including funds held for the benefit of policyholders 10,362 9,818
The Group’s cash and cash equivalents are held in the following currencies: pounds sterling 31 per cent, US dollars 28 per cent, Euro 24 per cent and other currencies 17 per cent (2016: pounds sterling 38 per cent, US dollars 25 per cent, Euro 20 per cent and other currencies 17 per cent).
Accruals and deferred income 1,233 1,150 Other creditors 7,289 6,788 Creditors arising from direct insurance and reinsurance operations 2,296 2,520 Interest payable 100 90 Funds withheld under reinsurance of the REALIC business 2,664 2,851 Other items 603 426
(iv) Operational borrowings attributable to shareholder‑financed operations within other operations, in respect of Prudential Capital’s short‑term fixed income security programme
Investment in joint ventures and associates accounted for using the equity method – – 768 768 144 – 912 825
Liabilities held for sale D1 – – – – – – – 3,758 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3.
Note The statement of financial position for with‑profits business comprises the with‑profits assets and liabilities of the Hong Kong, Malaysia and Singapore operations. Assets and liabilities of other participating business are included in the column for ‘Other business’.
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Reinsurers’ share of insurance contract liabilities – 6,424 6,424 – – 6,424 7,224
Investment in joint ventures and associates accounted for using the equity method 464 – – 464 40 – 504 448
Unallocated surplus of with‑profits funds C4.1 13,477 – – 13,477 – – 13,477 11,650 Operational borrowings attributable to
Obligations under funding, securities lending and sale and repurchase agreements 748 – 610 1,358 – – 1,358 1,497 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 3,409 1,667 167 5,243 – – 5,243 5,594
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Notes (i) Includes the Scottish Amicable Insurance Fund which, at 31 December 2017, have total assets and liabilities of £5,768 million (2016: £6,101 million). The PAC with‑profits sub‑fund
C3.1 Group assets and liabilities – measurement (a) Determination of fair value The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange‑quoted investments or by using quotations from independent third parties such as brokers and pricing services or by using appropriate valuation techniques.
Other than the loans which have been designated at fair value through profit or loss, the loans and receivables have been shown net of provisions for impairment. The fair value of loans have been estimated from discounted cash flows expected to be received. The discount rate is updated for the market rate of interest where applicable.
With-profits Loans – – 2,023 2,023 Equity securities and portfolio holdings in unit trusts 57,347 4,470 351 62,168
Total financial investments, net of derivative liabilities 86,490 53,095 6,262 145,847
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 158,631 457 10 159,098
Other investments (including derivative assets) 12 4 8 24 Derivative liabilities – (1) – (1)
Total financial investments, net of derivative liabilities 163,636 5,686 18 169,340
Total financial investments, net of derivative liabilities 23,555 65,034 3,494 92,083
Total financial investments, net of derivative liabilities 273,681 123,815 9,774 407,270 Investment contract liabilities without discretionary participation features held at fair value – (17,397) – (17,397) Borrowings attributable to with‑profits operations – – (1,887) (1,887) Net asset value attributable to unit holders of consolidated unit trusts and
Other financial liabilities held at fair value – – (3,031) (3,031)
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Assets and liabilities at amortised cost for which fair value is disclosed The table below shows the assets and liabilities carried at amortised cost on the statement of financial position but for which fair value is disclosed in the financial statements. The assets and liabilities that are carried at amortised cost but where the carrying value approximates the fair value, are excluded from the analysis below.
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The fair value of the assets and liabilities in the table above, with the exception of the subordinated and senior debt issued by the parent company, has been estimated from the discounted cash flows expected to be received or paid. Where appropriate, the observable market interest rate has been used and the assets and liabilities are classified within level 2. Otherwise, they are included as level 3 assets or liabilities. During 2017, the assumptions applied within the discounted cash flow model used to value the equity release mortgage loans held by the UK insurance operations were refined to reflect developing market practice, including consideration of the Prudential Regulation Authority’s industry wide review in this area and resulting guidance. This refinement incorporates inputs relevant to determining the discount rate that are not market observable. As a result, these loans (£1,429 million at 31 December 2017) have been transferred from level 2 to level 3 in the table above.
(c) Valuation approach for level 2 fair valued assets and liabilities A significant proportion of the Group’s level 2 assets are corporate bonds, structured securities and other non‑national government debt securities. These assets, in line with market practice, are generally valued using independent pricing services or third‑party broker quotes. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances, stale price reviews and variance analysis on prices achieved on subsequent trades.
Pricing services, where available, are used to obtain the third‑party broker quotes. Where pricing service providers are used, a single valuation is obtained and applied.
Generally, no adjustment is made to the prices obtained from independent third parties. Adjustment is made in only limited circumstances, where it is determined that the third‑party valuations obtained do not reflect fair value (eg either because the value is stale and/or the values are extremely diverse in range). These are usually securities which are distressed or that could be subject to a debt restructure or where reliable market prices are no longer available due to an inactive market or market dislocation. In these instances, prices are derived using internal valuation techniques including those as described below in this note with the objective of arriving at a fair value measurement that reflects the price at which an orderly transaction would take place between market participants on the measurement date. The techniques used require a number of assumptions relating to variables such as credit risk and interest rates. Examples of such variables include an average credit spread based on the corporate bond universe and the relevant duration of the asset being valued. Prudential determines the input assumptions based on the best available information at the measurement dates. Securities valued in such manner are classified as level 3 where these significant inputs are not based on observable market data.
Of the total level 2 debt securities of £115,141 million at 31 December 2017 (2016: £116,257 million), £13,910 million are valued internally (2016: £12,708 million). The majority of such securities are valued using matrix pricing, which is based on assessing the credit quality of the underlying borrower to derive a suitable discount rate relative to government securities of a comparable duration. Under matrix pricing, the debt securities are priced taking the credit spreads on comparable quoted public debt securities and applying these to the equivalent debt instruments factoring in a specified liquidity premium. The majority of the parameters used in this valuation technique are readily observable in the market and, therefore, are not subject to interpretation.
(d) Fair value measurements for level 3 fair valued assets and liabilities Reconciliation of movements in level 3 assets and liabilities measured at fair value The following table reconciles the value of level 3 fair valued assets and liabilities at 1 January 2017 to that presented at 31 December 2017.
Total financial investments, net of derivative liabilities 8,327 156 (384) 3,258 (1,715) (317) 236 305 (92) 9,774
Borrowings attributable to with‑profits operations – (13) – – – 115 (1,989) – – (1,887)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (883) (559) – (13) – 1,276 (234) – – (413)
Total financial investments, net of derivative liabilities 7,491 342 861 1,058 (1,210) (169) 210 138 (394) 8,327
Of the total net losses and gains in the income statement of £(402) million (2016: £320 million), £(139) million (2016: £242 million) relates to net unrealised gains and losses of financial instruments still held at the end of the year, which can be analysed as follows: Loans 20 – Equity securities (12) 8 Debt securities (5) 71 Other investments (22) 182 Derivative liabilities 4 – Borrowings attributable to with‑profit operations (13) – Net asset value attributable to unit holders of consolidated unit trusts and similar funds (123) (18) Other financial liabilities 12 (1)
Of the total net losses and gains in the income statement of £415 million (2016: £273 million), £394 million (2016: £286 million) relates to net unrealised gains of investment properties still held at the end of the year.
The fair value estimates are made at a specific point in time, based upon available market information and judgements about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time a significant volume of a particular financial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the financial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the financial instrument.
(b) Private equity and venture investments in both debt and equity securities of £217 million (2016: £956 million) which are valued internally using discounted cash flows based on management information available for these investments. The significant unobservable inputs include the determination of expected future cash flows on the investments being valued, determination of the probability of counterparty default and prepayments and the selection of appropriate discount rates. The valuation is performed in accordance with International Private Equity and Venture Capital Association Valuation guidelines. These investments were principally held by consolidated investment funds that are managed on behalf of third parties.
(d) Liabilities of £(403) million (2016: £(883) million) for the net asset value attributable to external unit holders in respect of the consolidated investment funds, which are non‑recourse to the Group. These liabilities are valued by reference to the underlying assets.
(e) Derivative liabilities of £(512) million (2016: £(516) million) which are valued internally using the discounted cash flow method in line with standard market practices but are subject to independent assessment against external counterparties’ valuations.
(f) Other sundry individual financial investments of £81 million (2016: £93 million).
(b) A net liability of £(184) million (2016: £(243) million) is held to support non‑linked shareholder‑backed business. If the value of all the level 3 instruments held to support non‑linked shareholder‑backed business valued internally decreased by 10 per cent, the change in valuation would be £18 million (2016: £24 million), which would reduce shareholders’ equity by this amount before tax. All this amount passes through the income statement substantially as part of short‑term fluctuations in investment returns outside of operating profit.
During the year, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to level 2 of £1,389 million and transfers from level 2 to level 1 of £411 million. These transfers which relate to equity securities and debt securities arose to reflect the change in the observed valuation inputs and in certain cases, the change in the level of trading activities of the securities.
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(f) Valuation processes applied by the Group The Group’s valuation policies, procedures and analyses for instruments categorised as level 3 are overseen by Business Unit committees as part of the Group’s wider financial reporting governance processes. The procedures undertaken include approval of valuation methodologies, verification processes, and resolution of significant or complex valuation issues. In undertaking these activities the Group makes use of the extensive expertise of its asset management functions. In addition the Group has minimum standards for independent price verification to ensure valuation accuracy is regularly independently verified. Adherence to this policy is monitored across the business units.
With the exception of certain debt securities for US insurance operations classified as ‘available‑for‑sale’ under IAS 39 as disclosed in notes C3.2 (b) to (d) below, the Group’s debt securities are carried at fair value through profit or loss.
(a) Credit rating Debt securities are analysed below according to external credit ratings issued, with equivalent ratings issued by different ratings agencies grouped together. Standard & Poor’s ratings have been used where available, if this isn’t the case Moody’s and then Fitch have been used as alternatives. In the table below, AAA is the highest possible rating. Investment grade financial assets are classified within the range of AAA to BBB‑ ratings. Financial assets which fall outside this range are classified as below BBB‑. Debt securities with no external credit rating are classified as ‘Other’.
The credit ratings, information or data contained in this report which are attributed and specifically provided by S&P, Moody’s and Fitch Solutions and their respective affiliates and suppliers (‘Content Providers’) is referred to here as the ‘Content’. Reproduction of any Content in any form is prohibited except with the prior written permission of the relevant party. The Content Providers do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. The Content Providers expressly disclaim liability for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold any such investment or security, nor does it address the suitability of an investment or security and should not be relied on as investment advice.
(c) Movements in unrealised gains and losses on Jackson available-for-sale securities The movement in the statement of financial position value for debt securities classified as available‑for‑sale was from a net unrealised gain of £676 million to a net unrealised gain of £1,205 million as analysed in the table below.
Below 80%: Residential mortgage‑backed securities – sub‑prime – – – – Commercial mortgage‑backed securities – – 8 (3) Other asset‑backed securities 10 (4) 9 (8) Government bonds – – – –
Further, the following table shows the age analysis as at 31 December, of the securities whose fair values were below 80 per cent of the book value: Age analysis
(e) Asset-backed securities The Group’s holdings in Asset‑Backed Securities (ABS), which comprise Residential Mortgage‑Backed Securities (RMBS), Commercial Mortgage‑Backed Securities (CMBS), Collateralised Debt Obligations (CDO) funds and other asset‑backed securities, at 31 December are as follows: Shareholder-backed operations Asia operations note (i) 118 130 US operations note (ii) 3,226 4,321 UK and Europe operations (2017: 34% AAA, 16% AA) note (iii) 1,070 1,464 Other operations note (iv) 589 771
(iii) UK and Europe operations The majority of holdings of the shareholder‑backed business are UK securities and relate to PAC’s annuity business. Of the holdings of the with‑profits operations, £1,913 million
(2016: £1,623 million) relates to exposure to the US markets with the remaining exposure being primarily to the UK market. (iv) Other operations Other operations’ exposure to asset‑backed securities is held by Prudential Capital with no sub‑prime exposure. Of the £589 million, 96 per cent (2016: 95 per cent) are graded
(f) Group sovereign debt and bank debt exposure The Group exposures held by the shareholder‑backed business and with‑profits funds in sovereign debts and bank debt securities at 31 December are analysed as follows: Exposure to sovereign debts
With-profits funds Italy – 31 31 – – – 31 62
During the year ended 31 December 2017, net impairment credit of £1 million (2016: charge of £(44) million) were recognised for available‑for‑sale securities and loans and receivables analysed as follows: Available‑for‑sale debt securities held by Jackson 8 (20) Loans and receivables* (7) (24)
In 2017, the Group realised gross losses on sales of available‑for‑sale securities of £155 million (2016: £152 million) with 97 per cent (2016: 59 per cent) of these losses related to the disposal of fixed maturity securities of the top 10 individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £155 million (2016: £152 million), £3 million (2016: £94 million) relates to losses on sales of impaired and deteriorating securities.
The effect of changes in the key assumptions that underpin the assessment of whether impairment has taken place depends on the factors described in note A3.1. A key indicator of whether such impairment may arise in future, and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available‑for‑sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned.
For 2017, the amount of gross unrealised losses for fixed maturity securities classified as available‑for‑sale under IFRS in an unrealised loss position was £106 million (2016: £675 million). Note B1.2 provides further details on the impairment charges and unrealised losses of Jackson’s available‑for‑sale securities.
(b) Additional information on US mortgage loans In the US, mortgage loans are all commercial mortgage loans that are secured by the following property types: industrial, multi‑family residential, suburban office, retail or hotel. The US insurance operations’ commercial mortgage loan portfolio does not include any single‑family residential mortgage loans and is therefore not exposed to the same risk of defaults associated with residential sub‑prime mortgage loans. The average loan size is £12.6 million (2016: £12.4 million). The portfolio has a current estimated average loan to value of 55 per cent (2016: 59 per cent).
At 31 December 2017, Jackson had no mortgage loans where the contractual terms of the agreements had been restructured (2016: none).
(c) Additional information on UK mortgage loans During 2017, the UK with‑profits fund invested in an entity that holds a portfolio of buy‑to‑let mortgage loans. The vehicle financed its acquisitions through the issue of debt instruments, largely to external parties, securitised upon the loans acquired. These third‑party borrowings have no recourse to any other assets of the Group and the Group’s exposure is limited to the amount invested by the UK with‑ profits fund.
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Operational borrowings attributable to shareholder‑financed operations C6.2 1,791 1,130 597 69 – – – – 1,796
Obligations under funding, securities lending and sale and repurchase agreements 5,662 5,662 – – – – – – 5,662
Operational borrowings attributable to shareholder‑financed operations C6.2 2,317 1,657 607 69 – – – – 2,333
Obligations under funding, securities lending and sale and repurchase agreements 5,031 5,031 – – – – – – 5,031
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 8,687 8,687 – – – – – – 8,687
The majority of derivative assets and liabilities have been included at fair value within the one year or less column, representing the basis on which they are managed (ie to manage principally asset or liability value exposures). The Group has no cash flow hedges and in general, contractual maturities are not considered essential for an understanding of the timing of the cash flows for these instruments. The only exception is certain identified interest rate swaps which are fully expected to be held until maturity solely for the purposes of matching cash flows on separately held assets and liabilities. For these instruments the undiscounted cash flows (including contractual interest amounts) due to be paid under the swap contract assuming conditions are consistent with those at year end are included in the column relating to the contractual maturity of the derivative.
Most investment contracts have options to surrender early, often subject to surrender or other penalties. Therefore, most contracts can be said to have a contractual maturity of less than one year, but the additional charges and term of the contracts mean these are unlikely to be exercised in practice and the more useful information is to present information on expected payment.
The maturity profile above excludes certain corporate unit‑linked business with gross policyholder liabilities of £12 billion (2016: £11 billion) which have no stated maturity but which are repayable on demand.
The vast majority of the Group’s financial assets are held to back the Group’s policyholder liabilities. Although asset/liability matching is an important component of managing policyholder liabilities (both those classified as insurance and those classified as investments), this profile is mainly relevant for managing market risk rather than liquidity risk. Within each business unit this asset/liability matching is performed on a portfolio‑by‑portfolio basis.
In terms of liquidity risk, a large proportion of the policyholder liabilities contain discretionary surrender values or surrender charges, meaning that many of the Group’s liabilities are expected to be held for the long term. Much of the Group’s investment portfolios are in marketable securities, which can therefore be converted quickly to liquid assets.
(ii) 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 comprising 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 C3.4(b) below for derivative assets. The collateral in place in relation to derivatives is described in note C3.4(c) below. Note C3.3 describes the security for these loans held by the Group. The Group’s exposure to credit risk is further discussed in note C7 below.
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The amount of exchange loss recognised in the income statement in 2017, except for those arising on financial instruments measured at fair value through profit or loss, is £112 million (2016: £1,005 million gain). This constitutes £1 million gain (2016: £0.4 million gain) on Medium Term Notes liabilities and £113 million of net loss (2016: £1,005 million net gain), mainly arising on investments of the PAC with‑profits fund. The gains/losses on Medium Term Notes liabilities are fully offset by value movements on cross‑currency swaps, which are measured at fair value through profit or loss.
(b) Derivatives and hedging Derivatives The Group enters into a variety of exchange traded and over‑the‑counter derivative financial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross‑currency swaps, swaptions and credit default swaps.
All over‑the‑counter derivative transactions, with the exception of some Asia 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.
Hedging The Group has formally assessed and documented the effectiveness of the following net investment hedges under IAS 39. At 31 December 2017, the Group has designated perpetual subordinated capital securities totalling US$4.3 billion (2016: US$4.5 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £3,140 million as at 31 December 2017 (2016: £3,644 million). The foreign exchange gain of £325 million (2016: loss of £389 million) on translation of the borrowings to pounds sterling at the statement of financial position date is recognised in the translation reserve in shareholders’ equity. This net investment hedge was 100 per cent effective.
At 31 December 2017, the Group has £8,232 million (2016: £8,545 million) of lent securities and assets subject to repurchase agreements, of which £8,182 million (2016: £8,113 million) related to the PAC with‑profits fund. The cash and securities collateral held or pledged under such agreements were £8,733 million (2016: £9,086 million) of which £8,679 million (2016: £8,653 million) was held by the PAC with‑profits fund.
Collateral and pledges under derivative transactions At 31 December 2017, the Group had pledged £2,302 million (2016: £1,853 million) for liabilities and held collateral of £3,958 million (2016: £2,788 million) in respect of over‑the‑counter derivative transactions.
The following tables present the gross and net information about the Group’s financial instruments subject to master netting arrangements: Net amount
Financial liabilities: Securities lending and repurchase agreements (1,410) – 52 1,332 (26)
Notes (i) The Group has not offset any of the amounts included in the consolidated statement of financial position. (ii) Represents the amount that could be offset under master netting or similar arrangements where the Group does not satisfy the full criteria to offset on the consolidated statement of financial position.
In the tables above, the amounts of assets or liabilities included in the consolidated statement of financial position would be offset first by financial instruments that have the right of offset under master netting or similar arrangements with any remaining amount reduced by the amount of cash and securities collateral. The actual amount of collateral may be greater than amounts presented in the tables.
The note provides information of policyholder liabilities and unallocated surplus of with‑profits funds held on the Group’s statement of financial position: C4.1 Movement and duration of liabilities (a) Group overview (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds
Comprising: – Policyholder liabilities on the consolidated statement of financial position 41,255 138,913 142,350 322,518 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,553 – 10,543 13,096 – Group's share of policyholder liabilities of joint ventures and associate‡ 4,970 – – 4,970
Comprising: – Policyholder liabilities on the consolidated statement of financial position§ (excludes £32 million classified as unallocated to a segment) 62,898 180,724 167,589 411,211
– Unallocated surplus of with-profits funds on the consolidated statement of financial position 3,474 – 13,477 16,951
– Group's share of policyholder liabilities of joint ventures and associate‡ 7,467 – – 7,467 Average policyholder liability balances†
The items above represent the amount attributable to changes in policyholder liabilities and unallocated surplus of with‑profits funds as a result of each of the components listed. The policyholder liabilities shown include investment contracts without discretionary participation features (as defined in IFRS 4) and their full movement in the year but exclude liabilities that have not been allocated to a reporting segment. The items above are shown gross of external reinsurance.
Note (a) Including net flows of the Group’s insurance joint ventures and associate.
(iii) Movement in insurance contract liabilities and unallocated surplus of with-profits funds Further analysis of the movement in the year of the Group’s insurance contract liabilities, gross and reinsurance share, and unallocated surplus of with‑profits funds is provided below: Insurance contract liabilities Unallocated surplus of with-profits funds £m Gross £m
Income and expense included in the income statement and other comprehensive income 31,142 422 2,949 Foreign exchange translation differences (19,405) (667) (315)
In each of 2017 and 2016, the Group’s UK and Europe insurance business entered into longevity reinsurance transactions on certain aspects of the UK’s annuity liabilities. Further information on these transactions is provided in note B3(c). The gains and losses recognised in profit and loss for the other reinsurance contracts written in the year were immaterial.
(b) Asia insurance operations (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds A reconciliation of the total policyholder liabilities and unallocated surplus of with‑profits funds of Asia insurance operations from the beginning of the year to the end of the year is as follows: With-profits business £m
Comprising: – Policyholder liabilities on the consolidated statement of financial position 18,381 13,355 9,519 41,255 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,553 – – 2,553 – Group’s share of policyholder liabilities relating to joint ventures
Reclassification of Korea life business as held for sale* – (2,187) (625) (2,812) Premiums
Shareholders' transfers post‑tax (54) – – (54) Investment‑related items and other movements note (d) 4,385 2,830 967 8,182 Foreign exchange translation differences note (a) (2,401) (807) (740) (3,948)
§ The policyholder liabilities of the with‑profits business of £32,963 million, shown in the table above, is after deducting the intra‑group reinsurance liabilities ceded by UK and Europe insurance operations of £1,235 million to the Hong Kong with‑profits business (2016: £1,302 million). Including this amount the Asia with‑profits policyholder liabilities are £34,198 million.
Notes (a) Movements in the year have been translated at the average exchange rates for the year. The closing balance has been translated at the closing spot rates as at the end of the year.
Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows have increased by £1,093 million to £6,875 million in 2017 predominantly reflecting continued growth of the in‑force book and increased flows from new business. (c) Investment‑related items and other movements for 2017 principally represent equity market gains and falls in bond yields during the year, in a number of business units with the greatest impact being on with‑profits and unit‑linked business.
(ii) Duration of liabilities The table below shows the carrying value of policyholder liabilities and the maturity profile of the cash flows on a discounted basis for 2017 and 2016, taking account of expected future premiums and investment returns: Policyholder liabilities 62,898 53,716
Expected maturity: (iii) Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2017, the policyholder liabilities and unallocated surplus for Asia operations excluding joint ventures and after deducting intra‑group reinsurance liabilities ceded by UK and Europe of £66,372 million (2016: £56,383 million), net of external reinsurance of £1,961 million (2016: £1,539 million), comprised the following: Hong Kong 29,411 23,852
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US$1.35/£1.00 (2016: US$1.24/£1.00). Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows were £3,137 million in 2017, reflecting continued strong inflows into the variable annuity business. (c) Positive investment‑related items and other movements in variable annuity separate account liabilities of £15,956 million for 2017 primarily reflects the increases in equities and bond values during the year. Fixed annuity, GIC and other business investment and other movements of £295 million primarily reflect the increase in guarantee reserve in the year.
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Comprising: – Unallocated surplus of with-profits funds 13,477 – – 13,477
* Averages have been based on opening and closing balances and exclude unallocated surplus of with‑profits funds. † Includes the Scottish Amicable Insurance Fund.
Notes (a) Net flows improved from negative £(2,527) million in 2016 to positive £736 million in 2017, due primarily to higher premium flows into our with‑profits funds following increased sales into with‑profits savings and retirement products. This has been offset by lower premiums into our annuity business following our withdrawal from this market in the UK. The level of inflows/outflows for unit‑linked business remains subject to annual variation as it is driven by corporate pension schemes with transfers in or out from a small number of schemes influencing the level of flows in the period.
(ii) Duration of liabilities With the exception of most unitised with‑profits bonds and other whole of life contracts, the majority of the contracts of UK and Europe insurance operations have a contract term. In effect, the maturity term of the other contracts reflects the earlier of death, maturity, or the policy lapsing. In addition, as described in note A3.1, with‑profits contract liabilities include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
The following tables show the carrying value of the policyholder liabilities and the maturity profile of the cash flows, on a discounted basis for 2017 and 2016: 2017 £m
Expected maturity: — The cash flow projections of expected benefit payments used in the maturity profile table above are from value of in‑force business and exclude the value of future new business, including future vesting of internal pension contracts.
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(iii) Annuitant mortality Mortality assumptions for UK annuity business are set in light of recent population and internal experience. The assumptions used are based on standard population mortality tables (PCMA08/PCFA08 for males/females in 2017 and PCMA00/PCFA00 in 2016), with an allowance for expected future mortality improvements. The standard population tables are adjusted to reflect the features of the Company’s portfolio. For 2017 these portfolio‑specific adjustments have been revised so that adjustments are now applied on a per policy basis, rather than across larger groupings, and therefore disclosure of broad percentage adjustments to the standard tables would no longer appropriately reflect the methodology applied. Where annuities have been sold on an enhanced basis to impaired lives, an adjustment is made for the additional expected mortality.
For annuities in deferment, the tables used were AM92 – four years (males) and AF92 – four years (females) for 2017 and 2016.
The approach to determining the contract liabilities is generally driven by the local solvency basis. A gross premium valuation method is used in those countries where a risk‑based capital framework is adopted for local solvency. Under the gross premium valuation method, all cash flows are valued explicitly using best estimate assumptions with a suitable margin for prudence. This is achieved either through adding an explicit allowance for assumptions to deviate from best estimate or by applying an overlay constraint so that no negative reserves (ie where future premium inflows are expected to exceed prudent future claims and outflows) are derived at an individual policyholder level or a combination of both.
For India and Taiwan, US GAAP is applied for measuring insurance liabilities. For these countries, the future policyholder benefit provisions for non‑linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claims expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business.
The attaching liabilities reflect the unit value obligation driven by the value of the investments of the unit fund. Additional technical provisions are held for guaranteed benefits beyond the unit fund value using a gross premium valuation method. These additional provisions are recognised as a component of other business liabilities.
The policyholder of a fixed interest rate annuity pays Jackson a premium, which is credited to the policyholder’s account. Periodically, interest is credited to the policyholder’s account and in some cases administrative charges are deducted from the policyholder’s account. Jackson makes benefit payments at a future date as specified in the policy based on the value of the policyholder’s account at that date.
Fixed index annuities vary in structure but are generally deferred annuities that enable policyholders to obtain a portion of an equity‑ linked return (based on participation rates and caps), and provide a guaranteed minimum return. Fixed index annuities accounted for 5 per cent (2016: 6 per cent) of Jackson’s policy and contract liabilities at 31 December 2017.
Guaranteed minimum rates are generally set at 1.0 to 3.0 per cent. At 31 December 2017, Jackson had fixed index annuities allocated to indexed funds totalling £6.3 billion (2016: £7.3 billion) in account value with minimum guaranteed rates on index accounts ranging from 1.0 per cent to 3.0 per cent and a 1.77 per cent average guaranteed rate (2016: 1.0 per cent to 3.0 per cent and a 1.77 per cent average guarantee rate).
Jackson also offers fixed interest accounts on some fixed index annuity products. At 31 December 2017, fixed interest accounts of fixed index annuities totalled £2.5 billion (2016: £2.6 billion) in account value.
The liability for policyholder benefits that represent the guaranteed minimum return is determined similarly to the liabilities of the fixed interest annuity above. The equity‑linked return option within the contract is treated as an embedded liability under US GAAP and therefore this element of the liability is recognised at fair value.
The rate of return depends upon the performance of the selected fund portfolio. Policyholders may allocate their investment to either the fixed account or a selection of variable accounts. Subject to benefit guarantees, investment risk on the variable account is borne by the policyholder, while investment risk on the fixed account is borne by Jackson through guaranteed minimum fixed rates of return. At 31 December 2017, 5 per cent (2016: 6 per cent) of variable annuity funds were in fixed accounts.
Jackson had variable annuity funds in fixed accounts totalling £5.9 billion (2016: £7.3 billion) with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 1.68 per cent average guaranteed rate (2016: 1.0 per cent to 3.0 per cent and a 1.64 per cent average guaranteed rate).
Jackson hedges these risks using derivative instruments as described in note C7.3.
Jackson regularly evaluates estimates used and adjusts the benefit guarantee liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised.
Non‑performance risk is incorporated into the fair value calculation through the use of discount interest rates sourced from an AA corporate credit curve as a proxy for Jackson’s own credit risk. Other risk margins, particularly for policyholder behaviour and long‑term volatility, are also incorporated into the model through the use of explicitly conservative assumptions. On a periodic basis, Jackson validates the resulting fair values based on comparisons to other models and market movements.
Guaranteed Minimum Income Benefits are reinsured, subject to a deductible and annual claim limits. As this reinsurance benefit is net settled, it is considered to be a derivative under IAS 39, and is therefore recognised at fair value with the change in fair value included as a component of short‑term fluctuations.
Excluding the business that is subject to the retrocession treaties at 31 December 2017, Jackson had interest‑sensitive life business in force with total account value of £6.3 billion (2016: £7.1 billion), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.67 per cent average guaranteed rate (2016: 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate).
With‑profits contracts provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘regular’ and ‘final’.
Regular bonus rates are determined for each type of policy primarily by targeting the bonus level at a prudent proportion of the long‑term expected future investment return on underlying assets, reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers.
A final bonus which is normally declared annually, may be added when a claim is paid or when units of a unitised product are realised.
Persistency assumptions are set based on the results of the most recent experience analysis looking at the experience over recent years of the relevant business.
Maintenance and, for some classes of business, termination expense assumptions are expressed as per policy amounts. They are set based on the expenses incurred during the year, including an allowance for ongoing investment expenditure and allocated between entities and product groups in accordance with the operation’s internal cost allocation model. Expense inflation assumptions are set consistent with the economic basis and based on the inflation swap spot curve.
The contract liabilities for with‑profits business also require assumptions for mortality. These are set based on the results of recent experience analysis.
A range of with‑profits contracts offering policyholders a choice of investment profiles.
In normal investment conditions the EGR is expected to reflect PAC’s view of how the funds will perform over the longer term. An adjustment is made to the smoothed unit value if it moves outside of a specified range relative to the value of the underlying assets.
As with‑profits contracts, the liability for PruFund contracts are calculated in accordance with the methodology applied to other WPSF contracts, as described above.
SAIF is a ring‑fenced with‑profits sub‑fund of PAC. No new business is written in SAIF, although regular premiums are still being paid on in‑force policies. The fund is solely for the benefit of policyholders of SAIF. Shareholders have no interest in the profits of this fund although they are entitled to asset management fees on this business. The process for determining policyholder bonuses of SAIF with‑profits policies, is similar to that for the with‑profits policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefits.
Provision is made for the risks attaching to some SAIF unitised with‑profits policies that have (Market Value Reduction) MVR‑free dates and for those SAIF products which have a guaranteed minimum benefit on death or maturity of premiums accumulated at 4 per cent per annum.
Expense Maintenance expense assumptions are expressed as per policy amounts. They are set based on the expenses incurred during the year, including an allowance for ongoing investment expenditure and allocated between entities and product groups in accordance with the operation’s internal cost allocation model. A margin for adverse deviation is added to this amount. Expense inflation assumptions are set consistent with the economic basis and based on the inflation swap spot curve.
With-profits Written in the with‑profits fund, these combine the income features of annuity products with the investment smoothing features of with‑profits products and enable policyholders to obtain exposure to investment return on the with‑profits fund equity shares, property and other investment categories over time.
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Unit-linked UK and Europe insurance operations also have a book of unit‑linked policies.
For unit‑linked contracts the attaching liability reflects the unit value obligation and, in the case of policies classified as insurance contracts, provision for expenses and mortality risk. The latter component is determined by applying mortality assumptions on a basis that is appropriate for the policyholder profile.
Operation of the UK with-profits sub-funds The WPSF mainly contains with‑profits business but it also contains some non‑profit business (unit‑linked, term assurances and annuities). The WPSF’s profits, apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution, are determined via the annual actuarial valuation.
Application of significant judgement Determining bonuses using the table described in the material features table above requires the PAC Board to apply significant judgement in many respects, including in particular the following: — Determining what constitutes fair treatment of customers; — Smoothing of investment returns; and — Determining at what level to set bonuses to ensure that they are competitive.
Key assumptions The overall rate of return on investments and the expectation of future investment returns are the most important influences in bonus rates, subject to the smoothing described below. Prudential determines the assumptions to apply in respect of these factors, including the effects of reasonably likely changes in key assumptions, in the context of the overarching discretionary and smoothing framework that applies to its with‑profits business. As such, it is not possible to specifically quantify the effects of each of these assumptions, or of reasonably likely changes in these assumptions.
— A With‑Profits Committee of independent individuals, which assesses the degree of compliance with the PPFM and the manner in which conflicting rights have been addressed.
Determination of bonus rates In determining bonus rates for the UK with‑profits policies, smoothing is applied to the allocation of the overall earnings of the UK with‑profits fund of which the investment return is a significant element.
(including charge for provision for asset shares and excluding policyholder bonuses) (16,389) (17,300) Earned premiums, net of reinsurance 12,508 9,261 Other income 35 177 Acquisition costs and other expenditure (1,732) (1,288) Share of profits from investment joint ventures 106 22 Tax charge (440) (739)
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Net book amount at end of year 1,458 24 1,482 1,628
Goodwill – attributable to shareholders 1,458 1,475 Venture fund investments – attributable to with‑profits funds 24 153
Other goodwill attributable to shareholders represents amounts allocated to entities in Asia and, until August 2017, the US operations. These goodwill amounts are not individually material.
Impairment testing Goodwill does not generate cash flows independently of other groups of assets and thus is assigned to cash‑generating units for the purposes of impairment testing. These cash‑generating units are based upon how management monitors the business and represent the lowest level to which goodwill can be allocated on a reasonable basis.
With the exception of M&G, the goodwill attributable to shareholders mainly relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the current in‑force business as determined using the EEV methodology. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The methodology and assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report.
Goodwill for venture fund investments is tested for impairment by comparing the business’s carrying value, including goodwill to its recoverable amount (fair value less costs to sell).
M&G The recoverable amount for the M&G business (which is now part of the UK and Europe operating segment) has been determined by calculating the value in use of M&G Group Limited and its subsidiaries (considered to be a cash‑generating unit during 2017). This has been calculated by aggregating the present value of future cash flows expected to be derived from the M&G business.
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, such as changes in global equity markets and trends in fund flows, are considered by management in arriving at the expectations for the final projections for the plan; ii The assumed growth rate on forecast cash flows beyond the terminal year of the plan after considering expected future and past growth rates. A growth rate of 1.7 per cent (2016: 2.0 per cent) has been used to extrapolate beyond the plan period; iii The risk discount rate. Differing discount rates have been applied in accordance with the nature of the individual component businesses. For the most material component retail and institutional business, a risk discount rate of 12 per cent (2016: 12 per cent) has been applied to post‑tax cash flows. The pre‑tax risk discount rate was 15 per cent (2016: 16 per cent); 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.
Present value of acquired in‑force policies for insurance contracts as classified under IFRS 4 (PVIF) 36 43 Distribution rights and other intangibles 1,597 1,534
Disposals and transfers – – – – – – (268) Exchange differences and other movements (40) (752) 1 – (8) (799) 1,475 Amortisation of DAC related to net unrealised valuation movements on the US insurance operation's available‑ for‑sale securities recognised within other comprehensive income† – (76) – – – (76) 76 * PVIF and other intangibles includes amounts in relation to software rights with additions of £38 million, amortisation of £32 million, foreign exchange losses of £5 million and a balance at 31 December 2017 of £67 million.
† Under the Group’s application of IFRS 4, US GAAP is used for measuring the insurance assets and liabilities of its US and certain Asia operations. Under US GAAP, most of the US insurance operation’s products are accounted for under Accounting Standard no. 97 of the Financial Accounting Standards Board (FAS 97) whereby deferred acquisition costs are amortised in line with the emergence of actual and expected gross profits which are determined using an assumption for long‑term investment returns for the separate account of 7.4 per cent (2016: 7.4 per cent) (gross of asset management fees and other charges to policyholders, but net of external fund management fees). The amounts included in the income statement and other comprehensive income affect the pattern of profit emergence and thus the DAC amortisation attaching. DAC amortisation is allocated to the operating and non‑operating components of the Group’s supplementary analysis of profit and other comprehensive income by reference to the underlying items (see note C7.3 (iv)).
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Note All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts: Gross amount 156 145 Accumulated amortisation (93) (81)
(ii) Present value of acquired in-force (PVIF) and other intangibles attributable to shareholders
(ii) Distribution rights relate to fees paid in relation to the bancassurance partnership arrangements for the bank distribution of Prudential’s insurance products for a fixed period of time. The distribution rights amounts are amortised over the term of the distribution contracts.
(iii) Software is amortised over its useful economic life, which generally represents the licence period of the software acquired.
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¤20m Medium Term Notes 2023 (Tier 2) note (vii) 18 17
Notes (i) These debt tier classifications are consistent with the treatment of capital for regulatory purposes under the Solvency II regime. The Group has designated all US$4,275 million (2016: US$4,525 million) of its US dollar denominated subordinated debt as a net investment hedge under IAS 39 to hedge the currency risks related to the net investment in Jackson.
(ii) The senior debt ranks above subordinated debt in the event of liquidation. (iii) The Prudential Capital bank loan of £275 million is drawn at a cost of 12 month GBP LIBOR plus 0.33 per cent. The loan was renewed in December 2017 maturing on 20 December 2022 with an option to repay annually.
(v) In December 2017, the Company repaid its US$1,000 million 6.5 per cent Tier 2 perpetual subordinated notes. (vi) These borrowings can be converted, in whole or in part, at the Company’s option and subject to certain conditions, on any interest payment date, into one or more series of
Prudential plc has debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential plc’s long‑term senior debt is rated A+, A2 and A from Standard & Poor’s, Moody’s and Fitch, while short‑term ratings are A‑1, P‑1 and F1 respectively.
The financial strength of The Prudential Assurance Company Limited is rated AA by Standard & Poor’s, Aa3 by Moody’s and AA by Fitch.
Jackson National Life Insurance Company’s financial strength is rated AA by Standard & Poor’s, A1 by Moody’s, AA by Fitch and A+ by AM Best.
Borrowings in respect of short‑term fixed income securities programmes 1,085 1,651
Note Other borrowings mainly include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson. In addition, other borrowings include amounts whose repayment to the lender is contingent upon future surplus emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
† The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinated to the entitlements of the policyholders of that fund.
C7.1 Group overview The Group’s risk framework and the management of the risk, including those attached to the Group’s financial statements including financial assets, financial liabilities and insurance liabilities, together with the inter‑relationship with the management of capital have been included in the audited sections of the ‘Report on the risks facing our business and how these are managed’.
With‑profits business Net neutral direct exposure (indirect exposure only) Investment performance subject to smoothing through declared bonuses
Unit‑linked business Net neutral direct exposure (indirect exposure only) Investment performance through asset management fees
Credit risk Interest rate risk Profit and loss and shareholders’ equity are volatile for these risks as they affect the values of derivatives and embedded derivatives and impairment losses. In addition, shareholders’ equity is volatile for the incidence of these risks on unrealised appreciation of fixed income securities classified as available‑for‑sale under IAS 39
Impact of diversification on risk exposure The Group benefits from diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types. Relevant correlation factors include: Correlation across geographic regions: — Financial risk factors; and — Non‑financial risk factors.
The sensitivities below do not reflect that assets and liabilities are actively managed and may vary at the time any actual market movement occurs. There are strategies in place to minimise the exposure to market fluctuations. For example, as market indices fluctuate, Prudential would take certain actions including selling investments, changing investment portfolio allocation and adjusting bonuses credited to policyholders. In addition, these analyses do not consider the effect of market changes on new business generated in the future.
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The estimated sensitivity to the decrease and increase in interest rates at 31 December 2017 and 2016 is as follows: Decrease
The pre‑tax impacts, if they arose, would mostly be recorded within the category short‑term fluctuations in investments returns in the Group’s segmental analysis of profit before tax.
The degree of sensitivity of the results of the non‑linked shareholder‑backed business of the Asia operations to movements in interest rates depends upon the degree to which the liabilities under the ‘grandfathered’ IFRS 4 measurement basis reflects market interest rates from period‑to‑period. For example for those countries, such as those applying US GAAP, the results can be more sensitive as the effect of interest rate movements on the backing investments may not be offset by liability movements.
Equity price risk The non‑linked shareholder‑backed business has limited exposure to equity and property investment (31 December 2017: £1,764 million). Generally changes in equity and property investment values are not directly offset by movements in non‑linked policyholder liabilities.
Profit before tax attributable to shareholders (478) (239) (386) (192) Related deferred tax (where applicable) 7 4 4 2
ii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Asia insurance operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2017, the rates for the most significant operations are given in note A1.
Profit before tax attributable to shareholders (155) (97) 189 118 Profit for the year (135) (77) 165 94 Shareholders’ equity, excluding goodwill, attributable to Asia operations (492) (442) 601 540
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Jackson’s derivative programme is used to manage interest rate risk associated with a broad range of products and equity market risk attaching to its equity‑based products. Movements in equity markets, equity volatility, interest rates and credit spreads materially affect the carrying value of derivatives that are used to manage the liabilities to policyholders and backing investment assets. Movements in the carrying value of derivatives combined with the use of US GAAP measurement (as ‘grandfathered’ under IFRS 4) for the insurance contracts assets and liabilities, which is largely insensitive to current period market movements mean that the Jackson total profit (ie including short‑term fluctuations in investment returns) is sensitive to market movements. In addition to these effects the Jackson shareholders’ equity is sensitive to the impact of interest rate and credit spread movements on the value of fixed income securities. Movements in unrealised appreciation on these securities are included as movement in shareholders’ equity (ie outside the income statement).
Swaption contracts These contracts provide the purchaser with the right, but not the obligation, to require the writer to pay the present value of a long‑duration interest rate swap at future exercise dates. Jackson both purchases and writes swaptions in order to hedge against significant movements in interest rates.
These derivatives (including various call and put options and options contingent on interest rates and currency exchange rates) are used to hedge Jackson’s obligations associated with its issuance of certain VA guarantees. Some of these annuities and guarantees contain embedded options that are fair valued for financial reporting purposes.
Combination net deposits plus minimum return, highest specified anniversary account value minus withdrawals post‑anniversary
Account balances of contracts with guarantees were invested in variable separate accounts as follows: Mutual fund type: Money market 681 994
Net sensitivity of profit after tax and shareholders’ equity 874 265 489 207 690 317 241 38
C Balance sheet notes continued ii Sensitivity to interest rate risk Except in the circumstances of interest rate scenarios where the guarantee rates included in contract terms are higher than crediting rates that can be supported from assets held to cover liabilities, the accounting measurement of fixed annuity liabilities of Jackson’s products is not generally sensitive to interest rate risk. This position derives from the nature of the products and the US GAAP basis of measurement. The GMWB features attached to variable annuity business (other than ‘for life’ components) are accounted for under US GAAP as embedded derivatives which are fair‑valued and, therefore, will be sensitive to changes in interest rates.
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within the income statement. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease and increase in interest rates at 31 December 2017 and 2016 is as follows: Decrease Increase Decrease Increase of 2% of 1% of 1% of 2% of 2% of 1% of 1% of 2%
Profit and loss: Pre‑tax profit effect (net of related changes in
Other comprehensive income: Direct effect on carrying value of debt securities (net of related changes in amortisation of DAC) 3,063 1,700 (1,700) (3,063) 3,364 1,883 (1,883) (3,364)
Related effect on movement in deferred tax (643) (357) 357 643 (1,177) (659) 659 1,177
Total net effect on shareholders' equity (802) (167) (258) (419) 303 318 (532) (884)
iii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2017, the average and closing rates were US$1.29 (2016: US$1.35) and US$1.35 (2016: US$1.24) to £1.00, respectively. A 10 per cent increase (weakening of the dollar) or decrease (strengthening of the dollar) in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows: A 10% increase in US$:£ exchange rates
Profit before tax attributable to shareholders (54) (48) 66 59 Profit for the year (20) (54) 24 66 Shareholders’ equity attributable to US insurance operations (456) (473) 557 578
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alue (EEV ) basis results 07 A dditional inform ation iv Other sensitivities The total profit of Jackson is sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts.
For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest‑sensitive life business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For interest‑sensitive business, the key assumption is the expected long‑term spread between the earned rate and the rate credited to policyholders. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges) all of which are based on a combination of actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual experience is measured by internally developed expense, mortality and persistency studies.
For variable annuity business, an assumption made is the expected long‑term level of separate account returns, which for 2017 was 7.4 per cent (2016: 7.4 per cent). The impact of using this return is reflected in two principal ways, namely: — Through the projected expected gross profits that are used to determine the amortisation of deferred acquisition costs. This is applied through the use of a mean reversion technique which is described in more detail in note A3.1 above; and
Jackson is sensitive to mortality risk, lapse risk and other types of policyholder behaviour, such as the utilisation of its GMWB product features. Jackson’s persistency assumptions reflect a combination of recent experience for each relevant line of business and expert judgement, especially where a lack of relevant and credible experience data exists. These assumptions vary by relevant factors, such as product, policy duration, attained age and for variable annuity lapse assumptions, the extent to which guaranteed benefits are ‘in the money’ relative to policy account values. Changes in these assumptions, which are assessed on an annual basis after considering recent experience, could have a material impact on policyholder liabilities and therefore on profit before tax. See further information in note B1.2.
The shareholder results of the UK with‑profits fund are currently one‑ninth of the cost of bonuses declared to with‑profits policyholders. For certain unitised with‑profits products, such as the PruFund range of funds, the bonuses represent the policyholders’ net return based on the smoothed unit price of the selected investment fund. Investment performance is a key driver of bonuses declared, and hence the shareholder results. Due to the ‘smoothed’ basis of bonus declaration, the sensitivity to short‑term investment performance is relatively low. However, long‑term investment performance and persistency trends may affect future shareholder transfers.
Shareholder-backed annuity business Profits from shareholder‑backed annuity business are most sensitive to: — The extent to which the duration of the assets held closely matches the expected duration of the liabilities under the contracts; — Actual versus expected default rates on assets held; — The difference between long‑term rates of return on corporate bonds and risk‑free rates; — The variance between actual and expected mortality experience; — The extent to which changes to the assumed rate of improvements in mortality give rise to changes in the measurement of liabilities; and
In addition the level of profit is affected by change in the level of reinsurance cover. A decrease in assumed mortality rates of 1 per cent would decrease pre‑tax profit by approximately £66 million (2016: £67 million). A
decrease in credit default assumptions of five basis points would increase pre‑tax profit by £198 million (2016: £200 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase pre‑tax profit by £40 million (2016: £41 million). The effect on profit would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above. The net effect on profit after tax and shareholders’ equity from all the changes in assumptions as described above would be an increase of approximately £143 million (2016: £144 million). See C4.1(d)(iii) for further details on mortality assumptions.
Unit-linked and other business Unit‑linked and other business represents a comparatively small proportion of the in‑force business of the UK and Europe insurance operations.
Due to the matching of policyholder liabilities to attaching asset value movements, the UK unit‑linked business is not directly affected by market or credit risk. The liabilities of the other business are also broadly insensitive to market risk. Profits from unit‑linked and similar contracts primarily arise from the excess of charges to policyholders for management of assets, over expenses incurred. The former is most sensitive to the net accretion of funds under management as a function of new business and lapse and timing of death. The accounting impact of the latter is dependent upon the amortisation of acquisition costs in line with the emergence of margins (for insurance contracts) and amortisation in line with service provision (for the investment management component of investment contracts). By virtue of the design features of most of the contracts which provide low levels of mortality cover, the profits are relatively insensitive to changes in mortality experience.
The close matching by the Group of assets of appropriate duration to annuity liabilities is based on maintaining economic and regulatory capital. Liabilities are measured differently under Solvency II reporting requirements than under IFRS resulting in an alteration to the assets used to measure the IFRS annuity liabilities. As a result, IFRS has a different sensitivity to interest rate and credit risk than under Solvency II.
Carrying value of debt securities and derivatives 13,497 5,805 (4,659) (8,541) 12,353 5,508 (4,527) (8,313)
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A 10 or 20 per cent increase in their value would have an approximately equal and opposite effect on profit and shareholders’ equity to the sensitivities shown above. The market risk sensitivities shown above reflect the impact of temporary market movements, and, therefore the primary effect of such movements would, in the Group’s segmental analysis of profits, be included within the short‑term fluctuations in investment returns.
C8.1 Deferred tax The statement of financial position contains the following deferred tax assets and liabilities in relation to: 2017 £m
The deferred tax balances at 31 December 2017 and 2016 arise in the following parts of the Group: Deferred tax assets Deferred tax liabilities * The 2016 comparative results have been re‑presented from those previously published for the reassessment of the Group’s operating segments as described in note B1.3.
The taxation regimes applicable across the Group often apply separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of deferred tax assets. For the 2017 full year results and financial position at 31 December 2017 the following tax benefits have not been recognised: Tax benefit £m Losses £bn Tax benefit £m Losses £bn
Of the unrecognised trading losses, losses of £41 million will expire within the next seven years, the rest have no expiry date.
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Under IAS 19 ‘Employee Benefits’ and IFRIC 14 ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’, the Group is only able to recognise a surplus to the extent that it is able to access the surplus either through an unconditional right of refund or through reduced future contributions relating to ongoing service of active members. The Group has no unconditional right of refund to any surplus in PSPS. Accordingly, the PSPS surplus recognised is restricted to the present value of the economic benefit to the Group from the difference between the estimated future ongoing contributions and the full future cost of service for the active members. In contrast, the Group is able to access the surplus of SASPS and M&GGPS. Therefore, the amounts recognised for these schemes are the IAS 19 valuation amount (either a surplus or deficit).
IAS 19 pension asset (liability) on the Group statement of financial position note (iv) 236 (137) (42) (1) 56 159 (237) (50) (1) (129)
Group consolidation) and the liabilities of the schemes. (iv) At 31 December 2017, the PSPS pension asset of £236 million (2016: £159 million) and the other schemes’ pension liabilities of £180 million (2016: £288 million) are included within
Triennial actuarial valuations Defined benefit pension schemes in the UK are generally required to be subject to full actuarial valuations every three years in order to assess the appropriate level of funding for schemes in relation to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. The actuarial valuation differs from the IAS 19 accounting basis valuation in a number of respects, including the discount rate assumption where IAS 19 prescribes a rate based on high‑quality corporate bonds while a more ‘prudent’ assumption is used for the actuarial valuation.
No deficit funding required from 1 January 2016 * The triennial valuations for PSPS and M&GGPS as at 5 April 2017 and 31 December 2017 respectively are currently in progress.
For male (female) non‑pensioners 107 per cent (92 per cent) of the 2000 series rates (PNMA00/PNFA00).
Allowance for future improvements to post-retirement mortality For males (females) up to 2009 100 per cent (75 per cent) of Medium Cohort subject to a minimum rate of improvement of 2.00 per cent per annum (1.25 per cent per annum) up to age 90, decreasing linearly to zero by age 120. From 2010 onwards, in line with the CMI’s 2009 projection model with a long‑term rate of 1.75 per cent per annum (1.50 per cent per annum), and minor scheme‑specific calibrations.
All of the Group’s three UK defined benefit pension schemes (PSPS, SASPS and M&GGPS) are final salary schemes, which are closed to new entrants.
The Trustees of each scheme set the general investment policy and specify any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegate the responsibility for selection and realisation of specific investments to the Investment Managers. The Trustees consult the Principal Employer, (eg The Prudential Assurance Company for PSPS), on the investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustees.
For PSPS, a significant portion of the scheme assets are invested in liability matching assets such as bonds and gilts including index‑linked gilts to partially hedge against inflation. In addition, PSPS has maintained a portfolio of interest rate and inflation swaps to match more closely the duration and inflation profile of its assets to its liabilities.
The calculations are based on current mortality estimates with an allowance made for future improvements in mortality. This allowance reflected the CMI’s 2014 mortality improvements model, with scheme‑specific calibrations. For immediate annuities in payment, in 2017 and 2016, a long‑term mortality improvement rate of 1.75 per cent per annum and 1.25 per cent per annum was applied for males and females, respectively.
Shareholders' share: Gross of tax surplus (deficit) 138 (30) 80 31 219
Shareholders' share: Gross of tax surplus (deficit) (11) (34) 111 31 97
* 89 per cent of the bonds are investment graded (2016: 93 per cent). † 96 per cent of the total value of the scheme assets are derived from quoted prices in an active market (2016: 98 per cent). None of the scheme assets included shares in Prudential plc or property occupied by the Prudential Group. The IAS 19 basis plan assets at 31 December 2017 of £8,766 million (2016: £8,872 million) is different from the economic basis plan assets of £8,917 million (2016: £9,006 million) as shown above due to the exclusion of investment in Prudential insurance policies, by M&GGPS as described above.
Other adjustments including for investments in Prudential insurance policies note (ii)
Benefit payments (479) 479 – – – – – Employers’ contributions note (iii) 50 – 50 – 50 – 50 Employees’ contributions 1 (1) – – – – – Actuarial gains and losses note (iv) 119 – 119 87 206 (6) 200 Transfer into investment in
Net surplus (deficit), end of year 8,917 (8,225) 692 (485) 207 (151) 56 2016 £m Net surplus (deficit), beginning
Benefit payments (350) 350 – – – – – Employers’ contributions note (iii) 45 – 45 – 45 – 45 Employees’ contributions 2 (2) – – – – – Actuarial gains and losses note (iv) 1,203 (1,645) (442) 274 (168) (13) (181) Transfer into investment in
Net surplus (deficit), end of year 9,006 (8,443) 563 (558) 5 (134) (129)
(ii) The adjustments for investments in Prudential insurance policies are consolidation adjustments for intra‑group assets and liabilities with no impact to operating results. (iii) Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2018 amount to £50 million (2017: £45 million). (iv) The actuarial gains and losses attributable to policyholders and shareholders as shown in the table above are analysed as follows: Actuarial gains and losses Return on the scheme assets less amount included in interest income 119 1,203 (Losses) on changes in demographic assumptions (10) (18) (Losses) on changes in financial assumptions (101) (1,733) Experience gains on scheme liabilities 111 106
Effect of derecognition of PSPS surplus 87 274 Consolidation adjustment for investments in Prudential insurance policies and other adjustments (6) (13)
Assumption applied Impact of sensitivity on scheme liabilities on IAS 19 basis 2017 2016 Sensitivity change in assumption 2017 2016
Discount rate 2.5% 2.6% Decrease by 0.2% Increase in scheme liabilities by: Other schemes 5.4% 5.3%
Rate of inflation 3.1% 3.2% RPI: Decrease by 0.2% Decrease in scheme liabilities by: with consequent reduction in salary increases
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At 31 December 2017, there were options outstanding under save as you earn schemes to subscribe for shares as follows: Number of shares to subscribe for
The Company purchased the following number of shares in respect of employee incentive plans. The shares purchased each month are as follows: Number of shares 2017 share price
Other than set out above the Group did not purchase, sell or redeem any Prudential plc listed securities during 2017 or 2016.
More details on holding company cash flows and balances are given in the section II(a) of the additional unaudited financial information. While the Group at a consolidated level is subject to the Solvency II requirements, at a business unit level capital is defined by local capital regulations and local business needs.
Each of the Group’s long‑term business operations is capitalised to a sufficiently strong level for its individual circumstances. The Group manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities in each business. As a result of the diversity of products offered by Prudential and the different regulatory regimes under which it operates, the Group employs differing methods of asset/liability and capital management, depending on the business concerned.
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Adjustments to regulatory basis Unallocated surplus of with‑profits funds 3,474 2,667 Deferred acquisition costs, distribution rights and goodwill of non‑participating business not recognised for regulatory reporting (1,515) (1,365) Other adjustments 2,411 1,628
The capital requirements of significant operations are: China A risk‑based capital, risk management and governance framework, known as the China Risk Oriented Solvency System (C‑ROSS), applies in China. Under C‑ROSS, insurers are required to maintain a core solvency ratio (core capital over minimum capital) and a comprehensive solvency ratio (actual capital over minimum capital) of not lower than 50 per cent and 100 per cent, respectively. The actual capital is the difference between the admitted assets and admitted liabilities.
Hong Kong The capital requirement varies by underlying risk and duration of liabilities, but is generally determined as a percentage of mathematical reserves and capital at risk. Mathematical reserves are based on a best estimate basis with prudent margins for adverse deviations, discounted at a valuation interest rate based on a blend between the risk‑adjusted portfolio yield and reinvestment rate.
Indonesia Solvency capital is determined using a risk‑based capital approach. Insurance companies in Indonesia are expected to maintain the level of net assets above 100 per cent of solvency capital.
Malaysia A risk‑based capital framework applies in Malaysia. The local regulator has set a Supervisory Target Capital Level of 130 per cent below which supervisory actions of increasing intensity will be taken. Each insurer is also required to set its own Individual Target Capital Level to reflect its own risk profile and this is expected to be higher than the Supervisory Target Capital Level.
Singapore A risk‑based capital framework applies in Singapore. A registered insurer incorporated in Singapore is required at all times to maintain a minimum level of paid‑up ordinary share capital and to ensure that its financial resources are not less than the greater of (i) the total risk requirement arising from the assets and liabilities of the insurer, calculated in accordance with the Singapore Insurance Act; or (ii) a minimum amount of S$5 million (Singapore dollars). The regulator also has the authority to direct that the insurer satisfy additional capital adequacy requirements in addition to those set forth under the Singapore Insurance Act if it considers such additional requirements appropriate.
The regulatory framework for Jackson is governed by the requirements of the US NAIC approved Risk‑Based Capital standards. Under these requirements life insurance companies report using a formula‑based capital standard which includes components calculated by applying after‑tax factors to various asset, premium and reserve items and a separate model‑based component for market risk associated primarily with variable annuity products. The after‑tax factors were not adjusted to reflect the impact of US Tax Reform. At 31 December 2017, Jackson had a permitted practice in effect as granted by the local regulator allowing Jackson to carry certain interest rate swaps at book value, as if statutory hedge accounting were in place, instead of at fair value as would have been otherwise required. Jackson is required to demonstrate the effectiveness of its interest rate swap programme pursuant to the Michigan Insurance Code. The total effect of this permitted practice, net of tax, was to decrease statutory surplus by £355 million at 31 December 2017.
Under the equivalence provisions of Solvency II, Jackson is incorporated into the Group’s Solvency II position at a level equal to available capital in excess of 250 per cent of the US local minimum risk‑based capital requirement level at which corrective action commences.
(c) Transferability of available capital In the UK PAC is required to meet the Solvency II capital requirements as a company as a whole, ie covering both its ring‑fenced with‑profits funds and non‑profit funds. Further, the surplus of the with‑profits funds is ring‑fenced from the shareholder balance sheet with restrictions as to its distribution. Distributions from the with‑profits funds to shareholders continue to reflect the shareholders’ one‑ninth share of the cost of declared policyholders’ bonuses.
Arising on acquisitions of subsidiaries* – 178 178 – – –
At 31 December * Arising on an acquisition made for venture fund purposes by the PAC with‑profits fund.
The Group’s policy is to let investment properties to tenants through operating leases. Minimum future rentals to be received on non‑cancellable operating leases of the Group’s freehold investment properties are receivable in the following periods: Less than 1 year 322 314
The total minimum future rentals to be received on non‑cancellable sub‑leases for the Group’s investment properties held under finance leases at 31 December 2017 are £1,527 million (2016: £2,238 million).
On 18 May 2017, the Group announced that it had completed the sale of its life insurance subsidiary in Korea, PCA Life Insurance Co. Ltd. to Mirae Asset Life Insurance Co. Ltd., following regulatory approvals. The transaction, announced on 10 November 2016, was for a consideration of KRW170 billion (equivalent to £117 million at 17 May 2017 closing rate). The proceeds, net of £9 million of related expenses, were £108 million.
On completion of the sale the cumulative foreign exchange translation gain of the Korea life business of £61 million, that had arisen from 2004 (the year of the Group’s conversion to IFRS) to disposal was recycled from other comprehensive income through the profit and loss account in 2017 as required by IAS 21. The adjustment has no net effect on shareholders’ equity. The net contribution from the Korea life business to the 2017 profit after tax is the £61 million gain arising from the recycling of foreign exchange translation gains previously recognised in other comprehensive income and other elements in various line items of £5 million.
The 2016 income statement recorded a charge for remeasurement of Korea life business classified as held for sale of £(238) million. For 2016 the result for the year, including short‑term fluctuations in investment returns, together with the adjustment to the carrying value gave rise to an aggregate loss of £(227) million. To facilitate comparisons of businesses retained by the Group, the supplementary analysis of profit shown in note B1.1 shows separately the results of the Korea life business.
Support for with-profits sub-funds by shareholders’ funds PAC is liable to meet its obligations to with‑profits policyholders even if the assets of the with‑profits sub‑funds are insufficient to do so. The assets, represented by the unallocated surplus of with‑profits funds, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (‘the excess assets’) in the with‑profits sub‑funds could be materially depleted over time by, for example, a significant or sustained equity market downturn, costs of significant fundamental strategic change or a material increase in the pension mis‑selling provision. In the unlikely circumstance that the depletion of the excess assets within the long‑term fund was such that the Group’s ability to satisfy policyholders’ reasonable expectations was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders’ funds to the with‑profits sub‑funds to provide financial support.
Matters relating to with‑profits sub‑funds: — Pension mis‑selling review – The UK insurance regulator required all UK life insurance companies to review sales of personal pensions policies for potential mis‑selling. Offers to all cases were made by 30 June 2002. Costs arising from this review are met by the excess assets of the PAC with‑profits sub‑fund and hence have not been charged to the asset shares used in the determination of policyholder bonus rates. Prudential has given an assurance that these deductions from excess assets will not impact its bonus or investment policy for policies within the with‑profits sub‑funds that were in force at 31 December 2003. This assurance does not apply to new business since 1 January 2004. In the unlikely event that such deductions would affect the bonus or investment policy for the relevant policies, Prudential has stated it would make available support to the sub‑fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged.
— Guaranteed annuities – A provision for guaranteed annuity products of £53 million was held (2016: £62 million) in the PAC with‑profits sub‑fund.
In addition, Prudential has put in place intra‑group arrangements to formalise undertakings by Prudential to the regulators of the Hong Kong subsidiaries regarding their solvency levels.
Sale of £12.0 billion* UK annuity portfolio In March 2018, M&G Prudential also announced the sale of £12.0 billion* of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion* of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. Further details are set out in the CFO Report.
www.prudential.co.uk Annual Report 2017 Prudential plc 285 01 G roup overview 02 Strategic report 03 G
In 2017 and 2016, other transactions with directors were not deemed to be significant both by virtue of their size and in the context of the directors’ financial positions. All of these transactions are on terms broadly equivalent to those that prevail in arm’s length transactions.
Apart from these transactions with directors, no director had interests in shares, transactions or arrangements that require disclosure, other than those given in the Directors’ remuneration report. Key management remuneration is disclosed in note B2.3.
Future minimum lease payments for non‑cancellable operating leases fall due during the following periods: Not later than 1 year 113 107 Later than 1 year and not later than 5 years 284 209 Later than 5 years 118 96 Future minimum sub‑lease rentals received for non‑cancellable operating leases for land and buildings 56 60 Minimum lease rental payments included in consolidated income statement 123 115
In addition, 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 2017 were £176 million (2016: £458 million).
At 31 December 2017, Jackson has unfunded commitments of £414 million (2016: £465 million) related to its investments in limited partnerships and £214 million (2016: £201 million) related to commercial mortgage loans and other fixed maturities. These commitments were entered into in the normal course of business and a material adverse impact on the operations is not expected to arise from them.
Joint ventures represent arrangements where the controlling parties through contractual or other agreement have the rights to the net assets of the arrangements. The Group has shareholder‑backed joint venture insurance and asset management businesses in China with CITIC Group, and until September 2016 in India with ICICI Bank (see below). In addition, there is an asset management joint venture in Hong Kong with Bank of China International Holdings Limited (BOCI) and Takaful general and life insurance joint venture in Malaysia.
The investments in these joint ventures have the same accounting year end as the Group. The Group’s associates, which are also accounted for under the equity method, include PPM South Africa and from September 2016 the Indian insurance entity, see below. In addition, the Group has investments in Open‑Ended Investment Companies (OEICs), unit trusts, funds holding collateralised debt obligations, property unit trusts and venture capital investments of the PAC with‑profits funds where the Group has significant influence. As allowed under IAS 28, these investments are accounted for on a fair value through profit or loss basis. The aggregate fair value of associates accounted for at fair value through profit or loss, where there are published price quotations, is approximately £2.4 billion at 31 December 2017 (2016: £3.5 billion).
The Group’s share of the profits (including short‑term fluctuations in investment returns), net of related tax, and carrying amount of interest in joint ventures and associates, which are equity accounted as shown in the consolidated income statement comprises the following: Joint ventures and associates
Shareholder‑backed business 196 161 PAC with‑profits fund (prior to offsetting effect in movement in unallocated surplus) 106 21
Share of profits from joint ventures and associates, net of related tax 121 60 – – 106 15 302 – 302
There is no other comprehensive income in the joint ventures and associates. There has been no unrecognised share of losses of a joint venture or associate that the Group has stopped recognising in the total income.
M&G Group Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Financial Services Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Other subsidiaries, joint ventures, associates and significant holdings of the Group – no shares held directly by the parent company, Prudential plc or its nominees
Allied Life Brokerage Agency, Inc OS 100.00% 400 East Court Avenue, Des Moines, IA 50309, USA
BOCHK Aggressive Growth Fund OS 60.22% 27th Floor, Bank of China Tower, 1 Garden Road, Central and Western District, Hong Kong
BOCI ‑ Prudential Asset Management Limited OS 36.00% 27th Floor, Bank of China Tower, 1 Garden Road, Central and Western District, Hong Kong
Canada Property (Trustee) No 1 Limited OS 100.00% Lime Grove House, Green Street, St Helier, Jersey, JE1 2ST
Canada Property Jersey No. 2 Trust OS 100.00% Lime Grove House, Green Street, St Helier, Jersey, JE1 2ST
Carraway Guildford (Nominee A) Limited OS 100.00% 13 Castle Street, St Helier, Jersey, JE4 5UT
Carraway Guildford Investments Unit Trust OS 100.00% 13 Castle Street, St Helier, Jersey, JE4 5UT
Centaurus Retail LLP LPI 50.00% 40 Broadway, London, SW1H 0BU, UK
Centre Capital Non‑Qualified Investors IV AIV Orion, LP LPI 76.80% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA
Centre Capital Non‑Qualified Investors IV AIV‑RA, LP LPI 31.92% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA
CEP IV‑A Chicago AIV, LP LPI 31.92% 615 South Dupont Highway, Dover, DE 19901, USA
CEP IV‑A Davenport AIV, LP LPI 31.92% 615 South Dupont Highway, Dover, DE 19901, USA
CF Prudential European QIS Fund OS 97.68% 17 Rochester Row, London, SW1P 1QT, UK
CF Prudential UK Growth QIS Fund OS 94.27% 17 Rochester Row, London, SW1P 1QT, UK
CITIC‑CP Asset Management Co., Ltd. MI 26.95% No.128 North Zhangjiabang Road, Pudong District, Shanghai, China
CITIC‑Prudential Fund Management Co., Ltd. MI 49.00% Level 9, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong, Shanghai, China
CITIC‑Prudential Life Insurance Company Limited MI 50.00% East Tower, World Financial Centre, No. 1 East Third Ring Middle Road, Chaoyang District, Beijing, China
Clairvest Equity Partners IV‑A LP LPI 31.87% 22 St Clair Avenue East, Suite 1700, Toronto, ON M4T 2S3, Canada
Cribbs Causeway Merchants Association Limited LBG 100.00% The Mall at Cribbs Causeway, Bristol, BS34 5DG, UK
Cribbs Mall Nominee (1) Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK