— The information given in the Strategic Report and the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements.
In particular, we are required to report to you if: — We have identified material inconsistencies between the knowledge we acquired during our audit and the directors’ statement that they consider that 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 Group’s position and performance, business model and strategy; or
— The Audit Committee report does not appropriately address matters communicated by us to the audit committee.
— The parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or
7. Scope of report and responsibilities As explained more fully in the directors’ responsibilities statement set out on page 292, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/ auditscopeukco2014a which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
Notes on the EEV basis results 302 1 Basis of preparation 302 2 Results analysis by business area 304 3 Analysis of new business contribution 305 4 Operating profit from business in force 307 5 Short-term fluctuations in investment returns 308 6 Effect of changes in economic assumptions 309 7 Net core structural borrowings of shareholder-financed operations 310 8 Analysis of movement in free surplus 313 9 Reconciliation of movement in shareholders’ equity 314 10 Reconciliation of movement in net worth and value of in-force for long-term business 316 11 Expected transfer of value of in-force business to free surplus 317 12 Sensitivity of results to alternative assumptions 318 13 Methodology and accounting presentation 327 15 Effect of Solvency II on EEV basis results on 1 January 2016 328 16 New business premiums and contributions
Other income and expenditure note (i) (566) (531) Solvency II and restructuring costs note (ii) (51) (36) Results of the sold PruHealth and PruProtect businesses – 11
* In order to show the UK long-term business on a comparable basis, the 2014 comparative results exclude the contribution from the sold PruHealth and PruProtect businesses which is shown separately.
Notes (i) EEV basis other income and expenditure represents the post-tax IFRS basis result less the unwind of expected margins on the internal management
of the assets of the covered business (as explained in note 13(a)(vii)) and an adjustment for the shareholders’ share of the pension costs attributable to the with-profits business.
(iii) The comparative results have been prepared using previously reported average exchange rates for the year.
Based on post-tax operating profit including longer-term investment returns (in pence) 191.2p 160.7p Based on post-tax profit attributable to equity holders of the Company (in pence) 154.8p 170.4p Average number of shares (millions) 2,553 2,549
Operating profit based on longer-term investment returns 4,881 4,096 Short-term fluctuations in investment returns 5 (1,208) 763 Effect of changes in economic assumptions 6 57 (369) Mark to market value movements on core borrowings 221 (187) Gain on sale of PruHealth and PruProtect† – 44 Costs of domestication of Hong Kong branch – (4) Total non-operating (loss) profit (930) 247
† In November 2014, PAC completed the sale of its 25 per cent equity stake in the PruHealth and PruProtect businesses to Discovery Group Europe Limited resulting in a gain of £44 million in 2014.
Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds (327,711) (314,822) Less shareholders’ accrued interest in the long-term business 19,404 17,350
Based on EEV basis shareholders’ equity of £32,359 million (2014: £29,161 million) (in pence) 1,258p 1,136p Number of issued shares at year end (millions) 2,572 2,568
A detailed description of the EEV methodology and accounting presentation is provided in note 13.
The 2014 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2014 CER comparative results are translated at 2015 average exchange rates.
Solvency II and restructuring costs (51) (36) (36) (42)% (42)% Results of the sold PruHealth and PruProtect
Operating profit based on longer-term investment returns 4,881 4,096 4,220 19% 16%
Based on post-tax operating profit including longer-term investment returns 191.2p 160.7p 165.6p 19% 15%
Notes on the EEV basis results continued 3 Analysis of new business contribution
Asia operations note (ii) 2,853 15,208 1,490 52 9.8 US operations 1,729 17,286 809 47 4.7 UK insurance operations 1,025 9,069 318 31 3.5
Note The increase in new business contribution of £502 million from £2,115 million for 2014 to £2,617 million for 2015 comprises an increase on a CER basis of £442 million and an increase of £60 million for foreign exchange effects. The increase of £442 million on the CER basis comprises a contribution of £377 million for higher sales volumes, a £21 million effect of higher long-term interest rates (generated by the active basis of setting economic assumptions) (analysed as Asia £(2) million, US £20 million and UK £3 million) and a £44 million impact of pricing, product and other actions.
Unwind of discount and other expected returns 749 472 488 1,709 Effect of changes in operating assumptions 12 115 55 182 Experience variances and other items 70 412 2 484
Year-on-year change in effects of operating assumptions, experience variances and other items 58
Unwind of discount and other expected returns note (a) 749 648 Effect of changes in operating assumptions: Mortality and morbidity note (b) 63 27 Persistency and withdrawals note (c) (46) (17) Expense (1) (5) Other note (d) (4) 47 12 52 Experience variances and other items: Mortality and morbidity note (e) 58 23 Persistency and withdrawals note (f) 20 44 Expense note (g) (32) (27) Other including development expenses 24 (2)
of £119 million for the growth in the opening in-force value, partially offset by a £(10) million decrease from changes in interest rates and an £(8) million decrease for foreign exchange effects.
(c) The 2015 charge of £(46) million for persistency assumption changes comprises positive and negative contributions from our various operations, with positive persistency updates on health and protection products being more than offset by negative effects for unit-linked business. The 2014 charge of £(17) million mainly reflected increased partial withdrawal assumptions on unit-linked business in Korea.
sub-scale (China, Malaysia Takaful and Taiwan) and from short-term overruns in India.
Notes (a) The increase in unwind of discount and other expected returns of £90 million from £382 million for 2014 to £472 million for 2015 comprises a £56 million
(b) The credit of £139 million in 2015 (2014: £55 million) for persistency assumption changes principally relates to reduced lapse rates for variable annuity business to more closely align to recent experience.
(e) Other experience variances of £193 million in 2015 (2014: £118 million) include the effects of positive persistency experience and other favourable experience variances. The 2015 result benefits from higher levels of tax relief from prior period adjustments.
Notes (a) The increase in unwind of discount and other expected returns of £78 million from 2014 of £410 million to £488 million for 2015 comprises an effect
(e) The £75 million benefit arose from the specific management actions taken in the second half of 2015 to position the balance sheet more efficiently under the new Solvency II regime.
(f) The credit of £61 million for 2015 comprises assumption updates and experience variances for mortality, expense, persistency and other items.
Short-term fluctuations in investment returns included in profit for the year arise as follows: (i) Group summary
(ii) Asia operations The short-term fluctuations in investment returns for Asia operations comprise: Hong Kong (144) 178
Notes (a) The (charge) credit relating to fixed income securities comprises the following elements: – the impact on portfolio yields of changes in the asset portfolio in the year; – the excess of actual realised gains and losses over the amortisation of interest-related realised gains and losses recorded in the profit and loss account; and – credit experience (versus the longer-term assumption).
(iv) UK insurance operations The short-term fluctuations in investment returns for UK insurance operations comprise: Shareholder-backed annuity note (a) (88) 310 With-profits, unit-linked and other note (b) (106) 273
with-profits fund (including unallocated surplus) compared to the assumed rate of return of 5.4 per cent (2014: total return of 9.5 per cent compared to assumed rate of 5.0 per cent). This line also includes the effect of a partial hedge of future shareholder transfers expected to emerge from the UK’s with-profits sub-fund entered into to protect future shareholder with-profits transfers from declines in the UK equity market.
(iii) US operations The effect of changes in economic assumptions for US operations comprises: Variable annuity business 104 (228) Fixed annuity and other general account business 5 151
Note For 2015, the credit of £109 million mainly reflects the increase in the assumed separate account return and reinvestment rates for variable annuity business, following the 10 basis points increase in the US treasury rate (2014: decrease of 90 basis points), resulting in higher projected fee income and a decrease in projected benefit costs.
(iv) UK insurance operations The effect of changes in economic assumptions for UK insurance operations comprises: Shareholder-backed annuity business note (a) (56) 352 With-profits and other business note (b) 152 (375)
Notes (a) For shareholder-backed annuity business the overall negative (2014: positive) effect reflects the change in the present value of projected spread income arising
points increase in gilt rates (2014: decrease of 130 basis points), together with the impact from changes in the composition of the asset portfolio.
Holding company* cash and short-term investments (2,173) – (2,173) (1,480) – (1,480)
Core structural borrowings – central funds note 4,567 353 4,920 3,869 579 4,448
Broker-dealer and asset management note (ii)(b) 7 6 7 17% –
Effects of changes in operating assumptions, operating experience variances and other operating items 559 314 336 78% 66%
Asset management and general insurance commission note (ii)(b) 506 489 491 3% 3%
Investment in new business notes (a), (g) (745) – (745) (598) Business in force: Expected in-force cash flows (including expected return on net assets) 2,730 506 3,236 2,863 Effects of changes in operating assumptions, operating experience variances and other operating items 559 – 559 314
Net movement in free surplus 1,449 258 1,707 1,091 Balance at beginning of year: Effect of domestication of Hong Kong branch† – – – (35)
Representing: Balance at beginning of year: * In order to show the UK long-term business on a comparable basis, the 2014 comparative underlying movement in free surplus excludes the contribution from the sold PruHealth and PruProtect businesses.
Mark to market value movements on Jackson assets backing surplus and required capital note 9 (76) – (76) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 14 8 22 Other items note (f) 555 148 703
(f) Other items include the effect of intra-group loans, contingent loan repayments as shown in note 10(i), timing differences arising on statutory transfers and other non-cash items. For 2015, other items for long-term business include the effect of a classification change of £702 million from Other operations to UK insurance operations in order to align with Solvency II segmental reporting.
(h) The credit of £23 million in free surplus in 2015 reflects the release of required capital and transfer of value of in-force business on the completion of the sale of the Japan life business (see note 10).
) basis results 7 A dditional inform ation 9 Reconciliation of movement in shareholders’ equity
Other items taken directly to equity Exchange movements on foreign operations
Intra-group dividends (including statutory transfers) and investment in operations note (ii) (472) (465) (215) (1,152) 1,152 – External dividends – – – – (974) (974)
Notes (i) For the purposes of the table above, goodwill of £233 million (2014: £233 million) related to Asia long-term operations is included in Other operations. (ii) Intra-group dividends (including statutory transfers) represent dividends that have been declared in the year and amounts accrued in respect of statutory
Operating profit based on longer-term investment returns 2,544 355 2,899 2,064 4,963 Disposal of Japan life business 23 (48) (25) 25 – Other non-operating items (407) (216) (623) (483) (1,106)
Shareholders’ equity at end of year 5,642 4,704 10,346 22,431 32,777
US operations Shareholders’ equity at beginning of year 1,416 1,710 3,126 5,253 8,379 New business contribution note (ii) (267) 284 17 792 809 Existing business – transfer to net worth 1,064 (196) 868 (868) – Expected return on existing business note 4 42 49 91 381 472 Changes in operating assumptions and experience
Operating profit based on longer-term investment returns 1,159 159 1,318 489 1,807
Shareholders’ equity at end of year 1,567 1,806 3,373 6,114 9,487
UK insurance operations Shareholders’ equity at beginning of year 1,430 1,519 2,949 5,484 8,433 New business contribution note (ii) (65) 85 20 298 318 Existing business – transfer to net worth 573 (82) 491 (491) – Expected return on existing business note 4 47 37 84 404 488 Changes in operating assumptions and experience
Shareholders’ equity at end of year 2,572 1,512 4,084 5,563 9,647
Notes (i) For UK insurance operations, the amounts shown for intra-group dividends (including statutory transfers) in free surplus of £(436) million and in the value
of in-force of £221 million include the impact of intra-group contingent loan repayments during the year. Contingent loan funding represents amounts whose repayment to the lender is contingent upon future surpluses 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.
Post-tax new business contribution note 3 1,490 809 318 2,617 1,162 694 259 2,115 Free surplus invested in new business (413) (267) (65) (745) (346) (187) (65) (598)
Cost of time value of guarantees note (iv) (88) (1,012) – (1,100) (113) (462) – (575)
(iv) The increase in the cost of time value of guarantees for US operations from £(462) million in 2014 to £(1,012) million in 2015 primarily relates to variable annuity business, mainly arising from the level of equity market performance.
(v) Other movements for UK insurance operations include the effect of a classification change, as discussed in note 9(iii).
The discounted value of in-force business and required capital can be reconciled to the 2015 and 2014 totals in the tables below for the emergence of free surplus as follows: Required capital note 10 4,704 4,556 Value of in-force (VIF) note 10 22,431 20,375 Add back: deduction for cost of time value of guarantees note 10 1,100 575 Expected cash flow from sale of Japan life business – (23) Other items note (1,948) (1,382)
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2014 total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years
Long-term expected defaults – 5 bps increase – – (8) (8) – – (10) (10)
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long-term business operations and include the combined effect on the value of in-force business and net assets at the balance sheet dates indicated. If the change in assumption shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year. These are for the effect of economic assumption changes and short-term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition, for changes in interest rates, the effect shown above for Jackson would also be recorded within the fair value movements on assets backing surplus and required capital which are taken directly to shareholders’ equity.
Notes on the EEV basis results continued 12 Sensitivity of results to alternative assumptions continued
Covered business comprises the Group’s long-term business operations, with two exceptions: — The closed Scottish Amicable Insurance Fund (SAIF) which is excluded from covered business. SAIF is a ring-fenced sub-fund of the Prudential Assurance Company (PAC) long-term fund, established by a Court-approved Scheme of Arrangement in October 1997. SAIF is closed to new business and the assets and liabilities of the fund are wholly attributable to the policyholders of the fund.
(ii) Valuation of in-force and new business The embedded value results are prepared incorporating best-estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency, mortality and morbidity (as described in note 14). These assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the non-diversifiable risks associated with the cash flows that are not otherwise allowed for.
New business premiums reflect those premiums attaching to covered business, including premiums for contracts classified as investment products for IFRS basis reporting. New business premiums for regular premium products are shown on an annualised basis. Internal vesting business is classified as new business where the contracts include an open market option.
However, in determining the movements on the additional shareholders’ interest, the basis for calculating the Jackson EEV result acknowledges that, for debt securities backing liabilities, the aggregate EEV results reflect the fact that the value of in-force business instead incorporates the discounted value of future spread earnings. This value is not affected generally by short-term market movements on securities that, broadly speaking, are held for the longer term.
Fixed annuities provide that, at Jackson’s discretion, it may reset the interest rate credited to policyholders’ accounts, subject to a guaranteed minimum. The guaranteed minimum return varies from 1.0 per cent to 5.5 per cent for both years, depending on the particular product, jurisdiction where issued, and date of issue. For 2015, 87 per cent (2014: 86 per cent) of the account values on fixed annuities are for policies with guarantees of 3 per cent or less. The average guarantee rate is 2.6 per cent (2014: 2.7 per cent).
UK insurance operations For covered business the only significant financial options and guarantees in the UK insurance operations arise in the with-profits fund.
With-profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses – annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The PAC with-profits fund also held a provision on the Pillar I Peak 2 basis of £47 million at 31 December 2015 (31 December 2014: £50 million) to honour guarantees on a small number of guaranteed annuity option products.
In all instances, the modelled actions are in accordance with approved local practice and therefore reflect the options actually available to management. For the PAC with-profits fund, the actions assumed are consistent with those set out in the Principles and Practices of Financial Management which explains how regular and final bonus rates within the discretionary framework are determined, subject to the general legislative requirements applicable.
(vi) With-profits business and the treatment of the estate The proportion of surplus allocated to shareholders from the PAC with-profits fund has been based on the present level of 10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing final bonus rates (and related shareholder transfers) so as to exhaust the estate over the lifetime of the in-force with-profits business. In any scenarios where the total assets of the life fund are insufficient to meet policyholder claims in full, the excess cost is fully attributed to shareholders. Similar principles apply, where appropriate, for other with-profits funds of the Group’s Asia operations.
These allowances are initially reflected in determining best estimate returns and through the market risk allowance described above. However, for those businesses largely backed by holdings of debt securities, these allowances in the projected returns and market risk allowances may not be sufficient and an additional allowance may be appropriate.
(3) With-profits fund holdings of debt securities The UK with-profits fund holds debt securities as part of its investment portfolio backing policyholder liabilities and unallocated surplus. The assumed earned rate for with-profits holdings of corporate bonds is defined as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
Total profit attributable to shareholders and basic earnings per share include these items, together with actual investment returns. The Group believes that operating profit, as adjusted for these items, better reflects underlying performance.
For the purpose of determining the long-term returns for debt securities of US operations for fixed annuity and other general account business, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of end-of-year risk-free rates and equity risk premium. For US variable annuity separate account business, operating profit includes the unwind of discount on the opening value of in-force adjusted to reflect end-of-year projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
Principal economic assumptions The EEV basis results for the Group’s operations have been determined using economic assumptions where the long-term expected rates of return on investments and risk discount rates are set by reference to year end rates of return on government bonds. Expected returns on equity and property asset classes and corporate bonds are derived by adding a risk premium, based on the Group’s long-term view, to the risk-free rate.
inflation %New business In force 31 Dec 31 Dec 31 Dec 31 Dec
Total weighted risk discount rate note (a) 5.9 6.9 6.4 6.6
Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each country’s risk discount rates by reference to the
post-tax EEV basis new business result and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
(b) For Hong Kong, the assumptions shown are for US dollar denominated business. For other territories, the assumptions are for local currency denominated business.
(c) Equity risk premiums in Asia range from 3.5 per cent to 8.6 per cent (2014: from 3.5 per cent to 8.7 per cent). The mean equity return assumptions for the most significant equity holdings of the Asia operations were: Hong Kong 6.3 6.2
January to June issues 1.25 1.5 July to December issues 1.5 1.5
Fixed index annuity business: January to June issues 1.5 2.0 July to December issues 1.75 2.0
Institutional business 0.7 0.7 Allowance for long-term defaults included in projected spread note 13 (a)(viii) 0.24 0.25 Risk discount rate: Variable annuity: Risk discount rate 6.8 6.9 Additional allowance for credit risk included in risk discount rate note 13 (a)(viii) 0.2 0.2
Weighted average total: New business 6.7 6.7 In force 6.2 6.2
† Including the proportion of variable annuity business invested in the general account.
(vi) UK insurance operations — Interest rates are projected using a stochastic interest rate model calibrated to the current market yields. — Equity returns are assumed to follow a log-normal distribution. — The corporate bond return is calculated based on a risk-free bond return plus a mean-reverting spread. — Property returns are also modelled on a risk-free bond return plus a risk premium with a stochastic process reflecting total property returns.
Demographic assumptions Persistency, mortality and morbidity assumptions are based on an analysis of recent experience, but also reflect expected future experience. Where relevant, when calculating the time value of financial options and guarantees, policyholder withdrawal rates vary in line with the emerging investment conditions according to management’s expectations.
Expense assumptions Expense levels, including those of service companies that support the Group’s long-term business operations, are based on internal expense analysis investigations and are appropriately allocated to acquisition of new business and renewal of in-force business. Exceptional expenses are identified and reported separately. For mature business, it is Prudential’s policy not to take credit for future cost reduction programmes until the savings have been delivered. For businesses which are currently sub-scale (China, Malaysia Takaful and Taiwan), and India (where the business model is being adapted as the industry continues to adjust to regulatory changes), expense overruns are reported where these are expected to be short-lived.
For Asia operations, the expenses comprise costs borne directly and recharged costs from the Asia regional head office, that are attributable to covered business. The assumed future expenses for these operations also include projections of these future recharges. Development expenses are charged as incurred.
Tax rates The assumed long-term effective tax rates for operations reflect the incidence of taxable profits and losses in the projected cash flows as explained in note 13(a)(x).
The local standard corporate tax rates applicable for the most significant operations are as follows: Standard corporate tax rates %
US operations 35.0 UK operations† 2015: 20.0; from 2017: 19.0; from 2020: 18.0 * 16.5 per cent on 5 per cent of premium income † The impact of the reductions in future UK corporate tax rates on the opening value of in-force business is £55 million as shown in note 4(iv)(b).
15 Effect of Solvency II on EEV basis results on 1 January 2016
The Solvency II framework is effective from 1 January 2016. For our operations in Asia and the US, there is no impact on the EEV results since Solvency II does not act as the local constraint on the ability to distribute profits to the Group. The EEV basis results and profile of free surplus generation for these businesses will continue to be driven by local regulatory and target capital requirements.
For the UK insurance operations Solvency II will impact the EEV results as it changes the local regulatory valuation of net worth and capital requirements, affecting the components of the EEV and the expected profile of free surplus generation. In line with guidance provided by the CFO Forum in October 2015, the impact of Solvency II on the UK EEV has not been included in the results presented in this section. An early estimate on the likely impact of Solvency II on the EEV net worth and value of in-force business is provided in section II(i) of the additional unaudited information.
Notes on the EEV basis results continued 16 New business premiums and contributions note (i)
Group insurance operations Asia 2,120 2,272 2,641 2,010 2,853 2,237 15,208 12,331 US 17,286 15,555 – – 1,729 1,556 17,286 15,555 UK note (iv) 8,463 6,681 179 166 1,025 834 9,069 7,305
Asia insurance operations Cambodia – – 8 3 8 3 38 16 Hong Kong 546 419 1,158 603 1,213 645 7,007 3,861 Indonesia 230 280 303 357 326 385 1,224 1,619 Malaysia 100 117 201 189 211 201 1,208 1,284 Philippines 146 121 44 39 59 51 287 248 Singapore 454 677 264 289 309 357 2,230 2,683 Thailand 69 92 88 74 95 83 422 392 Vietnam 6 4 82 61 83 61 343 247
SE Asia operations including Hong Kong 1,551 1,710 2,148 1,615 2,304 1,786 12,759 10,350 China note (ii) 308 239 111 81 142 105 739 550 Korea 182 212 123 92 141 113 780 609 Taiwan 45 83 127 116 131 124 442 462 India note (iii) 34 28 132 106 135 109 488 360
US insurance operations Variable annuities 11,977 10,899 – – 1,198 1,090 11,977 10,899 Elite Access (variable annuity) 3,144 3,108 – – 314 311 3,144 3,108 Fixed annuities 477 527 – – 48 53 477 527 Fixed index annuities 458 370 – – 46 37 458 370 Wholesale 1,230 651 – – 123 65 1,230 651
Notes (i) The tables shown above are provided as an indicative volume measure of transactions undertaken in the reporting year that have the potential to generate
Our opinion on the EEV basis supplementary information is unmodified We have audited the EEV basis supplementary information of Prudential plc (the Company) for the year ended 31 December 2015 set out in the EEV basis results and Notes on the EEV basis results pages. The EEV basis supplementary information should be read in conjunction with the Group financial statements.
Respective responsibilities of directors and auditor As explained more fully in the directors’ responsibilities statement set out on page 329, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Scope of an audit of financial statements performed in accordance with ISAs (UK and Ireland) A description of the scope of an audit of financial statements is provided on our website at www.kpmg.com/uk/ auditscopeother2014 This report is made subject to important explanations regarding our responsibilities, as published on that website, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
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II. Other information 341 a Holding company cash flow 342 b Funds under management 343 c Solvency II capital position at 31 December 2015 346 d IGD capital position at 31 December 2015 347 e Reconciliation of expected transfer of value of in-force business
I: IFRS profit and loss information a Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: — Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets.
— With-profits business represents the gross of tax shareholders’ transfer from the with-profits fund for the year. — Insurance margin primarily represents profits derived from the insurance risks of mortality and morbidity. — Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses. — Acquisition costs and administration expenses represent expenses incurred in the year attributable to shareholders. It excludes items such as restructuring costs and Solvency II costs which are not included in the segment profit for insurance as well as items that are more appropriately included in other sources of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate).
Analysis of pre-tax IFRS operating profit by source and margin analysis of Group long-term insurance business The following analysis expresses certain of the Group’s sources of operating profit as a margin of policyholder liabilities or other suitable driver. Details on the calculation of the Group’s average policyholder liability balances are given in note (iv).
Impact of specific management actions in second half of 2015 ahead of Solvency II – – 339 339
Margin on revenues 1,545 – 176 1,721 Expenses: DAC adjustments note (vi) 92 191 (6) 277
Margin on revenues 1,532 – 176 1,708 Expenses: DAC adjustments note (vi) 92 206 (6) 292
Analysis of Asia operating profit drivers: — Spread income increased by 21 per cent at constant exchange rates to £153 million in 2015, predominantly reflecting the growth of the Asia non-linked policyholder liabilities.
— Fee income increased by 5 per cent at constant exchange rates from £154 million in 2014 to £162 million in 2015, broadly in line with the increase in movement in average unit-linked liabilities.
— Margin on revenues increased by £200 million at constant exchange rates to £1,732 million in 2015, primarily reflecting higher premium income recognised in the year.
— Acquisition costs increased by 13 per cent at constant exchange rates (AER 13 per cent) to £1,161 million in 2015, compared to the 26 per cent increase in APE sales (AER 28 per cent increase), resulting in a decrease in the acquisition costs ratio. The analysis above uses shareholder acquisition costs as a proportion of total APE sales. If with-profits APE sales were excluded from the denominator the acquisition cost ratio would become 68 per cent (2014: 66 per cent at CER), the small increase being the result of changes to product and country mix.
Analysis of US operating profit drivers: — Spread income declined by 6 per cent at constant exchange rates (AER increased by 2 per cent) to £746 million in 2015. The reported spread margin decreased to 241 basis points from 256 basis points in 2014 primarily due to lower investment yields. Spread income benefited from swap transactions previously entered into to more closely match the asset and liability duration. Excluding this effect, the spread margin would have been 166 basis points (2014 CER: 182 basis points and AER: 183 basis points).
— Administration expenses increased to £828 million in 2015 compared to £747 million for 2014 at constant exchange rates (AER £693 million), primarily as a result of higher asset-based commissions paid on the larger 2015 separate account balance subject to these trail commissions. These are paid on policy anniversary dates and are treated as an administration expense in this analysis. Excluding these trail commissions, the resulting administration expense ratio would be unchanged at 36 basis points (2014: CER 36 basis points and AER 36 basis points).
I: IFRS profit and loss information continued a Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued Analysis of pre-tax operating profit before and after acquisition costs and DAC adjustments note (iii)
Total operating profit before acquisition costs and DAC adjustments 2,412 2,412 2,127 2,127 2,293 2,293
Insurance margin 180 73 Margin on revenues 179 176 Expenses: Expected return on shareholders’ assets 127 137
— Margin on revenues represents premium charges for expenses and other sundry net income received by the UK. The 2015 margin remained stable at £179 million compared to the previous year.
— Acquisition costs incurred declined to £86 million, equivalent to 8 per cent of total APE sales in 2015 (2014: 12 per cent). The decline reflects a shift in business mix towards with-profits business where acquisition costs are funded by the estate. The acquisition cost ratio is also distorted by the high contribution to APE of bulk annuity sales in the year, where acquisition costs are comparatively lower. Acquisition costs expressed as a percentage of shareholder-backed APE sales (excluding the bulk annuity transactions) were 36 per cent (2014: 36 per cent).
— Administration expenses increased by £16 million to £159 million in 2015 largely due to increased spend associated with UK pension reforms.
— The contribution from specific management actions undertaken in the second half of 2015 to position the balance sheet more effectively under the new Solvency II regime was £339 million. Further explanation and analysis is provided in Additional Unaudited IFRS Financial Information section I(d).
Notes to sources of earnings tables (i) The ratio for acquisition costs is calculated as a percentage of APE sales including with-profits sales. Acquisition costs include only those relating to shareholderbacked business. (ii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. (iii) The 2014 comparative information has been presented at AER and CER so as to eliminate the impact of exchange translation. CER results are calculated by
(iv) For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as a proxy for average balances throughout the year. The calculation of average liabilities for Jackson is derived from month end balances throughout the year as opposed to opening and closing balances only. Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administrative expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson.
(v) In order to show the UK long-term business on a comparable basis, the 2014 comparative results exclude the contribution from the sold PruHealth and PruProtect businesses.
I: IFRS profit and loss information continued b Asia operations – analysis of IFRS operating profit by territory Operating profit based on longer-term investment returns for Asia operations is analysed as follows: AER
New business strain* (4) (18) (23) Business in force 1,155 1,021 1,015 Non-recurrent itemsnote (ii) 62 49 50 * The IFRS new business strain corresponds to approximately 0.1 per cent of new business APE premiums for 2015 (2014: approximately 0.8 per cent of new business APE).
(ii) Other non-recurrent items of £62 million in 2015 (2014: £49 million) represent a number of items none of which are individually significant and that are not anticipated to reoccur in subsequent years.
Operating income before performance-related fees 939 304 118 321 1,682 Performance-related fees 22 3 – – 25
Share of associate’s results 14 – – – 14 Group’s share of tax on joint ventures’ operating profit – (16) – – (16)
Average funds under management £252.5bn £85.1bn Margin based on operating income* 37bps 36bps Cost/income ratio† 57% 58%
Share of associate’s results 13 – – – 13 Group’s share of tax on joint ventures’ operating profit – (11) – – (11)
Shareholder annuity new business 66 57 123 162 In-force business: Impact of specific management actions ahead of Solvency II – 169 169 –
Underlying free surplus generated from in-force business 352 526 878 637
Unwind of discount and other expected return 245 243 488 410
Changes in operating assumptions and experience variances 57 59 116 74
Net cash remitted by business units: UK net remittances to the Group
Asia net remittances to the Group Asia paid to the Group: Long-term business 494 453 Other operations 74 60
Group invested in Asia: Long-term business (5) (3) Other operations (including funding of regional head office costs) (96) (110)
Operating holding company cash flow before dividend* 1,271 1,129 Dividend paid (974) (895)
Total holding company cash flow 673 (744) Cash and short-term investments at beginning of year 1,480 2,230 Foreign exchange movements 20 (6)
Cash and short-term investments at end of year 2,173 1,480 * Including central finance subsidiaries. † Non-operating net cash flow is principally for corporate transactions for distribution rights and acquired subsidiaries and issue and repayment of subordinated debt.
Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2015 of £6.0 billion (2014: £4.8 billion).
) basis results 7 A dditional inform ation c Solvency II capital position at 31 December 2015 The estimated Group Solvency II surplus at 31 December 2015 was £9.7 billion, before allowing for the 2015 second interim ordinary and special dividend.
Own funds 20.1 Solvency capital requirement 10.4 Surplus 9.7 Solvency ratio 193%
– Solvency Capital Requirement: represent 150 per cent of Jackson’s local US Risk Based Capital requirement (Company Action Level); — Non-recognition of a portion of Solvency II surplus capital relating to the Group’s Asia life operations, reflecting regulatory prudence; — Matching adjustment for UK annuities, based on the 31 December 2015 calibration published by the European Insurance and Occupational Pensions Authority; and
The Group’s Solvency II capital surplus excludes: — Diversification benefits between Jackson and the rest of the Group; — Surplus in ring-fenced with-profits funds including the shareholders’ share of the estate of with-profits funds; and — Surplus in pension funds.
Economic capital surplus as at 1 January 2015 9.7 Operating experience 2.4 Non-operating experience (including market movements) (0.6)
Other capital movements Subordinated debt issuance 0.6 Foreign currency translation impacts 0.2 Dividends paid (1.0)
— A £1.4 billion reduction in surplus due to the negative impact of Solvency II rules for ‘contract boundaries’ and a reduction in the capital surplus of the Group’s Asia life operations, as agreed with the Prudential Regulation Authority.
II: Other information continued c Solvency II capital position at 31 December 2015 continued The change in US treatment from including 150 per cent, rather than 250 per cent of US Risk Based Capital (Company Action Level) in the Group Solvency Capital Requirement, is offset by a corresponding reduction in the Group Own Funds and therefore has no impact on surplus despite the positive impact on the solvency ratio.
The impacts above, including the impact of the change in basis from economic capital to Solvency II, represent an overall reduction in the Group solvency ratio from 218 per cent to 193 per cent.
Capital generation and other movements 2.0 0.4 1.6 13% Methodology and calibration changes Changes to Own Funds (net of transitionals) and Solvency Capital
Effect of partial derecognition of Asia Solvency II surplus (1.4) – (1.4) (12)% US Risk Based Capital treatment (0.7) (0.7) – 6%
Analysis of Group Solvency Capital Requirements The split of the Group’s estimated Solvency Capital Requirement by risk type, including the capital requirements in respect of Jackson’s risk exposures based on 150 per cent of US Risk Based Capital requirements (Company Action Level) but with no diversification between Jackson and the rest of the Group, is as follows: Split of the Group’s estimated Solvency Capital Requirements
The key items of the reconciliation are: — £1.5 billion represents the adjustment required to the Group’s shareholders’ funds in order to convert Jackson’s contribution from an IFRS basis to the local statutory valuation basis. This item also reflects a derecognition of Own Funds of £0.7 billion, equivalent to the value of 100 per cent of Risk Based Capital requirements (Company Action Level), as agreed with the Prudential Regulation Authority; — £3.7 billion due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £4.4 billion due to the addition of subordinated debt which is treated as available capital under Solvency II but as a liability under IFRS; — £2.5 billion due to the inclusion of a risk margin for UK and Asia non-hedgeable risks, net of transitionals, all of which are not applicable under IFRS; — £3.1 billion due to the inclusion of the value of future shareholder transfers from with-profits business (excluding the shareholders’ share of the with-profits estate, for which no credit is given under Solvency II), which is excluded from the determination of the Group’s IFRS shareholders’ funds; — £8.6 billion due to differences in insurance valuation requirements between Solvency II and IFRS, with Solvency II Own Funds partially capturing the value of in-force business which is excluded from IFRS; — £0.9 billion due to the impact on the valuation of deferred tax assets and liabilities resulting from the other valuation differences noted above; and
Notes 1 The UK shareholder capital position represents the consolidated capital position of the shareholder funds of Prudential Assurance Company Ltd and
all its subsidiaries. 2 The UK with-profits capital position includes the Prudential Assurance Company with-profits sub-fund, the Scottish Amicable Insurance Fund and
II: Other information continued c Solvency II capital position at 31 December 2015 continued Reconciliation of UK with-profits IFRS unallocated surplus to Solvency II Own Funds2
A reconciliation from IFRS to Solvency I is disclosed annually in the Capital Position Statement in the Group IFRS financial statements. The additional reconciling items to Solvency II mainly reflect the risk margin net of transitionals, with other items including differences in the definition of the risk-free rate and the matching adjustment impact for non-profit annuity liabilities within the with-profits funds.
The movements in 2015 mainly comprise: — Net capital generation (inclusive of market and foreign exchange movements) mainly through operating earnings (in-force releases less investment in new business, net of tax) of £1.8 billion; and
IGD surplus represents the accumulation of surpluses across all of our operations based on local regulatory minimum capital requirements with some adjustments, pursuant to the requirements of Solvency I. The calculation does not fully adjust capital requirements for risk nor does it capture the true economic value of assets.
In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in-force business at 31 December 2015, the tables also present the expected future free surplus to be generated from the investment made in new business during 2015 over the same 40-year period.
Expected transfer of value of in-force business (VIF) and required capital to free surplus
Total free surplus expected to emerge in the next 40 years 26,208 12,697 11,870 50,775 3,858 2,011 765 6,634 * The analysis excludes amounts incorporated into VIF at 31 December 2015 where there is no definitive timeframe for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the estate. It also excludes any free surplus emerging after 2055.
The above amounts can be reconciled to the new business amounts as follows: Asia US UK Total
Discounted expected free surplus generation for years 2016 to 2055 1,720 1,286 373 3,379 Discounted expected free surplus generation for years 2055+ 153 – 2 155 Less: Free surplus investment in new business (413) (267) (65) (745)
† Other items represent the impact of the time value of options and guarantees on new business, foreign exchange effects and other non-modelled items. Foreign exchange effects arise as EEV new business profit amounts are translated at average exchange rates and the expected free surplus generation uses year end closing rates.
Less: Amounts expected to be realised in the current year (2,513) – – – – – – (2,513)
New business – 452 288 310 228 278 5,078 6,634 Operating movements – 5 35 25 50 29 Non-operating and other movements – (201) (116) (120) (110) (25) (392) (820)
2015 expected free surplus generation for years 2016 to 2055 – 2,621 2,463 2,383 2,378 2,388 38,542 50,775
Asia £m £m £m £m £m £m Other £m Total £m 2014 expected free surplus generation for years 2015 to 2054 953 920 883 846 819 796 19,360 24,577
2015 expected free surplus generation for years 2016 to 2055 – 1,015 962 926 905 871 21,529 26,208
£m £m £m £m £m £m Other £m Total £m 2014 expected free surplus generation for years 2015 to 2054 1,054 902 844 792 866 801 5,271 10,530
Less: Amounts expected to be realised in the current year (1,054) – – – – – – (1,054)
Foreign exchange differences – 52 50 46 50 47 301 546 New business – 276 120 131 65 106 1,313 2,011 Operating movements – 4 22 30 35 40 Non-operating and other movements – (114) (45) (48) (46) 24 762 664 2015 expected free surplus generation for years 2016 to 2055 – 1,120 991 951 970 1,018 7,647 12,697
Add: Expected free surplus to be generated in year 2055* – – – – – – 40 40
At 31 December 2015 the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £50.8 billion, up from the £47.1 billion expected at the end of 2014 reflecting the effect of new business written across all three business operations of £6.6 billion and a positive foreign exchange translation effect of £0.4 billion. These positive effects have been offset by a £(0.8) billion adverse effect reflecting operating, market assumption changes and other items. In Asia, these principally reflect the impact of falls in equity market returns and bond values. In the US these mainly reflect higher future separate account growth due to the increase in interest rates, together with improved persistency. Offsetting these positive impacts is the negative effect of lower than expected separate account growth in the year due to broadly flat equity market returns in 2015. In the UK, these mainly arise from the effect of longevity reinsurance transactions entered into during the year and the effect of a partial hedge to protect future shareholder with-profits transfers from declines in UK equity markets. The longevity reinsurance transactions executed this year had the effect of accelerating the generation of future free surplus into 2015. The overall growth in the Group’s undiscounted value of free surplus reflects our ability to write both growing and profitable new business.
Actual underlying free surplus generated in 2015 from life business in force at the end of 2015 was £3.3 billion including £0.6 billion of changes in operating assumptions and experience variances. This compares with the expected 2015 realisation at the end of 2014 of £2.5 billion. This can be analysed further as follows: Asia £m US £m UK £m Total £m
Underlying free surplus generated from in-force life business in 2015 985 1,426 878 3,289 2015 free surplus expected to be generated at 31 December 2014 953 1,054 506 2,513
The equivalent discounted amounts of the undiscounted expected transfers from in-force business and required capital into free surplus shown previously are as follows: Discounted expected generation from all in-force business at 31 December
Total discounted free surplus expected to emerge in the next 40 years 11,307 8,740 5,677 25,724 1,720 1,286 373 3,379
II: Other information continued e Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued The above amounts can be reconciled to the Group’s financial statements as follows: Discounted expected generation from all in-force business for years 2016-2055 25,724 Discounted expected generation from all in-force business for years after 2055 563
Discounted expected generation from all in-force business at 31 December 2015 26,287 Add: Free surplus of life operations held at 31 December 2015 5,642 Less: Time value of guarantees (1,100) Other non-modelled items 1,948
Notes 1 US$ linked – comprising the Hong Kong and Vietnam operations where the currencies are pegged to the US dollar, and the Malaysia and Singapore operations
) basis results 7 A dditional inform ation g Option schemes The Group presently grants share options through four schemes and exercises of the options are satisfied by the issue of new shares. Executive directors and eligible employees based in the UK may participate in the UK savings-related share option scheme. Executives and eligible employees based in Asia as well as eligible employees based in Europe can participate in the international savings-related share option scheme while agents based in certain regions of Asia can participate in the international savings-related share option scheme for non-employees. Employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan, which currently has no outstanding options in issue. Further details of the schemes and accounting policies are detailed in note B3.2 of the IFRS basis consolidated financial statements.
The weighted average fair value of options granted under the plan in the year was £2.90.
II: Other information continued g Option schemes continued International savings-related share option scheme
The weighted average fair value of options granted under the plan in the year was £2.87.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £15.88.
The weighted average fair value of options granted under the plan in the year was £3.02.
) basis results 7 A dditional inform ation h Selected historical financial information of Prudential The following table sets forth Prudential’s selected consolidated financial data for the periods indicated. Certain data is derived from Prudential’s audited consolidated financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and as adopted by the European Union (EU) and European Embedded Value (EEV).
Acquisition costs and other expenditure (8,208) (6,752) (6,861) (6,032) (4,717) Finance costs: interest on core structural borrowings of
Cumulative exchange loss recycled from other comprehensive income (46) – – – – Remeasurement adjustments – (13) (120) – –
Tax (charge) credit attributable to policyholders’ returns (173) (540) (447) (370) 7
Profit before tax attributable to shareholders 3,148 2,614 1,635 2,747 1,866 Tax (charge) credit attributable to shareholders’ returns (569) (398) (289) (584) (415)
Based on profit for the year attributable to the equity holders of the Company: Basic earnings per share (in pence) 101.0p 86.9p 52.8p 85.1p 57.1p Diluted earnings per share (in pence) 100.9p 86.8p 52.7p 85.0p 57.0p
Dividend per share declared and paid in reporting period (in pence) 38.05p 35.03p 30.52p 25.64p 25.19p
Operating profit based on longer-term investment returns note 2 4,007 3,186 2,954 2,520 2,017
As of and for the year ended 31 December 2015 £bn 2014 £bn 2013 £bn 2012 £bn 2011 £bn
EEV shareholders’ equity, excluding non-controlling interests 32.4 29.2 24.9 22.4 19.6 Insurance Groups Directive capital surplus before final dividend note 4 5.5 4.7 5.1 5.1 4.0
Notes 1 This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. 2 Operating profits are determined on the basis of including longer-term investment returns. EEV and IFRS operating profits are stated after excluding the effect
The impact of Solvency II on the EEV net worth and value of in-force business reported on 1 January 2016 are shown below: Adjustment to shareholders’ equity at 1 January 2016
Note The Solvency II framework requires technical provisions to be valued on a best estimate basis and capital requirements to be risk-based. It also requires the establishment of a risk margin (which for business in force at 31 December 2015 can be broadly offset by transitional measures). As a result of applying this framework, the EEV net worth increased by £3,108 million following the release of the prudent regulatory margins previously included under Solvency I, and also from the recognition within net worth of a portion of future shareholder transfers expected from the with-profits fund. The higher net worth is mirrored by increases in required capital reflecting the higher solvency capital requirements of the new regime.
The net value of in-force business (VIF) is correspondingly impacted as follows: – The release of prudent regulatory margins and recognition of a portion of future shareholders’ transfers within net worth leads to a corresponding reduction in VIF; – The run-off of the risk margin, net of transitional measures, is now captured in VIF; and – The cost of capital deducted from gross VIF increases as a result of higher Solvency II capital requirements; The overall impact of these changes is to reduce the value of in-force by £3,412 million. The overall impact on the Group’s EEV of the above changes is a reduction of £304 million.
Total free surplus expected to emerge in the next 40 years 5,677 7,229 1,552 25,724 27,276 1,552 c The above amounts can be reconciled to the Group’s financial statements as follows: Reconciliation of discounted expected free surplus generation to EEV
Discounted expected generation from all in-force business for years 2016-2055 25,724 27,276 1,552 Discounted expected generation from all in-force business for years after 2055 563 578 15
Discounted expected generation from all in-force business at 31 December 2015 26,287 27,854 1,567 Add: Free surplus of life operations held at 31 December 2015 5,642 3,958 (1,684) Less: Time value of guarantees (1,100) (1,100) – Other non-modelled items 1,948 1,761 (187)
A number of risk factors affect Prudential’s operating results and financial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, and any forward looking statements are made subject to the reservations specified below under ‘Forward Looking Statements’.
— increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline.
Upheavals in the financial markets may affect general levels of economic activity, employment and customer behaviour. As a result, insurers may experience an elevated incidence of claims, lapses, or surrenders of policies, and some policyholders may choose to defer or stop paying insurance premiums. The demand for insurance products may also be adversely affected. In addition, there may be a higher incidence of counterparty failures. If sustained, this environment is likely to have a negative impact on the insurance sector over time and may consequently have a negative impact on Prudential’s business and its balance sheet and profitability. For example, this could occur if the recoverable value of intangible assets for bancassurance agreements and deferred acquisition costs are reduced. New challenges related to market fluctuations and general economic conditions may continue to emerge.
For some non-unit-linked investment products, in particular those written in some of the Group’s Asian operations, it may not be possible to hold assets which will provide cash flows to match those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets where regulated surrender values are set with reference to the interest rate environment prevailing at the time of policy issue. This results in a mismatch due to the duration and uncertainty of the liability cash flows and the lack of sufficient assets of a suitable duration. While this residual asset/liability mismatch risk can be managed, it cannot be eliminated. Where interest rates in these markets remain lower than those used to calculate surrender values over a sustained period, this could have a material adverse effect on Prudential’s reported profit.
In the US, fluctuations in prevailing interest rates can affect results from Jackson which has a significant spread based business, with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates. Declines in spread from these products or other spread businesses that Jackson conducts, and increases in surrender levels arising from interest rate rises, could have a material impact on its businesses or results of operations.
Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. The value of these guarantees is affected by market factors (such as interest rates, equity values, bond spreads and realised volatility) and policyholder behaviour. There could be market circumstances where the derivatives that Jackson enters into, to hedge its market risks, may not fully cover its exposures under the guarantees. The cost of the guarantees that remain unhedged will also affect Prudential’s results.
) basis results 7 A dditional inform ation www.prudential.co.uk Annual Report 2015 Prudential plc 359 the economic or local regulatory results that may be less significant under IFRS reporting.
Prudential is subject to the risk of potential sovereign debt credit deterioration owing to the amounts of sovereign debt obligations held in its investment portfolio Prudential is subject to the risk of potential sovereign debt credit deterioration on the amounts of sovereign debt obligations held in its investment portfolio.
Investing in sovereign debt creates exposure to the direct or indirect consequences of political, social or economic changes (including changes in governments, heads of states or monarchs) in the countries in which the issuers are located and the creditworthiness of the sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due to the geographical diversity of Prudential’s businesses, Prudential is subject to the risk of exchange rate fluctuations. Prudential’s operations in the US and Asia, which represent a significant proportion of operating profit based on longer-term investment returns and shareholders’ funds, generally write policies and invest in assets denominated in local currencies. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon the translation of results into pounds sterling. This exposure is not currently separately managed. The currency exposure relating to the translation of reported earnings could impact on financial reporting ratios such as dividend cover, which is calculated as operating profit after tax on an IFRS basis, divided by the dividends relating to the reporting year. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within other comprehensive income. Consequently, this could impact on Prudential’s gearing ratios (defined as debt over debt plus shareholders’ funds). The Group’s surplus capital position for regulatory reporting purposes may also be affected by fluctuations in exchange rates with possible consequences for the degree of flexibility the Prudential has in managing its business.
The European Union’s Solvency II Directive came into effect on 1 January 2016. This measure of regulatory capital is more volatile than under the previous Solvency I regime and regulatory policy may evolve under the new regime. The European Commission will review elements of the Solvency II legislation from 2016 onwards including a review of the Long Term Guarantee measures by 1 January 2021.
Currently there are also a number of other global regulatory developments which could impact the way in which Prudential is supervised in its many jurisdictions. These include the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in the US, the work of the Financial Stability Board (FSB) on Global Systemically Important Insurers (G-SIIs) and the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) being developed by the International Association of Insurance Supervisors (IAIS).
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the US that, among other reforms to financial services entities, products and markets, may subject financial institutions designated as systemically important to heightened prudential and other requirements intended to prevent or mitigate the impact of future disruptions in the US financial system. The full impact of the Dodd-Frank Act on Prudential’s businesses is not currently clear, as many of its provisions are primarily focused on the banking industry, have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years.
The IAIS has various initiatives which are detailed in this section. On 18 July 2013, it published a methodology for identifying G-SIIs, and a set of policy measures that will apply to them, which the FSB endorsed. Groups designated as a G-SII are subject to additional regulatory requirements, including enhanced group-wide supervision, effective resolution planning, development of a Systemic Risk Management Plan, a Recovery Plan and a Liquidity Risk Management Plan. Prudential’s designation as a G-SII was reaffirmed on 3 November 2015. Prudential is monitoring the development and potential impact of the policy measures and is continuing to engage with the PRA on the implications of the policy measures and Prudential’s designation as a G-SII.
Any changes or modification of IFRS accounting policies may require a change in the future results or a retrospective adjustment of reported results.
Regulators’ interest may include the approach that product providers use to select third party distributors and to monitor the appropriateness of sales made by them. In some cases, product providers can be held responsible for the deficiencies of third-party distributors.
In the US, there has been significant attention on the different regulatory standards applied to investment advice delivered to retail customers by different sectors of the industry. As a result of reports relating to perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms. This includes focus on the suitability of sales of certain products, alternative investments and the widening of the circumstances under which a person or entity providing investment advice with respect to certain employee benefit and pension plans would be considered a fiduciary which would subject the person or entity to certain regulatory requirements. There is a risk that new regulations introduced may have a material adverse effect on the sales of the products by Prudential and increase Prudential’s exposure to legal risks.
In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. New requirements could be introduced in these and other regulatory regimes that challenge current practices, or could retrospectively be applied to sales made prior to their introduction, which could have a negative impact on Prudential’s business or reported results.
The Prudential Assurance Company Limited’s financial strength is rated Aa3 by Moody’s, AA by Standard & Poor’s and AA by Fitch. These ratings are all on a stable outlook.
Prudential is continually enhancing its IT environment to remain secure against emerging threats, together with increasing its ability to detect system compromise and recover should such an incident occur. However, there can be no assurance that such events will not take place with adverse consequential effects on Prudential’s business and financial position.
Another example is the impact of epidemics and other effects that give rise to a large number of deaths or additional sickness claims. Significant influenza epidemics have occurred a number of times over the past century but the likelihood, timing or the severity of future epidemics cannot be predicted. The effectiveness of external parties, including governmental and non-governmental organisations, in combating the spread and severity of any epidemics could have a material impact on the Group’s loss experience.
Prudential’s Articles of Association contain an exclusive jurisdiction provision Under Prudential’s Articles of Association, certain legal proceedings may only be brought in the courts of England and Wales. This applies to legal proceedings by a
Bonuses Bonuses refer to the non-guaranteed benefit added to participating life insurance policies and are the way in which policyholders receive their share of the profits of the policies. There are normally two types of bonuses: — Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and
Endowment product An ordinary individual life insurance product that provides the insured party with various guaranteed benefits if it survives specific maturity dates or periods stated in the policy. Upon the death of the insured party within the coverage period, a designated beneficiary receives the face value of the policy.
) basis results 7 A dditional inform ation www.prudential.co.uk Annual Report 2015 Prudential plc 365 actual interest credited may be higher and is linked to an equity index over its indexed option period.
Guaranteed annuities Policies that pay out a fixed amount of benefit for a defined period.
Health and protection These comprise health and personal accident insurance products, which provide morbidity or sickness benefits and include health, disability, critical illness and accident coverage. Health and protection products are sold both as standalone policies and as riders that can be attached to life insurance products. Health and protection riders are presented together with ordinary individual life insurance products for purposes of disclosure of financial information.
OIEC Open ended investment company A collective investment fund structured as a limited company in which investors can buy and sell shares.
Present value of new business premiums or PVNBP The present value of new business premiums is calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
Separate account A separate account is a pool of investments held by an insurance company not in or ‘separate’ from its general account. They generally accrue to the policyholder. A separate account allows an investor to choose an investment category according to his individual risk tolerance, and desire for performance.
) basis results 7 A dditional inform ation www.prudential.co.uk Annual Report 2015 Prudential plc 367
Unallocated surplus Unallocated surplus is recorded wholly as a liability and represents the excess of assets over policyholder liabilities for Prudential’s with-profits funds. The balance retained in the unallocated surplus represents cumulative income arising on the withprofits business that has not been allocated to policyholders or shareholders.
Annual General Meeting The 2016 Annual General Meeting will be held in the Churchill Auditorium at the Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on 19 May 2016 at 11.00am.
Documents on display The terms and conditions of all Directors’ appointments are available for inspection at the Company’s registered office during normal business hours and at the Annual General Meeting.
All Directors are required to hold a minimum number of shares under guidelines approved by the Board, which they would also be expected to retain as described on page 104 and page 121 of the Directors’ remuneration report.
) basis results 7 A dditional inform ation www.prudential.co.uk Annual Report 2015 Prudential plc 369
Authority to issue shares The Directors require authority from shareholders in relation to the issue of shares. Whenever shares are issued, these must be offered to existing shareholders pro rata to their holdings unless the directors have been given authority by shareholders to issue shares without offering them first to existing shareholders. Prudential seeks authority from its shareholders on an annual basis to issue shares up to a maximum amount and to issue up to 5 per cent of its issued share capital without offering them to existing shareholders, in line with relevant regulations and best practice. Disapplication of statutory pre-emption procedures is also sought for rights issues. The existing authorities to issue shares and to do so without observing pre-emption rights are due to expire at the end of this year’s Annual General Meeting. An ordinary resolution and a special resolution to approve the renewal of these authorities respectively will be put to shareholders at the Annual General Meeting on 19 May 2016.
Authority to purchase own shares The directors also require authority from shareholders in relation to the purchase of the Company’s own shares. Prudential seeks authority by special resolution on an annual basis for the buyback of its own shares in accordance with the relevant provisions of the Companies Act 2006 and other related guidance. This authority has not been used since it was last granted at the 2015 Annual General Meeting. This existing authority is due to expire at the end of this year’s Annual General Meeting and a special resolution to renew the authority will be put to shareholders at the Annual General Meeting on 19 May 2016.
Record date 29 March 2016 29 March 2016 29 March 2016
Textel 0371 384 2255 (for hard of hearing). Lines are open from 8.30am to 5.30pm (UK), Monday to Friday. International shareholders tel +44 (0) 121 415 7026
Cash dividend alternative The Company operates a Dividend Re-investment Plan (DRIP). Shareholders who have elected for the DRIP will automatically receive shares for all future dividends in respect of which a DRIP alternative is offered. The election may be cancelled at any time by the shareholder. Further details of the DRIP and the timetable are available on the Company’s website at www.prudential.co.uk/ prudential-plc/investors
Dividends paid on shares held within pensions and Individual Savings Accounts (ISAs) will continue to be tax free.
IMPORTANT: You will be required to retain details of any dividend payments you receive and complete Tax Returns where required. For further advice please contact a tax or financial adviser who in the UK must be authorised by the Financial Conduct Authority.
Forward-looking statements This document may contain ‘forwardlooking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations and including, without limitation, statements containing the words ‘may’, ‘will’, ‘should’, ‘continue’, ‘aims’, ‘estimates’, ‘projects’, ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward-looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward-looking statements involve risk and uncertainty.
A number of important factors could cause Prudential’s actual future financial condition or performance or other indicated results to differ materially from those indicated in any forward-looking statement. Such factors include, but are not limited to, future market conditions, including fluctuations in interest rates and exchange rates, the potential for a sustained low-interest rate environment, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives; the impact of continuing designation as a Global Systemically Important Insurer or ‘G-SII’; the impact of competition, economic uncertainty, inflation, and deflation; the effect on Prudential’s business and results from, in particular, mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards, accounting standards or relevant regulatory frameworks, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate; and the impact of legal actions and disputes. These and other important factors may, for example, result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefits. Further discussion of these and other important factors that could cause Prudential’s actual future financial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the ‘Risk factors’ heading in the Annual Report and the ‘Risk factors’ heading of Prudential’s most recent annual report on Form 20-F filed with the U.S. Securities and Exchange Commission. Prudential’s most recent Annual Report and Form 20-F are available on its website at www.prudential.co.uk