Level 3: Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs) Level 3 principally includes investments in private equity funds, investments in property funds which are exposed to bespoke properties or risks, investments which are internally valued or subject to a significant number of unobservable assumptions and certain derivatives which are bespoke or long dated. It also includes debt securities which are rarely traded or traded only in privately negotiated transactions and hence where it is difficult to assert that these have been based on observable market data. The inherent nature of the vast majority of these assets means that, in normal market conditions, there is unlikely to be significant change in the specific underlying assets classified as level 3. At 31 December 2010 the Group held £4,194 million (2009: £5,190 million), two per cent of the fair valued financial instruments (2009: three per cent), within level 3. Of these amounts £3,359 million (2009: £3,510 million) was held by the Group’s participating funds and therefore shareholders’ profit and equity are not impacted by movements in the valuation of these financial instruments. Total level 3 assets represented 3.3 per cent of the total assets of the participating funds at 31 December 2010 (2009: 3.7 per cent). Total level 3 liabilities at 31 December 2010 were £371 million out of total participating fund liabilities of £112,196 million (2009: £348 million out of £104,817 million). Of the £866 million level 3 fair valued financial investments at 31 December 2010 (2009: £1,684 million), net of derivative liabilities which support non-linked shareholder-backed business (1.6 per cent of the total financial investments net of derivative liabilities backing this business) (2009: 3.6 per cent), £728 million are externally valued and £138 million are internally valued (2009: £1,653 million and £31 million respectively). Internal valuations, which represent 0.2 per cent of the total financial investments net of derivative liabilities supporting non-linked shareholder-backed business at 31 December 2010 (2009: 0.06 per cent), are inherently more subjective than external valuations. If the value of all level 3 investments backing non-linked shareholder-backed business was varied downwards by 10 per cent, the change in valuation would be £14 million (2009: £3 million), which would reduce shareholders’ equity by this amount before tax. Of this amount a £7 million decrease (2009: £5 million increase) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and a £7 million decrease (2009: offset by an £8 million decrease) would be included as part of other comprehensive income, being unrealised movements on assets classified as available-for-sale.
WITH-PROFITS Equity securities and portfolio holdings in unit trusts 29,675 1,281 415 31,371 Debt securities 11,114 41,375 772 53,261 Other investments (including derivative assets) 137 1,207 2,543 3,887 Derivative liabilities (56) (626) (25) (707)
GROUP TOTAL Loans – 227 – 227 Equity securities and portfolio holdings in unit trusts 84,755 1,304 576 86,635 Debt securities 25,287 89,948 1,117 116,352 Other investments (including derivative assets) 232 2,441 3,106 5,779 Derivative liabilities (136) (1,675) (226) (2,037)
UNIT-LINKED AND VARIABLE ANNUITY SEPARATE ACCOUNT Equity securities and portfolio holdings in unit trusts 38,616 4 – 38,620
Total financial investments, net of derivative liabilities 41,929 5,609 40 47,578 Investment contracts without discretionary participation features held at fair value – (12,242) – (12,242) Net asset value attributable to unit holders of consolidated unit trusts and
Total financial investments, net of derivative liabilities 6,475 38,845 1,684 47,004 Investment contracts without discretionary participation features held at fair value – (1,598) – (1,598) Net asset value attributable to unit holders of consolidated unit trusts and
Derivative liabilities (25) – – – – – – – (25)
Total financial investments, net of derivative liabilities 40 – 3 2 (4) (18) – (21) 2
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (42) (17) (1) (16) 43 – – – (33)
WITH-PROFITS Equity securities and portfolio holdings in unit trusts 509 (3) (1) 26 (56) – – – 475
Total financial investments, net of derivative liabilities 3,973 (230) (101) 479 (359) (17) 142 (54) 3,833 Net asset value attributable to unit holders of consolidated unit trusts and similar funds (381) 9 – 49 – – – – (323)
NON-LINKED SHAREHOLDER-BACKED Equity securities and portfolio holdings in unit trusts 318 (47) (34) 21 (55) – – (24) 179
Interest rate risk The following table shows an analysis of the classes of financial assets and liabilities and their direct exposure to interest rate risk. Each applicable class of the Group’s financial assets or liabilities is analysed between those exposed to fair value interest rate risk, cash flow interest rate risk and those with no direct interest rate risk exposure: 2010 £m
FINANCIAL LIABILITIES Core structural borrowings of shareholder-financed operations 3,394 – – 3,394 Operational borrowings attributable to shareholder-financed operations 2,128 620 3 2,751 Borrowings attributable to with-profits funds 804 312 168 1,284 Obligations under funding, securities lending and sale and repurchase agreements 611 2,871 – 3,482 Investment contracts without discretionary participation features 1,098 867 13,840 15,805
FINANCIAL LIABILITIES Core structural borrowings of shareholder-financed operationsH13 3,394 148 588 733 1,394 877 1,343 1,422 6,505 Operational borrowings attributable to shareholder-financed operationsH13 2,751 2,351 435 9 9 9 31 – 2,844 Borrowings attributable to with-profits fundsH13 1,284 228 882 102 – – – 205 1,417 Obligations under funding, securities lending and sale and repurchase agreements 3,482 3,482 – – – – – – 3,482
Net asset value attributable to unit holders of consolidated unit-trusts and similar funds 3,809 3,809 – – – – – – 3,809 ii) Maturity analysis of derivatives The following table provides a maturity analysis of derivative assets and liabilities: 2010 £m
After 3 years to 5 years After 5 years Total 2009 £m
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 is in marketable securities, which can therefore be converted quickly to liquid assets. For the reasons above an analysis of the Group’s assets by contractual maturity is not considered necessary to evaluate the nature and extent of the Group’s liquidity risk.
Credit risk The Group’s maximum exposure to credit risk of financial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk. These assets comprise cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note G3 for derivative assets. The collateral in place in relation to derivatives is described in G4. Notes D2, D3 and D4, describe the security for these loans held by the Group, as disclosed at the start of this note. Of the total loans and receivables held £74 million (2009: £64 million) are past their due date but have not been impaired. Of the total past due but not impaired, £26 million is less than one year past their due date and £9 million is more than six months but less than one year past their due date (2009: £64 million and £11 million respectively). The Group expects full recovery of these loans and receivables. No further analysis has been provided of the age of financial assets that are past due at the end of the reporting period but not impaired as the amounts are immaterial. No further analysis has been provided of the element of loans and receivables that was neither past due nor impaired for the total portfolio. This is on the grounds of immateriality of the difference between the neither past due nor impaired elements and the total portfolio. Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £97 million (2009: £55 million). There was no collateral held against loans that are past due and impaired or that are past due but not impaired at 31 December 2010 (2009: £nil). In addition, during the year the Group took possession of £22 million (2009: £15 million) of other collateral held as security, which mainly consists of assets that could be readily convertible into cash.
The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note G3 below). The amount of exchange gains recognised in the income statement in 2010, except for those arising on financial instruments measured at fair value through profit and loss, is £82 million (2009: £201 million losses). This constitutes £16 million losses (2009: £41 million losses) on Medium Term Notes (MTN) liabilities and £98 million of net gains (2009: £160 million net losses), mainly arising on investments of the PAC with-profits fund. The gains/losses on MTN liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit and loss.
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 are conducted under standardised ISDA (International Swaps and Derivatives Association Inc) master agreements and the Group has collateral agreements between the individual Group entities and relevant counterparties in place under each of these market master agreements. The total fair value balances of derivative assets and liabilities as at 31 December 2010 were as follows: 2010 £m
UK insurance operations Notional amount on which future payments are based
Inflation swaps 3,032 2,945 – – Credit default swaps 1,148 20 26 – Credit derivatives – – – 134 Put options – – 8,048 –
* In addition, the other operations, including the Group Treasury function and the Asian operations, have cross-currency swap assets and liabilities with notional amounts of £492 million (2009: £819 million) and £209 million (2009: £122 million) respectively, forward currency contracts assets and liabilities with notional amounts of £2,619 million (2009: £570 million) and £440 million (2009: £958 million) respectively, interest rate swaps assets and liabilities of £832 million (2009: £793 million) and of £195 million (2009: £522 million), respectively, and cliquet options assets of £nil (2009: £7 million).
These derivatives are used for efficient portfolio management to obtain cost effective and efficient exposure to various markets in accordance with the Group’s investment strategies and to manage exposure to interest rate, currency, credit and other business risks. See also note D3 for use of derivatives by the Group’s US operations. The Group uses various interest rate derivative instruments such as interest rate swaps to reduce exposure to interest rate volatility. The UK insurance operations use various currency derivatives in order to limit volatility due to foreign currency exchange rate fluctuations arising on securities denominated in currencies other than sterling. See also note G2 above. In addition, total return swaps and interest rate swaps are held for efficient portfolio management. As part of the efficient portfolio management of the PAC with-profits fund, the fund may, from time to time, invest in cash-settled forward contracts over Prudential plc shares, which are accounted for consistently with other derivatives. This is in order to avoid a mismatch of the with-profits investment portfolio with the investment benchmarks set for its equity-based investment funds. The contracts will form part of the long-term investments of the with-profits fund. These contracts are subject to a number of limitations for legal and regulatory reasons.
Some of the Group’s products, especially those sold in the US, have certain guarantee features linked to equity indexes. A mismatch between product liabilities and the performance of the underlying assets backing them, exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to match asset performance with liabilities under equity-indexed products. The US operations and some of the UK operations hold large amounts of interest-rate sensitive investments that contain credit risks on which a certain level of defaults is expected. These entities have purchased some swaptions in order to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets.
Fair value hedges The Group used interest rate derivatives to hedge the interest rate exposures on its US$300 million, 6.5 per cent perpetual subordinated capital securities until September 2010. The hedge terminated at this point. The impact on the Group’s income statement was immaterial. Where the hedge relationship has been de-designated and re-designated, the fair value adjustment to the hedged item up to the point of de-designation continues to be reported as part of the basis of the hedged item and is amortised to the income statement based on a recalculated effective interest rate over the residual period to the first break clause date of the perpetual subordinated capital securities. The Group has chosen to designate as a fair value hedge certain fixed to floating rate swaps which hedge the fair value exposure to interest rate movements of certain of the Group’s operational borrowings. The fair value of the derivatives designated as fair value hedges above at 31 December 2010, was an asset of £5 million (2009: asset of £7 million and liability of £1 million). Movements in the fair value of the hedging instruments of a net loss of £1 million (2009: net loss of £11 million) and the hedged items of a net gain of £1 million (2009: net gain of £11 million) are recorded in the income statement in respect of the fair value hedges above.
Net investment hedges The Group has designated perpetual subordinated capital securities totalling US$2.3 billion (2009: US$1.55 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £1,462 million as at 31 December 2010 (2009: £966 million). The foreign exchange loss of £45 million (2009: gain of £118 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.
In accordance with the Group’s accounting policy set out in note A4, impairment reviews were performed for available-for-sale securities and loans and receivables. In addition, impairment reviews were undertaken for the reinsurers’ share of insurance contract liabilities. During the year ended 31 December 2010, impairment losses of £145 million (2009: £647 million) were recognised for available-forsale securities and loans and receivables. These were £124 million (2009: £630 million) in respect of available-for-sale securities held by Jackson and £21 million (2009: £17 million) in respect of loans and receivables. The 2010 impairment charge for loans and receivables of £21 million (2009: £17 million) relates to loans held by the UK with-profits fund and mortgage loans held by Jackson. Impairment losses recognised on available-for-sale securities amounted to £124 million (2009: £630 million). Of this amount, 90 per cent (2009: 86 per cent) has been recorded on structured asset-backed securities, primarily due to reduced cash flow expectations on such securities that are collateralised by diversified pools of primarily below investment grade securities. Of the losses related to the impairment of fixed maturity securities, the top five individual corporate issuers made up 32 per cent (2009: 11 per cent), reflecting a deteriorating business outlook of the companies concerned. The impairment losses have been recorded in ‘investment return’ in the income statement. In 2010, the Group realised gross losses on sales of available-for-sale securities of £160 million (2009: £134 million) with 45 per cent (2009: 60 per cent) of these losses related to the disposal of fixed maturity securities of 15 (2009: five) individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £160 million (2009: £134 million), £99 million (2009: £6 million) relates to losses on sales of impaired and deteriorating securities. The effect of those reasonably likely changes in the key assumptions underlying the estimates that underpin the assessment of whether impairment has taken place depends on the factors described in note A3. 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 2010 the amounts of gross unrealised losses for fixed maturity securities classified as available-for-sale under IFRS in an unrealised loss position was £370 million (2009: £966 million). Notes B1 and D3 provide further details on the impairment charges and unrealised losses of Jackson’s available-for-sale securities.
Disposal of Taiwan Agency business – (44) Additional consideration paid on previously acquired businesses – 13 Acquisition of UOB Life Assurance Limited in Singapore 141 – Exchange differences 15 –
Impairment testing Goodwill does not generate cash flows independently of other groups of assets and thus is assigned to cash generating units (CGUs) for the purposes of impairment testing. These CGUs are based upon how management monitors the business and represent the lowest level to which goodwill can be allocated on a reasonable basis. An allocation to CGUs of the Group’s goodwill attributable to shareholders is shown below: ‘Other’ represents goodwill amounts allocated across CGUs in Asia and US operations. Other goodwill amounts are not individually material. During 2010 £141 million (SGD313 million) of goodwill was recognised upon the acquisition of UOB Life Assurance Limited. Upon translation at the year end exchange rate, the carrying value of this UOB Life Assurance goodwill at 31 December 2010 was £156 million.
Assessment of whether goodwill may be impaired Goodwill is tested for impairment by comparing the CGU’s carrying amount, including any goodwill, with its recoverable amount. With the exception of M&G, the goodwill attributable to shareholders in the statement of financial position mainly relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the business as determined using the EEV methodology, as described in note D1. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report. In particular at 31 December 2010, the EEV of the CGU containing the UOB Life Assurance goodwill (being the Singapore insurance operations) materially exceeded its IFRS net asset value and so no impairment was deemed to arise.
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, e.g. changes in global equity markets, are considered by management in arriving at the expectations for the financial projections for the plan.
ii The assumed growth rate on forecast cash flows beyond the terminal year of the plan. A growth rate of 2.5 per cent (2009: 2.5 per cent) has been used to extrapolate beyond the plan period representing management’s best estimate view of the long-term growth rate of the business after considering the future and past growth rates and external sources of data.
iii The risk discount rate. Differing discount rates have been applied in accordance with the nature of the individual component businesses. For retail and institutional business a risk discount rate of 12 per cent (2009: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 16 per cent (2009: 16 per cent). Management have determined the risk discount rate by reference to an average implied discount rate for comparable UK listed asset managers calculated by reference to risk-free rates, equity risk premiums of five per cent and an average ‘beta’ factor for relative market risk of comparable UK listed asset managers. A similar approach has been applied for the other component businesses of M&G.
Japanese life company The aggregate goodwill impairment of £120 million at 31 December 2010 and 2009 relates to the goodwill held in relation to the Japanese life operation which was impaired in 2005.
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 70 52 Present value of future profits of acquired investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 – 1 Distribution rights 113 66
Total of deferred acquisition costs and other intangible assets 4,609 4,049
Acquisition of UOB Life Assurance Ltd – – – – 12 12 – Amortisation to the income statement: Amortisation related to short-term fluctuations in investment returns – 358 – – – 358 153
Change in shadow DAC related to movement in unrealised appreciation of Jackson’s securities classified as available-for-sale (see note D3(g) for explanation) – (496) – – – (496) (1,069)
Note i The DAC amount in respect of US insurance operations includes £2,834 million (2009: £1,938 million) in respect of variable annuity business, £1,229 million (2009: £1,164 million) in respect of other business and £(520) million (2009: £(10) million) in respect of cumulative shadow DAC.
Exchange differences 122 (537) Change in shadow DAC related to movement in unrealised appreciation of Jackson’s securities classified as available-for-sale (496) (1,069) Dilution of holding in PruHealth (7) – DAC movement on sale of Taiwan agency business – (436)
Deferred acquisition costs related to investment management contracts attributable to shareholders Incremental costs associated with the origination of investment management contracts written by the Group’s insurance and asset management businesses are capitalised and amortised as the related revenue is recognised.
AT 1 JANUARY Gross amount 79 84 Accumulated amortisation (13) (5)
Note i In addition to the acquired assets and liabilities of UOB Life Assurance in 2010, as explained in note I1, the Group entered into distribution agreements with UOB for consideration of SGD 110 million (£50 million). The distribution rights have been accounted for as an intangible asset.
AT 1 JANUARY Gross amount 103 115 Accumulated amortisation (6) (2)
Additions – – Amortisation charge (4) (4) Exchange differences 4 (12)
The movement on reinsurers’ share of insurance contract liabilities is as follows: Movement in the year 31 24 Foreign exchange translation differences 22 (86)
Assets Of the £555 million (2009: £636 million) current tax recoverable, the majority is expected to be recovered in one year or less.
US insurance operations 1,391 1,944 Asian insurance operations 98 132 Other operations 485 340
The decrease in deferred tax asset primarily relates to the reduction in unrealised losses on investments due to the improved investment markets. Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying temporary differences can be deducted. The taxation regimes applicable across the Group 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. Accordingly, for the 2010 results and statement of financial position at 31 December 2010, the possible tax benefit of approximately £143 million (2009: £257 million), which may arise from capital losses valued at approximately £0.5 billion (2009: £1.2 billion), is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £298 million (2009: £607 million), which may arise from tax losses and other potential temporary differences totalling £1.2 billion (2009: £2.1 billion) is sufficiently uncertain that it has not been recognised. Forecasts as to when the tax losses and other temporary differences are likely to be utilised indicate that they may not be utilised in the short-term.
Liabilities The current tax liability decreased to £831 million (2009: £1,215 million) due to an exceptional tax credit which primarily relates to the impact of a settlement agreed with the UK tax authorities together with the ability to recognise a tax credit on costs incurred in relation to the terminated AIA transaction.
The increase in deferred tax liability primarily relates to the rise in deferred acquisition costs (shown within short-term timing differences above) as a result of the increase in insurance new business during the year. Unprovided deferred income tax liabilities on temporary differences associated with investments in subsidiaries, associates and interests in joint ventures are considered to be insignificant due to the availability of various UK tax exemptions and reliefs. The UK government’s tax rate change to 27 per cent has had the effect of reducing the UK with-profits and shareholder-backed business elements of the net deferred tax balances as at 31 December 2010 by £11 million. The tax change to 27 per cent is effective from 1 April 2011 but enacted at 31 December 2010.The subsequent proposed phased rate changes to 24 per cent are expected to have the effect of reducing the UK with-profits and shareholder-backed business elements of the net deferred tax balances at 31 December 2010 by £65 million.
OTHER DEBTORS Premiums receivable: From policyholders 141 148 From intermediaries 28 17 From reinsurers 27 82
Disposals (including amounts disposed of with the Taiwan agency business) (99) – (15) (114) Reclassified as investment property* – (131) – (131)
YEAR ENDED 31 DECEMBER 2010 Opening net book amount 153 – 214 367
The income statement includes the following items in respect of investment properties: Rental income from investment properties 625 755 Direct operating expenses (including repairs and maintenance expenses) arising from investment properties that generated rental income during the year 125 131
The present values of these minimum lease payments are: Less than 1 year 7 8
The investments noted in the table above have the same accounting year end as the Group, except for ICICI Prudential Life Insurance Company Limited and Prudential ICICI Asset Management Company Limited. Although these investments have reporting periods ending 31 March, 12 months of financial information up to 31 December is recorded. Accordingly, the information covers the same period as that of the Group. The summarised financial data for the Group’s share of investments in joint ventures is as follows: FINANCIAL POSITION Current assets 327 386 Non-current assets 3,386 2,462
Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, treasury bills and other short-term highly liquid investments with less than 90 days maturity from the date of acquisition. Cash and cash equivalents included in the cash flow statement comprise the following statement of financial position amounts: Cash equivalents 464 236
SHARE CAPITAL AND SHARE PREMIUM Share capital 127 127 Share premium 1,856 1,843 RESERVES Retained earnings 4,982 3,964 Translation reserve 454 203 Available-for-sale reserve 612 134
January 9,338 6.38 6.38 59,530 February 11,638 5.68 5.68 66,046 March 3,908,274 5.16 6.09 20,884,460 April 11,129 5.63 5.63 62,601 May 14,638 5.59 5.59 81,753 June 190,991 5.26 5.66 1,075,712 July 13,457 5.14 5.14 69,102 August 10,016 5.86 5.86 58,644 September 13,727 5.25 5.84 78,539 October 11,634 6.37 6.37 74,108 November 385,321 5.74 6.49 2,244,770 December 1,153,611 6.04 6.65 7,445,358
All share transactions were made on an exchange other than the Stock Exchange of Hong Kong. The Company did not buy back any of its own shares during 2010 or 2009.
The available-for-sale reserve represents gains or losses arising from changes in the fair value of available-for-sale securities of Jackson, net of the related change in amortisation of deferred income and acquisition costs and of the related tax.
Income and expense included in the income statement 22,412 245 Foreign exchange translation differences 3,193 (11) Dilution of holding in PruHealth (27) –
CENTRAL OPERATIONS Subordinated debt: ¤20m Medium-Term Subordinated Notes 2023note ii 17 17 18
* These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the FSA Handbook. † The senior debt ranks above subordinated debt in the event of liquidation.
Company’s option and subject to certain conditions, on any interest payment date falling on or after 23 March 2010 and 23 March 2011 respectively, into one or more series of Prudential preference shares.
BORROWINGS IN RESPECT OF SHORT-TERM FIXED INCOME SECURITIES PROGRAMMES Commercial paper 2,311 2,031 Medium-Term Notes 2010 – 7 Bank Notes 2013 249 –
OTHER BORROWINGS Bank loans and overdrafts 5 148 Obligations under finance leases 2 3 Other borrowingsnote iv 347 359
Jackson. iii Piedmont is an investment trust investing in certain asset-backed and mortgage-backed securities in the US. These borrowings pertain to debt instruments issued to external parties. iv Other borrowings represents amounts whose repayment to the lender is contingent on future surpluses emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on the contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
v In addition to the listed debt above, £200 million Floating Rate Notes were issued by Prudential plc in October 2010 which mature in April 2011. These Notes have been wholly subscribed by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. These Notes were originally issued in October 2008 and have been reissued upon their maturity.
Non-recourse borrowings of consolidated investment funds note i 1,287 1,016 £100m 8.5% Undated Subordinated Guaranteed Bonds of Scottish Amicable Finance plc note ii 100 100 Other borrowings (predominantly obligations under finance leases) 135 168
Deficit, gross of deferred tax, based on scheme assets held, including investments in Prudential insurance policies: Attributable to PAC with-profits fund (i.e. absorbed by the liability for unallocated surplus) 106 122 Attributable to shareholder-financed operations (i.e. to shareholders’ equity) 114 128
Comprising: Legal provisions 20 15 Restructuring provisions 26 17 Other provisions 236 174
Restructuring provisions Restructuring provisions of £26 million (2009: £17 million) primarily relate to restructuring activities of UK insurance operations. The provisions pertain to property liabilities resulting from the closure of regional sales centres and branches and staff terminations and other transformation costs to enable streamlining of operations. These activities resulted in additional provisions in 2010 of £14 million. During 2010, £2 million (2009: £1 million) of unused provision was released, and £3 million (2009: £3 million) was paid. We expect the provision balance to be paid out within the next six years.
Other provisions Other provisions of £236 million (2009: £174 million) include provisions of £200 million (2009: £143 million) relating to staff benefit schemes which are mostly benefits that will generally be paid out within the next three years. During 2010, another £148 million (2009: £112 million) was provided (including exchange movement of £2 million (2009: £6 million)), £6 million (2009: £10 million) of unused provision was released and £92 million (2009: £54 million) was paid. Other provisions also include £28 million (2009: £27 million) relating to various onerous contracts where, in 2010, an additional £10 million (2009: £15 million) was provided and £8 million (2009: £4 million) was used. Other provisions also include £4 million (2009: £4 million) of regulatory provisions, where £nil (2009: £9 million) was provided, £1 million (2009: £2 million) of unused provision was released and £nil (2009: £3 million) was paid.
Additional details on the Prudential Staff Pension Scheme and these features are included in note I3. Consistent with the Company’s expectations as to the decision of the Court, no amount has been provided in the 2010 financial statements for this item. In addition to the legal proceedings relating to Jackson mentioned under the legal provisions section above, and PSPS, the Group is involved in other litigation and regulatory issues. Whilst the outcome of each of the above matters cannot be predicted with certainty, the Company believes that the ultimate outcome of such litigation and regulatory issues will not have a material adverse effect on the Group’s financial condition, results of operations, or cash flows.
The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling including administration costs. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased. The costs associated with the pension mis-selling review have been met from the inherited estate (see below). Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders’ pay-out values have been unaffected by pension mis-selling. In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment policy and it gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing. The bonus and investment policy for each type of with-profits policy is the same irrespective of whether or not the assurance applies and this is expected to continue for the foreseeable future. Hence removal of the assurance for new business has had no impact on policyholder returns.
Support for long-term business funds by shareholders’ funds As a proprietary insurance company, PAC is liable to meet its obligations to policyholders even if the assets of the long-term 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 long-term 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 long-term funds to provide financial support. In 1997, the business of SALAS, a mutual society, was transferred to PAC. In effecting the transfer, a separate sub-fund, SAIF, was established within PAC’s long-term business fund. This sub-fund contains all the with-profits business and all other pension business that was transferred. No new business has been or will be written in the sub-fund and the sub-fund is managed to ensure that all the invested assets are distributed to SAIF policyholders over the lifetime of SAIF policies. With the exception of certain amounts in respect of the unitised with-profits life business, all future earnings arising in SAIF are retained for SAIF policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is attributable to the policyholders of the fund. Shareholders have no interest in the profits of SAIF but are entitled to the asset management fees paid on this business. With the exception of certain guaranteed annuity products mentioned earlier in this note, and certain products which include a minimum guaranteed rate of accumulation, the majority of SAIF with-profits policies do not guarantee minimum rates of return to policyholders. Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency. Due to the quality and diversity of the assets in SAIF and the ability of SAIF to revise guaranteed benefits in the event of an asset shortfall, the directors believe that the probability of either the PAC long-term fund or the Group’s shareholders’ funds having to contribute to SAIF is remote.
Total assets include loans and receivables with a fair value of £15 million. This value represents the gross contractual amount and all amounts have been collected. The consolidated statement of cash flows contains a £133 million net cash outflow in respect of this acquisition representing cash consideration of £220 million, acquisition related costs paid of £2 million less cash and cash equivalents acquired of £89 million.
Impact of acquisition on the results of the Group Included in the Group’s consolidated profit before tax for the year is £8 million attributable to UOB Life Assurance Limited in Singapore. Consolidated revenue, including investment returns, for the year includes £125 million in respect of UOB Life Assurance Limited in Singapore. Had the acquisition been effected at 1 January 2010, the revenue and profit of the Group from continuing operations for the year ended 31 December 2010 would not have been materially different.
I2: DILUTION OF THE GROUP’S HOLDING IN PRUHEALTH IN 2010 AND SALE OF TAIWAN AGENCY BUSINESS IN 2009 a Dilution of the Group’s holding in PruHealth in 2010 On 1 August 2010, Discovery Holdings of South Africa, the Group’s joint venture partner in its investment in PruHealth, completed the acquisition of the entire share capital of Standard Life Healthcare, a wholly-owned subsidiary of the Standard Life Group, for £138 million. Discovery funded the purchase of the Standard Life Healthcare transaction, and contributed Standard Life Healthcare to PruHealth as a capital investment on completion. As a result of the transaction, Discovery have increased their shareholding in PruHealth from the previous level of 50 per cent to 75 per cent, and Prudential’s shareholding has been reduced from 50 per cent of the previous joint venture structure to 25 per cent of the new structure with the much enlarged business. As a result of this dilution in holding and the consequential loss of control, PruHealth has been reclassified from a joint venture to an associate and the entity is no longer proportionally consolidated from the date of the transaction. In accordance with IAS 31 ‘Interests in joint ventures’ a gain of £30 million arises upon the dilution, representing the difference between the fair value of the enlarged 25 per cent investment still held and the book value of the original 50 per cent investment holding.
The costs of employment were: Business operations: Wages and salaries 1,052 878 Social security costs 69 61 Other pension costs (see below) 95 95 Pension actuarial and other losses (gains) charged to income statement 26 138
b Pension plans i Defined benefit plans 1 Summary The Group business operations operate a number of pension schemes. The specific features of these plans vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS); 86 per cent (2009: 86 per cent) of the underlying scheme liabilities of the Group defined benefit schemes are accounted for within PSPS. The Group also operates two smaller defined benefit schemes for UK employees in respect of Scottish Amicable and M&G. For all three schemes the projected unit method was used for the most recent full actuarial valuations. There is also a small defined benefit scheme in Taiwan but as part of the sale of the Taiwan agency business completed in June 2009, the Group settled the majority of the obligations under the scheme as a significant number of employees transferred out. Defined benefit schemes in the UK are generally required to be subject to full actuarial valuation 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. PSPS was last actuarially valued as at 5 April 2008. This valuation demonstrated the scheme to be 106 per cent funded by reference to the Scheme Solvency Target that forms the basis of the scheme’s statutory funding objective. No formal deficit funding plan was required. However, in recognition of the fall in value of the Scheme’s investments between 5 April 2008 and the completion of the actuarial valuation, an additional funding akin to deficit funding was agreed with the Trustees. This is subject to a reassessment when the next valuation is completed. The total contribution being currently made by the Group into the scheme, representing the annual accrual cost and deficit fundings, are £50 million per annum. Deficit funding for PSPS is apportioned in the ratio of 70/30 between the PAC life fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant to current activity. In 2010, total contributions for the year including expenses and augmentations were £55 million at 31 December (2009: £67 million). The market value of scheme assets as at 5 April 2008 was £4,759 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the valuation were as follows: Rate of increase in salaries Nil Rate of inflation 3.5% Rate of increase of pensions in payment for inflation: Guaranteed (maximum 5%) 3.5% Guaranteed (maximum 2.5%) 2.5% Discretionary Nil Expected returns on plan assets 4.55%
Mortality assumptions The tables used for PSPS pensions in payment at 5 April 2008 were: Base post retirement mortality: For current male (female) pensioners 108.6 per cent (103.4 per cent) of the mortality rates of the 2000 series mortality tables, published by the Continuous Mortality Investigation Bureau. For male (female) non-pensioners 113.4 per cent (97.4 per cent) of the 2000 series rates.
Allowance for future improvements to post retirement mortality: For males (females) 100 per cent (75 per cent) of Medium Cohort subject to a minimum rate of improvement of 1.75 per cent (1 per cent) up to the age of 90, decreasing linearly to zero by age of 120.
On the economic basis (including investments of the M&G scheme in Prudential policies as assets), for 2010, a £27 million (2009: £32 million) pre-tax shareholder charge to operating results based on longer-term returns arises. In addition, outside the operating result but included in total profits is a pre-tax shareholder loss of £10 million (2009: £74 million) for shareholders’ share of actuarial and other gains and losses. In addition, also on the economic basis, the PAC with-profits sub-fund was charged £18 million (2009: charge of £16 million) for its share of the pension charge of PSPS and Scottish Amicable and charged with £5 million (2009: £81 million) for its share of net actuarial and other losses on the scheme assets and liabilities. As shareholder profits for the PAC with-profits sub-fund reflects the surplus for distribution, these amounts are effectively absorbed by an increased credit in the income statement for the transfer to the liability for unallocated surplus. At 31 December 2010, after the effect of the application of IFRIC 14, the total share of the liability for deficit funding on PSPS and the deficit on the smaller Scottish Amicable Scheme attributable to the PAC with-profits fund amounted to a liability of £99 million (2009: £110 million) net of related tax relief.
2 Corporate governance The rules of the Group’s largest pension arrangement, the defined benefit section of PSPS, a final salary scheme, specify that, in exercising its investment powers, the Trustee’s objective is to achieve the best overall investment return consistent with the security of the assets of the scheme. In doing this, consideration is given to the nature and duration of the scheme’s liabilities. The Trustee sets the benchmark for the asset mix, following analysis of the liabilities by the Scheme’s Actuary and, having taken advice from the Investment Managers, then selects benchmark indices for each asset type in order to measure investment performance against a benchmark return. The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the Actuarial Valuation, or earlier if the Scheme Actuary recommends. Interim reviews are conducted annually based on changing economic circumstances and financial market levels. The Trustee sets the general investment policy and specifies any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegates the responsibility for selection and realisation of specific investments to the Investment Managers. In carrying out this responsibility, the Investment Managers are required by the Pensions Act 1995 to have regard to the need for diversification and suitability of investments. Subject to a number of restrictions contained within the relevant asset management agreements, the Investment Managers are authorised to invest in any class of investment asset. However, the Investment Managers will not invest in any new class of investment asset without prior consultation with the Trustee. The Trustee consults the Principal Employer, the Prudential Assurance Company, on these investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustee.
3 Assumptions The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended 31 December were as follows: Discount rate* 5.45 5.8 Rate of increase in salaries 5.55 5.7 Rate of inflation 3.55 3.7 Rate of increase of pensions in payment for inflation: Expected returns on plan assets 5.9 4.5 * The discount rate has been determined by reference to an ‘AA’ corporate bond index adjusted, where applicable, to allow for the difference in duration between the index and the pension liabilities.
† The rates of 2.5 per cent shown are those for PSPS. Assumed rates of increase of pensions in payment for inflation for all other schemes are 3.55 per cent in 2010 (2009: 3.7 per cent).
The calculations are based on current actuarially calculated mortality estimates with a specific allowance made for future improvements in mortality. The 2010 specific allowance is in line with custom calibration of the 2009 mortality model from the Continuous Mortality Investigation Bureau of the Institute and Faculty of Actuaries (‘CMI’). The 2009 specific allowance was broadly based on adjusted versions of the medium cohort projections prepared by the CMI.
The mean term of the current PSPS liabilities is around 18 years. Using external actuarial advice provided by the scheme actuaries being Towers Watson for the valuation of PSPS, Aon Consulting Limited for the M&G scheme, and Xafinity Consulting for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2010, applying the principles prescribed by IAS 19.
4 Summary financial position The Group liability in respect of defined benefit pension schemes is as follows: Economic position: Deficit, gross of deferred tax, based on scheme assets held, including investments in Prudential insurance policies: Attributable to the PAC with-profits fund (i.e. absorbed by the liability for unallocated surplus) (106) (122) Attributable to shareholder-backed operations (i.e. to shareholders’ equity) (114) (128)
Deficit under IAS 19 included in provisions in the statement of financial position – as explained in note 7 below (447) (437)
5 Group economic financial position The following tables illustrate the movement on the financial position of the Group’s defined benefit pension schemes on an economic basis. The underlying position on an economic basis reflects the assets (including investments in Prudential policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. At 31 December 2010, the investments in Prudential policies comprise £118 million (2009: £101 million) for PSPS and £227 million (2009: £187 million) for the M&G scheme. Separately, the economic financial position also includes the effect of the application of IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. For PSPS, where there are constraints in the trust deed to prevent the company access, the surplus is not recognised and a liability to additional funding is established (as described earlier).
Shareholders’ share: Gross of tax surplus (deficit) 53 (18) (38) 51 48
Shareholders’ share: Gross of tax surplus (deficit) (181) (9) 28 – (162)
Shareholders’ share: Gross of tax surplus (deficit) (128) (27) (10) 51 (114)
Total (charge) credit without the effect of IFRIC 14 (7) (71) Effect of IFRIC 14 for pension schemes (38) 23
b The components of the credit (charge) for actuarial and other gains and losses (gross of allocation of the share attributable to the PAC with-profits fund but excluding the charge relating to the sold Taiwan agency business) are as follows: Actual less expected return on assets 306 108 Losses on changes of assumptions for plan liabilities (411) (521) Experience (losses) gains on liabilities (4) 76
c On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the underlying statements of financial position of the schemes at 31 December were: PSPS £m
Present value of benefit obligations (4,866) (826) (5,692) (4,436) (738) (5,174)
Effect of the application of IFRIC 14 for pension schemes: Derecognition of PSPS surplus (485) – (485) (513) – (513) Adjust for deficit funding for PSPS (47) – (47) (75) – (75)
ii The resulting scheme deficit arising from the excess of liabilities over assets at 31 December 2010 of £220 million (2009: £250 million) comprised a deficit of £106 million (2009: £122 million) attributable to the PAC with-profits fund and deficit of £114 million (2009: £128 million) attributable to shareholder operations.
Actuarial and other gains and losses (15) (155) Movement due to the sold Taiwan agency business and exchange translation difference – 17
7 IAS 19 basis financial position as consolidated The IAS 19 basis pensions deficit can be summarised as follows: Fair value of plan assets, end of year 5,659 5,224 5,057 5,150 4,988 Present value of funded benefit obligation (5,438) (4,951) (4,493) (4,826) (5,023)
Present value of unfunded obligations (M&G scheme)* (254) (223) (180) (189) (187)
Deficit recognised in the statement of financial position (447) (437) (306) (355) (380)
COMPONENTS OF NET PERIODIC PENSION COST Current service cost (38) (34) Interest cost (294) (277) Expected return on assets – economic basis 325 240 Less: expected return on investments of scheme assets in Prudential insurance policies (21) (16) Expected return on assets – IAS 19 basis† 304 224
Actuarial gains and losses – economic basis (109) (337) Less: actuarial gains on investments of scheme assets in Prudential insurance policies (20) 8
Actuarial gains and losses – IAS 19 basis* (as referred to in note I3a) (26) (138)
The long-term expected rate of return has been taken to be the weighted average (by market value) of the long-term expected rates of return on each major asset class shown below: SCHEME ASSETS (IAS 19 BASIS BEFORE EFFECT OF IFRIC 14)
Underlying scheme assets in surplus (deficit) of benefit obligation, before the effect of IFRIC 14 (33) 50 384 135 (222)
8 Sensitivity of the pension scheme liabilities of the PSPS, Scottish Amicable and M&G pension schemes to key variables The table below shows the sensitivity of the underlying PSPS, Scottish Amicable and M&G pension scheme liabilities at 31 December 2010 of £4,866 million, £572 million and £254 million respectively (2009: £4,436 million, £515 million and £223 million) to changes in discount rates and inflation rates. In addition, the table below shows the sensitivity of the underlying PSPS, Scottish Amicable and M&G pension scheme liabilities at 31 December 2010 to changes to mortality rate assumptions.
Discount rate Increase by 0.2% from 5.45% to 5.65% Decrease in scheme liabilities by: PSPS 3.5% Scottish Amicable 4.9% M&G 4.8%
Rate of inflation Decrease by 0.2% from 3.55% to 3.35% with Decrease in scheme liabilities by: consequent reduction in salary increases PSPS 1.0%
Discount rate Decrease by 0.2% from 5.8% to 5.6% Increase in scheme liabilities by: PSPS 3.5% Scottish Amicable 5.2% M&G 4.9%
Rate of inflation Decrease by 0.2% from 3.7% to 3.5% with Decrease in scheme liabilities by: consequent reduction in salary increases PSPS 0.9%
9 Transfer value of PSPS scheme At 31 December 2010, it is estimated that the assets of the scheme are broadly sufficient to cover the liabilities of PSPS on a ‘buyout’ basis including an allowance for expenses. The ‘buyout’ basis refers to a basis that might apply in the circumstance of a transfer to another appropriate financial institution. In making this assessment it has been assumed that a more conservative investment strategy applies together with a more prudent allowance for future mortality improvements and no allowance for discretionary pension increases.
Movements in share awards outstanding under the Group’s share-based compensation plans relating to Prudential plc shares at 31 December 2010 and 2009 were as follows: Awards outstanding under incentive plans including conditional options
Expected option life (years) 3.00 3.49 3.00 3.67 Weighted average exercise price (£) – 4.61 – 2.96
Under IFRS, compensation costs for all share-based compensation plans are determined using either the Black-Scholes model or the Monte Carlo model. Share options and awards are valued using the share price at the date of grant. The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black-Scholes model to value all options and awards other than the GPSP, for which the Group uses a Monte Carlo model in order to allow for the impact of the TSR performance conditions. These models are used to calculate fair values for share options and awards at the grant date based on the quoted market price of the stock at the measurement date, the amount, if any, that the employees are required to pay, the dividend yield, expected volatility, risk-free interest rates and exercise prices. The expected volatility is measured as the standard deviation of expected share price returns based on statistical analysis of daily share prices over a period up to the grant date equal to the expected life of options. Risk-free interest rates are UK gilt rates with projections for three and five-year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over the year of grant and expected dividends are not incorporated into the measurement of fair value. For the GPSP, volatility and correlation
c Total share-based payment expense Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows: Share-based compensation expense 47 37 Amount accounted for as equity-settled 37 29 Carrying value at 31 December of liabilities arising from share-based payment transactions 17 13 Intrinsic value of above liabilities for which rights had vested at 31 December 6 7
Total key management remuneration includes total directors’ emoluments of £14,225,000 (2009: £15,090,000) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report, and additional amounts in respect of pensions and share-based payments. Further information on directors’ remuneration is given in the directors’ remuneration report.
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts 1.9 1.8 Fees payable to the Company’s auditor and its associates for other services: Audit of subsidiaries and associates pursuant to legislation 6.1 5.5 Other services supplied pursuant to legislation 2.4 2.7 Other services relating to taxation 0.4 0.6 Valuation and actuarial services 0.1 0.1 Services relating to other corporate finance transactions 0.1 0.7 All other services 1.0 1.0 Services relating to the AIA transaction 5.5 –
All services were specifically approved by the Prudential Group Audit Committee. The Audit Committee regularly monitors the non-audit services provided to the Group by its auditor and has developed a formal Auditor Independence Policy which sets out the types of services that the auditor may provide, consistent with the guidance in Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’ and with the provisions of the US Sarbanes-Oxley Act. The Audit Committee annually reviews the auditor’s objectivity and independence. More information on these issues is given in the corporate governance report within this Annual Report.
i Principal subsidiaries The principal subsidiary undertakings of the Company at 31 December 2010, all wholly owned were: Main activity Country of incorporation
The Prudential Assurance Company Limited Insurance England and Wales Prudential Annuities Limited* Insurance England and Wales Prudential Retirement Income Limited (PRIL)* Insurance Scotland M&G Investment Management Limited* Asset management England and Wales Jackson National Life Insurance Company* Insurance US Prudential Assurance Company Singapore (Pte) Limited* Insurance Singapore * Owned by a subsidiary undertaking of the Company.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for PRIL which operates mainly in England and Wales. Details of all Prudential subsidiaries, joint ventures and associates will be annexed to the next Annual Returns of Prudential plc filed with the UK Registrar of Companies and the Registrar of Companies in Hong Kong.
ii Dividend restrictions and minimum capital requirements Certain Group subsidiaries are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company. UK insurance companies are required to maintain solvency margins which must be supported by capital reserves and other resources, including unrealised gains on investments. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, without the prior regulatory approval, dividends cannot be distributed if all dividends made within the preceding 12 months exceed the greater of Jackson’s statutory net gain from operations or 10 per cent of Jackson’s statutory surplus for the prior year. In 2010, the maximum amount of dividends that could be paid by Jackson without prior regulatory approval is US$377 million (£241 million) (in 2009: US$454 million (£281 million)). The Group’s Asian subsidiaries may remit dividends to the Group, in general, provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations. The Group capital position statement for life assurance businesses is set out in note D5, showing the available capital reflecting the excess of regulatory basis over liabilities for each fund or group of companies determined by reference to the local regulation of the subsidiaries. In addition, disclosure is also provided in note D5 of the local capital requirement of each of the fund or group of companies.
i Operating leases The Group leases various offices to conduct its business. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
The charge of £14 million in 2009, which is net of £nil tax, reflects completion adjustments for a previously disposed business.
Structural borrowings of shareholder-financed operations comprise core debt of the parent company and Jackson surplus notes. Core debt excludes borrowings to support short-term fixed income securities programmes, non-recourse borrowings of investment subsidiaries of shareholder-financed operations and other borrowings of shareholder-financed operations. Cash flows in respect of these borrowings are included within cash flows from operating activities. Structural borrowings of with-profits operations relate solely to the £100 million 8.5 per cent undated subordinated guaranteed bonds which contribute to the solvency base of the Scottish Amicable Insurance fund (SAIF) a ring-fenced sub-fund of the PAC with-profits fund. Cash flows in respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash flows from operating activities.
In January 2011, the Company issued US$550 million 7.75 per cent Tier 1 subordinated debt, primarily to retail investors. The proceeds, net of costs, were US$539 million and are intended to finance the repayments of the ¤500 million Tier 2 subordinated notes in December 2011.
operating profit based on longer-term investment returns by driver 362 (b) Asian operations – analysis of IFRS operating profit by territory 363 (c) Analysis of asset management operating profit based on longer-term investment returns
III. IFRS balance sheet information 365 (a) Memorandum fair value of Jackson's GMDB and
IV. Other information 368 (a) Funds under management 368 (b) Effect of foreign currency rate movements on results 371 (c) Option schemes
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).
Profit (loss) before tax attributable to shareholders 1,461 746 (450) 1,063 1,281 Tax (charge) credit attributable to shareholders’ returns (25) (55) 59 (354) (365)
Profit (loss) from continuing operations after tax 1,436 691 (391) 709 916 Discontinued operations (net of tax) – (14) – 241 (105)
Operating profit based on longer-term investment returns2 1,941 1,564 1,212 1,152 1,068 Short-term fluctuations in investment returns on shareholder-
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and excluding 2010 exceptional tax credit) (in pence) 62.0p 47.5p 38.1p 31.3p 28.8p
Operating profit based on longer-term investment returns2 3,696 3,090 2,865 2,353 1,998 Short-term fluctuations in investment returns on shareholder-
Annual premium equivalent (APE) sales: EEV new business profit (NBP) 2,028 1,619 1,205 1,103 975
As of and for the Year Ended 31 December 2010 £m 2009 £m 2008 £m 2007 £m 2006 £m
EEV shareholders’ equity, excluding non-controlling interests 18.2 15.3 15.0 14.6 11.9 Insurance Groups Directive capital surplus (as adjusted)5 4.3 3.4 1.5 1.9 1.2
Notes 1 This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. 2 Operating profits are determined on the basis of including longer-term investment returns. EEV and IFRS operating profits are stated after excluding the effect of short-term fluctuations in investment returns against long-term assumptions, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, transaction costs arising from business combinations in the period, costs associated with the terminated AIA transaction, and the effect of disposal and results of the Taiwan agency business, for which the sale process was completed in June 2009. In 2010, the Group amended the presentation of IFRS operating profit for its US insurance operations to remove the net equity hedge accounting effect (incorporating related amortisation of deferred acquisition costs) and include it in short-term fluctuations. The prior period comparatives for 2009 and 2008 have been amended accordingly.
4 Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations.
5 The surpluses shown are before allowing for the final dividends for each year, which are paid in the following year. The 2010 surplus is estimated. Since 2007, following the sale of Egg Banking, Prudential has been subject to the capital adequacy requirements of the Insurance Groups Directive (IGD) which applies to groups whose activities are mainly in the insurance sector. Prior to the sale of Egg Banking, Prudential was subject to the capital adequacy requirements of the Financial Conglomerates Directive (FCD) which applies to groups with significant crosssector activities in insurance and banking/investment services. Prudential was classified as an insurance conglomerate under the FCD. As the requirements for insurance conglomerates under the FCD are closely aligned to the requirements for insurance groups under the IGD, the move for Prudential from FCD to IGD did not result in a significant impact.
ii Fee income represents profits driven by net investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses.
v Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses.
Spread income 70 692 251 – 1,013 Fee income 122 506 60 – 688 With-profits 32 – 310 – 342 Insurance margin 392 188 12 – 592 Margin on revenues 1,018 – 223 – 1,241 Expenses Acquisition costs (656) (851) (167) – (1,674) Administration expenses (467) (344) (113) – (924) DAC adjustments 2 517 (1) – 518 Expected return on shareholder assets 19 125 98 – 242
Total operating profit based on longer-term investment returns 604 855 1,003 (521) 1,941 * Including restructuring and Solvency II implementation costs.
II(a): ANALYSIS OF LONG-TERM INSURANCE BUSINESS PRE-TAX IFRS OPERATING PROFIT BASED ON LONGER-TERM
Spread income 31 524 198 – 753 Fee income 80 324 54 – 458 With-profits 29 – 281 – 310 Insurance margin 253 154 41 – 448 Margin on revenues 766 – 275 – 1,041 Expenses Acquisition costs (605) (690) (192) – (1,487) Administration expenses (382) (259) (173) – (814) DAC adjustments 150 467 (3) – 614 Expected return on shareholder assets 25 98 125 – 248 Non-recurrent release of reserves for Malaysia life operations 63 – – – 63
Total operating profit based on longer-term investment returns 465 622 895 (418) 1,564 2008i £m
Margin analysis of 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 of the Group’s average policyholder liability balances are given in note B6(e).
Spread income 1,013 53,858 188 753 51,000 148 534 44,281 121 Fee income 688 57,496 120 458 43,373 106 403 38,850 104 With-profits 342 89,693 38 310 84,063 37 425 89,075 48 Insurance margin 592 448 347 Margin on revenues 1,241 1,041 986 Expenses Acquisition costs* (1,674) 3,492 (48)% (1,487) 2,896 (51)% (1,242) 2,879 (43)%
Spread income 70 4,393 159 31 3,152 98 38 2,421 157 Fee income 122 11,222 109 80 8,107 99 54 6,419 84 With-profits 32 10,135 32 29 8,371 35 30 7,168 42 Insurance margin 392 253 198 Margin on revenues 1,018 766 672 Expenses Acquisition costs* (656) 1,508 (44)% (605) 1,261 (48)% (619) 1,216 (51)%
* The ratio for acquisition costs is calculated as a percentage of APE including with-profits sales and Japan (2010: £7 million; 2009: £52 million). Acquisition costs include only those relating to shareholders.
Analysis of Asian operating profit drivers: • Spread income has increased from £31 million in 2009 to £70 million in 2010. This increase arises primarily as a result of improved investment return in Vietnam (where the return in 2009 was particularly low compared to both 2008 and 2010) and additional dividend income received in Japan.
• Fee income has increased both in absolute terms by £42 million and as an improvement in margin, which has increased 10 bps to 109 bps. This primarily relates in a change in mix towards those countries with a higher asset management fee margin (e.g. Indonesia) from countries where fees charged are lower.
• Insurance margin has increased by £139 million from £253 million in 2009 to £392 million in 2010. This reflects the continued growth in the in-force book, which has a relatively high proportion of risk-based products. 2010 includes £19 million relating to reserving changes in India and China.
Spread income 692 28,496 243 524 29,248 179 461 25,322 182 Fee income 506 25,921 195 324 17,589 184 292 14,783 198 With-profits – – – Insurance margin 188 154 161 Margin on revenues – – – Expenses Acquisition costs (851) 1,164 (73)% (690) 912 (76)% (451) 716 (63)%
• Acquisition costs have increased in 2010 in absolute terms compared to 2009 following an increase in sales volumes. However, acquisition costs as a percentage of APE has fallen from 76 per cent in 2009 to 73 per cent in 2010 as more advisers are electing to take asset-based commission, which is paid over the life of the policy based on fund value. This asset-based commission is treated as an administration expense in this analysis as opposed to a cost of acquisition, resulting in a lower acquisition cost ratio but a higher administration expenses margin.
Spread income 251 20,969 120 198 18,600 106 35 16,538 21 Fee income 60 20,353 29 54 17,677 31 57 17,648 32 With-profits 310 79,558 39 281 75,692 37 395 81,907 48 Insurance margin 12 41 (12) Margin on revenues 223 275 314 Expenses Acquisition costs* (167) 820 (20)% (192) 723 (27)% (172) 947 (18)%
Analysis of UK operating profit drivers: • Spread income has increased by £53 million to £251 million in 2010, reflecting in a higher margin of 120 bps, up from 106 bps in 2009. The improved margin primarily reflects the beneficial impacts of the bulk annuity deal written in 2010, improved margins on retail annuity new business and improved spread on equity release business following its closure to new business. Spread income was lower in 2008 due to lower margins on new business and the establishment of credit default and deflation reserves in that year in light of the credit crisis offset by the impact of actions to rebalance the credit portfolio.
• Margin on revenues represents premiums charges for expenses and other sundry net income received by the UK. Lower amounts were recorded in 2010 (£223 million) compared to 2009 (£275 million) reflecting, in part, lower premiums from shareholder-backed retail business in 2010 as compared to 2009.
• Insurance margin has fallen by £29 million to £12 million in 2010, reflecting that 2009 included a one-off benefit of £34 million in respect of a longevity swap on certain aspects of the UK’s annuity back-book liabilities, which was not repeated in 2010.
• Acquisition costs as a percentage of new business sales has fallen from 27 per cent in 2009 to 20 per cent in 2010. This reflects in part the impact of the bulk annuity deal which contributed £88 million APE in the period with a relatively low level of acquisition costs, together with the closure of equity release to new business as well as on-going cost saving initiatives.
Notes i For the Malaysia life business, under the basis applied previously, 2008 IFRS basis liabilities were determined on the local regulatory basis using prescribed interest rates such that a high degree of prudence resulted. As of 1 January 2009, the local regulatory basis has been replaced by the Malaysian authority’s risk-based capital (RBC) framework. In the light of this development, the Company has re-measured the liabilities by reference to the method applied under the new RBC framework, which is more realistic than the previous approach, but with an overlay constraint to the method such that negative reserves derived at an individual policyholder level are not included. This change has resulted in a one-off release from liabilities at 1 January 2009 of £63 million.
iii The operating profit of £60 million from India, a joint venture, includes £36 million arising from changes that improve the reserving estimation technique.
II(c): ANALYSIS OF ASSET MANAGEMENT OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNS
Operating profit based on longer-term investment returns 246 72 38 22 378
Average funds under management (FUM)† £186.5 bn £47.2 bn Margin based on operating income† 34 bps 40 bps Cost/income ratio‡ 63% 64%
Operating profit based on longer-term investment returns 177 55 61 4 297
Average funds under management (FUM)† £157.5 bn £39.6 bn Margin based on operating income† 31 bps 40 bps Cost/income ratio‡ 65% 67%
Operating income before performance-related fees 480 144 123 139 886 Performance-related fees 43 3 – – 46
Average funds under management (FUM)† £154.0 bn £36.9 bn Margin based on operating income† 34 bps 40 bps Cost/income ratio‡ 61% 66%
‡ Cost/income ratio is calculated as a percentage of income excluding performance-related fees.
II(c): ANALYSIS OF ASSET MANAGEMENT OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT
i M&G and Asia asset management businesses can be further analysed as follows: M&G
Where a significant insurance element is present, such as for Guaranteed Minimum Death Benefit (GMDB) and ‘for life’ GMWB, the guarantees are accounted for as part of the accounting applied to the host insurance contracts. Under IFRS 4, the insurance contract accounting applied prior to IFRS adoption has continued to be applied. Accordingly for US variable annuity business the US GAAP standards applicable to insurance contract accounting are applied. Consistent with that approach, the GMDB and ‘for life’ GMWB guarantees are valued under FASB Accounting Standards codification Topic 944 (sub-topics 944-20, 944-40 and 944-80), formerly known as ‘SOP 03-1’ (Statement of Position 03-1: ‘Accounting and Reporting by Insurance Enterprises Contracts and for Separate Accounts’).
The SOP 03-1 fee assessment, on the other hand, is recomputed at each valuation date to take into account emerging experience and cash flow timing differences. After redetermination based on valuation date parameters, the new fee assessment is applied retrospectively from issue date to recompute the current reserve provision. This retrospective aspect of the calculation is not present in the FAS 157 methodology.
III(a): MEMORANDUM FAIR VALUE OF JACKSON’S GMDB AND GMWB LIABILITIES > CONTINUED
As recorded in the 31 December 2010 financial statements: Note GMDB
Hypothetical IAS 39 basis fair value 6 870 280 1,150 Adjustment to full fees 7 (200) (600) (800)
3 Change in discount rate: 8.4 per cent to 4.8 per cent, producing significantly higher values, both for future benefit payments and future fees, with a net increase in liability. The absolute impact of this item will be influenced not only by the rate difference, but also by current market conditions, as the proportional impact of a particular rate change will be diluted if applied to a lower absolute value of future cash flows.
4 Change in equity volatility assumption: 15 per cent to 24 per cent, producing higher values, primarily for future benefit payments. The impact is muted for GMWBs due primarily to the length of time until benefit payments occur, and also by the SOP 03-1 methodology itself.
6 Representation of an approximate hypothetical IAS 39 (FAS 157) value were all guaranteed benefits to be reported on this basis. 7 Value of actual fees collected, on an IAS 39 assumption basis, over and above those already considered in the reserve calculation. The reserve calculation restricts the level of future guarantee fees to a level that is sufficient to meet the expected benefit payments at issue using at issue assumptions to avoid profit recognition at inception.
8 Resulting modified hypothetical IAS 39 value including adjustment for the value of fees in excess of those considered in the reserve calculation.
Accounts carrying value to hypothetical IAS 39 basis fair value £m
Accounts carrying value to hypothetical fair value with full fee recognition £m
ASIAN OPERATIONS Insurance operations Net assets of operation 1,913 1,382 Acquired goodwill 236 80 Total 2,149 1,462 Asset management Net assets of operation 197 161 Acquired goodwill 61 61
UK OPERATIONS Insurance operations: Long-term business operations 2,115 1,902 Other 33 37
M&G Net assets of operation 254 173 Acquired goodwill 1,153 1,153
Closing equity shareholders' funds 8,031 6,271 Net asset value per share attributable to equity shareholdersnote i 315p 248p
Asian operations US operations UK operations Total 2010 £bn 2009 £bn 2010 £bn 2009 £bn 2010 £bn 2009 £bn 2010 £bn 2009 £bn
i Rates of exchange The profit and loss accounts of foreign subsidiaries are translated at average exchange rates for the year. Assets and liabilities of foreign subsidiaries are translated at closing exchange rates. Foreign currency borrowings that have been used to provide a hedge against Group equity investments in overseas subsidiaries are also translated at closing exchange rates. The impact of these translations is recorded as a component of the movement in shareholders’ equity.
Hong Kong 12.17 12.01 12.52 12.14 Indonesia 14,106.51 14,033.41 15,171.52 16,173.28 Malaysia 4.83 4.97 5.53 5.51 Singapore 2.01 2.11 2.27 2.27 India 70.01 70.66 75.15 75.70
UK operations Long-term business 673 606 General insurance commission 46 51
Operating profit from continuing operations based on longer-term investment returns 1,941 1,609
IV(b): EFFECT OF FOREIGN CURRENCY RATE MOVEMENTS ON RESULTS > CONTINUED
Asian operations: New business: Excluding Japan 902 783 Japan (1) (13)
US operations New business 761 673 Business in force 697 576
UK operations New business 365 230 Business in force 571 640
Other income and expenditure (494) (434) Restructuring costs (28) (27) Solvency II costs (46) –
Operating profit from continuing operations based on longer-term investment returns 3,696 3,193
Notes i The ‘as published’ operating profit for 2010 and ‘memorandum’ operating profit for 2009 have been calculated by applying average 2010 exchange rates (CER).
The total number of securities available for issue under the scheme is 2,737,324, which represents 0.108 per cent of the issued share capital at 31 December 2010.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £5.83.
The total number of securities available for issue under the scheme is 41,451, which represents 0.002 per cent of the issued share capital at 31 December 2010.
The fair value of options granted under the Plan in the period was £2.91.
The total number of securities available for issue under the scheme is 3,373,847, which represents 0.133 per cent of the issued share capital at 31 December 2010.
The fair values of options granted under the Plan in the period was £2.91.
CURRENT ASSETS Debtors: Amounts owed by subsidiary undertakings 4,244 2,760 Deferred tax 345 180 Other debtors 6 7 Derivative assets 8 112 151 Cash at bank and in hand 162 360
LESS LIABILITIES: AMOUNTS FALLING DUE WITHIN ONE YEAR Commercial paper 7 (2,311) (2,031)
Other borrowings 7 (249) – Amounts owed to subsidiary undertakings (3,398) (3,326)
The Company has not prepared a cash flow statement on the basis that its cash flow is included within the cash flow statement in the consolidated financial statements. The Company has also taken advantage of the exemption within FRS 29, ‘Financial Instruments: Disclosures’, from the requirements of this standard on the basis that the Company’s results are included in the publicly available consolidated financial statements of the Group that include disclosures that comply with IFRS 7, ‘Financial Instruments: Disclosures’, which is equivalent to FRS 29.
In addition, following the UK Government’s announcement in July 2010 of the use of the Consumer Price Index (CPI) rather than the Retail Price Index (RPI) in its determination of the statutory minimum pension increases for private sector occupational pension schemes, in December 2010, the ASB’s Urgent Issues Task Force (UITF) published its abstract UITF 48 providing guidance on the accounting implications of the change. See note 9 for further details.
Further, in 2010, the Company adopted the Improvements to Financial Reporting Standards 2009, the Amendment to FRS 25 ‘Financial Instruments: Presentation’ – Puttable Financial Instruments and Obligations Arising On Liquidation. Their adoption had no material impact on the financial statements of the Company.
Foreign currency translation Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas subsidiaries are translated at year-end exchange rates. The impact of these currency translations is recorded within the profit and loss account for the year.
Under FRS 20, where the Company, as the parent company, has the obligation to settle the options or awards of its equity instruments to employees of its subsidiary undertakings, and such share-based payments are accounted for as equity-settled in the Group financial statements, the Company records an increase in the investment in the subsidiary undertakings for the value of the share options and awards granted with a corresponding credit entry recognised directly in equity. The value of the share options and awards granted is based upon the fair value of the options and awards at the grant date, the vesting period and the vesting conditions.
Profit for the financial year of the Company (including dividends from subsidiaries) in accordance with IFRS 873 908
Share in the IFRS profit (loss) of the Group, net of distributions to the Company 558 (232)
PROFIT AFTER TAX OF THE GROUP ATTRIBUTABLE TO SHAREHOLDERS IN ACCORDANCE WITH IFRS 1,431 676
NET EQUITY Shareholders’ equity of the Company in accordance with UK GAAP 4,267 3,826 IFRS adjustment (51) (53)
The profit for the financial year of the Company in accordance with UK GAAP and IFRS includes dividends declared in the year from subsidiary undertakings of £1,318 million and £1,039 million for the years ended 31 December 2010 and 2009, respectively.
At 1 January 10,071 899 Transfer of investment in subsidiary undertaking (667) – Additional investment in subsidiary undertakings 6 – Foreign exchange movement – 16 Loan repayment – (66)
The transfer of investment in subsidiary undertaking relates to the sale of shares in a central finance subsidiary to another such company. The additional investment in subsidiary undertakings relates to share-based payments reflecting the value of payments settled by the Company for the employees of its subsidiary undertakings in 2010.
Details of all Prudential subsidiaries, joint ventures and associates will be annexed to the Company’s next Annual Returns filed with the UK Registrar of Companies and the Registrar of Companies in Hong Kong.
Recorded in the balance sheet as: Subordinated liabilitiesnote vii 2,718 2,687 Debenture loans 549 549
Notes i The €500 million 5.75 per cent borrowings have been swapped into borrowings of £333 million with interest payable at six month £LIBOR plus 0.962 per cent.
ii The €20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These borrowings have been swapped into borrowings of £14 million with interest payable at three month £LIBOR plus 1.2 per cent. iii The US$250 million 6.75 per cent borrowings and the US$300 million 6.5 per cent borrowings can be converted, in whole or in part, at the
Company’s option and subject to certain conditions, on any interest payment date falling on or after 23 March 2010 and 23 March 2011, respectively into one or more series of Prudential preference shares.
iv Interest on the US$300 million 6.5 per cent borrowings was swapped into floating rate payments but, in 2008, swapped back into fixed rate payments of 6.5 per cent until September 2010. Upon the maturity of the floating to fixed swap in September 2010, the fixed to floating swap was also cancelled. Hedge accounting was applied at both the Group consolidated level and Company level until the cancellation of the fixed to floating interest rate of swap of the US$300 million 6.5 per cent borrowings in September 2010. Due to different dates of commencement of this accounting treatment, the hedge values differed between these two levels.
v These borrowings support a short-term fixed income securities programme. vi The Company issued £200 million Floating Rate Notes in 2010 which mature in April 2011. All Notes have been subscribed to by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. These Notes were originally issued in October 2008 and have been reissued upon their maturity.
vii The interests of the holders of the Subordinated Notes and the Subordinated Capital Securities are subordinate to the entitlements of other creditors of the Company.
Derivative financial instruments held to manage interest rate and currency profile: Interest rate swaps 13 – 33 8 Cross-currency swaps 99 – 118 – Inflation-linked swap – 146 – 128
The change in fair value of the derivative financial instruments of the Company was a loss before tax of £33 million (2009: gain before tax of £83 million).
The Company had a US$300 million fair value hedge in place which hedged the interest rate exposure on the US$300 million 6.5 per cent perpetual subordinated capital securities until the hedge was cancelled in September 2010.
Equities 8.2 8.5 6.8 Bonds 4.6 5.3 4.8 Properties 6.9 6.75 6.1 Other assets 4.75 4.75 2.0
Further details of the Scheme, including mortality assumptions, are shown in note I3 ‘Staff and pension plans’ of the notes on the financial statements of the Group.
The assets and liabilities of the Scheme were: 31 Dec 2010 31 Dec 2009 31 Dec 2008 31 Dec 2007 31 Dec 2006
Equities 548 10.3 830 16.8 823 17.1 1,278 26.1 1,346 28.3 Bonds 3,864 72.2 3,406 68.8 2,430 50.6 1,134 23.2 2,077 43.8 Properties 199 3.7 272 5.5 283 5.9 545 11.2 580 12.2 Cash-like investments 740 13.8 441 8.9 1,267 26.4 1,932 39.5 745 15.7
Surplus in the Scheme recognised by the Company 56 52 50 163 48
Amount reflected in the balance sheet of the Company, net of deferred tax 41 37 36 117 34
Underlying Scheme liabilities and assets The change in the present value of the underlying Scheme liabilities and the change in the fair value of the underlying Scheme assets are as follows: Present value of Scheme liabilities, at 1 January 4,436 4,075 Service costs 25 23 Interest costs 251 242 Employee contributions 1 2 Actuarial losses 369 315 Benefit payments (216) (221)
Fair value of Scheme assets, at 1 January 4,949 4,803 Expected return on Scheme assets 287 213 Employee contributions 1 2 Employer contributions* 55 67 Actuarial gains 275 85 Benefit payments (216) (221)
Fair value of Scheme assets, at 31 December 5,351 4,949 * The contributions include deficit funding, ongoing service contributions, expenses and augmentations.
Actuarial gains (losses): Actual less expected return on Scheme assets (5% (2009: 2%)
(2008: 3%) (2007: 0%) (2006: 0%) of liabilities) 1 59 127 (10) 17 Changes in assumptions underlying the present value of
Actuarial (losses) gains attributable to the Company (14) (3) (143) 91 118
The total actual return on Scheme assets was a gain of £562 million (2009: £298 million). The experience gains on Scheme liabilities in 2008 of £127 million related mainly to the ‘true-up’ reflecting improvements in data consequent upon the 2008 triennial valuation.
A summary of the ordinary shares in issue is set out below: Issued shares of 5 pence each fully paid
At 1 January 2,532,227,471 127 1,843 Shares issued under share option schemes 2,455,227 – 13 Shares issued in lieu of cash dividends 10,911,808 – 62 Reserve movements in respect of shares issued in lieu of cash dividends – – (62)
The profit after tax of the Company for the year was £881 million (2009: £913 million). After dividends of £511 million (2009: £481 million), actuarial losses net of tax in respect of the pension scheme of £10 million (2009: £2 million), share-based payment credits of £6 million (2009: £10 million) and scrip dividends of £62 million (2009: £136 million), retained profit at 31 December 2010 amounted to £2,284 million (2009: £1,856 million).
A reconciliation of the movement in shareholders’ funds of the Company for the years ended 31 December 2010 and 2009 is given below: Profit for the year note 4 881 913
Actuarial losses recognised in respect of the pension scheme net of related taxnote 9 (10) (2) Share-based paymentsnote 5 6 10 New share capital subscribednote 10 75 141
a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note I5 ‘Key management remuneration’ of the notes on the financial statements of the Group.
In addition, the Company paid fees for other services of £6.0 million (2009: £0.2 million). e In certain instances the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
The dividend will distribute an estimated £439 million of shareholders’ funds. The scrip dividend alternative is not being offered in respect of this dividend. In its place, shareholders will be offered a Dividend Reinvestment Plan (DRIP).
The directors of Prudential plc, whose names and positions are set out on pages 100 to 103 confirm that to the best of their knowledge: • The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and
We have audited the financial statements of Prudential plc for the year ended 31 December 2010 set out on pages 153 to 352 and 375 to 386. The financial reporting framework that has been applied in the preparation of the group financial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU. The financial reporting framework that has been applied in the preparation of the parent company financial statements is applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice).
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 387, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors.
Under the Listing Rules we are required to review: • the directors’ statement, set out on page 121, in relation to going concern; • the part of the Corporate Governance Statement set out in the Governance report relating to the Company’s compliance with the nine provisions of the June 2008 Combined Code specified for our review; and
• certain elements of the report to shareholders by the Board on directors’ remuneration.
ASIAN OPERATIONS New business: Excluding Japan 2 902 725 Japaniv (1) (12)
UK OPERATIONS New business 2 365 230 Business in force 3 571 640
Analysed as profits (losses) from: New business: Excluding Japan 2 2,028 1,619 Japaniv (1) (12)
ii The value of future profits or losses from asset management and service companies that support the Group’s covered businesses are included in the profits for new business and the in-force value of the Group’s long-term business. The results of the Group’s asset management operations include the profits from management of internal and external funds. For EEV basis reporting, Group shareholders’ other income is adjusted to deduct the expected margins for the period on management of covered business. The deduction is on a basis consistent with that used for projecting the results for covered business. Group operating profit accordingly includes the variance between actual and expected profit in respect of covered business.
iii Restructuring costs comprise the charge of £(26) million recognised on an IFRS basis and an additional £(2) million recognised on the EEV basis for the shareholders’ share of restructuring costs incurred by the PAC with-profits fund (2009: £(23) million on an IFRS basis and an additional £(4) million on the EEV basis). For 2010, Solvency II implementation costs comprise the charge of £(45) million recognised on an IFRS basis and an additional £(1) million recognised on the EEV basis.
iv New business profits for the Group’s Japanese insurance subsidiary, which ceased selling new business with effect from 15 February 2010, have been presented separately from those of the remainder of the Group.
v Exchange translation The comparative results have been prepared using previously reported average exchange rates for the year.
Based on profit after tax and non-controlling interests of £2,573m (2009: £1,245m) 12 101.9p 49.8p * Excluding an exceptional tax credit of £158 million which primarily relates to the impact of a settlement agreed with the UK tax authorities – see note 11.
Dividends relating to reporting year: Interim dividend (2010 and 2009) 6.61p 6.29p Final/second interim dividend (2010 and 2009) 17.24p 13.56p
Dividends declared and paid in reporting year: Current year interim dividend 6.61p 6.29p Second interim/final dividend for prior year 13.56p 12.91p
Profit for the year attributable to equity shareholders 2,573 1,245 Items taken directly to equity: Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year 659 (761)
SHAREHOLDERS’ EQUITY AT END OF YEAR (EXCLUDING NON-CONTROLLING INTERESTS) 7,10 18,207 15,273
US operations: Net assets of operations 4,799 106 4,905 4,122 95 4,217 Acquired goodwill – 16 16 – 16 16
SHAREHOLDERS’ EQUITY AT END OF YEAR (EXCLUDING NON-CONTROLLING INTERESTS) 7 18,450 (243) 18,207 15,422 (149) 15,273
Representing: Net assets 18,214 (1,473) 16,741 15,342 (1,379) 13,963 Acquired goodwill 236 1,230 1,466 80 1,230 1,310
TOTAL ASSETS LESS LIABILITIES, BEFORE DEDUCTION FOR INSURANCE FUNDS 231,667 201,501 Less insurance funds:* Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds (223,636) (195,230) Less shareholders’ accrued interest in the long-term business 10,176 9,002
SHAREHOLDERS’ EQUITY (EXCLUDING NON-CONTROLLING INTERESTS) 7,10 18,207 15,273 * Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.
a Covered business The EEV results for the Group are prepared for ‘covered business’, as defined by the EEV Principles. Covered business represents the Group’s long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The EEV basis results for the Group’s covered business are then combined with the IFRS basis results of the Group’s other operations.
With two principal exceptions, covered business comprises the Group’s long-term business operations. The principal exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and for the presentational treatment of the financial position of the Group’s principal defined benefit pension scheme, the Prudential Staff Pension Scheme (PSPS). A small amount of UK Group pensions business is also not modelled for EEV reporting purposes.
As regards PSPS, the deficit funding liability attaching to the shareholder-backed business is included in the total for Other operations, reflecting the fact that the deficit funding is being paid for by the parent company, Prudential plc.
b Methodology i Embedded value Overview The embedded value is the present value of the shareholders’ interest in the earnings distributable from assets allocated to covered business after sufficient allowance has been made for the aggregate risks in that business. The shareholders’ interest in the Group’s long-term business comprises: • present value of future shareholder cash flows from in-force covered business (value of in-force business), less deductions for: − the cost of locked-in required capital; − the time value of cost of options and guarantees; • locked-in required capital; and • shareholders’ net worth in excess of required capital (free surplus).
The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in note 1c(iv)) no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profit before tax. Separately, the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items, as explained in note 1c(i).
Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency and mortality. 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.
Principal economic assumptions For the Group’s UK and US operations, the 2010 and 2009 EEV basis results 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 period end rates of return on cash or fixed income securities (the ‘active’ basis).
For Asian operations, the 2009 EEV basis results for Japan, Korea and US dollar denominated business written in Hong Kong were determined on the ‘active’ basis. For other Asian countries the investment return assumptions and risk discount rates for 2009 were based on an assessment of longer-term economic conditions (the ‘passive’ basis).
Total (53) Effect on short-term fluctuations in investment returns and changes in economic assumptions 16
New business The contribution from new business represents profits determined by applying operating assumptions as at the end of the year.
Cost of capital A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as required capital. The cost is the difference between the nominal value of the capital and the discounted value of the projected releases of this capital allowing for investment earnings (net of tax) on the capital.
Where required capital is held within a with-profits long-term fund, the value placed on surplus assets in the fund is already discounted to reflect its release over time and no further adjustment is necessary in respect of required capital.
Non-participating long-term products are the only ones where the insurer is contractually obliged to provide guarantees on all benefits. Whole of life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequent with market conditions are written in the Korean life operations and also are a feature of the UOB in-force book acquired in 2010. The amounts of these policies written in these operations are much smaller than the amounts of similar policies written by the Taiwan Life business which was sold in the first half of 2009, as detailed in note 19.
US operations (Jackson) The principal options and guarantees in Jackson are associated with the fixed annuity and Variable Annuity (VA) lines of business.
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 with-profits fund held a provision on the Pillar I Peak 2 basis of £24 million (2009: £31 million) at 31 December 2010 to honour guarantees on a small amount of guaranteed annuity option products.
The Group’s main exposure to guaranteed annuity options in the UK is through SAIF and a provision on the Pillar I Peak 2 basis of £336 million (2009: £284 million) was held in SAIF at 31 December 2010 to honour the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance Company long-term fund which is attributable to policyholders of the fund, the movement in the provision has no direct impact on shareholders.
The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations. Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of long-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for correlation between the various asset classes. Details of the key characteristics of each model are given in note 16.
The beta of a portfolio or product measures its relative market risk. The risk discount rates reflect the market risk inherent in each product group and hence the volatility of product cash flows. These are determined by considering how the profits from each product are affected by changes in expected returns on various asset classes. By converting this into a relative rate of return it is possible to derive a product specific beta.
In the annuity MCEV calculations, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for expected long-term defaults, credit risk premium and short-term downgrades and defaults. For the purposes of presentation in the EEV results, the results on this basis are reconfigured. Under this approach the projected earned rate of return on the debt securities held is determined after allowing for expected long-term defaults and, where necessary, an additional allowance for an element of short-term downgrades and defaults to bring the allowance in the earned rate up to best estimate levels. The allowances for credit risk premium and additional short-term default allowance are incorporated into the risk margin included in the discount rate.
iv Management actions In deriving the time value of financial options and guarantees, management actions in response to emerging investment and fund solvency conditions have been modelled. Management actions encompass, but are not confined to investment allocation decisions, levels of reversionary and terminal bonuses and credited rates. Bonus rates are projected from current levels and varied in accordance with assumed management actions applying in the emerging investment and fund solvency conditions.
vi Pension costs The Group operates three defined benefit schemes in the UK. The principal scheme is the Prudential Staff Pension Scheme (PSPS). The other two, much smaller, schemes are the Scottish Amicable and M&G schemes.
Under the EEV basis the IAS 19 basis surpluses (to the extent not restricted under IFRIC 14) or deficits are initially allocated in the same manner. The shareholders’ 10 per cent interest in the PAC with-profits fund estate is determined after inclusion of the portion of the IAS 19 basis surpluses or deficits attributable to the fund. Adjustments under EEV in respect of accounting for surpluses or deficits on the Scottish Amicable Pension Scheme are reflected as part of UK operations and for other defined benefit schemes the adjustments are reflected as part of ‘Other operations’, as shown in note 7.
viii Foreign currency translation Foreign currency profits and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year-end rates of exchange. The purpose of translating the profits and losses at average exchange rates, notwithstanding the fact that EEV profit represents the incremental value added on a discounted cash flow basis, is to maintain consistency with the methodology applied for IFRS basis reporting.
c Accounting presentation i Analysis of profit before tax To the extent applicable, presentation of the EEV profit for the year is consistent with the basis that the Group applies for analysis of IFRS basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results including longer-term investment returns and, except as explained in note 1c(iv) below, the unwind of discount on the value of in-force business. Operating results include the impact of routine changes of estimates and non-economic assumptions.
In 2009, during the severe equity market conditions experienced in the first quarter, coupled with historically high equity volatility, the Group incurred non-recurrent costs from an exceptional short-dated hedge to protect against potential tail events on the Group IGD capital position in addition to regular operational hedging programmes. These costs incurred in 2009 have been shown separately within short-term fluctuations in investment returns. Also, in June 2009, the Group completed the disposal of the Taiwan agency business. The effect of this disposal and the results of the Taiwan agency business have been presented separately outside of the operating result.
ii Operating profit For the investment element of the assets covering the net worth of long-term insurance business, investment returns are recognised in operating results at the expected long-term rate of return. These expected returns are calculated by reference to the asset mix of the portfolio. For the purpose of calculating the longer-term investment return to be included in the operating result of the PAC with-profits fund of UK operations, where assets backing the liabilities and unallocated surplus are subject to market volatility, asset values at the beginning of the reporting period are adjusted to remove the effects of short-term market movements as explained in note 1c (iv) below.
For the purpose of determining the long-term returns for debt securities of US operations for fixed annuity and other general account business, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of year-end 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 year-end projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
For UK annuity business, rebalancing of the asset portfolio backing the liabilities to policyholders may from time to time take place to align it more closely with the internal benchmark of credit quality that management applies. Such rebalancing will result in a change in the projected yield on the asset portfolio and the allowance for default risk. The net effect of these changes is reflected in the result for the year. In general, the effect is booked in operating results.
iii Effect of changes in operating assumptions Operating profits include the effect of changes to operating assumptions on the value of in-force at the end of the period. For presentational purposes, the effect of change is delineated to show the effect on the opening value of in-force with the experience variance being determined by reference to the end of period assumptions.
Actuarial and other gains and losses For pension schemes in which the IAS 19 position reflects the difference between the assets and liabilities of the scheme, actuarial and other gains and losses comprise: • the difference between actual and expected return on the scheme assets; • experience gains and losses on scheme liabilities; • the impact of altered economic and other assumptions on the discounted value of scheme liabilities; and • for pension schemes where the IAS 19 position reflects a deficit funding obligation, actuarial and other gains and losses includes the movement in estimates of deficit funding requirements.
vi Effect of changes in economic assumptions Movements in the value of in-force business at the beginning of the period caused by changes in economic assumptions, net of the related change in the time value of cost of option and guarantees, are recorded in non-operating results.
China 10.32 10.46 11.02 10.70 9.86 Hong Kong 12.17 12.01 12.52 12.14 11.14 India 70.01 70.66 75.15 75.70 70.05 Indonesia 14,106.51 14,033.41 15,171.52 16,173.28 15,799.22 Korea 1,776.86 1,786.23 1,880.45 1,989.75 1,810.92 Malaysia 4.83 4.97 5.53 5.51 5.02 Singapore 2.01 2.11 2.27 2.27 2.07 Taiwan 45.65 48.65 51.65 51.65 47.28 US 1.57 1.55 1.61 1.57 1.44 x Discontinued operations The charge of £(14) million in 2009, which is net of £nil tax, reflected completion adjustments for a previously disposed business.
Asian operationsnotes v, vi 1,104 1,391 1,501 7,493 902 60 12.0 US operationsnote vii 11,417 22 1,164 11,572 761 65 6.6 UK insurance operationsnote viii 5,656 254 820 6,842 365 45 5.3
iii New business contributions represent profits determined by applying operating assumptions as at the end of the year. In general, the use of point of sale or end of period economic assumptions is not significant in determining the new business contribution for different types of business and across financial reporting periods. However, to obtain proper measurement of the new business contribution for business which is interest rate sensitive, it is appropriate to use assumptions reflecting point of sale market conditions, consistent with how the business was priced. In practice, the only area within the Group where this has a material effect is for UK shareholder-backed annuity business. For other business within the Group end of period economic assumptions are used.
vii The decrease in new business margin for US operations from 2009 to 2010 primarily reflects the changes to the assumed new business spread margins for Fixed Annuity and Fixed Index Annuity business as described in note 16a.
viii The increase in new business margin for UK operations from 2009 to 2010 primarily reflects the signing of a bulk annuity buy-in insurance agreement.
Notes a The increase in unwind of discount and other expected returns from £489 million for 2009 to £573 million for 2010 mainly arises from the growth in the opening value of the in-force book.
The negative effect of the change in persistency assumptions of £(78) million in 2009 is mainly a direct consequence of the impact on policyholders’ savings behaviour from adverse economic and market conditions, arising mostly with investment related products, principally in Korea (£(25) million), Indonesia (£(24) million) and Hong Kong (£(12) million).
e The credit of £72 million for other assumption changes in 2009 comprises the one-off positive impact of £69 million for altered projected net of tax cash flows arising from a regulatory reclassification of health and protection products in Hong Kong, a credit of £13 million for the effect of altered application of the Group’s EEV methodology and a net charge of £(10) million for other items. The £13 million effect comprises adjustments for asset management margins in Indonesia and Korea of £37 million and a charge of £(24) million to better align the assumed capital requirement with internal management and pricing bases, primarily in China, Indonesia, Philippines and Vietnam, and other minor adjustments with a neutral net effect.
f The favourable effect of £45 million in 2010 (2009: £52 million) for mortality and morbidity experience variances reflects better than expected experience, most significantly in Hong Kong, Singapore and Malaysia.
h The negative persistency experience variance of £(48) million in 2010 mainly arises in India of £(27) million relating to higher paid-ups and surrenders on unit-linked business and in Malaysia of £(26) million for higher partial withdrawals on unit-linked business as customers sought to monetise a proportion of their funds following two years of exceptional returns.
Notes a The increase in unwind of discount and other expected returns from £344 million for 2009 to £369 million for 2010 primarily represents an increase in the return on net worth arising from a higher opening value between 1 January 2009 and 1 January 2010. b The positive impact of the change in GMWB policyholder behaviour assumptions of £156 million for 2009 reflects the altered assumptions relating to the utilisation of withdrawal features available to policyholders on Variable Annuity (VA) contracts which have been modified to take account of the more recent experience of policyholder behaviour when benefits are ‘in the money’. Previously, policyholder behaviour for the utilisation of GMWB was assumed to be largely driven by the extent to which benefits were in the money. For 2009, the assumption was altered to take account of recent experience which shows that the attained age of the policyholder is the key factor in determining utilisation levels.
c The credit of £10 million for updates to mortality assumptions in 2010 represents a credit of £29 million for business other than variable annuity, reflecting recent experience, partially offset by a negative effect on variable annuity business of £(19) million for a change in the modelling of mortality rates. The £33 million credit for mortality in 2009 primarily reflects lower mortality rates for the Life of Georgia business, based upon actual experience since the acquisition of the business in 2005.
e The charge of £(34) million for other operating assumption changes in 2010 includes a credit of £4 million for the overall effect of changes to persistency assumptions and the net effect of a number of items including a charge of £(19) million for the altered projection of life reserves run-off. The effect of other changes in assumptions in 2009 of £(75) million primarily represents the negative impact of changes in persistency assumptions of £(53) million, reflecting an increase in the assumed utilisation of the partial withdrawal option on Variable and Fixed Annuity business of £(29) million and £(24) million for the effect of other altered lapse rates, in line with experience.
f The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults. The spread experience variance in 2010 is a positive £158 million, arising principally from transactions undertaken in the year to more closely match the overall asset and liability duration the effect of which is expected to persist in 2011 but at a reduced level.
g The amortisation of interest-related gains and losses reflects the same treatment applied to the supplementary analysis of IFRS profit. When bonds that are neither impaired nor deteriorating are sold and reinvested there will be a consequent change in the investment yield. The realised gain or loss is amortised into the result over the period when the bonds would have otherwise matured to better reflect the long-term returns included in operating profits. The increase in amortisation of interest-related gains and losses from £59 million in 2009 to £82 million in 2010 reflects the increased level of realised gains in the second half of 2009, on which a full year’s amortisation is recognised in 2010.
i The positive mortality experience variance of £21 million (2009: £32 million) primarily relates to life products. j The positive persistency experience variance of £23 million primarily arises from favourable experience on annuity and institutional business.
Prudential plc Annual Report 2010 3 OPERATING PROFIT FROM BUSINESS IN FORCE > CONTINUED
d At 31 December 2010 a change to reduce the UK corporate tax rate from 28 per cent to 27 per cent with effect from 1 April 2011 had been enacted in the legislative process. The effect of the change in the corporate tax rate of £41 million represents the pre-tax benefit arising from the change in projecting the tax cash flows attaching to in-force business.
e The credit of £52 million in 2009 includes a credit of £22 million for the effects of rebalancing the UK annuity business asset portfolio backing the liabilities to policyholders, reflecting the altered value arising from the revised projected yield and allowances for default risk.
Short-term fluctuations in investment returns, net of the related change in the time value of cost of options and guarantees, arise as follows: Insurance operations: Asianote i 287 437 USnote ii (678) (401) UKnote iii 336 445 Other operations: IGD hedge costsnote iv – (235)
Actual less long-term return on equity based investments and other itemsb 5 (144) Investment return related (loss) gain due primarily to changed expectation of profits on in-force variable annuity business in future periods based on current period equity returns, net of related hedging activity for equity related productsc (332) 110
Notes a The charges relating to fixed income securities for 2010 of £(351) million and 2009 of £(367) million shown above primarily represent the excess of credit-related losses in the year on the US statutory basis over the amortisation of interest-related gains and longer-term default assumption included within operating profit, together with for 2010, the impact of de-risking activities within the portfolio.
iii UK insurance operations The short-term fluctuations in investment returns for UK insurance operations represents: With-profitsa 218 430 Shareholder-backed annuityb 84 (40) Unit-linked and otherc 34 55
c The credit of £34 million for 2010 (2009: credit of £55 million) primarily relates to unit-linked business representing the increase in capitalised value of future fees arising from the positive movements in market values experienced during the relevant reporting periods.
ii The charge of £(1) million for the effect of changes in economic assumptions, net of the related change in the time value of cost of options and guarantees, for US operations for 2010 reflects the following: Effect of changes in treasury rates, beta and equity risk premium:a Fixed annuity and other general account business 111 (398) Variable Annuity (VA) business (112) 181
For 2009, the effect of these changes resulted in an overall charge for fixed annuity and other general account business of £(398) million and an overall credit on VA business of £181 million, reflecting the increase in the risk-free rate of 1.6 per cent.
iii The effect of changes in economic assumptions, net of the related change in the time value of cost of options and guarantees, of a credit of £62 million for UK insurance operations for 2010 comprises the effect of: Shareholderbacked
Notes a For 2010, the effects of decreases in expected long-term rates of return and risk discount rates for shareholder-backed annuity business primarily reflect the reduction in gilt rates of 0.4 per cent, as shown in note 16a. In 2009, the overall charge of £(19) million reflects the effects of regular economic assumption changes. However, the amounts for the component line items shown above reflect a change in the composition of the default allowance between best estimate levels (which are reflected in the long-term rates of return) and allowance for credit risk premium and additional short-term defaults reflected in the risk discount rate.
b For 2010, the credit of £115 million for with-profits and other business reflects a decrease in risk discount rates which more than offsets the reduction in fund earned rates, primarily driven by the decrease in gilt rates of 0.4 per cent in the year. In 2009, the charge of £(199) million for with-profits and other business reflects the fact that the risk discount rate has increased significantly more than the earned rate as a result of the revised correlation assumptions, lower equity backing ratio and very low cash return.
ASIAN OPERATIONS Long-term business: Net assets of operations – EEV basis shareholders’ fundsnote iv 7,445 5,781 Acquired goodwillnote iii 236 80 7,681 5,861 Asset management:note i
OTHER OPERATIONS Holding company net borrowings at market value note 9 (2,212) (1,780) Other net assets (liabilities)note i 149 (65)
Total long-term business operations 8,079 10,371 18,450 6,375 9,047 15,422 Other operationsnote ii (48) (195) (243) (104) (45) (149)
iii The increase in acquired goodwill for Asian long-term business operations from £80 million in 2009 to £236 million in 2010 represents £141 million arising from the acquisition of United Overseas Bank Life Assurance Limited (as shown in note 17) and £15 million for exchange rate movements.
Free surplus is the excess of the net worth over the capital required to support the covered business. Where appropriate, adjustments are made to the regulatory basis net worth from the local regulatory basis so as to include backing assets movements at fair value rather than cost so as to comply with the EEV Principles. Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements, as described in note 1b(ii).
Free surplus of long-term business, asset management and UK general insurance commission
Business in force: Expected in-force cash flows (including expected return on net assets) 1,829 310 2,139 Effects of changes in operating assumptions, operating experience variances and other operating items 220 – 220 1,404 310 1,714 Changes in non-operating itemsnote iii (120) 26 (94)
Group’s shareholder-backed operations together with the shareholders’ 10 per cent interest in the value movements on the assets in the with-profits funds.
v Exchange movements, timing differences and other items represent: 2010 £m
Notes i EEV basis holding company borrowings comprise: Perpetual subordinated capital securities (Innovative Tier 1) 1,491 1,351 Subordinated debt (Lower Tier 2) 1,372 1,372 Senior debt 581 543
UK general insurance commission – – – – 46 46 M&G – – – – 284 284 Asian asset management operations – – – – 72 72 US broker-dealer and asset management – – – – 22 22 Other income and expenditure – – – – (494) (494)
OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNS 1,446 1,454 901 3,801 (105) 3,696
OTHER MOVEMENTS Exchange movements on foreign operations and net investment hedgesnote i 530 124 – 654 5 659 Related tax – – – – 34 34 Intra-group dividends (including statutory
NET INCREASE IN SHAREHOLDERS’ EQUITY 1,664 677 531 2,872 62 2,934 Shareholders’ equity at 1 January 2010notes ii and 7 5,781 4,122 5,439 15,342 (69) 15,273
Adjustment for net of tax asset management projected profits of covered business (11) (3) (20) (34)
Total tax charge on operating profit based on longer-term investment returns, excluding exceptional tax credit 992 866
TOTAL TAX CHARGE ON OPERATING PROFIT BASED ON LONGER-TERM INVESTMENT RETURNS, INCLUDING EXCEPTIONAL TAX CREDITnote ii 834 866
TAX CREDIT ON ITEMS NOT INCLUDED IN OPERATING PROFIT: Tax credit on short-term fluctuations in investment returnsnote iii (222) (26) Tax credit on shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (2) (23) Tax charge (credit) on effect of changes in economic assumptions 13 (336) Tax credit on costs of terminated AIA transaction (93) –
Notes i Including tax relief on Asia development expenses and restructuring costs borne by UK insurance operations. ii The tax charge on operating profit based on longer-term investment returns in 2010 of £834 million includes an exceptional tax credit of £158 million which primarily relates to the impact of the settlement agreed with the UK tax authorities. iii The tax charge on short-term fluctuations in investment returns for 2010 of £(222) million includes a credit of £52 million for a net present value reduction in US deferred tax liabilities following changes to variable annuity reserving in accordance with revised statutory guidance.
Operating EPS: Operating profit before tax 3,696 3,090 Tax excluding exceptional tax credit (992) (866) Non-controlling interests (4) (3)
Operating profit after tax and non-controlling interests excluding exceptional tax credit 2,700 2,221 Exceptional tax credit* 158 –
Total EPS: Profit from continuing operations before tax 3,107 1,743 Tax (530) (481) Discontinued operations (net of tax) – (14) Non-controlling interests (4) (3)
Total profit after tax and non-controlling interests 2,573 1,245 Total EPS (pence) including exceptional tax credit 101.9p 49.8p
Average number of shares (millions) 2,524 2,501 * The tax charge attributable to shareholders’ return includes an exceptional tax credit of £158 million which primarily relates to the impact of a settlement agreed with the UK tax authorities.
The average number of shares reflects the average number in issue adjusted for shares held by employee share trusts and consolidated unit trusts and OEICs which are treated as cancelled.
Total (645) 461 (184) 1,616 1,432 Existing business – transfer to net worth 1,690 (372) 1,318 (1,318) – Expected return on existing business 139 84 223 918 1,141 Changes in operating assumptions and experience variances 220 (4) 216 (86) 130 Changes in non-operating assumptions, experience variances
Exchange movements on foreign operations and net investment hedges 78 119 197 457 654
Acquisition of United Overseas Bank (UOB) Life 18 48 66 13 79 Intra-group dividends (including statutory transfer)
and investment in operationsnote v (720) – (720) – (720) Mark to market value movements on Jackson assets backing surplus and required capital 68 – 68 – 68 Other transfers from net worth (45) – (45) – (45)
Total (280) 84 (196) 867 671 Existing business – transfer to net worth 500 20 520 (520) – Expected return on existing business 103 (9) 94 404 498 Changes in operating assumptions and experience variances 3 (15) (12) (40) (52) Changes in non-operating assumptions and experience variances and non-controlling interests 146 1 147 61 208
PROFIT AFTER TAX AND NON-CONTROLLING INTERESTS FROM LONG-TERM BUSINESS 422 57 479 103 582
Intra-group dividends (including statutory transfer) and investment in operations (81) – (81) – (81)
Mark to market value movements on Jackson assets backing surplus and required capital 68 – 68 – 68
Free surplus invested in new business (278) (300) (65) (643) (2) (645)
Pre-tax new business contributionnote 2 725 664 230 1,619 (12) 1,607 Tax (180) (232) (64) (476) – (476)
Post-tax new business contribution per £1 million free surplus invested 2.4 1.3 1.6 1.7 (0.8) 1.7
Total post-tax new business contribution 1,432 1,131 iii New business contribution and free surplus invested in new business for the Group’s Japanese insurance subsidiary, which ceased selling new business with effect from 15 February 2010, have been presented separately from those of the remainder of the Group.
Value of in-force business before deduction of cost of capital and of guarantees 4,605 2,351 4,181 11,137 Cost of capital (198) (175) (221) (594) Cost of time value of guarantees (12) (208) (40) (260)
Net value of in-force business 4,395 1,968 3,920 10,283 a The increase in cost of capital for Asian operations from 2009 of £(198) million to £(321) million at 2010 mainly arises from the addition of new business, the effect of changes in economic assumptions resulting from changes in economic factors (including the impact of moving from a ‘passive’ to ‘active’ basis as described in note 1b) and the impact of foreign exchange.
b The increase in the cost of time value of guarantees for US operations from 2009 of £(208) million to 2010 of £(270) million primarily relates to Variable Annuity (VA) business, mainly arising from the new business written in the period, reflecting the significant increase in VA sales.
c The increase in the cost of time value of guarantees for UK operations from 2009 of £(40) million to 2010 of £(89) million primarily reflects the effects of short-term fluctuations in investment returns together with the reduction in risk free rate of 0.4 per cent.
v The amounts shown in respect of free surplus and the value of in-force business for Asian and UK operations for intra-group dividends and investment in operations include the impact of contingent loan funding.
Asian operations 6,329 2,304 1,407 866 591 1,161 US operations 4,078 2,358 1,007 421 173 119 UK insurance operations 4,583 1,792 1,173 755 468 395 2009 £m
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2009 Total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 20+ years
a Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2010 (31 December 2009) and the new business contribution after the effect of required capital for 2010 and 2009 to: • one per cent increase in the discount rates; • one per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); • one per cent rise in equity and property yields; • 10 per cent fall in market value of equity and property assets (not applicable for new business contribution); • holding company statutory minimum capital (by contrast to economic capital); • five basis point increase in long-term expected defaults; and • 10 basis point increase in the liquidity premium for UK shareholder-backed annuities.
Interest rates – 1% increase (7) 34 (8) 19 Interest rates – 1% decrease (20) (40) 8 (52) Equity/property yields – 1% rise 41 63 12 116 Long-term expected defaults – 5 bps increase – – (13) (13) Liquidity premium – 10 bps increase – – 26 26 * The impact of the sensitivities above for Japan for 2010 is negligible.
Equity/property yields – 1% rise 31 39 11 81 Long-term expected defaults – 5 bps increase – – (9) (9) Liquidity premium – 10 bps increase – – 18 18
* The impact of the sensitivities above for Japan for 2010 is negligible.
Maintenance expenses – 10% decrease 19 9 8 36 Lapse rates – 10% decrease 56 34 11 101 Mortality and morbidity – 5% decrease 37 7 (11) 33 Change representing effect on: Life business 37 7 1 45 UK annuities – – (12) (12)
Maintenance expenses – 10% decrease 104 39 48 191 Lapse rates – 10% decrease 293 158 67 518 Mortality and morbidity – 5% decrease 233 81 (181) 133 Change representing effect on: Life business 233 81 12 326 UK annuities – – (193) (193)
Maintenance expenses – 10% decrease 77 33 43 153 Lapse rates – 10% decrease 232 141 70 443 Mortality and morbidity – 5% decrease 169 78 (157) 90 Change representing effect on: Life business 169 78 11 258 UK annuities – – (168) (168)
Effect of proposed change in UK corporation tax rates The 2010 results include the impact of the change in UK corporate tax rate that has been enacted to reduce the rate from 28 to 27 per cent from 1 April 2011. The effect of further reductions in the UK corporate tax rate to reduce the rate by one per cent per annum each year from the effective rate of 27 per cent applied in 2010 to 24 per cent in 2014 would increase the net of tax value of the in-force business of UK insurance operations at 1 January 2010 by around £80 million.
a Principal economic assumptions Deterministic assumptions The tables below summarise the principal financial assumptions: Assumed investment returns reflect the expected future returns on the assets held and allocated to the covered business at the valuation date.
Equity risk premiums in Asia range from 3.25 per cent to 8.7 per cent (2009: 3.0 per cent to 8.35 per cent). In the US and the UK, the equity risk premium is 4.0 per cent (2009: 4.0 per cent).
Risk discount rate: New business 10.45 5.1 13.1 13.0 4.9 7.9 7.0 13.2 5.4 5.0 10.5 18.85 In force 10.45 5.1 13.1 13.0 4.9 8.1 7.1 13.2 6.1 5.2 10.5 18.85 Expected long-term rate of inflation 2.5 2.25 4.0 5.0 – 3.0 2.5 4.0 2.0 1.0 3.0 5.5 Government bond yield 3.95 3.3 8.1 7.75 1.1 4.6 4.0 6.4 2.7 1.6 3.8 12.1
Hong Kong notes iii,v India Indonesia notes iii,vi Japan Korea note vi Malaysia notes iv,v
Risk discount rate: New business 11.75 5.5 14.25 13.8 5.1 8.2 9.1 15.75 5.7 7.5 13.0 16.75 In force 11.75 5.7 14.25 13.8 5.1 8.4 9.3 15.75 6.8 7.5 13.0 16.75 Expected long-term rate of inflation 4.0 2.25 5.0 6.0 – 2.75 2.75 5.0 1.75 2.25 3.0 6.0 Government bond yield 8.25 3.9 9.25 10.25 1.9 5.5 6.5 9.25 4.25 5.5 6.75 10.25
iii The assumptions shown are for US dollar denominated business which comprises the largest proportion of the in-force Hong Kong business. The risk discount rates shown for Indonesia and Philippines are for local currency denominated business which comprises the largest proportion of the in-force business in those territories.
Fixed Annuity business (including the proportion of variable annuity business invested in the general account):note i
iii Credit risk treatment The projected cash flows incorporate the expected long-term spread between the earned rate and the rate credited to policyholders. The projected earned rates reflect book value yields which are adjusted over time to reflect projected reinvestment rates. Positive net cash flows are assumed to be reinvested in a mix of corporate bonds, commercial mortgages and limited partnerships. The yield on those assets is assumed to grade from the current level to a yield that allows for a long-term assumed credit spread on the reinvested assets of 1.25 per cent over 10 years. The expected new business spread margins are determined after allowing for a Risk Margin Reserve (RMR) allowance for 2010 of 26 bps (2009: 28 bps) for longer-term defaults as described in note 1b(iii). The RMR of 26 bps represents the allowance, as at the valuation applied in the cash flow projections of the value of the in-force business.
The results for Jackson reflect the application of the discount rates shown above, which for 2010 and 2009 reflect the inclusion of an additional allowance for a combination of credit risk premium and short-term default allowance as described in note 1b(iii) and note 5.
Notes i The risk discount rate applied to shareholder-backed annuity business has been determined after allowing for credit risk as detailed in note iv below. ii The risk discount rates for new business and business in force for UK insurance operations other than shareholder-backed annuities reflect weighted rates based on the type of business.
b 11 basis points for fixed annuities and 9 basis points for inflation-linked annuities in respect of long-term credit risk premium for the potential volatility in default levels. This is derived by applying the 95th worst percentile from Moody’s data from 1970 to 2009, to the asset portfolios.
c 43 basis points for fixed annuities and 39 basis points for inflation-linked annuities in respect of additional short-term credit risk, reflecting short-term credit rating downgrades and defaults in excess of the long-term assumptions. This element of the overall credit assumption has not been derived by reference to credit spreads; rather it has been reduced in order to offset the impact of actual downgrades during the period on the long-term assumptions in (a) and (b) above and increased to eliminate the positive experience variance that would otherwise have arisen from the small number of actual defaults that were experienced in the period. In addition, the assumptions have been updated to reflect changes in the asset mix, arising particularly from the sale of subordinated financial debt and the addition of higher credit quality new business assets (compared to the in-force portfolio).
The overall allowance for credit risk is prudent by comparison with historic rates of default and would be sufficient to withstand a wide range of extreme credit events over the expected lifetime of the annuity business.
Stochastic assumptions The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations described above. Assumptions specific to the stochastic calculations, such as the volatilities of asset returns, reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of longer-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with allowance for correlation between the various asset classes. Details are given below of the key characteristics and calibrations of each model.
Asian operations • The same asset return models as used in the UK, appropriately calibrated, have been used for the Asian operations as described for
• The stochastic cost of guarantees is primarily only of significance for the Hong Kong, Korea, Malaysia and Singapore operations. • The mean stochastic returns are consistent with the mean deterministic returns for each country. The expected volatility of equity returns for 2010 and 2009 ranges from 18 per cent to 35 per cent, and the volatility of government bond yields ranges for 2010 from 0.9 per cent to 2.4 per cent (2009: 1.3 per cent to 2.4 per cent).
US operations (Jackson) • Interest rates are projected using a log-normal generator calibrated to the market yield curve at the valuation date; • Corporate bond returns are based on Treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and • Variable annuity equity returns and bond interest rates have been stochastically generated using a log-normal model with parameters determined by reference to historical data. The volatility of equity fund returns for 2010 ranges from 19.0 per cent to 32.1 per cent, (2009: 18.6 per cent to 28.1 per cent) depending on the risk class and the class of equity, and the standard deviation of interest rates ranges from 2.0 per cent to 2.4 per cent (2009: 1.4 per cent to 1.6 per cent).
c Expense assumptions Expense levels, including those of service companies that support the Group’s long-term business operations, are based on internal expense analysis investigations and are appropriately allocated to acquisition of new business and renewal of in-force business. Exceptional expenses are identified and reported separately. It is Prudential’s policy not to take credit for future cost reduction programmes until the savings have been delivered. For Asian life operations, the expenses comprise costs borne directly and recharged costs from the Asia Regional Head Office, that are attributable to covered business. The assumed future expenses for these operations also include projections of these future recharges. Expenditure of the Regional Head Office that is not allocated to the covered business or asset management operations is charged as incurred. These costs are primarily for corporate related activities. Development expenses are also charged as incurred. Corporate expenditure for Group Head Office, to the extent not allocated to the PAC with-profits funds, together with Solvency II implementation and restructuring costs, are charged to EEV basis results as incurred.
19 SALE OF THE TAIWAN AGENCY BUSINESS IN 2009 2009 £m
Representing: Profit arising on sale and result for long-term business operations 148 Goodwill written off (44) Adjustments in respect of restructuring costs borne by non-covered business (13)
In January 2011, the Company issued US$550 million 7.75 per cent Tier 1 subordinated debt, primarily to retail investors. The proceeds, net of costs, were US$539 million and are intended to finance the repayment of the ¤500 million Tier 2 subordinated notes in December 2011.
GROUP INSURANCE OPERATIONS Asia – excl Japannote iii 1,104 785 1,391 1,131 1,501 1,209 7,493 5,982 US 11,417 8,885 22 24 1,164 912 11,572 9,048 UK 5,656 4,768 254 246 820 723 6,842 5,902
GROUP TOTAL – EXCL JAPAN 18,177 14,438 1,667 1,401 3,485 2,844 25,907 20,932 Japannote iii 13 57 6 46 7 52 39 263
ASIAN INSURANCE OPERATIONS Hong Kong 107 94 276 232 287 241 1,693 1,414 Indonesia 141 41 269 186 283 190 1,011 671 Malaysia 58 63 198 140 204 146 1,153 814 Philippines 64 14 17 10 23 11 108 39 Singapore 318 297 143 98 175 128 1,357 1,033 Thailand 15 14 25 14 26 16 100 54 Vietnam 1 1 41 35 41 35 148 128
TOTAL ASIAN OPERATIONS – EXCL JAPAN 1,104 785 1,391 1,131 1,501 1,209 7,493 5,982
UK INSURANCE OPERATIONS Direct and partnership annuities 593 590 – – 59 59 593 590 Intermediated annuities 221 242 – – 22 24 221 242 Internal vesting annuities 1,235 1,357 – – 124 136 1,235 1,357
Corporate pensions 228 192 198 191 221 210 1,099 1,007 Onshore bonds 1,660 1,444 – – 166 145 1,660 1,444 Other products 774 881 56 55 133 143 1,089 1,200 Wholesalenote iv 945 62 – – 95 6 945 62
ii The table above includes new business for the Taiwan bank distribution operation. New business of the Taiwan Agency business, which was sold in June 2009, is excluded from the table.
STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE EUROPEAN EMBEDDED VALUE (EEV) BASIS SUPPLEMENTARY INFORMATION
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 434, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Our responsibility is to audit, and express an opinion on, the supplementary information in accordance with the terms of our engagement and having regard to International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors.
Scope of the audit of the supplementary information An audit involves obtaining evidence about the amounts and disclosures in the supplementary information sufficient to give reasonable assurance that the supplementary information is free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to Group’s circumstances and have been consistently applied and adequately disclosed; and the reasonableness of significant accounting estimates made by the directors. In view of the purpose for which the supplementary information has been prepared, however, we did not assess the overall presentation of the supplementary information which would have been required if we were to express an audit opinion under International Standards on Auditing (UK and Ireland).
A number of factors (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 report, is not updated, and any forward looking statements are made subject to the reservations specified below under ‘Forward Looking Statements’.
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Uncertain or negative trends in international economic and investment climates could adversely affect Prudential’s business and profitability. The adverse effects of volatility arising from such uncertainty and negative trends, including the unprecedented market dislocation across asset classes and geographical markets witnessed in 2008 and in the first half of 2009, have been and would be felt principally through the following: • investment impairments or reduced investment returns, as a result of market volatility, could impair Prudential’s ability to write significant volumes of new business which would have a negative impact on its assets under management and profit; • higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses, as experienced during 2008 and 2009, when illiquidity and credit spreads reached all-time highs; • Prudential in the normal course of business enters into a variety of transactions with counterparties, including derivative transactions. Failure of any of these counterparties to discharge their obligations, or where adequate collateral is not in place, could have an adverse impact on Prudential’s results; and
• estimates of the value of financial instruments are difficult because in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain value and estimates of value require substantial elements of judgement, assumptions and estimates (which may change over time). Increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline.
In the US, fluctuations in prevailing interest rates can affect results from Jackson National Life Insurance Company (‘Jackson’) which has a significant spread-based business, with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates.
Declines in spread from these products or other spread businesses that Jackson conducts could have a material impact on its businesses or results of operations. Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. There could be unforeseen market circumstances where the derivatives that it enters into to hedge its market risks may not fully offset its losses, and any cost of the guarantees that remain unhedged will also affect Prudential’s results.
Current EU directives, including the EU Insurance Groups Directive (IGD) require European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a somewhat higher amount of regulatory capital at the group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. The EU is also developing a new solvency framework for insurance companies, referred to as ‘Solvency II’. The new approach will be based on the concept of three pillars – minimum capital requirements, supervisory review of firms’ assessment of risk, and enhanced disclosure requirements – and will cover valuations, the treatment of insurance groups, the definition of capital and the overall level of capital requirements. A key aspect of Solvency II is that the assessment of risks and capital requirements will be aligned more closely with economic capital methodologies, and may allow Prudential to make use of its internal economic capital models, if approved by the Financial Services Authority (FSA) or other relevant supervisory authority. The Solvency II Directive was formally approved by a meeting of the EU’s Economic and Financial Affairs Council on 10 November 2009. The European Commission is in the process of consulting on the detailed rules that will complement the high-level Principles of the Directive, referred to as ‘implementing measures’, which are not expected to be finalised until late 2011. There is a significant uncertainty regarding the final outcome of this process. As a result there is a risk that the effect of the measures finally adopted could be adverse for Prudential, including potentially a significant increase in capital required to support its business.
European Embedded Value (EEV) basis results are published as supplementary information by Prudential using principles issued by the European CFO (Chief Financial Officers) Forum. The EEV basis is a value-based reporting method for Prudential’s long-term business which is used by market analysts and which underpins a significant part of the key performance indicators used by Prudential’s management for both internal and external reporting purposes. In June 2008, in an effort to improve the consistency and transparency of embedded value reporting, the CFO Forum published the Market Consistent Embedded Value (MCEV) Principles. Following a review of the impact of turbulent market conditions on the MCEV Principles, the CFO Forum announced in May 2009 the postponement of the mandatory reporting on an MCEV basis and subsequently, in October 2009, changes in the Principles to allow for the inclusion of a liquidity premium, which is the additional return investors require for investing in less liquid assets and is a key component in the calculation of the profitability of UK annuity business. It also announced that it was performing further work to develop more detailed application guidance to increase consistency going forward. When the work has been completed, Prudential will consider its approach to the new Principles. The adoption of the new Principles would give rise to different embedded value results from those prepared under the application of European Embedded Value Principles.
In the US, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund, fixed index annuity and insurance product industries. This focus includes new regulations in respect of the suitability of sales of certain products. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.
Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential is, and may be in the future, subject to legal actions, disputes and regulatory investigations in the ordinary course of its insurance, investment management and other business operations. These legal actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specific to Prudential or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations (including tax) or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provided in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s results of operations or cash flows.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and hurt its relationships with creditors or trading counterparties Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in most of Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings, as a result of, for example, decreased profitability, increased costs, increased indebtedness or other concerns, could have an adverse effect on its ability to market products and retain current policyholders. In addition, the interest rates Prudential pays on its borrowings are affected by its debt credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations.
Further, because of the long-term nature of much of the Group’s business, accurate records have to be maintained for significant periods. Prudential’s systems and processes incorporate controls which are designed to manage and mitigate the operational risks associated with its activities. For example, any weakness in the administration systems or actuarial reserving processes could have an impact on its results of operations during the effective period. Prudential has not experienced or identified any operational risks in its systems or processes during 2010, which have subsequently caused, or are expected to cause, a significant negative impact on its results of operations.
Adverse experience against the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations Prudential needs to make assumptions about a number of factors in determining the pricing of its products and setting reserves and for reporting its capital levels and the results of its long-term business operations. For example, the assumption that Prudential makes about future expected levels of mortality is particularly relevant for its UK annuity business. In exchange for a premium equal to the capital value of their accumulated pension fund, pension annuity policyholders receive a guaranteed payment, usually monthly, for as long as they are alive. Prudential conducts rigorous research into longevity risk, using data from its substantial annuitant portfolio. As part of its pension annuity pricing and reserving policy, Prudential’s UK business assumes that current rates of mortality continuously improve over time at levels based on adjusted data from the Continuous Mortality Investigations (CMI) as published by the Institute and Faculty of Actuaries. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
Another example is the impact of epidemics and other effects that cause a large number of deaths. Significant influenza epidemics have occurred three times in the last 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.
As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments The Group’s insurance and investment management operations are generally conducted through direct and indirect subsidiaries
Prudential operates in a number of markets through joint ventures and other arrangements with thirdparties (including in China and India), involving certain risks that Prudential does not face with respect to its consolidated subsidiaries Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures (including in China and India). For the Group’s joint venture operations, management control is exercised jointly with the venture participants. The level of control exercisable by the Group depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants. Prudential may also face financial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encounters financial difficulty. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third-parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could adversely affect the results of operations of Prudential.
Changes in tax legislation may result in adverse tax consequences Tax rules, including those relating to the insurance industry, and their interpretation, may change, possibly with retrospective effect, in any of the jurisdictions in which Prudential operates. Significant tax disputes with tax authorities, and any change in the tax status of any member of the Group or in taxation legislation or its interpretation could affect Prudential’s profitability and ability to provide returns to shareholders or alter the post-tax returns to shareholders.
Dividend mandates Shareholders may find it convenient to have their dividends paid directly to their bank or building society account. If you wish to take advantage of this facility, please call Equiniti and request a Cash Dividend Mandate form. Alternatively, you may download a form from www.prudential.co.uk/ prudential-plc/investors/shareholder_services/forms
Payment date 26 May 2011 26 May 2011 26 May 2011 On or about 2 June 2011
Hong Kong branch register The Company operates a branch register for shareholders in Hong Kong. All enquiries regarding Hong Kong branch register accounts and requests for the Chinese version of the 2010 Annual Report should be directed to Computershare Hong Kong Investor Services Limited, 17M Floor, Hopewell Centre, 183 Queen’s Road East, Wan Chai, Hong Kong. Telephone: +852 2862 8555. Dividends will be paid in Hong Kong Dollars to shareholders on the Hong Kong Register.
Singapore shareholder enquiries Shareholders who have shares standing to the credit of their securities accounts with CDP in Singapore may refer queries to the CDP at 4 Shenton Way, #02-01, SGX Centre 2, Singapore 068807. Telephone +65 6535 7511. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker. Dividends will be paid in Singapore Dollars to shareholders with shares standing to the credit of a Central Deposit and Securities account.
Irish branch register The Company operates a branch register for shareholders in Ireland. All enquiries regarding Irish branch register accounts should be directed to Capita Registrars (Ireland) Limited, Unit 5, Manor Street Business Park, Manor Street, Dublin 7. Telephone: + 353 1 810 2400.
American Depositary Receipts (ADRs) The Company’s ordinary shares are listed on the New York Stock Exchange in the form of American Depositary Shares, evidenced by ADRs and traded under the symbol PUK. Each American Depositary Share represents two ordinary shares. All enquiries regarding ADR holder accounts should be directed to JP Morgan, the authorised depositary bank, at JPMorgan Chase & Co, P O Box 64504, St.Paul, MN 55164-0504, USA, Telephone General (800) 990-1135 or from outside the US +651 453-2128 or log on to www.adr.com
Prudential plc Laurence Pountney Hill London EC4R 0HH Tel: +44 (0)20 7220 7588 www.prudential.co.uk
M&G Laurence Pountney Hill London EC4R 0HH Tel: +44 (0)20 7626 4588 www.mandg.co.uk
Prudential Corporation Asia 13th Floor One International Finance Centre 1 Harbour View Street Central Hong Kong Tel: +852 2918 6300 www.prudentialcorporation-asia.com
Forward-Looking Statements This report may contain certain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its current goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore you should not place undue reliance on them. By their nature, all forward-looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future financial condition or performance or other indicated results to differ materially from those indicated in any forward-looking statement. Such factors include, but are not limited to, future market conditions, fluctuations in interest rates and exchange rates, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives related to the financial crisis and the effect of the European Union’s
‘Solvency II’ requirements on Prudential’s capital maintenance requirements; the impact of competition, inflation, and deflation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards or accounting standards, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate; and the impact of legal actions and disputes. These and other important factors may for example result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefits. Further discussion of these and other important factors that could cause Prudential’s actual future financial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the heading ‘Risk factors’ in this Report and in Item 3 ‘Risk Factors’ of Prudential’s most recent annual report on Form 20-F filed with the U.S. Securities and Exchange Commission, as well as under the heading ‘Risk factors’ in any subsequent Prudential Half Year Financial Report. This Annual Report and subsequent Half Year Financial Report are/will be available on the Company’s website at www.prudential.co.uk.
Any forward-looking statements contained in this report are made only as of the date hereof. Prudential undertakes no obligation to update the forward-looking statements contained in this statement or any other forward-looking statements it may make, whether as a result of future events, new information or otherwise except as required pursuant to the Prospectus Rules, the Listing Rules, the Disclosure and Transparency Rules, the Hong Kong Listing Rules or the SGX-ST listing rules.