PLTIP Awards made under the PLTIP are currently subject to the achievement of IFRS profit targets, relative TSR and, from 2017, a balanced scorecard of measures: — IFRS profit was selected as a performance measure for the PLTIP (as well as the AIP) because it is central to the management of the business and a key driver of shareholder value; — Relative TSR was selected as a performance measure because it focuses on the value delivered to shareholders – aligning the long-term interests of shareholders with those of executives; and
For market-based performance conditions (eg relative TSR) the Committee requires that performance is in the upper quartile, relative to Prudential’s peer group, for awards to vest in full.
The principles that apply to Executive Directors are cascaded to other employees in their business unit. Senior leaders in the Group participate in annual bonus schemes which have performance conditions that mirror the CEO for their business unit. In addition, they are eligible to receive awards under the long-term incentive plans with performance conditions appropriate for their role.
— Performance must be achieved within the Group’s and business units’ risk framework and appetite.
The approach to recruiting a Non-executive Director or a Chairman is outlined on page 148.
Benefits and pension The benefits for a new Executive Director will be consistent with those outlined in the fixed pay policy table.
The variable remuneration opportunities for a new Executive Director would be consistent with the limits and structures outlined in the variable pay policy table.
On joining the Board from within the Group, the Committee may allow an executive to retain any outstanding deferred bonus and/or long-term incentive awards and/or other contractual arrangements that they held on their appointment. These awards (which may have been made under plans not listed in this policy) would remain subject to the original rules, performance conditions and vesting schedule applied to them when they were awarded.
If a newly-appointed Executive Director forfeits one or more long-term incentive awards on leaving a previous employer, these may be replaced with Prudential awards with an equivalent value. Replacement awards will generally be made under the terms of a long-term incentive plan approved by shareholders, and vest on the same schedule as the foregone awards. Where foregone awards were subject to performance conditions, performance conditions will be applied to awards replacing foregone long-term incentive awards; these will be the same as those applied to the long-term incentive awards made to Prudential executives in the year in which the forfeited award was made.
The Committee may consider compensating a newly-appointed executive for other relevant contractual rights forfeited when leaving their previous employer.
This provision would only be used to compensate for remuneration forfeited on leaving a previous employer.
In agreeing the terms of departure for any Executive Director, other than on death or disablement, the Company will have regard to the need to mitigate the costs for the Company.
If an Executive Director is dismissed for cause their contract would be terminated with immediate effect and they would not receive any payments in relation to their notice period.
Prior to release, awards remain subject to the malus terms originally applied to them.
Should an executive die, outstanding deferred bonus awards will be released as soon as possible after the date of death.
Executive Directors will normally retain their unvested long-term incentive awards. These awards will ordinarily be pro-rated based on time employed, will vest on the original timescale and will remain subject to the original performance conditions assessed over the entire performance period.
Prior to release, awards remain subject to the malus terms and holding periods originally applied to them.
Any Executive Director dismissed for cause would not be eligible for any bonus that has not been paid.
Consistent with other employees in their business unit, Executive Directors may receive payments to compensate them for the loss of employment rights on termination. Payments may include: — A nominal amount for agreeing to non-solicitation and confidentiality clauses; — Directors and Officers insurance cover for a specified period following the executives’ termination date; — Payment for outplacement services; — Reimbursement of legal fees; and
In the event of a corporate transaction (eg takeover, material merger, winding up etc), the Remuneration Committee will determine whether awards will: — Vest in part or in full; and/or
— Lapse and, in exchange, the participant will be granted an award under any other share or cash incentive plan which the Remuneration Committee considers to be broadly equivalent to the award; and/or
Prudential does not consult with employees when setting the Directors’ remuneration policy: Prudential is a global organisation with employees, and agents in multiple business units and geographies. As such, there are practical challenges associated with consulting with employees directly on this matter. The Committee will keep this under review. As many employees are also shareholders, they are able to participate in binding votes on the Directors’ remuneration policy and annual votes on the Annual report on remuneration.
Non-executive Directors will be expected to attain this level of share ownership within three years of their date of appointment.
Chairman The Chairman receives an annual fee for the performance of their role. This fee is agreed by the Remuneration Committee and is paid to the Chairman in cash, subject to the appropriate deductions. On appointment, the fee may be fixed for a specified period of time. Following the fixed period (if applicable) this fee will be reviewed annually. Changes in the fee are effective from 1 July.
The maximum paid will be the cost to the Company of providing these benefits.
Recruitment of a new Chairman or Non-executive Director The fees for a new Non-executive Director will be consistent with the current basic fee paid to other Non-executive Directors (as set out in the Annual report on remuneration for that year) and will be reflective of their additional responsibilities as chair and/or members of Board committees.
Notice periods – Non-executive Directors and Chairman Non-executive Directors are appointed pursuant to letters of appointment with notice periods of six months without liability for compensation. A contractual notice period of 12 months by either party applies for the Chairman. The Chairman would not be entitled to any payments for loss of office.
For information on the terms of appointment for the Chairman and Non-executive Directors please see page 133 of the Corporate governance report.
The Committee has the authority to apply clawback and/or a malus adjustment to all, or a portion of, an M&G Executive LTIP award. More details about clawback and malus are set out above.
The maximum vesting under the M&G Executive LTIP is 100 per cent of the number of phantom shares originally awarded.
The phantom share price at vesting is determined by the increase or decrease in M&G’s profitability with profit and investment performance adjustments also applied.
Where the investment performance of M&G’s funds is in the top two quartiles during the three-year performance period, the value of phantom shares vesting will be enhanced. The value of phantom shares may be doubled if performance is in the top quartile. Investment performance in the bottom quartile will result in awards being forfeited, irrespective of any profit growth.
Buy-out award for the Chief Executive, M&G (the Prudential plc 2016 Recruitment Plan) In line with the announcement made on 1 February 2016, the Company entered into an agreement with Anne Richards to compensate her for unvested share awards that she forfeited as a consequence of joining Prudential.
Details of this award are set out on page 129 of the Annual report on remuneration.
Reimbursed business expenses, and associated tax liabilities (such as, taxes levied by country revenue services on short-term business travellers eg when overseas-based Directors travel to Board meetings held in the UK) are included as a benefit for the avoidance of doubt.
Component Changes to policy approved at 2014 AGM Reason for changes
The Committee has the power to recover all, or a portion of, awards made since 2015 in specific circumstances and within a defined time frame.
The M&G Executive LTIP has been replaced with a commensurate PLTIP award for the Chief Executive, M&G.
In line with the requirements of the UK Corporate Governance Code, the Committee has had the power to recover (clawback) awards made since 2015 in specific circumstances and within a defined time frame. For clarity, this power is now reflected in the policy.
The two-year holding period is consistent with investor guidance for shares to have at least a five-year performance and holding period.
Shareholders are in favour of simplification, in particular, using a single long-term incentive plan for Executive Directors and the Committee shared this view. Delivering more of the Chief Executive, M&G incentive in Prudential shares strengthens her alignment with the Company’s shareholders and is consistent with the way in which other Executive Directors are rewarded.
The share ownership guidelines have been updated as follows: — Increased from 350 per cent of base salary to 400 per cent of base salary for the Chief Executive; and
Shareholding guidelines among large listed companies have continued to increase over recent years and the Committee wanted to recognise this and to maximise the Executive Directors’ community of interest with the Company’s shareholders.
— Clarify that performance conditions will be applied where foregone awards were subject to performance conditions.
The updates to the policy are intended to give the Committee a range of approaches which might be used in replacing awards forfeited by a newly-appointed Director on their departure from their previous employer. This is in line with our overriding principle that replacement awards should, as far as possible, reflect the terms of those forfeited.
The policy on payment of loss of office has been clarified to: — Specifically state that should an Executive Director die while serving as a Director, a time pro-rated bonus may be awarded but deferral would not be applied; and
This new section has been added in response to a request from shareholders to set out the Committee’s discretion on corporate transactions. These provisions appear in the Rules of the PLTIP which were approved by shareholders in 2013 but are now included in the policy for completeness.
As part of the continuing implementation of Solvency II, the weightings of Penny James’s AIP performance targets (with effect from 2017) have been changed so that her entire AIP outcome relates to a combination of functional and personal measures.
— Balanced scorecard of strategic measures (25 per cent of award).
As part of the continuing implementation of Solvency II, the weightings of Penny James’s LTIP performance targets (with effect from 2017) will be different to the other Executive Directors and will be: — Relative TSR (50 per cent of award); — Group IFRS profit (20 per cent of award); and
Under the Group TSR measure, 25 per cent of the award vests for TSR at the median of the peer group increasing to full vesting for performance within the upper quartile. Following a comprehensive review of the peer group, supported by the Remuneration Committee’s independent adviser and the Group’s Investor Relations team, three companies (Aflac, Munich Re and Swiss Re) have been removed for the 2017 awards because their products and geographic footprints are insufficiently similar to those of the Group.
The peer group for the 2017 awards is: Aegon Aviva AIA AIG Allianz Manulife AXA Generali Legal & General Prudential Financial MetLife Sun Life Financial Old Mutual Zurich Insurance Group Standard Life
Under the IFRS measure, 25 per cent of the award vests for meeting the threshold IFRS profit set at the start of the performance period increasing to full vesting for performance at or above the stretch level.
Under the balanced scorecard, performance is assessed for each of the four measures, at the end of the three year performance period. Each of the measures has equal weighting and these measures are set out below.
Capital measure Cumulative three-year Solvency II Group operating capital generation (as captured in published disclosures) relative to plan.
Conduct measure Through appropriate management action, ensure there are no significant conduct/culture/governance issues which result in significant capital add-ons or material fines.
Chairman and Non-executive Directors Fees for the Chairman and Non-executive Directors were reviewed in 2016 with changes effective from 1 July 2016 as set out on page 130. The next review will be effective 1 July 2017.
Notes 1 The awards for Barry Stowe were made in ADRs (1 ADR = 2 ordinary shares). The figures in the table are represented in terms of ordinary shares. 2 The awards in 2013, 2014 and 2015 for Mike Wells were made in ADRs (1 ADR = 2 ordinary shares). The award in 2016 was made in ordinary shares. The figures in the table are represented in terms of ordinary shares.
Face value of conditional share awards outstanding at 1 January 2016
Deferred 2012 Group deferred bonus plan award 2013 5,677 5,677 – 31 Dec 15 31 Mar 16 1,083 1,301
Deferred 2013 Group deferred bonus plan award 2014 4,880 184 5,064 31 Dec 16 1,317
Deferred 2014 Group deferred bonus plan award 2015 3,943 148 4,091 31 Dec 17 1,672
Deferred 2014 annual incentive award 2015 27,992 1,054 29,046 31 Dec 17 1,672
Deferred 2015 annual incentive award 2016 107,566 4,052 111,618 31 Dec 18 1,279
Deferred 2012 annual incentive award 2013 86,586 86,586 – 31 Dec 15 31 Mar 16 1,055 1,301
Deferred 2014 PCA deferred bonus plan award 2015 82,290 2,305 84,595 31 Dec 16 1,672
4 The PCA deferred bonus plan is an arrangement for executives and senior management of PCA. Tony Wilkey was a participant of this plan until his appointment to the Board on 1 June 2015 and has not been eligible for new awards since this date. 5 A dividend equivalent was accumulated on these awards.
Details of Executive Directors’ rights under the SAYE scheme are set out in the ‘Statement of Directors’ shareholdings’.
Prudential Corporation Asia All Employee Share Purchase Plan (PruSharePlus) From August 2014, all Asia-based employees were able to purchase Prudential plc shares up to a value of £5,000 per year from their gross salary through the PruSharePlus. For every two shares bought by the employee, one additional matching share is awarded which is purchased by Prudential on the open market. Dividend shares accumulate while the employee participates in the plan. If the employee withdraws from the plan, or leaves the Group, matching shares may be forfeited.
The table below provides information about shares purchased under the PruSharePlus together with matching shares (awarded on a 1:2 basis) and dividend shares.
* Following his appointment to the Board, Tony Wilkey is no longer eligible to participate in the PruSharePlus with effect from the anniversary of his joining the plan.
Cash-settled long-term incentive awards This information has been prepared in line with the reporting requirements of the Hong Kong Stock Exchange and sets out Executive Directors’ outstanding share awards and share options. For details of the cash-settled long-term incentive awards held by some Executive Directors, please see our Annual report on remuneration.
Five highest paid individuals Of the five individuals with the highest emoluments in 2016, two were Executive Directors whose emoluments are disclosed in this report. The aggregate of the emoluments of the other three individuals for 2016 were as follows: Base salaries, allowances and benefits in kind 3,257 Pension contributions 123 Performance related pay 18,952
Financial statements 160 Index to Group IFRS financial statements 309 Parent company financial statements 311 Notes on the parent company financial statements 318 Statement of Directors’ responsibilities in respect of the
Annual Report and the financial statements 319 Independent auditor’s report to the members of Prudential plc
Primary statements 161 Consolidated income statement 162 Consolidated statement of comprehensive income 163 Consolidated statement of changes in equity: 2016 165 Consolidated statement of financial position 166 Consolidated statement of cash flows
Section B: Earnings performance B1 Analysis of performance by segment 178 B1.1 Segment results – profit before tax 179 B1.2 Short-term fluctuations in investment returns on shareholder-backed business 181 B1.3 Determining operating segments and performance measure of operating segments 185 B1.4 Segmental income statement 188 B1.5 Other investment return 189 B2 Profit before tax – asset management operations 190 B3 Acquisition costs and other expenditure 190 B3.1 Staff and employment costs 191 B3.2 Share-based payment 193 B3.3 Key management remuneration 193 B3.4 Fees payable to the auditor 194 B4 Effect of changes and other accounting features on insurance assets and liabilities 194 B5 Tax charge 199 B6 Earnings per share 200 B7 Dividends
C4.1 Movement and duration of liabilities 229 C4.1(a) Group overview 232 C4.1(b) Asia insurance operations 234 C4.1(c) US insurance operations 236 C4.1(d) UK insurance operations C4.2 Products and determining contract liabilities 238 C4.2(a) Asia 240 C4.2(b) US 246 C4.2(c) UK C5 Intangible assets 251 C5(a) Goodwill 252 C5(b) Deferred acquisition costs and other intangible assets C6 Borrowings 255 C6.1 Core structural borrowings of shareholder- financed operations 256 C6.2 Other borrowings 256 C6.3 Maturity analysis C7 Risk and sensitivity analysis 257 C7.1 Group overview 259 C7.2 Asia insurance operations 260 C7.3 US insurance operations 265 C7.4 UK insurance operations 267 C7.5 Asset management and other operations C8 Tax assets and liabilities 268 C8.1 Deferred tax 268 C8.2 Current tax 269 C9 Defined benefit pension schemes 275 C10 Share capital, share premium and own shares 276 C11 Provisions C12 Capital 276 C12(a) Group objectives, policies and processes for managing capital 277 C12(b) Local capital regulations 279 C12(c) Transferability of available capital 279 C13 Property, plant and equipment 280 C14 Investment properties
Section E: Further accounting policies 302 E1 Other significant accounting policies
Benefits and claims (60,948) (30,547) Outward reinsurers’ share of benefit and claims 2,412 1,389 Movement in unallocated surplus of with-profits funds (830) (498)
Acquisition costs and other expenditure B3 (8,848) (8,208) Finance costs: interest on core structural borrowings of shareholder-financed operations (360) (312) Remeasurement of carrying value of Korea life business classified as held for sale D1 (238) – Disposal of Japan life business – cumulative exchange loss recycled from other comprehensive income – (46)
Profit for the year attributable to equity holders of the Company 1,921 2,579
Other comprehensive income: Items that may be reclassified subsequently to profit or loss Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year A1 1,148 68 Cumulative exchange loss of sold Japan life business recycled through profit or loss – 46 Related tax 13 4
Related change in amortisation of deferred acquisition costs C5 (b) 76 337 Related tax (17) 339
Other comprehensive income (loss) for the year, net of related tax 1,099 (489)
Shareholders’ share of actuarial gains and losses on defined benefit pension schemes, net of tax – – (93) – – (93) – (93)
Total comprehensive income for the year – – 2,601 118 (629) 2,090 – 2,090
Share capital and share premium New share capital subscribed C10 – 7 – – – 7 – 7
Treasury shares Movement in own shares in respect of share-based payment plans – – (38) – – (38) – (38) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – 20 – – 20 – 20
Deferred acquisition costs and other intangible assets C5(b) 10,807 8,472 Property, plant and equipment C13 743 1,197 Reinsurers’ share of insurance contract liabilities C4.1(a)(iv) 10,051 7,903 Deferred tax assets C8.1 4,315 2,819 Current tax recoverable C8.2 440 477 Accrued investment income C1 3,153 2,751 Other debtors C1 3,019 1,955 Investment properties C14 14,646 13,422 Investment in joint ventures and associates accounted for using the equity method D6 1,273 1,034
The consolidated financial statements on pages 161 to 308 were approved by the Board of Directors on 13 March 2017. They were signed on its behalf: Paul Manduca Chairman
Interest income and expense and dividend income included in result before tax (9,749) (8,726) Other non-cash items note (ii) 834 234 Operating cash items: Interest receipts 7,886 7,316 Dividend receipts 2,286 1,777 Tax paid note (v) (950) (1,340)
Notes (i) This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders. (ii) Other non-cash items consist of the adjustment of non-cash items to profit before tax. (iii) Structural borrowings of shareholder-financed operations exclude borrowings to support short-term fixed income securities programmes, non-recourse borrowings of investment subsidiaries of shareholder-financed operations and other borrowings of shareholder-financed operations. Cash flows in respect of these borrowings are included within cash flows from operating activities.
(v) Tax paid includes £226 million (2015: £229 million) paid on profits taxable at policyholder rather than shareholder rates.
The Group IFRS accounting policies are the same as those applied for the year ended 31 December 2015 with the exception of the adoption of the new and amended accounting standards as described in note A2.
The exchange movement arising during 2016 recognised in other comprehensive income is: Asia operations† 785 (5) US operations 853 238 Unallocated to a segment (central funds)* (490) (119)
The adoption of these pronouncements has had no impact on these financial statements.
IFRS 4 requires contracts written by insurers to be classified as either ‘insurance’ contracts or ‘investment’ contracts. The classification of the contract determines its accounting. Judgement is applied in the classification of these contracts.
Contracts which transfer significant insurance risk to the Group are classified as insurance contracts. Contracts that transfer financial risk to the Group but not significant insurance risk are termed investment contracts. Furthermore, some contracts, both insurance and investment, contain discretionary participating features representing the contractual right to receive additional benefits as a supplement to guaranteed benefits that (a) are likely to be a significant portion of the total contract benefits; (b) have amount or timing contractually at the discretion of the insurer; and (c) are contractually based on asset or fund performance, as discussed in IFRS 4. Insurance contracts and investment contracts with discretionary participation features are accounted for under IFRS 4. Investment contracts without discretionary participation features are accounted for as financial instruments.
— Whole life contracts — Unit-linked policies — Accident and health policies
Due to their significance to the Group’s business, the measurement of policyholder liabilities and unallocated surplus of with-profits is a critical accounting policy.
The measurement basis of policyholder liabilities is dependent upon the classification of the contracts under IFRS 4 described above.
IFRS 4 permits the continued usage of previously applied Generally Accepted Accounting Practices (GAAP) for insurance contracts and investment contracts with discretionary participating features.
FRS 27 and the ABI SORP were withdrawn in the UK for the accounting periods beginning in or after 2015. As used in these consolidated financial statements, the terms ‘FRS 27’ and the ‘ABI SORP’ refer to the requirements of these pronouncements prior to their withdrawal.
The policies applied in each business unit are noted below. Additional details are discussed in note C4.2
Asia insurance operations The policyholder liabilities for businesses in Asia are generally determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with the modified statutory basis. Refinements to the local reserving methodology are generally treated as changes in estimates, dependent on their nature. In some operations, including Taiwan, local GAAP is not an appropriate starting point and US GAAP principles are therefore applied.
The future policy-related liabilities must include a market consistent valuation of costs of guarantees, options and smoothing, less any related charges, and this amount is determined using either a stochastic approach, hedging costs or a series of deterministic projections with attributed probabilities.
The shareholders’ share of future costs of bonuses is included within the liabilities for unallocated surplus. Shareholder’s share of profit is recognised in line with the distribution of bonuses to policyholders.
Measured in accordance with IAS 39 to reflect the deposit nature of the arrangement, with premiums and claims reflected as deposits and withdrawals and taken directly to the statement of financial position as movements in the financial liability balance.
Incremental, directly attributable acquisition costs relating to the investment management element of these contracts are capitalised and amortised in line with the related revenue. If the contracts involve up-front charges, this income is also deferred and amortised through the income statement in line with contractual service provision in accordance with IAS 18.
Represents the excess of assets over policyholder liabilities for the Group’s with-profits funds in the UK, Hong Kong, Malaysia and Singapore that have yet to be appropriated between policyholders and shareholders. The unallocated surplus is recorded wholly as a liability with no allocation to equity. The annual excess (shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to policyholders and shareholders, is transferred to (from) the unallocated surplus each year through a charge (credit) to the income statement. The balance retained in the unallocated surplus represents cumulative income arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance of the unallocated surplus is determined after full provision for deferred tax on unrealised appreciation on investments.
Under IAS 39, unless carried at amortised cost (subject to impairment provisions where appropriate) under the held-to-maturity category, debt securities are also carried at fair value. The Group has chosen not to classify any financial assets as held-to-maturity. Debt securities of Jackson are designated as available-for-sale with value movements, unless impaired, being recorded as movements within other comprehensive income. Impairments are recorded in the income statement.
The basis of calculation of operating profit is disclosed in note B1.3.
Costs of acquiring new insurance business, principally commissions, marketing and advertising and certain other costs associated with policy insurance and underwriting that are not reimbursed by policy charges, are specifically identified and capitalised as part of deferred acquisition costs.
US insurance operations The Group’s US insurance operations apply FAS ASU 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ and capitalises only those incremental costs directly relating to successfully acquiring a contract.
For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest-sensitive life business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For fixed and fixed index annuity and interest-sensitive life business, the key assumption is the long-term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of Jackson’s actual industry experience and future expectations. A detailed analysis of actual mortality, lapse and expenses experience is performed using internally developed experience studies.
However, to ensure that the methodology does not over anticipate a reversion to the long-term level of returns following adverse markets, the mean reversion technique has a cap and floor feature whereby the projected returns in each of the next five years can be no more than 15 per cent per annum and no less than 0 per cent per annum (both gross of asset management fees and other charges to policyholders, but net of external fund management fees) in each year.
Jackson uses shadow accounting to make adjustments to the deferred acquisition costs which are recognised directly in other comprehensive income. To the extent that recognition of unrealised gains or losses on available-for-sale securities causes adjustments to the carrying value and amortisation patterns of deferred acquisition costs and deferred income, these adjustments are recognised in other comprehensive income to be consistent with the treatment of the gains or losses on the securities. More precisely, shadow DAC adjustments reflect the change in deferred acquisition costs that would have arisen if the assets held in the statement of financial position had been sold, crystallising unrealised gains or losses, and the proceeds reinvested at the yields currently available in the market.
Determination of impaired value In estimating the present value of future cash flows for determining the impaired value of instruments held at amortised cost, the Group looks at the expected cash flows of the assets and applies historical loss experience of assets with similar credit risks that has been adjusted for conditions in the historical loss experience which no longer exist, or for conditions that are expected to arise. The estimated future cash flows are discounted using the financial asset’s original or variable effective interest rate and exclude credit losses that have not yet been incurred.
The Group applies estimates and assumptions in determining when an impairment in value has occurred on financial investments classified as ‘available-for-sale’ or ‘at amortised cost’.
Available-for-sale securities The Group’s review of fair value involves several criteria, including economic conditions, credit loss experience, other issuer-specific developments and future cash flows. These assessments are based on the best available information at the time. Factors such as market liquidity, the widening of bid/ask spreads and a change in cash flow assumptions can contribute to future price volatility. If actual experience differs negatively from the assumptions and other considerations used in the consolidated financial statements, unrealised losses currently in equity may be recognised in the income statement in future periods. Additional details on the impairments of the available-for-sale securities of Jackson are described in note C3.2(c).
The majority of the US insurance operation’s debt securities portfolio are accounted for on an available-for-sale basis. The consideration of evidence of impairment requires management’s judgement. In making this determination a range of market and industry indicators are considered including the severity and duration of the decline in fair value and the financial condition and prospects of the issuer.
The Group monitors a number of internal and external factors, including indications that the financial performance of the arrangement is likely to be worse than originally expected and changes in relevant legislation and regulatory requirements that could impact the Group’s ability to continue to sell new business through the bancassurance channel, to assess for indications of impairment.
Accounting pronouncements endorsed by the EU but not yet effective IFRS 15, ‘Revenue from Contracts with Customers’ This standard effective for annual periods beginning on or after 1 January 2018, provides a single framework to recognise revenue for contacts with different characteristics and overrides the framework provided for such contracts in other standards. The contracts excluded from the scope of this standard include: — Lease contracts within the scope of IAS 17 ’Leases’; — Insurance contracts within the scope of IFRS 4, ‘Insurance Contracts’; and — Financial instruments within the scope of IAS 39 ‘Financial Instruments’.
IFRS 9, ‘Financial instruments: Classification and measurement’ In July 2014, the IASB published a complete version of IFRS 9 with the exception of macro hedge accounting. The standard becomes mandatorily effective for the annual periods beginning on or after 1 January 2018, with early application permitted and transitional rules apply.
This standard replaces the existing IAS 39, ’Financial Instruments – Recognition and Measurement’, and will affect: — The classification and the measurement of financial assets and liabilities. Under IFRS 9, financial assets are classified under one of the following categories: amortised cost, fair value through other comprehensive income (FVOCI) and fair value through profit or loss (FVTPL) based on their contractual cash flow characteristics and/or the business model in which they are held. The existing amortised cost measurement for financial liabilities is largely maintained under IFRS 9 but for financial liabilities designated at FVTPL, changes in fair value due to changes in entity’s own credit risk, required by IFRS 13, are to be recognised in other comprehensive income; — The calculation of the impairment charge relevant for financial assets held at amortised cost or FVOCI. A new impairment model based on an expected credit loss approach replaces the existing IAS 39 incurred loss impairment model; and
The new standard brings most leases on-balance sheet for lessees under a single model, eliminating the distinction between operating and finance leases. For lessee accounting, this has the effect of bringing most of the existing operating leases to be accounted for in a similar manner as finance leases under the existing IAS 17, ‘Leases’. Lessor accounting however remains largely unchanged from IAS 17.
— Amendments to IAS 40, Transfers of Investment Property, issued in December 2016 and effective from 1 January 2018.
Asia operations Asia insurance operations* B4(a) 1,503 1,171 1,303 28% 15%
Operating profit based on longer-term investment returns 4,256 3,969 4,333 7% (2)% Short-term fluctuations in investment returns on shareholder-backed business B1.2 (1,678) (755) (827) (122)% (103)% Amortisation of acquisition accounting adjustments note (iv) (76) (76) (85) 0% 11% (Loss) profit attaching to the held for sale Korea life business D1 (227) 56 62 n/a n/a Cumulative exchange loss on the sold Japan life business recycled from
Notes (i) The Group’s UK insurance operations transferred its general insurance business to Churchill in 2002. General insurance commission represents the commission receivable net of
(ii) US insurance operations The short-term fluctuations in investment returns for US insurance operations are reported net of related credit for amortisation of deferred acquisition costs, of £565 million as shown in note C5(b) (2015: £93 million) and comprise amounts in respect of the following items: Net equity hedge result note (a) (1,587) (504) Other than equity-related derivatives note (b) (126) 29 Debt securities note (c) 201 1 Equity-type investments: actual less longer-term return 35 19 Other items 22 31
Notes (a) Net equity hedge result The purpose of the inclusion of this item in short-term fluctuations in investment returns is to segregate the amount included in pre-tax profit that relates to the accounting
2 Adjustments in respect of fee assessments and claim payments; 3 Fair value movements on free-standing equity derivatives held to manage equity exposures of the variable annuity guarantees and fixed index annuity embedded options. 4 Related changes to DAC amortisation in accordance with the policy that DAC is amortised in line with emergence of margins. The net equity hedge result therefore includes significant accounting mismatches and other factors that detract from the presentation of an economic result. These other
The fluctuations for this item therefore include significant accounting mismatches caused by: – The fair value movements booked in the income statement on the derivative programme being in respect of the management of interest rate exposures of the variable and
fixed index annuity business, as well as the fixed annuity business guarantees and durations within the general account; – Fair value movements on Jackson’s debt securities of the general account which are recorded in other comprehensive income rather than the income statement; and – The mixed measurement model that applies for the GMIB and its reinsurance.
Total (charges) credits in the year (118) (73) Less: Risk margin allowance deducted from operating profit based on longer-term investment returnsnote 89 83
Interest-related realised gains: Arising in the year 376 102 Less: Amortisation of gains and losses arising in current and prior years to operating profit based on longer-term
Note The debt securities of Jackson are held in the general account of the business. Realised gains and losses are recorded in the income statement with normalised returns included
— Loss attaching to the held for sale Korea life business. See note D1 for further details; and — The recycling of the cumulative exchange translation loss on the sold Japan life business from other comprehensive income to the income statement in 2015.
Determination of operating profit based on longer-term investment returns for investment and liability movements: (a) General principles (i) UK style with-profits business The operating profit based on longer-term returns reflects the statutory transfer gross of attributable tax. Value movements in the underlying assets of the with-profits funds do not affect directly the determination of operating profit.
(ii) Unit-linked business The policyholder unit liabilities are directly reflective of the underlying asset value movements. Accordingly, the operating results based on longer-term investment returns reflect the current period value movements in both the unit liabilities and the backing assets.
Equity-type securities For equity-type securities, the longer-term rates of return are estimates of the long-term trend investment returns for income and capital having regard to past performance, current trends and future expectations. Equity-type securities held for shareholder-financed operations other than the UK annuity business, unit-linked and US variable annuity are of significance for the US and Asia insurance operations. Different rates apply to different categories of equity-type securities.
Derivative value movements Generally, derivative value movements are excluded from operating results based on longer-term investment returns (unless those derivative value movements broadly offset changes in the accounting value of other assets and liabilities included in operating profit). The principal example of non-equity based derivatives (for example, interest rate swaps and swaptions) whose value movements are excluded from operating profit arises in Jackson, as discussed below in section (c).
(b) Asia insurance operations (i) Business where policyholder liabilities are sensitive to market conditions For certain Asia non-participating business, for example in Hong Kong, the economic features are more akin to asset management products with policyholder liabilities reflecting asset shares over the contract term. For these products, the charge for policyholder benefits in the operating results should reflect the asset share feature rather than volatile movements that would otherwise be reflected if the local regulatory basis (also applied for IFRS basis) was used.
Equity-type securities For Asia insurance operations, investments in equity securities held for non-linked shareholder-backed operations amounted to £1,405 million as at 31 December 2016 (2015: £840 million). The rates of return applied in 2016 ranged from 3.2 per cent to 13.9 per cent (2015: 3.5 per cent to 13.0 per cent) with the rates applied varying by territory. These rates are broadly stable from period to period but may be different between countries reflecting, for example differing expectations of inflation in each territory. The assumptions are for the returns expected to apply in equilibrium conditions. The assumed rates of return do not reflect any cyclical variability in economic performance and are not set by reference to prevailing asset valuations.
(ii) US variable and fixed index annuity business The following value movements for Jackson’s variable and fixed index annuity business are excluded from operating profit based on longer-term investment returns. See note B1.2 note (ii): — Fair value movements for equity-based derivatives; — Fair value movements for embedded derivatives for the ‘not for life’ portion of GMWB and fixed index annuity business, and GMIB reinsurance (see below); — Movements in the accounts carrying value of GMDB and the ‘for life’ portion of GMWB and GMIB liabilities, for which, under the ‘grandfathered’ US GAAP applied under IFRS for Jackson’s insurance assets and liabilities, the measurement basis gives rise to a muted impact of current period market movements; — A portion of the fee assessments as well as claim payments, in respect of guarantee liabilities; and — Related amortisation of deferred acquisition costs for each of the above items.
(d) UK Insurance operations (i) Shareholder-backed annuity business For this business, policyholder liabilities are determined by reference to current interest rates. The value movements of the assets covering liabilities are closely correlated with the related change in liabilities. Accordingly, asset value movements are recorded within the ‘operating results based on longer-term investment returns’. Policyholder liabilities include a margin for credit risk. Variations between actual and best estimate expected impairments are recorded as a component of short-term fluctuations in investment returns.
Credit experience reflects the impact of defaults and other similar experience, such as asset exchanges arising from debt restructuring by issuers that include effectively an element of permanent impairment of the security held. Positive or negative experience compared with assumptions is included within short-term fluctuations in investment returns without further adjustment. The effects of other changes to credit risk provisioning are included in the operating result, as is the net effect of changes to the valuation rate of interest due to portfolio rebalancing to align more closely with management benchmark.
(e) Fund management and other non-insurance businesses For these businesses, the particular features applicable for life assurance noted above do not apply. For these businesses, it is inappropriate to include returns in the operating result on the basis described above. Instead, it is appropriate to generally include realised gains and losses in the operating result with temporary unrealised gains and losses being included in short-term fluctuations. In some instances, it may also be appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time period that reflects the underlying economic substance of the arrangements.
Benefits and claims and movements in unallocated surplus of with-profits funds, net
Disposal of Japan life business: Cumulative exchange loss recycled from other comprehensive
Profit attaching to the held for sale Korea life business 56 – – – – – – 56 – 56
Cumulative exchange loss on the sold Japan life business (46) – – – – – – (46) – (46)
10 per cent). Total revenue from external customers of Hong Kong is £6,313 million (2015: £3,836 million). (vi) Due to the nature of the business of the Group, there is no reliance on any major customers.
Realised and unrealised gains (losses) and gains (losses) on securities at fair value through profit or loss 28,489 (4,572) Realised and unrealised (losses) and gains on derivatives at fair value through profit or loss (7,050) (1,701) Realised gains on available-for-sale securities, previously recognised in other comprehensive income* 270 49 Realised gains (losses) on loans 91 (50)
Share of profit from joint ventures and associates, net of related tax 13 – – 54 67 55
Notes (i) The segment revenue of the Group’s asset management operations includes: NPH broker-dealer fees which represent commissions received that are then paid on to the writing brokers on sales of investment products. To reflect their commercial nature the
Asset management fee income 900 934 Other income 23 5 Staff costs (332) (293) Other costs (212) (240)
Acquisition costs incurred for insurance policies (3,687) (3,275) Acquisition costs deferred less amortisation of acquisition costs 923 431 Administration costs and other expenditure (5,522) (4,746) Movements in amounts attributable to external unit holders of consolidated investment funds (562) (618)
(b) The charge for non-deferred acquisition costs and the amortisation of those costs that are deferred, was £(2,764) million (2015: £(2,844) million). These amounts comprise £(2,734) million and £(30) million for insurance and investment contracts respectively (2015: £(2,817) million and £(27) million respectively).
(d) There were no fee expenses relating to financial liabilities held at amortised cost included in acquisition costs in 2016 and 2015. (e) The segmental analysis of other interest expense and depreciation and amortisation included within total acquisition costs and other
The costs of employment were: Business operations: Wages and salaries 1,483 1,370 Social security costs 110 101
B3.2 Share-based payment (a) Description of the plans The Group operates a number of share award and share option plans that provides Prudential plc shares to participants upon vesting. The plans in operation include Prudential Long-Term Incentive Plan (PLTIP), Annual Incentive Plan (AIP), savings-related share option schemes, share purchase plans and deferred bonus plans. Some of these plans are participated in by executive directors, the details of which are described in the directors’ remuneration report. In addition, the following information is provided.
Eligible Jackson employees were previously granted share awards under a long-term incentive plan that rewarded the achievement of shareholder value targets. These awards were in the form of a contingent right to receive shares or a conditional allocation of shares. These share awards have vesting periods of four years and are at nil cost to the employee. Award holders do not have any right to dividends or voting rights attaching to the shares. The shares are held in the employee share trust in the form of American Depository Receipts that are tradable on the New York Stock Exchange. The final awards under this arrangement were made in 2012.
(b) Outstanding options and awards The following table shows movement in outstanding options and awards under the Group’s share-based compensation plans at 31 December 2016 and 2015: Options outstanding under SAYE schemes
(c) Fair value of options and awards The fair value amounts estimated on the date of grant relating to all options and awards, were determined by using the following assumptions: Prudential LTIP (TSR)
Expected option life (years) – 3.70 – – 3.79 – Weighted average exercise price (£) – 11.04 – – 11.11 –
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 Prudential LTIP (TSR) for which the Group uses a Monte Carlo model in order to allow for the impact of the LTIP (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.
(d) Share-based payment expense charged to the income statement Total expense recognised in the year in the consolidated financial statements relating to share-based compensation is as follows: Share-based compensation expense 126 111 Amount accounted for as equity-settled 127 110 Carrying value at 31 December of liabilities arising from share-based payment transactions – 6 Intrinsic value of above liabilities for which rights had vested at 31 December – 6
Total key management remuneration is analysed in the following table: Salaries and short-term benefits 20.7 17.1 Post-employment benefits 1.3 1.1 Share-based payments 18.7 15.5
Total key management remuneration includes total directors’ remuneration of £37.9 million (2015: £42.7 million) less LTIP releases of £10.1 million (2015: £19.4 million) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report. Further information on directors’ remuneration is given in the directors’ remuneration report.
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts 2.0 2.0 Fees payable to the Company’s auditor and its associates for other services: Audit of subsidiaries pursuant to legislation 7.5 7.2 Audit-related assurance services 3.9 3.1 Tax compliance services 0.1 0.7 Other assurance services 2.1 2.2 Services relating to corporate finance transactions – 0.2 All other services 0.6 1.2
The following features are of relevance to the determination of the 2016 results: (a) Asia insurance operations In 2016, the IFRS operating profit based on longer-term investment returns for Asia insurance operations included a net credit of £67 million (2015: £62 million) representing a small number of non-recurring items, including a gain resulting from entering into a reinsurance contract in the year.
(b) UK insurance operations Annuity business Allowance for credit risk For IFRS reporting, the results for UK shareholder-backed annuity business are particularly sensitive to the allowances made for credit risk. The allowance is reflected in the deduction from the valuation rate of interest for discounting projected future annuity payments to policyholders that would have otherwise applied. The credit risk allowance comprises an amount for long-term best estimate defaults and additional provisions for credit risk premium, the cost of downgrades and short-term defaults.
The IFRS credit risk allowance made for the ex-PRIL UK shareholder-backed fixed and linked annuity business equated to 43 basis points at 31 December 2016 (31 December 2015: 43 basis points). The allowance represented 26 per cent of the bond spread over swap rates (31 December 2015: 25 per cent).
Other assumption changes For the shareholder-backed business, in addition to the movement in the credit risk allowance discussed above, the net effect of routine changes to assumptions in 2016 was a credit of £16 million (2015: credit of £31 million).
(a) Total tax charge by nature of expense The total tax charge in the income statement is as follows: Tax charge Current
Current tax expense: Corporation tax (1,464) (782) Adjustments in respect of prior years 87 48
Deferred tax arising from: Origination and reversal of temporary differences 64 (40) Impact of changes in local statutory tax rates 6 22 Credit in respect of a previously unrecognised tax loss, tax credit or temporary difference from a prior
The current tax charge of £1,377 million (2015: £734 million) includes £53 million (2015: £35 million) in respect of the tax charge for the Hong Kong operation. The Hong Kong current tax charge is calculated as 16.5 per cent for all periods on either (i) 5 per cent of the net insurance premium or (ii) the estimated assessable profits, depending on the nature of the business written.
Tax (charge) to policyholders’ returns (421) (516) (937) (173) Tax (charge) credit attributable to shareholders (956) 602 (354) (569)
The principal reason for the increase in the tax charge attributable to policyholders’ returns is an increase in realised and unrealised gains on equity and bond investments in the with-profits fund of the main UK insurance business. The principal reason for the decrease in the tax charge attributable to shareholders’ returns is a deferred tax credit on derivative fair value movements in the US insurance operations. The main elements of the deferred tax credit shown in the table below are a charge of £437 million relating to unrealised gains and losses on investments reflecting an increase in unrealised gains on investments in the Group’s insurance operations and a credit of £573 million relating to short-term temporary differences reflecting deferred tax assets on derivative fair value movements in the US insurance operations.
(b) Reconciliation of effective tax rate In the reconciliation below, the expected tax rates reflect the corporate income tax rates that are expected to apply to the taxable profit of the relevant business. Where there are profits of more than one jurisdiction the expected tax rates reflect the corporation tax rates weighted by reference to the amount of profit contributing to the aggregate business result. In the column ‘Attributable to policyholders’, the 100 per cent expected tax rate is the result of accounting for policyholder income after the deduction of expenses and movement on unallocated surpluses and on an after tax basis, the effect of which leaves the profit equal to the tax charge.
Tax at the expected rate 229 185 205 (61) 558 937 1,495 Effects of recurring tax
Tax on non-operating profit (15) (533) 30 (22) (540) n/a n/a Actual tax rate: Operating profit based on longer-term investment returns Including non-recurring tax
The more significant reconciling items are explained below: Asia insurance operations The £28 million reconciling item ‘income not taxable or taxable at concessionary rates’ primarily reflects income taxable at rates lower than the expected rates in Malaysia and Singapore. It is lower than the 2015 adjustment of £42 million due to the absence of non-taxable gains on domestic securities in Taiwan.
There is no significant movement in the reconciling items from 2015. The £29 million reconciling item ‘effect of results of the joint ventures and associates’ arises from the accounting requirement for
The £58 million reconciling item ‘write down of Korea life business’ reflects the non-tax deductible write down of the held for sale Korea life business.
Tax at the expected rate 249 420 215 (32) 852 173 1,025 Effects of recurring tax
Tax on non-operating profit (5) (172) (24) (16) (217) n/a n/a Actual tax rate: Operating profit based on longer-term investment returns
Based on profit for the year 2,275 (354) 1,921 75.0p 75.0p 2015*
Earnings per share are calculated based on earnings attributable to ordinary shareholders, after related tax and non-controlling interests. The weighted average number of shares for calculating earnings per share, which excludes those held in employee share trusts and
Dividends paid in reporting year: Current year first interim ordinary dividend 12.93p 332 12.31p 315 Second interim ordinary dividend/final ordinary dividend for prior year 26.47p 679 25.74p 659 Special dividend 10.00p 256 – –
Assets held for sale D1 3,863 – 726 – – – – – – 4,589 Cash and cash
and other liabilities note (iii) 5,887 4,749 6,176 553 4,396 455 53 1,546 (9,990) 13,825
Liabilities held for sale D1 3,758 – 535 – – – – – – 4,293
Assets held for sale – – 2 – – – – – – 2 Cash and cash
Borrowings attributable to with-profits operations – – 1,332 – – – – – – 1,332
and other liabilities note (iii) 4,476 4,069 5,430 404 3,361 204 51 1,302 (8,881) 10,416
The Group’s cash and cash equivalents are held in the following currencies: pounds sterling 38 per cent, US dollars 25 per cent, Euro 20 per cent and other currencies 17 per cent (2015: pounds sterling 30 per cent, US dollars 36 per cent, Euro 12 per cent and other currencies 22 per cent).
(iv) Central operations borrowings, in respect of Prudential Capital’s short-term fixed income security programme
consolidated unit trusts and similar funds 1,770 1,144 179 3,093 2,802
Core structural borrowings of shareholder-financed operations – 202 202 169 Operational borrowings attributable to shareholder-financed
for using the equity method 409 – – – 409 434
Assets held for sale note (ii) 726 – – – 726 2
Borrowings attributable to with-profits operations 1,345 – – – 1,345 1,332 Obligations under funding, securities lending and sale and
Accruals deferred income and other liabilities 4,649 129 1,398 1,527 6,176 5,430
C3.1 Group assets and liabilities – measurement (a) Determination of fair value The fair values of the financial instruments, for which fair valuation is required under IFRS, are determined by the use of current market bid prices for exchange-quoted investments or by using quotations from independent third parties such as brokers and pricing services, or by using appropriate valuation techniques.
With-profits Loans – – 27 27 Equity securities and portfolio holdings in unit trusts 45,181 3,669 690 49,540
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 146,637 374 22 147,033
Total financial investments, net of derivative liabilities 247,043 122,764 8,327 378,134 Investment contract liabilities without discretionary participation features
held at fair value – (16,425) – (16,425) Net asset value attributable to unit holders of consolidated unit trusts and
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 116,691 354 22 117,067
Equity securities and portfolio holdings in unit trusts 153,282 3,564 607 157,453
Borrowings attributable to the with-profits funds – (1,270) (74) (1,344) (1,332) Obligations under funding, securities lending and sale and
(c) Valuation approach for level 2 fair valued assets and liabilities A significant proportion of the Group’s level 2 assets are corporate bonds, structured securities and other non-national government debt securities. These assets, in line with market practice, are generally valued using independent pricing services or third-party broker quotes. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances, stale price reviews and variance analysis on prices achieved on subsequent trades.
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,036) (18) (2) – 24 271 (122) – – (883)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,291) (160) (1) (5) 9 412 – – – (1,036)
Valuation approach for level 3 fair valued assets and liabilities Financial instruments at fair value Investments valued using valuation techniques include financial investments which, by their nature, do not have an externally quoted price based on regular trades, and financial investments for which markets are no longer active as a result of market conditions eg market illiquidity. The valuation techniques used include comparison to recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation. These techniques may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments. When determining the inputs into the valuation techniques used priority is given to publicly available prices from independent sources when available, but overall the source of pricing is chosen with the objective of arriving at a fair value measurement that reflects the price at which an orderly transaction would take place between market participants on the measurement date.
The fair value estimates are made at a specific point in time, based upon available market information and judgements about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Group’s entire holdings of a particular financial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the financial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the financial instrument.
At 31 December 2016, the Group held £4,593 million (2015: £4,108 million) of net financial instruments at fair value within level 3. This represents 1 per cent (2015: 1 per cent) of the total fair valued financial assets net of fair valued financial liabilities.
(b) Private equity and venture investments of £956 million (2015: £852 million) which were valued internally based on management information available for these investments. These investments were principally held by consolidated investment funds that are managed on behalf of third parties.
(d) Derivative liabilities of £(516) million (2015: £(353) million) which are valued internally using standard market practices but are subject to independent assessment against external counterparties’ valuations.
(e) Other sundry individual financial investments of £93 million (2015: £56 million).
Of the internally valued net asset referred to above of £72 million (2015: net liability of £(77) million): (a) A net asset of £315 million (2015: £29 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.
(e) Transfers into and transfers out of levels The Group’s policy is to recognise transfers into and transfers out of levels as of the end of each half year reporting period except for material transfers which are recognised as of the date of the event or change in circumstances that caused the transfer.
In addition, in 2016, the transfers into level 3 were £138 million and the transfers out of level 3 were £394 million. These transfers were between levels 3 and 2 and primarily for equity securities and debt securities.
(f) Valuation processes applied by the Group The Group’s valuation policies, procedures and analyses for instruments categorised as level 3 are overseen by business unit committees as part of the Group’s wider financial reporting governance processes. The procedures undertaken include approval of valuation methodologies, verification processes, and resolution of significant or complex valuation issues. In undertaking these activities the Group makes use of the extensive expertise of its asset management functions.
C3.2 Debt securities This note provides analysis of the Group’s debt securities, including asset-backed securities and sovereign debt securities.
US Implicit ratings of other US debt securities based on NAIC* valuations (see below)
Total US debt securities† 40,745 34,071 * A 1990 SEC rule that facilitates the resale of privately placed securities under Rule 144A that are without SEC registration to qualified institutional investors. The rule was designed to develop a more liquid and efficient institutional resale market for unregistered securities.
† Debt securities for US operations included in the statement of financial position comprise: Available-for-sale 40,645 33,984 Fair value through profit or loss: Securities held to back liabilities for funds withheld under reinsurance arrangement 100 87
Assets fair valued at below book value Book value* 14,617 13,163
Assets fair valued at or above book value Book value* 25,352 20,229
Fair value (as included in statement of financial position) 26,703 21,494
The available-for-sale debt securities of Jackson are analysed into US Treasuries and other debt securities as follows: US Treasuries Book value* 5,486 3,477 Net unrealised (loss) gain (412) (30) (436) 54
Fair value 40,645 33,984 * Book value represents cost/amortised cost of the debt securities. † Translated at the average rate of US$1.3546: £1.00.
(d) US debt securities classified as available-for-sale in an unrealised loss position (i) Fair value of securities as a percentage of book value The following table shows the fair value of the debt securities in a gross unrealised loss position for various percentages of book value: Fair value
Below 80%: Residential mortgage-backed securities – sub-prime – – 4 (1) Commercial mortgage-backed securities 8 (3) – – Other asset-backed securities 9 (8) 9 (7) Government bonds – – – –
(e) Asset-backed securities The Group’s holdings in Asset-Backed Securities (ABS), which comprise Residential Mortgage-Backed Securities (RMBS), Commercial Mortgage-Backed Securities (CMBS), Collateralised Debt Obligations (CDO) funds and other asset-backed securities, at 31 December are as follows: Shareholder-backed operations Asia insurance operations note (i) 130 111 US insurance operations note (ii) 4,321 4,320 UK insurance operations (2016: 25% AAA, 40% AA) note (iii) 1,464 1,531 Asset management operations note (iv) 771 911
Notes (i) Asia insurance operations The Asia insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations. Of the £357 million, 99 per cent
CDO funds (2016: 35% AAA, 5% AA, 23% A), including £nil exposure to sub-prime 50 52 Other ABS (2016: 21% AAA, 18% AA, 52% A), including £129 million exposure to sub-prime 1,005 581
(iii) UK insurance operations The majority of holdings of the shareholder-backed business are UK securities and relate to PAC’s annuity business. Of the holdings of the with-profits operations, £1,623 million
(f) Group sovereign debt and bank debt exposure The Group exposures held by the shareholder-backed business and with-profits funds in sovereign debts and bank debt securities at 31 December are analysed as follows:
With-profits funds Italy – 62 62 – – – 62 57
The effect of changes in the key assumptions that underpin the assessment of whether impairment has taken place depends on the factors described in note A3.1. A key indicator of whether such impairment may arise in future, and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available-for-sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned.
For 2016, the amount of gross unrealised losses for fixed maturity securities classified as available-for-sale under IFRS in an unrealised loss position was £675 million (2015: £673 million). Note B1.2 provides further details on the impairment charges and unrealised losses of Jackson’s available-for-sale securities.
— Certain policy loans of the US insurance operations that are held to back liabilities for funds withheld under reinsurance arrangements and are also accounted on a fair value basis.
* All mortgage loans are secured by properties. In the US, mortgage loans are all commercial mortgage loans that are secured on the following property types: industrial, multi-family residential, suburban office, retail or hotel. By carrying value, 96 per cent of the £1,642 million (2015: 78 per cent of the £1,508 million) mortgage loans held for UK shareholder-backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 30 per cent (2015: 30 per cent).
‡ Other loans held in UK with-profits funds are commercial loans and comprise mainly syndicated loans. The majority of other loans in shareholder-backed business in Asia are commercial loans held by the Malaysia operation and which are all investment graded by two local rating agencies.
At 31 December 2016, Jackson had no mortgage loans where the contractual terms of the agreements had been restructured (2015: none).
BBB+ to BBB- 248 607 BB+ to BB- 185 119 B and other 1 2
Maturity analysis of derivatives The following table shows the gross and net derivative positions together with a maturity profile of the net derivative position: Carrying value of net derivatives £m Maturity profile of net derivative position £m
The majority of derivative assets and liabilities have been included at fair value within the one year or less column, representing the basis on which they are managed (ie to manage principally asset or liability value exposures). The Group has no cash flow hedges and in general, contractual maturities are not considered essential for an understanding of the timing of the cash flows for these instruments. The only exception is certain identified interest rate swaps which are fully expected to be held until maturity solely for the purposes of matching cash flows on separately held assets and liabilities. For these instruments, the undiscounted cash flows (including contractual interest amounts) due to be paid under the swap contract, assuming conditions are consistent with those at year end, are included in the column relating to the contractual maturity of the derivative.
(ii) Credit risk The Group’s maximum exposure to credit risk of financial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk comprising cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note C3.4(b) below for derivative assets. The collateral in place in relation to derivatives is described in note C3.4(c) below. Note C3.3 describes the security for these loans held by the Group.
Of the total loans and receivables held, £27 million (2015: £27 million) are past their due date but are not impaired. Of the total past due but not impaired, £20 million are less than one year past their due date (2015: £22 million). The Group expects full recovery of these loans and receivables.
Of these financial assets, 52 per cent (2015: 53 per cent) are held by the PAC with-profits fund, allowing the fund to obtain exposure to foreign equity markets.
The amount of exchange gain recognised in the income statement in 2016, except for those arising on financial instruments measured at fair value through profit or loss, is £1,005 million (2015: £138 million gain). This constitutes £0.4 million gain (2015: £1 million loss) on Medium Term Notes liabilities and £1,005 million of net gain (2015: £139 million net gain), mainly arising on investments of the PAC with-profits fund. The gains/losses on Medium Term Notes liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit or loss.
(b) Derivatives and hedging Derivatives The Group enters into a variety of exchange traded and over-the-counter derivative financial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.
Hedging The Group has formally assessed and documented the effectiveness of the following net investment hedges under IAS 39: At 31 December 2016, the Group has designated perpetual subordinated capital securities totalling US$4.5 billion (2015: US$2.8 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £3,644 million as at 31 December 2016 (2015: £1,895 million). The foreign exchange loss of £389 million (2015: loss of £104 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.
(c) Derecognition, collateral and offsetting Securities lending and reverse repurchase agreements The Group has entered into securities lending (including repurchase agreements) whereby blocks of securities are loaned to third parties, primarily major brokerage firms. Typically, the value of collateral assets granted to the Group in these transactions is in excess of the value of securities lent, with the excess determined by the quality of the collateral assets granted. Collateral requirements are calculated on a daily basis. The loaned securities are not removed from the Group’s consolidated statement of financial position, rather they are retained within the appropriate investment classification. Collateral typically consists of cash, debt securities, equity securities and letters of credit.
At 31 December 2016, the Group has £8,545 million (2015: £5,995 million) of lent securities and assets subject to repurchase agreements, of which £8,113 million (2015: £4,687 million) related to the PAC with-profits fund. The cash and securities collateral held or pledged under such agreements were £9,086 million (2015: £6,542 million) of which £8,653 million (2015: £5,002 million) was held by the PAC with-profits fund.
Offsetting assets and liabilities The Group’s derivative instruments, repurchase agreements and securities lending agreements are subject to master netting arrangements and collateral arrangements. A master netting arrangement with a counterparty creates a right of offset for amounts due to and due from that same counterparty that is enforceable in the event of a default or bankruptcy. The Group recognises amounts subject to master netting arrangements on a gross basis within the consolidated balance sheets.
Financial liabilities: Securities lending and repurchase agreements (1,979) – 199 1,780 –
In the tables above, the amounts of assets or liabilities presented in the consolidated statement of financial position are offset first by financial instruments that have the right of offset under master netting or similar arrangements with any remaining amount reduced by the amount of cash and securities collateral. The actual amount of collateral may be greater than amounts presented in the tables.
The note provides information of policyholder liabilities and unallocated surplus of with-profits funds held on the Group’s statement of financial position: C4.1 Movement and duration of liabilities C4.1(a) Group overview (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds
Comprising: – Policyholder liabilities on the consolidated statement of financial position 38,705 126,746 144,088 309,539 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,102 – 10,348 12,450 – Group’s share of policyholder liabilities of joint ventures and associate‡ 4,215 – – 4,215
Net flows: Shareholders’ transfers post-tax (43) – (214) (257) Investment-related items and other movements (364) (3,824) 2,319 (1,869) Foreign exchange translation differences 194 7,515 14 7,723
Reclassification of Korea life business as held for sale* (2,812) – – (2,812) Net flows: Shareholders’ transfers post-tax (44) – (215) (259) Investment-related items and other movements 2,005 5,690 18,626 26,321 Foreign exchange translation differences 9,075 27,825 527 37,427
† Averages have been based on opening and closing balances and adjusted for acquisitions, disposals and corporate transactions in the year and exclude unallocated surplus of with-profits funds.
The items above represent the amount attributable to changes in policyholder liabilities and unallocated surplus of with-profits funds as a result of each of the components listed. The policyholder liabilities shown include investment contracts without discretionary participation features (as defined in IFRS 4) and their full movement in the year. The items above are shown gross of external reinsurance.
The analysis includes the impact of premiums, claims and investment movements on policyholders’ liabilities. The impact does not represent premiums, claims and investment movements as reported in the income statement. For example, the premiums shown above will exclude any deductions for fees/charges. Claims represent the policyholder liabilities provision released, rather than the claim amount paid to the policyholder.
Comprising: – Policyholder liabilities on the consolidated statement of financial position 22,874 138,913 52,824 214,611 – Group’s share of policyholder liabilities relating to joint ventures 4,970 – – 4,970
Reclassification of Korea life business as held for sale* (2,812) – – (2,812) Net flows: Investment-related items and other movements 1,116 5,690 6,980 13,786 Foreign exchange translation differences 4,617 27,825 – 32,442
Comprising: – Policyholder liabilities on the consolidated statement of financial position 26,450 177,626 56,158 260,234 – Group’s share of policyholder liabilities relating to joint ventures 6,401 – – 6,401 * The reclassification of Korea life business as held for sale reflects the value of policyholder liabilities held at 1 January 2016. No other amounts are shown within the 2016 analysis above in respect of Korea.
(iii) Movement in insurance contract liabilities and unallocated surplus of with-profits funds Further analysis of the movement in the year of the Group’s insurance contract liabilities, gross and reinsurance share, and unallocated surplus of with-profits funds is provided below: Insurance contract liabilities Unallocated surplus of
The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group from its liability to its policyholders, the Group participates in such agreements for the purpose of managing its loss exposure. The Group evaluates the financial condition of its reinsurers and monitors concentration of credit risk from similar geographic regions, activities or economic characteristics of the reinsurers to minimise its exposure from reinsurer insolvencies. Of the reinsurers’ share of insurance contract liabilities balance of £10,051 million at 31 December 2016 (2015: £7,903 million), 85 per cent (2015: 90 per cent) were ceded by the Group’s UK and US operations, of which 96 per cent (2015: 96 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above.
Comprising: – Policyholder liabilities on the consolidated statement of financial position 18,381 13,355 9,519 41,255 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,553 – – 2,553 – Group’s share of policyholder liabilities relating to joint ventures and
www.prudential.co.uk� Annual�Report�2016 Prudential plc 233 05 Financial statem ents * The reclassification of Korea life business as held for sale reflects the value of policyholder liabilities held at 1 January 2016. No other amounts are shown within the 2016 analysis above in respect of Korea. If Korea life business had been excluded from the 2015 figures, the average policyholder liability balance for 2015 would have been £41,814 million in total allocated £17,446 million, £13,940 million and £10,428 million for its with-profits business, unit-linked business and other business, respectively.
(ii) Duration of liabilities The table below shows the carrying value of policyholder liabilities and the maturity profile of the cash flows on a discounted basis for 2016 and 2015, taking account of expected future premiums and investment returns: Policyholder liabilities 53,716 41,255
Expected maturity: (iii) Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2016, the policyholder liabilities and unallocated surplus for Asia operations of £56.4 billion (2015: £43.8 billion), net of reinsurance of £1,539 million (2015: £798 million), excluding joint ventures, comprised the following: Hong Kong 23,852 16,234
C4.1(c) US insurance operations (i) Analysis of movements in policyholder liabilities A reconciliation of the total policyholder liabilities of US insurance operations from the beginning of the year to the end of the year is as follows: US insurance operations
Net flows note (b) 4,393 805 5,198 Transfers from general to separate account 1,164 (1,164) – Investment-related items and other movements note (c) 5,246 444 5,690 Foreign exchange translation differences note (a) 18,586 9,239 27,825
Notes (a) Movements in the year have been translated at an average rate of US$1.35/£1.00 (2015: US$1.53/£1.00). The closing balances have been translated at a closing rate of
C4.1(d) UK insurance operations (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of UK insurance operations from the beginning of the year to the end of the year is as follows: With-profits sub-funds†
Comprising: – Unallocated surplus of with-profits funds 10,348 – – 10,348
Comprising: – Unallocated surplus of with-profits funds 10,543 – – 10,543
Notes (a) Net outflows improved from £3,662 million in 2015 to £2,527 million in 2016, due primarily to higher premium flows into our with-profits funds following increased sales into with-profits savings and retirement products. This has been offset by lower premiums into our annuity business following our staged withdrawal from this market in the UK. (b) Investment-related items and other movements of £18,626 million mainly reflects investment return earned in the year, attributable to policyholders. Gains on shareholder-backed annuity business reflects a fall in bond yields over 2016.
(ii) Duration of liabilities With the exception of most unitised with-profits bonds and other whole of life contracts, the majority of the contracts of the UK insurance operations have a contract term. In effect, the maturity term of the other contracts reflects the earlier of death, maturity, or the policy lapsing. In addition, as described in note A3.1, with-profits contract liabilities include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
Expected maturity: — The cash flow projections of expected benefit payments used in the maturity profile table above are from value of in-force business and exclude the value of future new business, including future vesting of internal pension contracts.
— Benefit payments do not reflect the pattern of bonuses and shareholder transfers in respect of the with-profits business. — Shareholder-backed annuity business includes the ex-PRIL and the legacy PAC shareholder annuity business. — Investment contracts under ‘Other’ comprise certain unit-linked and similar contracts accounted for under IAS 39 and IAS 18. — For business with no maturity term included within the contracts; for example, with-profits investment bonds such as Prudence Bonds, an assumption is made as to likely duration based on prior experience.
Males Females Males Females 2016 CMI 2014 For males: with a long-term improvement rate of 2.25% pa*
PCFA00 2015 CMI 2014 For males: with a long-term improvement rate of 2.25% pa*
Participating products often offer a guaranteed maturity or surrender value. Declared regular bonus are guaranteed once vested. Future bonus rates and cash dividends are not guaranteed. Market value adjustments and surrender penalties are used for certain products where the law permits such adjustments. Guarantees are predominantly supported by segregated life funds and their estates.
Non-participating savings and/or protection where the benefits are guaranteed, or determined by a set of defined market-related parameters.
The approach to determining the contract liabilities is generally driven by the local solvency basis. A gross premium valuation method is used in those countries where a risk-based capital framework is adopted for local solvency. Under the gross premium valuation method, all cash flows are valued explicitly using best estimate assumptions. In applying this approach, an overlay constraint to the method is applied such that no negative reserves are derived at an individual policyholder level.
In Vietnam, the Company uses an estimation basis aligned substantially to that used by the countries applying the gross premium valuation method.
Unit-linked Combines savings with protection, the cash value of the policy depends on the value of the underlying unitised funds.
Health and protection features are offered as supplements to the products listed above or sold as stand-alone products. Protection covers mortality or morbidity benefits including health, disability, critical illness and accident coverage.
The determination of the liabilities of health and protection contracts are driven by the local solvency basis. A gross premium valuation method is used in those countries where a risk-based capital framework is adopted for local solvency. Under the gross premium valuation method, all cash flows are valued explicitly using best estimate assumptions. In applying this approach, an overlay constraint to the method is applied such that no negative reserves are derived at an individual policyholder level.
Fixed interest rate annuities are primarily deferred annuity products that are used for asset accumulation in retirement planning and for providing income in retirement. At 31 December 2016, fixed interest rate annuities accounted for 8 per cent (2015: 9 per cent) of policy and contract liabilities of Jackson.
The policy provides that at Jackson’s discretion it may reset the interest rate, subject to a guaranteed minimum.
Guaranteed minimum interest rate. At 31 December 2016, Jackson had fixed interest rate annuities totalling £14.2 billion (2015: £12.1 billion) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 2.96 per cent average guaranteed rate (2015: 1.0 per cent to 5.5 per cent and a 3.00 per cent average guaranteed rate).
— Any probable future loss on the contract (ie premium deficiency).
Approximately 62 per cent (2015: 62 per cent) of the fixed interest rate annuities Jackson wrote in 2016 provide for a (positive or negative) market value adjustment (‘MVA’) on surrender. This formula-based adjustment approximates the change in value that assets supporting the product would realise as interest rates move.
Fixed index annuities vary in structure but are generally deferred annuities that enable policyholders to obtain a portion of an equitylinked return (based on participation rates and caps), and provide a guaranteed minimum return. Fixed index annuities accounted for 6 per cent (2015: 6 per cent) of Jackson’s policy and contract liabilities at 31 December 2016.
The liability for policyholder benefits that represent the guaranteed minimum return is determined similarly to the liabilities of the fixed interest annuity above. The equity-linked return option within the contract is treated as an embedded liability under IAS 39 and therefore this element of the liability is recognised at fair value.
Jackson hedges these risks using equity options and futures contracts as described in note C7.3.
Determined each period end by estimating the expected value of benefits in excess of the projected account balance and recognising the excess ratably over the life of the contract based on total expected assessments. At 31 December 2016, these liabilities were valued using a series of stochastic investment performance scenarios, a mean investment return of 7.4 per cent (2015: 7.4 per cent) net of external fund management fees, and assumptions for policyholder behaviour, mortality and expense that are similar to those used in amortising the capitalised acquisition costs.
This feature is no longer offered and existing coverage is substantially reinsured.
Life insurance Life products include term life and interest-sensitive life (universal life and variable universal life). Life insurance products accounted for 10 per cent (2015: 11 per cent) of Jackson’s policy and contract liabilities at 31 December 2016. Jackson discontinued new sales of life insurance products in 2012.
Excluding the business that is subject to the retrocession treaties at 31 December 2016, Jackson had interest sensitive life business in force with total account value of £7.1 billion (2015: £6.1 billion), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate (2015: 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate).
For universal life and variable universal life a retrospective deposit method is used to determine the liability for policyholder benefits. This is then augmented by additional liabilities to account for no-lapse guarantees, profits followed by losses, contract features such as persistency bonuses, and cost of interest rate guarantees.
Institutional products are: guaranteed investment contracts (GICs), funding agreements (including agreements issued in conjunction with Jackson’s participation in the US Federal Home Loan Bank programme) and Medium Term Note funding agreements. At 31 December 2016 institutional products accounted for 1% of contract liabilities (2015: 3%).
With-profits contracts provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘regular’ and ‘final’.
Regular bonus rates are determined for each type of policy primarily by targeting the bonus level at a prudent proportion of the long-term expected future investment return on underlying assets, reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers.
In normal investment conditions, PAC expects changes in regular bonus rates to be gradual over time. However, PAC retains the discretion whether or not to declare a regular bonus each year, and there is no limit on the amount by which regular bonus rates can change.
For with-profits business a market consistent valuation is performed. Additional assumptions required are for persistency and the management actions under which the fund is managed. Assumptions used for a market-consistent valuation typically do not contain margins, whereas those used for the valuation of other classes of business do.
The provisions have been determined on a basis consistent with the detailed methodology included in regulations contained in the PRA’s previously issued rules for the determination of reserves on the PRA’s ‘realistic’ Peak 2 basis. Though no longer in force for regulatory purposes, these rules continue to be applied to determine with-profits contract liabilities in accordance with IFRS 4. In aggregate, the regime has the effect of placing a value on the liabilities of UK withprofits contracts, which reflects the amounts expected to be paid based on the current value of investments held by the with-profits funds and current circumstances. These contracts are a combination of insurance and investment contracts with discretionary participation features, as defined by IFRS 4.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £571 million was held in SAIF at 31 December 2016 (2015: £412 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefit of policyholders of SAIF, this provision has no impact on the financial position of the Group’s shareholders’ equity.
Annuity liabilities are calculated as the expected future value of future annuity payments discounted by a valuation interest rate.
Key assumptions include: Mortality The mortality assumptions are set in light of recent population and internal experience. The assumptions used are percentages of standard actuarial mortality tables with an allowance for future mortality improvements. Where annuities have been sold on an enhanced basis to impaired lives an additional age adjustment is made. The percentages of the standard table used are selected according to the source of business.
Valuation interest rates Valuation interest rates used to discount the liabilities are based on the yields as at the valuation date on the assets backing the technical provisions. For fixed interest securities the internal rate of return of the assets backing the liabilities is used. Properties are valued using the lower of the rental yield and the redemption yield, and for equities it is the greater of the dividend yield and the average of the dividend yield and the earnings yield. An adjustment is made to the yield on non-risk-free fixed-interest securities and property to reflect credit risk.
For unit-linked contracts the attaching liability reflects the unit value obligation and provision for expenses and mortality risk. The latter component is determined by applying mortality assumptions on a basis that is appropriate for the policyholder profile.
In accordance with industry-wide regulatory requirements, the PAC board has appointed: — A Chief Actuary who provides the PAC board with all actuarial advice; — A With-Profits Actuary whose specific duty is to advise the PAC board on the reasonableness and proportionality of the manner in which its discretion has been exercised in applying the Principles and Practices of Financial Management and the manner in which any conflicting interests have been addressed; and
Smoothing of investment return In determining bonus rates for the UK with-profits policies, smoothing is applied to the allocation of the overall earnings of the UK with-profits fund of which the investment return is a significant element.
Net income of the fund before movement in unallocated surplus 3,318 2,325 Movement in unallocated surplus (1,169) (168)
Goodwill comprises: M&G – attributable to shareholders 1,153 1,153 Other – attributable to shareholders 322 310
The value in use is particularly sensitive to a number of key assumptions as follows: i The set of economic, market and business assumptions used to derive the three-year plan. The direct and secondary effects of recent developments, eg changes in global equity markets, are considered by management in arriving at the expectations for the financial projections for the plan; ii The assumed growth rate on forecast cash flows beyond the terminal year of the plan. A growth rate of 2.0 per cent (2015: 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; C5 Intangible assets
C Balance sheet notes Continued 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 (2015: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 16 per cent (2015: 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 4.25 per cent and an average ‘beta’ factor for relative market risk of comparable UK listed asset managers. A similar approach has been applied for the other component businesses of M&G; and iv That asset management contracts continue on similar terms. Management believes that any reasonable change in the key assumptions would not cause the recoverable amount of M&G to fall below its carrying amount.
The deferred acquisition costs and other intangible assets attributable to shareholders comprise:
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 (PVIF) 43 45 Distribution rights and other intangibles 1,534 1,355
Deferred acquisition costs PVIF and other intangibles* Total TotalAsia US UK
valuation movements on the US insurance operation’s available-for-sale securities recognised within other comprehensive
† Under the Group’s application of IFRS 4, US GAAP is used for measuring the insurance assets and liabilities of its US and certain Asia operations. Under US GAAP, most of the US insurance operation’s products are accounted for under Accounting Standard no. 97 of the Financial Accounting Standards Board (FAS 97) whereby deferred acquisition costs are amortised in line with the emergence of actual and expected gross profits which are determined using an assumption for long-term investment returns for the separate account of 7.4 per cent (2015: 7.4 per cent) (gross of asset management fees and other charges to policyholders, but net of external fund management fees). The amounts included in the income statement and other comprehensive income affect the pattern of profit emergence and thus the DAC amortisation attaching. DAC amortisation is allocated to the operating and non-operating components of the Group’s supplementary analysis of profit and other comprehensive income by reference to the underlying items.
US insurance operations The DAC amount in respect of US insurance operations comprises amounts in respect of:
The application of the mean reversion formula, (described in note A3.1) has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. In 2017, it would take approximate movements in separate account values of more than either negative 19 per cent or positive 63 per cent for the mean reversion assumption to move outside the corridor.
Exchange differences 1,408 – 330 – Disposals and transfers (251) – – – Change in shadow DAC related to movement in unrealised appreciation of
(ii) Distribution rights relate to fees paid in relation to the bancassurance partnership arrangements for the bank distribution of Prudential’s insurance products for a fixed period of time. The distribution rights amounts are amortised over the term of the distribution contracts. (iii) Software is amortised over its useful economic life, which generally represents the licence period of the software acquired.
US$250m 6.75% Notes (Tier 1) note (vi) 202 170 US$300m 6.5% Notes (Tier 1) note (vi) 243 203 US$700m 5.25% Notes (Tier 2) note (vi) 565 472 US$550m 7.75% Notes (Tier 1) note (vi) 445 372 US$1,000m 5.25% Notes (Tier 2) note (iv) 800 – US$725m 4.375% Notes (Tier 2) note (v) 580 –
Holding company total 6,321 4,567 Prudential Capital bank loan note (iii) 275 275 Jackson US$250m 8.15% Surplus Notes 2027 note (viii) 202 169
regime. The Group has designated all US$4.5 billion (2015: US$2.8 billion) of its US dollar denominated subordinated debt as a net investment hedge under IAS 39 to hedge the
currency risks related to the net investment in Jackson. (ii) The senior debt ranks above subordinated debt in the event of liquidation.
(iii) The Prudential Capital bank loan of £275 million is drawn at a cost of 12 month GBP LIBOR plus 0.4 per cent and matures on 20 December 2017. (iv) In June 2016, the Company issued core structural borrowings of US$1,000 million 5.25 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were £681 million. (v) In September 2016, the Company issued core structural borrowings of US$725 million 4.38 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were
Prudential preference shares. (vii) The ¤20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These have been swapped into borrowings of £14 million with interest
Prudential plc has debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential plc’s long-term senior debt is rated A+, A2 and A from Standard & Poor’s, Moody’s and Fitch, while short-term ratings are A-1, P-1 and F1 respectively.
Prudential Assurance Co. Singapore (Pte) Ltd.’s (Prudential Singapore) financial strength is rated AA by Standard & Poor’s. All ratings on Prudential and its subsidiaries have been reaffirmed on stable outlook except for PAC, which was placed on negative
Commercial Paper 1,052 1,107 Medium Term Notes 2018 note (i) 599 598
Borrowings in respect of short-term fixed income securities programmes note (i) 1,651 1,705
Notes (i) In January and November 2015, the Company issued £300 million Medium Term Notes that will mature in January 2018 and November 2018 respectively. The proceeds, net of
costs, were £299 million for the January 2015 issue and £299 million for the November 2015 issue. (ii) Other borrowings mainly include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson. In
addition, other borrowings include amounts whose repayment to the lender is contingent upon future surplus emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
Non-recourse borrowings of consolidated investment funds* 1,189 1,158 £100m 8.5% undated subordinated guaranteed bonds of Scottish Amicable Finance plc† 100 100 Other borrowings (predominantly obligations under finance leases) 60 74 * In all instances the holders of the debt instruments issued by these subsidiaries and funds do not have recourse beyond the assets of these subsidiaries and funds. † The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinated to the entitlements of the
C7.1 Group overview The Group’s risk framework and the management of the risk, including those attached to the Group’s financial statements including financial assets, financial liabilities and insurance liabilities, together with the inter-relationship with the management of capital, have been included in the audited sections of the Group Chief Risk Officer’s report on the risks facing our business and how these are managed.
The financial and insurance assets and liabilities on the Group’s balance sheet are, to varying degrees, subject to market and insurance risk and other changes of experience assumptions that may have a material effect on IFRS basis profit or loss and shareholders’ equity. The market and insurance risks, including how they affect Group’s operations and how these are managed are discussed in the Group Chief Risk Officer’s report.
The most significant items that the IFRS shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business is sensitive to are shown in the following tables. The distinction between direct and indirect exposure is not intended to indicate the relative size of the sensitivity.
Correlation across risk factors: — Longevity risk; — Expenses; — Persistency; and — Other risks.
C7.2 Asia insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The Asia operations sell with-profits and unit-linked policies, and the investment portfolio of the with-profits funds contains a proportion of equities. Non-participating business is largely backed by debt securities or deposits. The Group’s exposure to market risk arising from its Asia operations is therefore at modest levels. This reflects the fact that the Asia operations have a balanced portfolio of with-profits, unit-linked and other types of business.
In Asia, adverse persistency experience can impact the IFRS profitability of certain types of business written in the region. This risk is managed at a business unit level through regular monitoring of experience and the implementation of management actions as necessary. These actions could include product enhancements, increased management focus on premium collection, as well as other customer retention efforts. The potential financial impact of lapses is often mitigated through the specific features of the products, eg surrender charges, or through the availability of premium holiday or partial withdrawal policy features.
In summary, for Asia operations, the operating profit based on longer-term investment returns is mainly affected by the impact of market levels on unit-linked persistency, and other insurance risks. At the total IFRS profit level the Asia result is affected by short-term value movements on the asset portfolio for non-linked shareholder-backed business.
For the sensitivity analysis as shown in the table below, the reasonably possible interest rate movement used is 1 per cent for all territories.
Net effect on profit and shareholders’ equity 172 (447) 151 (280)
The degree of sensitivity of the results of the non-linked shareholder-backed business of the Asia operations to movements in interest rates depends upon the degree to which the liabilities under the ‘grandfathered’ IFRS 4 measurement basis reflects market interest rates from period to period. For example, for those countries, such as those applying US GAAP, the results can be more sensitive as the effect of interest rate movements on the backing investments may not be offset by liability movements.
An additional factor to the direction of the sensitivity of the Asia operations as a whole is movement in the country mix.
Equity price risk The non-linked shareholder-backed business has limited exposure to equity and property investment (31 December 2016: £1,410 million). Generally changes in equity and property investment values are not directly offset by movements in non-linked policyholder liabilities.
The estimated sensitivity to a 10 per cent and 20 per cent change in equity and property prices for shareholder-backed Asia other business (including those held by the Group’s joint venture and associate businesses), which would be reflected in the short-term fluctuation component of the Group’s segmental analysis of profit before tax, at 31 December 2016 and 2015 would be as follows: Decrease Decrease of 20% of 10% of 20% of 10%
Profit before tax attributable to shareholders (386) (192) (225) (112) Related deferred tax (where applicable) 4 2 21 10
Net effect on profit and shareholders’ equity (382) (190) (204) (102)
A 10 or 20 per cent increase in their value would have an approximately equal and opposite effect on profit and shareholders’ equity to the sensitivities shown above.
Insurance risk Many of the territories in Asia are exposed to mortality/morbidity risk and provision is made within policyholder liabilities on a prudent regulatory basis to cover the potential exposure. If these prudent assumptions were strengthened by 5 per cent then it is estimated that post-tax profit and shareholders’ equity would be decreased by approximately £61 million (2015: £43 million). Mortality and morbidity have a symmetrical effect on the portfolio and any weakening of these assumptions would have a similar equal and opposite impact.
ii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Asia insurance operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2016, the rates for the most significant operations are given in note A1.
Profit before tax attributable to shareholders (97) (94) 118 115 Profit for the year (77) (79) 94 97 Shareholders’ equity, excluding goodwill, attributable to Asia operations (442) (367) 540 449
Jackson’s main exposures are to market risk through its exposure to interest rate risk and equity risk. Approximately 91 per cent (2015: 92 per cent) of its general account investments support fixed interest rate and fixed index annuities, variable annuity fixed account deposits and guarantees, life business and surplus, and 9 per cent (2015: 8 per cent) support institutional businesses. All of these types of business contain considerable interest rate guarantee features and, consequently, require that the assets that support them are primarily fixed income or fixed maturity.
The principal types of derivatives used by Jackson and their purpose are as follows: Derivative Purpose
Interest rate swaps These generally involve the exchange of fixed and floating payments over the period for which Jackson holds the instrument without an exchange of the underlying principal amount. These agreements are used for hedging purposes.
Swaption contracts These contracts provide the purchaser with the right, but not the obligation, to require the writer to pay the present value of a long-duration interest rate swap at future exercise dates. Jackson both purchases and writes swaptions in order to hedge against significant movements in interest rates.
C Balance sheet notes Continued i Sensitivity to equity risk At 31 December 2016 and 2015, Jackson had variable annuity contracts with guarantees, for which the net amount at risk (‘NAR’) is defined as the amount of guaranteed benefit in excess of current account value, as follows: Minimum return
† Ranges shown based on simple interest. The upper limits of 5 per cent or 8 per cent simple interest are approximately equal to 4.1 per cent and 6 per cent respectively, on a compound interest basis over a typical 10-year bonus period. For example 1 + 10 x 0.05 is similar to 1.04 growing at a compound rate of 4 per cent for a further nine years.
As noted above, Jackson is exposed to equity risk through the options embedded in the fixed index annuity liabilities and guarantees included in certain variable annuity benefits as illustrated above. This risk is managed using an equity hedging programme to minimise the risk of a significant economic impact as a result of increases or decreases in equity market levels, while taking advantage of naturally offsetting exposures in Jackson’s operations. Jackson purchases external futures and options that hedge the risks inherent in these products, while also considering the impact of rising and falling guaranteed benefit fees.
At 31 December 2016, the estimated sensitivity of Jackson’s profit and shareholders’ equity to immediate increases and decreases in equity markets is shown below. The sensitivities are shown net of related changes in DAC amortisation.
The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2016 and 2015.
C Balance sheet notes Continued ii Sensitivity to interest rate risk Except in the circumstances of interest rate scenarios where the guarantee rates included in contract terms are higher than crediting rates that can be supported from assets held to cover liabilities, the accounting measurement of fixed annuity liabilities of Jackson’s products is not generally sensitive to interest rate risk. This position derives from the nature of the products and the US GAAP basis of measurement. The GMWB features attached to variable annuity business (other than ‘for life’ components) are accounted for as embedded derivatives which are fair valued and, therefore, will be sensitive to changes in interest rate.
Other comprehensive income: Direct effect on carrying value of debt securities (net of related changes in amortisation of DAC) 3,364 1,883 (1,883) (3,364) 3,167 1,782 (1,782) (3,167)
Related effect on movement in deferred tax (1,177) (659) 659 1,177 (1,108) (624) 624 1,108
Total net effect on shareholders’ equity 303 318 (532) (884) 904 607 (750) (1,331)
www.prudential.co.uk� Annual�Report�2016 Prudential plc 265 05 Financial statem ents iv Other sensitivities The total profit of Jackson is sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts.
C7.4 UK insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The IFRS basis results of the UK insurance operations are most sensitive to asset/liability matching, mortality and default rate experience and longevity assumptions and the difference between the return on corporate bond and risk-free rate for shareholder-backed annuity business of the PAC non-profit sub-fund. Further details are described below.
The shareholder results of the UK with-profits fund correspond to the shareholders’ share of the cost of bonuses declared on the with-profits business, which is currently one-ninth of the cost of bonuses declared. Investment performance is a key driver of bonuses, and hence the shareholders’ share of the cost of bonuses. Due to the ‘smoothed’ basis of bonus declaration, the sensitivity to investment performance in a single year is low relative to movements in the period to period performance. However, over multiple periods, it is important as it may affect future expected shareholder transfers. Altered persistency trends may affect future expected shareholder transfers.
Shareholder-backed annuity business Profits from shareholder-backed annuity business are most sensitive to: — The extent to which the duration of the assets held closely matches the expected duration of the liabilities under the contracts; — Actual versus expected default rates on assets held; — The difference between long-term rates of return on corporate bonds and risk-free rates; — The variance between actual and expected mortality experience; — The extent to which changes to the assumed rate of improvements in mortality give rise to changes in the measurement of liabilities; and — Changes in renewal expense levels.
Unit-linked and other business Unit-linked and other business represents a comparatively small proportion of the in-force business of the UK insurance operations.
Sensitivity to interest rate risk and other market risk By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK insurance operations are, except annuity business, not generally exposed to interest rate risk. At 31 December 2016, annuity liabilities accounted for 98 per cent (2015: 98 per cent) of UK shareholder-backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure is very substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mis-matching profits or losses to arise.
In addition, the shareholder-backed portfolio of UK non-linked insurance operations covering liabilities and shareholders’ equity includes equity securities and investment properties. Excluding any second order effects on the measurement of the liabilities for future cash flows to the policyholder, a fall in their value would have given rise to the following effects on pre-tax profit, profit after tax and shareholders’ equity.
A 10 or 20 per cent increase in their value would have an approximately equal and opposite effect on profit and shareholders’ equity to the sensitivities shown above. The market risk sensitivities shown above reflect the impact of temporary market movements, and therefore, the primary effect of such movements would, in the Group’s segmental analysis of profits, be included within the short-term fluctuations in investment returns.
A 10 per cent increase in the relevant exchange rates (strengthening of the pound sterling) would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Eastspring Investments and US asset management operations, by £12 million and £47 million respectively (2015: £11 million and £38 million, respectively).
Unrealised losses or gains on investments 23 21 (1,534) (1,036) Balances relating to investment and insurance contracts 1 1 (730) (543) Short-term temporary differences 4,196 2,752 (3,071) (2,400)
Of the short-term temporary differences of £4,196 million, £3,843 million relating to the US insurance operations is expected to be recovered in line with the run-off of the in-force book, and the remaining balances of the £353 million are expected to be recovered within 10 years.
Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is 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 often apply separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of deferred tax assets. For the 2016 full year results and financial position at 31 December 2016, the following tax benefits have not been recognised: Tax benefit £m Losses £bn Tax benefit £m Losses £bn
The reduction in the UK corporation tax rate to 17 per cent from 1 April 2020 was substantively enacted on 6 September 2016, and has had the effect of reducing the UK with-profits and shareholder-backed business element of the overall net deferred tax liabilities by £5 million as at 31 December 2016. The effects of these changes are reflected in the financial statements for the year ended 31 December 2016.
(a) Background and summary economic and IAS 19 financial positions The Group’s businesses operate a number of pension schemes. The specific features of these schemes vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS). PSPS accounts for 82 per cent (2015: 84 per cent) of the underlying scheme liabilities of the Group’s defined benefit schemes.
The Group asset/liability in respect of defined benefit pension schemes is as follows: PSPS note (i)
Less: unrecognised surplus note (i) (558) – – – (558) (800) – – – (800)
Economic surplus (deficit) (including investment in Prudential insurance policies) 159 (237) 84 (1) 5 169 (82) 75 (1) 161
‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position.
Funding level at the last valuation 107 per cent 78 per cent 99 per cent
Deficit funding arrangement agreed with the Trustees based on the last valuation
For PSPS, the market value of the scheme assets as at the 5 April 2014 valuation was £6,165 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the 2014 valuation were as follows: %
Rate of increase of pensions in payment for inflation: Guaranteed (maximum 5%) 2.8 Guaranteed (maximum 2.5%) 2.5 Discretionary Nil
Allowance for future improvements to post-retirement mortality For males (females) up to 2009 100 per cent (75 per cent) of Medium Cohort subject to a minimum rate of improvement of 2.00 per cent per annum (1.25 per cent per annum) up to age 90, decreasing linearly to zero by age 120. From 2010 onwards, in line with the CMI’s 2009 projection model with a long-term rate of 1.75 per cent per annum (1.50 per cent per annum), and minor scheme-specific calibrations.
The Trustee of each of the schemes manages the investment strategy of the scheme to achieve an acceptable balance between investing in the assets that most closely match the expected benefit payments and assets that are expected to achieve a greater return, in the hope of reducing the contributions required or providing additional benefits to members.
Rate of increase of pensions in payment for inflation: PSPS: Other schemes 3.2 3.0 * 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 calculations are based on current mortality estimates with an allowance made for future improvements in mortality. This allowance was updated in 2016 to reflect the CMI’s 2014 mortality improvements model, with scheme-specific calibrations. For immediate annuities in payment, in 2016 and 2015, a long-term mortality improvement rate of 1.75 per cent per annum and 1.25 per cent per annum was applied for males and females, respectively.
The underlying pension 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. The IAS 19 basis excludes the investments in Prudential policies. At 31 December 2016, the investments in Prudential insurance policies comprise £134 million (2015: £77 million) for the M&GGPS and there were no investments in Prudential insurance policies for PSPS and SASPS (2015: £125 million for PSPS). In principle, on consolidation, the investments are eliminated against policyholder liabilities of UK insurance operations, so that the formal IAS 19 position for the scheme in isolation excludes these items. This treatment applies to the M&GGPS investments. However, in 2015, as a substantial portion of the Company’s interest in the underlying surplus of PSPS was not recognised, the adjustment was not necessary for the PSPS investments.
Less: amount attributable to PAC with-profits fund (658) (12) 261 (16) (425)
Less: amount attributable to PAC with-profits fund 573 21 (185) – 409
With the effect of IFRIC 14 Surplus (deficit) 161 (33) (168) 45 5 Less: amount attributable to PAC with-profits fund (85) 9 76 (16) (16)
Shareholders’ share: Gross of tax surplus (deficit) 76 (24) (92) 29 (11)
Underlying investments of the schemes On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the plans’ assets at 31 December comprise the following investments: PSPS £m
IAS 19 basis net deficit 2016 £m Net surplus (deficit), beginning of
2015 £m Net deficit, beginning of year 8,067 (7,312) 755 (710) 45 (132) (87)
Net surplus (deficit), end of year 7,819 (6,858) 961 (800) 161 (77) 84
Notes (i) Maturity profile of the benefit obligations The weighted average duration of the benefit obligations of the schemes is 19.5 years (2015: 18.2 years).
The losses of £1,733 million in 2016 on change in financial assumptions primarily reflect the effect of the decrease in the discount rate used in determining the scheme liabilities from 3.8 per cent in 2015 to 2.6 per cent in 2016. These losses were partially offset by the increase in the return on the scheme assets, which was greater than the amount included in interest income by £1,203 million.
(d) Sensitivity of the pension scheme liabilities to key variables The sensitivity information below is based on the core scheme liabilities and assumptions at the balance sheet date. The sensitivity is calculated based on a change in one assumption with all other assumptions being held constant. As such, interdependencies between the assumptions are excluded.
Increase in scheme liabilities by: PSPS 3.5% 3.2% Other schemes 3.7% 2.8%
Shares issued under share-based schemes 8,606,615 1 12 4,675,008 – 7
Transactions by Prudential plc and its subsidiaries in Prudential plc shares The Group buys and sells Prudential plc shares (‘own shares’) either in relation to its employee share schemes or via transactions undertaken by authorised investment funds that the Group is deemed to control. The cost of own shares of £226 million as at 31 December 2016 (2015: £219 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans. At 31 December 2016, 10.7 million (2015: 10.5 million) Prudential plc shares with a market value of £175 million (2015: £161 million) were held in such trusts, all of which are for employee incentive plans. The maximum number of shares held during 2016 was 11.2 million which was in June 2016.
Charged to income statement: Notes (i) Restructuring provisions 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.
(ii) Other provisions comprise staff benefits provisions of £415 million (2015: £384 million) that are generally expected to be paid out within the next three years, provisions for onerous contracts of £20 million (2015: £31 million), other provisions of £35 million (2015: £79 million) and a provision for review of past annuity sales of £175 million (2015: £nil). Prudential has agreed with the Financial Conduct Authority (FCA) to review annuities sold without advice after 1 July 2008 to its contract-based defined contribution pension customers. The review will examine whether customers were given sufficient information about their potential eligibility to purchase an enhanced annuity, either from Prudential or another pension provider. The review is expected to commence in 2017 and last a period of three years. A provision of £175 million has been established at 31 December 2016 to cover the costs of undertaking the review and any potential redress. The ultimate amount that will be expended by the Group on the review remains uncertain. Although the Group’s professional indemnity insurance may mitigate the overall financial impact of this review, with potential insurance recoveries of up to £175 million, no such recovery has been factored in the provision, in accordance with the requirements of IAS 37, ‘Provisions, Contingent Liabilities and Contingent Assets’.
(a) Group objectives, policies and processes for managing capital (i) Capital measure The Group manages its Group Solvency II own funds as its measure of capital. At 31 December 2016, estimated Group Solvency II Own Funds were £24.8 billion.
(ii) External capital requirements From 1 January 2016, Solvency II is the Group’s consolidated capital regime. Solvency II is a risk-based solvency framework required under the European Solvency II Directive as implemented by the Prudential Regulatory Authority in the UK. The Solvency II surplus represents the aggregated capital held by the Group less solvency capital requirements.
More details on holding company cash flows and balances are given in the section II(a) of the additional unaudited financial information. While the Group at a consolidated level is subject to the Solvency II requirements, at a business unit level capital is defined by local capital regulations and local business needs. Each of the Group’s long-term business operations is capitalised to a sufficiently strong level for its individual circumstances.
(b) Local capital regulations The most significant local capital requirements are: (i) Asia insurance operations The estimated capital position for Asia life insurance operations with reconciliation to shareholders equity is shown below: Group IFRS shareholders’ equity 4,993 3,956
Adjustments to regulatory basis Unallocated surplus of with-profits funds 2,667 2,553 Deferred acquisition costs, distribution rights and goodwill of non-participating business not recognised for regulatory reporting (1,365) (1,301) Other adjustments 1,627 (31)
Indonesia Solvency capital is determined using a risk-based capital approach. Insurance companies in Indonesia are expected to maintain the level of net assets above 120 per cent of solvency capital.
(ii) US insurance operations The estimated capital position for Jackson with reconciliation to shareholders equity is shown below: Group IFRS shareholders’ equity 5,204 4,154
Total available capital resources of life assurance businesses on local regulatory bases 4,295 3,466
(iii) UK insurance operations From 1 January 2016, UK insurance operations are subject to Solvency II capital requirements on an individual basis. The UK solvency capital requirement has been met during 2016.
Gains (losses) during the year 339 8 (23) 122 446 392 Movement in capital requirement (46) – – (8) (54) 36 Capital injection – – – – – 4 Distributions made to the parent company (290) (18) (45) (79) (432) (262)
(c) Transferability of available capital In the UK, the Solvency II regime became effective on 1 January 2016. PAC is required to meet the Solvency II capital requirements as a company as a whole, ie covering both its ring-fenced with-profits funds and non-profit funds. Further, the surplus of the with-profits funds is ring-fenced from the shareholder balance sheet with restrictions as to its distribution. Distributions from the with-profits funds to shareholders continue to reflect the shareholders’ one-ninth share of the cost of declared policyholders’ bonuses.
For Jackson, capital retention is maintained at a level consistent with an appropriate rating by Standard & Poor’s. Currently, Jackson is rated AA. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, dividends which exceed the greater of statutory net gain from operations less net realised investments losses for the prior year or 10 per cent of Jackson’s prior year end statutory surplus, excluding any increase arising from the application of permitted practices, require prior regulatory approval.
Tangible assets Of the £392 million of tangible assets, £247 million were held by the Group’s with-profits operations, primarily by the consolidated subsidiaries for venture fund and other investment purposes of the PAC with-profits fund.
Capital expenditure: property, plant and equipment by segment The capital expenditure of £333 million (2015: £216 million) arose as follows: £244 million in UK, £17 million in US and £61 million in Asia in insurance operations with the remaining balance of £11 million arising from asset management operations and unallocated corporate expenditure (2015: £143 million in UK, £20 million in US and £35 million in Asia in insurance operations with the remaining balance of £18 million arising from asset management operations and unallocated corporate expenditure).
Investment properties principally relate to the PAC with-profits fund and are carried at fair value. A reconciliation of the carrying amount of investment properties at the beginning and end of the year is set out below: Additions: Resulting from property acquisitions 1,338 680 Resulting from expenditure capitalised 189 77
Net gain from fair value adjustments 273 537 Net foreign exchange differences 97 21 Transfers (to) from held for sale assets (41) 5
The Group’s policy is to let investment properties to tenants through operating leases. Minimum future rentals to be received on non-cancellable operating leases of the Group’s freehold investment properties are receivable in the following periods: Less than 1 year 314 309
Remeasurement of carrying value on classification as held for sale (238) – – Amounts that would otherwise be classified within: Operating profit based on longer-term investment returns 20 38 42 Short-term fluctuations in investment returns (9) 18 20
(Loss) profit attaching to held for sale Korea life business (227) 56 62
The assets and liabilities of the Korea life business classified as held for sale on the statement of financial position as at 31 December 2016 are as follows: 2016 £m
Adjustment for remeasurement of the carrying value of the business to fair value less costs to sell2 (238)
Net assets 105 1 The investments of the Korea life business comprise primarily Equity securities and portfolio holdings in unit trusts (£2,527 million as at 31 December 2016). 2 The remeasurement adjustment of £238 million comprises the write down of goodwill of £15 million and other non-current assets within the scope of IFRS 5 of £16 million
3 The Korea life business has non-linked liabilities and linked liabilities at 31 December 2016 of £749 million and £2,576 million respectively (2015: £625 million and £2,187 million respectively).
Litigation and regulatory matters In addition to the matters set out in note C11 in relation to the Financial Conduct Authority review of past annuity sales, the Group is involved in various litigation and regulatory issues. These may from time to time include class actions involving Jackson. While the outcome of such litigation and regulatory issues cannot be predicted with certainty, the Company believes that their ultimate outcome will not have a material adverse effect on the Group’s financial condition, results of operations, or cash flows.
Matters relating to with-profits sub-funds: — Pension mis-selling review – The UK insurance regulator required all UK life insurance companies to review sales of personal pensions policies for potential mis-selling. Offers to all cases were made by 30 June 2002. Costs arising from this review are met by the excess assets of the PAC with-profits sub-fund and hence have not been charged to the asset shares used in the determination of policyholder bonus rates. Prudential has given an assurance that these deductions from excess assets will not impact its bonus or investment policy for policies within the with-profits sub-funds that were in force at 31 December 2003. This assurance does not apply to new business since 1 January 2004. In the unlikely event that such deductions would affect the bonus or investment policy for the relevant policies, Prudential has stated it would make available support to the sub-fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged.
— Scottish Amicable Insurance sub-fund – Policies within this sub-fund (a with-profits sub-fund closed to new business) contain minimum levels of guaranteed benefit to policyholders. Should the assets of the sub-fund be inadequate to meet the guaranteed benefit obligations of the policyholders of SAIF, the PAC with-profits sub-fund would be liable to cover any such deficiency in the first instance.
In addition, certain pensions products within this sub-fund have guaranteed annuity rates at retirement, for which a provision of £571 million was held within the sub-fund (2015: £412 million).
— Guaranteed annuities – A provision for guaranteed annuity products of £62 million was held (2015: £47 million) in the PAC withprofits sub-fund.
In addition, Prudential has put in place intra-group arrangements to formalise undertakings by Prudential to the regulators of the Hong Kong subsidiaries regarding their solvency levels.
Dividends The second interim ordinary dividend for the year ended 31 December 2016, that was approved by the Board of Directors after 31 December 2016 is described in note B7.
Future minimum sub-lease rentals received for non-cancellable operating leases for land and buildings 60 66 Minimum lease rental payments included in consolidated income statement 115 105
At 31 December 2016, Jackson has unfunded commitments of £465 million (2015: £299 million) related to its investments in limited partnerships and £201 million (2015: £64 million) related to commercial mortgage loans and other fixed maturities. These commitments were entered into in the normal course of business and a material adverse impact on the operations is not expected to arise from them.
(b) Investments in joint ventures and associates Joint ventures represent arrangements where the controlling parties through contractual or other agreement have the rights to the net assets of the arrangements. The Group has shareholder-backed joint venture insurance and asset management businesses in China with CITIC Group, and until September 2016 in India with ICICI Bank (see below). In addition, there is an asset management joint venture in Hong Kong with Bank of China International Holdings Limited (BOCI) and Takaful general and life insurance joint venture in Malaysia.
The Group’s share of the profits (including short-term fluctuations in investment returns), net of related tax, and carrying amount of interest in joint ventures and associates, which are equity accounted as shown in the consolidated income statement comprises the following: Joint ventures and associates
Share of profits from joint ventures and associates, net of related tax 94 – 21 13 – – 54 182 – 182
(c) Related undertakings In accordance with Section 409 of the Companies Act 2006 a list of Prudential Group’s subsidiaries, joint ventures, associates and significant holdings (being holdings of more than 20 per cent) along with the classes of shares held, the registered office address and the country of incorporation, and the effective percentage of equity owned at 31 December 2016 is disclosed below.
Allied Life Brokerage Agency, Inc Ordinary shares 100.00% 400 East Court Avenue, Des Moines Iowa, 50309, USA
BOCHK Balanced Growth Fund Ordinary shares 39.05% 12th Floor and 25th Floor, Citicorp Centre, 18 Whitfield Road, Causeway Bay, Wan Chai, Hong Kong
BOCI - Prudential Asset Management Limited Ordinary shares 36.00% 27/F, Bank of China Tower, 1 Garden Road, Hong Kong
Brier Capital LLC Limited liability company 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA
Brooke Holdings LLC Ordinary shares 100.00% 1105 N Market Street, Suite 1300, Wilmington, DE 19801, USA
BWAT Retail Nominee (1) Limited Ordinary shares 50.00% Laurence Pountney Hill, London EC4R 0HH, UK
Canada Property Jersey No. 2 Trust Units 100.00% Lime Grove House, Green Street, St Helier, Jersey JE1 2STCanada Property Jersey Trust Units 100.00%
Ordinary shares 66.00% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham B2 5PP, UK
Carraway Guildford (Nominee A) Limited Ordinary shares 100.00% 13 Castle Street, St Helier, Jersey JE4 5UT
Carraway Guildford General Partner Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Centaurus Retail LLP Limited partnership interest 50.00% 40 Broadway, London SW1H 0BU, UK
CEP IV-A CWV AIV Limited Partnership Limited partnership interest 31.92% 850 New Burton Road, Ste. 201, Dover, DE 19904, USA
CF Prudential European QIS Fund Ordinary shares 97.72% 17 Rochester Row, London SW1P 1QT, UK
CF Prudential UK Growth QIS Fund Ordinary shares 98.60% 17 Rochester Row, London SW1P 1QT, UK
Ownership interest 50.00% East Tower, World Financial Centre, No.1 East Third Ring Middle Road, Chaoyang District, Beijing, China 100020
CITIC-CP Asset Management Co., Ltd. Ownership interest 26.95% No.128 North Zhangjiabang Road, Pudong District, Shanghai, China
Cribbs Causeway Merchants Association Ltd Limited by guarantee 100.00% The Mall at Cribbs Causeway, Bristol, BS34 5DG, UK
Curian Capital, LLC Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA
Eastspring Investments – Cash Reserve Fund Ordinary shares 100.00% Prudential Tower 23rd Floor, Jl. Jendral Sudirman Kav.79, Jakarta Selatan 12910, Indonesia
Eastspring Investments (Hong Kong) Limited Ordinary shares 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong
Eastspring Investments (Singapore) Limited Ordinary shares 100.00% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983
Ordinary shares 100.00% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea
Ordinary shares 97.01% 70, Yeoui-daero, Yeongdeungpo-gu, Seoul, 15/F, Shinhan Investment Tower, Seoul Special City, 07325, Korea
Eastspring Investments Dragon Peacock Fund Ordinary shares 83.12% 26, Boulevard Royal, L-2449 Luxembourg
Ownership interest 100.00% 23/F, Saigon Trade Center, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam
Ordinary shares 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront Port Louis, Mauritius
Eastspring Investments Services Pte. Ltd. Ordinary shares 100.00% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983
Ordinary shares 97.53% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea
Ordinary shares 91.69% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983
Ordinary shares 99.95% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea
Eastspring Real Assets Partners Ordinary shares 100.00% PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands
Eastspring Securities Investment Trust Co., Ltd. Ordinary shares 99.54% 4F, No.1 Songzhi Road, Taipei 110, Taiwan
Empire Holding S.a.r.l. (In liquidation) Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg
Falan GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK
Foudry Properties Limited Ordinary shares 50.00% Clearwater Court, Vastern Road, Reading RG1 8DB, UK
Global Low Volatility Equity fund D Acc Ordinary shares 94.59% 26, Boulevard Royal, L-2449 Luxembourg
Holtwood Limited Ordinary shares 100.00% International House, Castle Hill, Victoria Road, Douglas, IM2 4RB, Isle of Man
Hyde Holdco 1 Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Ordinary shares 25.83% ICICI PruLife Towers, 1089 Appasaheb Marathe Marg, Prabhadevi, Mumbai 400025, India
IFC Holdings, Inc. Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA
Infracapital (AIRI) GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UKInfracapital (AIRI) Holdings Limited Ordinary shares 100.00%
Infracapital (Sense) Holdings Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Infracapital F1 GP2 Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Infracapital SLP Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Ordinary shares 100.00% 208 South LaSalle Street Suite 814 Chicago, IL 60604, USA
Jackson National Life (Bermuda) Limited Ordinary shares 100.00% Cedar House, 41 Cedar Avenue, Hamilton HM 12, Bermuda
Jackson National Life Distributors LLC Membership interest 100.00% 1209 Orange St, Wilmington, DE 19801, USA
Ordinary shares 100.00% 2900 Westchester Av, Suite 305, Purchase, NY 10577, USA
Jefferies Capital Partners V, L.P. Limited partnership interest 21.92% The Corporation Trust Company, Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801, USA JNL Strategic Income Fund LLC Membership interest 100.00%
Livicos Limited Ordinary shares 100.00% Montague House, Adelaide Road, Dublin 2, Ireland
M&G European Credit Investment Fund Ordinary shares 100.00% 80, Route d’Esch, L-1470 Luxembourg
M&G European Select Fund Ordinary shares 37.30% Laurence Pountney Hill, London EC4R 0HH, UK
M&G Gilt & Fixed Interest Income Fund Ordinary shares 41.11% Laurence Pountney Hill, London EC4R 0HH, UK
M&G Global Leaders Fund Ordinary shares 24.28% Laurence Pountney Hill, London EC4R 0HH, UK
M&G Investment Management Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
M&G Investments (Hong Kong) Limited Ordinary shares 100.00% 6th Floor, Alexandra House, 18 Chater Road, Central Hong Kong, Hong Kong
M&G Investments (Singapore) Pte. Ltd. Ordinary shares 100.00% 10 Marina Boulevard, 39 Marina Bay Financial Centre, Singapore 018983
M&G Investments Japan Co., Ltd. Ordinary shares 100.00% 3-1 Toranomon, 4 Chome, Minato-ko, Tokyo 105-6009, Japan
M&G RE Espana 2016 S.L. Ordinary shares 100.00% Plaza de Colon, Torre II, Planta 14, 28046, Madrid, Spain
M&G Real Estate Funds Management S.a.r.l. Ordinary shares 100.00% 34-38, Avenue de la Liberté, L-1930 Luxembourg
M&G Real Estate Japan Co. Ltd Ordinary shares 100.00% Shiroyama Trust Tower, Tokyo, Japan
M&G Real Estate Korea Co. Ltd Ordinary shares 100.00% Kyobo Building, Seoul, Korea
M&G RED II Employee Feeder GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK
M&G RED III GP Limited Ordinary shares 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey GY1 1WG
M&G RED III SLP GP Limited Ordinary shares 100.00% Burness Paull LLP, 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK
M&G RED SLP GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK
M&G RPF GP Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Ordinary shares 100.00% 78 Sir John Rogerson’s Quay, Dublin 2, D02 RK57, Ireland
M&G UK Companies Financing Fund II LP Limited partnership interest 48.32% Laurence Pountney Hill, London EC4R 0HH UK
M&G UK Residential Property Fund Class founder units 48.37% 34-38, Avenue de la Liberté, L-1930 Luxembourg
M&G UKCF II GP Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Manchester Nominee (1) Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Minster Court Estate Management Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Mission Plans of America, Inc Ordinary shares 100.00% 1999 Bryan Street Suite 900, Dallas, TX 75201, USA
MM and S (2375) Limited Ordinary shares 100.00% Mazars Llp, 90 St. Vincent Street, Glasgow G2 5UB, UK
Murphy & Partners Fund, LP Limited partnership interest 21.07% Corporation Service Company 2711 Centerville Road, Ste 400, Wilmington, DE 19808, USA
National Planning Corporation Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA
Nova Sepadu Sdn. Bhd. Ordinary shares 51.00% Suite 1005, 10th Floor Wisma Hamzah-Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia
Oaktree Business Park Limited Ordinary shares 12.50% Laurence Pountney Hill, London EC4R 0HH, UK
Optimus Point Management Company Limited Ordinary shares 99.95% Barrat House Cartwright Way, Bardon Hill, Coalville, Leicestershire LE67 1UF, UK
PCA Life Assurance Co. Ltd. Ordinary shares 99.79% 8/F, No.1 Songzhi Road, Taipei 11047, Taiwan
PCA Reinsurance Co. Ltd. Ordinary shares 100.00% Unit Level 13(A), Main Office Tower, Financial Park Labuan, Jalan Merdeka, 87000 Federal Territory of Labuan, Malaysia
PGDS (US One) LLC Membership interest 100.00% 1209 Orange St, Wilmington, DE 19801, USA
PPM America Capital Partners II, LLC Membership interest 63.45% 774 Walker Road, Suite C, Dover, DE 19904, USA
PPM America Capital Partners, LLC Membership interest 19.38% 774 Walker Road, Suite C, Dover, DE 19904, USA
Prudence Foundation Limited Limited by guarantee 100.00% 13/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong
Prudential (Cambodia) Life Assurance Plc. Ordinary shares 100.00% 20F, #445, Monivong Blvd, Boeung Prolit, 7 Makara, Phnom Penh Tower Phnom Penh, Cambodia
Prudential (Namibia) Unit Trusts Limited Ordinary shares 100.00% 6 Feld Street, Windhoek, Namibia
Ordinary shares 100.00% 30 Cecil Street, #30-01 Prudential Tower, Singapore 049712
Ordinary shares and 6% Cumulative Preference Shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Prudential Corporation Holdings Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Ordinary shares 100.00% Mazars LLP, 90 St. Vincent Street, Glasgow G2 5UB, UK
Ordinary shares 100.00% 59/F, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong
Prudential GP Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK
Prudential Greenfield GP LLP Limited partnership interest 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Prudential Greenfield SLP GP LLP Limited partnership interest 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK
Prudential International Assurance plc Ordinary shares 100.00% Montague House, Adelaide Road, Dublin 2, Ireland
Prudential Investments Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Prudential Life Assurance Kenya Limited Ordinary shares 100.00% 5th Ngong Avenue, Nairobi, Kenya
Prudential Lifetime Mortgages Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK
Prudential Pensions Management Zambia Ordinary shares 49.00% 226 Finsbury House, Buteko Avenue, Ndola, Zambia
Ordinary shares & A Class shares 49.99% PO Box 44813, Claremont 7735, South Africa
Prudential Properties Trusty Pty Limited Unclassified shares 100.00% Darling Park Tower 2, Sydney, Australia
Prudential Property Holding Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Prudential Retirement Income Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK
Prudential Services Asia Sdn. Bhd. Ordinary shares Class D Preference shares
Suite 1005, 10th Floor, Wisma Hamzah-Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia
Prudential Services Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Prudential Services Singapore Pte. Ltd. Ordinary shares 100.00% 80 Robinson Road, #21-01/02 Singapore 068898
Prudential UK Services Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK
Randolph Street LP Limited partnership interest 100.00% Corporation Service Company, 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA
REALIC of Jacksonville Plans, Inc. Ordinary shares 100.00% 9235 Katy Freeway, Houston, TX 77255, USA
Ordinary shares 100.00% Prudential Tower 23rd Floor, Jl. Jendral Sudirman Kav.79, Jakarta Selatan, 12910, Indonesia
Rift GP 1 Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UKRift GP 2 Limited Ordinary shares 100.00%
ROP, Inc Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA
ScotAm Pension Trustees Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK
Scottish Amicable Life Assurance Society No share capital 100.00% Craigforth, Stirling FK9 4UE UK
Ordinary shares 100.00% Mazars LLP, 90 St Vincent Street, Glasgow G2 5UB, UK
Sectordate Ltd A Ordinary shares 32.60% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham B2 5PP, UK
Silverfleet Capital 2004 LP Limited Partnership Interest 100.00% 1 Royal Plaza, St Peters Port, Guernsey, GY1 2HL
Smithfield Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
SMLLC General Partner 100.00% The Corporation Trust Company, 1209 Orange Street, Wilmington, DE 19801, USA
Squire Capital I LLC Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA
Sri Han Suria Sdn. Bhd. Ordinary shares Class A and B Preference shares
St Edward Homes Limited Ordinary shares 50.00% Berkeley House, 19 Portsmouth Road, Cobham KT11 1JG, UK St Edwards Strand Partnership Limited partnership interest
Stableview Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Staple Limited Ordinary shares 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn Road, Yannawa Subdistrict, Sathorn District, Bangkok, Thailand
Ordinary shares 99.93% 9/9 Sathorn Building, 20th– 27th Floor, South Sathorn Road, Yannawa, Sahtorn, Bangkok 10120, Thailand
The St Edward Homes Partnership Limited partnership interest 49.95% Berkeley House, 19 Portsmouth Road, Cobham, KT11 1JG, UK
The Strand Property Unit Trust Units 50.00% Liberte house, 19-23 La Motte Street, St Helier, Jersey, Channel Islands, JE2 4SYThe Two Rivers Trust Units 50.00%
THMI, Inc. Ordinary shares 75.80% Prentice-Hall Corporation, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, USA
Two Rivers Limited Partnership Ordinary shares 50.00% Bow Bells House, 1 Bread Street, London EC4M 9HH, UK
Two Snowhill Birmingham Sarl Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg
US Strategic Income Bond Fund D USD Acc Ordinary shares 100.00% 26, Boulevard Royal, L-2449 Luxembourg
US Total Return Bond Fund D USD Acc Ordinary shares 100.00%
Warren Farm Office Village Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK
Wynnefield Private Equity Partners I, L.P. Limited partnership interest 99.00% PHS Corporate Services Inc. 1313 N. Market St, Ste 5100, Wilmington, DE 19801, USA
Wynnefield Private Equity Partners II, L.P. Limited partnership interest 99.00% The Corporation Trust Company Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801 USA
(iii) Structured entities Structured entities are those that have been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity. Voting rights relate to administrative tasks. Relevant activities are directed by means of contractual arrangements. The Group invests in structured entities such as: — Open-Ended Investment Companies (OEICs); — Unit Trusts (UTs); — Limited partnerships; — Variable interest entities; — Investment vehicles within separate accounts offered through variable annuities; — Collateralised debt obligations; — Mortgage-backed securities; and — Similar asset-backed securities.
— Where the entity is managed by a Group asset manager, and the Group’s ownership holding in the entity exceeds 50 per cent, the Group is judged to have control over the entity.
— Where the entity is managed by a Group asset manager, and the Group’s ownership holding in the entity is less than 20 per cent, the Group is judged to not have control over the entity.
Where the Group is deemed to control these entities, they are treated as a subsidiary and are consolidated, with the interests of investors other than the Group being classified as liabilities, and appear as net asset value attributable to unit holders of consolidated unit trusts and similar funds.
Statement of financial position line items Equity securities and portfolio holdings in unit trusts 16,489 120,411 – 12,945 91,022 – Debt securities – – 12,220 – – 11,735
(e) Financial investments other than instruments classified as long-term business contracts (i) Investment classification The Group holds financial investments in accordance with IAS 39, whereby subject to specific criteria, financial instruments are required to be accounted for under one of the following categories: — Financial assets and liabilities at fair value through profit or loss – this comprises assets and liabilities designated by management as fair value through profit or loss on inception and derivatives that are held for trading. These investments are measured at fair value with all changes thereon being recognised in investment return in the income statement; — Financial investments on an available-for-sale basis – this comprises assets that are designated by management as available-for-sale and/or do not fall into any of the other categories. These assets are initially recognised at fair value plus attributable transaction costs.
— Available-for-sale assets are subsequently measured at fair value. Interest income is recognised on an effective interest basis in the income statement. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset. Except for foreign exchange gains and losses on debt securities, which are included in the income statement, unrealised gains and losses are recognised in other comprehensive income. Upon disposal or impairment, accumulated unrealised gains and losses are transferred from other comprehensive income to the income statement as realised gains or losses; and
The Group uses the trade date method to account for regular purchases and sales of financial assets. Where assets and liabilities have been valued at fair value or measured on a different basis but fair value is disclosed, the Group has followed the principles under IFRS 13 ‘Fair Value Measurement’.
The Group does not regularly seek to apply fair value or cash flow hedging treatment under IAS 39. The Group has no fair value and cash flows hedges under IAS 39 at 31 December 2016 and 2015.
For UK with-profits funds the derivative programme is used for the purposes of efficient portfolio management or reduction in investment risk.
For Jackson, an extensive derivative programme is maintained. Value movements on the derivatives held can be very significant in their effect on shareholder results. Further details on this aspect of the Group’s financial reporting are described in note B1.2.
(iii) Embedded derivatives Embedded derivatives are present in host contracts issued by various Group companies, in particular Jackson. They are embedded within other non-derivative host financial instruments and insurance contracts to create hybrid instruments. Embedded derivatives meeting the definition of an insurance contract are accounted for under IFRS 4. Where economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host instrument, and where the hybrid instrument is not measured at fair value with the changes in fair value recognised in the income statement, the embedded derivative is bifurcated and carried at fair value as a derivative in accordance with IAS 39. For Jackson’s ‘not for life’ Guaranteed Minimum Withdrawal Benefit and Fixed Index Annuity reserves the determination of fair value requires assumptions regarding future mix of Separate Account assets, equity volatility levels, and policyholder behaviour.
The Group derecognises financial liabilities only when the obligation specified in the contract is discharged, cancelled or has expired.
Asset management comprises both internal and third-party asset management services, inclusive of portfolio and mutual fund management, where the Group acts as an adviser, and broker-dealer activities. The nature of the products and the managing of the business differ from the risks inherent in the insurance operations segments, and the regulatory environment of the asset management industry differs from that of the insurance operations segments.
Further information on the Group’s operating segments is provided in note B1.3.
The aggregate of the actuarially determined service costs of the currently employed personnel, and the net interest on the net defined benefit liability (asset) at the start of the period, is charged to the income statement. Actuarial and other gains and losses as a result of changes in assumptions or experience variances are recognised as other comprehensive income.
(k) Tax Current tax expense is charged or credited based upon amounts estimated to be payable or recoverable as a result of taxable amounts for the current year and adjustments made in relation to prior years. Prudential is subject to tax in numerous jurisdictions and the calculation of the total tax charge inherently involves a degree of estimation and judgement. The positions taken in tax returns where applicable tax regulation is subject to interpretation are recognised in full in the determination of the tax charge in the financial statements if the Group considers that it is probable that the taxation authority will accept those positions. Otherwise, provisions are established based on management’s estimate and judgement of the likely amount of the liability, or recovery by providing for the single best estimate of the most likely outcome or the weighted average expected value where there are multiple outcomes.
Income and expenses of entities sold during the period are included in the income statement up to the date of disposal. The gain or loss on disposal is calculated as the difference between sale proceeds net of selling costs, less the net assets of the entity at the date of disposal, adjusted for foreign exchange movements attaching to the sold entity that are required to be recycled to the income statement under IAS 21.
(m) Goodwill Goodwill arising on acquisitions of subsidiaries and businesses is capitalised and carried on the Group statement of financial position as an intangible asset at initial value less any accumulated impairment losses. Goodwill impairment testing is conducted annually and when there is an indication of impairment. For the purposes of impairment testing, goodwill is allocated to cash generating units.
(n) Intangible assets Intangible assets acquired on the purchase of a subsidiary or portfolio of contracts are measured at fair value on acquisition. Deferred acquisition costs are accounted for as described in notes A3.1(d) and A3.1(f) above. Other intangible assets, such as distribution rights and software, are valued initially at the price paid to acquire them and are subsequently carried at cost less amortisation and any accumulated impairment losses. Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contract. Amounts for distribution rights are amortised on a basis to reflect the pattern in which the future economic benefits are expected to be consumed by reference to new business production levels. The same principles apply to determining the amortisation method for other intangible assets unless the pattern cannot be determined reliably, in which case a straight line method is applied. Amortisation of intangible assets is charged to the ‘acquisition costs and other expenditure’ line in the consolidated income statement.
(o) Cash and cash equivalents 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.
(r) Foreign exchange The Group’s consolidated financial statements are presented in pounds sterling, the Group’s presentation currency. Accordingly, the results and financial position of foreign subsidiaries must be translated into the presentation currency of the Group from their functional currencies, ie the currency of the primary economic environment in which the entity operates. All assets and liabilities of foreign subsidiaries are converted at year end exchange rates while all income and expenses are converted at average exchange rates where this is a reasonable approximation of the rates prevailing on transaction dates. The impact of these currency translations is recorded as a separate component in the statement of comprehensive income.
(s) Earnings per share Basic earnings per share is calculated by dividing the earnings attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the year, excluding those held in employee share trusts and consolidated unit trusts and OEICs, which are treated as cancelled.
Transactions with owners, recorded directly in equity New share capital subscribed – 7 – 7 Share based payment transactions – – 7 7
Total contributions by and distributions to owners 1 12 (1,261) (1,248)
The financial statements of the Company, which comprise the statement of financial position, statement of changes in equity and related notes, are prepared in accordance with UK Generally Accepted Accounting Practice, including Financial Reporting Standard 101 Reduced Disclosure Framework (‘FRS 101’) and Part 15 of the Companies Act 2006.
In preparing these financial statements, the Company applies the recognition, measurement and disclosure requirements in International Financial Reporting Standards (‘IFRS’) as issued by the International Accounting Standards Board (‘IASB’) and endorsed by the EU, but makes amendments where necessary in order to comply with the Companies Act 2006 and has set out below where advantage of the FRS 101 disclosure exemptions has been taken. The Company has also taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profit and loss account.
— A cash flow statement and related notes; — Disclosures in respect of transactions with wholly-owned subsidiaries within the Prudential Group; — Disclosure in respect of capital management; and — The effects of new but not yet effective IFRSs.
As the consolidated financial statements of the Group include the equivalent disclosure, the Company has also applied the exemptions available under FRS 101 in respect of the following disclosures: — IFRS 2 ‘Share Based Payments’ in respect of Group-settled share-based payments; and — Disclosure required by IFRS 7 ‘Financial Instrument Disclosures’ and IFRS 13 ‘Fair Value Measurement’.
The accounting policies set out in note 3 below have, unless otherwise stated, been applied consistently to all periods presented in these financial statements.
The assets and liabilities of the defined benefit pension schemes of the Prudential Group are subject to a full triennial actuarial valuation using the projected unit method. Estimated future cash flows are then discounted at a high quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities, where appropriate, to determine their present value. These calculations are performed by independent actuaries.
The aggregate of the actuarially determined service costs of the currently employed personnel and the net income (interest) on the net scheme assets (liabilities) at the start of the period, is recognised in the profit or loss account. Actuarial gains and losses as a result of the changes in assumptions, experience variances or the return on scheme assets excluding amounts included in the net deferred benefit asset (liability) are recorded in other comprehensive income.
Under IFRS 2 ‘Share-based payment’, 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 equitysettled in the Group financial statements, the Company records an increase in the investment in 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 after tax Profit for the financial year of the Company (including dividends from subsidiaries) in accordance
with FRS 101 and IFRS 840 920 Share in the IFRS result of the Group, net of distributions to the Company* 1,081 1,659
Shareholders’ equity of the Group in accordance with IFRS 14,666 12,955 * The ‘share in the IFRS result and net equity of the Group’ lines represent the parent company’s equity in the earnings and net assets of its subsidiaries and associates.
At 1 January 12,514 Liquidation of subsidiary undertaking (1,600) Other movements (55)
for employees of its subsidiary undertakings, less £61 million relating to cash received from subsidiaries in respect of share awards. Subsidiary undertakings of the Company at 31 December 2016 are listed in note D6 of the Group financial statements.
Derivative financial instruments are held to manage certain macro-economic exposures. The change in fair value of the derivative financial instruments of the Company was a loss before tax of £122 million (2015: £7 million).
Notes on the parent company financial statements Continued 7 Pension scheme financial position
The majority of UK Prudential staff are members of the Group’s pension schemes. The largest scheme is the Prudential Staff Pension Scheme (the Scheme) which is primarily a closed defined benefit scheme.
At 31 December 2005, the allocation of surpluses and deficits attaching to the Scheme between the Company and the unallocated surplus of The Prudential Assurance Company Limited (PAC) with-profits fund was apportioned in the ratio 30/70 following detailed consideration of the sourcing of previous contributions. This ratio was applied to the base deficit position at 1 January 2006 and for the purpose of determining the allocation of the movements in that position up to 31 December 2016. The IAS 19 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity.
A description of the regulatory framework in which the Scheme operates, the governance of the Scheme, and the risks to which the Scheme exposes the Company is provided in note C9. The most recent full valuation has been updated to 31 December 2016, applying the principles prescribed by IAS 19. The actuarial assumptions used in determining the IAS 19 benefit obligations and the net periodic costs and sensitivity of IAS 19 benefit obligations to changes in the actuarial assumptions are also provided in note C9.
Fair value of Scheme assets 7,490 137 7,627 6,578 149 6,727 Present value of benefit obligations (6,910) (5,758)
The changes in the fair value of the underlying Scheme assets and the present value of the underlying benefit obligations are as follows: Fair value of Scheme assets
Total actuarial gains without the effect of IFRIC 14 (277) 64
Floating Rate Notes note (iv) – – – 200 – 200
The reduction in the UK corporation tax rate to 17 per cent from 1 April 2020 was substantively enacted on 6 September 2016 and does not have a material impact on the financial statements for the year ended 31 December 2016.
A summary of the ordinary shares in issue and the options outstanding to subscribe for the Company’s shares at 31 December 2016 is set out in note C10 of the Group financial statements.
Retained profit at 31 December 2016 amounted to £5,449 million (2015: £5,866 million). The retained profit includes distributable reserves of £2,962 million and non-distributable reserves of £2,487 million. The non-distributable reserves comprise £2,405 million relating to gains made by intermediate holding companies following the transfer at fair value of certain subsidiaries to other parts of the Group as part of internal restructuring exercises and £82 million of share-based payment reserves. The amount of £2,405 million is not able to be regarded as part of the distributable reserves of the parent company because the gains relate to intragroup transactions.
www.prudential.co.uk� Annual�Report�2016 Prudential plc 317 05 Financial statem ents 12 Other information a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note B3.3 of the Group financial statements.
b Information on transactions of the directors with the Group is given in note D4 of the Group financial statements. c The Company employs no staff. d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2015: £0.1 million) and for
Statement of Directors’ responsibilities in respect of the Annual Report and the financial statements
The Directors are responsible for preparing the Annual Report and the Group and parent company financial statements in accordance with applicable law and regulations.
Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In preparing each of the Group and parent company financial statements, the Directors are required to: — Select suitable accounting policies and then apply them consistently; — Make judgements and estimates that are reasonable and prudent; — For the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; — For the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and
Under applicable law and regulations, the Directors are also responsible for preparing a strategic report, directors’ report, directors’ remuneration report and corporate governance statement that comply with that law and those regulations.
2 Our assessment of risks of material misstatement In arriving at our audit opinion on the financial statements, the risks of material misstatement, in decreasing order of audit significance, that had the greatest effect on our audit, which are unchanged from 2015 were as follows: Policyholder liabilities (2016: £388,996 million, 2015: £322,518 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 168 (accounting policy) and pages 229 to 250 (financial disclosures)
The risk The Group has significant policyholder liabilities representing 85 per cent of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long term policyholder liabilities. Economic assumptions, including investment return, credit risk and associated discount rates, and operating assumptions including mortality, morbidity, expenses and persistency (including consideration of policyholder behaviour) are the key inputs used to estimate these long term liabilities.
— In the UK, the valuation of the policyholder liabilities in relation to the annuity business requires the exercise of significant judgement over the setting of mortality and credit risk assumptions.
Our procedures in the US included: — Considering the appropriateness of the assumptions used in the stochastic models for the valuation of the variable annuity guarantees.
Our procedures in the UK included: — Considering the appropriateness of the mortality assumptions used in the valuation of the annuity liabilities by reference to company and industry data on historical mortality experience and expectations of future mortality improvements, including evaluation of the choice of the Continuous Mortality Investigation (‘CMI’) model and the parameters used in relation to this.
— Considering the appropriateness of the credit risk methodology and assumptions by reference to industry practice and our expectation derived from market experience.
Our work on the policyholder liability adequacy test included assessing the reasonableness of the projected cash flows and challenging the assumptions adopted in the context of company and industry experience data and specific product features. We also performed test work to ensure the appropriateness of changes made to the policyholder liability reserving models during the year. We considered whether the Group’s disclosures in relation to the assumptions used in the calculation of policyholder liabilities are compliant with the relevant accounting requirements and appropriately represent the sensitivities of these assumptions to alternative scenarios and inputs.
Valuation of investments (2016: £421,688 million, 2015: £351,979 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 174 (accounting policy) and pages 209 to 228 (financial disclosures)
The areas that involved significant audit effort and judgement in 2016 were the valuation of illiquid positions within the financial investments portfolio representing 2 per cent of the Group’s total assets. These included unlisted equity, unlisted debt securities, certain derivatives and loans such as commercial mortgage loans and bridge loans. For these positions a reliable third party price was not readily available and therefore involved the application of expert judgement in the valuations adopted.
— Performing our own assessment of loan files to understand the performance of the loans. We examined the existing and prospective investee company cash flows in order to evaluate whether loans can be serviced or refinancing may be required and considered the impact on impairment testing performed.
Deferred acquisition costs (‘DAC’) (2016: £9,178 million, 2015: £7,022 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 172 (accounting policy) and pages 252 to 254 (financial disclosures)
The risk DAC represents 2 per cent of the Group’s total assets and involves judgements in the identification of the acquisition costs that may be deferred, the appropriateness of the deferral methodology adopted and the assessment of the recoverability of the asset.
The DAC associated with the US business, which represents 90 per cent of the total DAC, involves the greatest judgement in terms of measurement and recoverability. The amortisation and recoverability assessment of the US DAC asset is related to the achieved and projected future profit profile. This involves making assumptions about future investment returns and the consequential impact on fee income.
— Assessing the calculations performed including the appropriateness of the assumptions used in determining the estimated future profit profile and the extent of the associated adjustment necessary to the amortisation of the DAC asset. We compared the estimated future profits to the carrying value of the DAC asset to assess recoverability. Our work included assessing the reasonableness of assumptions such as the projected investment return by comparing against the Group’s investment portfolio mix and market return data.
We subjected the Group’s operations to audits for Group reporting purposes as follows: Full scope audits for Group reporting purposes in relation to the financial information of: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, and Thailand; and the fund management operations of M&G and Eastspring Singapore (new in scope for 2016).
For the remaining operations, we performed analysis at an aggregated Group level to re-examine our assessment that there were no significant risks of material misstatement within these operations.
The Group audit team visited ten component locations, comprising: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia and Thailand; the fund management operations in M&G and Eastspring Singapore; and
4 Our opinion on other matters prescribed by the Companies Act 2006 is unmodified In our opinion: — The part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and
— The information given in the Strategic Report and the Directors’ Report for the financial year is consistent with the financial statements.
— The disclosures on page 106 of the Annual Report concerning the use of the going concern basis of accounting.
6 We have nothing to report in respect of the matters on which we are required to report by exception Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading.
— We have not received all the information and explanations we require for our audit.
Prudential plc Annual Report 2016 www.prudential.co.uk324 325 Post-tax operating profit based on longer-term investment returns 326 Post-tax summarised consolidated income statement 327 Movement in shareholders’ equity 328 Summary statement of financial position
Notes on the EEV basis results 329 1 Basis of preparation 329 2 Effect of Solvency II implementation on EEV basis results on 1 January 2016 329 3 Results analysis by business area 332 4 Analysis of new business contribution 333 5 Operating profit from business in force 335 6 Short-term fluctuations in investment returns 337 7 Effect of changes in economic assumptions 338 8 Net core structural borrowings of shareholder-financed operations 338 9 Reconciliation of movement in shareholders’ equity 340 10 Analysis of movement in net worth and value of in-force for long-term business 342 11 Analysis of movement in free surplus 345 12 Expected transfer of value of in-force business and required capital to free surplus 346 13 Sensitivity of results to alternative assumptions 348 14 Methodology and accounting presentation 358 16 New business premiums and contributions 360 17 Agreement to sell Korea life business
Description of EEV basis reporting In broad terms, IFRS profit for long-term business reflects the aggregate of results on a traditional accounting basis. By contrast, EEV is a way of reporting the value of the life insurance business.
The EEV basis results have been prepared in accordance with the amended EEV Principles dated April 2016, prepared by the CFO Forum of major European insurers. The 2016 results for UK insurance operations have been prepared to reflect the Solvency II regime. The 2015 results for UK insurance operations were prepared reflecting the Solvency I basis, being the regime applicable for the year. There is no change to the basis of preparation for Asia and US operations. The EEV Principles provide consistent definitions, a framework for setting actuarial assumptions, and an approach to the underlying methodology and disclosures.
Results prepared under the EEV Principles capture the discounted value of future profits expected to arise from the current book of long-term business. The results are prepared by projecting cash flows, by product, using best estimate assumptions for all relevant factors. Furthermore, in determining these expected profits, full allowance is made for the risks attached to their emergence and the associated cost of capital, taking into account recent experience in assessing likely future persistency, mortality, morbidity and expenses. Further details are explained in notes 14 and 15.
www.prudential.co.uk� Annual�Report�2016 Prudential plc 325 06 European Em bedded V alue (EEV
Excluding UK bulk annuities 4 268 201 UK bulk annuities – 117
Asia operations 3,199 2,381 US operations 1,968 1,815 UK operations† 1,029 1,261 Other income and expenditure (679) (566) Solvency II and restructuring costs (57) (51) Interest received on tax settlement 37 –
Operating profit based on longer-term investment returns 5,497 4,840 Short-term fluctuations in investment returns 6 (507) (1,215) Effect of changes in economic assumptions 7 (60) 66 Mark to market value movements on core borrowings (4) 221 Loss attaching to the held for sale Korea life business 17 (410) 39 Total non-operating results (981) (889)
Based on post-tax operating profit including longer-term investment returns (in pence)* 214.7p 189.6p Based on post-tax profit attributable to equity holders of the Company (in pence) 176.4p 154.8p Average number of shares (millions) 2,560 2,553 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details).
www.prudential.co.uk� Annual�Report�2016 Prudential plc 327 06 European Em bedded V alue (EEV
Profit for the year attributable to equity shareholders 4,516 3,951 Items taken directly to equity: Exchange movements on foreign operations and net investment hedges 9 4,211 244
Mark to market value movements on Jackson assets backing surplus and required capital 9 (11) (76)
As previously reported 9 32,359 29,161 Effect of implementation of Solvency II on 1 January 2016* 2 (473) –
Shareholders’ equity at end of year 40,829 (1,861) 38,968 33,010 (651) 32,359
Holding company net borrowings at market * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year.
Total assets less liabilities, before deduction for insurance funds* 407,928 340,666 Less insurance funds:†
Total IFRS basis shareholders’ equity 9 14,666 12,955 Additional EEV basis retained profit‡ 9 24,302 19,404
* Annualised return on embedded value is based on EEV post-tax operating profit, as a percentage of opening EEV basis shareholders’ equity. † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year.
www.prudential.co.uk� Annual�Report�2016 Prudential plc 329 06 European Em bedded V alue (EEV
A detailed description of the EEV methodology and accounting presentation is provided in note 14.
As reported at 31 December 2015 32,359 Opening adjustment at 1 January 2016 for long-term business operations
Group total shareholders’ equity as at 1 January 2016 note (c) 31,886
Notes (a) The Solvency II framework requires technical provisions to be valued on a best estimate basis and capital requirements to be risk-based. It also requires the establishment of a risk margin (which for business in force at 31 December 2015 can be broadly offset by transitional measures). As a result of applying this framework the EEV net worth increased by £2,760 million reflecting the release of the prudent regulatory margins previously included under Solvency I, and also from the recognition within net worth of a portion of future shareholder transfers expected from the with-profits fund. The higher net worth incorporated increases in required capital reflecting the higher solvency capital requirements of the new regime.
The impact of Solvency II in 2016 for UK insurance operations is estimated to have reduced total operating profit from new and in-force business by £(39) million.
Notes on the EEV basis results Continued 3 Results analysis by business area continued
Solvency II and restructuring costs (57) (51) (51) (12)% (12)% Interest received on tax settlement 37 – – n/a n/a
Operating profit based on longer-term investment returns† 5,497 4,840 5,359 14% 3%
Profit for the year attributable to shareholders 4,516 3,951 4,344 14% 4%
Based on post-tax operating profit including longer-term investment returns*† 214.7p 189.6p 209.9p 13% 2%
Total excluding UK bulk annuities 5,315 39,275 2,492 47 6.3 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year.
(ii) Asia operations – new business contribution by territory 2016 £m 2015*£m
Unwind of discount and other expected returns 866 583 445 1,894 Effect of changes in operating assumptions 54 170 25 249 Experience variances and other items 124 428 (95) 457 2015*£m
Movement in effect of changes in operating assumptions, experience variances and other items (including foreign exchange of £84 million) 49
Notes on the EEV basis results Continued 5 Operating profit from business in force continued
Unwind of discount and other expected returns note (a) 866 725 Effect of changes in operating assumptions: Mortality and morbidity 33 63 Persistency and withdrawals note (b) (47) (46)
Experience variances and other items: Mortality and morbidity note (d) 71 54 Persistency and withdrawals note (e) 52 17 Expense note (f) (23) (32)
Notes (a) The increase in unwind of discount and other expected returns of £141 million from £725 million for 2015 to £866 million for 2016 comprises a positive £61 million impact for the growth in the opening in-force value, a positive £81 million foreign exchange effect and a net £(1) million effect for movements in long-term interest rates. (b) The 2016 charge of £(47) million (2015: £(46) million) for persistency assumption changes comprises positive and negative contributions from our various operations, with positive persistency updates on health and protection products being more than offset by negative effects for unit-linked business.
(d) The positive mortality and morbidity experience variance in 2016 of £71 million (2015: £54 million) mainly reflects better than expected experience in a number of territories. (e) The positive £52 million for persistency and withdrawals experience in 2016 (2015: £17 million) comprises positive and negative contributions from various operations, with positive persistency experience on health and protection products which more than offsets negative experience on unit-linked products. (f) The negative expense experience variance in 2016 of £(23) million (2015: £(32) million) principally arises in operations which are currently sub-scale (China, Malaysia Takaful and
Unwind of discount and other expected returns note (a) 583 472 Effect of changes in operating assumptions note (b) 170 115 Experience variances and other items: Spread experience variance note (c) 119 149 Amortisation of interest-related realised gains and losses note (d) 88 70 Other note (e) 221 193
Notes (a) The increase in unwind of discount and other expected returns of £111 million from £472 million for 2015 to £583 million for 2016 comprises a positive £40 million effect for the underlying growth in the in-force book, a positive £60 million foreign exchange effect and an £11 million impact of the 20 basis points increase in the US 10-year treasury yield during the year.
(c) The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults (see note 15(ii)). The spread experience variance in 2016 of £119 million (2015: £149 million) includes the positive effect of transactions previously undertaken to more closely match the overall asset and liability duration. The reduction compared to the prior year reflects the effects of declining yields in the portfolio caused by the prolonged low interest rate environment.
Total UK insurance operations 375 545 * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year.
(b) The credit of £25 million (2015: £55 million) for the reduction in UK corporate tax rate reflects the beneficial effect of applying a lower corporation tax rate (see note 15) to future life profits from in-force business in the UK.
(d) The 2016 benefit of £110 million (2015: £75 million) arises from the specific management actions to improve solvency, including the effect of repositioning the fixed income asset portfolio.
(f) The 2016 credit of £30 million (2015: £61 million) comprises assumption updates and experience variances for mortality, expense, persistency and other items.
(ii) Asia operations The short-term fluctuations in investment returns for Asia operations comprise: 2016 £m 2015*£m
* The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details).
(iii) US operations The short-term fluctuations in investment returns for US operations comprise: Investment return related experience on fixed income securities note (a) (85) (17) Investment return related impact due to changed expectation of profits on in-force variable annuity business in future periods based on current year separate account return, net of related hedging activity and other items note (b) (1,017) (736)
Notes (a) The charge relating to fixed income securities comprises the following elements: – the impact on portfolio yields of changes in the asset portfolio in the year; – the excess of actual realised gains and losses over the amortisation of interest-related realised gains and losses recorded in the profit and loss account; and – credit experience (versus the longer-term assumption).
(b) This item reflects the net impact of: – changes in projected future fees and future benefit costs arising from the difference between the actual growth in separate account asset values in the current year of 8.9 per cent and that assumed at the start of the year of 6.0 per cent; and – related hedging activity arising from realised and unrealised gains and losses on equity-related hedges and interest rate options, and other items.
Shareholder-backed annuity business note (a) 431 (88) With-profits and other business note (b) 438 (106)
The effects of changes in economic assumptions for in-force business included in the profit for the year arise as follows: (i) Group summary 2016 £m 2015*£m
Asia operations note (ii) 70 (139) US operations note (iii) 45 109 UK insurance operations note (iv) (175) 96 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details).
(iii) US operations The effect of changes in economic assumptions for US operations comprises: Variable annuity business 86 104 Fixed annuity and other general account business (41) 5
Note For 2016, the credit of £45 million mainly reflects the increase in the assumed separate account return and reinvestment rates for variable annuity business, following the 20 basis points increase in the US 10-year treasury yield, resulting in higher projected fee income and a decrease in projected benefit costs. For fixed annuity and other general account business, the impact reflects the effect on the present value of future projected spread income of applying a higher discount rate on the opening value of the in-force book.
(iv) UK insurance operations The effect of changes in economic assumptions for UK insurance operations comprises: 2016 £m 2015*£m
Shareholder-backed annuity business note (a) (113) (56) With-profits and other business note (b) (62) 152
Notes (a) For shareholder-backed annuity business the overall negative effect of £(113) million for 2016 (2015: £(56) million) reflects an increase in the cost of capital, driven by the lower interest rates, partially offset by the change in the present value of projected spread income arising mainly from the adoption of lower risk discount rates as shown in note 15(iii). (b) The charge of £(62) million for 2016 (2015: credit of £152 million) reflects the net effect of changes in expected future fund earned rates and risk discount rates (as shown in note 15(iii)).
Note In June 2016, the Company issued core structural borrowings of US$1,000 million 5.25 per cent Tier 2 perpetual subordinated notes. The proceeds net of costs were £681 million. In September 2016, the Company issued core structural borrowings of US$725 million 4.38 per cent Tier 2 perpetual subordinated notes. The proceeds net of costs were £546 million. The movement in IFRS basis core structural borrowings from 2015 to 2016 also includes foreign exchange effects.
Operating profit based on longer-term investment returns: Long-term business: Asset management and general insurance commission – – – – 508 – 508
Other items taken directly to equity: Exchange movements on foreign operations
Shareholders’ equity at end of year 18,472 11,805 10,307 40,584 2,454 (4,070) 38,968
Representing: Statutory IFRS basis shareholders’ equity: Total IFRS basis shareholders’ equity 4,747 5,204 5,974 15,925 2,454 (3,713) 14,666 Additional retained profit (loss) on an EEV basis note (iv) 13,725 6,601 4,333 24,659 – (357) 24,302
Statutory IFRS basis shareholders’ equity: Total IFRS basis shareholders’ equity 3,789 4,154 5,397 13,340 2,354 (2,739) 12,955 Additional retained profit (loss) on an EEV basis note (iv) 9,920 5,333 4,056 19,309 – (378) 18,931 * The balance at the beginning of the year has been presented after the adjustments for the impact of Solvency II for UK insurance operations at 1 January 2016 (see note 2 for details), together with the effect of a classification change (see note (v) below).
(ii) Intra-group dividends represent dividends that have been declared in the year and investments in operations reflect increases in share capital. The amounts included in note 11 for these items are as per the holding company cash flow at transaction rates. The difference primarily relates to intra-group loans, foreign exchange and other non-cash items. (iii) Other movements include reserve movements in respect of the shareholders’ share of actuarial gains and losses on defined benefit pension schemes, share capital subscribed, share-based payments and treasury shares.
(v) Other opening adjustments represents the effect of a classification change of £345 million from Other operations to UK insurance operations of £279 million and to Asia insurance operations of £66 million in order to align with Solvency II segmental reporting, which has no overall effect on the Group’s EEV.
Notes on the EEV basis results Continued 10 Analysis of movement in net worth and value of in-force for long-term business 2016 £m
Group Shareholders’ equity at beginning of year: Existing business – transfer to net worth 3,060 (637) 2,423 (2,423) – Expected return on existing business note 5 99 193 292 1,602 1,894 Changes in operating assumptions and
Intra-group dividends and investment in operations (1,263) – (1,263) – (1,263)
Shareholders’ equity at end of year* 5,351 10,296 15,647 24,937 40,584
Profit for the year from long-term business 798 61 859 55 914
www.prudential.co.uk� Annual�Report�2016 Prudential plc 341 06 European Em bedded V alue (EEV
Existing business – transfer to net worth 680 (332) 348 (348) – Expected return on existing business note 5 13 86 99 346 445 Changes in operating assumptions and
Profit for the year from long-term business 707 140 847 457 1,304 * Opening adjustments represent the impact of implementation of Solvency II for UK insurance operations at 1 January 2016 (see note 2 for details), together with the effect of a classification change, as discussed in note 9(v).
Value of in-force business before deduction of cost of capital and time value of guarantees 15,371 8,584 3,468 27,423 11,280 7,355 3,043 21,678
Notes on the EEV basis results Continued 11 Analysis of movement in free surplus