— The 2014 salary increase for the Chief Financial Officer was 5 per cent, all other executive directors received a 3 per cent increase. These uplifts are in line with 2014 salary increase budgets for other employees across our business units (3 per cent to 6 per cent). 2014 salaries are set out in the ‘Our executive remuneration at a glance’ section.
— No changes will be made to executive directors’ maximum opportunities under the annual bonus and long-term incentive awards other than for the Chief Financial Officer. The Chief Financial Officer’s 2014 long-term incentive award increased to 250 per cent of salary.
— The performance measures attached to 2014 bonuses and long-term incentive awards remain unchanged from those set out in the ’Remuneration in respect of 2013’ section of this report.
Notes 1 The awards for Barry Stowe and Mike Wells were made in ADRs. The figures in the table are represented in terms of ordinary shares (1 ADR = 2 shares). 2 In 2010 a scrip dividend equivalent and in 2011, 2012 and 2013 a DRIP dividend equivalent were accumulated on these awards. 3 The table above reflects the maximum number of shares (150 per cent of the original number awarded) which may be released to Mike Wells under the
R em u n eratio n rep o rt Su p p lem en tary in fo rm atio n 121 Prudential plc Annual Report 2013
Face value of conditional share awards outstanding at 1 January 2013
See page 111 for a description of the JNL LTIP. Performance over the period from 2009 to 2012 resulted in a payment of £1,117,509 to Mike Wells during 2013. Performance over the period from 2010 to 2013 will result in a payment of £633,946 being paid to Mike Wells in 2014. The awards above were made before Mike Wells became an executive director and it is anticipated that no further awards will be made to him under this plan.
Deferred 2009 annual incentive award 2010 40,474 40,474 – 31 Dec 12 02 Apr 13 552.5 1,083
Deferred 2010 annual incentive award 2011 58,314 1,522 59,836 31 Dec 13 721.5
Deferred 2011 annual incentive award 2012 52,446 1,368 53,814 31 Dec 14 750
Deferred 2011 annual incentive award 2012 96,336 2,514 98,850 31 Dec 14 750
R em u n eratio n rep o rt Su p p lem en tary in fo rm atio n 123 Prudential plc Annual Report 2013
In 2013, participants could elect to enter into savings contracts of up to £250 per month for a period of three or five years. At the end of this term, participants may exercise their options within six months and purchase shares. If an option is not exercised within six months, participants are entitled to a refund of their cash savings plus interest, if applicable under the rules. Shares are issued to satisfy those options which are exercised. No options may be granted under the schemes if the grant would cause the number of shares which have been issued, or which remain issuable pursuant to options granted in the preceding 10 years under the scheme and any other option schemes operated by the Company, or which have been issued under any other share incentive scheme of the Company, to exceed 10 per cent of the Company’s ordinary share capital at the proposed date of grant.
Share Incentive Plan (SIP) UK-based executive directors are also eligible to participate in the Company’s HMRC approved Share Incentive Plan (SIP). In 2013, all UK based employees were able to purchase Prudential plc shares up to a value of £125 per month from their gross salary (partnership shares) through the SIP. For every four partnership shares bought, an 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 SIP together with Matching Shares (awarded on a 1:4 basis) and dividend shares.
Five highest paid individuals Of the five individuals with the highest emoluments in 2013, three were directors whose emoluments are disclosed in this report.
Their emoluments were within the following bands: Number of five highest paid employees 2013
F in an cial statem en ts 125 Prudential plc Annual Report 2013 126 Index to Group IFRS financial statements 281 Balance sheet of the parent company 282 Notes on the parent company financial statements 290 Statement of directors’ responsibilities in respect of the annual report and the financial statements 291 Independent auditor’s report to the members of Prudential plc only
Benefits and claims (42,227) (44,116) Outward reinsurers’ share of benefit and claims 622 259 Movement in unallocated surplus of with-profits funds (1,549) (1,287)
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)† 2,082 3,117 Less tax charge attributable to policyholders’ returns (447) (370)
Profit for the year attributable to equity holders of the Company 1,346 2,163
Based on profit attributable to the equity holders of the Company: B6 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013 as described in note A2. Accordingly, the 2012 comparative results and related notes have been adjusted retrospectively from those previously published.
Items that will not be reclassified to profit or loss Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes: Related tax 14 (11)
P rim ary statem en ts 129 Prudential plc Annual Report 2013
Total comprehensive income for the year – – 1,298 (255) (1,034) 9 – 9
Treasury shares Movement in own shares in respect of share-based payment plans – – (10) – – (10) – (10) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – (31) – – (31) – (31)
Net increase (decrease) in equity – 6 574 (255) (1,034) (709) (4) (713)
Treasury shares Movement in own shares in respect of share-based payment plans – – (13) – – (13) – (13) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – 36 – – 36 – 36
Consolidated statement of financial position Assets 31 December Note 2013 £m 2012* £m 2011*‡ £m
Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets C5.1(b) 5,295 4,177 4,143
Intangible assets attributable to with-profits funds: Goodwill in respect of acquired subsidiaries for venture fund and other investment purposes C5.2(a) 177 178 178 Deferred acquisition costs and other intangible assets C5.2(b) 72 78 89
Investments of long-term business and other operations: Investment in joint ventures and associates accounted for using the equity method D7 809 635 516 Financial investments†: Equity securities and portfolio holdings in unit trusts 120,222 98,626 85,963
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities 218,185 205,484 177,611 Investment contract liabilities with discretionary participation features 35,592 33,812 29,745 Investment contract liabilities without discretionary participation features 20,176 18,378 16,967 Unallocated surplus of with-profits funds 12,061 10,589 9,215
‡ As a result of the adoption of the new accounting standards described above, the 2011 balance sheet has been presented in accordance with IAS 1.
P rim ary statem en ts 133 Prudential plc Annual Report 2013
Cash flows from investing activities Purchases of property, plant and equipment C13 (221) (139) Proceeds from disposal of property, plant and equipment 42 14 Acquisition of subsidiaries and distribution rights, net of cash balancenote (iii) D1 (405) (224) Change to Group’s holdings, net of cash balancenote (iii) – 23
Interest paid (9) (9) Equity capital: Issues of ordinary share capital 6 17 Dividends paid (781) (655)
Cash and cash equivalents at end of year 6,785 6,126 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013, as described in note A2. Accordingly, the 2012 comparative results and related notes have been adjusted retrospectively from those previously published.
(iii) The acquisition of Thanachart Life and the related distribution agreements in 2013 resulted in a net cash outflow of £396 million. The acquisition of REALIC in 2012, resulted in a net cash outflow of £224 million and a further cash payment of £9 million in 2013. See note D1 for further details. The net cash inflow of £23 million for change in Group’s holdings in 2012 was in respect of the dilution of M&G’s holdings in PPM South Africa resulting in a reclassification from a subsidiary to an associate.
Background Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international financial services group with its principal operations in Asia, the US and the UK. Prudential offers a wide range of retail financial products and services and asset management services throughout these territories. The retail financial products and services principally include life insurance, pensions and annuities as well as collective investment schemes.
Except for the adoption of the new and amended accounting standards for Group IFRS reporting as described in note A2 below, the accounting policies applied by the Group in determining the IFRS basis results in this report are the same as those previously applied in the Group’s consolidated financial statements for the year ended 31 December 2012.
The Group has early adopted the standards from 1 January 2013 and has applied the requirements for the relevant interests in accordance with the transition provisions of IFRS 11. The Group has recognised its investment in joint ventures as the aggregate of the carrying amounts of the assets and liabilities that were previously proportionately consolidated by the Group. This determines the deemed cost of the Group’s investments in joint ventures for applying equity accounting.
The Group’s investments in joint ventures affected by these standards are as described in note D7 and there is no change to the classification of these investments as joint ventures.
IFRS 10, ’Consolidated financial statements’, IFRS 12, ’Disclosures of interest in other entities’, and IAS 27, ‘Separate financial statements’
The standard changes the definition of control such that an investor has control over an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has ability to influence those returns through power over the investee.
The Group has assessed whether the investment holdings as at 1 January 2013 that need to be consolidated under IAS 27 for SIC12 differ under IFRS 10. Where consolidation has led to the additional funds being consolidated, the principal effect has been to ‘gross up’ the consolidated statement of financial position for: (i) the difference between the net value of the newly consolidated assets and liabilities (including those attributable to external parties) and the previous carrying value for the Group’s interest; and
IFRS 13 creates a uniform framework to explain how to measure fair value and aims to enhance fair value disclosures.
The revision to the assumption relating to expected returns altered the pension costs by an insignificant amount, with a corresponding equal and opposite effect on the actuarial gains and losses included in other comprehensive income.
These amendments, effective from 1 January 2013, require items in other comprehensive income to be presented separately based on whether or not they may be recycled to profit or loss in the future.
The Group has adopted these amendments from 1 January 2013 and amended the presentation of the statement of other comprehensive income.
A2: Adoption of new and amended accounting standards in 2013 continued
The amendment requires additional disclosures for recognised financial instruments that have been offset in accordance with IAS 32 or are subject to enforceable master netting agreements or similar arrangements.
This is disclosure only requirement with the relevant disclosures provided in note C3.5(c).
Additional information on the quantitative effect of the adoption of the new and amended accounting standards on the Group’s primary financial statements and supplementary analysis of profit is provided in note D5. For some of these changes additional disclosure requirements apply. These are reflected in the financial statements.
A3.1 Accounting policies and use of estimates and judgements The consolidated financial statements have been prepared in accordance with IFRS and IFRS Interpretations Committee (IFRIC) interpretations issued and effective for the year ended 31 December 2013.
a Critical accounting policies, accounting estimates and judgements Prudential believes that its critical accounting policies are limited to those references in the table below: Critical accounting policies Accounting policy reference
Classification of insurance and investment contracts A3.1(c) Measurement of policyholder liabilities A3.1(d) Measurement of deferred acquisition costs A3.1(f) Determination of fair value of financial investments A3.1(j)(ii) Determining impairment relating to financial assets A3.1(j)(iii)
ack gro u n d an d acco u n tin g p o licies 137 Prudential plc Annual Report 2013
The Group’s insurance operations invests in a number of limited partnerships, either directly or through unit trusts, through a mix of capital and loans. These limited partnerships are managed by general partners, in which the Group hold equity. Such interest in general partners and limited partnerships provide the Group with voting and similar rights to participate in the governance framework of the relevant activities in which limited partnerships are engaged in. Accounting for the limited partnerships as subsidiaries, joint ventures, associates or other financial investments depends on the terms of each partnership agreement and the shareholdings in the general partners. In the context of direct investment in limited partnerships, the following circumstances may indicate a relationship in which, in substance, the Group controls and consequently consolidates a limited partnership: — The Group has existing rights that give it the current ability to direct the relevant activities of the limited partnership, ie activities that significantly affect the generation of economic returns from the limited partnership’s operation; — The Group has the power to obtain the significant benefits of the activities of the limited partnerships. Generally, it is presumed that the Group has significant benefits if its participation in the limited partnership is greater than 20 per cent; and
The Group does not have a material percentage of non-controlling interests in its subsidiaries.
The Group adopted IFRS 11 for investments in joint ventures from 1 January 2013 and accordingly are accounted for using the equity method of accounting. In line with the transition provision requirements, the Group has recognised its investment in joint ventures at 1 January 2012, as the aggregate of the carrying amounts of the assets and liabilities that were previously proportionately consolidated by the Group. This determines the deemed cost of the Group’s investment in joint ventures for applying equity accounting. The effect of adoption of IFRS 11 is disclosed in note A2. Investments in associates are initially recognised at cost and adjusted thereafter for the change in Group’s share of net assets of the associates. The Group’s share of profit or loss of its joint ventures and associates is recognised in the income statement and its share of movements in other comprehensive income is recognised in other comprehensive income.
iii Structured entities Structured entities are those which have been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. In addition to the entities discussed above in A3.1b(i) and A3.1b(ii), the Group as part of its business strategy invests in structured entities such as Open-Ended Investment Companies (OEICs), Unit Trusts (UTs), variable interest entities, investment vehicles within separate accounts offered through variable annuities, collateral debt obligations, mortgage-backed securities, and similar asset-backed securities.
Where the Group’s asset manager set up the open-ended investment companies and unit trusts as part of asset management operations, the Group’s interest is limited to the administration fees charged to manage the assets of such entities. With no participation in these entities, the Group does not retain risks associated with open-ended investment companies and unit trusts and is deemed to be acting as an agent.
Other structured entities The Group holds investments in mortgage-backed securities, collateral debt obligations and similar asset-backed securities that are actively traded in a liquid market. The Group is not the sponsor of the vehicles in which it holds investments and has no administrative rights over the vehicle’s activities. The Group generates returns and retains the ownership risks commensurate to its holding and its exposure to the investments. Accordingly the Group does not have power over the relevant activities of such vehicles and all are carried at fair value through profit and loss within financial investments in the consolidated statement of financial position.
The table below provides aggregate carrying amounts of the investments in unconsolidated structured entities reported in the Group’s statement of financial position: 2013 £m
US — Variable annuity contracts — Fixed annuity contracts — Life insurance contracts
— Certain unit-linked savings and similar contracts d Measurement of policyholder liabilities and unallocated surplus of with-profits funds The measurement basis of policyholder liabilities is dependent upon the classification of the contracts under IFRS 4 described in note A3.1(c) above.
IFRS 4 permits the continued usage of previously applied GAAP for insurance contracts and investment contracts with discretionary participating features. Accordingly, except for UK regulated with-profits funds as discussed below, the modified statutory basis (MSB) of reporting as set in the Statement of Recommended Practice (SORP) issued by Association of British Insurers (ABI) has been adopted by the Group on first time application of IFRS in 2005.
For the operations in India, Japan, Taiwan and, until 2012, Vietnam, the local GAAP is not appropriate as a starting point in the context of the MSB, and, instead, the accounting for insurance contracts is based on US GAAP. For these operations the business written is primarily non-participating linked and participating business. The future policyholder benefit provisions for non-participating linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claim expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business. Where appropriate, liabilities for participating business for these operations include provisions for the policyholders’ interest in investment gains and other surpluses that have yet to be declared as bonuses.
UK insurance operations The UK regulated with-profits funds are accounted for by the voluntary application of the UK accounting standard FRS 27, ‘Life Assurance’ that requires liabilities to be calculated as the realistic basis liabilities. The realistic basis liabilities are measured by reference to the PRA’s Peak 2 basis of reporting. This Peak 2 basis requires the value of liabilities to be calculated as: — A with-profits benefits reserve, plus — Future policy related liabilities, plus — The realistic current liabilities of the fund.
ii Investment contracts with discretionary participation features For investment contracts with discretionary participation features, the accounting basis is consistent with the accounting for similar with-profits insurance contracts. Other investment contracts are accounted for on a basis that reflects the hybrid nature of the arrangements whereby part is accounted for as a financial instrument under IAS 39 and the investment management service component is accounted for under IAS 18.
For those investment contracts in the US with fixed and guaranteed terms, the Group uses the amortised cost model to measure the liability.
ack gro u n d an d acco u n tin g p o licies 141 Prudential plc Annual Report 2013 f Deferred acquisition costs for insurance contracts Except for acquisition costs of with-profits contracts of the UK regulated with-profits funds, which are accounted for under the realistic PRA regime, costs of acquiring new insurance business are accounted for in a way that is consistent with the principles of the ABI SORP with deferral and amortisation against margins in future revenues on the related insurance policies. 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. In general, this deferral is presentationally shown by an explicit carrying value for in the balance sheet. However, in some Asia operations the deferral is implicit through the reserving methodology. The recoverability of the explicitly and implicitly deferred acquisition costs is measured and is deemed impaired if the projected margins are less than the carrying value. To the extent that the future margins differ from those anticipated, then an adjustment to the carrying value will be necessary.
For interest-sensitive 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.
ii Use of fair value The Group uses current bid prices to value its investments with quoted prices. Actively traded investments without quoted prices are valued using prices provided by third parties. If there is no active established market for an investment, the Group applies an appropriate valuation technique such as a discounted cash flow technique.
The financial investments measured at fair value are classified into the following three level hierarchy on the basis of the lowest level of inputs that is significant to the fair value measurement of the financial investment concerned: Level 1: Quoted prices (unadjusted) in active markets for identical assets and liabilities. Level 2: Inputs other than quoted prices included within level 1 that are observable either directly or indirectly (ie derived from prices). Level 3: Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs).
The duration and extent to which the amortised cost exceeds fair value
For Jackson’s residential mortgage-backed and other asset-backed securities, all of which are classified as available-for-sale, the model used to analyse cash flows begins with the current delinquency experience of the underlying collateral pool for the structure, by applying assumptions about how much of the currently delinquent loans will eventually default, and multiplying this by an assumed loss severity. Additional factors are applied to anticipate ageing effects. After applying a cash flow simulation an indication is obtained as to whether or not the security has suffered, or is anticipated to suffer, contractual principal or interest payment shortfalls. If a shortfall applies an impairment charge is recorded. The difference between the fair value and book cost for unimpaired securities designated as available-for-sale is accounted for as unrealised gains or losses, with the movements in the accounting period being included in other comprehensive income.
Assets held at amortised cost Except for certain loans of the UK insurance operations and Jackson National Life, which are accounted for on a fair value through profit and loss basis, and as described below, financial assets classified as loans and receivables under IAS 39 are carried at amortised cost using the effective interest rate method. The loans and receivables include loans collateralised by mortgages, deposits and loans to policyholders. In estimating future cash flows, the Group looks at the expected cash flows of the assets and applies historical loss experience of assets with similar credit risks that has been adjusted for conditions in the historical loss experience which no longer exist or for conditions that are expected to arise. The estimated future cash flows are discounted using the financial asset’s original or variable effective interest rate and exclude credit losses that have not yet been incurred.
Certain mortgage loans of the UK insurance operations and, consequent upon the purchase of REALIC in 2012 by Jackson, policy loans held to back funds withheld under reinsurance arrangements have been designated at fair value through profit and loss as these loan portfolios are managed and evaluated on a fair value basis.
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.
ack gro u n d an d acco u n tin g p o licies 145 Prudential plc Annual Report 2013 vii Securities lending including repurchase agreements The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not derecognised; rather, they continue to be recognised within the appropriate investment classification. The Group’s policy is that collateral in excess of 100 per cent of the fair value of securities loaned is required from all securities’ borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
ix Financial liabilities designated at fair value through profit and loss Consistent with the Group’s risk management and investment strategy and the nature of the products concerned, the Group has designated under IAS 39 classification certain financial liabilities at fair value through profit and loss as these instruments are managed and their performance evaluated on a fair value basis. These instruments include liabilities related to consolidated collateralised debt obligations and net assets attributable to unit holders of consolidated unit trusts and similar funds.
k Presentation of results before tax The total tax charge for the Group reflects tax that in addition to relating to shareholders’ profits is also attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. This is explained in more detail in note B5. Reported profit before the total tax charge is not representative of pre-tax profits attributable to shareholders. Accordingly, in order to provide a measure of pre-tax profits attributable to shareholders the Group has chosen to adopt an income statement presentation of the tax charge and pre-tax results that distinguishes between policyholder and shareholder components.
For shareholder-backed business, with the exception of debt securities held by Jackson and assets classified as loans and receivables at amortised cost, all financial investments and investment property are designated as assets at fair value through profit and loss. The short-term fluctuations affect the result for the year and the Group provides additional analysis of results before and after short-term fluctuations in investment returns, together with other items that are of a short-term, volatile or one-off nature. Short-term fluctuations in investment returns on such assets held by with-profits funds do not affect directly reported shareholder results. This is because (i) the unallocated surplus of with-profits funds is accounted for as a liability and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from unallocated surplus.
n Borrowings Although initially recognised at fair value, net of transaction costs, borrowings, excluding liabilities of consolidated collateralised debt obligations, are subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds (net of related issue costs) is amortised through the income statement to the date of maturity or, for hybrid debt, over the expected life of the instrument.
v 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.
y 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 whilst 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.
z 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 Open Ended Investment Companies (OEICs), which are treated as cancelled.
Offsetting Financial Assets and Financial Liabilities – Amendments to IAS 32 This amendment, effective on or after 1 January 2014, clarifies the offsetting criteria of financial assets and liabilities. In particular the amendment clarifies that in order to meet criteria to offset a financial asset and a financial liability, a right to set-off must be currently available rather than being contingent on a future event. Further, the right to set-off must be exercisable by any of the counterparties, both in the normal course of business and in the event of default, insolvency and bankruptcy. The Group is assessing the impact of this amendment but it is not expected to have a significant effect on the Group’s financial statements.
Annual improvements to IFRS – 2010-2012 Cycle and 2011-2013 Cycle These improvements include minor changes to ten IFRS standards, and are effective for annual periods beginning on or after 1 July 2014. The Group is assessing the impact of these amendments but they are not expected to have a significant effect on the Group’s financial statements.
Operating result before gain on sale of stake in China Life of Taiwan 1,003 862 Gain on sale of stake in China Life of Taiwan – 51
US operations Jackson (US insurance operations) B4(b) 1,243 964 Broker-dealer and asset management 59 39
Solvency II implementation costs (29) (48) Restructuring costsnote (iii) (12) (19)
Operating profit based on longer-term investment returns 2,954 2,520 Short-term fluctuations in investment returns on shareholder-backed business B1.2 (1,110) 187 Amortisation of acquisition accounting adjustments D1 (72) (19) Gain on dilution of Group holdingsnote (iv) D1 – 42 (Loss) profit attaching to held for sale Japan life businessnote (v) D1 (102) 17 Costs of domestication of Hong Kong branch D2 (35) –
Insurance operations: Asianote (ii) (204) 54 USnote (iii) (625) (90) UKnote (iv) (254) 136
Notes (i) General overview of defaults The Group did not experience any defaults on its shareholder-backed debt securities portfolio in 2013 or 2012. (ii) Asia insurance operations In Asia, the negative short-term fluctuations of £(204) million (2012: positive £54 million) primarily reflect net unrealised movements on bond holdings following a rise in bond yields during the year. (iii) US insurance operations The short-term fluctuations in investment returns for US insurance operations comprise the following items: Short-term fluctuations relating to debt securities Charges in the year: Losses on sales of impaired and deteriorating bonds (5) (23) Bond write downs (8) (37) Recoveries/reversals 10 13
Total charges in the yearnote (a) (3) (47) Less: Risk margin charge included in operating profit based on longer-term investment returnsnote (b) 85 79
Interest-related realised gains: Arising in the year 64 94 Less: Amortisation of gains and losses arising in current and prior years to operating profit based on longer-term investment returns (89) (91)
Total short-term fluctuations related to debt securities 42 32 Derivatives (other than equity-related): market value movements (net of related amortisation of deferred acquisition costs)note (c) (531) 135 Net equity hedge results (principally guarantees and derivatives, net of related amortisation of deferred acquisition costsnote (d) (255) (302) Equity-type investments: actual less longer-term return (net of related amortisation of deferred acquisition costs) 89 23 Other items (net of related amortisation of deferred acquisition costs) 30 22
(a) The charges on the debt securities of Jackson comprise the following: Residential mortgage-backed securities: Prime (including agency) 1 (4)
These losses and gains are in respect of interest rate swaps and swaptions and for the Guaranteed Minimum Income Benefit (GMIB) reinsurance. The swaps and swaptions are undertaken to manage interest rate exposures and durations within the general account and the variable annuity and fixed index annuity guarantees (as described in note (d) below). The GMIB reinsurance is in place so as to insulate Jackson from the GMIB exposure.
(d) Net equity hedge result: negative fluctuation of £(255) million (2012: negative fluctuation £(302) million). These amounts are in respect of the equity-based derivatives and associated guarantee liabilities of Jackson’s variable and fixed index annuity business. The equity based derivatives are undertaken to manage the equity risk exposure of the guarantee liabilities. The economic exposure of these guarantee liabilities also includes the effects of changes in interest rates which are managed through the swaps and swaptions programmes described in note (c) above.
The amounts reflect the net effect of: – Fair value movements on free-standing equity derivatives; – The accounting value movements on the variable annuity and fixed index annuity guarantee liabilities; – Fee assessments and claim payments in respect of guarantee liabilities; and – Related DAC amortisation.
In 2013, the negative fluctuation of £(255) million reflects the net effect of mark-to-market reductions on the free-standing derivatives being offset by reductions in the carrying amounts of those guarantees that are fair valued embedded derivatives. Both aspects reflect increased equity markets ( the S&P 500 increased by 30 per cent) with the value movement on the embedded derivatives also being affected by decreases in average implied volatility levels and the 1.3 per cent increase in Treasury bond interest rates.
(iv) UK insurance operations The negative short-term fluctuations in investment returns for UK insurance operations of £(254) million (2012: positive £136 million) reflect mainly net investment movements arising in the period on fixed income assets backing the capital of the annuity business following the rise in bond yields during the year. In addition, the amount for 2013 includes the effect of a partial hedge of future shareholder transfers expected to emerge from the UK’s with-profits sub-fund taken out during the year. This hedge reduces the risk arising from equity market declines.
(v) Economic hedge value movement This item represents the cost on short-dated hedge contracts taken out in first half of 2012 to provide downside protection against severe equity market falls through a period of particular uncertainty with respect to the Eurozone. The hedge contracts were terminated in the second half of 2012. (vi) Other Short-term fluctuations in investment returns of other operations, were negative £(27) million (2012: positive £119 million) representing principally unrealised value movements on investments and foreign exchange items.
(a) Debt, equity-type securities and loans Longer-term investment returns comprise actual income receivable for the period (interest/dividend income) and for both debt and equity-type securities longer-term capital returns.
arn in gs p erfo rm an ce 153 Prudential plc Annual Report 2013
Jackson is the shareholder-backed operation for which the distinction between impairment losses and interest-related realised gains and losses is in practice relevant to a significant extent. Jackson has used the ratings by Nationally Recognised Statistical Ratings Organisations (NRSRO) or ratings resulting from the regulatory ratings detail issued by the National Association of Insurance Commissioners (NAIC) developed by external third parties such as PIMCO or BlackRock Solutions to determine the average annual risk margin reserve to apply to debt securities held to back general account business. Debt securities held to back separate account and reinsurance funds withheld are not subject to risk margin reserve charge. Further details of the risk margin reserve charge, as well as the amortisation of interest-related realised gains and losses, for Jackson are shown in note B1.2.
At 31 December 2013, the level of unamortised interest-related realised gains and losses related to previously sold bonds for the Group was a net gain of £461 million (2012: net gain of £495 million).
For equity-type securities, the longer-term rates of return are estimates of the long-term trend investment return 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.
As at 31 December 2013, the equity-type securities for US insurance non-separate account operations amounted to £1,118 million (2012: £1,004 million). For these operations, the longer-term rates of return for income and capital applied in 2013 and 2012, which reflect the combination of risk free rates and appropriate risk premiums, are as follows: Equity-type securities such as common and preferred stock and portfolio holdings in mutual funds 5.7% to 6.8% 5.5% to 6.2% Other equity-type securities such as investments in limited partnerships and private equity funds 7.7% to 9.0% 7.5% to 8.2%
For Asia insurance operations, excluding assets of the Japan life held for sale business, investments in equity securities held for non-linked shareholder-financed operations amounted to £571 million as at 31 December 2013 (2012: £474 million). The rates of return applied in the years 2013 and 2012 ranged from 3.42 per cent to 13.75 per cent with the rates applied varying by territory.
The longer-term rates of return discussed above for equity-type securities are determined after consideration by the Group’s in-house economists of long-term expected real government bond returns, equity risk premium and long-term inflation. 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 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.
(b) 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: — Fair value movements for equity-based derivatives; — Fair value movements for embedded derivatives for Guaranteed Minimum Withdrawal Benefit ‘not for life’ and fixed index annuity business, and Guaranteed Minimum Income Benefit reinsurance (see note); — Movements in accounts carrying value of Guaranteed Minimum Death Benefit and Guaranteed Minimum Withdrawal Benefit ‘for life’ 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; — Fee assessments and claim payments, in respect of guarantee liabilities; and — Related amortisation of deferred acquisition costs for each of the above items.
The Guaranteed Minimum Income Benefit liability, which is fully reinsured, subject to a deductible and annual claim limits, is accounted for in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification ( ASC) Subtopic 944-80 Financial Services – Insurance – Separate Accounts (formerly SOP 03-1) under IFRS using ‘grandfathered’ US GAAP. As the corresponding reinsurance asset is net settled, it is considered to be a derivative under IAS 39, ‘Financial Instruments: Recognition and Measurement’, and the asset is therefore recognised at fair value. As the Guaranteed Minimum Income Benefit is economically reinsured the mark to market element of the reinsurance asset is included as a component of short-term fluctuations in investment returns.
(c) Other 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. Non-equity based derivatives are primarily held by Jackson as part of a broadly-based hedging programme for features of Jackson’s bond portfolio (for which value movements are booked in the statement of comprehensive income rather than the income statement), product liabilities (for which US GAAP accounting as ‘grandfathered’ under IFRS 4 does not fully reflect the economic features being hedged), and the interest rate exposure attaching to equity-based embedded derivatives.
However, some types of business movements in liabilities do require bifurcation to ensure that at the net level (ie after allocated investment return and change for policyholder benefits) the operating result reflects longer-term market returns.
UK shareholder-backed annuity business The operating result based on longer-term investment returns reflects the impact of value movements on policyholder liabilities for annuity business in PRIL and the PAC non-profit sub-fund after adjustments to allocate the following elements of the movement to the category of ‘short-term fluctuations in investment returns’: — The impact on credit risk provisioning of actual upgrades and downgrades during the period; — Credit experience compared to assumptions; and — Short-term value movements on assets backing the capital of the business.
Credit experience reflects the impact of defaults and other similar experience, such as asset exchanges arising from debt restructuring by issuers that include effectively an element of permanent impairment of the security held. Negative experience compared to assumptions is included within short-term fluctuations in investment returns without further adjustment. This is to be contrasted with positive experience where surpluses are retained in short-term allowances for credit risk for IFRS reporting purposes. 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 (including impairments) in the operating result with unrealised gains and losses being included in short-term fluctuations. For this purpose impairments are calculated as the credit loss determined by comparing the projected cash flows discounted at the original effective interest rate to the carrying value. In some instances it may also be appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time period that reflects the underlying economic substance of the arrangements.
Earned premiums, net of reinsurance 8,871 15,383 5,590 – – – 29,844 – 29,844
Total revenue, net of reinsurance 9,814 25,384 15,188 1,308 866 244 52,804 (429) 52,375
Benefits and claims and movements in unallocated surplus of with-profits funds, net of reinsurance (6,930) (23,706) (12,518) – – – (43,154) – (43,154)
Total charges, net of reinsurance (9,065) (24,831) (14,468) (857) (807) (193) (50,221) (219) (50,440)
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns)note (i) 778 553 803 463 59 74 2,730 (648) 2,082
Operating profit based on longer-term investment returns 1,001 1,243 735 441 59 74 3,553 (599) 2,954
Costs of domestication of Hong Kong branch – – (35) – – – (35) – (35)
Movement in unallocated surplus of with-profits fundsnote (iii) (518) – (769) – – – (1,287) – (1,287)
Benefits and claims and movements in unallocated surplus of with-profits funds, net of reinsurance (7,570) (18,711) (18,863) – – – (45,144) – (45,144)
Finance costs: interest on core structural borrowings of shareholder-financed operations – (13) – (16) – – (29) (251) (280)
Profit (loss) before tax attributable to shareholders 977 855 872 511 39 69 3,323 (576) 2,747
Operating profit based on longer-term investment returns 906 964 736 371 39 69 3,085 (565) 2,520
arn in gs p erfo rm an ce 157 Prudential plc Annual Report 2013
Notes (i) This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. (ii) Investment return principally comprises: – Interest and dividends; – Realised and unrealised gains and losses on securities and derivatives classified as fair value through profit and loss under IAS 39; and – Realised gains and losses, including impairment losses, on securities classified as available-for-sale under IAS 39. (iii) The movement in unallocated surplus of with-profits funds for Asia above includes movement relating to the Hong Kong branch of PAC. For the purpose of the presentation of unallocated surplus of with-profits funds within the statement of financial position, the Hong Kong branch balance is shown within the unallocated surplus of the PAC with-profits sub-fund.
Long-term business premiums Insurance contract premiums 28,339 26,650 Investment contracts with discretionary participation feature premiums 1,877 2,243 Inwards reinsurance premiums 286 220 Less: reinsurance premiums ceded (658) (491)
Investment return Realised and unrealised gains and losses on securities at fair value through profit and loss 12,879 15,270 Realised and unrealised losses and gains on derivatives at fair value through profit and loss (1,724) 75 Realised gains on available-for-sale securities, previously recognised in other comprehensive income 64 68 Realised gains (losses) on loans 11 (51) Interestnotes (i),(ii) 6,771 6,586
(ii) Interest income includes £5 million (2012: £13 million) accrued in respect of impaired securities. (iii) Fee income includes £44 million (2012: £35 million) relating to financial instruments that are not held at fair value through profit and loss. These fees primarily related to prepayment fees, late fees and syndication fees. (iv) The following table provides additional segmental analysis of revenue from external customers: 2013 £m
Revenue from external customers: Unallocated corporate – – 26 – 26 Intra-group revenue eliminated on consolidation (98) (86) (195) 379 –
Revenue from external customers: Unallocated corporate – – 19 – 19 Intra-group revenue eliminated on consolidation (84) (77) (172) 333 –
Total revenue from external customers 7,477 15,113 7,917 – 30,507 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Earned premiums, net of reinsurance 29,844 28,622 Fee income from investment contract business and asset management (presented as ‘Other income’) 2,184 1,885
The profit included in the income statement in respect of asset management operations for the year is as follows: 2013 £m 2012* £m
Charges (excluding charges of consolidated investment funds and NPH broker-dealer fees) (857) (303) (193) (1,353) (1,144)
Share of profit from joint ventures and associates, net of related tax 12 – 23 35 24
arn in gs p erfo rm an ce 159 Prudential plc Annual Report 2013
Notes (i) The segment revenue of the Group’s asset management operations is required to include: NPH broker-dealer fees represent commissions received that are then paid on to the writing brokers on sales of investment products. To reflect their commercial nature, the amounts are also wholly reflected as charges within the income statement. After allowing for these charges, there is no effect on profit from this item. The presentation in the table above shows the amounts attributable to this item so that the underlying revenue and charges can be seen.
Underlying profit before performance-related fees 358 298 Share of associate results 12 13 Performance-related fees 25 9
Operating profit from asset management operations 395 320 Operating profit from Prudential Capital 46 51
Total M&G operating profit based on longer-term investment returns 441 371
The difference between the fees and other income shown above in respect of asset management operations, and the revenue figure for M&G shown (excluding consolidated investment funds) in the main table primarily relates to the total revenue of Prudential Capital (including short-term fluctuations) of £144 million (2012: £218 million) and commissions which have been netted off in arriving at the fee income of £859 million (2012: £728 million) in the table above. The difference in the presentation of commission is aligned with how management reviews the business.
Acquisition costs incurred for insurance policies (2,553) (2,557) Acquisition costs deferred less amortisation of acquisition costs 566 595 Administration costs and other expenditure (4,303) (3,863) Movements in amounts attributable to external unit holders of consolidated investment funds (571) (207)
(c) Interest expense, excluding interest on core structural borrowings of shareholder-financed operations, which amounted to £(120) million (2012: £(140) million) and is included as part of investment management expenses. The segmental interest expense is analysed below.
(f) Segmental analysis of depreciation and amortisation expense, and interest expense: Depreciation and amortisation expense Interest expense
B3.1 Staff and employment costs The average number of staff employed by the Group during the year was: 2013 2012*
Business operations: Asia operations 12,239 11,284 US operations 4,414 4,000 UK operations 5,533 5,035
† The charge (credit) incorporates the effect of actuarial gains and losses.
arn in gs p erfo rm an ce 161 Prudential plc Annual Report 2013
B3.2 Share-based payments 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 which are in operation include Prudential Long Term Incentive Plan (PLTIP), Group Performance Share Plan (GPSP), Business Unit Performance Plan (BUPP), Jackson Long-Term Incentive Plan (Jackson LTIP), 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.
Employees and eligible agents in a number of geographies are eligible for plans similar to the HMRC approved Save As You Earn (SAYE) share option scheme in the UK. Eligible employees participate in the International savings-related share option scheme while eligible agents based in Hong Kong and Malaysia can participate in the non-employee savings-related share option scheme.
Share purchase plans Eligible employees outside the UK are invited to participate in arrangements similar to the Company’s HMRC approved UK SIP, which allows the purchase of Prudential plc shares. For instance, staff based in Ireland are eligible for the Share Participation Plan, approved by the Irish Revenue.
B3: Acquisition costs and other expenditure continued 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 2013 and 2012: Options outstanding under SAYE schemes
The weighted average share price of Prudential plc for the year ended 31 December 2013 was £11.14 compared to £7.69 for the year ended 31 December 2012.
Risk-free interest rates are UK gilt rates with projections for three-year and five-year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over a period of 12 months up to and including the date of grant. For the Prudential LTIP (TSR) and GPSP (TSR) volatility and correlation between Prudential and a basket of 18 competitor companies is required. For grants in 2013, an average index volatility and correlation of 26 per cent and 60 per cent respectively, were used. Market implied volatilities are used for both Prudential and the components of the index. Changes to the subjective input assumptions could materially affect the fair value estimate.
Total key management remuneration includes total directors’ remuneration of £48.9 million (2012: £40.1 million) less LTIP releases of £26.4 million (2012: £21.3 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 6.8 6.5 Audit-related assurance services 2.8 3.2 Tax compliance services 0.8 0.5 Other assurance services 1.1 0.5 Services relating to corporate finance transactions 0.5 0.4 All other services 1.2 1.2
In addition, there were fees incurred of £0.1 million (2012: £0.1 million) for the audit of pension schemes.
Prudential Retirement Income Limited (PRIL) is the principal company which writes the UK’s shareholder backed business. The weighted components of the bond spread over swap rates for shareholder-backed fixed and linked annuity business for PRIL, based on the asset mix at the these dates are shown below.
Movement in the credit risk allowance The movement during 2013 of the average basis points allowance for PRIL on Pillar 1 regulatory and IFRS bases are as follows: Pillar 1 Regulatory
Total allowance for credit risk at 31 December 2012 65 42 Credit rating changes 2 1 Asset trading (3) (2) New business and other (2) 2
The methodology applied is to retain favourable credit experience in short-term allowances for credit risk on the IFRS basis but such surplus experience is not retained in the Pillar 1 credit provisions.
Overall the movement has led to the credit allowance for Pillar 1 purposes to be 47 per cent (2012: 40 per cent) of the bond spread over swap rates. For IFRS purposes it represents 32 per cent (2012: 26 per cent) of the bond spread over swap rates.
The reserves for credit risk allowance at 31 December 2013 for the UK shareholder annuity fund were as follows: Pillar 1 Regulatory
Mortality and other assumption changes For the shareholder-backed business, the net effect of assumption changes was a credit of £20 million (2012: a charge of £17 million). This comprises the aggregate effect of changes to mortality assumptions offsetting releases of margins and altered expenses and other assumptions, where appropriate, in the two periods.
Current tax expense: Corporation tax (414) (942) Adjustments in respect of prior years 15 144
Until the end of 2012 for the Group’s UK life insurance companies, shareholders’ profits were calculated using regulatory surplus as a starting point, with appropriate deferred tax adjustments for IFRS. Beginning in 2013, under new UK life tax rules, shareholders’ profits are calculated using accounting profit or loss as a starting point.
In 2013, a deferred tax credit of £598 million (2012: charge of £198 million) has been taken through other comprehensive income.
Taxation charge: Variance from expected tax charge 140 – 140 166 – 166 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Analysed into: Tax charge (credit) on operating profit (loss) based on longer-term investment returns 173 343 132 (10) 638 Tax credit on non-operating loss (25) (242) (60) (22) (349)
Expected tax rate on total profit 23% 27% Actual tax rate: Operating profit based on longer-term investment returns 17% 22% Total profit 19% 17%
† The expected tax rates shown in the table above (rounded to the nearest whole percentage) reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
Operating profit (loss) based on longer-term investment returns 906 964 736 (86) 2,520
Analysed into: Tax charge on operating profit (loss) based on longer-term investment returns 133 272 126 36 567 Tax charge (credit) on non-operating profit (loss) 13 (38) 38 4 17
c Taxes paid In 2013 Prudential remitted £1.8 billion (2012: £2.2 billion) of tax to revenue authorities, this includes £418 million (2012: £925 million) of corporation tax, £236 million of other taxes and £1,143 million collected on behalf of employees, customers and third parties.
Taxes collected‡ Total * In certain countries such as the UK, the corporation tax payments for the Group’s life insurance businesses are based on taxable profits which include policyholder investment returns on certain life insurance products.
arn in gs p erfo rm an ce 169 Prudential plc Annual Report 2013
Based on profit for the year 1,635 (289) 1,346 52.8p 52.7p 2012*
Short-term fluctuations in investment returns on shareholder-backed business B1.2 187 (24) 163 6.4p 6.4p
Profit attaching to held for sale Japan life business D1 17 – 17 0.6p 0.6p
The tables above exclude actuarial and other gains and losses on defined benefit pension schemes which, following the changes to IAS 19 described in note A2, are now reported in Other Comprehensive Income. Furthermore, in order to facilitate comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the results attributable to the held for sale Japan life business are included separately within the supplementary analysis of profit.
The weighted average number of shares for calculating earnings per share: millions millions
Shares under option at end of year 10 9 Number of shares that would have been issued at fair value on assumed option price (6) (6)
Dividend per share Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders. The final dividend for the year ended 31 December 2012 of 20.79 pence per ordinary share was paid to eligible shareholders on 23 May 2013 and the 2013 interim dividend of 9.73 pence per ordinary share was paid to eligible shareholders on 26 September 2013.
The 2013 final dividend of 23.84 pence per ordinary share will be paid on 22 May 2014 in sterling to shareholders on the principal register and the Irish branch register at 6.00pm BST on 28 March 2014 (Record Date), and in Hong Kong dollars to shareholders on the Hong Kong branch register at 4.30pm Hong Kong time on the Record Date (HK Shareholders). Holders of US American Depositary Receipts (US Shareholders) will be paid their dividends in US dollars on or about 2 June 2014. The final dividend will be paid on or about 29 May 2014 in Singapore dollars to shareholders with shares standing to the credit of their securities accounts with The Central Depository (Pte.) Limited (CDP) at 5.00pm Singapore time on the Record Date (SG Shareholders). The dividend payable to the HK Shareholders will be translated using the exchange rate quoted by the WM Company at the close of business on 11 March 2014. The exchange rate at which the dividend payable to the SG Shareholders will be translated into SG$, will be determined by CDP.
alan ce sh eet n o tes 171 Prudential plc Annual Report 2013
Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets C5.1(b) 1,026 4,140 90 5,256 20 19 – 5,295
Intangible assets attributable to withprofits funds: Goodwill in respect of acquired subsidiaries for venture fund and other investment purposes C5.2(a) – – 177 177 – – – 177 Deferred acquisition costs and other intangible assets C5.2(b) 66 – 6 72 – – – 72
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Investment contract liabilities with discretionary participation features 240 – 35,352 35,592 – – – 35,592 Investment contract liabilities without discretionary participation features 130 2,440 17,606 20,176 – – – 20,176 Unallocated surplus of with-profits funds 77 – 11,984 12,061 – – – 12,061
Core structural borrowings of shareholder-financed operations: Subordinated debt – – – – – 3,662 – 3,662
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase
Intangible assets attributable to withprofits funds: Goodwill in respect of acquired subsidiaries for venture fund and other investment purposes C5.1(a) – – 178 178 – – – 178 Deferred acquisition costs and other intangible assets C5.2(b) 72 – 6 78 – – – 78
Financial investments: Equity securities and portfolio holdings in unit trusts 12,730 49,551 36,281 98,562 64 – – 98,626
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Investment contract liabilities with discretionary participation features 348 – 33,464 33,812 – – – 33,812 Investment contract liabilities without discretionary participation features 127 2,069 16,182 18,378 – – – 18,378 Unallocated surplus of with-profits funds (reflecting application of
Core structural borrowings of shareholder-financed operations: Subordinated debt – – – – – 2,577 – 2,577
Operational borrowings attributable to shareholder-financed operations C6.2 7 26 127 160 1 2,084 – 2,245
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – 920 1,461 2,381 – – – 2,381 Net asset value attributable to unit holders of consolidated unit trusts * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Of the other £4,355 million (2012: £4,096 million) of accrued investment income and other debtors, £350 million (2012: £523 million) is expected to be settled after one year or more.
Total cash and cash equivalents 6,785 6,126 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
(iv) Other liabilities comprise: Creditors arising from direct insurance and reinsurance operations 1,159 1,095 Interest payable 56 62 Other items† 2,521 2,285 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other
Deferred acquisition costs and other intangible assets 72 – – – – – 72 78
Financial investments: Equity securities and portfolio holdings in unit trusts 28,365 90,872 899 65 21 – 120,222 98,626
Assets held for sale D1 – 328 588 – – – 916 98 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 177 Prudential plc Annual Report 2013
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as
Total policyholder liabilities and unallocated surplus of with-profits funds C4 109,052 101,251 75,711 – – – 286,014 268,263
Notes (i) The statement of financial position for with-profits business comprises the with-profits assets and liabilities of the Hong Kong, Malaysia and Singapore with-profits operations. Assets and liabilities of other participating business are included in the column for ‘Other business’. (ii) For the purposes of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance is reported within the unallocated surplus of the PAC with-profits sub-fund of the UK insurance operations.
Deferred tax assets – 2,042 2,042 1,889 Other non-investment and non-cash assets note (iv) – 6,710 6,710 6,792 Investments of long-term business and other operations: Financial investments: Equity securities and portfolio holdings in unit trusts note (iii) 65,681 327 66,008 49,551
Equity and liabilities Equity Shareholders’ equity note (vi) – 3,446 3,446 4,343
Notes (i) These amounts are for Separate Account assets and liabilities for all variable annuity products comprising those with and without guarantees. Assets and liabilities attaching to variable annuity business that are not held in the separate account eg in respect of guarantees are shown within other business. (ii) Other investments comprise: Derivative assets* 766 1,546 Partnerships in investment pools and other† 791 750 * After taking account of the derivative liabilities of £515 million (2012: £645 million), which are also included in Other non-insurance liabilities, the derivative position for US operations is a net asset of £251 million (2012: £901 million).
† Partnerships in investment pools and other comprise primarily investments in limited partnerships. These include interests in the PPM America Private Equity Fund and diversified investments in 166 (2012: 167) other partnerships by independent money managers that generally invest in various equities and fixed income loans and securities.
(v) In addition to the policyholder liabilities above, Jackson has entered into a programme of funding arrangements under contracts, which, in substance are almost identical to GICs. The liabilities under these funding agreements totalled £485 million (2012: £825 million) and are included in other non-insurance liabilities in the statement of financial position above.
Operating profit based on longer-term investment returns B1.1 1,243 964 Short-term fluctuations in investment returns B1.2 (625) (90) Amortisation of acquisition accounting adjustments arising on the purchase of REALIC (65) (19)
Profit for the year (as above) 452 621 Items recognised in other comprehensive income: Exchange movements (32) (181) Unrealised valuation movements on securities classified as available-for-sale: Unrealised holding (losses) gains arising during the year (2,025) 930 Deduct net gains included in the income statement (64) (68)
Total unrealised valuation movements (2,089) 862 Related change in amortisation of deferred acquisition costsC5.1(b) 498 (270) Related tax 557 (205)
alan ce sh eet n o tes 181 Prudential plc Annual Report 2013
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes – 177 – – – 177 178 Deferred acquisition costs – 6 – – – 6 6
Other non-investment and non-cash assets 267 2,744 468 2,329 2,797 5,808 5,448 Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method – 383 – 66 66 449 259 Financial investments: Equity securities and portfolio holdings in unit trusts 2,060 21,767 15,917 1 15,918 39,745 36,281
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) 7,112 76,741 23,652 27,127 50,779 134,632 133,912 Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds)C4.1(d) – 11,984 – – – 11,984 10,526
Operational borrowings attributable to shareholder-financed operations – – – 74 74 74 127
(iii) The fund is solely for the benefit of policyholders of SAIF. Shareholders have no interest in the profits of this fund although they are entitled to asset management fees on this business. SAIF is a separate sub-fund within the PAC long-term business fund.
(iv) Other investments comprise: Derivative assets† 1,472 1,349 Partnerships in investment pools and other‡ 3,131 2,907 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 183 Prudential plc Annual Report 2013
Liabilities Core structural borrowing of shareholder-financed operations 275 – – 275 275 Intra-group debt represented by operational borrowings at
Group level note (ii) 1,933 – – 1,933 2,084 Other non-insurance liabilities note (iii) 3,251 184 77 3,512 2,297 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) The M&G statement of financial position includes the assets and liabilities in respect of Prudential Capital. (ii) Intra-group debt represented by operational borrowings at Group level. Operational borrowings for M&G are in respect of Prudential Capital’s short-term fixed income security programme and comprise: Commercial paper 1,634 1,535 Medium Term Notes 299 549
(iii) Other non-insurance liabilities consist primarily of intra-group balances, derivative liabilities and other creditors.
Other non-investment and non-cash assets: Property, plant and equipment – – 920 920 Reinsurers’ share of insurance contract liabilities – – 6,838 6,838 Deferred tax assets – – 2,412 2,412 Current tax recoverable – – 244 244 Accrued investment income – – 2,609 2,609 2,609 Other debtors – – 1,746 1,746 1,746
alan ce sh eet n o tes 185 Prudential plc Annual Report 2013 2013 £m
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities – – 218,185 218,185 Investment contract liabilities with discretionary participation featuresnote (iii) – – 35,592 35,592 Investment contract liabilities without discretionary participation features 17,736 – 2,440 20,176 20,177 Unallocated surplus of with-profits funds – – 12,061 12,061
C3: Assets and liabilities – Classification and Measurement continued 2012* £m
Investments of long-term business and other operationsnote (ii): Investment properties 10,554 – – 10,554 10,554 Investments accounted for using the equity method – – 635 635 Loansnote (iv) 2,068 – 10,675 12,743 13,255 Equity securities and portfolio holdings in unit trusts 98,626 – – 98,626 98,626 Debt securitiesnote (v) 106,082 32,825 – 138,907 138,907 Other investmentsnote (vi) 7,547 – – 7,547 7,547 Deposits – – 12,248 12,248 12,248
(vi) See note C3.5(b) for details of the derivative assets included. The balance also contains the PAC with-profits fund’s participation in various investment funds and limited liability property partnerships.
C3.2 Group assets and liabilities – Measurement The section provides detail of the designation and valuation of the Group’s financial assets and liabilities shown under the following categories: a Determination of fair value The fair values of the assets and liabilities of the Group have been determined on the following bases.
The loans and receivables have been shown net of provisions for impairment. The fair value of loans has been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest where applicable.
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 90,645 191 36 90,872
Equity securities and portfolio holdings in unit trusts 841 100 44 985
In addition to the financial instruments shown above, the assets and liabilities held for sale on the consolidated statement of financial position at 31 December 2013 in respect of Japan life business included a net financial instruments balance of £934 million, primarily for equity securities and debt securities. Of this amount, £905 million has been classified as level 1 and £29 million as level 2.
Total financial investments, net of derivative liabilities 38,160 48,714 3,596 90,470
Other investments (including derivative assets) 26 10 – 36 Derivative liabilities – (1) – (1)
Total financial investments, net of derivative liabilities 14,192 55,196 2,642 72,030
Total financial investments, net of derivative liabilities 128,526 109,511 6,279 244,316 Investment contracts liabilities without discretionary participation features held at fair value – (16,309) – (16,309) Borrowings attributable to the with-profits fund held at fair value – (40) – (40) Net asset value attributable to unit holders of consolidated unit trusts and
Other financial liabilities held at fair value – (259) (2,021) (2,280)
When prices are not available from pricing services, quotes are sourced directly from brokers. Prudential seeks to obtain a number of quotes from different brokers so as to obtain the most comprehensive information available on their executability. Where quotes are sourced directly from brokers, the price used in the valuation is normally selected from one of the quotes based on a number of factors, including the timeliness and regularity of the quotes and the accuracy of the quotes considering the spreads provided. The selected quote is the one which best represents an executable quote for the security at the measurement date.
d Fair value measurements for level 3 fair valued assets and liabilities Reconciliation of movements in level 3 assets and liabilities measured at fair value The following table reconciles the value of level 3 fair valued assets and liabilities at 1 January 2013 to that presented at 31 December 2013.
Equity securities and portfolio holdings in unit trusts 568 50 (3) – 26 (73) – – – 84 (3) 649
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,224) (57) (1) – – 2 94 (141) – – – (1,327)
Total financial investments, net of derivative liabilities 4,293 331 (62) 1,858 997 (939) (85) 84 – 24 (222) 6,279
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (911) (20) (47) – (153) – – (93) – – – (1,224)
Of the total net gains and losses in the income statement of £480 million (2012: £419 million), £415 million (2012: £126 million) relates to net unrealised gains relating to financial instruments still held at the end of the period, which can be analysed as follows: Equity securities 46 27 Debt securities 30 51 Other investments 397 48 Derivative liabilities (8) – Net asset value attributable to unit holders of consolidated unit trusts and similar funds (57) – Other financial liabilities 7
The fair value estimates are made at a specific point in time, based upon available market information and judgments 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 2013 the Group held £3,385 million (2012: £3,034 million), 2 per cent of the total fair valued financial assets net of fair valued financial liabilities (2012: 1 per cent), within level 3.
Included within these amounts were loans of £1,887 million at 31 December 2013 (2012: £1,842 million), measured at the loan outstanding balance, attached to REALIC acquired in 2012 and held to back the liabilities for funds withheld under reinsurance arrangements. The funds withheld liability of £2,051 million at 31 December 2013 (2012: £2,021 million) was also classified within level 3, accounted for on a fair value basis being equivalent to the carrying value of the underlying assets.
Excluding the loans and funds withheld liability under REALIC’s reinsurance arrangements as described above, which amounted to a net liability of £(164) million (2012: £(179) million), the level 3 fair valued financial assets net of financial liabilities were £3,549 million (2012: £3,213 million). Of this amount, a net liability of £(304) million (2012: net liability of £(213) million) were internally valued, representing 0.1 per cent of the total fair valued financial assets net of financial liabilities (2012: 0.1 per cent). Internal valuations are inherently more subjective than external valuations. Included within these internally valued net liabilities were: (a) Debt securities of £118 million (2012: £75 million), which were either valued on a discounted cash flow method with an internally developed discount rate or on external prices adjusted to reflect the specific known conditions relating to these securities (eg distressed securities or securities which were being restructured).
(c) Liabilities of £(1,301) million (2012: £(1,199) million) for the net asset value attributable to external unit holders respect of the consolidated investment funds, which are non-recourse to the Group. These liabilities are valued by reference to the underlying assets.
(d) Other sundry individual financial investments of £1 million (2012: £7 million).
C3.3 Debt securities This note provides analysis of the Group’s debt securities, including asset-backed securities and sovereign debt securities, by segment.
Insurance operations: Asset management operations 2,045 1,839 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
The following table analyses debt securities of ’Other business’ which are not externally rated by S&P, Moody’s or Fitch.
Government bonds 387 58 Corporate bonds rated as investment grade by local external ratings agencies 491 428 Structured deposits issued by banks which are rated, but specific deposits are not 1 –
Residential mortgage-backed securities (RMBS) 1,760 2,400 Commercial mortgage-backed securities (CMBS) 2,339 2,639 Other debt securities 593 587
† Debt securities for US operations included in the statement of financial position comprise: Available-for-sale 30,205 32,825 Securities held at fair value through profit and loss to back liabilities for funds withheld under reinsurance arrangement 87 168
alan ce sh eet n o tes 197 Prudential plc Annual Report 2013 ii Valuation basis, presentation of gains and losses and securities in an unrealised loss position Under IAS 39, unless categorised as ‘held to maturity’ or ‘loans and receivables’ debt securities are required to be fair valued. Where available, quoted market prices are used. However, where securities do not have an externally quoted price based on regular trades or where markets for the securities are no longer active as a result of market conditions, IAS 39 requires that valuation techniques be applied. IFRS 13 requires classification of the fair values applied by the Group into a three level hierarchy. At 31 December 2013, 0.1 per cent of Jackson’s debt securities were classified as level 3 (31 December 2012: 0.1 per cent) comprising of fair values where there are significant inputs which are not based on observable market data.
Assets fair valued at below book value Book value* 10,825 4,551
(c) Age analysis of unrealised losses for the periods indicated The following table shows the age analysis of all the unrealised losses in the portfolio by reference to the length of time the securities have been in an unrealised loss position: Noninvestment
(d) Securities whose fair values were below 80 per cent of the book value £208 million of the £849 million of gross unrealised losses as shown in the table (a) above at 31 December 2013 (31 December 2012: £53 million of the £178 million of gross unrealised losses) related to securities whose fair values were below 80 per cent of the book value. The analysis of the £208 million (31 December 2012: £53 million), by category of debt securities and by age analysis indicating the length of time for which their fair value was below 80 per cent of the book value, is as follows: Category analysis Fair value Unrealised
The following table shows the age analysis as at 31 December 2013, of the securities whose fair values were below 80 per cent of the book value: Age analysis Fair value Unrealised
alan ce sh eet n o tes 199 Prudential plc Annual Report 2013 iii Ratings The following table summarises the securities detailed above by rating using S&P, Moody’s, Fitch and implicit ratings of mortgage-backed securities based on National Association of Insurance Commissioners (NAIC) valuations: S&P – AAA 132 187 S&P – AA+ to AA- 5,252 6,343 S&P – A+ to A- 7,728 7,728 S&P – BBB+ to BBB- 9,762 10,230 S&P – Other 941 1,173
† The amounts within ‘Other’ which are not rated by S&P, Moody’s nor Fitch, nor are MBS securities using the revised regulatory ratings, have the following NAIC classifications: For some mortgage-backed securities within Jackson, the table above includes these securities using the regulatory ratings detail issued by the NAIC. These regulatory ratings levels were established by external third parties (PIMCO for residential mortgage-backed securities and BlackRock Solutions for commercial mortgage-backed securities).
Where no external ratings are available, internal ratings produced by the Group’s asset management operation, which are prepared on the Company’s assessment of a comparable basis to external ratings, are used where possible. The £8,421 million total debt securities held at 31 December 2013 (2012: £8,345 million) which are not externally rated are either internally rated or unrated. These are analysed as follows: 2013 £m 2012* £m
The majority of unrated debt security investments were held in SAIF and the PAC with-profits fund and relate to convertible debt and other investments which are not covered by ratings analysts nor have an internal rating attributed to them. For the £2,627 million for PRIL and other annuity and long-term business investments for non-linked shareholder-backed business which are not externally rated, £605 million were internally rated AA+ to AA-, £948 million A+ to A-, £868 million BBB+ to BBB-, £65 million BB+ to BB- and £141 million were internally rated B+ and below or unrated.
d Asset management operations The debt securities are all held by M&G (Prudential Capital).
alan ce sh eet n o tes 201 Prudential plc Annual Report 2013 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 2013 is as follows: Shareholder-backed operations (excluding assets held in unit-linked funds): Asia insurance operationsnote (i) 139 144 US insurance operationsnote (ii) 4,692 5,626 UK insurance operations (2013: 36% AAA, 23% AA)note (iii) 1,727 1,408 Other operations note (iv) 667 566
(iii) UK insurance operations The majority of holdings of the shareholder-backed business relates to the UK market and primarily relates to investments held by PRIL. Of the holdings of the with-profits operations, £1,490 million (2012: £1,697 million) relates to exposure to the US markets and with the remaining exposure being primarily to the UK market.
(iv) Asset management operations Asset management operations’ exposure to asset-backed securities is held by Prudential Capital with no sub-prime exposure. Of the £667 million, 85 per cent
† The exposure to the United States sovereign debt comprises holdings of Jackson, the UK and Asia insurance operations.
The table above excludes assets held to cover linked liabilities and those of the consolidated unit trusts and similar funds. In addition, the table above excludes the proportionate share of sovereign debt holdings of the Group’s joint venture operations. As discussed in note A2 following the adoption of IFRS 11 these operations are accounted for using single line equity method in the balance sheet.
— Certain policy loans of the US insurance operations which are held to back liabilities for funds withheld under reinsurance arrangement and are also accounted on a fair value basis.
a Asia insurance operations The loans of the Group’s Asia insurance operations comprise: 2013 £m 2012* £m
Mortgage loans† 57 43 Policy loans† 611 602 Other loans‡ 254 361
Total Asia insurance operations loans 922 1,006 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Total US insurance operations loans 1,887 4,488 6,375 1,842 4,393 6,235 * All of the mortgage loans are commercial mortgage loans which are collateralised by properties. The property types are industrial, multi-family residential, suburban office, retail and hotel. The breakdown by property type is as follows:
† The policy loans are fully secured by individual life insurance policies or annuity policies. The purchase of REALIC in the second half of 2012 included policy loans which are accounted for at fair value through profit and loss to back liabilities for funds withheld under reinsurance. The policy loans are valued at £1,887 million at 31 December 2013 (2012: £1,842 million). All other policy loans are accounted for at amortised cost, less any impairment.
The US insurance operations’ commercial mortgage loan portfolio does not include any single-family residential mortgage loans and is therefore not exposed to the risk of defaults associated with residential sub-prime mortgage loans. The average loan size is £6.5 million (2012: £6.3 million). The portfolio has a current estimated average loan to value of 61 per cent (2012: 65 per cent).
c UK insurance operations The loans of the Group’s UK insurance operations comprise: 2013 £m 2012* £m
† The mortgage loans are collateralised by properties. By carrying value, 84 per cent of the £1,345 million held for shareholder-backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 30 per cent.
‡ Other loans held by the PAC with-profits fund are all commercial loans and comprise mainly syndicated loans.
Borrowings attributable to with-profits fundsC6.2 895 118 406 211 48 12 70 189 1,054
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,278 5,278 – – – – – – 5,278 2012* £m
Other liabilities 3,442 934 45 5 – – – 2,458 3,442 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,145 5,145 – – – – – – 5,145 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.:
alan ce sh eet n o tes 207 Prudential plc Annual Report 2013
After 3 years to years Total * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
The table below shows the maturity profile for investment contracts on an undiscounted basis to the nearest £ billion. This maturity profile has been based on the cash flow projections of expected benefit payments as part of the determination of the value of in-force business when preparing EEV basis results.
This table has been prepared on an undiscounted basis and accordingly the amounts shown for life assurance investment contracts differ from those disclosed on the statement of financial position. Durations of long-term business contracts, covering insurance and investment contracts, on a discounted basis are included in section C4.
In terms of liquidity risk a large proportion of the policyholder liabilities contain discretionary surrender values or surrender charges, meaning that many of the Group’s liabilities are expected to be held for the long term. Much of the Group’s investment portfolios are in marketable securities, which can therefore be converted quickly to liquid assets.
ii Market and other financial risks 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 (b) below for derivative assets. The collateral in place in relation to derivatives is described in note (c) below. Notes C3.4, describe the security for these loans held by the Group, as disclosed at the start of this note.
Of the total loans and receivables held, £14 million (2012: £25 million) are past their due date but have not been impaired. Of the total past due but not impaired, £9 million is less than one year past their due date (2012: £18 million). The Group expects full recovery of these loans and receivables.
In addition, during the year the Group took possession of £nil (2012: £16 million) of other collateral held as security, which mainly consists of assets that could be readily converted into cash.
Of these financial liabilities, 28 per cent (2012: 28 per cent) are held by the PAC with-profits fund, mainly relating to foreign currency borrowings.
The amount of exchange loss recognised in the income statement in 2013, except for those arising on financial instruments measured at fair value through profit and loss, is £284 million (2012: £213 million loss). This constitutes £1 million gain (2012: £1 million loss) on Medium Term Notes liabilities and £285 million of net loss (2012: £212 million net loss), 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 and loss.
Group total * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 209 Prudential plc Annual Report 2013
Movements in the fair value of the hedging instruments of a net gain of £0.3 million (2012: net loss of £3 million) and the hedged items of a net loss of £0.3 million (2012: net gain of £3 million) are recorded in the income statement in respect of these fair value hedges.
At 31 December 2013, the Group had lent £3,791 million (2012: £3,015 million) of securities of which £2,910 million (2012: £2,047 million) was lent by the PAC with-profits fund and held collateral under such agreements of £3,930 million (2012: £3,137 million) of which £3,012 million (2012: £2,138 million) was held by the PAC with-profits fund.
At 31 December 2013, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities. The fair value of the collateral held in respect of these transactions was £9,931 million (2012: £8,454 million).
In addition, at 31 December 2013, the Group had entered into repurchase transactions for which the fair value of the collateral pledged was cash of £17 million and securities of £524 million (2012: securities pledged of £100 million).
Financial assets: Derivative assets 3,683 (1,868) (536) (989) 290 Reverse repurchase agreements 8,454 – – (8,454) –
Notes (i) The Group has not offset any of the amounts presented in the consolidated statement of financial position. (ii) Represents the amount that could be offset under master netting or similar arrangements where Group does not satisfy the full criteria to offset on the consolidated statement of financial position.
During the year ended 31 December 2013, net impairment reversals of £17 million (2012: losses of £(50) million) were recognised for available-for-sale securities and loans and receivables analysed as shown in the attached table.
* Relates to loans held by the UK with-profits fund and mortgage loans held by Jackson: Impairment recognised on available-for-sale securities amounted to £(8) million (2012: £(37) million) arising from: Residential mortgage-backed securities (3) (8) Public fixed income – (2)
In 2013, the Group realised gross losses on sales of available-for-sale securities of £22 million (2012: £44 million) with 72 per cent (2012: 64 per cent) of these losses related to the disposal of fixed maturity securities of the top 10 individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £22 million (2012: £ 44 million), £5 million (2012: £23 million) relates to losses on sales of impaired and deteriorating securities.
The effect of those reasonably likely changes in the key assumptions that underpin the assessment of whether impairment has taken place depends on the factors described in note A3(j). 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.
Net flows: Shareholders’ transfers post tax (31) – (205) (236) Investment-related items and other movements 2,178 4,241 13,006 19,425 Foreign exchange translation differences (816) (3,678) (98) (4,592) Acquisition of REALICnote D1 – 12,912 – 12,912
alan ce sh eet n o tes 213 Prudential plc Annual Report 2013
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 reinsurance.
ii Analysis of movements in policyholder liabilities for shareholder-backed business 2012* £m
Net flowsnote (a) 1,982 9,597 (1,129) 10,450 Investment-related items and other movements 1,539 4,241 4,586 10,366 Acquisition of subsidiaries – 12,912 – 12,912 Foreign exchange translation differences (577) (3,678) – (4,255)
Comprising: Policyholder liabilities on the consolidated statement of financial position 18,113 92,261 49,505 159,879 Group’s share of policyholder liabilities relating to joint ventures 3,100 – – 3,100 2013 £m
Reclassification of Japan life business as held for salenote (b) (1,026) – – (1,026)
Investment-related items and other movements 622 8,219 2,312 11,153 Acquisition of subsidiaries 487 – – 487 Foreign exchange translation differences (1,714) (2,704) – (4,418)
Comprising: Policyholder liabilities on the consolidated statement of financial position 18,772 107,411 50,779 176,962 Group’s share of policyholder liabilities relating to joint ventures 3,159 – – 3,159 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Income and expense included in the income statement and other comprehensive income 16,561 – 1,381 Acquisition of REALIC 12,912 4,810 – Other movements in the year – (58) – Foreign exchange translation differences (4,352) (162) (7)
At 31 December 2012/1 January 2013 205,484 6,076 10,589 Reclassification of Japan life business as held for sale (1,026) – – Income and expense included in the income statement and other comprehensive income 18,133 – 1,507 Acquisition of Thanachart Life 487 – – Other movements in the year – 56 – Foreign exchange translation differences (4,893) (114) (35)
Asia US UK Total Total * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
The reinsurance asset for Jackson as shown in the table above primarily relates to certain fully collateralised former REALIC business retained by Swiss Re through 100 per cent reinsurance agreements. Jackson acquired the REALIC business in 2012 (see note D1(b)). Apart from the reinsurance acquired through the purchase of REALIC, the principal reinsurance ceded by Jackson outside the Group is on term life insurance, direct and assumed accident and health business and GMIB variable annuity guarantees. Net commissions received on ceded business and claims incurred ceded to external reinsurers totalled £37 million and £278 million respectively during 2013 (2012: £24 million and £123 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2013 or 2012.
The Group’s Asia and UK businesses do not cede significant amounts of business outside the Group. During 2013, the Group’s UK insurance business wrote a longevity swap on certain aspects of the UK’s annuity back-book liabilities. This resulted in a one-off benefit of £27 million to IFRS profit before tax. The gains and losses recognised in profit and loss for the other reinsurance contracts written in the year were immaterial.
C4.1(b) Asia insurance operations i Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of Asia insurance operations from the beginning of the year to the end of the year is as follows: With-profits
Comprising: Policyholder liabilities on the consolidated statement of financial position* 12,593 10,101 5,416 28,110 Unallocated surplus of with-profits funds on the consolidated statement of financial position 50 – – 50 Group’s share of policyholder liabilities relating to joint ventures‡ – 1,914 838 2,752
Comprising: Policyholder liabilities on the consolidated statement of financial position* 13,388 11,969 6,144 31,501 Unallocated surplus of with-profits funds on the consolidated statement of financial position 63 – – 63 Group’s share of policyholder liabilities relating to joint ventures‡ – 2,059 1,041 3,100
Reclassification of Japan life business as held for sale§ – (366) (660) (1,026)
Comprising: Policyholder liabilities on the consolidated statement of financial position* 13,138 11,918 6,854 31,910 Unallocated surplus of with-profits funds on the consolidated statement of financial position 77 – – 77 Group’s share of policyholder liabilities relating to joint ventures‡ – 1,847 1,312 3,159
* The 2012 comparative results in the consolidated statement of financial position have been adjusted retrospectively from those previously published for the application of the new accounting standards described in note A2.
Expected maturity: * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Total Asia operations 31,736 31,394 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 217 Prudential plc Annual Report 2013
Transfers from general to separate account 1,603 (1,603) – Investment-related items and other movementsnote (c) 8,725 (506) 8,219 Foreign exchange translation differencesnote (a) (1,931) (773) (2,704)
Notes (a) Movements in the year have been translated at an average rate of US$1.56/£1.00 (2012: US$1.58/£1.00). The closing balances have been translated at closing rate of US$1.66/£1.00 (2012: US$1.63/£1.00). Differences upon retranslation are included in foreign exchange translation differences.
ii Duration of liabilities The table below shows the carrying value of policyholder liabilities. The table below also shows the maturity profile of the cash flows on a discounted basis for 2013 and 2012: Fixed annuity and
The tables above show the carrying value of the policyholder liabilities. The tables’ notes below show the maturity profile of the cash flows for insurance contracts, as defined by IFRS, ie those containing significant insurance risk, and investment contracts, which do not.
Product guarantees in Asia can be broadly classified into four main categories, namely premium rate, cash value or interest rate guarantees, policy renewability, and convertibility options.
Subject to local market circumstances and regulatory requirements, the guarantee features described in note C4.2(c) in respect of UK business broadly apply to similar types of participating contracts written in the Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements.
For the countries which apply local GAAP adjusted to comply, where necessary, with modified statutory basis, the approach to determining the contract liabilities is 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.
For India, Japan, Taiwan, and until 2012, Vietnam, US GAAP is applied for measuring insurance assets and liabilities. For these countries, the future policyholder benefit provisions for non-linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claims expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business.
i Fixed annuities Fixed interest rate annuities At 31 December 2013, fixed interest rate annuities accounted for 10 per cent (2012: 13 per cent) of policy and contract liabilities of Jackson. Fixed interest rate annuities are primarily deferred annuity products that are used for asset accumulation in retirement planning and for providing income in retirement. They permit tax-deferred accumulation of funds and flexible payout options.
The policy provides that at Jackson’s discretion it may reset the interest rate, subject to a guaranteed minimum. At 31 December 2013, Jackson had fixed interest rate annuities totalling £11.2 billion (US$18.5 billion) (2012: £11.7 billion (US$19.0 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 3.05 per cent average guaranteed rate (2012: 1.0 per cent to 5.5 per cent and a 3.09 per cent average guaranteed rate).
Approximately 50 per cent (2012: 50 per cent) of the fixed interest rate annuities Jackson wrote in 2013 provide for a market value adjustment (‘MVA’) that could be positive or negative, on surrenders in the surrender period of the policy. This formula-based adjustment approximates the change in value that assets supporting the product would realise as interest rates move up or down. The minimum guaranteed rate is not affected by this adjustment. While the MVA feature minimises the surrender risk associated with certain fixed annuities, Jackson still bears a portion of the surrender risk on policies without this feature, and the investment risk on all fixed interest rate annuities. In certain cases, additional provisions are held to reflect the existence of guarantees offered in the past that are no longer supported by earnings on the existing asset portfolio.
Minimum guaranteed interest rate 2013 £m 2012 £m iv Life insurance Life insurance products accounted for 14 per cent (2012: 15 per cent) of Jackson’s policy and contract liabilities at 31 December 2013. Jackson discontinued new sales of life insurance products effective 1 August 2012 but increased its life insurance products book when it acquired REALIC in September 2012. Life products include term life and interest-sensitive life (universal life and variable universal life). Term life provides protection for a defined period and a benefit that is payable to a designated beneficiary upon death of the insured. Universal life provides permanent individual life insurance for the life of the insured and includes a savings element. Variable universal life is a type of life insurance policy that combines death benefit protection with the ability for the policyholder account to be invested in separate account funds. For certain fixed universal life plans, additional provisions are held to reflect the existence of guarantees offered in the past that are no longer supported by earnings on the existing asset portfolio.
At 31 December 2013, Jackson had interest sensitive life business in force with total account value of £5.7 billion (US$9.5 billion) (2012: £6.0 billion (US$9.7 billion)), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.65 per cent average guaranteed rate (2012: 2.5 per cent to 6.0 per cent with a 4.67 per cent average guaranteed rate). The table below shows the distribution of the interest-sensitive life business’ account values within this range of minimum guaranteed interest rates as at 31 December 2013 and 2012: Account value
Under US GAAP, investment contracts (as defined for US GAAP purposes) are accounted for by applying in the first instance a retrospective deposit method to determine the liability for policyholder benefits. This is then augmented by potentially three additional amounts. These amounts are for: — Any amounts that have been assessed to compensate the insurer for services to be performed over future periods (ie deferred income); — Any amounts previously assessed against policyholders that are refundable on termination of the contract; and — Any probable future loss on the contract (ie premium deficiency).
Variable annuity contracts written by Jackson may, as described above, provide for Guaranteed Minimum Death Benefit, Guaranteed Minimum Income Benefit, Guaranteed Minimum Withdrawal Benefit and Guaranteed Minimum Death Benefit features. In general terms, liabilities for these benefits are accounted for under US GAAP by using estimates of future benefits and fees under best estimate persistency assumptions.
In accordance with US GAAP, the ‘grandfathered’ basis for IFRS, which specifies how certain guarantee features should be accounted for, the Guaranteed Minimum Death Benefit and the ‘for life’ portion of Guaranteed Minimum Withdrawal Benefit liabilities are 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 2013, these liabilities were valued using a series of deterministic investment performance scenarios, a mean investment return of 7.4 per cent (2012: 8.4 per cent) net of external fund management fees, and assumptions for lapse, mortality and expense that are the same as those used in amortising the capitalised acquisition costs.
Guaranteed Minimum Income Benefit benefits are essentially fully reinsured, subject to a modest deductible and annual claim limits. As this reinsurance benefit is net settled, it is considered to be a derivative under IAS 39, and is therefore recognised at fair value with the change in fair value included as a component of short-term fluctuations. The direct GMIB liability is not considered a derivative instrument under IAS 39 and, as such, an accounting differences arises from this one-sided mark to market.
The assumptions used for calculating the direct Guaranteed Minimum Income Benefit liability at 31 December 2013 and 2012 are consistent with those used for calculating the Guaranteed Minimum Death Benefit and ‘for life’ Guaranteed Minimum Withdrawal Benefit liabilities. Guaranteed Minimum Withdrawal Benefit ‘not for life’ features are considered to be embedded derivatives under IAS 39. Therefore, provisions for these benefits are recognised at fair value. The change in these guaranteed benefit reserves, along with claim payments and associated fees included in reserves are included along with the hedge results in short-term fluctuations, resulting in removal of the market impact from the operating profit based on longer-term investment returns.
For Guaranteed Minimum Withdrawal Benefit and Guaranteed Minimum Income Benefit reinsurance embedded derivatives that are fair valued under IAS 39, Jackson bases its volatility assumptions on implied market volatility for periods ranging from 5 to 10 years where sufficient market liquidity is assumed to exist, followed by grading to long-term historical volatility levels beyond that point, and explicitly incorporates Jackson’s own credit risk in determining discount rates.
Non-performance risk is incorporated into the calculation through the use of discount interest rates sourced from a AA corporate credit curve. Other risk margins, particularly for policyholder behaviour are also incorporated into the model through the use of explicitly conservative assumptions. On a periodic basis, Jackson validates the resulting fair values based on comparisons to other models and market movements.
With the exception of the Guaranteed Minimum Death Benefit, Guaranteed Minimum Income Benefit, Guaranteed Minimum Withdrawal Benefit and Guaranteed Minimum Accumulation Benefit features of variable annuity contracts, the financial guarantee features of Jackson’s contracts are in most circumstances not explicitly valued, but the impact of any interest guarantees would be reflected as they are earned in the current account value (ie the US GAAP liability).
The effect of non-recurrent changes of assumptions used to measure insurance assets and liabilities of Jackson is shown in note B4(b).
c UK Features of products and guarantees Prudential’s long-term products in the UK consist of life insurance, pension products and pension annuities.
The WPSF held a provision of £36 million at 31 December 2013 (2012: £47 million) to honour guarantees on a small amount of guaranteed annuity products. SAIF’s exposure to guaranteed annuities is described below.
Regular bonus rates For regular bonuses, the 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. The expected future investment return is reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers. However, the rates declared may differ by product type, or by the date of payment of the premium, or date of issue of the policy, or if the accumulated annual bonuses are particularly high or low, relative to a prudent proportion of the achieved investment return.
When target bonus levels change, the PAC board of directors (PAC Board) has regard to the overall strength of the long-term fund when determining the length of time over which it will seek to achieve the amended prudent target bonus level.
Key assumptions As noted above, the overall rate of return on investments and the expectation of future investment returns are the most important influences in bonus rates, subject to the smoothing described below. Prudential determines the assumptions to apply in respect of these factors, including the effects of reasonably likely changes in key assumptions, in the context of the overarching discretionary and smoothing framework that applies to its with-profits business as described above. As such, it is not possible to specifically quantify the effects of each of these assumptions, or of reasonably likely changes in these assumptions.
— A With-Profits Committee of independent individuals, which assesses the degree of compliance with the PPFM and the manner in which conflicting rights have been addressed.
Net income of the fund before movement in unallocated surplus 3,236 2,840 Movement in unallocated surplus (1,294) (769)
Surplus for distribution allocated as follows: 90% policyholders’ bonus (as shown above) 1,749 1,865 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
ii Annuity business Prudential’s conventional annuities include level, fixed-increase and inflation-linked annuities, the link being to the Retail Price Index (RPI) in the majority of cases. They are mainly written within the subsidiaries PAL, PRIL, the PAC non-profit sub-fund and the PAC with-profits sub-fund, but there are some annuity liabilities in Prudential Pensions Limited and SAIF.
Tax assumptions are set equal to current rates of taxation. For non-profit business excluding unit-linked business, the 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 gross redemption yield is used except for the PAL (including the business recaptured by PAC WPSF in 2011) and PRIL annuity business where the internal rate of return of the assets backing the liabilities is used. Properties are valued using the rental 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. To calculate the non-unit reserves for linked business, assumptions have been set for the gross unit growth rate and the rate of inflation of maintenance expenses, as well as for the valuation interest rate as described above.
The PRA’s Peak 2 calculation under the realistic regime requirement is explained further in note A3.1(d) under the UK regulated with-profits section.
89% – 101% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2012 mortality model, with a long-term improvement rate of 1.50%.
In payment 93% – 99% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2011 mortality model, with a long-term improvement rate of 2.25%.
89% – 101% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2011 mortality model, with a long-term improvement rate of 1.50%.
92% – 96% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2011 mortality model, with a long-term improvement rate of 2.25%.
88% – 100% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2009 mortality model, with a long term improvement rate of 1.25%.
93% – 94% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2009 mortality model, with a long term improvement rate of 2.25%.
84% – 96% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2009 mortality model, with a long term improvement rate of 1.25%.
alan ce sh eet n o tes 229 Prudential plc Annual Report 2013 iv Unit-linked (non-annuity) and other non-profit business The majority of other long-term business written in the UK insurance operations is unit-linked business or other business with similar features. For these 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.
v Effect of changes in assumptions used to measure insurance assets and liabilities Credit risk There has been no change of approach in the setting of assumption levels of credit risk in 2013 and 2012. However, changes in the portfolio have given rise to altered levels of credit risk allowance as set out in note B4(c).
For the with-profits sub-fund, the aggregate effect of assumption changes in 2013 was a net credit to unallocated surplus of £200 million (2012: net charge of £90 million), relating to changes in mortality assumptions, offsetting releases of margins, and altered expense, persistency and economic assumptions, where appropriate in the two periods.
Cost At beginning of year 1,589 1,585 Additional consideration paid on previously acquired business – 2 Exchange differences (8) 2
The discounted cash flow valuation has been based on a three-year plan prepared by M&G, and approved by management, and cash flow projections for later years.
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 (2012: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 18 per cent (2012: 15 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 5 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.
Total of deferred acquisition costs and other intangible assets 5,295 4,177 * The 2012 comparative results have been retrospectively adjusted from those previously published for the application of IFRS 11 described in note A2 whereby equity presentation rather than proportionate consolidation for joint venture operations applies.
Effect of adoption of IFRS 11 note A2 (90) – – – – (90) (90)
Reclassification of Japan life as held for sale note D5 (28) – – – – (28) – Additions 202 716 3 12 297 1,230 1,059 Acquisition of subsidiaries – – – – 21 21 5 Amortisation to the income statement: Non-operating profit – 228 – – – 228 76
Disposals – – – – (1) (1) – Exchange differences and other movements (18) (117) – – (52) (187) (155) Amortisation of DAC related to net unrealised valuation movements on Jackson’s available-for-sale securities recognised within other comprehensive income – 498 – – – 498 (270)
† PVIF and other intangibles includes software rights of £56 million (2012: £60 million) with additions of £26 million, amortisation of £27 million, disposals and other movements of £1 million and exchange losses of £2 million. The additions of £297 million for PVIF and other intangibles in 2013 include the amount advanced to secure the exclusive 15-year bancassurance partnership agreement entered into with Thanachart Bank in Thailand. Further, the addition of £21 million for acquisition of subsidiaries is for the acquisition of Thanachart Life. The amount of £5 million for 2012 was for the acquisition of REALIC. See note D1 for further details.
US insurance operations Summary balances The DAC amount in respect of US insurance operations comprises amounts in respect of: Variable annuity business 3,716 3,330 Other business 868 821 Cumulative shadow DAC (for unrealised gains/losses booked in other comprehensive income)* (463) (952)
Under the mean reversion technique applied by Jackson, the projected level of return for each of the next five years is adjusted from period to period so that in combination with the actual rates of return for the preceding two years and the current period, the 7.4 per cent (2012: 8.4 per cent) annual return is realised on average over the entire eight-year period. Projected returns after the mean reversion period revert back to the 7.4 per cent (2012: 8.4 per cent) assumption.
As noted above, the application of the mean reversion formula has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. It would take a significant movement in equity markets in 2014 (outside the range of negative 37 per cent to positive 27 per cent) for the mean reversion assumption to move outside the corridor.
Exchange differences (138) – (148) – Change in shadow DAC related to movement in unrealised appreciation of
Note All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts: Gross amount 224 210 Accumulated amortisation (128) (110)
Present value of acquired in-force (PVIF) and other intangibles attributable to shareholders 2013 £m 2012* £m
All the goodwill relates to the UK insurance operations segment. The venture fund investments consolidated by the Group relates to investments of the PAC with-profits fund which are managed by M&G for which the goodwill is shown in the table above. Goodwill is tested for impairment of these investments by comparing the investment’s carrying value including goodwill with its recoverable amount (fair value less costs to sell). The fair value is determined by using a discounted cash flow valuation based on cash flow projections to 2016 prepared by management after considering the historical experience and future growth rates of the business. The key assumption applied in the calculations is the risk discount rate which were from 10 to 14 per cent. The discount rates were derived by reference to risk-free rates and an equity premium risk. In 2013 and 2012, none of the goodwill was impaired.
At 1 January Gross amount 92 96 Accumulated amortisation (22) (13)
alan ce sh eet n o tes 235 Prudential plc Annual Report 2013
Holding company operations: US$1,000m 6.5% Perpetual Subordinated Capital Securities 604 615 US$250m 6.75% Perpetual Subordinated Capital Securities note (vi) 151 154 US$300m 6.5% Perpetual Subordinated Capital Securities note (vi) 181 185 US$750m 11.75% Perpetual Subordinated Capital Securities 451 458 US$700m 5.25% Perpetual Subordinate Capital Securities note (iv), (vi) 417 – US$550m 7.75% Perpetual Subordinated Capital Securities note (vi) 329 334
(ii) The senior debt ranks above subordinated debt in the event of liquidation. (iii) The Prudential Capital bank loan of £275 million has been made in two tranches: a £160 million loan maturing on 20 December 2017, currently drawn at a cost of 12 month £LIBOR plus 0.4 per cent and a £115 million loan also maturing on 20 December 2017 and currently drawn at a cost of 12 month £LIBOR plus 0.59 per cent. (iv) In January 2013, the Company issued core structural borrowings of US$700 million 5.25 per cent Tier 1 Perpetual Subordinated Capital Securities primarily to retail investors in Asia. The proceeds, net of costs, were US$689 million.
Commercial paper 1,634 1,535 Medium Term Notes 2013 note (ii) – 250 Medium Term Notes 2015 299 299
Borrowings in respect of short-term fixed income securities programmes 1,933 2,084 Non-recourse borrowings of US operations 18 20
Notes (i) In addition to the debt listed above, £200 million Floating Rate Notes were issued by Prudential plc in October 2013 which will mature in April 2014. These Notes have been wholly subscribed by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. These notes were originally issued in October 2008 and have been reissued upon their maturity.
In addition, other borrowings include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson.
In all instances the holders of the debt instruments issued by these subsidiaries and funds do not have recourse beyond the assets of those subsidiaries and funds.
Non-recourse borrowings of consolidated investment funds 691 759 £100m 8.5% undated subordinated guaranteed bonds of Scottish Amicable Finance plc† 100 100 Other borrowings (predominantly obligations under finance leases) 104 109 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
† The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinate to the entitlements of the policyholders of that fund.
C6.3 Maturity analysis The following table sets out the contractual maturity analysis of the Group’s borrowings on the statement of financial position: Shareholder-financed operations With-profits operations
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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 ‘Group chief risk officer’s report on the risks facing our business and our capital strength’ within the Strategic Report.
Market risk is the risk that the fair value or future cash flows of a financial instrument or, in the case of liabilities of insurance contracts, their carrying value will fluctuate because of changes in market prices. Market risk comprises three types of risk, namely: — Foreign exchange risk: due to changes in foreign exchange rates; — Interest rate risk: due to changes in market interest rates; and — Other price risk: due to fluctuations in market prices (other than those arising from interest rate risk or foreign exchange risk).
Net neutral direct exposure (indirect exposure only) Investment performance subject to smoothing through declared bonuses
Credit risk for assets covering liabilities and shareholder capital Interest rate risk for assets in excess of liabilities ie assets representing shareholder capital
Detailed analyses of sensitivity of IFRS basis profit or loss and shareholders’ equity to key market and other risks by business unit are provided in notes C7.2, C7.3, C7.4 and C7.5. The sensitivity analyses provided show the effect on profit or loss and shareholders’ equity to changes in the relevant risk variables, all of which are reasonably possible at the relevant balance sheet date.
C7: Risk and sensitivity analysis continued i Sensitivity to risks other than foreign exchange risk With-profits business Similar principles to those explained for UK with-profits business in C7.4 apply to profit emergence for the Asia with-profits business. Correspondingly, the profit emergence reflects bonus declaration and is relatively insensitive to period by period fluctuations in insurance risk or interest rate movements.
Unit-linked business As for the UK insurance operations, for unit-linked business, the main factor affecting the profit and shareholders’ equity of the Asia operations is investment performance through asset management fees. The sensitivity of profits and shareholders’ equity to changes in insurance risk interest rate risk and credit risk are not material.
For the purposes of analysing sensitivity to variations in interest rates, reference has been made to the movements in the 10-year government bond rates of the territories. At 31 December 2013, 10-year government bond rates vary from territory to territory and range from 1.7 per cent to 9.0 per cent (2012: 0.6 per cent to 9.5 per cent).
Net effect on profit and shareholders’ equity 277 (175) 160 (216)
Equity price risk The non-linked shareholder business has limited exposure to equity and property investment (£571 million at 31 December 2013). Generally changes in equity and property investment values are not directly offset by movements in policyholder liabilities.
Net effect on profit and shareholders’ equity (90) (45) (103) (52)
alan ce sh eet n o tes 241 Prudential plc Annual Report 2013
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 would be decreased by approximately £38 million (2012: £30 million). Mortality and morbidity has 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 2013, the rates for the most significant operations are given in note A1.
Note Sensitivity on profit (loss) before tax ie aggregate of the operating profit based on longer-term investment returns and short-term fluctuations in investment returns.
Equity risk — Related to the incidence of benefits related to guarantees issued in connection with its VA contracts; and
— The risk of mismatch between the expected duration of certain annuity liabilities and repayment risk and extension risk inherent in mortgage-backed securities.
Jackson’s derivative programme is used to manage interest rate risk associated with a broad range of products and equity market risk attaching to its equity-based products. Movements in equity markets, interest rates and credit spreads materially affect the carrying value of derivatives which are used to manage the liabilities to policyholders and backing investment assets. Combined with the use of US GAAP measurement (as ‘grandfathered’ under IFRS 4) for the insurance contracts assets and liabilities which is largely insensitive to current period market movements, the Jackson total profit (ie including short-term fluctuations in investment returns) is very sensitive to market movements. In addition to these effects the Jackson shareholders’ equity is sensitive to the impact of interest rate and credit spread movements on the value of fixed income securities. Movements in unrealised appreciation on these securities are included as movement in shareholders’ equity (ie outside the income statement).
Jackson uses free-standing derivative instruments for hedging purposes. Additionally, certain liabilities, primarily trust instruments supported by funding agreements, fixed index annuities, certain GMWB variable annuity features and reinsured GMIB variable annuity features contain embedded derivatives as defined by IAS 39, ‘Financial Instruments: Recognition and Measurement’. Jackson does not account for such derivatives as either fair value or cash flow hedges as might be permitted if the specific hedge documentation requirements of IAS 39 were followed. Financial derivatives, including derivatives embedded in certain host liabilities that have been separated for accounting and financial reporting purposes are carried at fair value.
Value movements on the derivatives are reported within the income statement. In preparing Jackson’s segment profit as shown in note B1.1, value movements on Jackson’s derivative contracts are included within short-term fluctuations in investment returns and excluded from operating results based on longer-term investment returns.
Combination net deposits plus minimum return, highest specified anniversary account value minus withdrawals post-anniversary * Amounts shown for Guaranteed Minimum Withdrawal Benefit comprise sums for the ‘not for life’ portion (where the guaranteed withdrawal base less the account value equals to the net amount at risk (NAR)), and a ‘for life’ portion (where the NAR has been estimated as the present value of future expected benefit payment remaining after the amount of the ‘not for life’ guaranteed benefits is zero).
Account balances of contracts with guarantees were invested in variable separate accounts as follows: Mutual fund type: Money market 703 729
As noted above, Jackson is exposed to equity risk through the options embedded in the fixed index liabilities and Guaranteed Minimum Death Benefit and Guaranteed Minimum Withdrawal Benefit 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 separate account fees.
In addition to the exposure explained above, Jackson is also exposed to equity risk from its holding of equity securities, partnerships in investment pools and other financial derivatives, including that relating to the reinsurance of Guaranteed Minimum Income Benefit guarantees.
Pre-tax profit, net of related changes in amortisation of DAC 485 165 77 213 295 139 (105) (256)
Net sensitivity of profit after tax and shareholders’ equity 315 107 50 139 192 90 (68) (167)
alan ce sh eet n o tes 245 Prudential plc Annual Report 2013 ii Sensitivity to interest rate risk Notwithstanding the market risk exposure previously described, 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 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 attaching to variable annuity business (other than ‘for-life’) are accounted for as embedded derivatives which are fair valued and so will be sensitive to changes in interest rate.
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within the income statement. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease (subject to a floor of zero) and increase in interest rates at 31 December 2013 and 2012 is as follows: Decrease
Profit and loss: Pre-tax profit effect (net of related changes in amortisation of DAC) (128) (66) (52) (161) (187) – (54) (186) Related effect on charge for deferred tax 45 23 18 56 65 – 19 65
Related effect on movement in deferred tax (918) (517) 517 918 (889) (499) 499 889
iii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2013, the rates were US$1.56 (2012: US$1.58) and US$1.66 (2012: US$1.63) to £1.00 sterling, respectively. A 10 per cent increase or decrease in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows: A 10% increase in US$:£ exchange rates
Profit before tax attributable to shareholders note (50) (78) 61 95 Profit for the year (41) (56) 50 69 Shareholders’ equity attributable to US insurance operations (313) (395) 383 483
For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest sensitive life business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For interest-sensitive business, the key assumption is the expected long-term spread between the earned rate and the rate credited to policyholders, 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 actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual experience is measured by internally developed expense, mortality and persistency studies.
— The required level of provision for guaranteed minimum death benefit claims.
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 PRIL and the PAC non-profit sub-fund. Further details are described below.
With-profits sub-fund business The shareholder results of the UK with-profits business (including non-participating annuity business of the WPSF and of Prudential Annuities Limited (PAL), which is owned by the WPSF) are only sensitive to market risk through the indirect effect of investment performance on declared policyholder bonuses.
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.
alan ce sh eet n o tes 247 Prudential plc Annual Report 2013
The main market risk sensitivity for the UK shareholder-backed annuity business arises from interest rate risk on the debt securities which substantially represent shareholders’ equity. This shareholders’ equity comprises the net assets held within the long-term fund of the company that cover regulatory basis liabilities that are not recognised for IFRS reporting purposes, for example contingency reserves, and shareholder capital held outside the long-term fund.
Due to the matching of policyholder liabilities to attaching asset value movements the UK unit-linked business is not directly affected by market or credit risk. The liabilities of the other business are also broadly insensitive to market risk. Profits from unit-linked and similar contracts primarily arise from the excess of charges to policyholders for management of assets under the Company’s stewardship, over expenses incurred. The former is most sensitive to the net accretion of funds under management as a function of new business and lapse and timing of death. The accounting impact of the latter is dependent upon the amortisation of acquisition costs in line with the emergence of margins (for insurance contracts) and amortisation in line with service provision (for the investment management component of investment contracts). By virtue of the design features of most of the contracts which provide low levels of mortality cover, the profits are relatively insensitive to changes in mortality experience.
Carrying value of debt securities and derivatives 8,602 3,843 (3,170) (5,827) 9,006 3,993 (3,265) (5,983)
C7.5 Asset management and other operations a Asset management i Sensitivities to foreign exchange risk Consistent with the Group’s accounting policies, the profits of Eastspring Investments and US asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. The rates for the functional currencies of most significant operations are shown in note A1.
A 10 per cent increase in the relevant exchange rates 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 £21 million (2012: £10 million) and £44 million (2012: £29 million) respectively.
alan ce sh eet n o tes 249 Prudential plc Annual Report 2013
The table that follows provides a breakdown of the recognised deferred tax assets set out in the table above for both the short-term timing differences and unused tax losses split by business unit. The table also shows the period of estimated recoverability for each respective business unit. For these and each category of deferred tax asset recognised their recoverability against forecast taxable profits is not significantly impacted by any current proposed changes to future accounting standards.
Asia 24 1 to 3 years 20 3 to 5 years Jackson 1,733 With run-off of in-force book
UK long-term business 135 1 to 10 years 2 1 to 3 years Other 158 1 to 10 years 7 1 to 3 years
C8.2 Current tax asset and liability Of the £244 million (2012: £248 million) current tax recoverable, the majority is expected to be recovered in one year or less.
The current tax liability decreased to £395 million (2012: £443 million) reflecting the settlement of prior year balances in the UK and Asia following the agreement with taxation authorities.
C9: Defined benefit pension schemes a Summary and background information The Group asset/liability in respect of defined benefit pension schemes is as follows: PSPS Other schemes Total Total
Economic surplus (deficit) (including investment in Prudential insurance policies)note (c) 124 (80) 44 128
IAS 19 pension asset (liability) on the Group statement of financial position* 124 (194) (70) (41)
* At 31 December 2013, the PSPS pension asset of £124 million (2012: £164 million) and the other schemes’ pension liabilities of £194 million (2012: £205 million) are included within ‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position.
The Group also operates two smaller UK defined benefit schemes in respect of Scottish Amicable and M&G. In addition, there are two small defined benefit schemes in Taiwan which have negligible deficits.
The last completed actuarial valuation of PSPS was as at 5 April 2011, finalised in 2012 by CG Singer, Fellow of the Institute and Faculty of Actuaries, of Towers Watson Limited. This valuation demonstrated the scheme to be 111 per cent funded by reference to the Scheme Solvency Target that forms the basis of the scheme’s funding objective. Based on this valuation, future contributions into the scheme were reduced to the minimum level of contributions required under the scheme rules effective from July 2012. Excluding expenses, the contributions are now payable at approximately £6 million per annum for ongoing service of active members of the scheme. No deficit or other funding is required. Deficit funding for PSPS, where applicable, as applied prior to 2012, is apportioned in the ratio of 70/30 between the PAC with-profits fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant to current activity.
Mortality assumptions: The tables used for PSPS pensions in payment at 5 April 2011 were: Base post retirement mortality For current male (female) pensioners 113% (108%) of the mortality rates of the 2000 series mortality tables (PNMA00/PNFA00), published by the Continuous Mortality Investigation Bureau (CMI).
Allowance for future improvements to post retirement mortality For males (females) 100% (75%) of Medium Cohort subject to a minimum rate of improvement of 2.00% (1.25%) up to the age of 90, decreasing linearly to zero by age of 120 with a long-term rate of 1.75% pa (1.5% pa) but adjusted as follows: — Period improvements are blended between ages 60 to 80 to the long-term improvement rate over a 15 year period (compared with a 20 year period in the core CMI model); and
— Cohort improvements are assumed to dissipate over a 30 year period, or by age 90 if earlier (compared with a 40 year period, or by age 100 if earlier, in the core CMI model).
Summary economic and IAS 19 financial positions Under the IAS 19 ‘Employee Benefits’ valuation basis, the Group applies IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. Under IFRIC 14, a surplus is only recognised to the extent that the Company is able to access the surplus either through an unconditional right of refund to the surplus or through reduced future contributions relating to ongoing service, which have been substantively enacted or contractually agreed. Further, the IFRS financial position recorded, reflects the higher of any underlying IAS 19 deficit and any obligation for committed deficit funding where applicable. For PSPS, the Group does not have an unconditional right of refund to any surplus of the scheme.
The IAS 19 deficit of the SASPS at 31 December 2013 was a deficit of £115 million (2012: deficit of £74 million) and has been allocated approximately 50 per cent to the PAC with-profits fund and 50 per cent to the shareholders’ fund.
Risks to which the defined benefit schemes expose the Group Responsibility of making good of any deficit that may arise in the schemes lies with the employers of the schemes, which are subsidiaries of the Group. Accordingly, the pension schemes expose the Group to a number of risks and the most significant of which are detailed below: — Interest rate and investment risk – this risk arises because the schemes are not invested wholly in assets that most closely match the expected future cash flows. Therefore, falling equity markets and bond yields may lead to higher deficits in the schemes. Details of the investment portfolio of the schemes are provided in note 3; — Inflation risk – the majority of the benefit obligations of all three schemes are linked to inflation, and higher inflation will lead to higher liabilities; and
— Mortality risk – increases in life expectancy of the members would mean that benefits are paid for longer and will result in an increase in the scheme’s liabilities.
The Rules of the Group’s largest pension arrangement, the defined benefit section of PSPS, a final salary scheme, specify that, in exercising its investment powers, the Trustee’s objective is to achieve the best overall investment return consistent with the security of the assets of the scheme. In doing this, consideration is given to the nature and duration of the scheme’s liabilities. The Trustee sets the benchmark for the asset mix, following analysis of the liabilities by the Scheme’s Actuary and, having taken advice from the Investment Managers, then selects benchmark indices for each asset type in order to measure investment performance against a benchmark return.
The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the Actuarial Valuation, or earlier if the Scheme Actuary recommends. Interim reviews are conducted annually based on changing economic circumstances and financial market levels.
The investment policies and strategies for the other two UK defined benefit schemes (the SASPS and M&GGPS, which are both final salary schemes), follow similar principles, but have different target allocations reflecting the particular requirements of the schemes. All of the three UK schemes are closed to new entrants.
alan ce sh eet n o tes 253 Prudential plc Annual Report 2013 b Assumptions The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended 31 December were as follows: Discount rate* 4.4 4.4 Rate of increase in salaries 3.3 2.7 Rate of inflation†: Retail prices index (RPI) 3.3 2.7 Consumer prices index (CPI) 2.3 2.0
The calculations are based on current actuarially calculated mortality estimates with a specific allowance made for future improvements in mortality. The specific allowance made is in line with a custom calibration and has been updated in 2013 to reflect the 2011 mortality model from the Continuous Mortality Investigation Bureau of the Institute and Faculty of Actuaries (CMI). The tables used for PSPS immediate annuities in payment at 31 December 2013 were: Male: 112.0 per cent PNMA00 with improvements in line with a custom calibration of the CMI’s 2011 mortality model, with a long-term mortality improvement rate of 1.75 per cent per annum; and
The mean term of the current PSPS liabilities is around 17 years. Using external actuarial advice provided by the scheme actuaries being Towers Watson for the valuation of PSPS, Xafinity Consulting for SASPS and Aon Hewitt Limited for the M&GGPS, the most recent full valuations have been updated to 31 December 2013, applying the principles prescribed by IAS 19.
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 2013, the investments in Prudential insurance policies comprise £143 million (2012: £123 million) for PSPS and £114 million (2012: £169 million) for the M&GGPS. In principle, on consolidation, the investments are eliminated against policyholder liabilities of UK insurance operations so that the formal IAS 19 position for the schemes in isolation excludes these items. This treatment applies to the M&GGPS investments. However, as a substantial portion of the Company’s interest in the underlying surplus of PSPS is not recognised, the adjustment is not necessary for the PSPS investments.
Movements on the pension scheme deficit determined on the economic basis are as follows, with the effect of the application of IFRIC 14 being shown separately: 2013 £m
Less: amount attributable to PAC with-profits fund (787) (21) 366 (15) (457)
Less: amount attributable to PAC with-profits fund 709 32 (313) – 428
Shareholders’ share: Gross of tax surplus (deficit) (301) (7) 134 – (174)
Less: amount attributable to PAC with-profits fund (78) 11 53 (15) (29)
* The IAS 19 basis plan assets at 31 December 2013 of £6,687 million (2012: £6,905 million) is different from the economic basis plan assets of £6,944 million (2012: £7,197 million) as shown above due to the exclusion of investment in Prudential insurance policies, which are eliminated on consolidation of £257 million (2012: £292 million) comprising £143 million for PSPS (2012: £123 million) and £114 million for the M&GGPS scheme (2012: £169 million).
The expected maturity analysis of the benefit obligations as at 31 December 2012 is similar to those of 2013 above.
(iii) The adjustments for investments in Prudential insurance policies are consolidation adjustments for intragroup assets and liabilities with no impact to operating results.
(iv) Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2014 amounts to £56 million (2013: £56 million).
(v) The actuarial and other gains and losses attributable to policyholders and shareholders as shown in the table above are analysed as follows: Actuarial and other gains and losses Return on the scheme assets less amount included in interest income (366) (131) (Losses) gains on changes in demographic assumptions (22) 14 Losses on changes in financial assumptions (174) (287) Experience losses on scheme liabilities (1) (4)
Rate of inflation RPI: 3.3% RPI: 2.7% RPI: Decrease by 0.2% Decrease in scheme liabilities by: CPI: 2.3% CPI: 2.0% CPI: Decrease by 0.2% with consequent reduction in salary increases
Transactions by Prudential plc and its subsidiaries in Prudential plc shares The Group buys and sells Prudential plc (‘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 £141 million as at 31 December 2013 (2012: £97 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans. At 31 December 2013, 7.1 million (2012: 8.0 million) Prudential plc shares with a market value of £94.5 million (2012: £69 million) were held in such trusts all of which are for employee incentive plans.
All share transactions were made on an exchange other than the Stock Exchange of Hong Kong. Other than set out above the Group did not purchase, sell or redeem any Prudential plc listed securities during 2013 or 2012.
This statement sets out the estimated capital position of the Group’s subsidiaries, by life assurance and asset management operations by reference to the local regulations as at 31 December 2013.
C11.1 Life assurance business a Summary statement The Group’s estimated capital position for its life assurance subsidiaries with reconciliations to shareholders’ equity is shown below. In addition the statement provide an analysis of available capital for Group’s life assurance operations, determined by reference to the local regulations, to meet risks and regulatory requirements.
Group shareholders’ equity Held outside long-term funds: Held in long-term fundsnote (iii) – – – 2,064 – – 2,064 2,087
Adjustments to regulatory basis Unallocated surplus of with-profits fundsnote (v) – 11,984 11,984 – – 77 12,061 10,589 Shareholders’ share of realistic liabilities – (3,112) (3,112) – – – (3,112) (2,469) Deferred acquisition costs of non-participating business and goodwill not recognised for regulatory reporting – (5) (5) (89) (4,121) (784) (4,999) (4,201)
Jackson surplus notesnote (iv) – – – – 151 – 151 153 Investment and policyholder liabilities valuation differences between IFRS and regulatory basis for Jacksonnote (vii) – – – – 2,610 – 2,610 696
Pension liability difference between IAS 19 and regulatory basisnote (vii) – (55) (55) – – – (55) (107)
Valuation difference on PAL between IFRS basis and regulatory basis – (195) (195) – – – (195) (215)
Total available capital resources of life assurance businesses on local regulatory bases – 8,000 8,000 2,708 2,903 1,802 15,413 13,890
Total policyholder liabilities shown in the consolidated statement of financial position 7,112 76,741 83,853 50,779 107,411 31,910 273,953 257,674
(vi) Principally includes unit-linked and similar contracts in the UK and GIC liabilities of Jackson. (vii) The investment and policyholder liabilities valuation difference between IFRS and regulatory bases for Jackson is mainly due to not all investments being carried at fair value under the regulatory basis and also due to the valuation difference on annuity reserves. (viii) The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Group shareholders’ equity Held outside long-term funds: Held in long-term funds 2,064 – – 2,064
c Movement in total available capital Total available capital for the Group’s life assurance operations has changed as follows: £m
Changes in management policy (100) – – – (100) Changes in regulatory requirements 600 – – (23) 577 New business and other factorsnote (v) 300 216 4 170 690
(iv) Asia life assurance subsidiaries The increase of £181 million in 2013 reflects an underlying increase of £325 million (applying the relevant 2013 year end exchange rates) and £143 million of exchange translation loss.
i Asia insurance operations The available capital shown above of £1,802 million (2012: £1,621 million) represents the excess of local regulatory basis assets over liabilities before deduction of required capital of £699 million (2012: £661 million).
In 2013, the local regulatory basis in Indonesia was replaced with the Indonesian authority’s risk-based capital framework. In accordance with the framework, policy reserves for traditional business are determined on a gross premium reserve basis using prudent best estimate assumptions. For linked business, the value of the units are maintained with a non-unit reserve which is calculated in accordance with standard actuarial methodology.
Korea Policy reserves for traditional business are determined on net premium reserve basis using standard mortality and prescribed standard interest rates.
For linked business, the value of the units are held together with the non-unit reserves and calculated in accordance with the local regulator’s standard actuarial methodology.
A risk-based capital framework is applied in Korea. For local solvency, the regulatory minimum is 100 per cent of the risk-based capital. Further, in accordance with the local risk-based capital framework, insurers are expected to maintain a level of free surplus in excess of the capital requirements. The general target level for the solvency margin is greater than 150 per cent of the risk-based capital as required by the regulators.
For non-participating business, gross premium reserves determined using best estimate assumptions along with provisions of risk margin for adverse deviations discounted at the risk-free rate are held. For linked business the value of units is held together with a non-unit reserve calculated in accordance with standard actuarial methodology.
For non-participating business, gross premium reserves are held. For linked business the value of units is held together with a non-unit reserve calculated in accordance with standard actuarial methodology.
For non-participating business, the gross premium reserves are determined using best estimate assumptions along with provisions of risk margin for adverse deviations discounted at the risk-free rate.
Vietnam For traditional business, mathematical reserves are calculated using a modified net premium approach, set using assumptions agreed with the regulator.
The capital requirement is determined as 4 per cent of reserves plus a specified percentage of 0.1 per cent of sums at risk for policies with original term less than or equal to five years or 0.3 per cent of sums at risk for policies with original term of more than five years. An additional capital requirement of Vietnamese Dong 200 billion is also required for companies transacting unit-linked business.
iii UK insurance operations In the UK, the insurers, regulated by PRA, must hold capital resources equal at least to the Minimum Capital Requirement (MCR). In addition the rules require insurers to perform Individual Capital Assessments. Under these rules insurers must assess for themselves the amount of capital needed to back their business. If the PRA views the results of this assessment as insufficient, it may draw up its own Individual Capital Guidance for a firm, which can be superimposed as a requirement.
Determination of the ECR involves the comparison of two separate measurements of the firm’s resources requirement, which the PRA refers to as the ‘twin peaks’ approach.
The PRA’s basis of setting the risk capital margin is to target a level broadly equivalent to a Standard & Poor’s credit rating of BBB and to judge this by ensuring there are sufficient assets to absorb a one in 200 year event. The risk capital margin calculation achieves this by setting rules for the determination of margins to cover defined stress changes in asset values and yields for market risk, credit risk and termination risk for with-profits policies.
PAC has discretion in its management actions in the case of adverse investment conditions. Management actions encompass, but are not confined to, investment allocation decisions, levels of reversionary bonuses, crediting rates and total claim values.
Other UK life assurance subsidiaries and funds The available capital of £2,708 million (2012: £2,370 million) reflects the excess of regulatory basis assets over liabilities of the subsidiaries and funds, before deduction of the capital resources requirement of £1,364 million (2012: £1,376 million).
iv Group capital requirements In addition to the requirements at individual company level, PRA requirements under the IGD apply additional prudential requirements for the Group as a whole. Discussion of the Group’s estimated IGD position at 31 December 2013, together with market risk sensitivity disclosure provided to key management, is provided in the Strategic Report section of the Group’s 2013 Annual Report.
C11: Capital position statement continued f Sensitivity of liabilities and total capital to changed market conditions and capital management policies Prudential manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities Prudential has in each business. As a result of the diversity of products offered by Prudential and the different regulatory requirements in which it operates, Prudential employs differing methods of asset/liability and capital management, depending on the business concerned.
In addition, reserve adequacy testing under a range of scenarios and dynamic solvency testing is carried out, including under certain scenarios mandated by the UK, US and Asian regulators.
For example, for businesses that are most sensitive to interest rate changes, such as immediate annuity business, Prudential uses cash flow analysis to create a portfolio of debt securities whose value changes in line with the value of liabilities when interest rates change. This type of analysis helps protect profits from changing interest rates. This type of analysis is used in the UK for annuity business and by Jackson for its interest-sensitive and fixed index annuities and institutional products.
C11.2 Asset management operations – Regulatory and other surplus Certain asset management subsidiaries of the Group are subject to regulatory requirements. The movement in the year of the surplus regulatory capital position of those subsidiaries, combined with the movement in the IFRS basis shareholders’ funds for unregulated asset management operations, is as follows: Asset management operations
alan ce sh eet n o tes 265 Prudential plc Annual Report 2013
(ii) 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.
(iii) Other provisions comprise staff benefits provisions of £332 million, provisions for onerous contracts of £41 million and regulatory and other provisions of £41 million. Staff benefits are generally expected to be paid out within the next three years.
The provision balance is expected to be paid out within the next five years.
Property, plant and equipment comprise Group occupied properties and tangible assets. A reconciliation of the carrying amount of these items from the beginning of the year to the end of the year is as follows: 2013 £m 2012* £m
Arising on acquisitions of subsidiaries 1 77 78 – (1) (1)
At 31 December * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
The 2013 income statement includes rental income from investment properties of £606 million (2012: £544 million) and direct operating expenses including repairs and maintenance arising from these properties of £46 million (2012: £49 million).
Investment properties of £4,426 million (2012: £3,845 million) are held under finance leases. A reconciliation between the total of future minimum lease payments at the statement of financial position date, and their present value is shown below. This table also shows the minimum future rentals to be received on non-cancellable operating leases of the Group’s freehold investment properties in the following periods: 2013 £m 2012* £m
In addition to the purchase consideration, the Group incurred £4 million of acquisition related costs, of which £3 million was recognised as an expense in the consolidated income statement in the second half of 2012 and the remaining £1 million recognised in 2013.
The consolidated statement of cashflows contains a £396 million net cash outflow in respect of the acquisition of Thanachart Life and the cost of the distribution rights representing cash consideration paid of £400 million less cash and cash equivalents acquired of £4 million.
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Notes (i) The proforma shows the estimation of the Thanachart Life business’ contribution to the Group’s consolidated revenue and profit before tax for the period if the acquisition had occurred on 1 January 2013. In determining these amounts, it has been assumed that the fair value adjustments which arose on the date of acquisition would have been the same as if the acquisition had occurred on 1 January 2013. These amounts have been determined using actual results for the four month period to 2 May 2013 and the post-acquisition results from 3 May to 31 December 2013.
b Acquisition of Reassure America Life Insurance Company in 2012 On 4 September 2012, the Group through its indirect wholly-owned subsidiary, Jackson completed the acquisition of 100 per cent issued share capital of SRLC America Holding Corp. and its primary operating subsidiary, Reassure America Life Insurance Company (REALIC). REALIC is a US-based insurance company whose business model was to acquire, through purchase or reinsurance, closed blocks of insurance business, primarily life assurance risks. REALIC did not and does not write new business. At 31 December 2012, the purchase consideration was subject to final agreement under the terms of the transaction with Swiss Re. No goodwill was recognised under IFRS on the date of the completion of the acquisition as the purchase consideration paid was equivalent to the fair value of the identifiable assets and liabilities assumed.
The consolidated statement of cash flows in 2012 contained a £224 million net cash outflow in respect of this acquisition representing cash consideration of £371 million less cash and cash equivalents acquired of £147 million. In 2013 an additional cash outflow of £9 million was recorded reflecting the revised consideration.
(Loss) profit attaching to held for sale Japan life business (102) 17
The assets and liabilities of the Japan life business classified as held for sale on the statement of financial position as at 31 December 2013 are as follows: 2013 £m
Adjustment for remeasurement of the carrying value to fair value less costs to sell (120)
The consideration paid of £71 million was equivalent to the fair value of acquired assets and liabilities assumed. No goodwill has been recognised.
On 1 January 2014, following consultation with policyholders of PAC and regulators and court approval, the Hong Kong branch of PAC was transferred to separate subsidiaries established in Hong Kong. On an IFRS basis, approximately £12.6 billion of assets, £12.3 billion of liabilities (including policyholder liabilities of £10.2 billion and £1.7 billion of unallocated surplus) and £0.3 billion of shareholders’ funds (for the excess assets of the transferred non-participating business) have been transferred.
The costs of enabling the domestication in 2013 were £35 million. Within the Group’s supplementary analysis of profit, these costs have been presented as a separate category of items excluded from operating profit based on longer-term investment returns as shown in note B1.1.
In addition to the legal proceedings relating to Jackson mentioned under the legal provisions section in note C12, the Group is involved in other litigation and regulatory issues. Whilst the outcome of such litigation and regulatory issues cannot be predicted with certainty, the Company believes that their ultimate outcome will not have a material adverse effect on the Group’s financial condition, results of operations, or cash flows.
At 31 December 2013 the pension mis-selling provision was £286 million (31 December 2012: £306 million). The pension mis-selling provision is included within the liabilities in respect of investment contracts with discretionary participation features under IFRS 4 and is stochastically determined on a discounted basis. The average discount rate implied in the movement in the year is 3.4 per cent (2012: 2.3 per cent).
The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling including administration costs. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased.
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Guaranteed annuities PAC used to sell guaranteed annuity products in the UK and at 31 December 2013 held a provision of £36 million (2012: £47 million) within the main with-profits fund within policyholder liabilities to honour guarantees on these products. The Group’s main exposure to guaranteed annuities in the UK is through SAIF and at 31 December 2013 a provision of £328 million (2012: £371 million) was held in SAIF to honour the guarantees. As SAIF is a separate sub-fund of the PAC long-term business fund, attributable to the policyholders, the movement in this provision has no impact on shareholders.
Unclaimed Property Provision Jackson has received regulatory enquiries on a developing industry-wide matter regarding claims settlement practices and compliance with unclaimed property laws. Concurrently, some regulators and state legislatures have required and others are considering proposals that would require life insurance companies to take additional steps to identify unreported deceased policy and contract holders. Additionally, numerous states are contracting with independent firms to perform specific unclaimed property audits or targeted market conduct examinations covering claims settlement practices and procedures for escheating unclaimed property. One such firm has contracted with the treasury departments of 27 states to perform an examination of Jackson’s practices for handling unclaimed property. Any regulatory audits, related examination activity and internal reviews may result in additional payments to beneficiaries, escheatment of funds (ie, reversion of funds to the state) deemed abandoned under state laws, administrative penalties and changes in Jackson’s procedures for the identification of unreported claims and handling of escheatable property. At 31 December 2013, Jackson has accrued £12 million to cover any such liability.
Guarantees and commitments Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies and are financed by payments assessed on solvent insurance companies based on location, volume and types of business. The Group estimated its reserve for future guarantee fund assessments for Jackson, included within other liabilities to be £13 million at 31 December 2013 (2012: £31 million). Similar assessments for the UK businesses were not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies.
At 31 December 2013, Jackson has unfunded commitments of £298 million (2012: £325 million) related to its investments in limited partnerships and of £132 million (2012: £86 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
Final dividend The 2013 final dividend approved by the Board of Directors after 31 December 2013 is as described in note B7.
Total revenue, net of reinsurance 53,499 116 (1,240) – 52,375 Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (43,948) – 837 (43) (43,154) Acquisition costs and other expenditure (7,409) (116) 244 115 (7,166) Remeasurement of carrying value of Japan life business classified as held for sale (120) – – – (120) Share of profit from joint ventures and associates, net of related tax* – – 147 – 147
Less tax charge attributable to policyholders’ returns (437) – – (10) (447)
Earnings per share (in pence) Based on profit attributable to the equity holders of the Company:
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns) 3,188 – (20) (51) 3,117
Tax charge attributable to shareholders’ returns (613) – 18 11 (584)
Consolidated statement of comprehensive income and statement of changes in equity 2013 £m
Net increase in shareholders’ equity (709) – – – (709) At beginning of year 10,359 – – – 10,359
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, net of related tax – – – 34 34
Total comprehensive income for the year 2,368 – – – 2,368
Net increase in shareholders’ equity 1,795 – – – 1,795 At beginning of year 8,564 – – – 8,564
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 4,167 1,111 – – 5,278
Assets Intangible assets attributable to shareholders 5,699 – (91) – 5,608 Intangible assets attributable to with-profits funds 267 – – – 267 Reinsurers’ share of insurance contract liabilities 1,647 – (4) – 1,643 Other non-investment and non-cash assets 7,267 23 (91) – 7,199 Investments of long-term business and other operations: Investments accounted for using the equity method 70 – 446 – 516 Financial investments: Equity securities and portfolio holdings in unit trusts 87,349 (50) (1,336) – 85,963
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 3,840 284 – – 4,124
Equity Shareholders’ equity 8,564 – – – 8,564 Non-controlling interests 43 – – – 43
Cash and cash equivalents at end of year 7,211 (124) (302) – 6,785
th er n o tes 277 Prudential plc Annual Report 2013 2012 £m
Non-cash movements in operating assets and liabilities reflected in profit before tax and other items (2,742) 190 89 51 (2,412)
Operating profit based on longer-term investment returns Asia operations: Asia insurance operations: Before reclassification of held for sale Japan life business 1,009 (5) – 1,004 Reclassification of Japan life business (3) – – (3)
Reclassification from short-term fluctuations in investment returns 15 – – 15 Remeasurement of carrying value of Japan life business classified as held for sale (120) – – (120)
Costs of domestication of Hong Kong branch (35) – – (35)
Basic EPS based on operating profit based on longer-term investment returns after tax and non-controlling interests 90.9p – – 90.9p
Basic EPS based on total profit after tax and non-controlling interests 50.9p – 1.9p 52.8p
Short-term fluctuations in investment returns: Before reclassification of held for sale Japan life business 204 (3) 5 206 Reclassification of Japan life business (19) – – (19)
Basic EPS based on operating profit based on longer-term investment returns after tax and non-controlling interests 76.9p – – 76.9p
Under UK company law, dividends can only be paid if a UK company has distributable reserves sufficient to cover dividend. Further, UK insurance companies are required to maintain solvency margins in accordance with the Prudential Regulation Authority rules. The Group UK asset management company, M&G is also required to consider its capital requirements before making any distribution to the parent company.
The Group has various joint ventures relating to property investments held by the PAC with-profits fund. The results of these joint ventures are reflected in the movement in the unallocated surplus of the PAC with-profits funds and therefore do not affect shareholders’ results.
As a consequence of adoption of IFRS 11 ‘Joint Arrangements’ from 1 January 2013, the Group’s joint ventures are accounted for using the equity method. For these operations the net of tax results are reflected in the Group’s profit before tax.
The Group has two associates; PruHealth and PPM South Africa that are also accounted for under the equity method. In addition, the Group has investments in Open-Ended Investment Companies (OEICs), unit trusts, funds holding collateralised debt obligations, property unit trusts and venture capital investments of the PAC with-profits funds where the Group has significant influence. As allowed under IAS 28, these investments are accounted for as investments in associates and are carried at fair value through profit and loss. The aggregate fair value of associates carried at fair value through profit and loss where there are published price quotations is approximately £0.5 billion at 31 December 2013 (2012: £0.8 billion).
(OEICs), collateralised debt obligations and similar entities which are not consolidated and where a Group company acts as manager which are regarded as related parties for the purposes of IAS 24. The balances are included in the Group’s statement of financial position sheet at fair value or amortised cost in accordance with their IAS 39 classifications. The transactions are included in the income statement and include amounts paid on issue of shares or units, amounts received on cancellation of shares or units and paid in respect of the periodic charge and administration fee.
Apart from these transactions with directors, no director had interests in shares, transactions or arrangements that require disclosure, other than those given in the directors’ remuneration report. Key management remuneration is disclosed in note B3.3.
Future minimum sub-lease rentals received for non-cancellable operating leases for land and buildings 20 18 Minimum lease rental payments included in consolidated income statement 92 73 * The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new accounting standards described in note A2.
In addition, the Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. The contractual obligations to purchase or develop investment properties at 31 December 2013 were £92 million (2012: £5 million).
P aren t co m p an y 281 Prudential plc Annual Report 2013
Fixed assets Investments: Shares in subsidiary undertakings 5 18,216 11,929 Loans to subsidiary undertakings 5 1,497 1,164
Total net assets (excluding pension) 7,322 6,498 Pension asset (net of related deferred tax) 9 30 38
Prudential plc (the ‘Company’) is a parent holding company. The Company together with its subsidiaries (collectively, the ‘Group’) is an international financial services group with its principal operations in Asia, the US and the UK. In Asia, the Group has operations in Hong Kong, Malaysia, Singapore, Indonesia and other Asian countries. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company. In the UK, the Group operates through its subsidiaries, primarily The Prudential Assurance Company Limited, Prudential Annuities Limited, Prudential Retirement Income Limited and M&G Investment Management Limited. The Company is responsible for the financing of each of its subsidiaries.
The financial statements of the Company, which comprise the balance sheet and related notes, are prepared in accordance with Part 15 of the Companies Act 2006. The Company has taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profit and loss account.
Derivatives Derivative financial instruments are held to manage certain macro-economic exposures. Derivative financial instruments are carried at fair value with changes in fair value included in the profit and loss account.
P aren t co m p an y 283 Prudential plc Annual Report 2013
Actuarial gains and losses as a result of the changes in assumptions, the difference between actual and expected investment return on scheme assets and experience variances are recorded in the statement of total recognised gains and losses. Actuarial gains and losses also include adjustment for unrecognised pension surplus as described above.
Share-based payments The Group offers share award and option plans for certain key employees and a Save As You Earn (‘SAYE’) plan for all UK and certain overseas employees. The share-based payment plans operated by the Group are mainly equity-settled plans with a few cash-settled plans.
Under FRS 20 ‘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 equity-settled 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.
Share in the IFRS result of the Group, net of distributions to the Company† (249) 2,308
The profit (loss) for the financial year of the Company in accordance with UK GAAP and IFRS includes dividends declared in the year from subsidiary undertakings of £2,332 million and £501 million for the years ended 31 December 2013 and 2012, respectively.
As stated in note 3, under UK GAAP, the Company accounts for its investments in subsidiary undertakings at the lower of cost and estimated realisable value. For the purpose of this reconciliation, no adjustment is made to the Company in respect of any valuation adjustments to shares in subsidiary undertakings which would be eliminated on consolidation.
The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013 as described in note A2 of the Group financial statements. Accordingly, the 2012 figures for profit after tax of the Group have been adjusted retrospectively from those previously published.
P aren t co m p an y 285 Prudential plc Annual Report 2013 5 Investments of the Company 2013 £m
Net investment in subsidiary undertakings 6,281 – Net loan advance – 340 Other movements 6 – Foreign exchange movement – (7)
In February 2014, the Company dissolved part of the structure, resulting in a reduction of £12,791 million in the cost of shares in subsidiary undertakings, and at the same time, an increase of £6,326 million in the value of loans to subsidiary undertakings.
The Prudential Assurance Company Limited Insurance England and Wales Prudential Annuities Limited* Insurance England and Wales Prudential Retirement Income Limited (PRIL)* Insurance Scotland M&G Investment Management Limited* Asset management England and Wales Jackson National Life Insurance Company* Insurance US Prudential Assurance Company Singapore (Pte) Limited* Insurance Singapore PT Prudential Life Assurance* Insurance Indonesia * Owned by a subsidiary undertaking of the Company.
The Company has 100 per cent of the voting rights of the subsidiaries except the Indonesian subsidiary, where the Company has 94.6 per cent of the voting rights attaching to the aggregate of the shares across the types of capital in issue.
For each category of deferred tax asset recognised, its recoverability against forecast taxable profits is not significantly impacted by expected changes to accounting standards.
Borrowings are repayable as follows: Within 1 year or on demand – – 1,834 1,985 1,834 1,985
Recorded in the balance sheet as: Subordinated liabilitiesnote (iv) 3,662 2,577 Debenture loans 549 549
Cross-currency swap 3 – 3 – Inflation-linked swap – 199 – 190
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 2013. The FRS 17 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity.
The last completed triennial actuarial valuation of the Scheme was as at 5 April 2011. Further details on the results of this valuation and the total employer contributions to the Scheme for the year are provided in note C9, together with the key assumptions adopted, including mortality assumptions.
Using external actuarial advice provided by the professionally qualified actuaries, Towers Watson, for the valuation of the Scheme, the most recent full valuations have been updated to 31 December 2013 applying the principles prescribed by FRS 17. The long-term expected rates of return are set out below: Weighted average long-term expected rate of return 3.7 2.9 3.1
Notes on the parent company financial statements continued 9 Pension scheme financial position continued
Operating charge: Current service cost (17) (21) Past service cost (3) (106)
Actual less expected return on Scheme assets (5% (2012: 1%) (2011: 15%) (2010: 5%) (2009: 2%) of assets) (318) (45) 973 275 85
Total actuarial (losses) gains (7% (2012: 6%) (2011: 17%) (2010: 2%) (2009: 5%) of the present value of Scheme liabilities) (396) (297) 842 (94) (230)
Actuarial gains (losses) attributable to the Company before tax 8 35 (16) (14) (3)
P aren t co m p an y 289 Prudential plc Annual Report 2013
Total employer contributions expected to be paid into the Scheme for the year ending 31 December 2014 amount to £11 million, reflecting the annual accrual cost and expenses.
A summary of the ordinary shares in issue and the options outstanding to subscribe for the Company’s shares at 31 December 2013 is set out in note C10 of the Group financial statements.
11 Profit of the Company and reconciliation of the movement in shareholders’ funds
A reconciliation of the movement in shareholders’ funds of the Company is given below: Profit (loss) for the yearnote 4 1,579 (216)
Actuarial gains recognised in respect of the pension scheme, net of related taxnote 9 6 27 Share-based paymentsnote 5 6 6 New share capital subscribed 6 17
Net increase (decrease) in shareholders’ funds 816 (821) Shareholders’ funds at beginning of year 6,536 7,357
b Information on transactions of the directors with the Group is given in note D8 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 (2012: £0.1 million) and for other services were £0.1 million (2012: £0.6 million). e In certain instances, the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
In February 2014, the Company dissolved part of the Group’s corporate structure, resulting in a gain on dissolution of £595 million and a reduction of £12,791 million in the cost of shares in subsidiary undertakings. At the same time, there were increases of £6,326 million in loans to subsidiary undertakings and £127 million in current assets, and a reduction of £6,933 million in amounts owed to subsidiary undertakings, of which £819 million related to amounts falling due within one year and £6,114 million to amounts falling due after more than one year.
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
— The strategic report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
— The Annual Report and financial statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy.
2. Our assessment of risks of material misstatement In arriving at our audit opinion above on the financial statements the risks of material misstatement that had the greatest effect on our audit were as follows: Investments (£296,457 million) Refer to page 74 (Audit Committee report), pages 142 to 145 (accounting policy) and pages 188 to 211 (financial disclosures)
The risk – The Group’s investment portfolio represents 91 per cent of the Group’s total assets. Quoted prices from liquid market sources can be obtained for the substantial majority of the portfolio.
— Evaluating the testing performed by the group in order to identify any impairment in relation to loans by reviewing loan files to check performance of the loans. We obtained an understanding of existing and prospective investee company cash flows to understand whether loans can be serviced or refinancing may be required and considered the impact on impairment testing performed.
Our work included consideration of events which occurred subsequent to the year end up until the date of this audit report.
(b) Consideration of the appropriateness of the mortality and credit risk assumptions used in the valuation of the UK annuity liabilities by reference to company and industry data on historical mortality experience and expectations of future mortality. Our work on the credit risk assumptions primarily considered the appropriateness of management’s methodology and assumptions by reference to industry practice and our expectation derived from market experience.
Other key audit procedures included assessing the Group’s methodology for calculating the insurance liabilities and their analysis of the movements in insurance liabilities during the year, including consideration that the movements are in line with the assumptions adopted by the group, our understanding of developments in the business and our expectation derived from market experience. We considered the validity of management’s liability adequacy testing which is a key test performed to check that the liabilities are adequate in the context of expected experience. Our work on the liability adequacy test includes 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.
Deferred Acquisition Costs (‘DAC’) (£4,786 million) Refer to page 74 (Audit Committee report), page 141 (accounting policy) and pages 231 to 234 (financial disclosures)
The risk – DAC represents 1 per cent of the total assets and involves judgement in the identification of, and the extent to which, certain acquisition costs can be deferred, and assessment of recoverability of the asset. The DAC associated with the US business, which represents 86 per cent of total DAC, involves the greatest judgement in terms of measurement and recoverability. The amortisation of the DAC asset is related to the achieved and projected future profit profile.
3. Our application of materiality and an overview of the scope of our audit The materiality for the Group financial statements as a whole was set at £307 million. This was determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 3 per cent) which we consider to be one of the principal considerations for members of the company as it represents the residual interest that can be ascribed to shareholders after policyholder assets and corresponding liabilities have been accounted for.
The Senior Statutory Auditor, in conjunction with other senior staff in the Group team, also regularly attended component audit committee meetings (at a regional level for Asia) to understand at first hand the key risks and audit issues at a component level which may affect the Group financial statements.
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 for which the financial statements are prepared is consistent with the financial statements.
in an cial statem en ts In d ep en d en t au d ito r’s rep o rt 5. 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.
— The audit committee report does not appropriately address matters communicated by us to the audit committee.
— The parent company financial statements and the part of the directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or
Under the Listing Rules we are required to review: — The directors’ statement, set out on page 86, in relation to going concern; and
for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants London
V ) b asis resu lts 295 Prudential plc Annual Report 2013 296 Pre-tax operating profit based on longer-term investment returns 297 Summarised consolidated income statement 298 Movement in shareholders’ equity 299 Summary statement of financial position