The risk: The Group has significant insurance liabilities representing 87 per cent of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long-term policyholder liabilities. Economic assumptions, such as investment return and associated discount rates, and operating assumptions such as mortality and persistency are the key inputs used to estimate these long-term liabilities. The valuation of the guarantees in the US variable annuity business is a complex exercise as it involves exercising significant judgement over the relationship between the investment return attaching to these products and the guarantees contractually provided to policyholders and the likely policyholder behaviour in response to changes in investment performance. The valuation of the insurance liabilities in relation to the UK annuity business requires the exercise of significant judgement in the setting of mortality and credit risk assumptions.
Our response: We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included among others: (a) Consideration of the appropriateness of the economic assumptions used in the valuation of the US variable annuity guarantees in relation to investment mix and projected investment returns by reference to company specific and industry data, of future growth rates by reference to market trends, market volatility and associated discount rates used in the stochastic models used by the Group. Our work on the persistency assumptions primarily considered their appropriateness by reference to company and industry data on policyholder behaviour.
Our response – We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included: (i) evaluating the appropriateness of the deferral policy adopted by management by comparing it against the requirements of relevant accounting standards; (ii) evaluating whether costs are deferred in accordance with management’s deferral policy; and
(iii) assessing the calculations performed by the Group including the appropriateness of the assumptions used in determining the profit profile and the extent of the associated adjustment necessary to the DAC asset. Our work in this area included assessing the reasonableness of assumptions such as the projected investment return by comparing against the Group’s investment portfolio mix and market return data.
We also considered the adequacy of the Group’s disclosures about the degree of estimation involved in the valuation of DAC.
We agreed with the Group audit committee to report to it all corrected and uncorrected misstatements we identified through our audit with an individual value in excess of £15 million in addition to other audit misstatements below that threshold that we believe warranted reporting on qualitative grounds.
Audits for Group reporting purposes were performed at the following key components by component auditors in all locations except for the UK Group Head Office operations which were covered by the Group team in the UK: — Insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, Korea, Vietnam, India and Taiwan; — Fund management operations in the UK (M&G and Prudential Capital); and
These audits covered 91 per cent of total Group revenue; 95 per cent of Group profit before taxation; 95 per cent of total Group assets and 90 per cent of Group shareholders’ equity.
The audits undertaken for Group reporting purposes at the key reporting components of the Group were all performed to component materiality levels set by the Group audit team. These component materiality levels were set as £110 million for key reporting components in Asia and £140 million for all other key reporting components listed above to evaluate the impact of misstatements in aggregate on the Group financial statements.
Detailed audit instructions were sent to all the auditors in these locations. These instructions covered the significant audit areas that should be covered by these audits (which included the relevant risks of material misstatement detailed above), and set out the information required to be reported back to the Group audit team. The Group team held planning and risk assessment meetings with components in scope for Group reporting and participated in the separate individual local planning and risk assessment meetings.
— The part of the corporate governance statement on page 83 relating to the company’s compliance with the nine provisions of the 2010 UK Corporate Governance Code specified for our review; and
— Certain elements of the report to shareholders by the Board on directors’ remuneration.
Scope of report and responsibilities As explained more fully in the directors’ responsibilities statement set out on page 290, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/ auditscopeukco2013 which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
Description of EEV basis reporting In broad terms, IFRS profits for long-term business reflect the aggregate of results on a traditional accounting basis. By contrast, embedded value is a way of reporting the value of the life insurance business.
Results prepared under the EEV principles capture the discounted value of future profits expected to arise from the current book of long-term business. The results are prepared by projecting cash flows, by product, using best estimate assumptions for all relevant factors. Furthermore, in determining these expected profits full allowance is made for the risks attached to their emergence and the associated cost of capital, and takes into account recent experience in assessing likely future persistency, mortality and expenses. Further details are explained in note 15.
Long-term business* 5,641 4,434 Asset management* 574 479 Other results (635) (600)
V ) b asis resu lts 297 Prudential plc Annual Report 2013
Pre-tax operating profit based on longer-term investment returns Asia operations* 2,459 2,020 US operations 2,280 1,649 UK operations: UK insurance operations 1,062 899 M&G (including Prudential Capital) 441 371
† During 2012, the Group completed the acquisition of REALIC generating a gain of £453 million and M&G reduced its holding in PPM South Africa resulting in a reclassification from a subsidiary to an associate and a gain on dilution of £42 million.
Net increase in shareholders’ equity 9 2,413 2,806 Shareholders’ equity at beginning of year 9 22,443 19,637
Shareholders’ equity at end of year 9 24,856 22,443 * The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of revised IAS 19 – see note 18.
Asia operations: US operations: UK insurance operations: M&G: Net assets of operations – 449 449 – 392 392
Other operations: Holding company net borrowings at market value note 7 – (2,373) (2,373) – (2,282) (2,282)
V ) b asis resu lts 299 Prudential plc Annual Report 2013
Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds* (279,176) (261,409) Less shareholders’ accrued interest in the long-term business 15,206 12,084
Japan life business are included in total assets less liabilities, before deduction for insurance funds.
A detailed description of the EEV methodology and accounting presentation is provided in note 15.
Asia operations 2,125 11,375 1,460 69 12.8 US operations 1,573 15,723 1,086 69 6.9 UK insurance operations 725 5,978 297 41 5.0
Asia operations 1,897 10,544 1,266 67 12.0 US operations 1,462 14,600 873 60 6.0 UK insurance operations 836 7,311 313 37 4.3
Unwind of discount and other expected returns 846 608 547 2,001 595 412 482 1,489 Effect of changes in operating assumptions 17 116 122 255 22 35 87 144 Experience variances and other items 64 411 67 542 75 290 (16) 349 * The 2012 comparative results have been adjusted retrospectively from those previously published for the reclassification of the result attributable to the held for sale Japan life business – see note 18.
Notes (a) The increase in unwind of discount and other expected returns of £251 million from £595 million in 2012 to £846 million in 2013 reflects a £140 million effect of higher risk discount rates, driven by the increase in long-term interest rates, together with an effect of £111 million arising from the growth in the opening in-force value (adjusted for assumption changes) on which the discount rates are applied, partially offset by a £(21) million reduction due to unfavourable exchange rate movements, particularly in Indonesia, and a £21 million increase in the return on net worth.
(c) The charge for persistency and withdrawals assumption changes reflects a number of offsetting items including for 2013, the effect of strengthening lapse and premium holiday assumptions in Korea.
(d) In 2012 the charge of £(45) million for expense assumption changes principally arose in Malaysia and reflected changes to the pension entitlements of agents. (e) The favourable effect of mortality and morbidity experience in 2013 of £42 million (2012: £57 million) reflects continued better than expected experience, principally arising in Hong Kong, Indonesia and Singapore. (f) The persistency and withdrawals experience variance in 2013 of £44 million (2012: £52 million) principally reflects favourable experience in Hong Kong and
Notes on the EEV basis results continued 3 Pre-tax operating profit from business in force continued
Unwind of discount and other expected returns note (a) 608 412 Effect of changes in operating assumptions: Persistency note (b) 72 45 Variable annuity fees note (c) 50 (19)
(c) The effect of the change of assumption for variable annuity fees represents the capitalised value of the change in the projected policyholder advisory fees, which vary according to the size and the mix of variable annuity funds.
(d) The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults (see note 16(ii)(b)). The spread experience variance in 2013 of £274 million (2012: £205 million) includes the positive effect of transactions undertaken to more closely match the overall asset and liability duration.
(f) The credit of £48 million for other changes in experience variances and other items mainly reflects the positive persistency experience variance of £62 million (2012: £21 million) across all products.
Notes (a) The increase in unwind of discount and other expected returns of £65 million from £482 million in 2012 to £547 million for 2013 reflects a £34 million effect of higher discount rates, driven by the increase in gilt yields, a £24 million increase in the return on net worth and an effect of £7 million arising from the growth in the opening value of in-force.
(b) For 2013, the beneficial effect of the change in UK corporate tax rates of £122 million (2012: £87 million) reflects the combined effect of the reductions in corporate rates from 23 per cent to 21 per cent from April 2014 and 21 per cent to 20 per cent from April 2015 (2012: from 25 per cent to 23 per cent) which were both enacted in July 2013. Consistent with the Group’s approach of grossing up the movement in the post-tax value of in-force business for shareholder tax, the £122 million (2012: £87 million) benefit is presented gross.
(c) Other items of £67 million for 2013 includes the positive effects of rebalancing the investment portfolio backing annuity business. In 2012 the negative effect of £(16) million included a charge of £(52) million for the strengthening of mortality assumptions, net of reserve releases and the effects of portfolio rebalancing for annuity business.
The consideration for the transaction is THB 18.981 billion (£412 million), of which THB 17.500 billion (£380 million) was settled in cash on completion in May 2013 with a further payment of THB 0.946 billion (£20 million), for adjustments to reflect the net asset value as at completion date, paid in July 2013. In addition a deferred payment of THB 0.535 billion (£12 million) is payable 12 months after completion. The acquired assets are comprised of: £m
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.
The gain of £453 million reflects the fair value of the acquired business as determined by applying the same methodology as applied for Jackson’s non-variable annuity business. A risk discount rate of 4.3 per cent at the date of acquisition on 4 September 2012 was used.
Insurance operations: Asia* note (ii) (405) 362 US note (iii) (422) (254) UK note (iv) 35 315
(iii) US operations The short-term fluctuations in investment returns for US operations comprise the following items: Investment return related experience on fixed income securities note (a) 21 (99) Investment return related impact due to changed expectation of profits on in-force variable annuity business in future periods based on current period separate account return, net of related hedging activity note (b) (580) (183)
(c) Other items of £137 million in 2013 primarily reflects a beneficial impact of the excess of actual over assumed return from investments in limited partnerships.
(v) Other items 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.
(vi) Economic hedge value movements This item represents the cost of short-dated hedge contracts taken out in the 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.
V b asis resu lts 6 Effect of changes in economic assumptions
The effects of changes in economic assumptions for in-force business, net of the related change in the time value of cost of options and guarantees, included within profit before tax (including actual investment returns) arise as follows: (i) Group summary
Asia operations* note (ii) 283 (135) US operations note (iii) 372 85 UK insurance operations note (iv) 166 48 * The 2012 comparative results have been adjusted retrospectively from those previously published for the reclassification of the result attributable to the held for sale Japan life business – see note 18.
The charge of £(135) million in 2012 for the effect of changes in economic assumptions principally arose in Hong Kong of £(320) million, primarily reflecting the effect on projected cash flows of de-risking the asset portfolio and the reduction in fund earned rates on participating business, driven by the very low interest rate environment, and in Vietnam of £(47) million, following the fall in bond yields. There were partial offsets totalling £232 million, principally arising in Malaysia and Indonesia, mainly reflecting the positive impact of calculating projected health and protection profits at a lower rate, driven by the decrease in risk discount rates.
Notes (a) For fixed annuity and other general account business the charge of £(375) million in 2013 principally arises from the effect of a higher discount rate on the opening value of the in-force book, driven by the 130 basis points increase in the risk-free rate. The projected cash flows for this business principally reflect projected spread, with secondary effects on the cash flows also resulting from changes to assumed future yields and resulting policyholder behaviour. The credit of £20 million in 2012 reflected a 10 basis point decrease in the risk-free rate, partially offset by the effect for the acquired REALIC book (reflecting a 20 basis point increase in the risk-free rate from the 4 September acquisition date to 31 December 2012).
(c) In 2012, the effect of the change in tax regime of £(46) million reflected the change in pattern of taxable profits for shareholder-backed annuity business arising from the acceleration of tax payments due to the altered timing of relief on regulatory basis provisions.
Core structural borrowings – central funds† 4,211 392 4,603 3,126 536 3,662
Underlying movement: Investment in new business notes (ii), (viii) (637) – (637) (618) Business in force: Expected in-force cash flows (including expected return on net assets) 2,150 471 2,621 2,405 Effects of changes in operating assumptions, operating experience variances and other operating items 478 – 478 293
Effect of acquisition of REALIC – – – (169) Increase in EEV assumed level of required capital note 12 (58) – (58) – (Loss) profit attaching to held for sale Japan life business (40) – (40) 31 Other non-operating items note (iv) (739) 17 (722) (62)
(ii) Free surplus invested in new business represents amounts set aside for required capital and acquisition costs. (iii) For the purposes of this analysis, free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis shareholders’ equity.
V b asis resu lts 9 Reconciliation of movement in shareholders’ equity 2013 £m 2012* £m
Profit before tax (including actual investment returns) 2,228 2,174 1,183 5,585 79 5,664 4,957 Tax (charge) credit attributable to shareholders’ profit note 10: Tax on non-operating profit 69 12 (34) 47 23 70 (49)
Thanachart Life notes (vi) and 4 412 – – 412 (412) – –
Shareholders’ equity at 31 December 2013 note (i) 10,305 6,966 7,342 24,613 243 24,856 22,443
Balance at 1 January 2013/1 January 2012 Representing: Statutory IFRS basis shareholders’ equity 2,290 4,343 3,008 9,641 718 10,359 8,564 Additional retained profit (loss) on an EEV basis note (iv) 7,172 1,689 3,764 12,625 (541) 12,084 11,073 * The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of IFRS 11 and revised IAS 19 and for the reclassification of the result attributable to the held for sale Japan life business – see note 18.
Notes on the EEV basis results continued 9 Reconciliation of movement in shareholders’ equity continued
(iv) The additional retained loss on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of £(392) million (2012: charge of £(536) million), as shown in note 7.
(v) The (charge) credit for the shareholders’ share of actuarial and other gains and losses on defined benefit schemes comprises: 2013 £m 2012* £m
IFRS basis (48) 34 Additional shareholders’ interest note 15(c)(vi) (5) 10
EEV basis total (53) 44 * The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of revised IAS 19 – see note 18.
(vi) The £412 million transfer from Other operations to Asia operations represents the funding of Asia operations to purchase the bancassurance agreement and Thanachart Life (as shown in note 4).
The tax charge comprises: Tax charge on operating profit based on longer-term investment returns: Long-term business:*
Asia operations 494 420 US operations 695 513 UK insurance operations 198 168
Tax charge on profit attributable to shareholders (including tax on actual investment returns)† 1,306 1,188 * The tax charge on operating profit for long-term business includes tax on Solvency II and restructuring costs. † The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of IFRS 11 and revised IAS 19 – see note 18.
New business contribution note (iii) (310) 107 (203) 1,342 1,139 Existing business – transfer to net worth 713 29 742 (742) – Expected return on existing business 74 (1) 73 595 668 Changes in operating assumptions and experience variances* 32 (9) 23 61 84 Loss attaching to held for sale Japan life business note 4 (40) – (40) 5 (35)
New business contribution note (iii) (298) 288 (10) 716 706 Existing business – transfer to net worth 796 (296) 500 (500) – Expected return on existing business 41 53 94 301 395 Changes in operating assumptions and experience variances* 292 21 313 111 424 Increase in EEV assumed level of required capital note (vi) (58) 58 – (13) (13)
Shareholders’ equity at 31 December 2013 note (viii) 1,079 1,370 2,449 4,893 7,342 * Changes in operating assumptions and experience variances as reported above include development, Solvency II and restructuring costs.
Post-tax new business contribution 1,139 706 237 2,082 982 568 241 1,791
(iv) The value of in-force business includes the value of future margins from current in-force business less the cost of holding required capital and represents: Asia operations
Net value of in-force business 8,143 4,403 4,893 17,439 7,518 3,221 4,672 15,411
(v) The free surplus increase of £365 million in respect of the transaction with Thanachart Bank includes the purchase cost of the partnership agreement to enable future new sales through the bancasurrance channel. As new business is written, the carrying value of this purchase cost is amortised against the new business contribution line of this reconciliation.
(vi) The increase in required capital in US operations of £58 million reflects the effect of the change from 235 per cent to 250 per cent of risk-based capital. (vii) The decrease in the cost of time value of guarantees for US operations from £(650) million at 2012 to £(146) million at 2013 primarily relates to variable annuity business, mainly arising from the increase in the expected long-term separate account rate of return of 1.3 per cent driven by the increase in the US 10-year treasury bond rate and strong equity performance, partly offset by the impact from new business written in the year.
(viii) Effects of domestication of Hong Kong branch in 2014 The analysis of shareholders’ equity at 31 December 2013 does not incorporate the impact of the domestication of the Hong Kong branch which took effect on 1 January 2014. In order to align the corporate structure of the branch business in Hong Kong more closely with Prudential’s other Asia operations, the Board of PAC initiated a proposal to transfer the branch business to two Hong Kong-incorporated companies – Prudential Hong Kong Limited and Prudential General Insurance Hong Kong Limited – with one providing life insurance and the other providing general insurance.
Following consultation with policyholders of PAC and court approval, the assets and liabilities of the Hong Kong branch business of PAC transferred to separate subsidiaries on 1 January 2014. As a consequence of this restructuring, adjustments in respect of required capital, and the cost of that capital, will be necessary. This arises from the transfer of capital that was previously held within the UK business in respect of the Hong Kong branch operations and additional capital requirements that arise from the newly established subsidiaries. These will be reflected in the movements in net worth and value of in-force business reported in 2014 as adjustments to opening balances as follows: £m
The adjustments for UK insurance operations reflect the transfer of required capital, and attaching cost of capital, for amounts previously set aside whilst the Hong Kong business was a branch of Prudential Assurance Company, to the Asia operations segment. The adjustments for Asia operations reflect this transfer and the effects of additional capital requirements of the Hong Kong regulator under the arrangements for the newly domesticated business. The net effect reflects the higher required capital levels attributable to the stand-alone Hong Kong shareholder-backed long-term insurance business.
Note ‘Other items’ represent amounts incorporated into VIF where there is no definitive timeframe for when the payments will be made or receipts received. In particular, other items includes the deduction of the value of the shareholders’ interest in the estate, the value of which is derived by increasing final bonus rates so as to exhaust the estate over the lifetime of the in-force with-profits business. This is an assumption to give an appropriate valuation. To be conservative, this item is excluded from the expected free surplus generation profile below.
Cash flows are projected on a deterministic basis and are discounted at the appropriate risk discount rate. The modelled cash flows use the same methodology underpinning the Group’s embedded value reporting and so are subject to the same assumptions and sensitivities.
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2013 total as shown above 1-5 years 6 -10 years 11-15 years 16 -20 years 21-40 years 40+ years
Interest rates – 1% increase 23 72 (1) 94 33 104 6 143 Interest rates – 1% decrease (61) (107) – (168) (106) (161) (11) (278)
Interest rates – 1% decrease 200 (12) 443 631 85 49 399 533 Equity/property yields – 1% rise 370 250 210 830 328 230 202 760 Equity/property market values – 10% increase (183) (90) (238) (511) (159) (69) (309) (537) Statutory minimum capital 109 153 4 266 108 89 4 201 Long-term expected defaults – 5 bps increase – – (114) (114) – – (112) (112)
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long-term business operations and include the combined effect on the value of in-force business and net assets at the balance sheet dates indicated. If the change in assumption shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year. These are for the effect of economic assumption changes and, to the extent that asset value changes are included in the sensitivities, within short-term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition for Jackson, the fair value movements on assets backing surplus and required capital which are taken directly to shareholders’ equity would also be affected by changes in interest rates.
(a) Covered business The EEV results for the Group are prepared for ‘covered business’, as defined by the EEV Principles. Covered business represents the Group’s long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The results for covered business, including the Group’s investments in joint venture insurance operations, are presented on a pre-tax basis, with tax reported separately. The EEV basis results for the Group’s covered business are then combined with the IFRS basis results of the Group’s other operations. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management.
The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in note 15(c)(iv)) no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profit before tax. Separately, the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items (as explained in note 15(c)(i)).
Demographic assumptions Persistency, mortality and morbidity assumptions are based on an analysis of recent experience but also reflect expected future experience. Where relevant, when calculating the time value of financial options and guarantees, policyholder withdrawal rates vary in line with the emerging investment conditions according to management’s expectations.
Corporate expenditure comprises: — Expenditure for Group head office, to the extent not allocated to the PAC with-profits funds, together with Solvency II implementation and restructuring costs, which are charged to the EEV basis results as incurred; and
The total profit that emerges over the lifetime of an individual contract as calculated using the embedded value basis is the same as that calculated under the IFRS basis. Since the embedded value basis reflects discounted future cash flows, under this methodology the profit emergence is advanced, thus more closely aligning the timing of the recognition of profits with the efforts and risks of current management actions, particularly with regard to business sold during the year.
New business In determining the EEV basis value of new business, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out for statutory basis reporting.
However, in determining the movements on the additional shareholders’ interest, the basis for calculating the Jackson EEV result acknowledges that, for debt securities backing liabilities, the aggregate EEV results reflect the fact that the value of in-force business instead incorporates the discounted value of future spread earnings. This value is not affected generally by short-term market movements on securities that broadly speaking, are held for the longer-term.
Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for Jackson securities classified as available-for-sale, movements in unrealised appreciation on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.
Cost of capital A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as required capital. The cost is the difference between the nominal value of the capital and the discounted value of the projected releases of this capital allowing for investment earnings (post- tax) on the capital.
Jackson also issues fixed index annuities that enable policyholders to obtain a portion of an equity-linked return while providing a guaranteed minimum return. The guaranteed minimum returns would be of a similar nature to those described above for fixed annuities.
With-profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses – annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The with-profits fund also held a provision on the Pillar I Peak 2 basis of £36 million at 31 December 2013 (31 December 2012: £47 million) to honour guarantees on a small number of guaranteed annuity option products.
Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of long-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for correlation between the various asset classes. Details of the key characteristics of each model are given in notes 16(iv),(v) and (vi).
(ii) Level of required capital In adopting the EEV Principles, Prudential has based required capital on its internal targets subject to it being at least the local statutory minimum requirements. For with-profits business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is sufficient to meet the required capital requirements. For shareholder-backed business the following capital requirements apply: — Asia operations: the level of required capital has been set to an amount at least equal to the higher of local statutory requirements and the internal target; — US operations: the level of required capital has been set at 250 per cent (2012: 235 per cent) of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL); and
These allowances are initially reflected in determining best estimate returns and through the market risk allowance described above. However, for those businesses which are largely backed by holdings of debt securities these allowances in the projected returns and market risk allowances may not be sufficient and an additional allowance may be appropriate.
The practical application of the allowance for credit risk varies depending upon the type of business as described below.
US operations (Jackson) For Jackson business, the allowance for long-term defaults is reflected in the risk margin reserve (RMR) charge which is deducted in determining the projected spread margin between the earned rate on the investments and the policyholder crediting rate.
In the annuity MCEV calculations as the assets are generally held to maturity to match long duration liabilities, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for: — Expected long-term defaults derived as a percentage of historical default experience based on Moody’s data for the period 1970 to 2009 and the definition of the credit rating assigned to each asset held is the second highest credit rating published by Moody’s, Standard & Poor’s and Fitch; — A credit risk premium, which is derived as the excess over the expected long-term defaults, of the 95th percentile of historical cumulative defaults based on Moody’s data for the period 1970 to 2009, and subject to a minimum margin over expected long-term defaults of 50 per cent; — An allowance for a 1 notch downgrade of the asset portfolio subject to credit risk; and — An allowance for short-term downgrades and defaults.
A base level allowance of 50 basis points is applied to cover the non-diversifiable non-market risks associated with the Group’s businesses. For the Group’s US business and UK business other than shareholder-backed annuity, no additional allowance is necessary. For UK shareholder-backed annuity business a further allowance of 50 basis points is used to reflect the longevity risk which is of particular relevance. For the Group’s Asia operations in China, India, Indonesia, the Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points.
(iv) With-profits business and the treatment of the estate The proportion of surplus allocated to shareholders from the PAC with-profits fund has been based on the present level of 10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing final bonus rates (and related shareholder transfers) so as to exhaust the estate over the lifetime of the in-force with-profits business. In any scenarios where the total assets of the life fund are insufficient to meet policyholder claims in full, the excess cost is fully attributed to shareholders. Similar principles apply, where appropriate, for other with-profits funds of the Group’s Asia operations.
(vi) Foreign currency translation Foreign currency profits and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange. The principal exchange rates are shown in note A1 of the IFRS statements.
(c) Accounting presentation (i) Analysis of profit before tax To the extent applicable, the presentation of the EEV profit for the year is consistent with the basis that the Group applies for analysis of IFRS basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results including longer-term investment returns (which are determined as described in note 15(c)(ii) below) and incorporate the following: — New business contribution, as defined in note 15(b)(i); — Unwind of discount on the value of in-force business and other expected returns, as described in note 15(c)(iv) below; — The impact of routine changes of estimates relating to non-economic assumptions, as described in note 15(c)(iii) below; and — Non-economic experience variances, as described in note 15(c)(v) below.
Non-operating results comprise the recurrent items of short-term fluctuations in investment returns, the mark to market value movements on core borrowings and the effect of changes in economic assumptions.
(ii) Operating profit For the investment element of the assets covering the net worth of long-term insurance business, investment returns are recognised in operating results at the expected long-term rate of return. These expected returns are calculated by reference to the asset mix of the portfolio. For the purpose of calculating the longer-term investment return to be included in the operating result of the PAC with-profits fund of UK operations, where assets backing the liabilities and unallocated surplus are subject to market volatility, asset values at the beginning of the reporting period are adjusted to remove the effects of short-term market movements as explained in note 15(c)(iv) below.
For the purpose of determining the long-term returns for debt securities of US operations for fixed annuity and other general account business, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of end of year risk-free rates and equity risk premium. For US variable annuity separate account business, operating profit includes the unwind of discount on the opening value of in-force adjusted to reflect end of year projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
In applying this general approach, the unwind of discount included in operating profit for the with-profits business of UK insurance operations is determined by reference to the opening value of in-force, as adjusted for the effects of short-term investment volatility due to market movements (ie smoothed). In the summary statement of financial position and for total profit reporting, asset values and investment returns are not smoothed. At 31 December 2013 the shareholders’ interest in the smoothed surplus assets used for this purpose only were £136 million lower (31 December 2012: £121 million lower) than the surplus assets carried in the statement of financial position.
(v) Operating experience variances Operating profits include the effect of experience variances on non-economic assumptions, which are calculated with reference to the embedded value assumptions at the end of the reporting year, such as persistency, mortality and morbidity, expenses and other factors.
(vi) Pension costs Profit before tax Movements on the shareholders’ share of surpluses (to the extent not restricted by IFRIC 14) and deficits of the Group’s defined benefit pension schemes adjusted for contributions paid in the year are recorded within Other Comprehensive Income. Consistent with the basis of distribution of bonuses and the treatment of the estate described in notes 15(b)(i) and (iv), the shareholders’ share incorporates 10 per cent of the proportion of the financial position attributable to the PAC with-profits fund. The financial position is determined by applying the requirements of IAS 19 as booked for IFRS reporting.
(viii) Taxation The profit for the year for covered business is in most cases calculated initially at the post-tax level. For 2013 and 2012 the post-tax profit for covered business is then grossed up for presentation purposes at the rates of tax applicable to the countries and periods concerned. The overall tax rate includes the impact of tax effects determined on a local regulatory basis. Tax payments and receipts included in the projected cash flows to determine the value of in-force business are calculated using rates that have been substantively enacted by the end of the reporting period. Current taxation and other legislation have been assumed to continue unaltered except where changes have been announced and substantively enacted in the year. Additional detail of pre and post-tax EEV basis results are shown in the additional financial information.
(ix) Inter-company arrangements The EEV results for covered business incorporate annuities established in the PAC non-profit sub-fund from vesting pension polices in SAIF (which is not covered business). The EEV results also incorporate the effect of the reinsurance arrangement of non-profit immediate pension annuity liabilities of SAIF to PRIL. In addition, the free surplus and value of in-force business are calculated after taking account of the impact of contingent loan arrangements between Group companies (movements in the contingent loan liability are reflected via the projected cash flows in the value of in-force and the related funding is reflected in free surplus).
Deterministic assumptions The tables below summarise the principal financial assumptions: Assumed investment returns reflect the expected future returns on the assets held and allocated to the covered business at the valuation date.
Total weighted risk discount rate note (a) 8.1 6.8 7.2 6.1
Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each country’s risk discount rates by reference to the pre-tax EEV basis new business result and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
(d) Equity risk premiums in Asia (excluding those for the held for sale Japan life business) range from 3.5 per cent to 8.7 per cent for 2013 (2012: 3.5 per cent to 8.8 per cent).
January to June issues 1.2 1.4 July to December issues 1.75 1.1 Fixed Index Annuity business: January to June issues 1.45 1.75 July to December issues 2.00 1.35 Institutional business 0.75 1.25
Risk discount rate: New business 6.8 6.9 In force note (a) 8.3 8.0
Pre-tax expected long-term nominal rate of return for shareholder-backed annuity business: New business 4.2 4.2 In force note (a) 4.3 3.9
Other business: Risk discount rate: New business 6.1 5.2 In force 6.8 5.6
Pre-tax expected long-term nominal rates of investment return: UK equities 7.5 6.3 Overseas equities 7.1 to 9.2 5.8 to 9.6 15-year gilt rate 3.5 2.3 Corporate bonds 5.1 3.9
Notes (a) For shareholder-backed annuity business, the movements in the pre-tax long-term nominal rates of return and the risk discount rates for in-force business mainly reflect the effect of changes in asset yields.
(iv) Asia operations — The same asset return models as described for UK insurance operations below, appropriately calibrated, have been used for Asia operations. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK whilst property holdings do not represent a significant investment asset; — The stochastic cost of guarantees is primarily only of significance for the Hong Kong, Korea, Malaysia, Singapore and Taiwan operations; and
(v) US operations (Jackson) — Interest rates are projected using a log-normal generator calibrated to historical US Treasury yield curves; — Corporate bond returns are based on Treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and
(vi) UK insurance operations — Interest rates are projected using a two-factor model calibrated to the initial market yield curve; — The risk premium on equity assets is assumed to follow a log-normal distribution; — The corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and
Mean returns have been derived as the annualised arithmetic average return across all simulations and durations. For each projection year, standard deviations have been calculated by taking the square root of the annualised variance of the returns over all the simulations. These have been averaged over all durations in the projection. For equity and property, the standard deviations relate to the total return on these assets. The standard deviations applied for both years are as follows: %
V b asis resu lts 17 New business premiums and contributions note (i)
Asia insurance operations Cambodia – – 1 – 1 – 3 – Hong Kong 326 157 455 380 487 396 2,795 2,316 Indonesia 303 359 445 410 477 446 1,943 2,097 Malaysia 114 98 197 208 208 218 1,352 1,388 Philippines 193 172 34 28 53 45 299 254 Singapore 571 399 304 261 361 301 2,588 2,314 Thailand 66 12 61 36 68 37 289 140 Vietnam 2 1 54 44 54 45 204 159
SE Asia operations including Hong Kong 1,575 1,198 1,551 1,367 1,709 1,488 9,473 8,668 China note (ii) 114 37 71 53 83 56 409 277 Korea 311 94 82 86 113 95 641 438 Taiwan 102 172 107 138 117 156 491 723 India note (iii) 34 67 100 96 103 102 361 438
Total UK and Europe insurance operations 5,128 6,286 212 207 725 836 5,978 7,311
In July 2013 the Group agreed to sell, dependent on regulatory approval, its life insurance business in Japan which we closed to new business in 2010. Also, in 2013 the Group has adopted new accounting standards on ‘Joint arrangements’ (IFRS 11) and amendments to ‘Employee benefits’ (IAS 19), from 1 January 2013. Accordingly, the 2012 comparative EEV basis results have been retrospectively adjusted from those previously published for the application of the IFRS standards and for the reclassification of the result attributable to the held for sale Japan life business. The tables below show the results on the previous and revised basis of reporting.
Pre-tax operating profit based on longer-term investment returns 5,588 (8) – 5,580 Short-term fluctuations in investment returns: Before reclassification of held for sale Japan life business (790) – (1) (791) Reclassification of Japan life business (28) – – (28)
Mark to market value movements on core borrowings 152 – – 152 Costs of domestication of Hong Kong branch (35) – – (35)
Total net assets Total assets less liabilities, before deduction for insurance funds: Before reclassification of held for sale Japan life business 292,791 (3,151) – 289,640 Reclassification of Japan life business (814) – – (814)
Less insurance funds: Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds: Before reclassification of held for sale Japan life business (283,141) 3,151 – (279,990) Reclassification of Japan life business 814 – – 814
Less shareholders’ accrued interest in the long-term business 15,206 – 15,206
Pre-tax operating profit based on longer-term investment returns 4,319 (6) – 4,313 Short-term fluctuations in investment returns: Before reclassification of held for sale Japan life business 538 – 5 543 Reclassification of Japan life business (33) – – (33)
505 – 5 510 Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 62 – (62) – Effect of changes in economic assumptions: Before reclassification of held for sale Japan life business (16) – – (16) Reclassification of Japan life business 14 – – 14
Profit attaching to held for sale Japan life business: Reclassification from pre-tax operating profit based on longer-term investment returns 2 – – 2 Reclassification from short-term fluctuations in investment returns 33 – – 33 Reclassification from effect of changes in economic assumptions (14) – – (14)
Profit for the year attributable to shareholders 3,813 – (44) 3,769 Items taken directly to shareholders’ equity (1,007) – 44 (963)
Total net assets Total assets less liabilities, before deduction for insurance funds: 274,863 (3,095) – 271,768
For life insurance joint venture operations, the EEV results continue to be presented on a pre-tax basis, ie as for the Group’s other insurance businesses. (iii) Under the amended IAS 19 all actuarial gains and losses and related tax are recognised in the movement in shareholders’ equity rather than in the summarised consolidated income statement.
Our opinion on the EEV basis supplementary information is unmodified We have audited the EEV basis supplementary information of Prudential plc (the Company) for the year ended 31 December 2013 set out in the EEV basis results and Notes on the EEV basis results pages. The EEV basis supplementary information should be read in conjunction with the Group financial statements.
In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2013 has been properly prepared, in all material respects, in accordance with the European Embedded Value Principles issued in May 2004 by the European CFO Forum as supplemented by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 (together ‘the EEV Principles’) using the methodology and assumptions set out in the Notes on the EEV basis results.
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 331, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Scope of an audit of financial statements performed in accordance with ISAs (UK and Ireland) A description of the scope of an audit of financial statements is provided on our website at www.kpmg.com/uk/ auditscopeother2013. This report is made subject to important explanations regarding our responsibilities, as published on that website, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
Section 7 334 Index to the additional unaudited financial information 362 Risk factors 367 Glossary 371 Shareholder information 373 How to contact us
II. IFRS profit and loss information 338 a Analysis of long-term insurance business pre-tax
IFRS operating profit based on longer-term investment returns by driver 343 b Asia operations – analysis of IFRS operating profit by territory 344 c Analysis of asset management operating profit based on longer-term investment returns
A d d itio n al in fo rm atio n 335 Prudential plc Annual Report 2013
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (43,154) (45,144) (28,706) (39,687) (40,474)
Acquisition costs and other expenditure (6,861) (6,032) (4,717) (4,692) (4,463) Finance costs: interest on core structural borrowings
Remeasurement of carrying value of Japan life business classified as held for sale (120) – – – – Loss on sale of Taiwan agency business – – – – (559)
Share of profits from joint ventures and associates, net of related tax 147 135 76 64 29
Profit before tax attributable to shareholders 1,635 2,747 1,866 1,283 653 Tax (charge) credit attributable to shareholders’ returns (289) (584) (415) 43 (15)
Profit from continuing operations after tax 1,346 2,163 1,451 1,326 638 Discontinued operations (net of tax) – – – – (14)
Profit from continuing operations before tax attributable to shareholdersnote (2) 1,635 2,747 1,866 1,283 653
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and excluding 2010 exceptional tax credit) (in pence) 165.0p 124.9p 116.0p 107.4p 89.1p
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and including 2010 exceptional tax credit) (in pence) 165.0p 124.9p 116.0p 113.7p 89.1p * The Group has adopted new accounting standards on joint arrangements and amendments to employee benefits, from 1 January 2013, as described in note 1. Accordingly, the 2009 to 2012 comparative EEV results have been adjusted retrospectively from those previously published for the application of the IFRS standards and for the effect of the Japan life business sale agreement.
A d d itio n al in fo rm atio n 337 Prudential plc Annual Report 2013
As of and for the year ended 31 December 2013 £m 2012* £m 2011* £m 2010* £m 2009* £m
Core structural borrowings of shareholder-financed operations 4,636 3,554 3,611 3,676 3,394 * 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 2009 to 2012 comparative results and related notes have been adjusted retrospectively from those previously published.
As of and for the year ended 31 December 2013 £bn 2012 £bn 2011 £bn 2010 £bn 2009 £bn
EEV shareholders’ equity, excluding non-controlling interests 24.9 22.4 19.6 18.2 15.3 Insurance Groups Directive capital surplus (as adjusted)note (5) 5.1 5.1 4.0 4.3 3.4
Notes 1 This measure is the formal profit (loss) before tax measure under IFRS, but is not the result attributable to shareholders. 2 Operating profits are determined on the basis of including longer-term investment returns. EEV and IFRS operating profits are stated after excluding the effect of short-term fluctuations in investment returns against long-term assumptions, gain on dilution of Group’s holdings, the costs arising from the domestication of the Hong Kong business, (loss) profit attaching to held for sale Japan life insurance business and, in 2010, costs associated with the terminated AIA transaction. Separately, on the IFRS basis, operating profit also excludes amortisation of acquisition accounting adjustments. In addition, for EEV basis results, operating profit excludes the effect of changes in economic assumptions, the market value movement on core borrowings and, in 2012, the gain arising on the acquisition of REALIC.
II(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: i Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets; ii Fee income represents profits driven by net investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses; iii With-profits business represents the shareholders’ transfer from the with-profits fund in the year; iv Insurance margin primarily represents profits derived from the insurance risks of mortality, morbidity and persistency; v Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses; vi Acquisition costs and administration expenses represent expenses incurred in the year attributable to shareholders. It excludes items such as restructuring costs and Solvency II costs which are not included in the segment profit for insurance, as well as items that are more appropriately included in other source of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate); and vii DAC adjustments comprises DAC amortisation for the year, excluding amounts related to short-term fluctuations, net of costs deferred in respect of new business.
Expected return on shareholder assets 216 205 Gain on China Life (Taiwan) shares – 51
(iv) The Group has adopted new accounting standards on joint arrangements, as described in note A2. The only impact of the resulting change on the analysis above is to deduct the associated tax expense from the joint ventures’ operating profit by treating it as an administration expense. The impact of this change is explained in note (iii), to the ‘Analysis of pre-tax IFRS operating profit by source’ table earlier in this section. All other lines continue to include the Group’s share of the relevant part of the joint ventures’ pre-tax operating profit.
Expected return on shareholder assets 58 43 Gain on China Life (Taiwan) shares – 51
Notes (i) The ratio for acquisition costs is calculated as a percentage of APE including with-profits sales. Acquisition costs include only those relating to shareholderbacked business. (ii) The Group has adopted new accounting standards on joint arrangements, as described in note A2. The only impact of the resulting change on the analysis above is to deduct the associated tax expense from the joint ventures’ operating profit by treating it as an administration expense. The impact of this change is explained in note (iii) to the ‘Analysis of pre-tax IFRS operating profit by source’ table earlier in this section. All other lines continue to include the Group’s share of the relevant part of the joint ventures’ pre-tax operating profit.
— Fee income has increased from £141 million in 2012 to £154 million in 2013, broadly in line with the increase in movement in average unit-linked liabilities.
— Insurance margin has increased by £90 million from £589 million in 2012 to £679 million in 2013, predominantly reflecting the continued growth of the in-force book, which contains a relatively high proportion of risk-based products and management action on claims controls and pricing. Insurance margin includes non-recurring items of £52 million (2012: £48 million), reflecting items that are not expected to reoccur in the future.
— Margin on revenues has increased by £123 million from £1,439 million in 2012 to £1,562 million in 2013, primarily reflecting the higher premium income recognised in the year.
— Administration expenses have increased from £570 million in 2012 to £634 million in 2013 as the business continues to expand. The administration expense ratio remains broadly in line with prior periods at 300 basis points (2012: 306 basis points).
A d d itio n al in fo rm atio n 341 Prudential plc Annual Report 2013
Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administrative expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson.
— Administration expenses increased to £670 million during 2013 compared to £537 million in 2012, primarily as a result of higher asset- based commissions paid on the larger 2013 separate account balance. Asset-based commissions are paid upon policy anniversary dates and are treated as an administration expense in this analysis, as opposed to a cost of acquisition and are offset by higher fee income. Excluding the trail commissions previously mentioned, the resulting administration expense ratio would be lower at 44 basis points (2012: 48 basis points), reflecting the benefits of operational leverage.
Analysis of pre-tax operating profit before and after acquisition costs and DAC adjustments
Other DAC adjustments – amortisation of previously deferred acquisition costs: UK
— Insurance margin has increased from £39 million in 2012 to £89 million in 2013. This increase arises from our improved profits from our protection business, the non-recurrence of the 2012 effect of strengthening longevity assumptions on our annuity book and £27 million positive impact of undertaking a longevity swap on certain aspects of the UK’s annuity back-book liabilities in the first half of 2013.
The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. It is, therefore, impacted by the level of with-profit sales in the year. Acquisition costs as a percentage of shareholder-backed new business sales were 32 per cent in 2013 (2012: 33 per cent).
— Administration expenses at £124 million are £4 million lower than for 2012 due to lower project spend in the first half of the year. — Expected return on shareholder assets has increased from £107 million in 2012 to £134 million in 2013, principally due to improved investment returns in the year and higher surplus assets.
II(b) Asia operations – analysis of IFRS operating profit by territory Operating profit based on longer-term investment returns for Asia operations are analysed as follows: 2013 £m AER
Operating profit before gain on China Life of Taiwan 1,003 862 16% 20% Gain on sale of stake in China Life of Taiwannote (ii) – 51 (100)% (100)%
Share of associate’s results 13 – – – 13 Group’s share of tax on joint ventures’ operating profit – (6) – – (6)
Operating profit based on longer-term investment returns 320 69 51 39 479
Average funds under management £205.1bn £55.0bn Margin based on operating income* 36 bps 37 bps Cost/income ratio† 59% 64%
† Cost/income ratio represents cost as a percentage of operating income before performance related fees. ‡ Institutional includes internal funds.
(iii) The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new accounting standards described in note A2 following adoption of IFRS 11 for Group’s joint ventures. This amount is excluded from the cost for cost/income ratio purposes.
A d d itio n al in fo rm atio n 345 Prudential plc Annual Report 2013
UK Life fund paid to the Group Shareholder-backed business: Other UK paid to the Group 149 101 Group invested in UK – (4) Total shareholder-backed business 149 97
Group invested in Asia: Long-term business (9) (107) Other operations (including funding of regional head office costs) (101) (103)
M&G remittances to the Group 235 206 PruCap remittances to the Group 57 91
Operating holding company cash flow before dividend* 1,026 911 Dividend paid (781) (655)
Total holding company cash flow 858 181 Cash and short-term investments at beginning of year 1,380 1,200 Foreign exchange movements (8) (1)
Notes (i) Including Group’s share of assets managed by joint ventures. (ii) External funds shown above as at 31 December 2013 of £143.3 billion (2012: £121.4 billion) comprise £148.2 billion (2012: £133.5 billion) of funds managed by M&G
and Eastspring Investments as shown in note (c) below, less £4.9 billion (2012: £12.1 billion) that are classified within Prudential Group’s funds. The £148.2 billion (2012: £133.5 billion) investment products comprise £143.9 billion (2012: £129.5 billion) as published in the New Business schedules plus Asia Money Market Funds of £4.3 billion (2012: £4.0 billion).
Asia operations US operations UK operations Total 2013 £bn 2012* £bn 2013 £bn 2012* £bn 2013 £bn 2012* £bn 2013 £bn 2012* £bn
Total included in statement of financial position 34.8 35.6 104.3 91.4 156.8 153.7 295.9 280.7
Total Prudential Group funds under management 38.0 38.9 104.3 91.4 157.3 154.0 299.6 284.3 * 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.
† As included in the investments section of the consolidated statement of financial position at 31 December 2013, except for £0.3 billion (2012: £0.1 billion) investment properties which are held for sale or occupied by the Group and, accordingly under IFRS, are included in other statement of financial position captions.
A d d itio n al in fo rm atio n 347 Prudential plc Annual Report 2013 c Investment products – external funds under management 2013 £m
Note Including Asia Money Market Funds at 31 December 2013 of £4.3 billion (2012: £4.0 billion).
III(c) Additional information on pre and post-tax EEV basis results The Group intends to alter its basis of presentation of EEV results for 2014 and subsequent reporting periods to a post-tax basis, in line with the approach adopted by a number of international insurance groups. The following tables provide an analysis of the Group’s profit and loss account and key accompanying notes on a pre-tax and post-tax basis for the most recent reporting periods.
Effect of changes in operating assumptions 17 22 (13) 5 13 (6) Experience variances and other items 64 75 33 80 76 18
Long-term business 2,387 1,958 1,079 1,892 1,536 829 Eastspring Investments* 74 69 38 64 58 32 Development expenses (2) (7) (2) (1) (5) (2)
Effect of changes in operating assumptions 116 35 70 76 23 45 Experience variances and other items 411 290 180 349 238 164
UK operations New businessnote (ii) 297 313 130 237 241 100 Business in force: Unwind of discount and other expected returns 547 482 267 437 373 204
Effect of changes in operating assumptions 122 87 – 98 67 – Experience variances and other items 67 (16) 7 60 10 –
Operating profit based on longer-term investment returns 5,580 4,313 2,479 4,204 3,174 1,821
* The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of IFRS 11 and for the reclassification of the result attributable to the held for sale Japan life business – see note 18 of the EEV basis results section.
A d d itio n al in fo rm atio n 349 Prudential plc Annual Report 2013
Operating profit based on longer-term investment returns* 5,580 4,313 2,479 4,204 3,174 1,821
Notes (i) The tax rates include the impact of tax effects determined on a local regulatory basis. Tax payments and receipts included in the projected cash flows to determine the value of in-force business are calculated using rates that have been substantively enacted by the end of the reporting period. (ii) New business contribution
Expected transfer of value of in-force (VIF) and required capital business to free surplus 2013 £m
Total free surplus expected to emerge in the next 40 years 22,013 9,388 12,145 43,546 3,340 1,515 658 5,513 * The analysis excludes amounts incorporated into VIF at 31 December 2013 where there is no definitive timeframe for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the estate. It also excludes any free surplus emerging after 2053. Following its classification as held for sale, the Asia cash flows exclude any cash flows in respect of Japan.
The above amounts can be reconciled to the new business amounts as follows: 2013 £m
Pre-tax EEV new business profit 1,460 1,086 297 2,843 * Other items represent the impact of the time value of options and guarantees on new business, foreign exchange effects and other non-modelled items. Foreign exchange effects arise as EEV new business profit amounts are translated at average exchange rates and the expected free surplus generation uses year end closing rates.
A d d itio n al in fo rm atio n 351 Prudential plc Annual Report 2013
The undiscounted expected free surplus generation from all in-force business at 31 December 2013 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2012 as follows: Group £m £m £m £m £m £m Other £m Total £m 2012 expected free surplus generation for years 2013 to 2052 1,950 1,816 1,788 1,687 1,671 1,594 24,646 35,152
Less: amounts expected to be realised in the current year (719) – – – – – – (719)
New business – 116 140 142 111 107 2,724 3,340 Acquisition of Thanachart Life – 17 13 11 8 5 20 74 Operating movements – (21) (5) – 3 6 Non-operating and other movements† – 7 22 24 20 17 3,337 3,410 2013 expected free surplus generation for years 2014 to 2053 – 801 821 798 735 705 18,153 22,013
£m £m £m £m £m £m Other £m Total £m 2012 expected free surplus generation for years 2013 to 2052 785 572 600 557 587 551 3,897 7,549
Add: expected free surplus to be generated in year 2053* – – – – – – – –
At 31 December 2013, the total free surplus expected to be generated over the next five years (years 2014 to 2018 inclusive), using the same assumptions and methodology as underpin our embedded value reporting was £10.1 billion, an increase of £1.5 billion from the £8.6 billion expected over the same period at the end of 2012.
Transfer to free surplus in 2013 713 796 508 2,017 Expected return on free assets 74 41 18 133 Changes in operating assumptions and experience variances 32 292 154 478
The equivalent discounted amounts of the undiscounted totals shown previously are outlined below: 2013 £m
III(e) Foreign currency source of key metrics The tables below show the Group’s key free surplus, IFRS and EEV, metrics analysis by contribution by currency group: Free surplus and IFRS full year 2013 results
Methodology In line with Solvency II, for the Group’s European and Asia life business, and holding companies, the available capital is the value of assets in excess of liabilities. The key components of available capital are the market value of assets, insurance technical provisions (calculated as the sum of best estimate liabilities plus a risk margin) and other liabilities. Subordinated debt forms part of available capital, rather than being treated as a liability, since this debt is subordinated to policyholder claims.
As a general principle, both assets and liabilities are recognised at the value at which they could theoretically be transferred to a third party in an arms length transaction. On the asset side of the balance sheet, assets are mostly held at IFRS fair value. However, adjustments are required to IFRS values to eliminate intangible items such as goodwill and deferred acquisition costs and to take account of economic assets which are excluded from the current IFRS balance sheet such as the present value of future with-profits shareholder transfers.
The Economic Capital Requirement measures the potential reduction in the value of available capital over a one year time horizon, in an adverse 1-in-200 probability event, consistently with the Solvency II Directive. This allows for diversification effects between different risk types and between entities. No restrictions on the economic value of overseas surplus have been allowed for in assessing the capital position at Group level.
In addition to the assumption of US equivalence, and without applying restrictions to the economic value of overseas surplus, other key elements of Prudential’s methodology relating to areas that are presently unclear in the draft Solvency II rules, and which are likely to evolve as more detailed requirements are clarified, relate to: (i) The liability discount rate for UK annuities, which is currently set by applying a ‘liquidity premium’ in addition to the risk-free rate. This liquidity premium addition reflects the long-term buy-and-hold nature of the assets backing UK annuity liabilities, which are, therefore, not directly exposed to changes in market credit spreads, but instead to long-term default risk over the term of the assets. This liquidity premium will be replaced with the corresponding Solvency II ‘Matching Adjustment’ when the rules and interpretation relating to this Solvency II calculation are clarified; (ii) The impact of transitional arrangements on technical provisions, for which no allowance has been made in the economic capital position, but which may apply under Solvency II (although the use of this transitional is subject to regulatory approval and the extent to which it is permitted is likely to depend on the final Solvency II capital position); and
Assumptions The key assumptions required for the economic capital calibration are: (i) Assumptions used to derive non-market related best estimate liability cash flows, which are based on EEV best estimate assumptions; (ii) Assumptions used to derive market related best estimate liability cash flows, which are based on market data at the valuation date where this data is reliable and comes from a deep and liquid market, or on appropriate extrapolation methodologies where markets are not sufficiently liquid to be reliable; (iii) Assumptions underlying the calculation of the best estimate liability in respect of dynamic management actions and policyholder behaviour; (iv) Assumptions underlying the risk models used to calculate the 1-in-200 level capital requirements for the Economic Capital Requirement which are set using a combination of historic market, demographic and operating experience data and expert judgement; and (v) Assumptions on the dependencies between risks, which are calibrated using a combination of historic data and expert judgement.
Aside from UK annuities, no liquidity premium allowance has been assumed for any other lines of business.
Reconciliation of IFRS to economic available capital The table below shows the reconciliation of Group IFRS shareholders’ equity to available capital.
Note Based on the Group’s Solvency II internal model which has not been reviewed or approved by the Prudential Regulation Authority.
Analysis of Group Economic Capital Requirement The table below shows the split of the £7.2 billion Group Economic Capital Requirement by risk type1 at 31 December 2013. However, there are material areas of uncertainty with regard to methodology and assumptions in the internal model which remain subject to review and approval by the Prudential Regulation Authority. Therefore, the results shown below should not be interpreted as outputs from an approved internal model.
The Group’s most material risk exposures are to financial markets, in particular to equities and credit spreads, which we hold to generate a higher return on capital over the long term. The Group also has material insurance risk exposures including longevity risk from UK annuities, lapse risk across a wide range of products, and mortality and morbidity risk mainly arising from protection products written in Asia. These risks diversify strongly with market risks, even after allowing for market-related policyholder behaviour, thereby, increasing the return on capital which can be earned from the balanced mix of risks. A brief description of the most material risks is set out below: — The Group’s exposure to equities mainly arises from UK shareholder transfers linked to policyholder funds (partially offset by economic equity hedges) and from future fund management charges on unit-linked funds in Asia. The equity exposure arising from Jackson’s variable annuity business is mostly hedge; — The Group also has significant exposure to credit risk, mainly from the UK annuity portfolio and from Jackson’s fixed annuity credit portfolio. Credit exposures across the Group are carefully monitored and managed as part of the Group’s risk management framework; — The Group is exposed to movements in yields (interest rates), while falling interest rates increase the risks arising from policyholder guarantees in with-profits funds and variable annuities, falling interest rates also increase the value of future insurance profits; — The most material insurance risk exposures arise from UK longevity risk, and lapse, mortality and morbidity risk in Asia; and — The Group is also exposed to expense and operational risk, which is closely monitored and managed through internal control processes.
Sensitivity testing of Group economic solvency position Stress testing the economic capital position gives the following results (as at 31 December 2013): — An instantaneous 20 per cent fall in equity markets would reduce surplus by £0.3 billion but increase the economic solvency ratio to 260 per cent; — An instantaneous 40 per cent fall in equity markets would reduce surplus by £1.0 billion but increase the economic solvency ratio to 258 per cent; — A 100 basis points reduction in interest rates (subject to a floor of zero) would reduce surplus by £1.3 billion and reduce the economic solvency ratio to 225 per cent; — A 100 basis points increase in interest rates would increase surplus by £0.8 billion and increase the economic solvency ratio to 284 per cent; and
These sensitivity results demonstrate the resilience of the economic capital position following large falls in equity markets, sizeable reductions in yields and a severe credit event.
III(g) Option schemes The Group maintains four share option schemes satisfied by the issue of new shares. Executive directors and eligible employees based in the UK may participate in the UK savings-related share option scheme, executives based in Asia and eligible employees can participate in the international savings-related share option scheme. Employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan, and Hong Kong based agents can participate in the non-employee savings-related share option scheme. Further details of the schemes and accounting policies are detailed in note B3.2 of the IFRS basis consolidated financial statements.
All options were granted at £nil consideration. No options have been granted to substantial shareholders, suppliers of goods or services (excluding options granted to agents under the non-employee savings-related share option scheme) or in excess of the individual limit for the relevant scheme.
29 Sep 05 4.07 01 Dec 12 31 May 13 3,780 – (1,260) – – (2,520) – 20 Apr 06 5.65 01 Jun 13 30 Nov 13 7,322 – (7,322) – – – – 28 Sep 06 4.75 01 Dec 13 31 May 14 13,325 – (13,177) – – – 148 27 Sep 07 5.52 01 Dec 12 31 May 13 5,108 – (5,108) – – – – 27 Sep 07 5.52 01 Dec 14 31 May 15 1,668 – – – – – 1,668 25 Apr 08 5.51 01 Jun 13 30 Nov 13 26,509 – (26,367) – – (142) – 25 Apr 08 5.51 01 Jun 15 30 Nov 15 1,544 – – – – – 1,544 27 Apr 09 2.88 01 Jun 12 30 Nov 12 5,709 – (5,709) – – – – 27 Apr 09 2.88 01 Jun 14 30 Nov 14 1,719,205 – (27,753) (1,085) (26,797) (7,623) 1,655,947 25 Sep 09 4.25 01 Dec 12 31 May 13 40,985 – (39,875) – (854) (256) – 25 Sep 09 4.25 01 Dec 14 31 May 15 86,651 – (407) (3,659) – (178) 82,407
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £12.28.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £12.15.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £9.73.
26 Apr 07 5.72 01 Jun 12 30 Nov 12 12,779 – – – – (12,779) – 27 Sep 07 5.52 01 Dec 12 31 May 13 2,970 – (2,874) – – (96) – 25 Apr 08 5.51 01 Jun 13 30 Nov 13 3,834 – – (1,837) – – 1,997 25 Sep 09 4.25 01 Dec 12 31 May 13 16,676 – (16,673) – – (3) – 25 Sep 09 4.25 01 Dec 14 31 May 15 11,717 – – – – – 11,717
The total number of securities available for issue under the scheme is 4,030,506 which represents 0.157 per cent of the issued share capital at 31 December 2013.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £12.92.
A number of factors (risk factors) affect Prudential’s operating results and financial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, is not updated, and any forward-looking statements are made subject to the reservations specified below under ‘Forward Looking Statements’.
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profitability. Since 2008 Prudential has operated against a challenging background of periods of significant volatility in global capital and equity markets, interest rates and liquidity, and widespread economic uncertainty. Government interest rates also remain at or near historic lows in the US, the UK and some Asian countries in which Prudential operates. These factors have, at times during this period, had a material adverse effect on Prudential’s business and profitability.
— Increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline.
In the US, fluctuations in prevailing interest rates can affect results from Jackson which has a significant spreadbased business, with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates. Declines in spread from these products or other spread businesses that Jackson conducts, and increases in surrenders levels arising from interest rate rises, could have a material impact on its businesses or results of operations.
d d itio n al in fo rm atio n sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due to the geographical diversity of Prudential’s businesses, Prudential is subject to the risk of exchange rate fluctuations. Prudential’s operations in the US and Asia, which represent a significant proportion of operating profit based on longer-term investment returns and shareholders’ funds, generally write policies and invest in assets denominated in local currencies. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon translation of results into pounds sterling. This exposure is not currently separately managed. The currency exposure relating to the translation of reported earnings could impact on financial reporting ratios such as dividend cover, which is calculated as operating profit after tax on an IFRS basis, divided by the current year interim dividend plus the proposed final dividend. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within other comprehensive income. Consequently, this could impact on Prudential’s gearing ratios (defined as debt over debt plus shareholders’ funds).
Insurance Groups Directive (‘IGD’) require EU financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a higher amount of regulatory capital at the group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. The EU is also developing a new prudential regulatory framework for insurance companies, referred to as ‘Solvency II’. The approach is based on the concept of three pillars. Pillar 1 consists of the quantitative requirements, for example, the amount of capital an insurer should hold. Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers. Pillar 3 focuses on disclosure and transparency requirements.
The Solvency II Directive covers valuation, the treatment of insurance groups, the definition of capital and the overall level of capital requirements. A key aspect of Solvency II is that the assessment of risks and capital requirements are intended to be aligned more closely with economic capital methodologies, and may allow Prudential to make use of its internal economic capital models, if approved by the Prudential Regulation Authority (‘PRA’). The Solvency II Directive was formally approved by the Economic and Financial Affairs Council in November 2009 although its implementation was delayed pending agreement on a directive known as Omnibus II which, once adopted, will amend certain aspects of the Solvency II Directive. In November 2013, representatives from the European Parliament, the European Commission and the Council of the European Union reached an agreement on the Omnibus II Directive, which is currently expected to be adopted in early 2014. As a result, Solvency II is now expected to be implemented as of 1 January 2016, although the European Commission and the European Insurance and Occupational Pensions Authority (EIOPA) are continuing to develop the detailed rules that will complement the high-level principles of the Solvency II and Omnibus II Directives, which are not currently expected to be finalised until mid-2015. Further, the effective application of a number of key measures incorporated in the Omnibus II Directive, including the provisions for third-country equivalence, is expected to be subject to supervisory judgement and approval. As a result there is a risk that the effect of the measures
Risk factors continued finally adopted could be adverse for Prudential, including potentially a significant increase in the capital required to support its business and that Prudential may be placed at a competitive disadvantage to other European and non-European financial services groups.
In July 2013, the FSB announced the initial list of nine insurance groups that have been designated as G-SIIs. This list included Prudential as well as a number of its competitors. The designation as a G-SII is likely to lead to additional policy measures being applied to the designated group. Based on a policy framework released by the IAIS concurrently with the initial list, these additional policy measures will include enhanced Group-wide supervision. This enhanced supervision is intended to commence immediately and will include the development by July 2014 of a Systemic Risk Management Plan (SRMP) under supervisory oversight and implementation thereafter and, by the end of 2014, a group Recovery and Resolution Plan (RRP) and Liquidity Risk Management Plan (LRMP). The G-SII regime also introduces two types of capital requirements, the first, a Basic Capital Requirement (BCR), designed to act as a minimum group capital requirement and the second, a higher loss absorption (HLA) requirement for conducting non-traditional insurance and non-insurance activities. The IAIS released a consultation paper on the BCR in December 2013 and Prudential will participate in the field testing of the proposals (expected in the first half of 2014). Prudential is monitoring the development of, and the potential impact of, the framework of policy measures and engaging with the PRA on the implications of this designation. The IAIS currently expects to finalise the BCR and HLA proposals by November 2014 and the end of 2015 respectively. Implementation of the regime is likely to be phased in over a period of years with the BCR expected to be introduced between 2015 and 2019. The HLA requirement will apply from January 2019 to the insurance groups identified as G-SIIs in November 2017.
In the US, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund, fixed index annuity and insurance product industries. This focus includes new regulations in respect of the suitability of sales of certain products such as alternative investments. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.
In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. There is a risk that new requirements are introduced that challenge current practices, or are retrospectively applied to sales made prior to their introduction.
d d itio n al in fo rm atio n companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations (including tax) or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provided in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, other sanctions that might be applicable and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s reputation, results of operations or cash flows.
In Asia, the Group’s principal competitors in the region are international financial companies, including global life insurers such as Allianz, AXA, AIA, and Manulife and multinational asset managers such as J.P. Morgan Asset Management, Schroders, HSBC Global Asset Management and Franklin Templeton. In a number of markets, local companies have a very significant market presence.
These factors, among others, result in significant reliance on and require significant investment in IT, compliance and other operational systems, personnel and processes. In addition, Prudential outsources several operations, including a significant part of its UK back office and customer facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its UK annuity business. Prudential’s persistency assumptions reflect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also reflected in the assumption. If actual levels of future persistency are significantly lower than assumed (that is, policy termination rates are significantly higher than assumed), the Group’s results of operations could be adversely affected.
In common with other life insurers, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity levels and trends, policy surrender rates, investment performance and impairments, unit cost of administration and new business acquisition expense.
As a holding company, Prudential’s principal sources of funds are remittances from subsidiaries, shareholder-backed funds, the shareholder transfer from long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper. Certain of the subsidiaries are restricted by applicable insurance, foreign exchange and tax laws, rules and regulations that can limit the payment of dividends, which in some circumstances could limit the ability to pay dividends to shareholders or to make available funds held in certain subsidiaries to cover operating expenses of other members of the Group.
Prudential operates in a number of markets through joint ventures and other arrangements with third parties (including in China and India), involving certain risks that Prudential does not face with respect to its consolidated subsidiaries Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures (including in China and India). For the Group’s joint venture operations, management control is exercised jointly with the venture participants. The level of control exercisable by the Group depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants. Prudential may face financial, reputational and other exposure (including regulatory censure) in the event that any of its joint venture partners fails to meet its obligations under the joint venture, encounters financial difficulty, or fails to comply with local regulation or international standards such as those for the prevention of financial crime. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements or material failure in controls (such as those for the prevention of financial crime) could adversely affect the results of operations of Prudential.
Bulk annuity A bulk annuity, sometimes referred to as a bulk purchase annuity, is a contract between a defined benefit pension scheme and an insurance company, whereby an insurance company insures some or all of the liabilities of the pension scheme.
Deferred acquisition costs or DAC Acquisition costs are expenses of an insurer which are incurred in connection with the acquisition of new insurance contracts or the renewal of existing insurance policies. They include commissions and other variable sales inducements and the direct costs of issuing the policy, such as underwriting and other policy issue expenses. Typically, under IFRS, an element of acquisition costs are deferred ie not expensed in the year incurred, and instead amortised in the income statement in line with the emergence of surpluses on the related contracts.
Fixed index annuities These are similar to fixed annuities in that the contract holder pays the insurer a premium, which is credited to the contract holders’ account and, periodically, interest is credited to the contract holders’ account and administrative charges are deducted, as appropriate. An annual minimum interest rate may be guaranteed, although actual interest credited may be higher and is linked to an equity index over its indexed option period.
Guaranteed minimum accumulation benefit (GMAB) (US) A guarantee that ensures that the contract value of a variable annuity contract will be at least equal to a certain minimum amount after a specified number of years.
Investment-linked products or contracts Insurance products where the surrender value of the policy is linked to the value of underlying investments (such as collective investment schemes, internal investment pools or other property) or fluctuations in the value of underlying investment or indices. Investment risk associated with the product is usually borne by the policyholder. Insurance coverage, investment and administration services are provided for which the charges are deducted from the investment fund assets. Benefits payable will depend on the price of the units prevailing at the time of surrender, death or the maturity of the product, subject to surrender charges. These are also referred to as unit linked products or unit linked contracts.
Market value reduction (MVR) A reduction applied to the payment on with-profits bonds when policyholders surrender in adverse market conditions.
Net premiums Life insurance premiums, net of reinsurance ceded to third party reinsurers.
Single premiums Single premium policies of insurance are those that require only a single lump sum payment from the policyholder.
Unallocated surplus Unallocated surplus is recorded wholly as a liability and represents the excess of assets over policyholder liabilities for Prudential’s with-profits funds. The balance retained in the unallocated surplus represents cumulative income arising on the with-profits business that has not been allocated to policyholders or shareholders.
Shareholder enquiries For enquiries about shareholdings, including dividends and lost share certificates, please contact the Company Registrars: By post Equiniti Limited Aspect House Spencer Road Lancing West Sussex BN99 6DA
Calls to 0871 numbers are charged at 8p per minute plus network extras. Lines are open from 8.30am to 5.30pm (UK), Monday to Friday. International shareholders Tel: +44 (0) 121 415 7026
Dividend mandates Shareholders may have their dividends paid directly to their bank or building society account. If you wish to take advantage of this facility, please call Equiniti Limited (Equiniti) and request a cash dividend mandate form. Alternatively, shareholders may download the form from www.prudential.co.uk/prudential-plc/ investors/shareholder_services/forms
Electronic communications Shareholders are encouraged to elect to receive shareholder documents electronically by registering with Shareview at www.shareview.co.uk This will save on printing and distribution costs, and create environmental benefits. Shareholders who have registered will be sent an email notification whenever shareholder documents are available on the Company’s website and a link will be provided to that information. When registering, shareholders will need their shareholder reference number which can be found on their share certificate or proxy form. The option to receive shareholder documents electronically is not available to shareholders holding shares through The Central Depository (Pte) Limited (CDP). Please contact Equiniti if you require any assistance or further information.
— A choice of contact methods – via email, telephone or post.
Share dealing services The Company’s Registrars, Equiniti, offer a postal dealing facility for buying and selling Prudential plc ordinary shares; please see the Equiniti address opposite or telephone 0871 384 2248. They also offer a telephone and internet dealing service, Shareview, which provides a simple and convenient way of selling Prudential plc shares. For telephone sales call 0871 384 2020 between 8.30am and 4.30pm, Monday to Friday, and for internet sales log on to www.shareview.co.uk/dealing
Irish branch register The Company operates a branch register for shareholders in Ireland. All enquiries regarding Irish branch register accounts should be directed to Capita Asset Services, Shareholder solutions (Ireland), PO Box 7117, Dublin 2, Ireland, telephone + 353 1 553 0050.
Hong Kong branch register The Company operates a branch register for shareholders in Hong Kong. All enquiries regarding Hong Kong branch register accounts should be directed to Computershare Hong Kong Investor Services Limited, 17M Floor, Hopewell Centre, 183 Queen’s Road East, Wan Chai, Hong Kong, telephone +852 2862 8555.
Forward-looking statements This document may contain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations and including, without limitation, statements containing the words ‘may’, ‘will’, ‘should’, ‘continue’, ‘aims’, ‘estimates’, ‘projects’, ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward-looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward-looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future financial condition or performance or other indicated results to differ materially from those indicated in any forward-looking statement. Such factors include, but are not limited to, future market conditions, including fluctuations in interest rates and exchange rates and the potential for a sustained low-interest rate environment, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives related to the financial crisis and the effect of the European Union’s ‘Solvency II’ requirements on Prudential’s capital maintenance requirements; the impact of continuing designation as a Global Systemically Important Insurer or ‘G-SII’; the impact of competition, economic growth, inflation, and deflation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards, accounting standards or relevant regulatory frameworks, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate; and the impact of legal actions and disputes. These and other important factors may for example result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefits. Further discussion of these and other important factors that could cause Prudential’s actual future financial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the ‘Risk Factors’ heading in this document.
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