*�The�debt�securities�of�Jackson�are�held�in�the�general�account�of�the�business.�Realised�gains�and�losses�are�recorded�in�the�income�statement�with�normalised�returns�included� in�adjusted�IFRS�operating�profit�based�on�longer-term�investment�returns�with�variations�from�year�to�year�included�in�the�short-term�fluctuations�category.�The�risk�margin� reserve�charge�for�longer-term�credit-related�losses�included�in�adjusted�IFRS�operating�profit�based�on�longer-term�investment�returns�of�Jackson�for�2018�is�based�on�an� average�annual�risk�margin�reserve�of�18�basis�points�(2017:�21�basis�points)�on�average�book�values�of�US$57.1�billion�(2017:�US$55.3�billion)�as�shown�below: Moody’s rating category (or equivalent under NAIC ratings of mortgage-backed securities)
Determination of adjusted IFRS operating profit based on longer-term investment returns for investment and liability movements: (a) General principles (i) UK-style with-profits business The�adjusted�IFRS�operating�profit�based�on�longer-term�investment�returns�reflects�the�statutory�transfer�gross�of�attributable�tax.� Value�movements�in�the�underlying�assets�of�the�with-profits�funds�do�not�affect�directly�the�determination�of�adjusted�IFRS�operating� profit�based�on�longer-term�investment�returns.
(iv) Business where policyholder liabilities are sensitive to market conditions Under�IFRS,�the�degree�to�which�the�carrying�values�of�liabilities�to�policyholders�are�sensitive�to�current�market�conditions�varies� between�business�units�depending�upon�the�nature�of�the�‘grandfathered’�measurement�basis.�In�general,�in�those�instances�where�the� liabilities�are�particularly�sensitive�to�routine�changes�in�market�conditions,�the�accounting�basis�is�such�that�the�impact�of�market� movements�on�the�assets�and�liabilities�is�broadly�equivalent�in�the�income�statement,�and�adjusted�IFRS�operating�profit�based�on� longer-term�investment�returns�is�not�distorted.�In�these�circumstances,�there�is�no�need�for�the�movement�in�the�liability�to�be�bifurcated� between�the�elements�that�relate�to�longer-term�market�conditions�and�short-term�effects.
(b) Asia insurance operations (i) Business where policyholder liabilities are sensitive to market conditions For�certain�Asia�non-participating�business,�for�example�in�Hong�Kong,�the�economic�features�are�more�akin�to�asset�management� products�with�policyholder�liabilities�reflecting�asset�shares�over�the�contract�term.�Consequently,�for�these�products,�the�charge�for� policyholder�benefits�in�the�adjusted�IFRS�operating�profit�based�on�longer-term�investment�returns�reflects�the�asset�share�feature�rather� than�volatile�movements�that�would�otherwise�be�reflected�if�the�local�regulatory�basis�(also�applied�for�IFRS�basis)�was�used.�
(c) US insurance operations (i) Separate account business For�such�business�the�policyholder�unit�liabilities�are�directly�reflective�of�the�asset�value�movements.�Accordingly,�the�adjusted� IFRS�operating�profit�based�on�longer-term�investment�returns�reflect�the�current�period�value�movements�in�unit�liabilities�and�the� backing�assets.
(iii) Other derivative value movements The�principal�example�of�non-equity�based�derivatives�(for�example,�interest�rate�swaps�and�swaptions)�whose�value�movements�are� excluded�from�adjusted�IFRS�operating�profit�based�on�longer-term�investment�returns,�arises�in�Jackson.�Non-equity�based�derivatives� are�primarily�held�by�Jackson�as�part�of�a�broadly-based�hedging�programme�for�features�of�Jackson’s�bond�portfolio�(for�which�value� movements�are�booked�in�the�statement�of�other�comprehensive�income�rather�than�the�income�statement),�product�liabilities�(for�which� US�GAAP�accounting�as�‘grandfathered’�under�IFRS�4�does�not�fully�reflect�the�economic�features�being�hedged),�and�the�interest�rate� exposure�attaching�to�equity-based�product�options�.
Equity-type securities As�at�31�December�2018,�the�equity-type�securities�for�US�insurance�non-separate�account�operations�amounted�to�£1,359�million� (31�December�2017:�£946�million).�For�these�operations,�the�longer-term�rates�of�return�for�income�and�capital�applied�in�the�years� indicated,�which�reflect�the�combination�of�the�average�risk-free�rates�over�the�year�and�appropriate�risk�premiums�are�as�follows: Equity-type�securities�such�as�common�and�preferred�stock�and�portfolio�holdings�in�mutual�funds 6.7% to 7.2% 6.1%�to�6.5% Other�equity-type�securities�such�as�investments�in�limited�partnerships�and�private�equity�funds 8.7% to 9.2% 8.1%�to�8.5%
Earned�premiums,�net�of�reinsurance 15,894 17,347 (76) 33,165 36 33,201 Other�income note (ii),(iii) 309 50 1,595 1,954 39 1,993
Benefits�and�claims�and�movements�in� unallocated�surplus�of�with-profits�funds,� net�of�reinsurance note (i),(iv) (8,736) (8,790) 4,977 (12,549) (19) (12,568)
Earned�premiums,�net�of�reinsurance 15,032 14,812 12,076 41,920 23 41,943 Other�income note (ii),(iii) 307 669 1,234 2,210 48 2,258
Benefits�and�claims note (ii) (8,790) – – (8,790) (31,205) Interest�on�core�structural�borrowings (15) – – (15) (16) Acquisition�costs�and�other�operating�expenditure�note B2 (2,010) (135) 68 (2,077) (2,257) (Loss)�gain�on�disposal�of�businesses�and�corporate�
Wages�and�salaries� 1,656 1,774 Social�security�costs� 116 129 Defined�benefit�schemes* (29) (3) Defined�contribution�schemes 95 85 *�The�(credit)�incorporates�the�effect�of�actuarial�gains�and�losses.
(d) Share-based payment expense charged to the income statement Total�expense�recognised�in�the�year�in�the�consolidated�financial�statements�relating�to�share-based�compensation�is�as�follows: 2018� £m 2017� £m
Fees�payable�to�the�Company’s�auditor�for�the�audit�of�the�Company’s�annual�accounts 2.1 2.1 Fees�payable�to�the�Company’s�auditor�and�its�associates�for�other�services: Audit�of�subsidiaries�pursuant�to�legislation 9.2 8.3 Audit-related�assurance�services* 4.7 4.3 Other�assurance�services� 1.1 1.5 Services�relating�to�corporate�finance�transactions 0.2 0.4 All�other�services 1.0 0.7
B3 Effect of changes and other accounting matters on insurance assets and liabilities
(iii) UK and Europe insurance operations Annuity and other shareholder-backed business Allowance for credit risk For�IFRS�reporting,�the�results�for�UK�shareholder-backed�annuity�business�are�particularly�sensitive�to�the�allowance�made�for�credit�risk.� The�allowance�is�reflected�in�the�deduction�from�the�valuation�rate�of�interest�for�discounting�projected�future�annuity�payments� to�policyholders�that�would�have�otherwise�applied.�The�credit�risk�allowance�comprises�an�amount�for�long-term�best�estimate�defaults� and�additional�provisions�for�credit�risk�premium,�the�cost�of�downgrades�and�short-term�defaults.
Unrealised�gains�and�losses�on�investments 667 (185) Short-term�temporary�differences (198) (526) Balances�relating�to�investment�and�insurance�contracts (91) (156) Unused�tax�losses 23 (12) Capital�allowances (1) (5)
Tax�at�the�expected�rate 360 365 220 (171) 774 21.3% Effects�of�recurring�tax�reconciliation�items: Income�not�taxable�or�taxable�at�concessionary�rates (34) (17) (6) (2) (59) (1.6)% Deductions�not�allowable�for�tax�purposes� 39 3 15 10 67 1.8% Items�related�to�taxation�of�life�insurance��
Effects�of�non-recurring�tax�reconciliation�items: Adjustments�to�tax�charge�in�relation�to�prior�years – (17) (11) 14 (14) (0.4)% Movements�in�provisions�for�open�tax�matters note (v) 2 4 (2) 1 5 0.2%
(ii) Items related to taxation of life insurance businesses � The�£83�million�(2017:�£238�million)�reconciling�item�in�US�operations�reflects�the�impact�of�the�dividend�received�deduction�on�the�taxation�of�profits�from�variable�annuity�
(iii)� Effects of results of joint ventures and associates � Profit�before�tax�includes�Prudential’s�share�of�profits�after�tax�from�the�joint�ventures�and�associates.�Therefore,�the�actual�tax�charge�does�not�include�tax�arising�from�profit�
Effect�of�results�of�joint�ventures�and�associates (52) – (3) – (55) (1.7)% Irrecoverable�withholding�taxes – – – 54 54 1.6%
Dividends�relating�to�reporting�year: � First�interim�ordinary�dividend 15.67p 406 14.50p� 375 Second�interim�ordinary�dividend 33.68p 873 32.50p� 841
Assets�held�for�sale D1 – – 38 – – 38 Cash�and�cash�equivalents note (ii) 1,934 1,658 5,808 1,290 – 10,690
Unallocated�surplus�of�with-profits�funds C4.1 3,474 – 13,477 – – 16,951 Core�structural�borrowings�of�shareholder-financed�businesses C6.1 – 184 – 6,096 – 6,280 Operational�borrowings�attributable�to�shareholder-financed�
C1 Analysis of Group statement of financial position by segment continued
Notes (i)� Accrued investment income and other debtors 2018� £m 2017� £m
Accruals�and�deferred�income 1,700 1,233 Other�creditors 7,074 7,289 Creditors�arising�from�direct�insurance�and�reinsurance�operations 2,363 2,296 Interest�payable 117 100 Funds�withheld�under�reinsurance�of�the�REALIC�business 2,941 2,664 Other�items 1,053 603
Unit-linked and variable annuity separate account Equity�securities�and�portfolio�holdings�in�unit�trusts 158,631 457 10� 159,098
held�at�fair�value – (17,397) –� (17,397) Borrowings�attributable�to�with-profits�businesses – – (1,887)� (1,887) Net�asset�value�attributable�to�unit�holders�of�consolidated�unit�trusts�
Assets and liabilities at amortised cost and their fair value The�table�below�shows�the�assets�and�liabilities�carried�at�amortised�cost�on�the�statement�of�financial�position�and�their�fair�value.�The� assets�and�liabilities�that�are�carried�at�amortised�cost�but�where�the�carrying�value�approximates�the�fair�value,�are�excluded�from�the� analysis�below.
(c) Valuation approach for level 2 fair valued assets and liabilities A�significant�proportion�of�the�Group’s�level�2�assets�are�corporate�bonds,�structured�securities�and�other�non-national�government�debt� securities.�These�assets,�in�line�with�market�practice,�are�generally�valued�using�a�designated�independent�pricing�service�or�quote�from� third-party�brokers.�These�valuations�are�subject�to�a�number�of�monitoring�controls,�such�as�comparison�to�multiple�pricing�sources� where�available,�monthly�price�variances,�stale�price�reviews�and�variance�analysis�on�prices�achieved�on�subsequent�trades.
Equity�securities 38 (12) Debt�securities (16) (5) Other�investments� 370 (22) Derivative�liabilities 27 4 Borrowings�attributable�to�with-profits�businesses (23) (13) Net�asset�value�attributable�to�unit�holders�of�consolidated�unit�trusts�and�similar�funds 67 (123) Other�financial�liabilities 6 12
(e) Transfers into and transfers out of levels The�Group’s�policy�is�to�recognise�transfers�into�and�transfers�out�of�levels�as�of�the�end�of�each�half�year�reporting�period�except�for� material�transfers�which�are�recognised�as�of�the�date�of�the�event�or�change�in�circumstances�that�caused�the�transfer.�Transfers�are� deemed�to�have�occurred�when�there�is�a�material�change�in�the�observed�valuation�inputs�or�a�change�in�the�level�of�trading�activities� of�the�securities.
(f) Valuation processes applied by the Group The�Group’s�valuation�policies,�procedures�and�analyses�for�instruments�categorised�as�level�3�are�overseen�by�business�unit�committees� as�part�of�the�Group’s�wider�financial�reporting�governance�processes.�The�procedures�undertaken�include�approval�of�valuation� methodologies,�verification�processes,�and�resolution�of�significant�or�complex�valuation�issues.�In�undertaking�these�activities�the�Group� makes�use�of�the�extensive�expertise�of�its�asset�management�functions.�In�addition,�the�Group�has�minimum�standards�for�independent� price�verification�to�ensure�valuation�accuracy�is�regularly�independently�verified.�Adherence�to�this�policy�is�monitored�across�the� business�units.
(e) Asset-backed securities The�Group’s�holdings�in�Asset-Backed�Securities�(ABS),�which�comprise�Residential�Mortgage-Backed�Securities�(RMBS),�Commercial� Mortgage-Backed�Securities�(CMBS),�Collateralised�Debt�Obligations�(CDO)�funds�and�other�asset-backed�securities�are�as�follows: 31 Dec 2018� £m 31 Dec 2017� £m
Shareholder-backed business Asia�operations note (i) 121 118 US�operations note (ii) 3,604 3,226 UK�and�Europe�operations�(2018:�42%�AAA,�13%�AA) note (iii) 1,406 1,070 Other�operations note (iv) 445 589
With-profits business Asia�operations note (i) 235 233 UK�and�Europe�operations�(2018:�66%�AAA,�12%�AA) note (iii) 5,270 5,658
(f) Group sovereign debt and bank debt exposure The�Group�exposures�held�by�the�shareholder-backed�business�and�with-profits�funds�in�sovereign�debts�and�bank�debt�securities�are� analysed�as�follows: Exposure to sovereign debts �
Exposure to bank debt securities 31 Dec 2018� £m 2017� £m
(g) Impairment of US available-for-sale debt securities and other financial assets In�accordance�with�the�Group’s�accounting�policy�set�out�in�note�A3.1,�impairment�reviews�were�performed�for�available-for-sale� securities�and�loans�and�receivables.�
C3.3 Loans portfolio (a) Overview of loans portfolio Loans�are�accounted�for�at�amortised�cost�net�of�impairment�except�for: �— Certain�mortgage�loans�which�have�been�designated�at�fair�value�through�profit�or�loss�of�the�UK�and�Europe�insurance�operations�as� this�loan�portfolio�is�managed�and�evaluated�on�a�fair�value�basis;�and�
Net�asset�value�attributable� to�unit�holders�of� consolidated�unit�trusts� and�similar�funds� 11,651 11,651 – – – – – – 11,651 31 Dec 2017� £m
Counterparty Legal Entity Identifier (LEI) Relationship between parties Type of exemption
Comprising: – Policyholder liabilities on the consolidated statement of financial position note (i) 53,716 177,626 157,654 388,996 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,667 – 11,650 14,317 – Group's share of policyholder liabilities of joint ventures and associate note (ii) 6,401 – – 6,401
Comprising: – Policyholder liabilities on the consolidated statement of financial position note (i)
Addition�for�closed�block�of�group�payout�annuities�in�the�US note (iii) – 4,143 – 4,143 Investment-related�items�and�other�movements (1,204) (9,999) (1,975) (13,178) Foreign�exchange�translation�differences 1,148 10,945 – 12,093
Comprising: – Policyholder liabilities on the consolidated statement of financial position
(iv) Reinsurers’ share of insurance contract liabilities 31 Dec 2018� £m 2017� £m
C4.1(b) Asia insurance operations (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds A�reconciliation�of�the�total�policyholder�liabilities�and�unallocated�surplus�of�with-profits�funds�of�Asia�insurance�operations�from�the� beginning�of�the�year�to�the�end�of�the�year�is�as�follows: With-profits business £m� note�(vi)
Comprising: – Policyholder liabilities on the consolidated statement of financial position 27,266 14,289 12,161 53,716 – Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,667 – – 2,667 – Group's share of policyholder liabilities relating to joint ventures and associate note (i) – 3,218 3,183 6,401 Premiums�
Expected�maturity: 0�to�5�years 20 21 5�to�10�years 19 19 10�to�15�years 15 16 15�to�20�years 12 12 20�to�25�years 10 10 Over�25�years 24 22
(iii) Summary policyholder liabilities (net of reinsurance) and unallocated surplus At�31�December�2018,�the�policyholder�liabilities�and�unallocated�surplus�for�Asia�operations�excluding�joint�ventures�and�after� deducting�intra-group�reinsurance�liabilities�ceded�by�UK�and�Europe�of�£74,618�million�(2017:�£66,372�million),�net�of�external� reinsurance�of�£2,777�million�(2017:�£1,960�million),�comprised�the�following: 2018� £m 2017� £m
Fixed annuities and the fixed account portion of variable annuities £m
The�recent�declining�mortality�improvements�observed�in�population�data�were�considered�as�part�of�the�judgement�exercised�in� setting�the�2018�mortality�basis.�New�mortality�projection�models�are�released�regularly�by�the�Continuous�Mortality�Investigation� (CMI).�The�CMI�2016�model�was�used�to�produce�the�2018�results�and�the�CMI�2015�model�was�used�to�produce�the�2017�results.� The�default�calibration�of�CMI�2016�was�adopted�to�reflect�the�Company’s�view�of�future�mortality�improvements�based�on�a�range�of� possible�outcomes,�with�an�appropriate�margin�for�prudence.�The�mortality�improvement�assumptions�used�are�summarised�in�the� table�below: Year ended CMI Model, with calibration to reflect future mortality improvements 31 December 2018 CMI 2016 For males: with a long-term improvement rate of 2.25% pa For females: with a long-term improvement rate of 2.00% pa 31�December�2017 CMI�2015 For�males:�with�a�long-term�improvement�rate�of�2.25%�pa For�females:�with�a�long-term�improvement�rate�of�2.00%�pa
The�approach�to�determining�the� contract�liabilities�is�generally�driven� by�the�local�solvency�basis.�A�gross� premium�valuation�method�is�used�in� those�countries�where�a�risk-based� capital�framework�is�adopted�for�local� solvency.�Under�the�gross�premium� valuation�method,�all�cash�flows�are� valued�explicitly�using�best�estimate� assumptions�with�a�suitable�margin�for� prudence.�
The�policyholder�of�a�fixed�interest� rate�annuity�pays�Jackson�a� premium,�which�is�credited�to�the� policyholder’s�account.�Periodically,� interest�is�credited�to�the� policyholder’s�account�and�in�some� cases�administrative�charges�are� deducted�from�the�policyholder’s� account.�Jackson�makes�benefit� payments�at�a�future�date�as� specified�in�the�policy�based�on�the� value�of�the�policyholder’s�account� at�that�date.
Guaranteed�minimum�interest� rate.�At�31�December�2018,� Jackson�had�fixed�interest�rate� annuities�totalling�£12.6�billion� (2017:�£12.6�billion)�in�account� value�with�minimum�guaranteed� rates�ranging�from�1.0�per�cent�to� 5.5�per�cent�and�a�2.91�per�cent� average�guaranteed�rate�(2017:� 1.0�per�cent�to�5.5�per�cent� and�a�2.93�per�cent�average� guaranteed�rate).
This�is�then�augmented�by: �— Any�amounts�that�have�been�assessed� to�compensate�the�insurer�for�services� to�be�performed�over�future�periods� (ie�deferred�income); �— Any�amounts�previously�assessed� against�policyholders�that�are� refundable�on�termination�of�the� contract;�and
Guaranteed�minimum�rates�are� generally�set�at�1.0�to�3.0�per�cent.� At�31�December�2018,�Jackson�had� fixed�index�annuities�allocated�to� indexed�funds�totalling�£6.0�billion� (31�December�2017:�£6.3�billion)�in� account�value�with�minimum� guaranteed�rates�on�index�accounts� ranging�from�1.0�per�cent�to� 3.0�per�cent�and�a�1.77�per�cent� average�guaranteed�rate�(2017:� 1.0�per�cent�to�3.0�per�cent�and�a� 1.77�per�cent�average�guarantee� rate).
Group�payout�annuities�consist�of� a�block�of�defined�benefit�annuity� plans�assumed�from�John�Hancock� USA.�A�single�premium�payment� from�an�employer�(contract�holder)� funds�the�pension�benefits�for�its� employees�(participants).�The� contracts�are�tailored�to�meet�the� requirements�of�the�specific�pension� plan�being�covered.�This�is�a�closed� block�of�business�from�two� standpoints:�(1)�John�Hancock�USA� is�no�longer�selling�new�contracts� and�(2)�contract�holders� (companies)�are�no�longer�adding� additional�participants�to�these� defined�benefit�pension�plans.�The� majority�of�participants�are�in�the� payout�phase,�but�there�are�some� participants�in�the�deferral�phase.
Variable�annuities�are�deferred� annuities�that�have�the�same�tax� advantages�and�payout�options�as� fixed�interest�rate�and�fixed�index� annuities.�They�are�also�used�for� asset�accumulation�in�retirement� planning�and�to�provide�income�in� retirement.�At�31�December�2018,� variable�annuities�accounted�for� 75�per�cent�(2017:�77�per�cent)�of� Jackson’s�policy�and�contract� liabilities.
Non-performance�risk�is�incorporated� into�the�fair�value�calculation�through� the�use�of�discount�interest�rates� sourced�from�an�AA�corporate�credit� curve�as�a�proxy�for�Jackson’s�own� credit�risk.�Other�risk�margins,� particularly�for�policyholder�behaviour� and�long-term�volatility,�are�also� incorporated�into�the�model�through� the�use�of�explicitly�conservative� assumptions.�On�a�periodic�basis,� Jackson�validates�the�resulting�fair� values�based�on�comparisons�to�other� models�and�market�movements.
Unlike�traditional�with-profits� contracts,�no�regular�bonuses�are� declared.�Total�policyholder�return� is�determined�by�an�Expected� Growth�Rate�(EGR).�A�different�EGR� is�applied�for�each�of�the�different� PruFund�funds�within�the�range,� each�relating�to�the�individual�asset� mix�of�that�fund.�The�applicable� EGR,�net�of�the�relevant�charges,� is�applied�to�calculate�the�smoothed� unit�value�of�policyholder�funds.
Maintenance�and,�for�some�classes� of�business,�termination�expense� assumptions�are�expressed�as�per� policy�amounts.�They�are�set�based�on� the�expenses�incurred�during�the�year,� including�an�allowance�for�ongoing� investment�expenditure�and�allocated� between�entities�and�product�groups� in�accordance�with�the�operation’s� internal�cost�allocation�model.�Expense� inflation�assumptions�are�set�consistent� with�the�economic�basis�and�based�on� the�inflation�swap�spot�curve.
The�Group’s�main�exposure�to� guaranteed�annuities�in�the�UK� is�through�SAIF�and�a�provision� of�£361�million�was�held�in� SAIF�at�31�December�2018� (31�December�2017:� £503�million)�to�honour�the� guarantees.�As�SAIF�is�a� separate�sub-fund�solely�for�the� benefit�of�policyholders�of�SAIF,� this�provision�has�no�impact�on� the�financial�position�of�the� Group’s�shareholders’�equity.
Key�assumptions�include: Mortality The�mortality�assumptions�are�set�in� light�of�recent�population�and�internal� experience.�The�assumptions�used� are�adjusted�percentages�of�standard� actuarial�mortality�tables�with�an� allowance�for�future�mortality� improvements,�the�effect�of�antiselection �and�characteristics�specific� to�each�individual�policyholder.� Where�annuities�have�been�sold�on� an�enhanced�basis�to�impaired�lives� an�additional�age�adjustment�is�made.�
With-profits Written�in�the�with-profits�fund,� these�combine�the�income�features� of�annuity�products�with�the� investment�smoothing�features�of� with-profits�products�and�enable� policyholders�to�obtain�exposure�to� investment�return�on�the�withprofits �fund�equity�shares,�property� and�other�investment�categories� over�time.
Expense Maintenance�expense�assumptions�are� expressed�as�per�policy�amounts.�They� are�set�based�on�the�expenses�incurred� during�the�year,�including�an�allowance� for�ongoing�investment�expenditure� and�allocated�between�entities�and� product�groups�in�accordance�with�the� operation’s�internal�cost�allocation� model.�A�margin�for�adverse�deviation� is�added�to�this�amount.�Expense� inflation�assumptions�are�set�consistent� with�the�economic�basis�and�based�on� the�inflation�swap�spot�curve.�
For�those�contracts�where�the�level�of� insurance�risk�is�insignificant,�the�assets� and�liabilities�arising�under�the� contracts�are�distinguished�between� those�that�relate�to�the�financial� instrument�liability�and�acquisition� costs�and�deferred�income�that�relate� to�the�component�of�the�contract�that� relates�to�investment�management.� Acquisition�costs�and�deferred�income� are�recognised�consistent�with�the�level� of�service�provision�in�line�with�the� requirements�of�IFRS�15.
Net�income�of�the�fund: Investment�return (2,261) 9,985 Claims�incurred (8,776) (8,449) Movement�in�policyholder�liabilities (554) (10,011) Add�back�policyholder�bonuses�for�the�year�(as�shown�below) 2,345 2,071 Claims�incurred�and�movement�in�policyholder�liabilities
Carrying�value�at�beginning�of�year 1,458 24 1,482 1,628 Acquisition�of�TMB�Asset�Management�Co.,�Ltd.�in�Thailand�(see�note�D1.2) 181 – 181 – Other�additions�in�the�year�(see�below) – 195 195 9 Disposals/reclassifications�to�held�for�sale – (10) (10) (155)
(i) Deferred acquisition costs and other intangible assets attributable to shareholders Total�deferred�acquisition�costs�and�other�intangible�assets�attributable�to�shareholders�comprise: 31 Dec 2018� £m 31 Dec 2017� £m
Notes (a)� Total deferred acquisition costs and other intangible assets can be further analysed by business operations as follows: 31 Dec 2018� £m 2017� £m
(ii) Deferred acquisition costs related to insurance and investment contracts The�movements�in�deferred�acquisition�costs�relating�to�insurance�and�investment�contracts�are�as�follows: 2018� £m 2017� £m
¤20m�Medium�Term�Notes�2023�(Tier�2) note (vii) 18 18 £435m�6.125%�Notes�2031�(Tier�2) 431 430 £400m�11.375%�Notes�2039�(Tier�2) 399 397 £600m�5%�Notes�2055�(Tier�2) 591 591 £700m�5.7%�Notes�2063�(Tier�2) 696 696 £750m�5.625%�Notes�2051�(Tier�2) note (iv) 743 – £500m�6.25%�Notes�2068�(Tier�2) note (iv) 498 – US$500m�6.5%�Notes�2048�(Tier�2) note (iv) 391 –
(iv)� In�October�2018,�the�Company�issued�the�following�three�substitutable�core�structural�borrowings�as�part�of�the�process�required�before�demerger�to�rebalance�debt�across� M&GPrudential�and�Prudential�(see�below): � –�£750�million�5.625�per�cent�Tier�2�subordinated�notes�due�2051.�The�proceeds,�net�of�costs,�were�£743�million; � –�£500�million�6.25�per�cent�Tier�2�subordinated�notes�due�2068.�The�proceeds,�net�of�costs,�were�£498�million;�and � –�US$500�million�6.5�per�cent�Tier�2�subordinated�notes�due�2048.�The�proceeds,�net�of�costs,�were�£389�million�(US$498�million). (v)� In�December�2018,�the�Company�paid�£434�million�to�redeem�its�US$550�million�7.75�per�cent�Tier�1�perpetual�subordinated�notes.� (vi)� These�borrowings�can�be�converted,�in�whole�or�in�part,�at�the�Company’s�option�and�subject�to�certain�conditions,�on�any�interest�payment�date,�into�one�or�more�series�of�
Core structural borrowings Operational borrowings Borrowings 31 Dec 2018� £m 31 Dec 2017� £m 31 Dec 2018� £m 31 Dec 2017� £m 31 Dec 2018� £m 31 Dec 2017� £m
C7.1 Group overview The Group’s risk framework and the management of the risk, including those attached to the Group’s financial statements including financial assets, financial liabilities and insurance liabilities, together with the inter-relationship with the management of capital have been included in the audited sections of the ‘Chief Risk Officer’s Report of the risks facing our business and how these are managed’.
SAIF sub-fund Net neutral direct exposure (indirect exposure only) Asset management fees earned
Detailed analysis of sensitivity of IFRS basis profit or loss and shareholders’ equity to key market and other risks by business unit is provided in notes C7.2, C7.3, C7.4 and C7.5. The sensitivity analysis provided shows the effect on profit or loss and shareholders’ equity to changes in the relevant risk variables, all of which are reasonably possible at the relevant balance sheet date. In the equity risk sensitivity analysis shown below, the Group has considered the impact of an instantaneous 20 per cent fall in equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous fall but rather would be expected to occur over a period of time during which the Group would be able to put mitigating management actions in place. In addition, the equity risk sensitivity analysis provided assumed that all equity indices fall by the same percentage.
Impact of diversification on risk exposure The Group benefits from diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types. Relevant correlation factors include: Correlation across geographic regions: — Financial risk factors; and — Non-financial risk factors.
Other limitations on the sensitivities include: the use of hypothetical market movements to demonstrate potential risk that only represent Prudential’s view of reasonably possible near-term market changes and that cannot be predicted with any certainty; the assumption that interest rates in all countries move identically; the assumption that all global currencies move in tandem with the US dollar against pound sterling; and the lack of consideration of the inter-relation of interest rates, equity markets and foreign currency exchange rates.
In summary, for Asia operations, the adjusted IFRS operating profit based on longer-term investment returns is mainly affected by the impact of market levels on unit-linked persistency, and other insurance risks. At the total IFRS profit level the Asia result is affected by short-term value movements on the asset portfolio for non-linked shareholder-backed business.
(i) Sensitivity to risks other than foreign exchange risk Interest rate risk Excluding its with-profits and unit-linked businesses, the results of the Asia business are sensitive to the movements in interest rates.
For the purposes of analysing sensitivity to variations in interest rates, reference has been made to the movements in the 10-year government bond rates of the territories. At 31 December 2018, 10-year government bond rates vary from territory to territory and range from 0.9 per cent to 8.1 per cent (31 December 2017: 1.0 per cent to 7.5 per cent).
For the sensitivity analysis as shown in the table below, the reasonably possible interest rate movement used is 1 per cent for all local business units.
The estimated sensitivity to the decrease and increase in interest rates is as follows: Decrease of 1%
Profit before tax attributable to shareholders 312 (338) 2 (443) Related deferred tax (where applicable) (15) 26 (7) 20
Net effect on profit and shareholders’ equity 297 (312) (5) (423)
In addition, the degree of sensitivity of the results shown in the table above is dependent on the interest rate level at that point in time. An additional factor to the direction of the sensitivity of the Asia operations as a whole is movement in the country mix.
Equity price risk The non-linked shareholder-backed business has limited exposure to equity and property investment (31 December 2018: £2,151 million; 31 December 2017: £1,764 million). Generally, changes in equity and property investment values are not directly offset by movements in non-linked policyholder liabilities.
The estimated sensitivity to a 10 per cent and 20 per cent change in equity and property prices for shareholder-backed Asia other business (including those held by the Group’s joint venture and associate businesses), which would be reflected in the short-term fluctuation component of the Group’s segmental analysis of profit before tax, is as follows: Decrease Decrease of 20% of 10% of 20% of 10%
Profit before tax attributable to shareholders (557) (279) (478) (239) Related deferred tax (where applicable) 17 8 7 4
A 10 or 20 per cent increase in equity and property values would have an approximately equal and opposite effect on profit and shareholders’ equity to the sensitivities shown above.
Insurance risk Many of the business units in Asia are exposed to mortality/morbidity risk and provision is made within policyholder liabilities on a prudent regulatory basis to cover the potential exposure. If these prudent assumptions were strengthened by 5 per cent then it is estimated that post-tax profit and shareholders’ equity would be decreased by approximately £57 million (2017: £66 million). Mortality and morbidity have a broadly symmetrical effect on the portfolio and any weakening of these assumptions would have a similar equal and opposite impact.
Profit before tax attributable to shareholders (134) (155) 164 189 Profit for the year (113) (135) 138 165 Shareholders’ equity, excluding goodwill, attributable to Asia operations (543) (492) 664 601
Interest rate risk — Related to meeting guaranteed rates of accumulation on fixed annuity products following a sustained fall in interest rates; — Related to increases in the present value of projected benefits related to guarantees issued in connection with its variable annuity contracts following a sustained fall in interest rates especially if in conjunction with a fall in equity markets; — Related to the surrender value guarantee features attached to the Company’s fixed annuity products and to policyholder withdrawals following a sharp and sustained increase in interest rates; and
Jackson’s derivative programme is used to manage interest rate risk associated with a broad range of products and equity market risk attaching to its equity-based products. Movements in equity markets, equity volatility, interest rates and credit spreads materially affect the carrying value of derivatives that are used to manage the liabilities to policyholders and backing investment assets. Movements in the carrying value of derivatives combined with the use of US GAAP measurement (as ‘grandfathered’ under IFRS 4) for the insurance contracts assets and liabilities, which is largely insensitive to current period market movements, mean that the Jackson total profit (ie including short-term fluctuations in investment returns) is sensitive to market movements. In addition to these effects the Jackson shareholders’ equity is sensitive to the impact of interest rate and credit spread movements on the value of fixed income securities. Movements in unrealised appreciation on these securities are included as movement in shareholders’ equity (ie outside the income statement).
Jackson enters into financial derivative transactions, including those noted below to reduce and manage business risks. These transactions manage the risk of a change in the value, yield, price, cash flows or quantity of, or a degree of exposure, with respect to assets, liabilities or future cash flows, which Jackson has acquired or incurred.
Credit default swaps These swaps represent agreements under which the buyer has purchased default protection on certain underlying corporate bonds held in its portfolio. These contracts allow Jackson to sell the protected bonds at par value to the counterparty if a default event occurs in exchange for periodic payments made by Jackson for the life of the agreement.
The estimated sensitivity of Jackson’s profit and shareholders’ equity to equity and interest rate risks provided below is net of the related changes in amortisation of DAC. The effect on the related changes in amortisation of DAC provided is based on the current ‘grandfathered’ US GAAP DAC basis but does not include any effect from an acceleration or deceleration of amortisation of DAC.
Account balances of contracts with guarantees were invested in variable separate accounts as follows: Mutual fund type: £m £m
Net sensitivity of profit after tax and shareholders’ equity* 836 337 46 (99) 874 265 489 207 * The table above has been prepared to exclude the impact of the instantaneous equity movements on the separate account fees. In addition, the sensitivity movements shown include those relating to the fixed index annuity and the reinsurance of GMIB guarantees.
The above table provides sensitivity movements at a point in time while the actual impact on financial results would vary contingent upon the volume of new product sales and lapses, changes to the derivative portfolio, correlation of market returns and various other factors including volatility, interest rates and elapsed time.
The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2018 and 2017.
In addition, in the absence of hedging, equity and interest rate movements can both cause a loss directly or an increased future sensitivity to policyholder behaviour. Jackson has an extensive derivative programme that seeks to manage the exposure to such altered equity markets and interest rates.
C7.4 UK and Europe insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The IFRS basis results of the shareholder-backed business for the UK and Europe insurance operations are most sensitive to the following factors: — Asset/liability matching; — Default rate experience; — Annuitant mortality; and — The difference between the rates of return on corporate bonds and risk-free rates.
With-profits business With-profits sub-fund business The shareholder results of the UK with-profits business (including non-participating annuity business of the with-profits sub-fund) are only sensitive to market risk through the indirect effect of investment performance on declared policyholder bonuses.
The shareholder results of the UK with-profits fund are currently one-ninth of the cost of bonuses declared to with-profits policyholders. For certain unitised with-profits products, such as the PruFund range of funds, the bonuses represent the policyholders’ net return based on the smoothed unit price of the selected investment fund. Investment performance is a key driver of bonuses declared, and hence the shareholder results. Due to the ‘smoothed’ basis of bonus declaration, the sensitivity to short-term investment performance is relatively low. However, longer-term investment performance and persistency trends may affect future shareholder transfers.
In addition, the level of profit is affected by change in the level of reinsurance cover. A decrease in assumed mortality rates of 1 per cent would decrease pre-tax profit by approximately £37 million (2017: £66 million).
A decrease in credit default assumptions of five basis points would increase pre-tax profit by £99 million (2017: £198 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase pre-tax profit by £21 million (2017: £40 million). The effect on profit would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above. The net effect on profit after tax and shareholders’ equity from all the changes in assumptions as described above would be an increase of approximately £69 million (2017: £143 million). See C4.1(d)(iii) for further details on mortality assumptions.
Unit-linked and other business Unit-linked and other business represents a comparatively small proportion of the in-force business of the UK and Europe insurance operations.
Sensitivity to interest rate risk and other market risk By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK and Europe insurance operations are, except annuity business, not generally exposed to interest rate risk. At 31 December 2018, annuity liabilities accounted for 95 per cent (31 December 2017: 98 per cent) of UK non-linked shareholder-backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure is substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mis-matching profits or losses to arise.
C7.5 Asset management and other operations (i) Asset management (a) Sensitivities to foreign exchange risk Consistent with the Group’s accounting policies, the profits of Eastspring Investments and US asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. The rates for the functional currencies of most significant operations are shown in note A1.
(b) Sensitivities to other financial risks for asset management operations The profits of asset management businesses are sensitive to the level of assets under management, as this significantly affects the value of management fees earned by the business in the current and future periods. The Group’s asset management operations do not hold significant investments in property or equities.
Other operations are sensitive to credit risk on the loan portfolio of the Prudential Capital operation. Total debt securities held at 31 December 2018 by Prudential Capital were £1,884 million (2017: £2,238 million). Debt securities held by Prudential Capital are in general variable rate bonds and so market value is limited in sensitivity to interest rate movements and consequently any change in interest rates would not have a material impact on profit or shareholders’ equity.
Deferred tax assets Unrealised�losses�or�gains�on�investments 14 1 93 5 113 Balances�relating�to�investment�and�insurance�contracts 1 – – – 1
Deferred tax liabilities Unrealised�losses�or�gains�on�investments (1,748) 666 195 20 (867) Balances�relating�to�investment�and�insurance�contracts (872) (91) – (39) (1,002)
Corporate governance The�Group’s�UK�pension�schemes�are�established�under�trust�and�are�subject�to�UK�legal�requirements;�this�includes�being�subject�to� regulation�by�‘The�Pension�Regulator’�in�accordance�with�the�Pension�Act�1995.�Each�scheme�has�a�corporate�trustee�to�which�some� directors�are�appointed�by�Group�employers�with�the�remaining�directors�nominated�by�members�in�accordance�with�UK�legal� requirements.�The�trustees�have�the�ultimate�responsibility�to�ensure�that�the�scheme�is�managed�in�accordance�with�the�Trust�Deed�&� Rules.�The�trustees�act�in�the�best�interests�of�the�schemes’�beneficiaries;�this�includes�taking�appropriate�account�of�each�employer’s� legal�obligation�and�financial�ability�to�support�the�schemes,�when�setting�investment�strategy�and�when�agreeing�funding�with�the� employers.�The�employers’�contribution�commitments�are�formally�updated�at�each�triennial�valuation;�between�valuations�funding� levels�and�employer�strength�continue�to�be�monitored,�with�the�Trustees�being�able�to�bring�forward�the�next�triennial�valuation�if�they� consider�it�appropriate�to�do�so.
Application of IFRIC 14 for the derecognition of PSPS surplus Derecognition�of�surplus (485) (13) (179) – (677) Less:�amount�attributable�to�UK�with-profits�fund 363 8 132 – 503
Employees’�contributions 1 (1) – – – – – Actuarial�gains�and�losses note (d) (221) 524 303 (179) 124 10 134 Transfer�into�investment�in�Prudential�
Notes (a)� Maturity profile of the benefit obligations� � The�weighted�average�duration�of�the�benefit�obligations�of�the�schemes�is�18.4�years�(2017:�18.6�years).� � � The�following�table�provides�an�expected�maturity�analysis�of�the�benefit�obligations: All schemes� £m 1 year or less
Transactions by Prudential plc and its subsidiaries in Prudential plc shares The�Group�buys�and�sells�Prudential�plc�shares�(‘own�shares’)�either�in�relation�to�its�employee�share�schemes�or�via�transactions� undertaken�by�authorised�investment�funds�that�the�Group�is�deemed�to�control.�The�cost�of�own�shares�of�£170�million�as�at� 31�December�2018�(31�December�2017:�£250�million)�is�deducted�from�retained�earnings.�The�Company�has�established�trusts�to� facilitate�the�delivery�of�shares�under�employee�incentive�plans.�At�31�December�2018,�9.6�million�(31�December�2017:� 11.4�million)�Prudential�plc�shares�with�a�market�value�of�£135�million�(31�December�2017:�£218�million)�were�held�in�such�trusts�all�of� which�are�for�employee�incentive�plans.�The�maximum�number�of�shares�held�during�2018�was�14.9�million�which�was�in�March�2018.
(ii) US insurance operations The�estimated�capital�position�for�Jackson�with�reconciliation�to�shareholders’�equity�is�shown�below: 31 Dec 2018� £m 31 Dec 2017� £m
Distributions�made�to�the�parent�company (197) (97) (104) (398) (433) Exchange�and�other�movements – (121) 20 (101) (24)
Support for with-profits sub-funds by shareholders’ funds PAC�is�liable�to�meet�its�obligations�to�with-profits�policyholders�even�if�the�assets�of�the�with-profits�sub-funds�are�insufficient�to�do�so.� The�assets,�represented�by�the�unallocated�surplus�of�with-profits�funds,�in�excess�of�amounts�expected�to�be�paid�for�future�terminal� bonuses�and�related�shareholder�transfers�(‘the�excess�assets’)�in�the�with-profits�sub-funds�could�be�materially�depleted�over�time�by,� for�example,�a�significant�or�sustained�equity�market�downturn,�costs�of�significant�fundamental�strategic�change�or�a�material�increase�in� the�pension�mis-selling�provision.�In�the�unlikely�circumstance�that�the�depletion�of�the�excess�assets�within�the�long-term�fund�was�such� that�the�Group’s�ability�to�satisfy�policyholders’�reasonable�expectations�was�adversely�affected,�it�might�become�necessary�to�restrict� the�annual�distribution�to�shareholders�or�to�contribute�shareholders’�funds�to�the�with-profits�sub-funds�to�provide�financial�support.
Renewal of strategic bancassurance alliance with United Overseas Bank Limited In�January�2019,�the�Group�announced�the�renewal�of�its�regional�strategic�bancassurance�alliance�with�United�Overseas�Bank�Limited� (UOB).�The�new�agreement�extends�the�original�alliance,�which�commenced�in�2010�to�2034�and�increases�the�geographical�scope�to� include�a�fifth�market,�Vietnam,�alongside�the�existing�markets�across�Singapore,�Malaysia,�Thailand�and�Indonesia.
(b) Investments in joint ventures and associates Joint�ventures�represent�arrangements�where�the�controlling�parties�through�contractual�or�other�agreement�have�the�rights�to�the�net� assets�of�the�arrangements.�The�Group�has�shareholder-backed�joint�venture�insurance�and�asset�management�businesses�in�China�with� CITIC�Group,�and�a�joint�venture�asset�management�business�in�India�with�ICICI�Bank�.�In�addition,�there�is�an�asset�management�joint� venture�in�Hong�Kong�with�Bank�of�China�International�Holdings�Limited�(BOCI)�and�Takaful�insurance�joint�venture�in�Malaysia.�
Other subsidiaries, joint ventures, associates and significant holdings of the Group (no shares held directly by the parent company, Prudential plc or its nominees)
(c) Related undertakings continued Other subsidiaries, joint ventures, associates and significant holdings of the Group (no shares held directly by the parent company, Prudential plc or its nominees) continued
Jackson’s separate account assets These�are�investment�vehicles�that�invest�contract�holders’�premiums�in�equity,�fixed�income,�bonds�and�money�market�mutual�funds.� The�contract�holder�retains�the�underlying�returns�and�the�ownership�risks�related�to�the�underlying�investments.�The�shareholder’s� economic�interest�in�separate�accounts�is�limited�to�the�administrative�fees�charged.�The�separate�accounts�are�set�up�as�separate� regulated�entities�governed�by�a�Board�of�Governors�or�trustees�for�which�the�majority�of�the�members�are�independent�of�Jackson� or�any�affiliated�entity.�The�independent�members�are�responsible�for�any�decision�making�that�impacts�contract�holders’�interest� and�govern�the�operational�activities�of�the�entities’�advisers,�including�asset�managers.�Accordingly,�the�Group�does�not�control�these� vehicles.�These�investments�are�carried�at�fair�value�through�profit�or�loss�within�financial�investments�in�the�consolidated�statement� of�financial�position.
�— Financial�assets�and�liabilities�at�fair�value�through�profit�or�loss�–�this�comprises�assets�and�liabilities�designated�by�management�as� fair�value�through�profit�or�loss�on�inception�and�derivatives�that�are�held�for�trading.�These�investments�are�measured�at�fair�value� with�all�changes�thereon�being�recognised�in�investment�return�in�the�income�statement; �— Financial�investments�on�an�available-for-sale�basis�–�this�comprises�assets�that�are�designated�by�management�as�available-for-sale� and/or�do�not�fall�into�any�of�the�other�categories.�These�assets�are�initially�recognised�at�fair�value�plus�attributable�transaction�costs.� Available-for-sale�assets�are�subsequently�measured�at�fair�value.�Interest�income�is�recognised�on�an�effective�interest�basis�in�the� income�statement.�The�effective�interest�rate�is�the�rate�that�exactly�discounts�estimated�future�cash�receipts�through�the�expected� life�of�the�financial�instrument�or,�when�appropriate,�a�shorter�period�to�the�net�carrying�amount�of�the�financial�asset.�Except�for� foreign�exchange�gains�and�losses�on�debt�securities,�which�are�included�in�the�income�statement,�unrealised�gains�and�losses�are� recognised�in�other�comprehensive�income.�Upon�disposal�or�impairment,�accumulated�unrealised�gains�and�losses�are�transferred� from�other�comprehensive�income�to�the�income�statement�as�realised�gains�or�losses;�and
(iv) Securities lending and reverse repurchase agreements The�Group�is�party�to�various�securities�lending�agreements�(including�repurchase�agreements)�under�which�securities�are�loaned�to� third�parties�on�a�short-term�basis.�The�loaned�securities�are�not�derecognised;�rather,�they�continue�to�be�recognised�within�the� appropriate�investment�classification.�The�Group’s�policy�is�that�collateral�in�excess�of�100�per�cent�of�the�fair�value�of�securities�loaned�is� required�from�all�securities’�borrowers�and�typically�consists�of�cash,�debt�securities,�equity�securities�or�letters�of�credit.
(vi) Financial liabilities designated at fair value through profit or loss Consistent�with�the�Group’s�risk�management�and�investment�strategy�and�the�nature�of�the�products�concerned,�the�Group�has� designated�under�IAS�39�classification�certain�financial�liabilities�at�fair�value�through�profit�or�loss�as�these�instruments�are�managed� and�their�performance�evaluated�on�a�fair�value�basis.�These�instruments�include�liabilities�related�to�consolidated�collateralised�debt� obligations,�net�assets�attributable�to�unit�holders�of�consolidated�unit�trusts�and�similar�funds�and�policyholder�liabilities�for�investment� contracts�without�discretionary�participation�features�for�UK�and�Asia.
Amounts owed to subsidiary undertakings (936) (715) Tax payable (10) (10) Deferred tax liability 9 (12) (12) Accruals and deferred income (101) (79)
The financial statements of the parent company on pages 320 to 328 were approved by the Board of Directors on 12 March 2019 and signed on its behalf.
Total contributions by and distributions to owners – 21 (1,160) (1,139)
Transactions with owners, recorded directly in equity New share capital subscribed 1 16 – 17 Share based payment transactions – – – –
As the consolidated financial statements of the Group include the equivalent disclosures, the Company has also applied the exemptions available under FRS 101 in respect of the following disclosures: — IFRS 2 ‘Share Based Payments’ in respect of Group-settled share-based payments; — Disclosure required by IFRS 7 ‘Financial Instrument Disclosures’ and IFRS 13 ‘Fair Value Measurement’, except for the consequential amendments to IFRS 7 related to IFRS 9 which have not been adopted by the Group; and
In 2018, the Company adopted IFRS 9, ‘Financial Instruments’ which replaced IAS 39, ‘Financial Instruments – Recognition and Measurement’. Under IFRS 9, except for derivative instruments that are mandatorily classified as fair value through profit or loss, all of the financial assets and liabilities of the Company are classified as amortised cost. There was no significant change from previous IAS 39 classification. The Company changed its approach to assessing impairment on its loans and receivables from the IAS 39 incurred loss approach to the IFRS 9 expected credit loss approach. This resulted in a small amount of expected credit losses (£9 million) recognised in retained earnings as at 1 January 2018, the date of initial application relating to the amounts owed by subsidiary undertakings (£14 million at 31 December 2018). As permitted by IFRS 9, the Company has not restated its 2017 comparatives. The expected credit loss on the Company’s loans and receivables, the majority of which represent loans to its subsidiaries, have been assessed by taking into account the probability of default on those loans. In all cases the subsidiaries are expected to have sufficient resources to repay the loan either now or over time (based on projected earnings). The expected credit loss has therefore been limited to the impact of discounting the value of the loan between the balance sheet date and the anticipated recovery date. The expected credit loss in the period was a charge of £5 million.
The Company has also adopted IFRS 15, ‘Revenue from Contracts with Customers’ and Amendments to IFRS 2, ‘Share-based Payments’ as applied under FRS 101 in 2018, the adoption of which did not have an impact on the financial statements of the Company.
Investments in subsidiary undertakings Investments in subsidiary undertakings are shown at cost less impairment.
Borrowings Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profit and loss account to the date of maturity or, for subordinated debt, over the expected life of the instrument. Where modifications to borrowings do not result in a substantial difference to the terms of the instrument, any costs or fees incurred adjust the carrying amount of the liability and are amortised over the remaining expected life of the modified instrument.
Dividends Interim dividends are recorded in the period in which they are paid.
The parent company financial statements are prepared in accordance with FRS 101 and the Group financial statements are prepared in accordance with IFRS as issued by the IASB and endorsed by the EU. At 31 December 2018, there were no differences between FRS 101 and IFRS as issued by the IASB and endorsed by the EU in terms of their application to the parent company.
The tables below provide a reconciliation between the FRS 101 parent company results and the IFRS Group results.
Profit after tax Profit for the financial year of the Company (including dividends from subsidiaries)
in accordance with FRS 101 and IFRS 1,041 1,235 Accounting policy difference* 5 – Share in the IFRS result of the Group, net of distributions to the Company† 1,964 1,154
Profit after tax of the Group attributable to shareholders in accordance with IFRS 3,010 2,389
The profit for the financial year of the Company in accordance with IFRS includes dividends received in the year from subsidiary undertakings of £1,495 million and £1,685 million for the years ended 31 December 2018 and 2017, respectively.
Capital injections 88 – Amounts in respect of share based payments (61) (61)
In January 2018 the Company provided £88 million to M&G to support the seed funding of the new Luxembourg-based SICAV openended collective investment schemes.
In November 2018, the Company transferred ownership of four of its subsidiaries associated with the UK and Europe business to M&GPrudential under a share for share exchange, in preparation for the demerger of M&GPrudential and its subsidiaries from the Group. Shares in the four entities transferred: The Prudential Assurance Company Limited, M&G Investments Management Limited, Prudential Financial Services Limited and Prudential Property Services Limited, were transferred to M&GPrudential in return for shares in M&GPrudential. There is no change to the value recorded in the Company’s financial statements.
Amounts in respect of share-based payments of £(61) million (2017: £(61) million) comprise of £5 million (2017: £6 million) in respect of share-based payments reflecting the value of payments settled by the Company for employees of its subsidiary undertakings, less £(66) million (2017: £(67) million) relating to cash received from subsidiaries in respect of share awards.
A description of the regulatory framework in which the Scheme operates, the governance of the Scheme, and the risks to which the Scheme exposes the Company is provided in note C9 of the Group financial statements. The most recent full valuation has been updated to 31 December 2018, applying the principles prescribed by IAS 19. The actuarial assumptions used in determining the IAS 19 benefit obligations and the net periodic costs and sensitivity of IAS 19 benefit obligation to changes in the actuarial assumptions are also provided in note C9 of the Group financial statements.
Fair value of Scheme assets 6,718 357 7,075 7,231 243 7,474 Present value of benefit obligations (6,167) (6,753)
Underlying surplus in the Scheme 908 721 Effect of the application of IFRIC 14 for de-recognition of surplus (677) (485)
Surplus in the Scheme recognised by the Company† 69 71 * 93 per cent (2017: 93 per cent) of the bonds are investment grade. † The surplus in the Scheme recognised in the balance sheet of the Company represents the amount that is recoverable through reduced future contributions and is net of the apportionment to the UK with-profits fund.
Current service cost – (26) (26) – (26) GMP equalisation provision note (iv) – (31) (31) – (31)
Actuarial gains (losses) note (ii) (186) 409 223 (179) 44 Contributions paid by the employer note (iii) 10 – 10 – 10 Contributions paid by the employee – – – – – Benefits paid (397) 397 – – –
Actuarial gains attributable to the Company before tax† 19 34 * The total return on Scheme assets in 2018 was a loss of £(5) million (2017: gain £233 million). † Actuarial gains attributable to the Company are net of the apportionment to the UK with-profits fund and are related to the surplus recognised in the balance sheet of the Company.
In 2018, the gains included a debit of £48 million (2017: credit £31 million) for the adjustment to the unrecognised portion of surplus. The gains after tax of £16 million (2017: £28 million) are recorded in other comprehensive income.
Borrowings are repayable as follows: Notes (i) Further details on the core structural borrowings of the Company are provided in note C6.1 of the Group financial statements. (ii) The interests of the holders of the subordinated liabilities are subordinate to the entitlements of other creditors of the Company. (iii) These borrowings support a short-term fixed income securities programme.
Retained profit at 31 December 2018 amounted to £5,356 million (31 December 2017: £5,552 million). The retained profit includes distributable reserves of £2,814 million and non-distributable reserves of £2,542 million. The non-distributable reserves comprise £2,405 million relating to gains made by intermediate holding companies following the transfer at fair value of certain subsidiaries to other parts of the Group as part of internal restructuring exercises in previous years, £80 million of share-based payment reserves and £57 million net of taxation in relation the pension benefit surplus of the Company. The amount of £2,405 million is not able to be regarded as part of the distributable reserves of the parent company because the gains relate to intra-group transactions.
The retained profit of the Company is substantially generated from dividend income received from subsidiaries. The Group segmental analysis illustrates the generation of profit across the Group (see note B1 of the Group financial statements). The Group and its subsidiaries are subject to local regulatory minimum capital requirements, as set out in note C12 of the Group financial statements. A number of the principal risks set out in the ‘Report of the risks facing our business and how these are managed’ could impact the generation of profit in the Group’s subsidiaries in the future and hence impact their ability to pay dividends in the future.
and for other services were £0.1 million (2017: £0.1 million). e In certain instances, the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
The�Directors�are�responsible�for�keeping� adequate�accounting�records�that�are� sufficient�to�show�and�explain�the�parent� company’s�transactions�and�disclose�with� reasonable�accuracy�at�any�time�the� financial�position�of�the�parent�company� and�enable�them�to�ensure�that�its�financial� statements�comply�with�the�Companies� Act�2006.�They�have�general�responsibility� for�taking�such�steps�as�are�reasonably� open�to�them�to�safeguard�the�assets�of�the� Group�and�to�prevent�and�detect�fraud�and� other�irregularities.
330� Prudential plc� Annual�Report�2018� www.prudential.co.uk 1 Our opinion is unmodified We�have�audited�the�financial�statements� of�Prudential�plc�(‘the�Group�and�parent� company’)�for�the�year�ended� 31�December�2018�which�comprise: �— the�consolidated�income�statement,� consolidated�statement�of� comprehensive�income,�consolidated� statement�of�changes�in�equity,� consolidated�statement�of�financial� position�and�consolidated�statement� of�cash�flows,�and�the�related�notes,� including�accounting�policies�in�notes� A3�and�E1;�and
Basis for opinion We�conducted�our�audit�in�accordance� with�International�Standards�on�Auditing� (UK)�(‘ISAs�(UK)’)�and�applicable�law.� Our�responsibilities�are�described�below.� We�believe�that�the�audit�evidence�we�have� obtained�is�a�sufficient�and�appropriate� basis�for�our�opinion.�Our�audit�opinion� is�consistent�with�our�report�to�the� audit�committee.�
We�were�appointed�as�auditor�by�the� shareholders�in�October�1999.�The�period� of�total�uninterrupted�engagement� is�for�the�20�financial�years�ended� 31�December�2018.�We�have�fulfilled� our�ethical�responsibilities�under,�and� we�remain�independent�of�the�Group�in� accordance�with,�UK�ethical�requirements� including�the�Financial�Reporting�Council� (‘FRC’)�Ethical�Standard�as�applied�to� listed�public�interest�entities.�No�non-audit� services�prohibited�by�that�standard� were�provided.
2 Key audit matters: including our assessment of risks of material misstatement Key�audit�matters�are�those�matters�that,�in�our�professional�judgement,�were�of�most�significance�in�the�audit�of�the�financial�statements� and�include�the�most�significant�assessed�risks�of�material�misstatement�(whether�or�not�due�to�fraud)�identified�by�us,�including�those� which�had�the�greatest�effect�on:�the�overall�audit�strategy;�the�allocation�of�resources�in�the�audit;�and�directing�the�efforts�of�the� engagement�team.�We�summarise�below�the�key�audit�matters�in�arriving�at�our�audit�opinion�above,�together�with�our�key�audit� procedures�to�address�those�matters�and,�as�required�for�public�interest�entities,�our�results�from�those�procedures.�These�matters�were� addressed,�and�our�results�are�based�on�procedures�undertaken,�in�the�context�of,�and�solely�for�the�purpose�of,�our�audit�of�the�financial� statements�as�a�whole,�and�in�forming�our�opinion�thereon,�and�consequently�are�incidental�to�that�opinion,�and�we�do�not�provide�a� separate�opinion�on�these�matters.
Valuation of policyholder liabilities (2018: £409,301 million, 2017: £411,243 million). The risk compared to the prior year is unchanged. Refer to page 115 (Audit Committee report), page 181 (accounting policy) and pages 241 to 264 (financial disclosures). The risk Our response
Subjective valuation This�is�an�area�that�involves�significant�judgement�over�uncertain� future�outcomes,�mainly�the�ultimate�total�settlement�value�of�long� term�policyholder�liabilities.�Economic�assumptions,�including� investment�return,�credit�risk�and�associated�discount�rates,�and� operating�assumptions�including�mortality,�morbidity,�expenses,� utilisation�of�guarantees�and�persistency�(including�consideration� of�policyholder�behaviour)�are�the�key�inputs�used�to�estimate� these�long�term�liabilities,�in�addition�to�the�appropriate�design� and�calibration�of�complex�reserving�models.
Valuation of investments (2018: £418,105 million, 2017: £422,230 million). The risk compared to the prior year is unchanged. Refer to page 115 (Audit Committee report), page 187 (accounting policy) and pages 221 to 240 (financial disclosures) The risk Our response
Subjective valuation The�area�that�involved�significant�audit�effort�and�judgement�in� 2018�was�the�valuation�of�certain�harder�to�value�level�2�and�level�3� positions�within�the�financial�investments�portfolio�representing� 5�per�cent�of�the�Group’s�total�assets.�These�included�unlisted�debt� securities,�unlisted�loans�and�unlisted�funds�that�are�valued�by� reference�to�their�Net�Asset�Value�(‘NAV�funds’).�For�these� positions�a�reliable�third�party�price�was�not�readily�available�and� therefore�involved�the�application�of�expert�judgement�in�the� valuations�adopted.
Amortisation of US deferred acquisition costs (‘DAC’) (2018: £8,727 million, 2017: £8,197 million). The risk compared to the prior year is unchanged. Refer to page 115 (Audit Committee report), page 185 (accounting policy) and pages 266 to 268 (financial disclosures) The risk Our response
Determination of pension asset (restricted surplus) in respect of the defined benefit pension scheme (Pension asset (restricted surplus) – 2018: £69 million, 2017: £71 million). The risk compared to the prior year is unchanged. The risk relates to the parent company financial statements. Refer to page 115 (Audit Committee report), Refer to page 323 (accounting policy) and pages 284 to 290 (financial disclosures) The risk Our response
The impact of uncertainties due to the UK exiting the European Union on our audit Refer to page 52 (Group Chief Risk Officer’s Report), page 68 (viability statement), page 115 (Audit Committee Report) and page 194 (financial disclosures). The risk Our response
Levels of uncertainty due to Brexit All�audits�assess�and�challenge�the�reasonableness�of�estimates,� in�particular�as�described�in�the�valuation�of�policyholder�liabilities,� valuation�of�investments�and�the�determination�of�the�defined� benefit�pension�asset�(restricted�surplus)�above,�and�related� disclosures�and�the�appropriateness�of�the�going�concern�basis� of�preparation�of�the�financial�statements�(see�below).�All�of�these� depend�on�assessments�of�the�future�economic�environment� and�the�group’s�future�prospects�and�performance.�
We�subjected�the�Group’s�operations� to�audits�for�group�reporting�purposes� as�follows: Of�the�16�(2017:�16)�reporting�components� scoped�in�for�the�Group�audit,�we� subjected�10�(2017:�10)�to�full�scope�audits� for�group�reporting�purposes,�5�(2017:�6)� to�an�audit�of�account�balances�and�1� (2017:�Nil)�to�specified�risk-focused�audit� procedures.�The�components�for�which� we�performed�work�other�than�full�scope� audits�for�group�reporting�purposes�were� not�individually�significant�but�were� included�in�the�scope�of�our�group� reporting�work�as�they�did�present�specific� individual�audit�risks�that�needed�to�be� addressed�or�in�order�to�provide�further� coverage�over�the�Group’s�results.
The�components�subjected�to�an�audit� of�account�balances�included�Prudential� Capital,�Prudential�Pensions�Limited,� Prudential�Loan�Investment�Fund�(all�based� in�the�UK)�and�the�insurance�operations�in� China�and�Taiwan.�The�account�balances� audited�were�policyholder�liabilities,� investments�and�deferred�acquisition�costs.� Additionally,�we�subjected�Eastspring� Singapore�to�specified�risk-focused�audit� procedures�over�revenue.
The�Group�audit�team�visited�all� component�auditor�locations.�Video� and�telephone�conference�meetings�were� also�held�with�these�component�auditors.� At�these�visits�and�telephone�conference� meetings,�an�assessment�was�made� of�audit�risk�and�strategy,�the�findings� reported�to�the�Group�audit�team�were� discussed�in�more�detail,�key�working� papers�were�inspected�and�any�further� work�required�by�the�Group�audit�team�was� then�performed�by�the�component�auditor.
As�these�were�risks�that�could�potentially� cast�significant�doubt�on�the�Group’s�and� the�Company’s�ability�to�continue�as�a�going� concern,�we�considered�sensitivities�over� the�level�of�available�financial�resources� indicated�by�the�Group’s�financial�forecasts� taking�account�of�reasonably�possible� (but�not�unrealistic)�adverse�effects�that� could�arise�from�these�risks�individually�and� collectively�and�evaluated�the�achievability� of�the�actions�the�Directors�consider�they� would�take�to�improve�the�position�should� the�risks�materialise.�We�also�considered� less�predictable�but�realistic�second�order� impacts,�such�as�failure�of�counterparties� who�have�transactions�with�the�Group� (such�as�banks�and�reinsurers)�to�meet� commitments�that�could�give�rise�to�a� negative�impact�on�the�Group’s�financial� position,�increased�illiquidity�which�also� adds�to�uncertainty�over�the�accessibility� of�financial�resources�and�may�reduce� capital�resources�as�valuations�decline� and�the�impact�of�Brexit�on�the�economic� environment�and�the�resulting�impact� on�the�Group’s�capital�resources.�
�— The�directors’�confirmation�within� the�viability�statement�on�page�68,� that�they�have�carried�out�a�robust� assessment�of�the�principal�risks�facing� the�Group,�including�those�that�would� threaten�its�business�model,�future� performance,�solvency�and�liquidity; �— The�principal�risks�disclosures�on�pages� 52�to�69�describing�these�risks�and� explaining�how�they�are�being�managed� and�mitigated;�and
6 We have nothing to report in respect of the matters on which we are required to report by exception Under�the�Companies�Act�2006�we�are� required�to�report�to�you�if,�in�our�opinion: �— Adequate�accounting�records�have�not� been�kept�by�the�parent�company,�or� returns�adequate�for�our�audit�have�not� been�received�from�branches�not�visited� by�us;�or�
7 Respective responsibilities Directors’ responsibilities As�explained�more�fully�in�their�statement� set�out�on�page�329,�the�directors�are� responsible�for�the�preparation�of�the� financial�statements�including�being� satisfied�that�they�give�a�true�and�fair�view.� They�are�also�responsible�for:�such�internal� control�as�they�determine�is�necessary� to�enable�the�preparation�of�financial� statements�that�are�free�from�material� misstatement,�whether�due�to�fraud�or� error;�assessing�the�Group�and�parent� company’s�ability�to�continue�as�a�going� concern,�disclosing,�as�applicable,�matters� related�to�going�concern;�and�using�the� going�concern�basis�of�accounting�unless� they�either�intend�to�liquidate�the�Group�or� the�parent�company�or�to�cease�operations,� or�have�no�realistic�alternative�but�to�do�so.�
The�potential�effect�of�these�laws�and� regulations�on�the�financial�statements� varies�considerably.�Firstly,�the�Group�is� subject�to�laws�and�regulations�that�directly� affect�the�financial�statements�including� financial�reporting�legislation�(including� related�companies�legislation),�distributable� profits�legislation�and�taxation�legislation� and�we�assessed�the�extent�of�compliance� with�these�laws�and�regulations�as�part� of�our�procedures�on�the�related�financial� statement�items.
Secondly,�the�Group�is�subject�to�many� other�laws�and�regulations�where�the� consequences�of�non-compliance�could� have�a�material�effect�on�amounts�or� disclosures�in�the�financial�statements,� for�instance�through�the�imposition�of�fines� or�litigation�or�the�loss�of�the�Group’s� licence�to�operate.�We�identified�the�area�of� regulatory�capital�as�that�most�likely�to�have� such�an�effect�recognising�the�financial�and� regulated�nature�of�the�Group’s�activities.� Auditing�standards�limit�the�required�audit� procedures�to�identify�non-compliance� with�these�laws�and�regulations�to�enquiry� of�the�directors�and�other�management� and�inspection�of�regulatory�and�legal� correspondence,�if�any.�These�limited� procedures�did�not�identify�actual�or� suspected�non-compliance.
Shareholders’ equity at end of year 50,639 (857) 49,782 46,161 (1,463) 44,698
Total net assets attributable to equity holders of the Company 8 49,782 44,698
Net asset value per share 31 Dec 2018� 31 Dec 2017�
Annual premium equivalents (APE) note 15 2018� £m 2017� £m % change
Operating profit based on longer-term investment returns 7,563 6,598 6,382 15% 19%
(ii) Asia new business contribution by business unit 2018� £m 2017� £m
Unwind�of�discount�and�other�expected�returns 1,007 694 465 2,166 Effect�of�changes�in�operating�assumptions 241 196 195 632 Experience�variances�and�other�items 89 347 13 449
Unwind�of�discount�and�other�expected�returns note (a) 474 465 Change�in�longevity�assumption�basis note (b) 330 195 Other�items note (c) 218 13
Asia�operations note (ii) (1,029) 887 US�operations note (iii) (1,481) 582 UK�and�Europe�operations note (iv) (721) 621 Other�operations 12 21
Investment�return�related�experience�on�fixed�income�securities note (a) 60 (46) Investment�return�related�impact�due�to�changed�expectation�of�profits�on�in-force variable�annuity�business�in�future�periods�based�on�current�year separate�account�return,�net�of�related�hedging�activity�and�other�items note (b) (1,541) 628
(i) Group summary for long-term business operations 2018� £m 2017� £m
Asia note (ii) 115 (95) US note (iii) 197 (136) UK�and�Europe note (iv) (166) 129
A dditional inform ation 7 Net core structural borrowings of shareholder-financed businesses 31 Dec 2018� £m 31 Dec 2017� £m
Notes on the EEV basis results continued 8 Reconciliation of movement in shareholders’ equity 2018� £m
Operating profit based on longer-term investment returns 1,012 145 1,157 3,230 4,387
Operating profit based on longer-term investment returns 1,124 (230) 894 409 1,303
Notes on the EEV basis results continued 10 Analysis of movement in free surplus
US operations Underlying�free�surplus�generated�from�in-force�life�business 1,641 1,575 1,520 4% 8% Investment�in�new�business note (iii)(a) (225) (254) (245) 11% 8%
Net�cash�flows�to�parent�company note (c) (699) (342) (691) (1,732) 1,732 – External�dividends – – – – (1,244) (1,244) Exchange�rate�movements,�timing�differences�
Net movement in free surplus (436) 239 1,513 1,316 1,234 2,550 Balance�at�beginning�of�year 2,470 1,928 3,180 7,578 1,774 9,352
Notes on the EEV basis results continued 10 Analysis of movement in free surplus continued
Net�cash�flows�to�parent�company note (c) (645) (475) (668) (1,788) 1,788 – External�dividends – – – – (1,159) (1,159) Exchange�rate�movements,�timing�differences�
Net movement in free surplus 328 (490) 1,174 1,012 126 1,138 Balance�at�beginning�of�year 2,142 2,418 2,006 6,566 1,648 8,214
Balance at end of year 2,470 1,928 3,180 7,578 1,774 9,352
A dditional inform ation 11 Expected transfer of value of in-force business and required capital to free surplus
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2018 total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years 2017� £m
�— 0.5�per�cent�decrease�in�interest�rates�and�risk�discount�rates,�including�consequential�changes�(assumed�investment�returns�for�all� asset�classes,�market�values�of�fixed�interest�assets); �— 1�per�cent�rise�in�equity�and�property�yields; �— 10�per�cent�fall�in�market�value�of�equity�and�property�assets�(embedded�value�only); �— The�statutory�minimum�capital�level�in�contrast�to�EEV�basis�required�capital�(embedded�value�only);�and �— 5�basis�points�increase�in�UK�long-term�expected�defaults.
(i) Sensitivity analysis – economic assumptions continued New business contribution from long-term business operations 2018� £m 2017� £m
(ii) Sensitivity analysis – non-economic assumptions The�tables�below�show�the�sensitivity�of�the�embedded�value�as�at�31�December�2018�and�31�December�2017�and�the�new�business� contribution�after�the�effect�of�required�capital�for�2018�and�2017�for�long-term�business�operations�to: �— 10�per�cent�proportionate�decrease�in�maintenance�expenses�(for�example�a�10�per�cent�sensitivity�on�a�base�assumption�of�£10� per�annum�would�represent�an�expense�assumption�of�£9�per�annum); �— 10�per�cent�proportionate�decrease�in�lapse�rates�(for�example�a�10�per�cent�sensitivity�on�a�base�assumption�of�5�per�cent�would� represent�a�lapse�rate�of�4.5�per�cent�per�annum);�and
(i) Methodology Overview The�embedded�value�is�the�present�value�of�the�shareholders’�interest�in�the�earnings�distributable�from�assets�allocated�to�covered� business�after�sufficient�allowance�has�been�made�for�the�aggregate�risks�in�that�business.�The�shareholders’�interest�in�the�Group’s� long-term�business�comprises: �— The�present�value�of�future�shareholder�cash�flows�from�in-force�covered�business�(value�of�in-force�business),�less�deductions�for: �– The�cost�of�locked-in�required�capital;�and �– The�time�value�of�cost�of�options�and�guarantees; �— Locked-in�required�capital;�and �— The�shareholders’�net�worth�in�excess�of�required�capital�(free�surplus).
(d) Financial options and guarantees Nature of financial options and guarantees in Prudential’s long-term business Asia Subject�to�local�market�circumstances�and�regulatory�requirements,�the�guarantee�features�described�below�in�respect�of�UK�and�Europe� business�broadly�apply�to�similar�types�of�participating�contracts�in�Asia�which�are�principally�written�in�Hong�Kong,�Singapore�and� Malaysia.�Participating�products�have�both�guaranteed�and�non-guaranteed�elements.
(h) Allowance for risk and risk discount rates Overview Under�the�EEV�Principles,�discount�rates�used�to�determine�the�present�value�of�future�cash�flows�are�set�by�reference�to�risk-free�rates� plus�a�risk�margin.
(3) With-profits fund holdings of debt securities The�with-profits�fund�holds�debt�securities�as�part�of�its�investment�portfolio�backing�policyholder�liabilities�and�unallocated�surplus.� The�assumed�earned�rate�for�with-profit�holdings�of�corporate�bonds�is�defined�as�the�risk-free�rate�plus�an�assessment�of�the�long-term� spread�over�riskfree,�net�of�expected�long-term�defaults.�This�approach�is�similar�to�that�applied�for�equities�and�properties�for�which�the� projected�earned�rate�is�defined�as�the�risk-free�rate�plus�a�long-term�risk�premium.
(i) Methodology continued Allowance for non-diversifiable non-market risks The�majority�of�non-market�and�non-credit�risks�are�considered�to�be�diversifiable.�An�allowance�for�non-diversifiable�non-market�risks�is� estimated�as�set�out�below: 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�Asia�operations�in�Indonesia,�the�Philippines,�Taiwan,�Thailand�and�Vietnam,�additional�allowances�are� applied�for�emerging�market�risk�ranging�from�100�to�250�basis�points.�The�level�of�these�allowances�are�reviewed�and�updated�based�on� an�assessment�of�a�range�of�pre-defined�emerging�market�risk�indicators,�as�well�as�the�Group’s�exposure�and�experience�in�the�business� units.�At�31�December�2018,�the�China�allowance�for�non-market�risk�was�reduced�reflecting�the�growth�in�the�size�of�the�business,� increasing�management�exposure�and�experience�in�the�country�and�an�improvement�in�our�risk�assessment�of�the�market.�For�the� Group’s�US�business�and�UK�and�Europe�business,�no�additional�allowance�is�necessary.
(ii) Accounting presentation (a) Analysis of post-tax profit To�the�extent�applicable,�the�presentation�of�the�EEV�post-tax�profit�for�the�year�is�consistent�with�the�classification�between�operating� and�non-operating�results�with�the�basis�that�the�Group�applies�for�the�analysis�of�IFRS�basis�results.�Operating�results�reflect�underlying� results�including�longer-term�investment�returns,�which�are�determined�as�described�in�note�13(ii)(b)�and�incorporate�the�following: �— New�business�contribution,�as�defined�in�note�13(i)(b); �— Unwind�of�discount�on�the�value�of�in-force�business�and�other�expected�returns,�as�described�in�note�13(ii)(c); �— The�impact�of�routine�changes�of�estimates�relating�to�operating�assumptions,�as�described�in�note�13(ii)(d);�and� �— Operating�experience�variances,�as�described�in�note�13(ii)(e).
(c) Unwind of discount and other expected returns The�Group’s�methodology�in�determining�the�unwind�of�discount�and�other�expected�returns�is�by�reference�to: �— The�value�of�in-force�business�at�the�beginning�of�the�year�(adjusted�for�the�effect�of�current�year�economic�and�operating�assumption� changes);�and
Risk discount rate % 10-year government bond yield % Expected long-term
Overseas�equities 6.5 to 10.1 6.2�to�10.1 15-year�gilt�yield 1.7 1.6 Corporate�bonds 3.5 3.4
(vi) UK and Europe (M&GPrudential) �— Interest�rates�are�projected�using�a�stochastic�interest�rate�model�calibrated�to�the�current�market�yields; �— Equity�returns�are�assumed�to�follow�a�log-normal�distribution; �— The�corporate�bond�return�is�calculated�based�on�a�risk-free�return�plus�a�mean-reverting�spread; �— Property�returns�are�also�modelled�based�on�a�risk-free�return�plus�a�risk�premium�with�a�stochastic�process�reflecting�total�property� returns;�and
Asia�operations: Hong�Kong � 16.5�per�cent�on�5�per�cent�of�premium�income Indonesia � 25.0 Malaysia� � 24.0 Singapore � 17.0
South-east Asia operations including Hong Kong 1,842 2,011 2,832 2,857 3,016 3,058 17,745 17,508
Notes on the EEV basis results continued 16 Impact of US tax reform
The directors have chosen to prepare supplementary information in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (‘the EEV Principles’) using the methodology and assumptions set out in the Notes on the EEV basis results.
In�our�opinion,�the�EEV�basis� supplementary�information�of�the� Company�for�the�year�ended�31�December� 2018�has�been�properly�prepared,�in�all� material�respects,�in�accordance�with�the� European�Embedded�Value�Principles� dated�April�2016�by�the�European� Insurance�CFO�Forum�(“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�375,�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) A�description�of�the�scope�of�an�audit� of�financial�statements�is�provided�on� our�website�at�www.kpmg.com/uk/ auditscopeukco2014a.�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.
�— With-profits�represent�the�pre-tax�shareholders’�transfer�from�the�with-profits�funds�for�the�year. �— Insurance margin�primarily�represents�profits�derived�from�the�insurance�risks�of�mortality�and�morbidity. �— Margin on revenues�primarily�represents�amounts�deducted�from�premiums�to�cover�acquisition�costs�and�administration�expenses. �— Acquisition costs and administration expenses�represent�expenses�incurred�in�the�year�attributable�to�shareholders.�These� exclude�items�such�as�restructuring�costs�which�are�not�included�in�the�segment�profit�for�insurance,�as�well�as�items�that�are�more� appropriately�included�in�other�sources�of�earnings�lines�(eg�investment�expenses�are�netted�against�investment�income�as�part�of� spread�income�or�fee�income�as�appropriate).�
Notes to sources of earnings tables throughout I(a) (i)� The�ratio�of�acquisition�costs�is�calculated�as�a�percentage�of�APE�sales�including�with-profits�sales.�Acquisition�costs�include�only�those�relating�to�shareholder-backed�business.� (ii)� Margin�represents�the�operating�return�earned�in�the�year�as�a�proportion�of�the�relevant�class�of�average�policyholder�liabilities�excluding�unallocated�surplus.� (iii)� The�2017�comparative�information�has�been�presented�at�AER�and�CER�to�eliminate�the�impact�of�foreign�exchange�translation.�CER�results�are�calculated�by�translating�prior�
Analysis of Asia adjusted IFRS operating profit based on longer-term investment returns by driver: �— Spread�income�has�increased�on�a�CER�basis�by�2�per�cent�(AER:�decreased�by�1�per�cent)�to�£232�million�in�2018,�with�a�decrease� in�the�margin�on�a�CER�basis�from�139�basis�points�in�2017�to�123�basis�points�in�2018�(AER:�decreased�from�143�basis�points�in�2017� to�123�basis�points�in�2018)�predominantly�reflecting�the�change�in�investment�mix,�country�and�product�mix.
� � Analysis of US adjusted IFRS operating profit based on long-term investment returns by driver: �— Spread�income�has�decreased�by�20�per�cent�on�a�CER�basis�(AER:�22�per�cent)�to�£583�million�in�2018.�The�reported�spread�margin� decreased�to�155�basis�points�from�193�basis�points�in�2017,�primarily�due�to�the�impact�of�increasing�LIBOR�on�interest�rate�swaps,� lower�investment�yields�and�maturing�of�swaps�previously�entered�into�to�more�closely�match�the�asset�and�liability�duration.� Excluding�the�effect�of�these�historic�swap�transactions,�the�spread�margin�would�have�been�130�basis�points�(2017:�144�basis�points� at�CER�and�AER).
Insurance�margin 50 55 Margin�on�revenues 149 189 Expenses: � DAC�adjustments 4 4 Expected�return�on�shareholder�assets 102 104
� � Analysis of UK and Europe adjusted IFRS operating profit based on longer-term investment returns by driver: �— Spread�income�has�reduced�from�£137�million�in�2017�to�£84�million�in�2018�reflecting�the�run-off�of�the�in-force�annuity�portfolio� and�the�effect�of�the�reinsurance�of�£12.0�billion�of�annuity�portfolios�to�Rothesay�Life�entered�into�in�March�2018.�
South-east Asia operations including Hong Kong 1,687 1,531 1,469 10% 15%
Operating�income�(net�of�commission) note (i) 1,115 441 Operating�expense note (i) (654) (232) Share�of�associate’s�results 16 – Group’s�share�of�tax�on�joint�ventures’�operating�profit – (27)
Operating�income�(net�of�commission) note (i) 1,087 438 Operating�expense note (i) (602) (238) Share�of�associate’s�results 15 – Group's�share�of�tax�on�joint�ventures'�operating�profit – (24)
I(d) Contribution to UK long-term financial metrics from specific management actions undertaken to position the balance sheet more efficiently under the Solvency II regime In�2018,�further�management�actions�were�taken�to�improve�the�solvency�of�the�UK�and�Europe�insurance�operations�and�to�mitigate� market�risks.�These�actions�included�repositioning�the�fixed�income�asset�portfolio�to�improve�the�trade-off�between�yield�and�credit�risk.� No�new�longevity�reinsurance�transactions�were�undertaken�in�2018�(2017:�longevity�reinsurance�transactions�entered�into�covering� £0.5�billion�of�IFRS�annuity�liabilities).
Expected�in-force�and�return�on�net�worth 686 706 Longevity�reinsurance�transactions – 15 Other�management�actions�to�improve�solvency 54 385 Changes�in�longevity�assumption�basis 364 179 Provision�for�the�review�of�past�annuity�sales – (187) Insurance�recoveries�in�respect�of�above�costs 138 – Provision�for�guaranteed�minimum�pension�equalisation (95) –
Unwind�of�discount�and�other�expected�return 474 465 Longevity�reinsurance�transactions – (6) Other�management�actions�to�improve�solvency 141 127 Changes�in�longevity�assumption�basis 330 195 Provision�for�the�review�of�past�annuity�sales – (187) Insurance�recoveries�in�respect�of�above�costs 138 – Provision�for�guaranteed�minimum�pension�equalisation (48) –
Net cash remitted by business units: UK and Europe: � With-profits�remittance 233 215 � Shareholder-backed�insurance�business�remittance 97 105 � Asset�management�remittance 324 323
Operating holding company cash flow before dividend 1,302 1,318 Dividend�paid� (1,244) (1,159)
Operating holding company cash flow after dividend 58 159 Non-operating�net�cash�flow note (ii) 913 (511)
II(b) Funds under management (a) Summary For�our�asset�management�businesses,�funds�managed�on�behalf�of�third�parties�are�not�recorded�on�the�balance�sheet.�They�are,� however,�a�driver�of�profitability.�We�therefore�analyse�the�movement�in�the�funds�under�management�each�period,�focusing�on�those� which�are�external�to�the�Group�and�those�primarily�held�by�the�insurance�businesses.�The�table�below�analyses,�by�segment,�the�funds� of�the�Group�held�in�the�statement�of�financial�position�and�the�external�funds�that�are�managed�by�Prudential’s�asset�management� operations.
(b) Investment products – external funds under management 2018� £m 2017� £m
M&G Eastspring Investments £bn £bn 31 Dec 2018 note £bn 31 Dec 2017 note� £bn
Estimated Group shareholder Solvency II capital position* 31 Dec 2018 31 Dec 2017
IFRS�shareholders’�equity 17.2 16.1 Restate�US�insurance�entities�from�IFRS�to�local�US�statutory�basis� (2.5) (3.0) Remove�DAC,�goodwill�and�intangibles (4.6) (4.0) Add�subordinated�debt� 7.2 5.8 Impact�of�risk�margin�(net�of�transitional�measures)� (3.8) (3.9) Add�value�of�shareholder�transfers 5.3 5.3 Liability�valuation�differences� 13.3 12.1 Increase�in�net�deferred�tax�liabilities�resulting�from�liability�valuation�differences�above (1.5) (1.6)
Own�Funds�(£bn) 8.8 14.0 Solvency�Capital�Requirement�(£bn) 5.1 7.9 Surplus (£bn) 3.7 6.1 Solvency�ratio�(%) 172% 178%
Estimated UK with-profits Solvency II capital position* 31 Dec 2018 31 Dec 2017
Own�Funds�(£bn) 9.7 9.6 Solvency�Capital�Requirement�(£bn) 4.2 4.8 Surplus (£bn) 5.5 4.8 Solvency�ratio�(%) 231% 201%
Reconciliation of UK with-profits funds 31 Dec 2018� £bn 31 Dec 2017� £bn
Discounted�expected�free�surplus�generation�for�years�2019�to�2058 2,754 1,386 458 4,598 Discounted�expected�free�surplus�generation�for�years�after�2058 863 – 1 864 Less:�Free�surplus�investment�in�new�business (488) (225) (102) (815)
Asia operations £m £m £m £m £m £m Other £m Total £m 2017�expected�free�surplus�generation�
US operations £m £m £m £m £m £m Other £m Total £m 2017�expected�free�surplus�generation�
Underlying free surplus generated from in-force life business before restructuring costs in 2018 1,500 1,641 1,277 4,418 2018�free�surplus�expected�to�be�generated�at�31�December�2017 1,393 1,464 671 3,528
II(d) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued
UK�sterling notes (ii),(iv) 39% 15% 49% US�dollar note (iv) 33% 40% 14%
Beginning End Beginning of year Granted Exercised Cancelled Forfeited Lapsed End of year 21�Sep�12 � 6.29 01�Dec�17 31�May�18 662 – (662) – – – –
21�Sep�17 14.55 01�Dec�22 31�May�23 3,298 – – – – – 3,298 18�Sep�18 13.94 01�Dec�21 31�May�22 – 22,005 – – – – 22,005 18�Sep�18 13.94 01�Dec�23 31�May�24 – 1,076 – – – – 1,076
18�Sep�18 13.94 01�Dec�21 31�May�22 – 184,780 – – – – 184,780 18�Sep�18 13.94 01�Dec�23 31�May�24 – 118,243 – – – – 118,243
II(g) Selected historical financial information of Prudential The�following�table�sets�forth�Prudential’s�selected�consolidated�financial�data�for�the�periods�indicated.�Certain�data�is�derived�from� Prudential’s�audited�consolidated�financial�statements�prepared�in�accordance�with�International�Financial�Reporting�Standards�(IFRS)� as�issued�by�the�International�Accounting�Standards�Board�(IASB)�and�as�adopted�by�the�European�Union�(EU)�and�European�Embedded� Value�(EEV).�
(Loss)�gain�on�disposal�of�businesses�and�corporate�transactions (80) 223 – (46) (13) Re-measurement�of�the�sold�Korea�life�business – 5 (238) – –
Based�on�profit�for�the�year�attributable�to�the�equity�holders� of�the�Company�(in�pence): Dividend�per�share�declared�and�paid�in�reporting�period 48.17p 45.07p 49.40p 38.05p 35.03p � Interim�ordinary�dividend/final�ordinary�dividend 48.17p 45.07p 39.40p 38.05p 35.03p � Special�dividend – – 10.00p – –
New business data 2018� £m 2017� £m 2016� £m 2015� £m 2014� £m
Statement of financial position data 31 December 2018� £m 2017� £m 2016� £m 2015� £m 2014� £m
31 December 2018� £bn 2017� £bn 2016� £bn 2015� £bn 2014� £bn
Funds�under�management note (iii) 657 669 602 509 496 EEV�shareholders’�equity,�excluding�non-controlling�interests 49.8 45 39.0 32.4 29.2 Group�shareholder�Solvency�II�surplus note (iv) 17.2 13.4 12.5 9.7 n/a Insurance�Groups�Directive�capital�surplus�before�final�dividend n/a n/a n/a 5.5 4.7
III(a) Reconciliation of adjusted IFRS operating profit based on longer-term investment returns to profit before tax The�annual�report�uses�alternative�performance�measures�(APMs)�to�provide�more�relevant�explanations�of�the�Group’s�financial�position� and�performance.�This�section�sets�out�explanations�for�each�APM�and�reconciliations�to�relevant�IFRS�balances.
III(b) Calculation of return on IFRS shareholders’ funds Return�on�IFRS�shareholders’�funds�is�calculated�as�operating�profit�based�on�longer-term�investment�returns�net�of�tax�and�non-controlling� interests�divided�by�opening�shareholders’�funds.�Operating�profit�based�on�longer-term�investment�returns�is�reconciled�to�IFRS�profit� before�tax�in�note�B1�to�the�IFRS�financial�statements.
Operating expense used in cost/income ratio 654 602 Investment�return (14) –
III(f) Reconciliation of Asia renewal insurance premium to gross earned premiums Asia�renewal�insurance�premium�is�calculated�as�IFRS�gross�earned�premiums�less�new�business�premiums�and�adjusted�for�the� contribution�from�joint�ventures.
III(g) Reconciliation of APE new business sales to earned premiums The�Group�reports�APE�new�business�sales�as�a�measure�of�the�new�policies�sold�in�the�year.�This�differs�from�the�IFRS�measure�of� premiums�earned�as�shown�below: � � � Note 2018� £m 2017� £m
Gross premiums earned B1.4 47,224 44,005 Outward�reinsurance�premiums note (iii) B1.4 (14,023) (2,062)
III(i) Reconciliation of EEV operating profit based on longer-term investment returns To�the�extent�applicable,�the�presentation�of�the�EEV�post-tax�profit�for�the�year�is�consistent�in�the�classification�between�operating�and� non-operating�results�with�the�basis�that�the�Group�applies�for�the�analysis�of�IFRS�basis�results.�Operating�results�reflect�underlying� results�including�longer-term�investment�returns,�which�are�determined�following�the�EEV�Principles�issued�by�the�European�Insurance� CFO�Forum.�
III(k) Calculation of EEV shareholders’ funds per share EEV�shareholders’�funds�per�share�is�calculated�as�closing�EEV�shareholders’�funds�divided�by�the�number�of�issued�shares�at�the�balance� sheet�date.�EEV�shareholders’�funds�per�share�excluding�goodwill�attributable�to�shareholders�is�calculated�in�the�same�manner,�except� goodwill�attributable�to�shareholders�is�deducted�from�closing�EEV�shareholders’�funds.
Shareholders’ funds per share excluding goodwill attributable to shareholders (in pence) 1,856p 1,671p
Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Uncertainty,�fluctuations�or�negative� trends�in�international�economic�and� investment�climates�could�have�a�material� adverse�effect�on�Prudential’s�business� and�profitability.�Prudential�operates�in�a� macroeconomic�and�global�financial�market� environment�that�presents�significant� uncertainties�and�potential�challenges.� For�example,�government�interest�rates� in�the�US,�the�UK�and�some�Asian�countries� in�which�Prudential�operates�remain�low� relative�to�historical�levels.
The�adverse�effects�of�such�factors�could� be�felt�principally�through�the�following� items: �— Reduced�investment�returns�arising� on�the�Group’s�portfolios�including� impairment�of�debt�securities�and�loans,� which�could�reduce�Prudential’s�capital� and�impair�its�ability�to�write�significant� volumes�of�new�business,�increase�the� potential�adverse�impact�of�product� guarantees,�and/or�have�a�negative� impact�on�its�assets�under�management� and�profit; �— Higher�credit�defaults�and�wider�credit� and�liquidity�spreads�resulting�in� realised�and�unrealised�credit�losses; �— Failure�of�counterparties�who�have� transactions�with�Prudential�(eg�banks� and�reinsurers)�to�meet�commitments� that�could�give�rise�to�a�negative�impact� on�Prudential’s�financial�position�and� on�the�accessibility�or�recoverability� of�amounts�due�or,�for�derivative� transactions,�adequate�collateral�not� being�in�place; �— Estimates�of�the�value�of�financial� instruments�becoming�more�difficult� because�in�certain�illiquid�or�closed� markets,�determining�the�value�at� which�financial�instruments�can�be� realised�is�highly�subjective.�Processes� to�ascertain�such�values�require� substantial�elements�of�judgement,� assumptions�and�estimates�(which� may�change�over�time);�and
�— Increased�illiquidity,�which�also�adds� to�uncertainty�over�the�accessibility� of�financial�resources�and�may�reduce� capital�resources�as�valuations�decline.� This�could�occur�where�external�capital� is�unavailable�at�sustainable�cost,� increased�liquid�assets�are�required�to� be�held�as�collateral�under�derivative� transactions�or�redemption�restrictions� are�placed�on�Prudential’s�investments� in�illiquid�funds.�In�addition,�significant� redemption�requests�could�also�be� made�on�Prudential’s�issued�funds�and� while�this�may�not�have�a�direct�impact� on�the�Group’s�liquidity,�it�could�result�in� reputational�damage�to�Prudential.�The� potential�impact�of�increased�illiquidity� is�more�uncertain�than�for�other�risks� such�as�interest�rate�or�credit�risk.�
In�general,�upheavals�in�the�financial� markets�may�affect�general�levels�of� economic�activity,�employment�and� customer�behaviour.�As�a�result,�insurers� may�experience�an�elevated�incidence�of� claims,�lapses,�or�surrenders�of�policies,� and�some�policyholders�may�choose�to� defer�or�stop�paying�insurance�premiums.� The�demand�for�insurance�products�may� also�be�adversely�affected.�In�addition,� there�may�be�a�higher�incidence�of� counterparty�failures.�If�sustained,�this� environment�is�likely�to�have�a�negative� impact�on�the�insurance�sector�over�time� and�may�consequently�have�a�negative� impact�on�Prudential’s�business�and�its� balance�sheet�and�profitability.�For� example,�this�could�occur�if�the�recoverable� value�of�intangible�assets�for�bancassurance� agreements�and�deferred�acquisition�costs� are�reduced.�New�challenges�related�to� market�fluctuations�and�general�economic� conditions�may�continue�to�emerge.�
Also,�Jackson�has�a�significant�spread� based�business�with�the�significant� proportion�of�its�assets�invested�in�fixed� income�securities�and�its�results�are� therefore�affected�by�fluctuations�in� prevailing�interest�rates.�In�particular,�fixed� annuities�and�stable�value�products�written� by�Jackson�expose�Prudential�to�the�risk� that�changes�in�interest�rates,�which�are�not� fully�reflected�in�the�interest�rates�credited� to�customers,�will�reduce�spread.�The� spread�is�the�difference�between�the�rate� of�return�Jackson�is�able�to�earn�on�the� assets�backing�the�policyholders’�liabilities� and�the�amounts�that�are�credited�to� policyholders�in�the�form�of�benefit� increases,�subject�to�minimum�crediting� rates.�Declines�in�spread�from�these� products�or�other�spread�businesses� that�Jackson�conducts,�and�increases� in�surrender�levels�arising�from�interest� rate�rises,�could�have�a�material�impact� on�its�businesses�or�results�of�operations.�
A�significant�part�of�the�profit�from� M&GPrudential’s�insurance�operations� is�related�to�bonuses�for�policyholders� declared�on�with-profits�products,� which�are�broadly�based�on�historical� and�current�rates�of�return�on�equity,�real� estate�and�fixed�income�securities,�as�well� as�Prudential’s�expectations�of�future� investment�returns.�This�profit�could� be�lower�in�a�sustained�low�interest� rate�environment.
Moreover,�governments�may�use�a�variety� of�techniques,�such�as�intervention�by�their� central�banks�or�imposition�of�regulatory� controls�or�taxes,�to�devalue�their� currencies’�exchange�rates,�or�may�adopt� monetary�and�other�policies�(including�to� manage�their�debt�burdens)�that�have�a� similar�effect,�all�of�which�could�adversely� impact�the�value�of�an�investment�in� sovereign�debt�even�in�the�absence�of� a�technical�default.�Periods�of�economic� uncertainty�may�affect�the�volatility�of� market�prices�of�sovereign�debt�to�a�greater� extent�than�the�volatility�inherent�in�debt� obligations�of�other�types�of�issuers.�
In�addition,�if�a�sovereign�default�or�other� such�events�described�above�were�to� occur,�other�financial�institutions�may�also� suffer�losses�or�experience�solvency�or� other�concerns,�and�Prudential�might�face� additional�risks�relating�to�any�debt�held�in� such�financial�institutions�held�in�its� investment�portfolio.�There�is�also�risk�that� public�perceptions�about�the�stability�and� creditworthiness�of�financial�institutions� and�the�financial�sector�generally�might�be� adversely�affected,�as�might�counterparty� relationships�between�financial�institutions.� If�a�sovereign�were�to�default�on�its� obligations,�or�adopted�policies�that� devalued�or�otherwise�altered�the� currencies�in�which�its�obligations�were� denominated�this�could�have�a�material� adverse�effect�on�Prudential’s�financial� condition�and�results�of�operations.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due�to�the�geographical�diversity�of� Prudential’s�businesses,�Prudential�is� subject�to�the�risk�of�exchange�rate� fluctuations.�Prudential’s�operations�in�the� US�and�Asia,�which�represent�a�significant� proportion�of�operating�profit�based�on� longer-term�investment�returns�and� shareholders’�funds,�generally�write� policies�and�invest�in�assets�denominated� in�local�currencies.�Although�this�practice� limits�the�effect�of�exchange�rate� fluctuations�on�local�operating�results,� it�can�lead�to�significant�fluctuations�in� Prudential’s�consolidated�financial� statements�upon�the�translation�of�results� into�pounds�sterling.�This�exposure�is�not� currently�separately�managed.�The� currency�exposure�relating�to�the� translation�of�reported�earnings�could� impact�financial�reporting�ratios�such�as� dividend�cover,�which�is�calculated�as� operating�profit�after�tax�on�an�IFRS�basis,� divided�by�the�dividends�relating�to�the� reporting�year.�The�impact�of�gains�or� losses�on�currency�translations�is�recorded� as�a�component�of�shareholders’�funds� within�other�comprehensive�income.� Consequently,�this�could�impact� Prudential’s�gearing�ratios�(defined�as� debt�over�debt�plus�shareholders’�funds).� The�Group’s�surplus�capital�position�for� regulatory�reporting�purposes�may�also�be� affected�by�fluctuations�in�exchange�rates� with�possible�consequences�for�the�degree� of�flexibility�that�Prudential�has�in� managing�its�business.�
The�European�Union’s�Solvency�II�Directive� came�into�effect�on�1�January�2016.� The�measure�of�regulatory�capital�under� Solvency�II�is�more�volatile�than�under�the� previous�Solvency�I�regime�and�regulatory� policy�may�further�evolve�under�the� regime.�The�European�Commission�began� a�review�in�late�2016�of�some�aspects�of�the� Solvency�II�legislative�package,�which�is� expected�to�continue�until�2021�and� includes�a�review�of�the�Long�Term� Guarantee�measures.�Prudential�applied� for,�and�has�been�granted�approval�by�the� UK�Prudential�Regulation�Authority�to�use� the�following�measures�when�calculating� its�Solvency�II�capital�requirements:�the� use�of�an�internal�model,�the�‘matching� adjustment’�for�UK�annuities,�the�‘volatility� adjustment’�for�selected�US�dollardenominated �business,�and�UK�transitional� measures�on�technical�provisions.� Prudential�also�has�permission�to�use� ‘deduction�and�aggregation’�as�the�method� by�which�the�contribution�of�the�Group’s� US�insurance�entities�to�the�Group’s� solvency�is�calculated,�which�in�effect� recognises�surplus�in�US�insurance�entities� in�excess�of�250�per�cent�of�local�US�Risk� Based�Capital�requirements.�For�as�long�as� Prudential�or�its�businesses�remain�subject� to�Solvency�II,�there�is�a�risk�that�changes� may�be�required�to�Prudential’s�approved� internal�model�or�other�Solvency�II� approvals,�which�could�have�a�material� impact�on�the�Group�Solvency�II�capital� position.�Where�internal�model�changes� are�subject�to�regulatory�approval,�there� is�a�risk�that�the�approval�is�delayed�or�not� given.�In�such�circumstances,�changes�in� our�risk�profile�would�not�be�able�to�be� appropriately�reflected�in�our�internal� model,�which�could�have�a�material�impact� on�the�Group’s�Solvency�II�capital�position.�
The�Dodd-Frank�Act�provides�for�a� comprehensive�overhaul�of�the�financial� services�industry�within�the�US�including� reforms�to�financial�services�entities,� products�and�markets.�The�full�impact� of�the�Dodd-Frank�Act�on�Prudential’s� businesses�remains�unclear,�as�many� of�its�provisions�are�primarily�focused�on� the�banking�industry,�have�a�delayed� effectiveness�and/or�require�rule-making� or�other�actions�by�various�US�regulators� over�the�coming�years.�There�is�also� potential�uncertainty�surrounding�future� changes�to�the�Dodd-Frank�Act�under�the� current�US�administration.
On�27�July�2017,�the�UK�FCA�announced� that�it�will�no�longer�persuade,�or�use�its� powers�to�compel,�panel�banks�to�submit� rates�for�the�calculation�of�LIBOR�after� 2021.�The�discontinuation�of�LIBOR�in� its�current�form�and�its�replacement�with� the�Sterling�Overnight�Index�Average� benchmark�(SONIA)�in�the�UK�(and� other�alternative�benchmark�rates�in� other�countries)�could,�among�other�things,� impact�the�Group�through�an�adverse� effect�on�the�value�of�Prudential’s�assets� and�liabilities�which�are�linked�to�or�which� reference�LIBOR,�a�reduction�in�market� liquidity�during�any�period�of�transition� and�increased�legal�and�conduct�risks�to� the�Group�arising�from�changes�required� to�documentation�and�its�related� obligations�to�its�stakeholders.�
Various�jurisdictions�in�which�Prudential� operates�have�created�investor� compensation�schemes�that�require� mandatory�contributions�from�market� participants�in�some�instances�in�the�event� of�a�failure�of�a�market�participant.�As�a� major�participant�in�the�majority�of�its� chosen�markets,�circumstances�could� arise�in�which�Prudential,�along�with�other� companies,�may�be�required�to�make� such�contributions.
The�Group’s�accounts�are�prepared�in� accordance�with�current�International� Financial�Reporting�Standards�(IFRS)� applicable�to�the�insurance�industry.� The�International�Accounting�Standards� Board�(IASB)�introduced�a�framework�that� it�described�as�Phase�I�which,�under�its� standard�IFRS�4�permitted�insurers�to� continue�to�use�the�statutory�basis�of� accounting�for�insurance�assets�and� liabilities�that�existed�in�their�jurisdictions� prior�to�January�2005.�In�May�2017,�the� IASB�published�its�replacement�standard� on�insurance�accounting�(IFRS�17,� ‘Insurance�Contracts’),�which�will�have�the� effect�of�introducing�fundamental�changes� to�the�statutory�reporting�of�insurance� entities�that�prepare�accounts�according� to�IFRS�from�2021.�In�November�2018,� the�IASB�tentatively�decided�to�delay�the� effective�date�of�IFRS�17�by�one�year�to� periods�beginning�on�or�after�1�January� 2022�and�is�considering�introducing�further� amendments�to�this�new�standard.�The� European�Union�will�apply�its�usual�process� for�assessing�whether�the�standard�meets� the�necessary�criteria�for�endorsement.� The�Group�is�reviewing�the�complex� requirements�of�this�standard�and� considering�its�potential�impact.�The� effect�of�changes�required�to�the�Group’s� accounting�policies�as�a�result�of� implementing�the�new�standard�is�currently� uncertain,�but�these�changes�can�be� expected�to,�amongst�other�things,�alter� the�timing�of�IFRS�profit�recognition.� Given�the�implementation�of�this�standard� is�likely�to�require�significant�enhancements� to�IT,�actuarial�and�finance�systems�of�the� Group,�it�will�also�have�an�impact�on�the� Group’s�expenses.
The implementation of complex strategic initiatives gives rise to significant execution risks, may affect the operational capacity of the Group, and may adversely impact the Group if these initiatives fail to meet their objectives As�part�of�the�implementation�of�its� business�strategies,�Prudential�has� commenced�a�number�of�significant� change�initiatives�across�the�Group,�many� of�which�are�interconnected�and/or�of�large� scale,�that�may�have�financial,�operational,� regulatory,�customer�and�reputational� implications�if�such�initiatives�fail�(either� wholly�or�in�part)�to�meet�their�objectives� and�could�place�strain�on�the�operational� capacity,�or�weaken�the�control� environment,�of�the�Group.�Implementing� further�strategic�initiatives�may�amplify� these�risks.�The�Group’s�current�significant� change�initiatives�include�the�combination� of�M&G�and�Prudential�UK�and�Europe,� the�proposed�demerger�of�M&GPrudential� and�the�intended�sale�of�part�of�the�UK� annuity�portfolio.�Significant�operational� execution�risks�arise�from�these�initiatives,� including�in�relation�to�the�separation�and� establishment�of�standalone�governance� under�relevant�regulatory�regimes,� business�functions�and�processes�(data,� systems,�people)�and�third�party� arrangements.�
�— There�may�be�increased�risk�of� operational�disruption�to�the�business,� in�particular�to�M&GPrudential.�Access� to�the�EU�market,�and�the�ability�to� service�EU�clients,�may�be�adversely� impacted.�Negative�market�sentiment� towards�the�UK�from�investors�may� result�in�negative�fund�flows�and�EU� service�providers�may�be�less�willing,� or�unable�to�service�UK�fund�managers,� both�of�which�may�negatively�impact� on�the�asset�management�business� of�M&GPrudential.�The�insurance� business�may�experience�higher� product�lapses�resulting�from�fund� outflows.�The�ability�to�retain�and� attract�appropriately�skilled�staff�from� the�EU�may�be�adversely�impacted.� Contractual�documentation�may�need� to�be�renegotiated�or�redrafted�in�order� to�remain�effective.
Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential�is,�and�may�in�the�future�be,� subject�to�legal�actions,�disputes�and� regulatory�investigations�in�various� contexts,�including�in�the�ordinary�course� of�its�insurance,�investment�management� and�other�business�operations.�These�legal� actions,�disputes�and�investigations�may� relate�to�aspects�of�Prudential’s�businesses� and�operations�that�are�specific�to� Prudential,�or�that�are�common�to� companies�that�operate�in�Prudential’s� markets.�Legal�actions�and�disputes�may� arise�under�contracts,�regulations� (including�tax)�or�from�a�course�of�conduct� taken�by�Prudential,�and�may�be�class� actions.�Although�Prudential�believes�that� it�has�adequately�provided�in�all�material� respects�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�imposed�and� the�inherent�unpredictability�of�litigation� and�disputes,�it�is�possible�that�an�adverse� outcome�could�have�an�adverse�effect� on�Prudential’s�reputation,�results�of� operations�or�cash�flows.
Prudential�believes�competition�will� intensify�across�all�regions�in�response� to�consumer�demand,�digital�and�other� technological�advances,�the�need�for� economies�of�scale�and�the�consequential� impact�of�consolidation,�regulatory�actions� and�other�factors.�Prudential’s�ability�to� generate�an�appropriate�return�depends� significantly�upon�its�capacity�to�anticipate� and�respond�appropriately�to�these� competitive�pressures.
Adverse experience in the operational risks inherent in Prudential’s business, and those of its material outsourcing partners, could disrupt its business functions and have a negative impact on its results of operations Operational�risks�are�present�in�all�of� Prudential’s�businesses,�including�the�risk� (from�both�Prudential�and�its�outsourcing� and�external�data�hosting�partners)�of� direct�or�indirect�loss�resulting�from� inadequate�or�failed�internal�and�external� processes,�systems�or�human�error,�fraud,� the�effects�of�natural�or�man-made� catastrophic�events�(such�as�natural� disasters,�pandemics,�cyber-attacks,� acts�of�terrorism,�civil�unrest�and�other� catastrophes)�or�from�other�external� events.�Exposure�to�such�events�could� disrupt�Prudential’s�systems�and� operations�significantly,�which�may�result� in�financial�loss�and�reputational�damage.
In�addition,�Prudential�also�relies�on�a� number�of�outsourcing�(including�external� data�hosting)�partners�to�provide�several� business�operations,�including�a�significant� part�of�the�UK�back�office�and�customer� facing�operations�as�well�as�a�number� of�IT�support�functions�and�investment� operations.�This�creates�reliance�upon� the�operational�performance�of�these� outsourcing�partners,�and�failure�to� adequately�oversee�the�outsourcing� partner,�or�the�failure�of�an�outsourcing� partner�(or�its�key�IT�and�operational� systems�and�processes)�could�result� in�significant�disruption�to�business� operations�and�customers.
There�is�an�increasing�requirement�and� expectation�on�Prudential�and�its�business� partners,�to�not�only�hold�customer,� shareholder�and�employee�data�securely,� but�use�it�in�a�transparent�and�appropriate� way.�Developments�in�data�protection� worldwide�(such�as�the�implementation�of� EU�General�Data�Protection�Regulation�that� came�into�force�on�25�May�2018)�may�also� increase�the�financial�and�reputational� implications�for�Prudential�following�a� significant�breach�of�its�(or�its�third-party� suppliers’)�IT�systems.�To�date,�Prudential� has�not�identified�a�failure�or�breach,�or�an� incident�of�data�misuse,�which�has�had�a� material�impact�in�relation�to�its�legacy�and� other�IT�systems�and�processes.�However,� it�has�been,�and�likely�will�continue�to�be,� subject�to�potential�damage�from�computer� viruses,�attempts�at�unauthorised�access� and�cyber�security�attacks�such�as�‘denial� of�service’�attacks�(which,�for�example,� can�cause�temporary�disruption�to� websites�and�IT�networks),�phishing�and� disruptive�software�campaigns.
Adverse experience relative to the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations 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�surrenders�and�take-up�rates�on� guarantee�features�of�products,�investment� performance�and�impairments,�unit�cost� of�administration�and�new�business� acquisition�expenses.�The�Group’s� businesses�are�subject�to�inflation�risk.� In�particular,�the�Group’s�medical�insurance� businesses�in�Asia�are�also�exposed�to� medical�inflation�risk.
Prudential�needs�to�make�assumptions� about�a�number�of�factors�in�determining� the�pricing�of�its�products,�for�setting� reserves,�and�for�reporting�its�capital�levels� and�the�results�of�its�long-term�business� operations.�For�example,�the�assumption� that�Prudential�makes�about�future� expected�levels�of�mortality�is�particularly� relevant�for�its�UK�annuity�business,�where� payments�are�guaranteed�for�at�least�as� long�as�the�policyholder�is�alive.�Prudential� conducts�rigorous�research�into�longevity� risk,�using�industry�data�as�well�as�its�own� substantial�annuitant�experience.�As�part� of�its�pension�annuity�pricing�and�reserving� policy,�Prudential’s�UK�business�assumes� that�current�rates�of�mortality�continuously� improve�over�time�at�levels�based�on� adjusted�data�and�informed�by�models� from�the�Continuous�Mortality� Investigation�(CMI)�as�published�by�the� Institute�and�Faculty�of�Actuaries.� Assumptions�about�future�expected�levels� of�mortality�are�also�of�relevance�to�the� Guaranteed�Minimum�Withdrawal�Benefit� (GMWB)�of�Jackson’s�variable�annuity�
Bancassurance The relationship with a bank to offer insurance products to the bank’s customers.
— Final bonus: an additional bonus expected to be paid when policyholders take money from the policies. If investment return has been low over the lifetime of the policy, a final bonus may not be paid. Final bonuses may vary and are not guaranteed.
C Cash surrender value The amount of cash available to a policy holder on the surrender of or withdrawal from a life insurance policy or annuity contract.
Constant exchange rate (CER) Prudential plc reports its results at both actual exchange rates (AER) to reflect actual results and also constant exchange rates (CER) to eliminate the impact from exchange translation. CER results are calculated by translating prior year results using current period foreign currency exchange rates ie current period average rates for the income statements and current period closing rate for the balance sheet.
European Embedded Value (EEV) Financial results that are prepared on a supplementary basis to the Group’s consolidated IFRS results and which are prepared in accordance with a set of Principles issued by the CFO Forum of European Insurance Companies dated April 2016. The principles are designed to capture the value of the new business sold in the period and of the business in force.
Funds under management (FUM) These comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations.
G Group free surplus Group free surplus at the end of the period comprises free surplus for the insurance businesses, representing the excess of the net worth over the required capital included in the EEV results, and IFRS net assets for the asset management businesses excluding goodwill. The free surplus generated during the period comprises the movement in this balance excluding foreign exchange, capital, and other reserve movements. Specifically, it includes amounts maturing from the in-force operations during the period less the investment in new business, the effect of market movements and other one-off items.
I In-force An insurance policy or contract reflected on records that has not expired, matured or otherwise been surrendered or terminated.
Internal vesting Internal vesting relates to proceeds from a Prudential policy which the policyholder has decided to reinvest in a Prudential annuity product.
N Net premiums Life insurance premiums, net of reinsurance ceded to third-party reinsurers.
O Open-ended investment company (OEIC) A collective investment fund structured as a limited company in which investors can buy and sell shares.
P Participating funds Distinct portfolios where the policyholders have a contractual right to receive at the discretion of the insurer additional benefits based on factors such as the performance of a pool of assets held within the fund, as a supplement to any guaranteed benefits. The insurer may either have discretion as to the timing of the allocation of those benefits to participating policyholders or may have discretion as to the timing and the amount of the additional benefits. For Prudential the most significant participating funds are with-profits funds for business written in the UK, Hong Kong, Malaysia and Singapore.
Prudential Regulation Authority (PRA) The PRA is a UK regulatory body responsible for Prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms.
S Scottish Amicable Insurance Fund (SAIF) SAIF is a ring-fenced sub-fund of the Prudential Assurance Company’s long-term fund following the acquisition of the mutually owned Scottish Amicable Life Assurance Society in 1997. The fund is solely for the benefit of policyholders of SAIF. Shareholders of Prudential plc have no interest in the profits of this fund although they are entitled to asset management fees on this business.
W Whole of life A type of life insurance policy that provides lifetime protection; premiums must usually be paid for life. The sum assured is paid out whenever death occurs. Commonly used for estate planning purposes.
Y Yield A measure of the income received from an investment compared to the price paid for the investment. Normally expressed as a percentage.
Company constitution Prudential is governed by the Companies Act 2006, other applicable legislation and regulations, and provisions in its Articles of Association (Articles). In 2018, the Company reviewed and updated its Articles in order to reflect changes to English company law and bring them into line with best practice. These updates were put to shareholders at the Company’s AGM held on 17 May 2018 and duly approved. The principal changes were summarised for shareholders in an appendix to the notice of meeting, these included, deleting articles relating to the allotment of shares and disapplication of pre-emption rights to reflect the Company’s practice of seeking authority from shareholders annually, giving the Company the ability to hold hybrid general meetings, amending the deemed delivery provision for communications sent to overseas shareholders and streamlining the process for selling shares belonging to untraced shareholders. Other amendments were made which were of a minor, technical or clarifying nature. The current Memorandum and Articles are available on the Company’s website.
Major shareholders The table below shows the holdings of major shareholders in the Company’s issued ordinary share capital, as at 31 December 2018, as notified and disclosed to the Company in accordance with the Disclosure Guidance and Transparency Rules.
UK register Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex, BN99 6DA, UK.
Singapore register Shareholders who have shares standing to the credit of their securities accounts with The Central Depository (PTE) Limited (CDP) in Singapore may refer queries to the CDP at 9 North Buona Vista Drive, #01-19/20, The Metropolis, Singapore 138588. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker.
www.pru.co.uk Tel +44 (0)800 000 000 www.mandg.co.uk Tel +44 (0)800 328 3192
www.prudential.co.uk Annual Report 2018 Prudential plc 1848 Prudential is established as Prudential Mutual Assurance, Investment and Loan Association in Hatton Garden, London, offering loans and life assurance to professional people.
1871 The Company becomes one of the first in the City to employ women. Calculating machines are also introduced, bringing efficiencies to the processing of an increasing volume of business.
1879 Prudential moves into Holborn Bars, a purpose-built office complex designed by Alfred Waterhouse. The building becomes a London landmark, and remains part of Prudential’s property portfolio to this day.
1912 Following the National Insurance Act, Prudential works with the government to run Approved Societies, providing sickness and unemployment benefits to five million people.
2010 Prudential plc is listed on stock exchanges in Hong Kong and Singapore.
2014 Prudential acquires businesses in Ghana and Kenya, marking its entry into the fast-growing African life insurance industry.
2017 M&G and Prudential UK & Europe combine to form M&GPrudential, a leading savings and investments business ideally positioned to target growing customer demand for comprehensive financial solutions.
2018 Prudential plc announces its intention to demerge its UK and Europe business, M&GPrudential, resulting in two separately listed companies, with different investment characteristics and opportunities.
Successive generations have looked to Prudential to safeguard their financial security – from industrial workers and their families in Victorian Britain to over 26 million customers worldwide today. Our financial strength, heritage, prudence and focus on our customers’ long-term needs ensure that people continue to turn to our trusted brands to help them plan for today and tomorrow.