(1 ADR = 2 shares). 2 In 2010 a scrip dividend equivalent and in 2011, 2012 and 2013 a DRIP dividend equivalent were accumulated on these awards. 3 This award attracts dividends in the form of cash rather than shares.
All-employee share plans It is important that all employees are offered the opportunity to own shares in Prudential, connecting them both to the success of the Company and to the interests of other shareholders. Executive directors are invited to participate in these plans on the same basis as other staff in their location. No directors or other employees are provided with loans to enable them to buy shares.
Save As You Earn (SAYE) schemes UK based executive directors are eligible to participate in the HM Revenue and Customs (HMRC) approved Prudential Savings-Related Share Option Scheme and Barry Stowe is invited to participate in the similar International Share Ownership Scheme. These schemes allow all eligible employees to save towards the exercise of options over Prudential plc shares with the option price set at the beginning of the savings period at a discount of up to 20 per cent of the market price.
Details of executive directors’ rights under the SAYE scheme are set out in the ‘Statement of directors’ shareholdings’.
SIP awards held in trust at 31 Dec 2013 (Number of shares)
Dilution Releases from the Prudential Long Term Incentive Plan, GPSP and BUPP are satisfied using new issue shares, rather than by purchasing shares in the open market. Shares relating to options granted under all-employee share plans are also satisfied by new issue shares. The combined dilution from all outstanding shares and options at 31 December 2013 was 0.2 per cent of the total share capital at the time. Deferred shares will continue to be satisfied by the purchase of shares in the open market.
The aggregate of the emoluments of the other two individuals for 2013 were as follows: Base salaries, allowances and benefits in kind 335 Pension contributions 70 Performance-related pay 24,601
Primary statements 127 Consolidated income statement 128 Consolidated statement of comprehensive income 129 Consolidated statement of changes in equity: 2013 131 Consolidated statement of financial position 133 Consolidated statement of cash flows
Section A: Background and accounting policies 134 A1 Background and basis of preparation 135 A2 Adoption of new and amended accounting standards in 2013 A3 Accounting policies 136 A3.1 Accounting policies and use of estimates and judgements 148 A3.2 New accounting pronouncements not yet effective
Section B: Earnings performance B1 Analysis of performance by segment 149 B1.1 Segment results – profit before tax 150 B1.2 Short-term fluctuations in investment returns on shareholder-backed business 152 B1.3 Determining operating segments and performance measure of operating segments 155 B1.4 Segmental income statement 157 B1.5 Revenue 158 B2 Profit before tax – asset management operations 159 B3 Acquisition costs and other expenditure 160 B3.1 Staff and employment costs 161 B3.2 Share-based payments 163 B3.3 Key management remuneration 163 B3.4 Fees payable to the auditor 164 B4 Effect of changes and other accounting features on insurance assets and liabilities 165 B5 Tax charge 169 B6 Earnings per share 170 B7 Dividends
Section C: Balance sheet notes C1 Analysis of Group position by segment and business type 171 C1.1 Group statement of financial position –
analysis by segment 176 C1.2 Group statement of financial position –
analysis by business type C2 Analysis of segment position by business type 178 C2.1 Asia insurance operations 179 C2.2 US insurance operations 181 C2.3 UK insurance operations 183 C2.4 Asset management operations C3 Assets and liabilities – Classification and Measurement 184 C3.1 Group assets and liabilities – Classification 188 C3.2 Group assets and liabilities – Measurement 195 C3.3 Debt securities 204 C3.4 Loans portfolio C3.5 Financial instruments – additional information 206 C3.5(a) Market risk 208 C3.5(b) Derivatives and hedging 209 C3.5(c) Derecognition, collateral and offsetting 211 C3.5(d) Impairment of financial assets C4 Policyholder liabilities and unallocated surplus of with-profits funds C4.1 Movement and duration of liabilities 212 C4.1(a) Group overview 215 C4.1(b) Asia insurance operations 217 C4.1(c) US insurance operations 218 C4.1(d) UK insurance operations
C4.2 Products and determining contract liabilities 220 C4.2(a) Asia 221 C4.2(b) US 224 C4.2(c) UK C5 Intangible assets C5.1 Intangible assets attributable to shareholders 230 C5.1(a) Goodwill attributable to shareholders 231 C5.1(b) Deferred acquisition costs and other intangible assets attributable to shareholders 234 C5.2 Intangible assets attributable to with-profits funds C6 Borrowings 235 C6.1 Core structural borrowings of shareholder-financed operations 236 C6.2 Other borrowings 236 C6.3 Maturity analysis C7 Risks and sensitivity analysis 237 C7.1 Group overview 239 C7.2 Asia insurance operations 241 C7.3 US insurance operations 246 C7.4 UK insurance operations 248 C7.5 Asset management and other operations C8 Tax assets and liabilities 249 C8.1 Deferred tax 250 C8.2 Current tax asset and liability 250 C9 Defined benefit pension schemes 257 C10 Share capital, share premium and own shares C11 Capital position statement 259 C11.1 Life assurance business 264 C11.2 Asset management operations –
regulatory and other surplus 265 C12 Provisions 266 C13 Property, plant and equipment 267 C14 Investment properties
Section D: Other notes 268 D1 Business acquisitions and disposals 270 D2 Domestication of the Hong Kong branch business 270 D3 Contingencies and related obligations 272 D4 Post balance sheet events 272 D5 Additional information on the effect of adoption of new and amended accounting standards 278 D6 Subsidiary undertakings 279 D7 Investments in joint ventures and associates 279 D8 Related party transactions 280 D9 Commitments
P rim ary statem en ts 127 Prudential plc Annual Report 2013
Earned premiums, net of reinsurance B1.5 29,844 28,622 Investment return B1.5 20,347 23,931 Other income B1.5 2,184 1,885
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (43,154) (45,144)
Acquisition costs and other expenditure B3 (6,861) (6,032) Finance costs: interest on core structural borrowings of shareholder-financed operations (305) (280) Remeasurement of carrying value of Japan life business classified as held for sale D1 (120) –
Share of profits from joint ventures and associates, net of related tax A2,D5 147 135
Other comprehensive (loss) income: Items that may be reclassified subsequently to profit or loss Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year A1 (255) (214) Related tax – (2)
Net unrealised valuation movements on securities of US insurance operations classified as available-for-sale: Net unrealised holding (losses) gains arising during the year (2,025) 930 Net gains included in the income statement on disposal and impairment (64) (68)
Total comprehensive income for the year 9 2,368 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013, as described in note A2. Accordingly, the 2012 comparative results and related notes have been adjusted retrospectively from those previously published.
Reserves Profit for the year – – 1,346 – – 1,346 – 1,346 Other comprehensive loss: Exchange movements on foreign operations and net investment hedges, net of related tax – – – (255) – (255) – (255) Net unrealised valuation movements, net of related change in amortisation of deferred acquisition costs and related tax – – – – (1,034) (1,034) – (1,034)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, net of tax – – (48) – – (48) – (48)
Share capital and share premium New share capital subscribed C10 – 6 – – – 6 – 6
Reserves Profit for the year – – 2,163 – – 2,163 – 2,163 Other comprehensive income (loss): Exchange movements on foreign operations and net investment hedges, net of related tax – – – (216) – (216) – (216) Net unrealised valuation movements, net of related change in amortisation of deferred acquisition costs and related tax – – – – 387 387 – 387
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, net of tax – – 34 – – 34 – 34
Total other comprehensive income (loss) – – 34 (216) 387 205 – 205
Reserve movements in respect of share-based payments – – 42 – – 42 – 42 Change in non-controlling interests arising principally from purchase and sale of property partnerships of the PAC with-profits fund and other consolidated investment funds – – – – – – (38) (38)
Share capital and share premium New share capital subscribed C10 1 16 – – – 17 – 17
Other non-investment and non-cash assets: Property, plant and equipment C13 920 754 737 Reinsurers’ share of insurance contract liabilities C4.1(a)iv 6,838 6,854 1,643 Deferred tax assets C8.1 2,412 2,306 2,261 Current tax recoverable C8.2 244 248 541 Accrued investment income C1.1 2,609 2,771 2,694
Assets held for sale§ D1(c) 916 98 3 Cash and cash equivalents 6,785 6,126 6,741 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013, as described in note A2. Accordingly, the 2012 and 2011 comparative balance sheets and the 2012 related notes have been adjusted retrospectively from those previously published.
† Included within financial investments are £3,791 million (2012: £3,015 million) of lent securities. ‡ The 2011 balance sheet has been presented to comply with the IAS 1 requirement that applies on adoption of new accounting standards. § The Group agreed in July 2013 to sell, subject to regulatory approval, its closed book life assurance business in Japan. As at 31 December 2013, the business was classified as held for sale.
Core structural borrowings of shareholder-financed operations: Other borrowings: Operational borrowings attributable to shareholder-financed operations C6.2 2,152 2,245 3,329 Borrowings attributable to with-profits operations C6.2 895 968 925
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements 2,074 2,381 3,114 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,278 5,145 4,124 Deferred tax liabilities C8.1 3,778 3,964 3,926 Current tax liabilities C8.2 395 443 928 Accruals and deferred income 824 751 654
Total equity and liabilities 325,932 307,644 270,018 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013 as described in note A2. Accordingly, the 2012 and 2011 comparative balance sheets and the 2012 related notes have been adjusted retrospectively from those previously published.
† The Group agreed in July 2013 to sell, subject to regulatory approval, its closed book life assurance business in Japan. As at 31 December 2013, the business was classified as held for sale.
The consolidated financial statements on pages 127 to 280 were approved by the Board of directors on 11 March 2014. They were signed on its behalf: Paul Manduca Chairman
Interest income and expense and dividend income included in result before tax (8,345) (7,772) Other non-cash itemsnote (ii) 81 188 Operating cash items: Interest receipts 6,961 6,483 Dividend receipts 1,738 1,530 Tax paid B5 (418) (925)
Net increase (decrease) in cash and cash equivalents 789 (513) Cash and cash equivalents at beginning of year 6,126 6,741 Effect of exchange rate changes on cash and cash equivalents (130) (102)
(v) Interest paid on structural borrowings of with-profits operations relate solely to the £100 million 8.5 per cent undated subordinated guaranteed bonds, which contribute to the solvency base of the Scottish Amicable Insurance Fund (SAIF), a ring-fenced sub-fund of the PAC with-profits fund. Cash flows in respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash flows from operating activities.
In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company (Jackson). The principal products of Jackson are fixed annuities (interest-sensitive, fixed index and immediate annuities), variable annuities, life insurance and institutional products.
The Group operates in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited (PAC), Prudential Annuities Limited (PAL), Prudential Retirement Income Limited (PRIL) and M&G Investment Management Limited. Long-term business products written in the UK are principally with-profits, including deposit administration, other conventional and unitised with-profits policies and non-participating pension annuities in the course of payment and unit-linked products.
Basis of preparation These statements have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (IASB) and as endorsed by the European Union (EU) as required by EU law (IAS Regulation EC1606/2032). EU-endorsed IFRS may differ from IFRS issued by the IASB if, at any point in time, new or amended IFRS have not been endorsed by the EU. At 31 December 2013, there were no unendorsed standards effective for the two years ended 31 December 2013 affecting the consolidated financial information of the Group and there were no differences between IFRS endorsed by the EU and IFRS issued by the IASB in terms of their application to the Group.
The exchanges rates applied for balances and transactions in currency other than the presentational currency of the Group, pounds sterling (GBP) were: Closing rate at
As a result, the exchange movement arising during 2013 recognised in other comprehensive income is: Asia operations (319) (87) US operations (37) (187) Unallocated to a segment (central funds)* 101 60 * The exchange rate movement unallocated to a segment mainly reflects the translation of currency borrowings which have been designated as a net investment hedge against the currency risk of the investment in Jackson.
The following accounting standards and amendments issued and endorsed for use in the EU have been adopted for 2013: Accounting standard Key requirements Impact on results
IFRS 11, ’Joint arrangements’, IFRS 12, ’Disclosures of interest in other entities’ and IAS 28, ’Investments in associates and joint ventures’
The standards are effective for annual periods beginning on or after 1 January 2014 for IFRS as endorsed by the EU and have been early adopted by the Group from 1 January 2013 with adjustments to comparative results.
IFRS 11 requires a joint venture to be recognised as an investment and be accounted for using the equity method in accordance with IAS 28.
IFRS 12 requires certain disclosures in respect of the Group’s interest in the joint ventures.
The standards are effective for annual periods beginning on or after 1 January 2014 for IFRS as endorsed by the EU and have been early adopted by the Group. Comparative results are retrospectively adjusted.
The standard is effective for annual periods beginning on or after 1 January 2013, with no adjustment to comparative results.
The Group has adopted the standard for 1 January 2013 and there is no material impact on the fair value measurement of the Group’s assets and liabilities.
These amendments are effective from 1 January 2013 and key revisions relevant to the Group are: (i) Presentation of actuarial gains and losses in ‘other comprehensive income’; (ii) The replacement of the expected return on plan assets with an amount based on the liability discount rate in the determination of pension costs; and
The Group has early adopted the amendment for 2013. The amendment effective in 2014 clarifies that the recoverable amount for a cash generating unit to which significant goodwill has been allocated is only required to be disclosed when an impairment loss has been recognised or reversed.
This note provides detailed accounting policies adopted by the Group to prepare the consolidated financial statements. With the exception of the consequential impact of the adoption of IFRS 13 on fair value measurement, which is not required to be applied retrospectively before 1 January 2013 (as explained in note A2), these accounting policies are applied consistently for all years presented and normally are not subject to changes unless new accounting standards, interpretations or amendments are introduced by the IASB.
The preparation of these financial statements requires Prudential to make estimates and judgements about future conditions. Prudential evaluates its estimates, including those related to long-term business provisioning and the fair value of assets. The table below sets out items that require the Group to make estimates and judgements in applying the relevant accounting policy: Critical accounting estimates and assumptions Accounting policy reference
— The Group’s current ability to join together with other partners to direct the activities of the partnership.
The Group performs a re-assessment of consolidation whenever there is a change in the substance of the relationship between the Group and a limited partnership. Where the Group is deemed to control a limited partnership, it is treated as a subsidiary and its results, assets and liabilities are consolidated. Where the Group holds a minority share in a limited partnership, with no control over their associated general partners, the investments are carried at fair value through profit and loss within financial investments in the consolidated statement of financial position.
ii Joint ventures and associates Joint ventures are joint arrangements arising from a contractual agreement whereby the Group and other investors have joint control of the net assets of the arrangement. In a number of these arrangements, the Group’s share of the underlying net assets may be less than 50 per cent but the terms of the relevant agreement make it clear that control is jointly exercised between the Group and the third party. Associates are entities over which the Group has significant influence, but it does not control. Generally it is presumed that the Group has significant influence if it holds between 20 per cent and 50 per cent voting rights of the entity.
Open-ended investment companies and unit trusts The Group invests in open-ended investment companies and unit trusts, which invest mainly in equities, bonds, cash and cash equivalents, and properties. The Group’s percentage ownership in these entities can fluctuate on a daily basis according to the participation of the Group’s and other investors in them. For these entities, the following circumstances may indicate, in substance, the Group has power over an entity: — The entity is managed by the Group’s asset manager and the Group holds a significant investment in the entity; and — Where the entity is managed by asset managers outside the Group, Prudential has existing rights that give it the ability to direct the current activities of the entity. In assessing the Group’s ability to direct an entity, the Group considers its ability relative to other investors. The Group has limited number of open-ended investment companies and unit trusts where it considers it has such ability.
Where the Group does not control these entities (as it is deemed to be acting as an agent) and they do not meet the definition of associates, they are carried at fair value through profit and loss within financial investments in the consolidated statement of financial position.
The Group generates returns and retains the ownership risks in investment vehicles commensurate to its participation and does not have any further exposure to the residual risks of the open-ended investment companies and unit trusts.
Jackson’s separate account assets Jackson offers variable contracts that invest contract holder’s premiums, at the contract holders’ direction, in investment vehicles (‘Separate Accounts’) that invest in equity, fixed income, bonds and money market mutual funds. The contract holder retains the underlying returns and the ownership risks related to the separate accounts and its 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 Companies or trustees for which the majority of the members are independent of Jackson or any affiliated entity. The independent members represent contract holders’ interest and are responsible for any decision making that impacts contract holders’ interest and governs the operational activities of the entities advisors, including asset managers managing the investment vehicles. Accordingly the Group has no control over these vehicles. These investments are carried at fair value through profit and loss within financial investments in the consolidated statement of financial position.
Statement of financial position line items Equity securities and portfolio holdings in unit trusts 78,856 65,681 – Debt securities – – 13,190
The Group generates returns and retains the ownership risks in these investments commensurate to its participation and does not have any further exposure to the residual risks or losses of the investments or the vehicles in which it holds investments.
As at 31 December 2013, the Group does not have an agreement, contractual or otherwise, or intention to provide financial support to structured entities that could expose the Group to a loss.
c Classification of insurance and investment contracts IFRS 4 requires contracts written by insurers to be classified as either ‘insurance contracts’ or ‘investment contracts’ depending on the level of insurance risk transferred. Insurance risk is a pre-existing risk, other than financial risk, transferred from the contract holder to the contract issuer. If significant insurance risk is transferred to the Group then it is classified as an insurance contract. Contracts that transfer financial risk to the Group but not significant insurance risk are termed investment contracts. Furthermore, some contracts, both insurance and investment, contain discretionary participating features representing the contractual right to receive additional benefits as a supplement to guaranteed benefits: a That are likely to be a significant portion of the total contract benefits; b Whose amount or timing is contractually at the discretion of the insurer; and c That are contractually based on asset or fund performance, as discussed in IFRS 4.
ack gro u n d an d acco u n tin g p o licies 139 Prudential plc Annual Report 2013
— Guaranteed investment contracts (GICs) — Minor amounts of ‘annuity certain’ contracts
For investment contracts that do not contain discretionary participating features, IAS 39 and, where the contract includes an investment management element, IAS 18, ’Revenue’, apply measurement principles to assets and liabilities attaching to the contract.
The policy of measuring contract liabilities at business unit level is noted below. Additional details are discussed in note C4.2.
Whilst the basis of valuation of liabilities in these businesses is in accordance with the requirements of the ABI SORP, it may differ from that determined on MSB for UK operations with the same features.
US insurance operations In accordance with the MSB, the policyholder liabilities for Jackson’s conventional protection-type policies are determined under US GAAP principles with locked in assumptions for mortality, interest, policy lapses and expenses along with provisions for adverse deviations. For non-conventional protection-type policies, the policyholder liabilities includes the policyholder account balance. Acquisition costs are accounted for as explained in section (f) below.
The with-profits benefits reserve is primarily based on the retrospective calculation of accumulated asset shares but is adjusted to reflect future policyholder benefits and other outgoings. Asset shares broadly reflect the policyholders’ share of the with-profits fund assets attributable to their policies.
The future policy related liabilities must include a market-consistent valuation of costs of guarantees, options and smoothing, less any related charges, and this amount is determined using either a stochastic approach, hedging costs or a series of deterministic projections with attributed probabilities.
Other UK insurance contracts that contain significant insurance risk include unit-linked, annuity and other non-profit business. For the purposes of local regulations, segregated accounts are established for linked business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefits are based on published mortality tables adjusted to reflect actual experience.
Those investment contracts without fixed and guaranteed terms are designated at fair value through profit and loss because the resulting liabilities are managed and their performance is evaluated on a fair value basis. Where the contract includes a surrender option, its carrying value is subject to a minimum carrying value equal to its surrender value.
e Reinsurance The measurement of reinsurance assets is consistent with the measurement of the underlying direct insurance contracts. The treatment of any gains or losses arising on the purchase of reinsurance contracts is dependent on the underlying accounting basis of the entity concerned amongst other things.
For US variable annuity business a key assumption is the investment return from the separate accounts, which is determined using a mean reversion methodology. Under the mean reversion methodology, projected returns over the next five years are flexed (subject to capping) so that, combined with the actual rates of return for the current and the previous two years is maintained. The projected rates of return are capped at no more than 15 per cent for each of the next five years. These returns affect the level of future expected profits through their effects on the fee income with consequential impact on the amortisation of deferred acquisition costs. The level of acquisition costs carried in the statement of financial position is also sensitive to unrealised valuation movements on debt securities held to back the liabilities and solvency capital. Further details are discussed in note C5.1(b).
UK insurance operations For UK regulated with-profits funds where the realistic FSA regime is applied, the basis of setting liabilities is such that it would be inappropriate for acquisition costs to be deferred; therefore these costs are expensed as incurred. The majority of the UK shareholder-backed business is individual and group annuity business where the incidence of acquisition costs is negligible.
j Financial investments other than instruments classified as long-term business contracts i Investment classification The Group holds financial investments in accordance with IAS 39 whereby, subject to specific criteria, financial instruments are required to be accounted for under one of the following categories: — Financial assets and liabilities at fair value through profit and loss – this comprises assets and liabilities designated by management as fair value through profit and 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 and/or do not fall into any of the other categories. These assets are initially recognised at fair value plus attributable transaction costs. For available-for-sale debt securities, the difference between their cost and par value is amortised to the income statement using the effective interest rate. 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; — Available-for-sale assets are subsequently measured at fair value. Interest income is recognised on an effective interest basis in the income statement. Except for foreign exchange gains and losses on debt securities, not in functional currency, 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
— Loans and receivables – except for those designated as at fair value through profit and loss or available-for-sale, these instruments comprise non-quoted investments that have fixed or determinable payments. These instruments include loans collateralised by mortgages, deposits, loans to policyholders and other unsecured loans and receivables. These investments are initially recognised at fair value plus transaction costs. Subsequently, these instruments are carried at amortised cost using the effective interest method.
If the market for a financial investment of the Group is not active, the fair value is determined by using valuation techniques. The Group establishes fair value for these financial investments by using quotations from independent third parties, such as brokers or pricing services or by using internally developed pricing models. Priority is given to publicly available prices from independent sources when available, but overall the source of pricing and/or the valuation technique is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The valuation techniques include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation and may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these financial investments.
ack gro u n d an d acco u n tin g p o licies 143 Prudential plc Annual Report 2013 iii Determining impairments’ relation to financial assets Available-for-sale securities The majority of Jackson’s debt securities portfolio is accounted for on an available-for-sale basis. The consideration of evidence of impairment requires management’s judgement. In making this determination the factors considered include, for example: Determining factors Consideration of evidence of impairment
If a loss event that will have a detrimental effect on cash flows is identified, an impairment loss is recognised in the income statement. The loss recognised is determined as the difference between the book cost and the fair value of the relevant impaired securities. This loss comprises the effect of the expected loss of contractual cash flows and any additional market-price-driven temporary reductions in values.
The Group’s review of fair value involves several criteria, including economic conditions, credit loss experience, other issuer-specific developments and future cash flows. These assessments are based on the best available information at the time. Factors such as market liquidity, the widening of bid/ask spreads and a change in cash flow assumptions can contribute to future price volatility. If actual experience differs negatively from the assumptions and other considerations used in the consolidated financial statements, unrealised losses currently in equity may be recognised in the income statement in future periods. Additional details on the impairments of the available-for-sale securities of Jackson are described in notes C3.5(d).
The risks inherent in reviewing the impairment of any investment include: the risk that market results may differ from expectations, facts and circumstances may change in the future and differ from estimates and assumptions, or the Group may later decide to sell the asset as a result of changed circumstances.
A3: Accounting policies continued iv Derivatives and hedge accounting Derivative financial instruments are used to reduce or manage investment, interest rate and currency exposures, to facilitate efficient portfolio management and for investment purposes.
The Group does not regularly seek to apply fair value or cash flow hedging treatment under IAS 39. The exceptions, where hedge accounting has been applied in 2013 and 2012, are summarised in note C3.5(b).
For UK with-profits funds the derivative programme derivatives are used for the purposes of efficient portfolio management or reduction in investment risk.
For shareholder-backed UK annuity business the derivatives are held to contribute to the matching, as far as practical, of asset returns and duration with those of liabilities to policyholders. The carrying value of these liabilities is sensitive to the return on the matching financial assets including derivatives held.
v Measurement and presentation of derivatives and debt securities of US insurance operations The policies for these items are significant factors in contributing to the volatility of the income statement result and shareholders’ equity. Under IAS 39, derivatives are required to be carried at fair value. Unless net investment hedge accounting is applied, value movements on derivatives are recognised in the income statement.
For derivative instruments of Jackson that are entered into to mitigate economic exposures, the Group has considered whether it is appropriate to undertake the necessary operational changes to qualify for hedge accounting so as to achieve matching of value movements in hedging instruments and hedged items in the performance statements. In reaching the decision, a number of factors were particularly relevant. These were: — IAS 39 hedging criteria have been designed primarily in the context of hedging and hedging instruments that are assessable as financial instruments that are either stand-alone or separable from host contracts, rather than, for example, duration characteristics of insurance contracts; — The high hurdle levels under IAS 39 of ensuring hedge effectiveness at the level of individual hedge transactions; — The difficulties in applying the macro hedge provisions under IAS 39 (which are more suited to banking arrangements) to Jackson’s derivative book; — The complexity of asset and liability matching of US life insurers such as those with Jackson’s product range; and finally — Whether it is possible or desirable, without an unacceptable level of costs and constraint on commercial activity, to achieve the accounting hedge effectiveness required under IAS 39.
Taking account of these considerations the Group has decided that, except for occasional circumstances, it is not appropriate to seek to achieve hedge accounting under IAS 39. As a result of this decision the total income statement results are more volatile as the movements in the value of Jackson’s derivatives are reflected within it. This volatility is reflected in the level of short-term fluctuations in investment returns, as shown in notes B1.1 and B1.2.
l Segments Under IFRS 8, ‘Operating Segments’, the Group determines and presents operating segments based on the information that is internally provided to the Group Executive Committee which is the Group’s chief operating decision maker.
m Segmental analysis of results and earnings attributable to shareholders The Group uses operating profit based on longer-term investment returns as the segmental measure of its results. The basis of calculation is disclosed in note B1.3.
A3: Accounting policies continued p Pension schemes For the Group’s defined benefit schemes, if the present value of the defined benefit obligation exceeds the fair value of the scheme assets, then a liability is recorded in the Group’s statement of financial position. By contrast, if the fair value of the assets exceeds the present value of the defined benefit obligation then the surplus will only be recognised if the nature of the arrangements under the trust deed, and funding arrangements between the Trustee and the Company, support the availability of refunds or recoverability through agreed reductions in future contributions. In addition, if there is a constructive obligation for the Company to pay deficit funding, this is also recognised such that the financial position recorded for the scheme reflects the higher of any underlying IAS 19 deficit and the obligation for deficit funding.
The aggregate of the actuarially determined service costs of the currently employed personnel and the net interest on the net defined benefit liability (asset) at the start of the period is charged to the income statement. Actuarial and other gains and losses as a result of changes in assumptions or experience variances are recognised as other comprehensive income.
r Tax Current tax expense is charged or credited based upon amounts estimated to be payable or recoverable as a result of taxable amounts for the current year. To the extent that losses of an individual UK company are not offset in any one year, they can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
u Intangible assets Intangible assets acquired on the purchase of a subsidiary or portfolio of contracts are fair valued at acquisition. Deferred acquisition costs are accounted for as described in policy notes (d) and (f) above. Other intangible assets, such as distribution rights and software, are valued initially at the price paid to acquire them and are subsequently carried at cost less amortisation and any accumulated impairment losses. Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contract. Amounts for distribution rights are amortised on a basis to reflect the pattern in which the future economic benefits are expected to be consumed by reference to new business levels. The same principles apply to determining the amortisation method for other intangible assets unless the pattern cannot be determined reliably, in which case a straight line method is applied.
w Shareholders’ dividends Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders.
Foreign currency borrowings that are used to provide a hedge against Group equity investments in overseas subsidiaries are translated at year end exchange rates and movements recognised in other comprehensive income. Other foreign currency monetary items are translated at year end exchange rates with changes recognised in the income statement.
A3.2 New accounting pronouncements not yet effective The following standards, interpretations and amendments have been issued but are not yet effective in 2013, including those which have not yet been adopted in the EU. This is not intended to be a complete list as only those standards, interpretations and amendments that could have an impact upon the Group’s financial statements are discussed.
IFRIC 21, ‘Levies’ IFRIC 21, ‘Levies’, issued in May 2013, is effective for annual periods beginning on or after 1 January 2014. It has not yet been endorsed for use in the EU. This interpretation clarifies that an entity recognises a liability for a levy imposed by a government (that is not income tax) when the activity that triggers payment, as identified by the relevant legislation, occurs. The Group is assessing the impact of this interpretation but it is not expected to have a material effect on the Group’s financial statements.
IFRS 9, ‘Financial instruments: Classification and measurement’ This standard when effective will automatically replace IAS 39, ’Financial Instruments – Recognition and measurement’. Under the current version of IFRS 9 the classification and hence measurement of financial assets would be on two bases, either amortised cost or fair value through profit or loss, rather than the existing four bases of classification. These requirements maintain the existing amortised cost measurement for most liabilities but will require changes in fair value due to changes in the entity’s own credit risk to be recognised in the other comprehensive income section of the comprehensive income statement, rather than within profit or loss for liabilities measured at fair value. Notwithstanding these prospective requirements, under the current version of IFRS 9, on 28 November 2012, the IASB released an exposure draft proposing amendments. The proposed changes would introduce a fair value through other comprehensive income category which would include certain financial assets that contain contractual cash flows that are solely payments of principal and interest and are held in a business model in which assets are managed both in order to collect contractual cash flows and for sale. The Group is assessing the impact of this standard and will consider the remaining phases of IFRS 9 when finalised by the IASB. IFRS 9 has not yet been endorsed for use in the EU and there is currently no mandatory effective date pending the finalisation of its remaining phases.
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Total Asia insurance operations after development expenses 1,001 906 Eastspring Investments 74 69
Total UK insurance operations 735 736 M&G (including Prudential Capital) 441 371
Other income and expenditure Investment return and other income 10 13 Interest payable on core structural borrowings (305) (280) Corporate expenditurenote (ii) (263) (231)
Based on operating profit based on longer-term investment returns 90.9p 76.9p Based on profit for the year 52.8p 85.1p * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) The Group’s UK insurance operations transferred its general insurance business to Churchill in 2002. General insurance commission represents the commission receivable net of expenses for Prudential-branded general insurance products as part of this arrangement.
(ii) Corporate expenditure as shown above is for Group Head Office and Asia Regional Head Office. (iii) Restructuring costs are incurred in the UK and represent one-off expenses incurred in securing expense savings. (iv) During 2012, M&G reduced its holdings in PPM South Africa resulting in a reclassification from a subsidiary to an associate giving rise to a gain on dilution of £42 million. (v) To facilitate comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the results attributable to the held for sale Japan life business are included separately within the supplementary analysis of profit above.
B1.2 Short-term fluctuations in investment returns on shareholder-backed business 2013 £m 2012* £m
Other operations: – Economic hedge value movementnote (v) – (32) – Othernote (vi) (27) 119 * The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new and amended accounting standards described in note A2. In addition, to facilitate comparisons of results that reflect the Group’s retained operations, the short-term fluctuations in investment returns attributable to the held for sale Japan life business are included separately within the supplementary analysis of profit.
Total residential mortgage-backed securities – (8) Corporate debt securities (1) (14)
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(b) The risk margin reserve charge for longer-term credit-related losses included in operating profit based on longer-term investment returns of Jackson for 2013 is based on an average annual risk margin reserve of 25 basis points (2012: 26 basis points) on average book values of US$54.4 billion (2012: US$47.6 billion) as shown below: Moody’s rating category (or equivalent under NAIC ratings of mortgage-backed securities)
Related change to amortisation of deferred acquisition costs (see below) 25 16 21 13
Risk margin reserve charge to operating profit for longer-term credit related losses (109) (69) (104) (66)
(c) Derivatives (other than equity-related): negative fluctuation of £(531) million (2012: positive fluctuation of £135 million) net of related amortisation of deferred acquisition costs.
In 2013, the negative fluctuation of £(531) million reflects principally the adverse mark-to-market impact of the 1.3 per cent increase in swap rates on the valuation of the interest rate swaps, swaptions, and the GMIB reinsurance asset.
Under the Group’s IFRS reporting of Jackson’s equity-based derivatives and associated guarantee liabilities significant accounting mismatches arise. This is because: – The free-standing derivatives and Guaranteed Minimum Withdrawal Benefit (GMWB) ‘not for life’ embedded derivative liabilities are required to be fair valued. These fair value movements include the effects of changes to levels of equity markets, implied volatility and interest rates. The interest rate exposure is managed through the derivative programme explained above in note (c); – The Guaranteed Minimum Death Benefit (GMDB) and GMWB ‘for life’ guarantees are valued under the US GAAP insurance measurement basis applied for IFRS in a way that substantially does not recognise the effect of equity market and interest rate changes.
B1.3 Determining operating segments and performance measure of operating segments Operating segments The Group’s operating segments, determined in accordance with IFRS 8, ‘Operating Segments’, are as follows: Insurance operations — Asia — US (Jackson) — UK
Asset management operations — M&G (including Prudential Capital) — Eastspring Investments — US broker-dealer and asset management (including Curian)
Performance measure The performance measure of operating segments utilised by the Company is IFRS operating profit attributable to shareholders based on longer-term investment returns, as described below. This measurement basis distinguishes operating profit based on long-term investment returns from other constituents of the total profit as follows: — Short-term fluctuations in investment returns; — Amortisation of acquisition accounting adjustments arising on the purchase of business. This comprises principally the charge for the adjustments arising on the purchase of REALIC in 2012; — For 2012, gain on dilution of the Group’s holdings in PPM South Africa; — (Loss) profit attaching to the held for sale Japan life business. See note D1 for further details; and — For 2013, the costs associated with the domestication of the Hong Kong branch.
Except in the case of assets backing the UK annuity, unit-linked and US variable annuity separate account liabilities, operating profit based on longer-term investment returns for shareholder-financed business is determined on the basis of expected longer-term investment returns. In the case of assets backing the UK annuity business, unit-linked and US variable annuity separate account liabilities, the basis of determining operating profit based on longer-term investment returns is as follows: — UK annuity business liabilities: For this business, policyholder liabilities are determined by reference to current interest rates. The value movements of the assets covering liabilities are closely correlated with the related change in liabilities. Accordingly, asset value movements are recorded within the ‘operating results based on longer-term investment returns’. Policyholder liabilities include a margin for credit risk. Variations between actual and best estimate expected impairments are recorded as a component of short-term fluctuations in investment returns; and
— Unit-linked and US variable annuity business separate account liabilities: For such business, the policyholder unit liabilities are directly reflective of the asset value movements. Accordingly, the operating results based on longer-term investment returns reflect the current period value movements in unit liabilities and the backing assets.
In the case of other shareholder-financed business, the measurement of operating profit based on longer-term investment returns reflects the particular features of long-term insurance business where assets and liabilities are held for the long-term and for which the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying performance of life businesses exclusive of the effects of short-term fluctuations in market conditions. In determining the profit on this basis, the following key elements are applied to the results of the Group’s shareholder-financed operations.
For debt securities backing non-linked shareholder-financed business of the UK insurance operations (other than the annuity business) and of the Asia insurance operations, the realised gains and losses are principally interest related. Accordingly, all realised gains and losses to date for these operations are being amortised over the period to the date those securities would otherwise have matured, with no explicit risk margin reserve charge.
The longer-term investment returns for the Asia insurance joint ventures accounted for on the equity method are determined on a similar basis as the other Asia insurance operations described above.
(d) Other liabilities to policyholders and embedded derivatives for product guarantees Under IFRS, the degree to which the carrying values of liabilities to policyholders are sensitive to current market conditions varies between territories 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 operating profit based on longer-term investments 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.
Examples where such bifurcation is necessary are: Asia – Hong Kong For certain non-participating business, the economic features are more akin to asset management products with policyholder liabilities reflecting asset shares over the contract term. For these products, the charge for policyholder benefits in the operating results should reflect the asset share feature rather than volatile movements that would otherwise be reflected if the local regulatory basis (also applied for IFRS basis) was used.
For other Hong Kong non-participating business, longer-term interest rates are used to determine the movement in policyholder liabilities for determining operating results. Similar principles apply for other Asia operations.
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Movement in unallocated surplus of with-profits fundsnote (iii) (255) – (1,294) – – – (1,549) – (1,549)
Remeasurement of carrying value of Japan life business classified as held for sale (120) – – – – – (120) – (120)
This is represented in the segmental analysis of profit from continuing operations before tax attributable to shareholders in note B1.1 as follows: Year ended 31 December 2013 £m
Amortisation of acquisition accounting adjustments (7) (65) – – – – (72) – (72)
Loss attaching to held for sale Japan life business (102) – – – – – (102) – (102)
Profit (loss) before tax attributable to shareholders 688 553 446 463 59 74 2,283 (648) 1,635
Earned premiums, net of reinsurance 7,270 14,467 6,885 – – – 28,622 – 28,622
Acquisition costs and other operating expenditureB3 (1,763) (1,079) (1,630) (696) (692) (175) (6,035) 3 (6,032)
Total charges, net of reinsurance (9,333) (19,803) (20,493) (712) (692) (175) (51,208) (248) (51,456)
Share of profit from joint ventures and associates, net of related tax 83 – 28 9 – 15 135 – 135
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns)note (i) 1,053 855 1,166 511 39 69 3,693 (576) 3,117
Tax charge attributable to policyholders’ returns (76) – (294) – – – (370) – (370)
This is represented in the segmental analysis of profit from continuing operations before tax attributable to shareholders in note B1.1 as follows: Year ended 31 December 2012* £m
Short-term fluctuations in investment returns on shareholder-backed business 54 (90) 136 98 – – 198 (11) 187
Gain on dilution of Group’s holdings – – – 42 – – 42 – 42 Amortisation of acquisition accounting
Profit (loss) before tax attributable to shareholders 977 855 872 511 39 69 3,323 (576) 2,747 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Fee income from investment contract business and asset managementnotes (iii),(iv) 2,184 1,885
Notes (i) The segmental analysis of interest income is as follows: Insurance operations Asset management operations
Total revenue from external customers 9,066 16,150 6,812 – 32,028 2012* £m
Revenue (excluding revenue of consolidated investment funds and NPH broker-dealer fees) 1,308 362 244 1,914 1,739
Comprising: Operating profit based on longer-term investment returnsnote (ii) 441 59 74 574 479 Short-term fluctuations in investment returnsnote (iii) 22 – – 22 98 Gain on dilution of Group’s holdings – – – – 42 * The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new and amended accounting standards described in note A2. One of the new accounting standards adopted was IFRS 11 which requires joint ventures to be equity accounted. Accordingly, share of profit from joint ventures and associates is disclosed as a separate line.
(ii) M&G operating profit based on longer-term investment returns: Asset management fee income 859 728 Other income 4 6 Staff costs (339) (289) Other costs (166) (147)
(iii) Short-term fluctuations in investment returns for M&G are primarily in respect of unrealised fair value movements on Prudential Capital’s bond portfolio.
Included in total acquisition costs and other expenditure are: (a) Total depreciation and amortisation expense of £(510) million (2012: £(727) million) relates primarily to amortisation of deferred acquisition costs of insurance contracts and asset management contracts. The segmental analysis of total depreciation and amortisation expense is analysed below.
(d) Finance costs of £(305) million (2012: £(280) million) comprising £(275) million (2012: £(251) million) of interest on core debt of the parent company, £(13) million (2012: £(13) million) on US insurance operations’ surplus notes and £(17) million (2012: £(16) million) on PruCap’s bank loan.
(e) Movements in amounts attributable to external unit holders are in respect of those OEICs and unit trusts which are required to be consolidated and comprises a charge of £(583) million (2012: £(261) million) for UK insurance operations and a credit of £12 million (2012: £54 million) for Asia insurance operations.
Insurance operations: Asset management operations: Eastspring Investments (3) (3) – –
Business operations: Wages and salaries 1,272 1,119 Social security costs 94 82
Deferred bonus plans The Company operates a number of deferred bonus schemes including the Group Deferred Bonus Plan, the Prudential Corporation Asia Deferred Bonus Plan (PCA DBP), the Prudential Capital Deferred Bonus Plan (PruCap DBP) and other arrangements. There are no performance conditions attached to deferred share awards made under these arrangements.
The following table provides a summary of the range of exercise prices for Prudential plc options outstanding at 31 December.
c Fair value of options and awards The fair value amounts estimated on the date of grant relating to all options (including conditional nil cost options) and awards, were determined using the Black-Scholes and the Monte Carlo option-pricing models using the following assumptions: Prudential LTIP/GPSP
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Compensation costs for all share-based compensation plans are determined using the Black-Scholes model, Monte Carlo model or other market consistent valuation methods. The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black-Scholes model to value all options and awards other than the Prudential LTIP (TSR), GPSP and UK BUPP, for which the Group uses a Monte Carlo model in order to allow for the impact of the TSR performance conditions. These models are used to calculate fair values for share options and awards at the grant date based on the quoted market price of the stock at the measurement date, the amount, if any, that the employees are required to pay, the dividend yield, expected volatility, risk-free interest rates and exercise prices.
For all options and awards, the expected volatility is based on the market implied volatilities for Prudential shares as quoted on Bloomberg. The Prudential specific at-the-money implied volatilities are adjusted to allow for the different terms and discounted exercise price on SAYE options by using information on the volatility surface of the FTSE 100.
d Share-based payment expense charged to the income statement Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows: Share-based compensation expense 83 58 Amount accounted for as equity-settled 63 42 Carrying value at 31 December of liabilities arising from share-based payment transactions 23 24 Intrinsic value of above liabilities for which rights had vested at 31 December 17 16
Total key management remuneration is analysed in the following table: Salaries and short-term benefits 16.5 13.8 Post-employment benefits 1.0 1.2 Share-based payments 14.3 11.8
The share-based payments charge comprises £9.3 million (2012: £8.0 million), which is determined in accordance with IFRS 2, ‘Share-Based Payments’ (see note B3.2) and £5.0 million (2012: £3.8 million) of deferred share awards.
B4: Effect of changes and other accounting features on insurance assets and liabilities
In addition to the effect of the new accounting pronouncements for 2013 as disclosed in note A2, the following features are of particular relevance to the determination of the 2013 results: a Asia insurance operations In 2013, the IFRS operating profit based on longer-term investment returns for Asia insurance operations included a net £44 million credit (2012: £48 million) representing a small number of non-recurring items.
In 2012, the basis of determining the valuation rate of interest was altered to align with a permitted practice of the Hong Kong authorities for regulatory reporting. The main change is to apply a valuation rate of interest that incorporates a reinvestment yield that is weighted by reference to current and the historical three-year average rather than the year end rate. The change reduced the carrying value of policyholder liabilities at 31 December 2012 by £95 million. This benefit is included within the short-term fluctuations in investment returns in the Group’s supplementary analysis of profit. The 2012 operating profit also included the £51 million gain on sale of stake in China Life of Taiwan.
b US insurance operations Amortisation of deferred acquisition costs Jackson applies a mean reversion technique for amortisation of deferred acquisition costs on variable annuity business which dampens the effects of short-term market movements on expected gross profits against which deferred acquisition costs are amortised. To the extent that the mean reversion methodology does not fully dampen the effects of market returns, there is a charge or credit for accelerated or decelerated amortisation. For 2013, reflecting the positive market returns in the year, there was a credit for decelerated amortisation of £82 million (2012: £56 million) to the operating profit based on longer-term investment returns. See note C5.1(b) for further details.
Other In 2013, Jackson revised its projected long-term separate account return from 8.4 per cent to 7.4 per cent net of external fund management fees. The effect of this change together with other assumption changes and recalibration of modelling of accounting values of guarantees gave rise to a net benefit of £6 million to profit before tax.
Bond spread over swap ratesnote (i) 133 – 133 161 – 161
Credit risk allowance Long-term expected defaultsnote (ii) 15 – 15 15 – 15
Notes (i) Bond spread over swap rates reflects market observed data.
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Total allowance for credit risk at 31 December 2013 62 43
Deferred tax arising from: Origination and reversal of temporary differences (392) (182) Impact of changes in local statutory tax rates 55 30 Expense in respect of a previously unrecognised tax loss, tax credit or temporary difference from a prior period – (4)
The current tax charge of £399 million includes £18 million (2012: £17 million) in respect of the tax charge for the Hong Kong operation. The Hong Kong current tax charge is calculated as 16.5 per cent for all periods on either (i) 5 per cent of the net insurance premium or (ii) the estimated assessable profits, depending on the nature of the business written.
The total tax charge comprises tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders as shown below.
Tax charge to policyholders’ returns (207) (240) (447) (370) Tax charge attributable to shareholders (192) (97) (289) (584)
The total deferred tax charge arises as follows: 2013 £m 2012* £m
Unrealised gains and losses on investments 69 (89) Balances relating to investment and insurance contracts (44) 467 Short-term timing differences (314) (206) Capital allowances (7) – Unused tax losses (41) (328)
Overview of reconciliation of effective tax rate 2013 £m 2012* £m
Reconciliation of tax charge on profit attributable to shareholders 2013 £m (except for tax rates)
Operating profit (loss) based on longer-term investment returns 1,001 1,243 735 (25) 2,954
Profit (loss) before tax attributable to shareholders 688 553 446 (52) 1,635
Tax at the expected tax rate 225 300 214 11 750 Effects of: Adjustment to tax charge in relation to prior years (14) 10 (26) (10) (40) Movements in provisions for open tax matters – (3) – 32 29 Income not taxable or taxable at concessionary rates (68) (68) – (2) (138) Deductions not allowable for tax purposes 29 – – 3 32 Impact of changes in local statutory tax rates – – (39) 9 (30) Deferred tax adjustments (5) – 8 – 3 Effect of results of joint ventures and associates (24) – – (5) (29) Irrecoverable withholding taxes – – – 14 14
Actual tax rate: Operating profit (loss) based on longer-term investment returns 15% 28% 17% (42)% 23%
† The expected tax rates shown in the table above reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for Other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
† Other taxes paid includes property taxes, withholding taxes, customs duties, stamp duties, employer payroll taxes and irrecoverable indirect taxes. ‡ Taxes collected are other taxes that Prudential remits to tax authorities which it is obliged to collect from employees, customers and third parties which includes sales/value added tax/goods and services taxes, employee and annuitant payroll taxes.
The 2013 corporation tax payments are lower than 2012 reflecting (i) refunds received in 2013 of overpaid tax in relation to prior period tax returns in Asia and US, (ii) US tax payments being reduced due to impact of tax relief on movements in derivatives held to manage Jackson’s exposure to financial markets, and (iii) reductions in UK equity and bond investment gains.
Loss attaching to held for sale Japan life business D1 (102) – (102) (4.0)p (4.0)p Costs of domestication of Hong Kong branch D2 (35) 7 (28) (1.1)p (1.1)p
Based on operating profit based on longer-term investment returns 2,520 (567) 1,953 76.9p 76.8p
Based on profit for the year 2,747 (584) 2,163 85.1p 85.0p * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Weighted average number of shares for calculation of: Basic earnings per share 2,548 2,541
Dividends relating to reporting year: Dividends declared and paid in reporting year: Current year interim dividend 9.73p 249 8.40p 215 Final dividend for prior year 20.79p 532 17.24p 440
To explain more comprehensively the assets, liabilities and capital of the Group’s businesses, it is appropriate to provide analyses of the Group’s statement of financial position by operating segment and type of business.
C1.1 Group statement of financial position – analysis by segment a Position as at 31 December 2013
Total policyholder liabilities and unallocated surplus of with-profits funds C4 31,987 107,411 146,616 286,014 – – – 286,014
Liabilities held for sale D1(c) 868 – – 868 – – – 868
alan ce sh eet n o tes 173 Prudential plc Annual Report 2013 b Position as at 31 December 2012
Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets C5.2(b) 819 3,222 105 4,146 13 18 – 4,177
Assets held for sale – – 98 98 – – – 98 Cash and cash equivalentsnote (iii) 1,545 513 2,668 4,726 918 482 – 6,126 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
‘realistic’ basis provisions for UK regulated with-profits funds) 63 – 10,526 10,589 – – – 10,589
Total policyholder liabilities and unallocated surplus of with-profits funds C4 31,564 92,261 144,438 268,263 – – – 268,263
Borrowings attributable to with-profits operations C6.2 – – 968 968 – – – 968
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Notes (i) The non-current assets of the Group comprise goodwill, intangible assets other than DAC and present value of acquired in-force business and property, plant and equipment included within ‘other non-investment and non-cash assets’. Items defined as financial instruments or related to insurance contracts are excluded. The Group’s total non-current assets at 31 December comprise: UK including insurance operations, M&G and central operations 2,090 1,927 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
† No individual country in Asia held non-current assets at the end of the year which exceeded 10 per cent of the Group total.
(ii) Included within other non-investment and non-cash assets are accrued investment income of £2,609 million (2012: £2,771 million) and other debtors of £1,746 million (2012: £1,325 million).
Of the total cash and cash equivalents £511 million (31 December 2012: £482 million) are held centrally and considered to be available for general use by the Group. The remaining funds are considered not to be available for general use by the Group, and include funds held for the benefit of policyholders.
† Of the £2,521 million (2012: £2,285 million) other items as at 31 December 2013, £2,051 million (2012: £2,021 million) related to liabilities for funds withheld under reinsurance arrangement of the Group’s US operations from the purchase of REALIC, as discussed in note D1.
Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets C5.1 – – 5,256 20 19 – 5,295 4,177
Unallocated surplus of with-profits funds 12,061 – – – – – 12,061 10,589
Core structural borrowings of shareholder-financed operations: Subordinated debt – – – – 3,662 – 3,662 2,577
Operational borrowings attributable to shareholder-financed operations C6.2 – – 216 3 1,933 – 2,152 2,245
Borrowings attributable to with-profits operations C6.2 895 – – – – – 895 968
Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets – – 1,026 1,026 819
Other non-investment and non-cash assets 320 131 622 1,073 1,023 Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method – – 268 268 284 Financial investments: Equity securities and portfolio holdings in unit trusts 4,538 9,274 571 14,383 12,730
Assets held for sale – 328 588 916 – Cash and cash equivalents 392 332 798 1,522 1,545
Operational borrowings attributable to shareholder-financed operations – – – – 7
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Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangibles – 4,140 4,140 3,222
Other investments note (ii) – 1,557 1,557 2,296 Deposits – – – 211
Core structural borrowings of shareholder-financed operations – 150 150 153 Operational borrowings attributable to shareholder-financed operations – 142 142 26 Deferred tax liabilities – 1,948 1,948 2,168 Other non-insurance liabilities note (v) – 4,659 4,659 4,775
(iii) Equity securities and portfolio holdings in unit trusts includes investments in mutual funds, the majority of which are equity-based. (iv) Included within other non-investment and non-cash assets of £6,710 million (2012: £6,792 million) were balances of £6,065 million (2012: £6,076 million) for reinsurers’ share of insurance contract liabilities. Of the £6,065 million as at 31 December 2013, £5,410 million related to the reinsurance ceded by the REALIC business acquired in 2012 (2012: £5,234 million). REALIC holds collateral for certain of these reinsurance arrangements with a corresponding funds withheld liability. As of 31 December 2013, the funds withheld liability of £2,051 million (2012: £2,021 million) was recorded within other non-insurance liabilities.
Total comprehensive (loss) income for the year (614) 827 Dividends, interest payments to central companies and other movements (283) (245)
Net (decrease) increase in equity (897) 582 Shareholders’ equity at beginning of year 4,343 3,761
C2.3 UK insurance operations Of the total investments of £154 billion in UK insurance operations, £98 billion of investments are held by SAIF and the PAC WPSF. Shareholders are exposed only indirectly to value movements on these assets.
Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets – – – 90 90 90 105
Assets held for sale – – – – – – 98 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
C2: Analysis of segment position by business type continued 2013 £m 2012* £m
Borrowings attributable to with-profits funds 12 883 – – – 895 968 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) The PAC with-profits sub-fund (WPSF) mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). Included in the PAC with-profits fund is £12.2 billion (2012: £13.3 billion) of non-profits annuities liabilities. The WPSF’s profits are apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution is determined via the annual actuarial valuation. For the purposes of this table and subsequent explanation, references to the WPSF also include, for convenience, the amounts attaching to the Defined Charges Participating Sub-fund which comprises 3.6 per cent of the total assets of the WPSF and includes the with-profits annuity business transferred to Prudential from the Equitable Life Assurance Society on 1 December 2007 (with assets of approximately £1.7 billion). Profits to shareholders on this with-profits annuity business emerge on a ‘charges less expenses’ basis and policyholders are entitled to 100 per cent of the investment earnings.
(ii) The Hong Kong branch balance is reported within the unallocated surplus of the PAC with-profits sub-fund and excludes policyholder liabilities of the Hong Kong branch of PAC.
† After including derivative liabilities of £804 million (2012: £1,010 million), which are also included in the statement of financial position, the overall derivative position was a net asset of £668 million (2012: £339 million).
‡ Partnerships in investment pools and other comprise mainly investments held by the PAC with-profits fund. These investments are primarily investments in limited partnerships and, additionally, investments in property funds.
Assets Intangible assets: Deferred acquisition costs and other intangible assets 17 2 1 20 13
Other non-investment and non-cash assets 1,210 198 67 1,475 1,142 Investments in joint ventures and associates accounted for using the equity method 34 – 58 92 92 Financial investments: Equity securities and portfolio holdings in unit trusts 54 – 11 65 64
Total intra-group debt represented by operational borrowings at Group level 1,933 2,084
Intangible assets attributable to shareholders: Goodwill – – 1,461 1,461 Deferred acquisition costs and other intangible assets – – 5,295 5,295
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes – – 177 177 Deferred acquisition costs and other intangible assets – – 72 72
Investments of long-term business and other operationsnote (ii): Investment properties 11,477 – – 11,477 11,477 Investments accounted for using the equity method – – 809 809 Loansnote (iv) 2,137 – 10,429 12,566 12,995 Equity securities and portfolio holdings in unit trusts 120,222 – – 120,222 120,222 Debt securitiesnote (v) 102,700 30,205 – 132,905 132,905 Other investmentsnote (vi) 6,265 – – 6,265 6,265 Deposits – – 12,213 12,213 12,213
Core structural borrowings of shareholder-financed operations: – – 4,636 4,636 5,066 Other borrowings: Operational borrowings attributable to shareholder-financed operations – – 2,152 2,152 2,152 Borrowings attributable to with-profits operations 18 – 877 895 909
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – – 2,074 2,074 2,085 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,278 – – 5,278 5,278 Deferred tax liabilities – – 3,778 3,778 Current tax liabilities – – 395 395 Accruals and deferred income – – 824 824 Other creditors 263 – 3,044 3,307 3,307 Provisions – – 635 635 Derivative liabilities 1,689 – – 1,689 1,689 Other liabilities 2,051 – 1,685 3,736 3,736
Intangible assets attributable to shareholders: Goodwill – – 1,469 1,469 Deferred acquisition costs and other intangible assets – – 4,177 4,177
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes – – 178 178 Deferred acquisition costs and other intangible assets – – 78 78
Other non-investment and non-cash assets: Property, plant and equipment – – 754 754 Reinsurers’ share of insurance contract liabilities – – 6,854 6,854 Deferred tax assets – – 2,306 2,306 Current tax recoverable – – 248 248 Accrued investment income – – 2,771 2,771 2,771 Other debtors – – 1,325 1,325 1,325
Assets held for sale 98 – – 98 98 Cash and cash equivalents – – 6,126 6,126 6,126 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 187 Prudential plc Annual Report 2013 2012* £m
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities – – 205,484 205,484 Investment contract liabilities with discretionary participation featuresnote (iii) – – 33,812 33,812 Investment contract liabilities without discretionary participation features 16,309 – 2,069 18,378 18,419 Unallocated surplus of with-profits funds – – 10,589 10,589
Core structural borrowings of shareholder-financed operations: – – 3,554 3,554 4,133 Other borrowings: Operational borrowings attributable to shareholder-financed operations – – 2,245 2,245 2,245 Borrowings attributable to with-profits operations 40 – 928 968 977
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements – – 2,381 2,381 2,400 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,145 – – 5,145 5,145 Deferred tax liabilities – – 3,964 3,964 Current tax liabilities – – 443 443 Accruals and deferred income – – 751 751 Other creditors 259 – 2,442 2,701 2,701 Provisions – – 591 591 Derivative liabilities 2,832 – – 2,832 2,832 Other liabilities 2,021 – 1,421 3,442 3,442 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) Assets carried at cost or amortised cost are subject to impairment testing where appropriate under IFRS requirements. This category also includes assets which are valued by reference to specific IFRS standards such as reinsurers’ share of insurance contract liabilities, deferred tax assets and investments accounted for under the equity method.
(iv) Loans and receivables are reported net of allowance for loan losses of £62 million (2012: £83 million). (v) As at 31 December 2013 £495 million (2012: £525 million) of convertible bonds were included in debt securities and £1,078 million (2012: £673 million) were included in borrowings.
The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange-quoted investments, or by using quotations from independent third-parties, such as brokers and pricing services or by using appropriate valuation techniques.
The fair value of the subordinated and senior debt issued by the parent company is determined using the quoted prices from independent third parties.
alan ce sh eet n o tes 189 Prudential plc Annual Report 2013
With-profits Equity securities and portfolio holdings in unit trusts 25,087 2,709 569 28,365
Total financial investments, net of derivative liabilities 148,263 104,814 6,763 259,840 Investment contracts liabilities without discretionary participation features held at fair value – (17,736) – (17,736) Borrowings attributable to the with-profits funds held at fair value – (18) – (18) Net asset value attributable to unit holders of consolidated unit trusts and
C3: Assets and liabilities – Classification and Measurement continued 31 Dec 2012* £m
With-profits Equity securities and portfolio holdings in unit trusts 22,057 2,496 480 25,033
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 72,488 183 39 72,710
Total financial investments, net of derivative liabilities 76,174 5,601 41 81,816
Equity securities and portfolio holdings in unit trusts 827 7 49 883
Equity securities and portfolio holdings in unit trusts 95,372 2,686 568 98,626
Total financial instruments at fair value 124,873 92,635 3,034 220,542 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
alan ce sh eet n o tes 191 Prudential plc Annual Report 2013
The fair value of the assets and liabilities in the table above, with the exception of the subordinated and senior debt issued by the parent company, has been estimated from the discounted cash flows expected to be received or paid. Where appropriate, the observable market interest rate has been used and the assets and liabilities are classified within level 2. Otherwise, they are included as level 3 assets or liabilities.
C3: Assets and liabilities – Classification and Measurement continued c Valuation approach for level 2 fair valued assets and liabilities A significant proportion of the Group’s level 2 assets are corporate bonds, structured securities and other non-national government debt securities. These assets, in line with market practice, are generally valued using independent pricing services or third-party broker quotes. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances, stale price reviews and variance analysis on prices achieved on subsequent trades.
Generally, no adjustment is made to the prices obtained from independent third parties. Adjustment is made in only limited circumstances, where it is determined that the third-party valuations obtained do not reflect fair value (eg either because the value is stale and/or the values are extremely diverse in range). These are usually securities which are distressed or that could be subject to a debt restructure or where reliable market prices are no longer available due to an inactive market or market dislocation. In these instances, prices are derived using internal valuation techniques including those as described above in this note with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The techniques used require a number of assumptions relating to variables such as credit risk and interest rates. Examples of such variables include an average credit spread based on the corporate bond universe and the relevant duration of the asset being valued. Prudential determines the input assumptions based on the best available information at the measurement dates. Securities valued in such manner are classified as level 3 where these significant inputs are not based on observable market data.
Of the total level 2 debt securities of £100,687 million at 31 December 2013 (2012: £105,105 million), £8,556 million are valued internally (2012: £8,248 million). The majority of such securities are valued using matrix pricing, which is based on assessing the credit quality of the underlying borrower to derive a suitable discount rate relative to government securities of a comparable duration. Under matrix pricing, the debt securities are priced taking the credit spreads on comparable quoted public debt securities and applying these to the equivalent debt instruments factoring in a specified liquidity premium. The majority of the parameters used in this valuation technique are readily observable in the market and, therefore, are not subject to interpretation.
alan ce sh eet n o tes 193 Prudential plc Annual Report 2013
Total financial investments, net of derivative liabilities 6,279 534 (45) – 122 (434) (67) 225 (28) 228 (51) 6,763
Total financial instruments at fair value 3,034 480 (5) – 122 (432) 171 (134) (28) 228 (51) 3,385
Equity securities and portfolio holdings in unit trusts 375 49 44 – 255 (98) – – – 6 (63) 568
Total financial instruments at fair value 3,382 352 (63) (217) 844 (939) (12) (115) – 24 (222) 3,034
(b) Private equity and venture investments of £878 million (2012: £904 million) which were valued internally based on management information available for these investments. These investments were principally held by consolidated investment funds which are managed on behalf of third parties.
alan ce sh eet n o tes 195 Prudential plc Annual Report 2013
Of the internally valued net liability referred to above of £(304) million (2012: net liability of £(213) million): (e) A net liability of £(380) million (2012: net liability of £(240) million) was held by the Group’s participating funds and therefore shareholders’ profit and equity are not impacted by movements in the valuation of these financial instruments.
(f) A net asset of £nil (2012: £3 million) was held by the Group’s unit-linked funds for which the investment return is wholly attributable to policyholders.
(g) A net asset of £76 million (2012: £24 million) was held to support non-linked shareholder-backed business. If the value of all the level 3 instruments held to support non-linked shareholder-backed business valued internally was varied downwards by 10 per cent, the change in valuation would be £8 million (2012: £2 million), which would reduce shareholders’ equity by this amount before tax. Of this amount, a decrease of £6 million (2012: an increase of £1 million) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and a £2 million decrease (2012: a £3 million decrease) would be included as part of other comprehensive income, being unrealised movements on assets classified as available-for-sale.
Other assets at fair value – Investment properties The investment properties of the Group are principally held by the UK insurance operations which are externally valued by professionally qualified external valuers using the Royal Institution of Chartered Surveyors (RICS) valuation standards. An ‘income capitalisation’ technique is predominantly applied for these properties. This technique calculates the value through the yield and rental value depending on factors such as the lease length, building quality, covenant and location. The variables used are compared to recent transactions with similar features to those of the Group’s investment properties. As the comparisons are not with properties which are virtually identical to Group’s investment properties, adjustments are made by the valuers where appropriate to the variables used. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of the properties.
During 2013, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to 2 of £471 million and transfers from level 2 to level 1 of £260 million. These transfers which relate to equity securities and debt securities arose to reflect the change in the observability of the inputs used in valuing these securities.
In addition, the transfers into and out of level 3 in 2013 were £228 million and £(51) million, respectively. These transfers were between levels 3 and 2 and primarily for equity securities and debt securities.
Debt securities are carried at fair value. The amounts included in the statement of financial position are analysed as follows, with further information relating to the credit quality of the Group’s debt securities at 31 December 2013 provided in the notes below.
C3: Assets and liabilities – Classification and Measurement continued a Asia insurance operations
Total US debt securities† 30,292 32,993 * A 1990 SEC rule that facilitates the resale of privately placed securities under Rule 144A that are without SEC registration to qualified institutional investors. The rule was designed to develop a more liquid and efficient institutional resale market for unregistered securities.
Except for certain assets covering liabilities that are measured at fair value, the debt securities of the US insurance operations are classified as ‘available-for-sale’. Unless impaired, fair value movements are recognised in other comprehensive income. Realised gains and losses, including impairments, recorded in the income statement are as shown in note B1.2 of this report.
Movements in unrealised gains and losses There was a movement in the statement of financial position value for debt securities classified as available-for-sale from a net unrealised gain of £2,807 million to a net unrealised gain of £781 million as analysed in the table below. This decrease reflects the effects of rising long-term interest rates.
Fair value (as included in statement of financial position) 9,976 4,373
Assets fair valued at or above book value Book value* 18,599 25,467
Fair value (as included in statement of financial position) 20,229 28,452
Total Book value* 29,424 30,018 Net unrealised gain (loss) 781 (2,089) 63 2,807
Debt securities classified as available-for-sale in an unrealised loss position (a) Fair value of securities as a percentage of book value The following table shows the fair value of the debt securities in a gross unrealised loss position for various percentages of book value: Fair value Unrealised
More than 10 years (558) (91) Mortgage-backed and other debt securities (62) (77)
Commercial mortgage-backed securities 16 (6) 10 (23) Other asset-backed securities 9 (6) 41 (20)
Moody’s – Aaa 65 55 Moody’s – Aa1 to Aa3 13 18 Moody’s – A1 to A3 65 21 Moody’s – Baa1 to Baa3 70 56 Moody’s – Other 10 13
Total debt securities 30,292 32,993 * The Securities Valuation Office of the NAIC classifies debt securities into six quality categories ranging from Class 1 (the highest) to Class 6 (the lowest). Performing securities are designated as Classes 1 to 5 and securities in or near default are designated Class 6.
C3: Assets and liabilities – Classification and Measurement continued c UK insurance operations
Total £m 2012* Total £m * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Internal ratings or unrated: AAA to A- 3,691 3,173 BBB to B- 3,456 3,810 Below B- or unrated 1,274 1,362
With-profits operations: Asia insurance operationsnote (i) 200 241 UK insurance operations (2013: 60% AAA, 12% AA)note (iii) 5,765 5,850
Notes (i) Asia insurance operations The Asia insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations. Of the £200 million, 53 per cent
CDO funds (2013: 25% AA, 19% A), including £nil exposure to sub-prime 46 44 Other ABS (2013: 25% AAA, 20% AA), including £69 million exposure to sub-prime 547 543
C3: Assets and liabilities – Classification and Measurement continued f Group sovereign debt and bank debt exposure The Group exposures held by the shareholder-backed business and with-profits funds in sovereign debts and bank debt securities at 31 December 2013: Exposure to sovereign debts 2013 £m 2012* £m
Other Europe (principally Belgium and Isle of Man) 45 45 50 41 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new accounting standards described in A2 and their consequential impact.
alan ce sh eet n o tes 203 Prudential plc Annual Report 2013
The table above excludes assets held to cover linked liabilities and those of the consolidated unit trusts and similar funds. In addition, the table above excludes the proportionate share of sovereign debt holdings of the Group’s joint venture operations. As discussed in note A2 following the adoption of IFRS 11 these operations are accounted for using a single line equity method in the balance sheet.
C3.4 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 and loss of the UK insurance operations as this loan portfolio is managed and evaluated on a fair value basis; and
The amounts included in the statement of financial position are analysed as follows: 2013 £m 2012* £m
Insurance operations: Asset management operations * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
† The mortgage and policy loans are secured by properties and life insurance policies respectively. ‡ The majority of the other loans are commercial loans held by the Malaysia operation and which are all investment graded by two local rating agencies.
alan ce sh eet n o tes 205 Prudential plc Annual Report 2013
At 31 December 2013, Jackson had mortgage loans with a carrying value of £47 million (2012: £78 million) where the contractual terms of the agreements had been restructured.
SAIF and PAC WPSF: Mortgage loans† 1,183 1,311 Policy loans 12 16 Other loans‡ 1,629 1,712
Total UK insurance operations loans 4,173 4,303 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
d Asset management operations The M&G loans relate to loans and receivables managed by Prudential Capital. These assets are generally secured but most have no external credit ratings. Internal ratings prepared by the Group’s asset management operations, as part of the risk management process, are: Loans and receivables internal ratings: AAA 108 – AA+ to AA- 28 – BBB+ to BBB- 516 836 BB+ to BB- 174 339
C3.5 Financial instruments – additional information a Market risk i Liquidity analysis Contractual maturities of financial liabilities The following table sets out the contractual maturities for applicable classes of financial liabilities, excluding derivative liabilities and investment contracts that are separately presented. The financial liabilities are included in the column relating to the contractual maturities at the undiscounted cash flows (including contractual interest payments) due to be paid assuming conditions are consistent with those of year end.
Operational borrowings attributable to shareholder-financed operationsC6.2 2,152 1,790 375 – – – – – 2,165
Operational borrowings attributable to shareholder-financed operationsC6.2 2,245 1,708 558 – – – – – 2,266
Borrowings attributable to with-profits fundsC6.2 968 115 542 199 71 12 73 129 1,141
Obligations under funding, securities lending and sale and repurchase agreements 2,381 2,381 – – – – – – 2,381
Most investment contracts have options to surrender early, often subject to surrender or other penalties. Therefore, most contracts can be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts means these are unlikely to be exercised in practice and the more useful information is to present information on expected payment.
The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of £13 billion (2012: £12 billion) which have no stated maturity but which are repayable on demand.
For the reasons above an analysis of the Group’s assets by contractual maturity is not considered appropriate to evaluate the nature and extent of the Group’s liquidity risk.
Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £59 million (2012: £86 million).
Further details of collateral and pledges are provided in note (c) below.
Of these financial assets, 58 per cent (2012: 56 per cent) are held by the PAC with-profits fund, allowing the fund to obtain exposure to foreign equity markets.
The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note (b) below).
The total fair value balances of derivative assets and liabilities as at 31 December 2013 were as follows: 2013 £m
The above derivative assets are included in ‘other investments’ in the statement of financial position and are used for efficient portfolio management to obtain cost effective and efficient management of exposure to various markets in accordance with the Group’s investment strategies and to manage exposure to interest rate, currency, credit and other business risks. The Group also uses interest rate derivatives to reduce exposure to interest rate volatility. In particular: — UK with-profits funds use derivatives for efficient portfolio management or reduction in investment risks. For UK annuity business derivatives are used to assist with asset and liability cash flow matching; — US operations and some of the UK operations hold large amounts of interest-rate sensitive investments that contain credit risks on which a certain level of defaults is expected. These businesses have purchased some swaptions to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets; and
Fair value hedges The Group had previously designated as a fair value hedge certain fixed to floating rate swaps which hedge the fair value exposure to interest rate movements of certain of the Group’s operational borrowings. All of these hedges were terminated by January 2013. The fair value of the derivatives designated as fair value hedges above at 31 December 2012 was an asset of less than £1 million.
Net investment hedges The Group has designated perpetual subordinated capital securities totalling US$3.55 billion (2012: US$2.85 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £2,133 million as at 31 December 2013 (2012: £1,746 million). The foreign exchange gain of £46 million (2012: loss of £81 million) on translation of the borrowings to pounds sterling at the statement of financial position date is recognised in the translation reserve in shareholders’ equity. This net investment hedge was 100 per cent effective.
c Derecognition, collateral and offsetting Securities lending and reverse repurchase agreements The Group has entered into securities lending (including repurchase agreements) whereby blocks of securities are loaned to third parties, primarily major brokerage firms. The amounts above the fair value of the loaned securities required to be received as collateral by the agreements depend on the quality of the collateral, calculated on a daily basis. The loaned securities are not removed from the Group’s consolidated statement of financial position, rather they are retained within the appropriate investment classification. Collateral typically consists of cash, debt securities, equity securities and letters of credit.
Collateral and pledges under derivative transactions At 31 December 2013, the Group had pledged £780 million (2012: £754 million) for liabilities and held collateral of £1,432 million (2012: £1,964 million) in respect of over-the-counter derivative transactions.
Financial liabilities: Securities lending (2,017) – 2,017 – – Repurchase agreements (100) – – 100 –
alan ce sh eet n o tes 211 Prudential plc Annual Report 2013 d Impairment of financial assets In accordance with the Group’s accounting policy set out in note A3(j), impairment reviews were performed for available-for-sale securities and loans and receivables. In addition, impairment reviews were undertaken for the reinsurers’ share of insurance contract liabilities.
Available-for-sale debt securities held by Jackson (8) (37) Loans and receivables* 25 (13)
The impairment recorded on the residential mortgage-backed securities was primarily due to reduced cash flow expectations on such securities that are collateralised by diversified pools of primarily below investment grade securities. Of the impaired losses of £8 million (2012: £37 million), the top five individual corporate issuers made up 57 per cent (2012: 74 per cent), reflecting a deteriorating business outlook of the companies concerned. The impairment losses have been recorded in ‘investment return’ in the income statement.
Jackson’s portfolio of debt securities is managed proactively with credit analysts closely monitoring and reporting on the credit quality of its holdings. Jackson continues to review its investments on a case-by-case basis to determine whether any decline in fair value represents an impairment. In addition, investments in structured securities are subject to a rigorous review of their future estimated cash flows including expected and stress case scenarios to identify potential shortfalls in contractual payments (both interest and principal). Impairment charges are recorded on structured securities when the Company forecasts a contractual payment shortfall. Situations where such a shortfall would not lead to a recognition of a loss are rare. However, some structured securities do not have a single determined set of future cash flows and instead, there can be a reasonable range of estimates that could potentially emerge. With this variability, there could be instances where the projected cash flow shortfall under management’s base case set of assumptions is so minor that relatively small and justifiable changes to the base case assumptions would eliminate the need for an impairment loss to be recognised. The impairment loss reflects the difference between the fair value and book value.
The note provides information of policyholder liabilities and unallocated surplus of with-profit funds held on the Group’s statement of financial position: C4.1 Movement and duration of liabilities C4.1(a) Group overview i Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds
Comprising: Policyholder liabilities on the consolidated statement of financial position* 28,110 69,189 127,024 224,323 Unallocated surplus of with-profits funds on the consolidated statement of financial position 50 – 9,165 9,215 Group’s share of policyholder liabilities of joint ventures§ 2,752 – – 2,752
Comprising: Policyholder liabilities on the consolidated statement of financial position* 31,501 92,261 133,912 257,674 Unallocated surplus of with-profits funds on the consolidated statement of financial position 63 – 10,526 10,589 Group’s share of policyholder liabilities of joint ventures§ 3,100 – – 3,100
Reclassification of Japan life business as held for sale† (1,026) – – (1,026) Net flows: Shareholders’ transfers post tax (38) – (192) (230) Investment-related items and other movements 462 8,219 7,812 16,493 Foreign exchange translation differences (2,231) (2,704) (117) (5,052) Acquisition of Thanachart Lifenote D1 487 – – 487
Comprising: Policyholder liabilities on the consolidated statement of financial position* 31,910 107,411 134,632 273,953 Unallocated surplus of with-profits funds on the consolidated statement of financial position 77 – 11,984 12,061 Group’s share of policyholder liabilities of joint ventures§ 3,159 – – 3,159
† The reclassification of Japan life business as held for sale reflects the value of policyholder liabilities held at 1 January 2013 following its reclassification during 2013 as held for sale. No other amounts are shown within the 2013 analysis above in respect of Japan. The comparatives include the Japan life business. If Japan life business had been excluded from the 2012 amount, the average policyholder liability balance for 2012 would have been £31,616 million for Asia.
‡ Averages have been based on opening and closing balances and adjusted for acquisitions and disposals in the year and exclude unallocated surplus of with-profits funds and adjusted for corporate transactions in the year.
§ The Group’s investment in joint ventures are accounted for on the equity method in the Group’s balance sheet. The Group’s share of the policyholder liabilities as shown above relate to the joint venture life business in China, India and of the Takaful business in Malaysia.
C4: Policyholder liabilities and unallocated surplus of with-profits funds continued iii Movement in insurance contract liabilities and unallocated surplus of with-profits funds Further analysis of the movement in the year of the Group’s insurance contract liabilities, gross and reinsurance share, and unallocated surplus of with-profits funds is provided below: Insurance contract liabilities*
iv Reinsurers’ share of insurance contract liabilities 2013 £m 2012* £m
The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group from its liability to its policyholders, the Group participates in such agreements for the purpose of managing its loss exposure. The Group evaluates the financial condition of its reinsurers and monitors concentration of credit risk from similar geographic regions, activities or economic characteristics of the reinsurers to minimise its exposure from reinsurer insolvencies. Of the reinsurers’ share of insurance contract liabilities balance of £6,838 million at 31 December 2013 (2012: £6,854 million), 96 per cent (2012: 97 per cent) were ceded by the Group’s UK and US operations, of which 93 per cent (2012: 92 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above.
alan ce sh eet n o tes 215 Prudential plc Annual Report 2013
† Averages have been based on opening and closing balances and adjusted for acquisitions and disposals in the year and exclude unallocated surplus of with-profits funds. ‡ The Group’s investment in joint ventures are accounted for on an equity method and the Group’s share of the policyholder liabilities as shown above relate to the joint venture life business in China, India and of the Takaful business in Malaysia.
§ The reclassification of Japan life business as held for sale reflects the value of policyholder liabilities held at 1 January 2013 following its reclassification during 2013 as held for sale. No other amounts are shown within the 2013 analysis above in respect of Japan. The 2012 comparatives include the Japan life business. If Japan life business had been excluded from the 2012 amount, the average policyholder liability balance for 2012 would have been £31,616 million in total allocated £12,990 million, £12,648 million and £5,978 million for its with-profits business, unit-linked business and other business respectively.
Notes (a) Movements in the year have been translated at the average exchange rates for the year ended 31 December 2013. The closing balance has been translated at the closing spot rates as at 31 December 2013. Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows have increased by £407 million to £2,828 million in 2013 compared with £2,421 million in 2012 reflecting increased flows from new business and growth in the in-force books.
(c) The rate of surrenders for shareholder-backed business (expressed as a percentage of opening liabilities after the removal of Japan) was 10.0 per cent in 2013, lower than the 10.6 per cent recorded in 2012. Maturities/deaths have increased from £658 million in 2012 to £997 million in 2013, primarily as a result of an increased number of endowment products within Hong Kong, Singapore and Thailand reaching their maturity point.
(d) Investment-related items and other movements for 2013 principally represents unrealised losses on bonds, following the rise in bond yields within the with-profits funds and positive investment gains from the Asia equity market in the unit-linked and other business.
ii Duration of liabilities The table below shows the carrying value of policyholder liabilities. The table below also shows the maturity profile of the cash flows on a discounted basis for 2013 and 2012, taking account of expected future premiums and investment returns: 2013 £m 2012* £m
iii Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2013, the summary policyholder liabilities and unallocated surplus for Asia operations of £32.0 billion (2012: £31.6 billion), net of reinsurance of £251 million (2012: £170 million), excluding joint ventures, comprised the following: 2013 £m 2012* £m
C4.1(c) US insurance operations i Analysis of movements in policyholder liabilities A reconciliation of the total policyholder liabilities of US insurance operations from the beginning of the year to the end of the year is as follows: US insurance operations
Transfers from general to separate account 1,577 (1,577) – Investment-related items and other movements 4,014 227 4,241 Foreign exchange translation differencesnote (a) (1,998) (1,680) (3,678) Acquisition of REALICnote (d) 64 12,848 12,912
* Averages have been based on opening and closing balances, and adjusted for acquisitions and disposals in the year.
(b) Net flows for the year were £9,635 million compared with £9,597 million in 2012. Gross inflows increased by 7 per cent primarily reflecting increased variable annuity new business volume. (c) Positive investment-related items and other movements in variable annuity separate account liabilities of £8,725 million for 2013 primarily reflects the increase in the US equity market during the year. Fixed annuity, GIC and other business investment and other movements primarily reflects the reduction in guarantee reserves (reflecting the impact of higher equity values and higher interest rates on these reserves), which has more than offset the increase in general account reserves which arise from interest credited to policyholder accounts in the year.
Shareholders’ transfers post tax (205) – – (205) Switches (236) 236 – – Investment-related items and other movements note (b) 8,656 1,941 2,409 13,006 Foreign exchange translation differences (98) – – (98)
Shareholders’ transfers post tax (192) – – (192) Switches (195) 195 – – Investment-related items and other movements note (b) 5,695 2,017 100 7,812 Foreign exchange translation differences (117) – – (117)
Notes (a) Net outflows increased from £4,454 million in 2012 to £5,325 million in 2013, driven primarily by lower sales of with-profits bonds in the year as a result from the implementation of the recommendations of the Retail Distribution Review and lower bulk annuity sales in 2013 compared to 2012. This increase is partly offset by a decrease in the outflow of the unit-linked business. The levels of inflows/outflows for unit-linked business is driven by corporate pension schemes with transfers in or out from only one or two schemes influencing the level of flows in the year. Excluding these transactions, the net flow in the unit-linked business for 2013 is broadly consistent to 2012.
(b) Investment-related items and other movements of £7,812 million reflects the strong growth in the UK equity markets in 2013, partly offset by the impact on liabilities of rising long-term bond yields.
alan ce sh eet n o tes 219 Prudential plc Annual Report 2013 ii Duration of liabilities With the exception of most unitised with-profits bonds and other whole of life contracts the majority of the contracts of the UK insurance operations have a contract term. In effect, the maturity term of the other contracts reflects the earlier of death, maturity, or lapsation. In addition, as described in note A3.1, with-profits contract liabilities include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
Expected maturity: Notes (i) The cash flow projections of expected benefit payments used in the maturity profile table above are from value of in-force business and exclude the value of future new business, including future vesting of internal pension contracts.
(ii) Benefit payments do not reflect the pattern of bonuses and shareholder transfers in respect of the with-profits business. (iii) Investment contracts under ‘Other’ comprise certain unit-linked and similar contracts accounted for under IAS 39 and IAS 18. (iv) For business with no maturity term included within the contracts, for example with-profits investment bonds such as Prudence Bonds, an assumption is made as to likely duration based on prior experience.
(v) The maturity tables shown above have been prepared on a discounted basis.
The terms and conditions of the contracts written by the Asia operations and in particular the products’ options and guarantees, vary from territory to territory depending upon local market circumstances.
In general terms, the Asia participating products provide savings and protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund as determined at the discretion of the insurers. The Asia operations’ non-participating term, whole life and endowment products offer savings and/or protection where the benefits are guaranteed, or determined by a set of defined market-related parameters. Unit-linked products combine savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. Health and Protection (H&P) policies provide mortality or morbidity benefits and include health, disability, critical illness and accident coverage. H&P products are commonly offered as supplements to main life policies but can be sold separately.
— Surrender values Surrender values are guaranteed for non-participating products and on the guaranteed portion of participating products. The surrender value of declared reversionary bonuses are also guaranteed once vested. Market value adjustments and surrender penalties are used for certain products and where the law permits such adjustments in cash values.
— Interest rate guarantees It is common in Asia for regulations or market-driven demand and competition to provide some form of capital value protection and minimum crediting interest rate guarantees. This would be reflected within the guaranteed maturity and surrender values.
Whole of life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions are written in the Korean life operations though this is not to a significant extent as Korea has a much higher proportion of linked and health business. The Korean business has non-linked liabilities and linked liabilities at 31 December 2013 of £547 million and £1,905 million respectively (2012: £505 million and £1,628 million respectively).
In Vietnam, the Company improved its estimation basis for liabilities in 2012 from one determined substantially by reference to US GAAP requirements. After making this change, the estimation basis for Vietnam was aligned substantially to that used by the countries applying the gross premium valuation method.
b US Features of products and guarantees Jackson provides long-term savings and retirement products to retail and institutional customers throughout the US. Jackson offers fixed annuities (fixed interest rate annuities, fixed index annuities and immediate annuities), variable annuities, life insurance and institutional products. Jackson discontinued offering life insurance products in August 2012.
The policyholder of 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.
Fixed index annuities Fixed index annuities accounted for 7 per cent (2012: 8 per cent) of Jackson’s policy and contract liabilities at 31 December 2013. Fixed index annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of an equity-linked return (based on participation rates and caps) but provide a guaranteed minimum return. These guaranteed minimum rates are generally set at 1.0 per cent to 3.0 per cent. Jackson had fixed index annuities allocated to indexed funds totalling £6.1 billion (US$10.2 billion) (2012: £5.6 billion (US$9.2 billion)) in account value with minimum guaranteed rates on index accounts ranging from 1.0 per cent to 3.0 per cent and a 1.85 per cent average guaranteed rate (2012: 1.0 per cent to 3.0 per cent and a 1.82 per cent average guarantee rate). Jackson also offers fixed interest accounts on some fixed index annuity products. Fixed interest accounts of fixed index annuities totalled £1.5 billion (US$2.5 billion) (2012: £1.5 billion (US$2.3 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 2.56 per cent average guaranteed rate (2012: 1.0 per cent to 3.0 per cent and a 2.53 per cent average guaranteed rate).
Jackson hedges the equity return risk on fixed index products using futures and options linked to the relevant index as well as through offsetting equity exposure in the variable annuities product. The cost of these hedges is taken into account in setting the index participation rates or caps. Jackson bears the investment risk and a portion of surrender risk on these products.
Immediate annuities At 31 December 2013, immediate annuities accounted for 1 per cent (2012: 1 per cent) of Jackson’s policy and contract liabilities. Immediate annuities guarantee a series of payments beginning within a year of purchase and continuing over either a fixed period of years and/or the life of the policyholder. If the term is for the life of the policyholder, then Jackson’s primary risk are mortality and reinvestment risks. The implicit interest rate on these products is based on the market conditions that exist at the time the policy is issued and is guaranteed for the term of the annuity.
ii Variable annuities At 31 December 2013, variable annuities accounted for 65 per cent (2012: 60 per cent) of Jackson’s policy and contract liabilities. Variable annuities are deferred annuities that have the same tax advantages and payout options as interest-sensitive and fixed index annuities. They are also used for asset accumulation in retirement planning and to provide income in retirement.
The primary differences between variable annuities and interest-sensitive or fixed index annuities are investment risk and return. If a policyholder chooses a variable annuity, the rate of return depends upon the performance of the selected fund portfolio. Policyholders may allocate their investment to either the fixed account or a selection of variable accounts. Investment risk on the variable account is borne by the policyholder, while investment risk on the fixed is borne by Jackson through guaranteed minimum fixed rates of return. At 31 December 2013, 6 per cent (2012: 8 per cent) of variable annuity funds were in fixed accounts. Jackson had accounts in variable annuities totalling £4.2 billion (US$7.0 billion) (2012: £4.3 billion (US$7.0 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 1.85 per cent average guaranteed rate (2012: 1.0 per cent to 3.0 per cent and a 1.89 per cent average guaranteed rate).
Jackson issues variable annuity contracts where it contractually guarantees to the contractholder either a) return of no less than total deposits made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial withdrawals plus a minimum return, or c) the highest contract value on a specified anniversary date adjusted for any withdrawals following the contract anniversary. These guarantees include benefits that are payable in the event of death (guaranteed minimum death benefit (GMDB)), annuitisation (guaranteed minimum income benefit (GMIB)), or at specified dates during the accumulation period (guaranteed minimum withdrawal benefit (GMWB) and guaranteed minimum accumulation benefit (GMAB)). Jackson hedges these risks using equity options and futures contracts as described in note C7.3. The GMAB and GMIB are no longer offered, with the existing GMIB coverage being substantially reinsured.
Jackson launched Elite Access in March 2012. Elite Access is a variable annuity which has no guaranteed benefits and provides tax efficient access to alternative investments. Single premium sales in 2013 were £2,585 million (2012: £849 million).
iii Aggregate distribution of account values The table below shows the distribution of account values for fixed annuities (fixed interest rate and fixed index) and the fixed account portion of variable annuities within the range of minimum guaranteed interest rates as described in notes i to ii above as at 31 December 2013 and 2012: Account value
Under a funding agreement, the policyholder either makes a lump sum deposit or makes specified periodic deposits. Jackson agrees to pay a rate of interest, which may be fixed but is usually a floating short-term interest rate linked to an external index. The average term of the funding agreements is one to two years. In 2013 and 2012, there were no funding agreements terminable by the policyholder with less than 90 days’ notice.
Determining contract liabilities Under the modified statutory basis of reporting applied under IFRS 4 for insurance contracts, providing the requirements of the Companies Act, UK GAAP standards and the ABI SORP are met, it is permissible to reflect the previously applied UK GAAP basis. Accordingly, and consistent with the basis explained in note A3.1, in the case of Jackson the carrying values of insurance assets and liabilities are consolidated into the Group accounts based on US GAAP. An overview of the deferral and amortisation of acquisition costs for Jackson is provided in note C5.1(b).
Capitalised acquisition costs and deferred income for these contracts are amortised over the life of the book of contracts. The present value of the estimated gross profits is generally computed using the rate of interest that accrues to policyholder balances (sometimes referred to as the contract rate). Estimated gross profits include estimates of the following elements, each of which will be determined based on the best estimate of amounts of the following individual elements over the life of the book of contracts without provision for adverse deviation for: — Amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances; — Amounts expected to be assessed for contract administration less costs incurred for contract administration; — Amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances; — Amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender charges); and
The direct Guaranteed Minimum Income Benefit liability is determined by estimating the expected value of the annuitisation benefits in excess of the projected account balance at the date of annuitisation and recognising the excess ratably over the accumulation period based on total expected assessments.
These products are written primarily in: — One of three separate sub-funds of the PAC long-term fund, namely the with-profits sub-fund (WPSF), SAIF, and the non-profit sub-fund; — Prudential Annuities Limited (PAL), which is owned by the PAC with-profits sub-fund; — Prudential Retirement Income Limited (PRIL), a shareholder-owned subsidiary; or — Other shareholder-backed subsidiaries writing mainly non-profit unit-linked business.
Further details on the determination of the two types of the bonuses, ‘regular’ and ‘final’ are provided below:
alan ce sh eet n o tes 225 Prudential plc Annual Report 2013
Accordingly, Prudential’s PPFM contains an explanation of how it determines regular and final bonus rates within the discretionary framework that applies to all with-profits policies, subject to the general legislative requirements applicable. The purpose of Prudential’s PPFM is therefore to: — Explain the nature and extent of the discretion available; — Show how competing or conflicting interests or expectations of different groups and generations of policyholders, and policyholders and shareholders are managed so that all policyholders and shareholders are treated fairly; and
Furthermore, in accordance with industry-wide regulatory requirements, the PAC Board has appointed: — An Actuarial Function Holder who provides the PAC Board with all actuarial advice; — A With-Profits Actuary whose specific duty is to advise the PAC Board on the reasonableness and proportionality of the manner in which its discretion has been exercised in applying the PPFM and the manner in which any conflicting interests have been addressed; and
Net income of the fund: Investment return 5,757 8,390 Claims incurred (6,681) (6,857) Movement in policyholder liabilities (197) (3,989) Add back policyholder bonuses for the year (as shown below) 1,749 1,865 Claims incurred and movement in policyholder liabilities
(including charge for provision for asset shares and excluding policyholder bonuses) (5,129) (8,981) Earned premiums, net of reinsurance 3,801 4,558 Other income 52 39 Acquisition costs and other expenditure (1,025) (907) Share of profits from investment joint ventures 88 27 Tax charge (308) (286)
The process for determining policyholder bonuses of SAIF with-profits policies, which constitute the vast majority of obligations of the funds, is similar to that for the with-profits policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefits ie in excess of those based on asset share.
alan ce sh eet n o tes 227 Prudential plc Annual Report 2013
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £328 million was held in SAIF at 31 December 2013 (2012: £371 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.
Since 2009, new mortality projection models have been released annually by the Continuous Mortality Investigation (CMI). The CMI 2011 model was used to produce the 2012 results, with calibration to reflect an appropriate view of future mortality improvements. The CMI 2012 model was used to produce the 2013 results, again with calibration to reflect an appropriate view of future mortality improvements.
The tables and range of percentages used are set out in the following tables: Non-profit annuities within the WPSF (including PAL) PRIL
84% – 98% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2012 mortality model, with a long-term improvement rate of 1.50%.
84% – 97% PCFA00 with future improvements in line with Prudential’s own calibration of the CMI 2011 mortality model, with a long-term improvement rate of 1.50%.
In payment 92% – 98% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2009 mortality model, with a long term improvement rate of 2.25%.
Goodwill attributable to shareholders comprises: Other goodwill represents amounts allocated to entities in Asia and the US operations in respect of acquisitions made prior to 2012. As discussed in note D1 there was no goodwill attached to the purchase of REALIC or Thanachart Life. Other goodwill amounts by acquired operations are not individually material.
The aggregate goodwill impairment of £120 million at 31 December 2013 and 2012 relates to the goodwill held in relation to the Japan life business which was impaired in 2005. The Group signed an agreement to sell the Japan life business in July 2013. The completion of the transaction is dependent on regulatory approval.
Assessment of whether goodwill may be impaired Goodwill is tested for impairment by comparing the cash-generating units carrying amount, including any goodwill, with its recoverable amount.
With the exception of M&G, the goodwill attributable to shareholders mainly relates to acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis of acquired life business with the value of the business as determined using the EEV methodology, as described in note 15. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report.
The value in use is particularly sensitive to a number of key assumptions as follows: i The set of economic, market and business assumptions used to derive the three-year plan. The direct and secondary effects of recent developments, eg changes in global equity markets, are considered by management in arriving at the expectations for the financial projections for the plan.
b Deferred acquisition costs and other intangible assets attributable to shareholders The deferred acquisition costs and other intangible assets attributable to shareholders comprise: 2013 £m 2012* £m
Deferred acquisition costs related to insurance contracts as classified under IFRS 4 4,684 3,776 Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 96 100
Total DAC for US operations 4,121 3,199 * Consequent upon the negative unrealised valuation movement in 2013 of £2,089 million (2012: positive unrealised valuation movement of £862 million), there is a credit of £498 million (2012: a debit of £270 million) for altered ‘shadow’ DAC amortisation booked within other comprehensive income. These adjustments reflect movement from period to period, in the changes to the pattern of reported gross profits that would have happened if the assets reflected in the statement of financial position had been sold, crystallising the unrealised gains and losses, and the proceeds reinvested at the yields currently available in the market. At 31 December 2013, the cumulative shadow DAC balance as shown in the table above was negative £463 million (2012: negative £952 million).
Overview of the deferral and amortisation of acquisition costs for Jackson Under IFRS 4, the Group applies ‘grandfathered’ US GAAP for measuring the insurance assets and liabilities of Jackson. In the case of Jackson term business, acquisition costs are deferred and amortised in line with expected profits. For annuity and interest-sensitive life business, acquisition costs are deferred and amortised in line with a combination of historical and future expected gross profits on the relevant contracts. For fixed and index annuity and interest-sensitive life business, the key assumption is the long-term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual spread analysis. Expected gross profits also depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual mortality, lapse and expense experience is performed using internally developed experience studies.
As with fixed and index annuity and interest-sensitive life business, acquisition costs for Jackson’s variable annuity products are amortised in line with the emergence of profits. The measurement of the amortisation in part reflects current period fees (including those for guaranteed minimum death, income, or withdrawal benefits) earned on assets covering liabilities to policyholders, and the historical and expected level of future gross profits which depends on the assumed level of future fees, as well as components related to mortality, lapse, and expense.
Mean reversion technique For variable annuity products, under US GAAP (as ‘grandfathered’ under IFRS 4) the projected gross profits, against which acquisition costs are amortised, reflect an assumed long-term level of returns on separate account investments which, as referenced in note A2, for Jackson, is 7.4 per cent (2012: 8.4 per cent ) after deduction of net external fund management fees. This is applied to the period end level of separate account assets after application of a mean reversion technique that removes a portion of the effect of levels of short-term variability in current market returns.
However, to ensure that the methodology does not over anticipate a reversion to trend following adverse markets, the mean reversion technique has a cap and floor feature whereby the projected returns in each of the next five years can be no more than 15 per cent per annum and no less than 0 per cent per annum (both gross of asset management fees) in each year.
Sensitivity of amortisation charge The amortisation charge to the income statement is reflected in both operating profit and short-term fluctuations in investment returns. The amortisation charge to the operating profit in a reporting period comprises: i a core amount that reflects a relatively stable proportion of underlying premiums or profit; and ii an element of acceleration or deceleration arising from market movements differing from expectations.
alan ce sh eet n o tes 233 Prudential plc Annual Report 2013
Disposals (0) – (1) (1) – – – – Exchange differences and other movements (11) (39) (2) (52) – (5) (1) (6)
Comprising: * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) All of the PVIF balances relate to insurance contracts and are accounted for under UK GAAP as permitted by IFRS 4. The PVIF attaching to investment contracts have been fully amortised. Amortisation is charged to the ‘acquisition costs and other operating expenditure’ line in the income statement over the period of provision of asset management services as those profits emerge.
(ii) Other intangibles comprise distribution and software rights. Distribution rights relate to facilitation fees paid in respect of the bancassurance partnership arrangements in Asia for the bank distribution of Prudential’s insurance products for a fixed period of time. The distribution rights amounts are amortised over the term of the distribution contracts. Software is amortised over its useful economic life, which generally represents the licence period of the software acquired. Amortisation is charged to the ‘acquisition costs and other expenditure’ line in the income statement.
C5.2 Intangible assets attributable to with-profits funds a Goodwill in respect of acquired investment subsidiaries for venture fund and other investment purposes
b Deferred acquisition costs and other intangible assets Other intangible assets in the Group consolidated statement of financial position attributable to with-profits funds consist of: Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund note 6 6 Distribution rights attributable to with-profits funds of the Asia insurance operations 60 70 Computer software attributable to with-profits funds of the Asia insurance operations 6 2
Note The above costs relate to non-participating business written by the PAC with-profits sub-fund. As the with-profit contracts are accounted for under the UK regulatory ‘realistic basis’, no deferred acquisition costs are established for this type of business.
Perpetual subordinated capital securities (Innovative Tier 1) note (i), (iv) 2,133 1,746
¤20m Medium Term Subordinated Notes 2023 note (vii) 17 16 £435m 6.125% Subordinated Notes 2031 429 429 £400m 11.375% Subordinated Notes 2039 388 386 £700m 5.7% Subordinated Notes 2063 note (v) 695 –
Holding company total 4,211 3,126 Prudential Capital bank loan note (iii) 275 275 Jackson US$250m 8.15% Surplus Notes 2027 (Lower Tier 2) note (i), (viii) 150 153
Notes (i) These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the Prudential Regulation Authority handbook.
Tier 1 subordinated debt is entirely US$ denominated. The Group has designated all US$3.55 billion (2012: US$2.85 billion) of its Tier 1 subordinated debt as a net investment hedge under IAS 39 to hedge the currency risks related to the net investment in Jackson.
(v) In December 2013, the Company issued core structural borrowings of £700 million Lower Tier 2 Subordinated notes primarily to UK institutional investors.
The proceeds, net of costs, were £695 million. (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 Prudential preference shares.
(vii) The €20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These have been swapped into borrowings of £14 million with interest payable at three month £LIBOR plus 1.2 per cent.
(viii) The Jackson’s borrowings are unsecured and subordinated to all present and future indebtedness, policy claims and other creditor claims of Jackson.
(ii) In January 2013 the Company repaid on maturity, £250 million Medium Term Notes included within borrowings in respect of short-term fixed income securities in the table above.
(iii) Other borrowings mainly include amounts whose repayment to the lender is contingent upon future surplus emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
As part of the risk management framework, the Group regularly monitors concentration of risk using a variety of risk monitoring tools, including scenario testing and sensitivity analysis of the Group’s capital and profitability metrics involving IGD, Group economic capital, EEV and IFRS, to help identify concentrations of risks by risk types, products and business units, as well as the benefits of diversification of risks (as described further below). Business units are also required to disclose to the Group risk function all material risks, along with information on their severity and likelihood, and mitigating actions taken or planned. Credit risk remains one of the largest risk exposures. This reflects the relative size of exposure in Jackson and the UK shareholder annuities business. The Group manages concentration of credit risks by setting limits on the maximum exposure to each counterparty based on their credit ratings.
The most significant items for which the IFRS shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business is sensitive to these variables are shown in the following tables. The distinction between direct and indirect exposure is not intended to indicate the relative size of the sensitivity.
Credit risk Interest rate risk Profit and loss and shareholders’ equity are volatile for these risks as they affect the values of derivatives and embedded derivatives and impairment losses. In addition, shareholders’ equity is volatile for the incidence of these risks on unrealised appreciation of fixed income securities classified as available-forsale under IAS 39
alan ce sh eet n o tes 239 Prudential plc Annual Report 2013
Impact of diversification on risk exposure The Group enjoys significant diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations through a broad mix of products types. This arises because not all risk scenarios are likely to happen at the same time and across all geographic regions. Relevant correlation factors include: Correlation across geographic regions: — Financial risk factors; and — Non-financial risk factors.
The effect of Group diversification across the Group’s life businesses is to significantly reduce the aggregate standalone volatility risk to IFRS operating profit based on longer-term investment returns. The effect is almost wholly explained by the correlations across risk types, in particular longevity risk.
The estimated sensitivity to the decrease and increase in interest rates at 31 December 2013 and 2012 is as follows: 2013 £m 2012* £m
A 10 per cent increase or decrease in these rates would have reduced or increased profit before tax attributable to shareholders, profit for the year and shareholders’ equity, excluding goodwill, attributable to Asia operations respectively as follows: A 10% increase in local currency to £ exchange rates
Profit before tax attributable to shareholders note (63) (90) 77 110 Profit for the year (49) (75) 60 92 Shareholders’ equity, excluding goodwill, attributable to Asia operations (246) (243) 300 297
C7.3 US insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks At the level of operating profit based on longer-term investment returns, Jackson’s results are sensitive to market conditions to the extent of income earned on spread-based products and second order equity-based exposure in respect of variable annuity asset management fees.
Interest rate risk — Related to meeting guaranteed rates of accumulation on fixed annuity products following a sharp and sustained fall in interest rates; — Related to the guarantee features attaching to the company’s products and to policyholder withdrawals following a sharp and sustained increase in interest rates; and
Put-swaption contracts These contracts provide the purchaser with the right, but not the obligation, to require the writer to pay the present value of a long-duration interest rate swap at future exercise dates. Jackson purchases and writes put-swaptions with maturities up to 10 years. Put-swaptions hedge against significant movements in interest rates.
These derivatives (including various call, put options and put spreads) are used to hedge Jackson’s obligations associated with its issuance of fixed index immediate and deferred annuities and certain VA guarantees. Some of these annuities and guarantees contain embedded options which are fair valued for financial reporting purposes.
Total return swaps Total return swaps in which Jackson receives equity returns or returns based on reference pools of assets in exchange for short-term floating rate payments based on notional amounts, are held for both hedging and investment purposes.
alan ce sh eet n o tes 243 Prudential plc Annual Report 2013 i Sensitivity to equity risk At 31 December 2013 and 2012, Jackson had variable annuity contracts with guarantees, for which the net amount at risk (‘NAR’) is defined as the amount of guaranteed benefit in excess of current account value, as follows: Minimum return
Combination net deposits plus minimum return, highest specified anniversary account value minus withdrawals post-anniversary
At 31 December 2013, the estimated sensitivity of Jackson’s profit, and shareholders’ equity to immediate increases and decreases in equity markets is shown below. The sensitivities are shown net of related changes in DAC amortisation.
Note 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 directional movements in the sensitivities reflect the hedging programme in place at 31 December 2013. In the equity risk sensitivity analysis shown above, 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 this would be expected to occur over a period of time during which the Group would be able to put in place mitigating management actions.
Total net effect on shareholders’ equity 1,623 917 (994) (1,811) 1,530 928 (963) (1,773)
These sensitivities are shown only for interest rates in isolation and do not include other movements in credit risk that may affect credit spreads and valuations of debt securities.
Note Sensitivity on profit before tax ie aggregate of the operating profit based on longer-term investment returns and short-term fluctuations in investment returns.
C7: Risk and sensitivity analysis continued iv Other sensitivities Total profit of Jackson is very sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts.
For variable annuity business, the key assumption is the expected long-term level of separate account returns, which for 2013 was 7.4 per cent (2012: 8.4 per cent). The impact of using this return is reflected in two principal ways, namely: — Through the projected expected gross profits which are used to determine the amortisation of deferred acquisition costs. This is applied through the use of a mean reversion technique which is described in more detail in note C5.1(b) above; and
The investment assets of PAC with-profits funds are subject to market risk. Changes in their carrying value, net of related changes to asset-share liabilities of with-profit contracts, affect the level of unallocated surplus of the fund. Therefore, the level of unallocated surplus is particularly sensitive to the level of investment returns on the portion of the assets that represents surplus. However, as unallocated surplus is accounted for as a liability under IFRS, movements in its value do not affect shareholders’ profit and equity.
In summary, profits from shareholder-backed annuity business are most sensitive to: — The extent to which the duration of the assets held closely matches the expected duration of the liabilities under the contracts; — Actual versus expected default rates on assets held; — The difference between long-term rates of return on corporate bonds and risk-free rates; — The variance between actual and expected mortality experience; — The extent to which changes to the assumed rate of improvements in mortality give rise to changes in the measurement of liabilities; and — Changes in renewal expense levels.
i Sensitivity to interest rate risk and other market risk By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK insurance operations are, except annuity business, not generally exposed to interest rate risk. At 31 December 2013 annuity liabilities accounted for 98 per cent (2012: 98 per cent) of UK shareholder-backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure to the PAC WPSF (for PAL) and shareholders (for annuity liabilities of PRIL and the non-profit sub-fund) is very substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mis-matching profits or losses to arise.
The close matching by the Group of assets of appropriate duration to annuity liabilities is based on maintaining economic and regulatory capital. The measurement of liabilities under capital reporting requirements and IFRS is not the same with contingency reserves and some other margins for prudence within the assumptions required under the regulatory solvency basis not included for IFRS reporting purposes. As a result IFRS equity is higher than regulatory capital and therefore more sensitive to interest rate and credit risk.
The estimated sensitivity of the UK non-linked shareholder-backed business (principally annuities business) to a movement in interest rates is as follows.
Net sensitivity of profit after tax and shareholders’ equity 862 382 (326) (618) 869 370 (307) (576)
Net sensitivity of profit after tax and shareholders’ equity (237) (118) (243) (122)
ii Sensitivities to other financial risks for asset management operations The principal sensitivities to other financial risk of asset management operations are credit risk on the bridging loan portfolio of the Prudential Capital operation and the indirect effect of changes to market values of funds under management. Due to the nature of the asset management operations there is limited direct sensitivity to movements in interest rates. Total debt securities held at 31 December 2013 by asset management operations were £2,045 million (2012: £1,839 million), the majority of which are held by the Prudential Capital operation. Debt securities held by M&G and 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. The Group’s asset management operations do not hold significant investments in property or equities.
b Other operations The Group holds certain derivatives that are used to manage foreign currency movements and macroeconomic exposures. The fair value of these derivatives is sensitive to the combined effect of movements in exchange rates, interest rates and inflation rates. The possible permutations cover a wide range of scenarios. For indicative purposes, a reasonably possible range of fair value movements could be plus or minus £75 million.
Unrealised losses or gains on investments 315 100 (1,450) (1,812) Balances relating to investment and insurance contracts 8 1 (451) (428) Short-term timing differences 2,050 2,092 (1,861) (1,715)
The deferred tax asset at 31 December 2013 and 2012 arises in the following parts of the Group: UK insurance operations: PAC with-profits fund (including PAL) 82 113
The taxation regimes applicable across the Group often apply separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of deferred tax assets. Accordingly, for the 2013 results and financial position at 31 December 2013 the possible tax benefit of approximately £127 million (2012: £158 million), which may arise from capital losses valued at approximately £0.6 billion (2012: £0.8 billion), is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £61 million (2012: £122 million), which may arise from trading tax losses and other potential temporary differences totalling £0.4 billion (2012: £0.5 billion) is sufficiently uncertain that it has not been recognised. Of these, losses of £54 million will expire within the next seven years. Of the remaining losses £0.5 million will expire within 20 years and the rest have no expiry date.
Under IAS 12, ‘Income Taxes’, deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled, based on the tax rates (and laws) that have been enacted or are substantively enacted at the end of the reporting periods.
Consolidation adjustment against policyholder liabilities for investment in Prudential insurance policies – (114) (114) (169)
Triennial actuarial valuations Defined benefit schemes in the UK are generally required to be subject to full actuarial valuations every three years in order to assess the appropriate level of funding for schemes in relation to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds.
alan ce sh eet n o tes 251 Prudential plc Annual Report 2013
The market value of PSPS scheme assets as at the 5 April 2011 valuation was £5,255 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the 2011 valuation were as follows.
For male (female) non-pensioners 107% (92%) of the 2000 series rates (PNMA00/PNFA00).
The last completed actuarial valuation of the Scottish Amicable Staff Pension Scheme (SASPS) was as at 31 March 2011, finalised in 2012 by Jonathan Seed, Fellow of the Institute and Faculty of Actuaries, of Xafinity Consulting. This valuation demonstrated the scheme to be 85 per cent funded. Based on this valuation, it was agreed with the Trustees that the existing level of deficit funding of £13.1 million per annum continues to be paid into the scheme until 31 December 2018, to eliminate the actuarial deficit. The deficit funding will be reviewed every three years at subsequent valuations.
The last completed actuarial valuation of the M&G Group Pension Scheme (M&GGPS) was as at 31 December 2011, finalised in 2012 by Paul Belok, Fellow of the Institute and Faculty of Actuaries, of Aon Hewitt Limited. This valuation demonstrated the scheme to be 83 per cent funded. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a three year period are being made from January 2013 of £18.6 million per annum for the first two years and £9.3 million in the third year.
The underlying IAS 19 surplus for PSPS at 31 December 2013 was £726 million (31 December 2012: £1,174 million) of which reflecting the arrangements under the scheme rules, only a portion of the surplus, being £124 million (2012: £164 million) is recognised as recoverable. The £124 million (2012: £164 million) represents the present value of the economic benefit to the Company from the difference between future ongoing contributions to the scheme and estimated accrued cost of service. Of this amount, £87 million has been allocated to the PAC with-profits fund and £37 million was allocated to the shareholders’ fund (2012: £115 million and £49 million, respectively).
The IAS 19 surplus of the M&GGPS on an economic basis at 31 December 2013 was a surplus of £36 million (2012: surplus of £38 million) and is wholly attributable to shareholders. The underlying position on an economic basis reflects the assets (including investments in Prudential insurance policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. As at 31 December 2013, the M&GGPS has invested £114 million in Prudential insurance policies (2012: £169 million). After excluding these investments that are offset against liabilities to policyholders, the IAS 19 basis position of the M&GGPS is a deficit of £78 million (2012: deficit of £131 million).
The PSPS scheme has entered into a derivatives based strategy to match the duration and inflation profile of its liabilities. This involved a reallocation from other investments to other assets with an interest and inflation swap overlay. In broad terms, the scheme is committed to making a series of payments related to LIBOR on a nominal amount and in return, the scheme receives a series of fixed and inflation-linked payments which match a proportion of its liabilities. As at 31 December 2013, the nominal value of the interest and inflation-linked swaps amounted to £0.8 billion (2012: £0.9 billion) and £2.7 billion (2012: £2.0 billion) respectively.
Rate of increase of pensions in payment for inflation: PSPS: Other schemes 3.3 2.7 * The discount rate has been determined by reference to an ‘AA’ corporate bond index, adjusted where applicable, to allow for the difference in duration between the index and the pension liabilities.
The tables used for PSPS immediate annuities in payment at 31 December 2012 were: Male: 108.6 per cent PNMA00 with improvements in line with a custom calibration of the CMI’s 2009 mortality model, with a long-term mortality improvement rate of 1.75 per cent per annum; and
The assumed life expectancies on retirement at age 60, based on the mortality table used was: 2013 years 2012 years
c Estimated pension scheme surpluses and deficits This section illustrates the financial position of the Group’s defined benefit pension schemes on an economic basis and the IAS 19 basis.
Shareholders’ share: Gross of tax surplus (deficit) 351 (6) (197) 41 189
Shareholders’ share: Gross of tax surplus (deficit) 50 (13) (63) 41 15
Underlying investments and liabilities of the schemes On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the plans’ net assets at 31 December comprise the following investments and liabilities: 2013 2012†
The movements in the IAS 19 pension schemes’ surplus and deficit between scheme assets and liabilities as consolidated in the financial statements were: Attributable to policyholders and shareholders 2013 £m
Net deficit, beginning of year 7,197 (6,059) 1,138 (1,010) 128 (169) (41)
Benefit payments (254) 254 – – – Employers’ contributionsnote (iv) 56 56 56 56 Employees’ contributions 2 (2) – – – Actuarial and other gains and
Net surplus (deficit), end of year 6,944 (6,298) 646 (602) 44 (114) (70)
Net deficit, beginning of year 7,164 (5,620) 1,544 (1,607) (63) (165) (228)
Past service costnote (vi) (106) (106) (106) (106) Net interest on net defined benefit
Net surplus (deficit), end of year 7,197 (6,059) 1,138 (1,010) 128 (169) (41)
Notes (i) The IAS 19 basis pensions deficit can be summarised as follows: Quoted prices in an active
Plan assets (IAS 19 basis before effect of IFRIC 14): Equities: Fair value of plan assets, end of year* 6,360 327 6,687 6,451 454 6,905 Present value of benefit obligation (6,298) (6,059)
Effect of the application of IFRIC 14 for pension schemes: Derecognition of PSPS’ surplus (602) (1,010) Consolidation adjustment in respect of investment of
(ii) Maturity profile of the benefit obligations The weighted average duration of the benefit obligations of the schemes is 18.2 years (2012: 18.1 years) The following table provides an expected maturity analysis of the benefit obligations as at 31 December 2013: 2013 £m 1 year or less After 1 year
Effect of derecognition of PSPS surplus 447 667 Consolidation adjustment for investments in Prudential insurance policies and other adjustments 1 (20)
(vi) During the first half of 2012, an exceptional discretionary increase to pensions in payment of PSPS was awarded which resulted in a past service cost of £106 million on the underlying surplus.
alan ce sh eet n o tes 257 Prudential plc Annual Report 2013 d Sensitivity of the pension scheme liabilities to key variables The total underlying Group pension scheme liabilities of £6,298 million (2012: £6,059 million) comprise £5,316 million (2012: £5,226 million) for PSPS and £982 million (2012: £833 million) for the other schemes. The table below shows the sensitivity of the underlying PSPS and the other scheme liabilities at 31 December 2013 and 2012 to changes in discount rate, inflation rates and mortality rates. The sensitivity information below is based on the core scheme liabilities and assumptions at the balance sheet date. The sensitivity is calculated based on a change in one assumption, with all other assumptions being held constant. As such, interdependencies between the assumptions are excluded.
The sensitivity of the underlying pension scheme liabilities to changes in discount, inflation and mortality rates as shown above does not directly equate to the impact on the profit or loss attributable to shareholders or shareholders’ equity, due to the effect of the application of IFRIC 14 on PSPS and the allocation of a share of the interest in financial position of the PSPS and Scottish Amicable schemes to the PAC with-profits fund as described above.
The sensitivity to the changes in the key variables as shown in the table above has no significant impact on the pension costs included in the Group’s operating results. This is due to the pension costs charged in each of the periods presented, being derived largely from market conditions at the beginning of the period. After applying IFRIC 14 and to the extent attributable to shareholders, any residual impact from the changes to these variables is reflected as actuarial gains and losses on defined benefit pension schemes within the supplementary analysis of profits.
Discount rate 4.4% 4.4% Decrease by 0.2% Increase in scheme liabilities by: Other schemes 5.1% 4.9%
At 31 December 2013, there were options outstanding under Save As You Earn schemes to subscribe for shares as follows: Number of shares to
The Company purchased the following number of shares in respect of employee incentive plans.
Cost £m * The maximum number of shares held in 2013 was 8.0 million which was in January 2013.
The shares purchased each month are as follows: Number of shares 2013 Share Price
* The 2012 comparative has been adjusted from previously published numbers.
The Group has consolidated a number of authorised investment funds where it is deemed to control these funds under IFRS. Some of these funds hold shares in Prudential plc. The total number of shares held by these funds at 31 December 2013 was 7.1 million (2012: 4.5 million) and the cost of acquiring these shares of £60 million (2012: £27 million) is included in the cost of own shares. The market value of these shares as at 31 December 2013 was £95 million (2012: £39 million). During 2013, these funds made net additions of 2,629,816 Prudential shares (2012: net disposals of 4,143,340) for a net increase of £33.1 million to book cost (2012: net decrease of £25.1 million).
alan ce sh eet n o tes 259 Prudential plc Annual Report 2013
Other liabilities: Insurance contracts: With-profits liabilities of non-UK regulated funds – – – – – 6,744 6,744 6,597 Unit-linked, including variable annuitynote (viii) – 32 32 6,127 65,681 11,918 83,758 67,382 Other life assurance businessnote (viii) 310 12,973 13,283 27,069 39,290 6,724 86,366 88,492 Investment contracts without discretionary participation features note (vi) – 23 23 17,583 2,440 130 20,176 18,378
Notes (i) WPSF unallocated surplus includes amounts related to the Hong Kong branch. Policyholder liabilities are included in the Asia life assurance subsidiaries. (ii) Excluding PAC shareholders’ equity that is included in ‘parent company and shareholders’ equity of other subsidiaries and funds’. (iii) The term shareholders’ equity held in long-term funds refers to the excess of assets over liabilities attributable to shareholders of funds which are required by law to be maintained ring-fenced with segregated assets and liabilities.
b Reconciliation to the Group total shareholders’ equity The table below reconciles shareholders’ equity held in life assurance operations (as shown in the table in note (a)) to the Group total shareholders’ equity as at 31 December 2013: 2013 £m
Notes (i) With-profits sub-fund The increase in 2013 of £1 billion reflects primarily the positive impact of investment returns earned on the opening available capital and rising yields. (ii) Jackson The increase of £4 million in 2013 reflects an underlying increase of £57 million (applying the 2013 year end exchange rate of US$1.66:£1.00) and £53 million of exchange translation loss.
The businesses in Asia are subject to local capital requirements in the jurisdictions in which they operate. The Hong Kong business branch of PAC and its capital requirements are subsumed within those of the PAC long-term fund. The Hong Kong business branch of PAC was transferred to separate subsidiaries established in Hong Kong on 1 January 2014 (see note D2). For the other material Asian operations, the details of the basis of determining regulatory capital and regulatory capital requirements are as follows: Indonesia Solvency capital is determined using a risk-based capital approach. Insurance companies in Indonesia are expected to maintain the level of net assets above 120 per cent of solvency capital.
The risk free rate is derived from the greater of the current yield curve of Thai government bonds or a weighted-average yield curve of the prior seven quarters Thai government bonds, as prescribed by the local regulator.
ii US insurance operations The regulatory framework for Jackson is governed by the requirements of the US NAIC approved risk-based capital standards. Under these requirements life insurance companies report using a formula-based capital standard that they calculate by applying factors to various asset, premium and reserve items and separate model based calculations of risk associated primarily with variable annuity products. The risk-based capital formula takes into account the risk characteristics of a company, including asset risk, insurance risk, interest rate risk, market risk and business risk.
The available capital of Jackson shown above of £2,903 million (2012: £2,899 million) reflects US regulatory basis assets less liabilities as adjusted for asset valuation reserves. The asset valuation reserve, which is reflected as available capital, is designed to provide for future credit-related losses on debt securities and losses on equity investments. Available capital includes a reduction for the effect of the interest maintenance reserve, which is designed by state regulators to defer recognition of non-credit related realised capital gains and losses and to recognise them ratably in the future.
Jackson’s risk-based capital ratio is significantly in excess of regulatory requirements. At 31 December 2013, Jackson had a permitted practice in effect as granted by the local regulator allowing Jackson to carry certain interest rate swaps at book value, as if statutory hedge accounting were in place, instead of at fair value as would have been otherwise required. Jackson was also required to demonstrate the effectiveness of its interest rate swap programme pursuant to the Michigan Insurance Code. The total effect of this permitted practice net of tax was to increase statutory surplus by £0.8 million at 31 December 2013.
Michigan insurance law specifically allows value of business acquired as an admitted asset as long as certain criteria are met. US NAIC standards limit the admitted amount of goodwill/value of business acquired generally to 10 per cent of capital and surplus. At 31 December 2013, Jackson reported £257 million of statutory basis value of business acquired as a result of the REALIC acquisition, which is fully admissible under Michigan insurance law.
alan ce sh eet n o tes 263 Prudential plc Annual Report 2013
Available capital of the with-profits sub-fund and Scottish Amicable Insurance Fund of £8.0 billion (2012: £7.0 billion) represents the excess of assets over liabilities on the PRA realistic basis. Unlike the previously discussed FRS 27 basis, realistic liabilities on the regulatory basis include the shareholders’ share of future bonuses. These amounts are shown before deduction of the risk capital margin which is estimated to be £0.9 billion at 31 December 2013 (2012: £1.5 billion).
For other UK long-term business subsidiaries, the amounts retained within the companies are at levels which provide an appropriate level of capital strength in excess of the regulatory minimum.
Available capital of the non-insurance business units is transferable to the life assurance businesses after taking account of an appropriate level of operating capital, based on local regulatory solvency targets, over and above basis liabilities.
Distributions made to the parent company (292) (6) (67) (365) (318)
Provision in respect of defined benefit pension schemes:C9 194 205 Other provisions (see below) 441 386
Charged to income statement: * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Notes (i) Total legal provisions at 31 December 2013 of £14 million related to Jackson. Jackson has been named in civil proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers in the US, alleging misconduct in the sale of insurance products. Of the £14 million legal provision as at 31 December 2013, £11 million has been established to cover this potential litigation and is expected to be utilised over the next five years.
Capital expenditure: property, plant and equipment by segment The capital expenditure of £125 million (2012: £135 million) arose as follows: £68 million in UK, £16 million in US and £23 million in Asia in insurance operations with the remaining balance of £18 million arising from asset management operations and unallocated corporate expenditure (2012: £80 million in UK, £24 million in US, £17 million in Asia in insurance operations and £10 million in other operations).
alan ce sh eet n o tes 267 Prudential plc Annual Report 2013
Investment properties principally relate to the PAC with-profits fund and are carried at fair value. A reconciliation of the carrying amount of investment properties at the beginning and end of the year is set out below: 2013 £m 2012* £m
Net gain (loss) from fair value adjustments 441 (215) Net foreign exchange differences (15) (52) Transfers from (to) held for sale assets 18 (97)
* The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future value of a factor that changes other than with the passage of time. There was no contingent rent recognised as income or expense in 2013 and 2012.
The total minimum future rentals to be received on non-cancellable sub-leases for the Group’s investment properties held under finance leases at 31 December 2013 are £2,315 million (2012: £2,439 million).
a Acquisition of Thanachart Life Assurance Company Limited and bancassurance partnership agreement with Thanachart Bank On 3 May 2013, the agreement Prudential plc, through its subsidiary Prudential Life Assurance (Thailand) Public Company Limited (Prudential Thailand), entered into in November 2012 to establish an exclusive 15-year partnership with Thanachart Bank Public Company Limited (Thanachart Bank) to develop jointly their bancassurance business in Thailand was launched. At the same time, Prudential Thailand completed the acquisition of 100 per cent of the voting interest in Thanachart Life Assurance Company Limited (Thanachart Life), a wholly-owned life insurance subsidiary of Thanachart Bank. This transaction builds on Prudential’s strategy of focusing on the highly attractive markets of South-east Asia and is in line with the Group’s multichannel distribution strategy.
The consideration for the transaction is THB 18.981 billion (£412 million), of which THB 17.500 billion (£380 million) was settled in cash on completion in May 2013 with a further payment of THB 0.946 billion (£20 million), for adjustments to reflect the net asset value as at completion date, paid in July 2013. In addition a deferred payment of THB 0.535 billion (£12 million) is payable 12 months after completion. Included in the total consideration of THB 18.981 billion (£412 million) was the cost of the distribution rights associated with the exclusive 15-year bancassurance partnership agreement with Thanachart Bank.
The purchase consideration paid was equivalent to the fair value of the acquired assets and liabilities assumed. No goodwill has been recognised.
Assets acquired and liabilities assumed at the date of acquisition The fair value of the acquired assets and liabilities are shown in the table below: Fair value recognised at date £m
Insurance contract liabilities were valued consistent with Prudential’s existing IFRS valuation basis for the Thailand Life business, determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP. In accordance with IFRS 3 ‘Business Combinations’, an acquired value of in-force business has been recognised.
Included within the identifiable assets as shown above are loans and other debtors acquired with fair values of £6 million. These values represent the gross contractual amounts all of which are expected to be collected.
(ii) The amortisation of acquisition accounting adjustments represents the amortisation of the acquired value of in-force business.
In the course of 2013, following the conclusion of an independent arbitration process over outstanding matters, the purchase consideration for REALIC was revised to £381 million in line with the re-measured value of the individual acquired assets and liabilities. This compares to the provisional estimates of £370 million for consideration and net assets reported in the 2012 consolidated IFRS financial statements.
c Agreement to sell Japan life business On 16 July 2013, the Group reached an agreement to sell the Group’s closed book life insurance business in Japan, PCA Life Insurance Company Limited to SBI Holdings Inc. for US$85 million (£51 million at 31 December 2013 closing exchange rate). Completion of the transaction is dependent on regulatory approval.
The Japan life business has been classified as held for sale in these consolidated financial statements in accordance with IFRS 5, ‘Non-current assets held for sale and discontinued operations’. Consistent with its classification as held for sale, the IFRS carrying value of the Japan life business has been set to £48 million at 31 December 2013, representing the proceeds, net of related expenses. This has resulted in a charge as for ‘Remeasurement of Japan life business classified as held for sale’ of £(120) million in the income statement.
In order to facilitate comparisons of the Group’s retained businesses, the supplementary analysis of profit of the Group as shown in note B1.1 has been adjusted to show separately the results for the Japan life business. Accordingly, the comparative results for 2012 have been retrospectively adjusted. For 2013 the result for the year, including short-term fluctuations in investment returns, together with the adjustment to the carrying value have given rise to an aggregate loss of £(102) million (2012: £17 million profit). This comprises: Remeasurement of carrying value on classification as held for sale (120) – Amounts that would otherwise be classified within: Operating profit based on longer-term investment returns 3 (2) Short-term fluctuations in investment returns 15 19
As these transactions are within the with-profits fund, they have no impact on shareholders’ profit or equity for the year ended 31 December 2013. The impact on the Group’s consolidated revenue, including investment returns, is not material. Had the acquisitions been effected at 1 January 2013, the revenue and profit of the Group for the year ended 31 December 2013 would not have been materially different.
This estate enables PAC to support with-profits business by providing the benefits associated with smoothing and guarantees, by providing investment flexibility for the fund’s assets, by meeting the regulatory capital requirements that demonstrate solvency and by absorbing the costs of certain significant events or fundamental changes in its long-term business without affecting the bonus and investment policies. The size of the inherited estate fluctuates from year to year depending on the investment return and the extent of its utilisation.
In 1997, the business of Scottish Amicable Life Assurance Society (SALAS), a mutual society, was transferred to PAC with the creation of, a separate sub-fund, Scottish Amicable Insurance Fund (SAIF) within PAC’s long-term business fund containing all the with-profits business and all other pension business that was transferred. No new business has been or will be written in the sub-fund and it is managed to ensure that all the invested assets are distributed to SAIF policyholders over the lifetime of SAIF policies. With the exception of certain amounts in respect of the unitised with-profits life business, all future earnings arising in SAIF are retained for SAIF policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is attributable to the policyholders of the fund. Shareholders have no interest in the profits of SAIF but are entitled to the asset management fees paid on this business.
SAIF with-profits policies contain minimum levels of guaranteed benefit to policyholders. In addition, as mentioned earlier in this note, certain pensions products have guaranteed annuity rates at retirement. Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations of the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency in the first instance.
(a) The aggregate effect of the adoption of the standards on the income statement, earnings per share, statement of comprehensive income, statement of changes in equity, statement of financial position and cash flow statement is shown in the tables below: Consolidated income statement 2013 £m
Effect of IFRS changes After changes IFRS 10 IFRS 11 IAS 19R
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns) 2,022 – (12) 72 2,082
Profit before tax attributable to shareholders 1,585 – (12) 62 1,635 Total tax charge attributable to policyholders and shareholders (724) – 12 (24) (736) Adjustment to remove tax charge (credit) attributable to
th er n o tes 273 Prudential plc Annual Report 2013 2012 £m
Total revenue, net of reinsurance 55,476 52 (1,090) – 54,438 Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (45,953) – 715 94 (45,144) Acquisition costs and other expenditure (6,335) (52) 220 (145) (6,312) Share of profit from joint ventures and associates, net of related tax* – – 135 – 135
Less tax charge attributable to policyholders’ returns (378) – 2 6 (370)
Profit for the year attributable to equity holders of the Company 2,197 – – (34) 2,163
Earnings per share (in pence) Based on profit attributable to the equity holders of the Company: * The effect of change from IFRS 11 in the table above includes the reclassification of the Group’s share of profit from its investments in associates into the line for share of profit from joint ventures and associates, net of related tax. These investments were already on the equity method accounting prior to 2013 but their results were previously included within the Investment return included with total revenue.
Profit for the year 1,298 – – 48 1,346 Exchange movements on foreign operations and net investment hedges, net of related tax (255) – – – (255) Net unrealised valuation on securities of US insurance operations classified as available-for-sale net of amortisation of deferred acquisition costs and related tax (1,034) – – – (1,034)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, net of related tax – – – (48) (48)
Total comprehensive income for the year 9 – – – 9
D5: Additional information on the effect of adoption of new and amended accounting standards continued 2012 £m
Profit for the year 2,197 – – (34) 2,163 Exchange movements on foreign operations and net investment hedges, net of related tax (216) – – – (216) Net unrealised valuation on securities of US insurance operations classified as available-for-sale net of amortisation of deferred acquisition costs and related tax 387 – – – 387
Assets Intangible assets attributable to shareholders 6,837 – (81) – 6,756 Intangible assets attributable to with-profits funds 249 – – – 249 Reinsurers’ share of insurance contract liabilities 6,846 – (8) – 6,838 Other non-investment and non-cash assets 8,038 21 (128) – 7,931 Investments of long-term business and other operations: Investments accounted for using the equity method 100 – 709 – 809 Financial investments: Equity securities and portfolio holdings in unit trusts 120,974 547 (1,299) – 120,222
th er n o tes 275 Prudential plc Annual Report 2013
Assets Intangible assets attributable to shareholders 5,736 – (90) – 5,646 Intangible assets attributable to with-profits funds 256 – – – 256 Reinsurers’ share of insurance contract liabilities 6,859 – (5) – 6,854 Other non-investment and non-cash assets 7,492 25 (113) – 7,404 Investments of long-term business and other operations: Investments accounted for using the equity method 113 – 522 – 635 Financial investments: Equity securities and portfolio holdings in unit trusts 99,958 172 (1,504) – 98,626
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 4,345 800 – – 5,145
Equity Shareholders’ equity 10,359 – – – 10,359 Non-controlling interests 5 – – – 5
D5: Additional information on the effect of adoption of new and amended accounting standards continued
Net cash flows from operating activities 1,750 (124) (302) – 1,324 Cash flows from investing activities (584) – – – (584) Cash flows from financing activities 49 – – – 49
Net increase in cash and cash equivalents 1,215 (124) (302) – 789 Cash and cash equivalents at beginning of year 6,126 – – – 6,126 Effect of exchange rate changes on cash and cash equivalents (130) – – – (130)
Cash flows from operating activities Profit before tax (being tax attributable to shareholders’
Net cash flows from operating activities 446 190 69 – 705 Cash flows from investing activities (326) – – – (326) Cash flows from financing activities (892) – – – (892)
Net decrease in cash and cash equivalents (772) 190 69 – (513) Cash and cash equivalents at beginning of year 7,257 (310) (206) – 6,741 Effect of exchange rate changes on cash and cash equivalents (101) – (1) – (102)
Cash and cash equivalents at end of year 6,384 (120) (138) – 6,126
(b) The effect of the adoption of the new and amended accounting standards in 2013 on the Group’s supplementary analysis of profit is shown in the table below.
Short-term fluctuations in investment returns: Before reclassification of held for sale Japan life business (1,095) 1 (1) (1,095) Reclassification of Japan life business (15) – – (15)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (63) – 63 – Amortisation of acquisition accounting adjustments (72) – – (72) Loss attaching to held for sale Japan life business: Reclassification from operating profit based on longer-term investment returns 3 – – 3
Operating profit based on longer-term investment returns Asia operations: Asia insurance operations: Before reclassification of held for sale Japan life business 913 (9) – 904 Reclassification of Japan life business 2 – – 2
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 50 – (50) – Amortisation of acquisition accounting adjustments (19) – – (19) Gain on dilution of Group holdings 42 – – 42 Profit attaching to held for sale Japan life business: Reclassification from operating profit based on longer-term investment returns (2) – – (2)
Reclassification from short-term fluctuations in investment returns 19 – – 19
Basic EPS based on total profit after tax and non-controlling interests 86.5p – (1.4)p 85.1p
Jackson is subject to state laws that limit the dividends payable to its parent company based on statutory capital and surplus and prior year earnings. Dividends in excess of these limitations require prior regulatory approval.
The Group capital position statement for life assurance businesses is set out in note C11.1, showing the available capital reflecting the excess of regulatory basis over liabilities for each fund or group of companies determined by reference to the local regulation of the subsidiaries. In addition, disclosure is also provided in note C11.1 of the local capital requirement of each of the funds, or group of companies.
th er n o tes 279 Prudential plc Annual Report 2013
Joint ventures represent arrangements where the parties who control the arrangement 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 business in China with CITIC Group, and in India with ICICI Bank. In addition, there is an asset management joint venture in Hong Kong with BOCI and a Takaful general and life insurance joint venture in Malaysia.
The joint ventures have no significant contingent liabilities or capital commitments to which the Group is exposed nor does the Group have any significant contingent liabilities or capital commitments in relation to its interest in the joint ventures.
Further, following the adoption of IFRS 11 in 2013 as described in note A2, the Group’s investments in joint ventures are now accounted for on an equity method basis. Previously, the assets and liabilities of these joint ventures were proportionally consolidated by the Group with any of their intra-group transactions eliminated on consolidation. There are no material transactions between these joint ventures and other Group companies.
In 2013 and 2012, other transactions with directors were not deemed to be significant both by virtue of their size and in the context of the directors’ financial positions. All of these transactions are on terms broadly equivalent to those that prevail in arm’s length transactions.
Future minimum lease payments for non-cancellable operating leases fall due during the following periods: Not later than 1 year 110 68 Later than 1 year and not later than 5 years 308 196 Later than 5 years 333 116
Amounts owed to subsidiary undertakings (2,462) (1,705) Tax payable (60) (103) Sundry creditors (4) (19) Accruals and deferred income (40) (46)
The financial statements of the parent company on pages 281 to 289 were approved by the Board of directors on 11 March 2014 and signed on its behalf.
Shares in subsidiary undertakings Shares in subsidiary undertakings are shown at the lower of cost and estimated realisable value.
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 hybrid debt, over the expected life of the instrument.
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19, ’Deferred tax’. The Company has chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of the discount on liabilities at the start of the period, gains and losses on settlements and curtailments, less the expected investment return on the scheme assets at the start of the period, is recognised in the profit and loss account. To the extent that part or all of the Company’s interest in the pension surplus is not recognised as an asset, the unrecognised surplus is initially applied to extinguish any past service costs, losses on settlements or curtailments that would otherwise be included in the profit and loss account. Next, the expected investment return on the scheme’s assets is restricted so that it does not exceed the total of the current service cost, interest cost and any increase in the recoverable surplus. Any further adjustment for the unrecognised surplus is treated as an actuarial gain or loss.
The Company financial statements are prepared in accordance with UK GAAP and the consolidated financial statements are prepared in accordance with IFRS as issued by the IASB and endorsed by the EU. The tables below provide a reconciliation between UK GAAP and IFRS.
Profit after tax Profit (loss) for the financial year of the Company in accordance with UK GAAP 1,579 (216) IFRS adjustment* 16 71
Profit (loss) for the financial year of the Company (including dividends from subsidiaries) in accordance with IFRS 1,595 (145)
Profit after tax of the Group attributable to shareholders in accordance with IFRS 1,346 2,163
Net equity Shareholders’ equity of the Company in accordance with UK GAAP and IFRS 7,352 6,536 Share in the IFRS net equity of the Group† 2,298 3,823
Shareholders’ equity of the Group in accordance with IFRS 9,650 10,359 * ‘IFRS adjustment’ in the above table represents the difference in the accounting treatment for pension schemes between UK GAAP and IFRS. † The ‘shares in the IFRS result and net equity of the Group’ lines represent the Company’s equity in the earnings and net assets of its subsidiaries and associates.
In 2013, as part of a process of simplifying the Group’s corporate structure, the Company reorganised some of its interests in intermediate holding companies, resulting in a net increase of £6,281 million in the cost of shares in subsidiary undertakings.
Other movements relate to share-based payments and reflect the value of payments settled by the Company for employees of its subsidiary undertakings in the year.
The principal subsidiary undertakings of the Company at 31 December 2013 were: Main activity Country of incorporation
Short-term timing differences 2 3 Unused deferred tax losses 7 44
Other borrowings: Floating Rate Notes 2014note (iii) – – 200 200 200 200 Medium-Term Notes 2013note (ii) – – – 250 – 250 Medium-Term Notes 2015note (ii) – – 299 299 299 299
Notes (i) Further details on the core structural borrowings of the Company are provided in note C6.1 of the Group financial statements. (ii) These borrowings support a short-term fixed income securities programme. (iii) The Company issued £200 million Floating Rate Notes in 2013 which mature in April 2014. These Notes have been wholly subscribed to by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. The Notes were originally issued in October 2008 and have been reissued upon their maturity.
(iv) The interests of the holders of the subordinated liabilities are subordinate to the entitlements of other creditors of the Company.
Derivative financial instruments are held to manage certain macro-economic exposures. The change in fair value of the derivative financial instruments of the Company was a loss before tax of £9 million (2012: gain before tax of £17 million).
P aren t co m p an y 287 Prudential plc Annual Report 2013 9 Pension scheme financial position
Equities 145 2.4 123 1.9 210 3.3 548 10.3 830 16.8 Bonds 5,048 83.5 5,247 82.0 5,547 86.2 3,864 72.2 3,406 68.8 Properties 71 1.2 167 2.6 297 4.6 199 3.7 272 5.5 Other assets 778 12.9 863 13.5 378 5.9 740 13.8 441 8.9
Total value of assets 6,042 100.0 6,400 100.0 6,432 100.0 5,351 100.0 4,949 100.0 Present value of Scheme
Surplus in the Scheme recognised by the Company 37 49 52 56 52
Amounts reflected in the balance sheet of the Company, net of deferred tax 30 38 39 41 37
The surplus in the Scheme recognised in the balance sheet of the Company represents the amount which is recoverable through reduced future contributions and is net of the apportionment to the PAC with-profits fund.
Underlying Scheme liabilities and assets The change in the present value of the underlying Scheme liabilities and the change in the fair value of the underlying Scheme assets are as follows: Present value of Scheme liabilities, at 1 January 5,226 4,844 Current service cost 17 21 Past service cost* 3 106 Interest cost 225 227 Employee contributions 1 1 Actuarial losses 78 252 Benefit payments (234) (225)
Fair value of Scheme assets, at 1 January 6,400 6,432 Expected return on Scheme assets 182 201 Employee contributions 1 1 Employer contributions* 11 36 Actuarial losses (318) (45) Benefit payments (234) (225)
Pension charge and actuarial (losses) gains of the Scheme and attributable to the Company The pension charge of the Scheme and the charge recognised in the Company’s profit and loss account are as follows: Pension charge: 2013 £m 2012 £m
Finance (expense) income: Interest on Scheme liabilities (225) (227) Expected return on Scheme assets 182 201
Experience (losses) gains on Scheme liabilities (0% (2012: 0%) (2011: 6%) (2010: 0%) (2009: 1%) of liabilities) (2) (19) 295 1 59
Changes in assumptions underlying the present value of Scheme liabilities (76) (233) (426) (370) (374)
The total actual return on Scheme assets was a loss of £136 million (2012: gain of £156 million). The experience gains on Scheme liabilities in 2011 of £295 million related mainly to improvements in data consequent upon the 2011 triennial valuation of the Scheme. The actuarial gains (losses) attributable to the Company are net of the apportionment to the PAC with-profits fund and are related to the surplus recognised in the balance sheet of the Company. In 2013, the actuarial losses attributable to the Company included an amount credited of £127 million (2012: £124 million) for the adjustment to the unrecognised portion of surplus which has not been deducted from the pension charge.
The actuarial gains before tax of £8 million (2012: £35 million) attributable to the Company are recorded in the statement of total recognised gains and losses. Cumulative actuarial gains as at 31 December 2013 amount to £101 million (2012: £93 million).
The profit after tax of the Company for the year was £1,579 million (2012: loss of £216 million). After dividends of £781 million (2012: £655 million), actuarial gains net of tax in respect of the pension scheme of £6 million (2012: £27 million) and share-based payment credits of £6 million (2012: £6 million), retained profit at 31 December 2013 amounted to £5,329 million (2012: £4,519 million). Retained profit includes £2,683 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. Because the gains relate to intra-group transactions, the amount of £2,683 million is not able to be regarded as part of the distributable reserves of the parent company. Under English company law, Prudential may pay dividends only if sufficient distributable reserves of the Company are available for the purpose and if the amount of its net assets is greater than the aggregate of its called up share capital and undistributable reserves (such as for example the share premium account) and the payment of the dividend does not reduce the amount of its net assets to less than that aggregate. At 31 December 2013, the UK GAAP retained earnings of the holding company from which distributable reserves may be derived were £5,329 million.
Shareholders’ funds at end of yearnote 4 7,352 6,536 12 Other information a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note B3.3 of the Group financial statements.
Subject to shareholders’ approval, in May 2014 the Company will pay a final dividend for the year ended 31 December 2013. Further details are provided in note B7 of the Group financial statements.
— Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business.
The directors of Prudential plc, whose names and positions are set out on pages 64 to 68 confirm that to the best of their knowledge: — The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and
In d ep en d en t au d ito r’s rep o rt 291 Prudential plc Annual Report 2013
Opinions and conclusions arising from our audit 1. Our opinion on the financial statements is unmodified We have audited the financial statements of Prudential plc for the year ended 31 December 2013 set out on pages 127 to 280 of the Group financial statements and pages 281 to 289 of the parent company statements. In our opinion: — The financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2013 and of the Group’s profit for the year then ended; — The Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union; — The parent company financial statements have been properly prepared in accordance with UK Accounting Standards; and
The areas that involved significant audit effort and judgement in 2013 were the valuation of illiquid positions within the financial investment portfolio representing 6 per cent of total investments. These included unlisted equity, unlisted debt securities, derivatives and loans such as commercial mortgage loans and bridge loans. For these positions a reliable third-party price was not readily available and therefore involved the application of expert judgement in the valuations adopted.
Policyholder Liabilities (£273,953 million) Refer to page 74 (Audit Committee report), pages 138 to 140 (accounting policy) and pages 212 to 229 (financial disclosures)