(2010: £352 million) were included in borrowings. (ii) Loans and receivables are reported net of allowance for loan losses of £89 million (2010: £52 million). (iii) See note G3 for details of the derivative assets included. The balance also contains the PAC with-profits fund’s participation in various investment funds and limited liability property partnerships.
(v) For financial liabilities designated as fair value through profit and loss, the impact on profit from movements in credit risk during 2011 and 2010 was negligible.
Level 1, 2 and 3 fair value measurement hierarchy of Group financial instruments The table below includes financial instruments carried at fair value analysed by level of the IFRS 7 defined fair value hierarchy. This hierarchy is based on the inputs to the fair value measurement and reflects the lowest level input that is significant to that measurement.
The classification criteria and its application to Prudential can be summarised as follows: Level 1 – quoted prices (unadjusted) in active markets for identical assets and liabilities Level 1 includes financial instruments where there is clear evidence that the valuation is based on a quoted publicly traded price in an active market (eg exchange listed equities, mutual funds with quoted prices and exchange traded derivatives).
Level 2 – inputs other than quoted prices included within level 1 that are observable either directly (ie as prices) or indirectly (ie derived from prices) Level 2 includes investments where a direct link to an actively traded price is not readily apparent, but which are valued using inputs which are largely observable either directly (ie as prices) or indirectly (ie derived from prices). 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. Pricing services, where available, are used to obtain the third-party broker quotes. Where pricing services providers are used, a single valuation is obtained and applied. When prices are not available from pricing services, quotes are sourced directly from brokers. Prudential seeks to obtain a number of quotes from different brokers so as to obtain the most comprehensive information available on their executability. Where quotes are sourced directly from brokers, the price used in the valuation is normally selected from one of the quotes based on a number of factors, including the timeliness and regularity of the quotes and the accuracy of the quotes considering the spreads provided. The selected quote is the one which best represents an executable quote for the security at the measurement date.
Level 3 – Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs) Level 3 includes investments which are internally valued or subject to a significant number of unobservable assumptions (eg private equity funds and certain derivatives which are bespoke or long dated). At 31 December 2011, the Group held £4,565 million (2010: £4,573 million), 2 per cent of the fair valued financial investments, net of derivative liabilities (2010: 2 per cent), within level 3. Of these amounts £3,732 million (2010: £3,705 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. At 31 December 2011, the £3,732 million (2010: £3,705 million) represented 4.3 per cent (2010: 4.2 per cent) of the total level 3 fair valued financial instruments, net of derivative liabilities of the participating funds. Of the £800 million level 3 fair valued financial investments, net of derivative liabilities at 31 December 2011 (2010: £866 million), which support non-linked shareholder-backed business (representing 1.3 per cent of the total fair valued financial investments net of derivative liabilities backing this business (2010: 1.6 per cent)), £757 million of net assets are externally valued and £43 million of net liabilities are internally valued (2010: net assets of £728 million and £138 million respectively). Internal valuations, which represent 0.1 per cent of the total fair valued financial investments net of derivative liabilities supporting non-linked shareholder-backed business at 31 December 2011 (2010: 0.2 per cent), are inherently more subjective than external valuations. If the value of all internally valued level 3 investments backing non-linked shareholder-backed business was varied downwards by 10 per cent, the change in valuation would be £4 million (2010: £14 million), which would reduce shareholders’ equity by this amount before tax. Of this amount a £1 million decrease (2010: £7 million increase) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and a £3 million decrease (2010: offset by a £7 million decrease) would be included as part of other comprehensive income, being unrealised movements on assets classified as available-for-sale.
With-profits Equity securities and portfolio holdings in unit trusts 24,001 1,762 284 26,047 Debt securities 13,298 43,279 655 57,232 Other investments (including derivative assets) 252 1,378 2,793 4,423 Derivative liabilities (214) (1,127) – (1,341)
Total financial investments, net of derivative liabilities 37,337 45,292 3,732 86,361 Percentage of total 43% 53% 4% 100%
Total financial investments, net of derivative liabilities 63,838 4,984 33 68,855 Percentage of total 93% 7% 0% 100%
Total financial investments, net of derivative liabilities 114,055 97,961 4,565 216,581 Borrowings attributable to the with-profits fund held at fair value – (39) – (39) Investment contract liabilities without discretionary participation features held at fair value – (15,056) – (15,056) Net asset value attributable to unit holders of consolidated unit trusts and
Total financial instruments at fair value 111,469 81,780 4,116 197,365 Percentage of total 57% 41% 2% 100%
Analysis of financial investment, net of derivative liabilities by business type
With-profits Equity securities and portfolio holdings in unit trusts 29,675 1,281 415 31,371 Debt securities 11,114 41,375 772 53,261 Other investments (including derivative assets) 137 1,207 2,543 3,887 Derivative liabilities (56) (626) (25) (707)
Total financial investments, net of derivative liabilities 40,870 43,237 3,705 87,812 Percentage of total 47% 49% 4% 100%
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 54,272 2 – 54,274 Debt securities 3,784 5,268 2 9,054 Other investments (including derivative assets) 43 88 – 131
Total financial investments, net of derivative liabilities 58,099 5,358 2 63,459 Percentage of total 92% 8% 0% 100%
Non-linked shareholder-backed Loans – 227 – 227 Equity securities and portfolio holdings in unit trusts 808 21 161 990 Debt securities 10,389 43,305 343 54,037 Other investments (including derivative assets) 52 1,146 563 1,761 Derivative liabilities (80) (1,049) (201) (1,330)
Reconciliation of movements in level 3 financial instruments measured at fair value The following tables reconcile the value of level 3 financial instruments at 1 January 2011 to that presented at 31 December 2011 and at 1 January 2010 to that presented at 31 December 2010. Total ’investment return’ in the income statement represents interest and dividend income, realised gains and losses, unrealised gains and losses on financial instruments classified at fair value through profit and loss and foreign exchange movements on an individual entity’s overseas investments. Total gains and losses recorded in other comprehensive income includes unrealised gains and losses on debt securities held as available-for-sale within Jackson and foreign exchange movements arising from the retranslation of the Group’s overseas subsidiaries and branches. The transfers in and out of level 3 during 2011 represent sundry individual financial investments, none of which are materially significant as highlighted in the table below. The transfers out from level 3 during 2010 comprise mainly transfers within the Jackson portfolio. Certain broker-priced assets of Jackson were previously classified as level 3 holdings as a result of illiquidity in the market and the resultant lack of observability into the assumptions used to produce those fair values. During 2010, as a result of ongoing consideration regarding the use of assumptions by pricing sources and the changes in the level of observability of these inputs over recent periods, Jackson determined that these assets would be more appropriately categorised as level 2. As a result, Jackson transferred debt securities of £606 million and derivative assets of £101 million from level 3 to level 2. The remaining transfers out of level 3 of the Group are primarily debt securities reclassifications from level 3 to level 2, which reflected improving liquidity during the period.
Reconciliation of movements in level 3 financial investments, net of derivative liabilities by business type
Total financial investments, net of derivative liabilities 3,705 269 (60) 814 (874) (19) 1 (104) 3,732
Total financial investments, net of derivative liabilities 2 1 – 31 – – 1 (2) 33
Total financial investments, net of derivative liabilities 866 33 14 182 (311) (2) 49 (31) 800
Group Total Equity securities and portfolio holdings in unit trusts 576 50 (1) 62 (278) – – (34) 375 Debt securities 1,117 46 5 274 (490) (21) 51 (73) 909 Other investments (including derivative
Total financial investments, net of derivative liabilities 4,573 303 (46) 1,027 (1,185) (21) 51 (137) 4,565
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (379) (78) – (10) 18 – – – (449)
With-profits Equity securities and portfolio holdings in unit trusts 475 (6) – 48 (59) – – (43) 415 Debt securities 1,213 (113) 18 15 (158) (34) 11 (180) 772 Other investments (including derivative
Group total reconciliation of movements in level 3, including other financial liabilities held at fair value
Of the total gains and losses in the income statement of £225 million gains (2010: £243 million gains), £99 million (2010: £315 million) relates to financial instruments still held at the end of the year, which can be analysed into gains (losses) as follows: Equity securities 49 18 Debt securities 20 110 Other investments 176 243 Derivative liabilities (68) (6) Net asset value attributable to unit holders of consolidated unit trusts and similar funds (78) (50)
Transfers between level 1 and level 2 During 2011, transfers from level 1 to level 2 amounted to £335 million (2010: £354 million) primarily in respect of certain investment funds held by the Group’s participating funds due to the change in the observability of the inputs used in valuing these funds.
Financial assets Deposits 887 8,941 124 9,952 Debt securities 110,168 5,824 360 116,352 Loans 6,238 3,001 22 9,261 Other investments (including derivatives) 1,616 448 3,715 5,779
Financial liabilities Core structural borrowings of shareholder-financed operations 3,676 – – 3,676 Operational borrowings attributable to shareholder-financed operations 2,624 377 3 3,004 Borrowings attributable to with-profits funds 679 710 133 1,522 Obligations under funding, securities lending and sale and repurchase agreements 631 3,568 – 4,199 Investment contracts without discretionary participation features 988 894 15,822 17,704 Derivative liabilities 705 431 901 2,037 Other liabilities 121 129 879 1,129
Liquidity analysis i 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.
Obligations under funding, securities lending and sale and repurchase agreements 3,114 3,114 – – – – – – 3,114
Financial liabilities Core structural borrowings of shareholder-financed operationsH13 3,676 164 861 731 1,314 835 1,244 1,469 6,618 Operational borrowings attributable
Other liabilities 1,129 867 16 50 – – – 196 1,129 Net asset value attributable to unit holders of consolidated unit trusts and similar funds 3,372 3,372 – – – – – – 3,372 ii Maturity analysis of derivatives The following table provides a maturity analysis of derivative assets and liabilities: Total carrying value 1 year or less
The net derivative positions as shown in the table above comprise the following derivative assets and liabilities: Derivative assets 3,655 2,039 Derivative liabilities (3,054) (2,037)
The majority of derivative assets and liabilities have been included at fair value within the one year or less column, representing the basis on which they are managed (ie to manage principally asset or liability value exposures). Contractual maturities are not considered essential for an understanding of the timing of the cash flows for these instruments and, in particular, the Group has no cash flow hedges. The only exception is certain identified interest rate swaps which are fully expected to be held until maturity solely for the purposes of matching cash flows on separately held assets and liabilities. For these instruments the undiscounted cash flows (including contractual interest amounts) due to be paid under the swap contract assuming conditions are consistent with those at year end are included in the column relating to the contractual maturity of the derivative. The table below shows the maturity profile for investment contracts on an undiscounted basis to the nearest billion. This maturity profile has been based on the cash flow projections of expected benefit payments as part of the determination of the value of in-force business when preparing EEV basis results.
The vast majority of the Group’s financial assets are held to back the Group’s policyholder liabilities. Although asset/liability matching is an important component of managing policyholder liabilities (both those classified as insurance and those classified as investments), this profile is mainly relevant for managing market risk rather than liquidity risk. Within each business unit this asset/liability matching is performed on a portfolio by portfolio basis. In terms of liquidity risk a large proportion of the policyholder liabilities contain discretionary surrender values or surrender charges, meaning that many of the Group’s liabilities are expected to be held for the long-term. Much of the Group’s investment portfolios are in marketable securities, which can therefore be converted quickly to liquid assets. For the reasons above an analysis of the Group’s assets by contractual maturity is not considered necessary to evaluate the nature and extent of the Group’s liquidity risk.
Currency risk As at 31 December 2011, the Group held 21 per cent (2010: 18 per cent) and 9 per cent (2010: 14 per cent) of its financial assets and financial liabilities respectively, in currencies, mainly US dollar and Euro, other than the functional currency of the relevant business unit. The financial assets, of which 55 per cent (2010: 70 per cent) are held by the PAC with-profits fund, allow the PAC with-profits fund to obtain exposure to foreign equity markets. The financial liabilities, of which 28 per cent (2010: 28 per cent) are held by the PAC with-profits fund, mainly relate to foreign currency borrowings.
The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note G3 below). The amount of exchange gains recognised in the income statement in 2011, except for those arising on financial instruments measured at fair value through profit and loss, is £1 million (2010: £82 million losses). This constitutes £11 million losses (2010: £16 million losses) on medium-term notes (MTN) liabilities and £12 million of net gains (2010: £98 million net losses), mainly arising on investments of the PAC with-profits fund. The gains/losses on MTN liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit and loss.
The above derivative assets are included in ‘other investments’ in the primary statements. These derivatives are used for efficient portfolio management to obtain cost-effective and efficient 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. See also note D3 for use of derivatives by the Group’s US operations. The Group uses various interest rate derivative instruments such as interest rate swaps to reduce exposure to interest rate volatility. The UK insurance operations use various currency derivatives in order to limit volatility due to foreign currency exchange rate fluctuations arising on securities denominated in currencies other than sterling. See also note G2 above. In addition, total return swaps and interest rate swaps are held for efficient portfolio management. Some of the Group’s products, especially those sold in the US, have certain guarantee features linked to equity indexes. A mismatch between guaranteed product liabilities and the performance of the underlying assets backing them, exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to match asset performance with liabilities under equity-indexed products. The 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 entities have purchased some swaptions in order to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets.
Fair value hedges The Group used interest rate derivatives to hedge the interest rate exposures on its US$300 million, 6.5 per cent perpetual subordinated capital securities until September 2010. The hedge terminated at this point. The impact on the Group’s 2010 income statement was immaterial. The Group has chosen to designate 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. The fair value of the derivatives designated as fair value hedges above at 31 December 2011, was an asset of £3 million (2010: asset of £5 million). Movements in the fair value of the hedging instruments of a net loss of £2 million (2010: net loss of £1 million) and the hedged items of a net gain of £2 million (2010: net gain of £1 million) are recorded in the income statement in respect of the fair value hedges above.
Net investment hedges The Group has designated perpetual subordinated capital securities totalling US$2.85 billion (2010: US$2.3 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 £1,834 million as at 31 December 2011 (2010: £1,462 million). The foreign exchange loss of £18 million (2010: loss of £45 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.
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 held 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. At 31 December 2011, the Group had lent £7,843 million (2010: £8,708 million), of which £5,820 million (2010: £6,488 million) was lent by the PAC with-profits fund of securities and held collateral under such agreements of £8,160 million (2010: £9,334 million) of which £6,108 million (2010: £6,910 million) was held by the PAC with-profits fund. At 31 December 2011, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities for the purchase price of £1,607 million (2010: £1,208 million), together with accrued interest.
Impairment losses recognised on available-for-sale securities amounted to £62 million (2010: £124 million). Of this amount, 34 per cent (2010: 90 per cent) has been recorded on structured asset-backed securities, primarily due to reduced cash flow expectations on such securities that are collateralised by diversified pools of primarily below investment grade securities. Of the losses related to the impairment of fixed maturity securities, the top five individual corporate issuers made up 75 per cent (2010: 32 per cent), reflecting a deteriorating business outlook of the companies concerned. The impairment losses have been recorded in ‘investment return’ in the income statement. In 2011, the Group realised gross losses on sales of available-for-sale securities of £43 million (2010: £160 million) with 64 per cent (2010: 45 per cent) of these losses related to the disposal of fixed maturity securities of 10 (2010: 15) individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £43 million (2010: £160 million), £32 million (2010: £99 million) relates to losses on sales of impaired and deteriorating securities. The effect of those reasonably likely changes in the key assumptions underlying the estimates that underpin the assessment of whether impairment has taken place depends on the factors described in note A3. A key indicator of whether such impairment may arise in future and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available-for-sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned. For 2011, the amount of gross unrealised losses for fixed maturity securities classified as available-for-sale under IFRS in an unrealised loss position was £246 million (2010: £370 million). Notes B1 and D3 provide further details on the impairment charges and unrealised losses of Jackson’s available-for-sale securities.
Cost At 1 January 1,586 1,430 Acquisition of UOB Life Assurance Limited in Singapore – 141 Exchange differences (1) 15
Japanese life company The aggregate goodwill impairment of £120 million at 31 December 2011 and 2010 relates to the goodwill held in relation to the Japanese life operation which was impaired in 2005.
b Deferred acquisition costs and other intangible assets attributable to shareholders The deferred acquisition costs and other intangible assets in the Group consolidated statement of financial position attributable to shareholders comprise: Deferred acquisition costs related to insurance contracts as classified under IFRS 4 4,640 4,316 Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 107 110
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 (PVIF) 64 70 Other intangibles* 258 171
At 1 January Gross amount 183 162 Accumulated amortisation (73) (55)
At 1 January Cost 203 – 175 12 Accumulated amortisation (133) – (123) (11)
Other intangibles 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.
Additions (including amounts arising on acquisition of subsidiaries) 96 50 24 27 120 77
At 1 January 166 124 Additions in the yearnote I8(iii) 12 42
All the goodwill relates to the UK insurance operations segment. The venture fund investments consolidated by the Group relates to investments by PAC with-profits fund managed by M&G. The goodwill shown in the table above relates to these venture fund investments. Goodwill is tested for impairment for these investments by comparing the investment’s carrying value including goodwill with its recoverable amount. The recoverable amount of the investments is determined by calculating their fair value less costs to sell. The fair value is determined by using a discounted cash flow valuation. The valuations are based on cash flow projections to 2015 prepared by management after considering the historical experience and future growth rates of the business. The key assumption applied in the calculations is the risk discount rate ranging from 10 to 14 per cent derived by reference to risk-free rates and an equity premium risk. In 2011, no goodwill was deemed to be impaired following the impairment testing carried out.
Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund The movement in deferred acquisition costs relating to insurance contracts attributable to the PAC with-profits fund is as follows: At 1 January 13 9 Additions – 9 Amortisation charge (7) (5)
Distribution rights attributable to with-profit funds of the Asian insurance operations Distribution rights relate to facilitation fees paid in relation to 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.
Amortisation charge (5) (4) Exchange differences 1 4 Reclassification (10) –
The movement on reinsurers’ share of insurance contract liabilities is as follows: At 1 January 1,167 1,114 Movement in the year 303 31 Foreign exchange translation differences 16 22
th er in fo rm atio n o n statem en t o f fin an cial p o sitio n item s
Assets Of the £546 million (2010: £555 million) current tax recoverable, the majority is expected to be recovered in one year or less.
The deferred tax asset at 31 December 2011 and 2010 arises in the following parts of the Group: UK insurance operations SAIF 1 2 PAC with-profits fund (including PAL) 78 108 Other 153 104 US insurance operations 1,392 1,391 Asian insurance operations 114 98 Other operations 538 485
The increase in the deferred tax asset primarily relates to additional short-term timing differences on US insurance reserves partially offset by the reduction in unrealised losses together with the utilisation of unused tax losses across the group. Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying temporary differences can be deducted. The taxation regimes applicable across the Group often apply separate rules to trading and capital profits and losses. The distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of deferred tax assets. Accordingly, for the 2011 results and financial position at 31 December 2011 the possible tax benefit of approximately £158 million (31 December 2010: £143 million), which may arise from capital losses valued at approximately £0.7 billion (31 December 2010: £0.5 billion), is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £147 million (31 December 2010: £298 million), which may arise from trading tax losses and other potential temporary differences totalling £0.6 billion (31 December 2010: £1.2 billion), is sufficiently uncertain that it has not been recognised. Of these, losses of £142 million will expire within the next nine years. The remaining losses have no expiry date. In the two tables that follow the Group has provided a further breakdown of the recognised deferred tax assets for both the short-term timing differences and unused tax losses split by business unit set out in the table at (ii) above. In addition we have detailed the period of estimated recoverability for each respective business unit. For these and each category of deferred tax asset recognised, their recoverability against forecast taxable profits is not significantly impacted by any current proposed changes to future accounting standards.
Asia 65 3 to 5 years JNL 1,206 70% to 90% within 10 years* UK long-term business 141 1 to 7 years Other 101 3 to 10 years * The remainder is expected to be recovered within 20 years
At 1 January 2010 Cost 173 506 679 Accumulated depreciation (20) (340) (360)
At 31 December 2011 Cost 262 915 1,177 Accumulated depreciation (29) (400) (429)
* At 31 December 2010 as previously published, tangible assets included computer software with a net book value of £58 million, which in these financial statements have been more appropriately classified as other intangible assets. These amounts have been transferred to other intangible assets and the comparative balances have been adjusted accordingly. This is only a presentational adjustment with no impact on the Group’s results or shareholders’ equity.
Future minimum lease payments are due as follows: Less than 1 year 7 7 1 to 5 years 26 28 Over 5 years 1,038 1,072
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 2011 and 2010. The Group’s policy is to rent investment properties to tenants through operating leases. Minimum future rentals to be received on non-cancellable operating leases are receivable in the following periods: Less than 1 year 430 601 1 to 5 years 1,407 2,121 Over 5 years 3,304 5,616
The total minimum future rentals to be received on non-cancellable sub-leases for land and buildings at 31 December 2011 are £2,553 million (2010: £3,366million).
There have been no changes recognised in the other comprehensive income of associates that would also be recognised in the other comprehensive income by the Group. The Group’s share of the assets, liabilities, revenues and profit and loss of associates accounted for using the equity method at 31 December 2011 and 2010 is as follows: Financial position Total assets (excluding goodwill) 109 70 Total liabilities (39) –
Results of operations Revenue* 81 39 Loss in the year* (3) (6)
Associates carried at fair value through profit and loss In addition to the above the Group has associates that are carried at fair value through profit and loss, as allowed under IAS 28, that comprise investments in OEICs, unit trusts, funds holding collateralised debt obligations, property unit trusts, and venture capital investments of the PAC with-profits funds where the Group has significant influence. These investments are incorporated both in the UK and overseas, and some have year ends which are non-coterminous with that of the Group. In these instances, the investments are recorded at fair value at 31 December 2011 based on valuations or pricing information at that specific date. The aggregate fair value of associates carried at fair value through profit and loss where there are published price quotations is approximately £4.8 billion (2010: £5 billion) at 31 December 2011. The aggregate assets of these associates are approximately £3.4 billion (2010: £6 billion). Aggregate liabilities, excluding liabilities to unit holders and shareholders for unit trusts and OEICs, are approximately £1.1 billion (2010: £1 billion). Fund revenues, with revenue arising in unit trusts and OEICs deemed to constitute the investment return for these vehicles, were approximately £0.3 billion (2010: £0.4 billion) and net profit in the year, excluding unit trusts and OEICs where all investment returns accrue to unit holders or shareholders respectively, was approximately £0.2 billion (2010: profit of £0.1 billion).
The investments noted in the table above have the same accounting year end as the Group, except for ICICI Prudential Life Insurance Company Limited and Prudential ICICI Asset Management Company Limited. Although these investments have reporting periods ending 31 March, 12 months of financial information up to 31 December is recorded. Accordingly, the information covers the same period as that of the Group. The summarised financial data for the Group’s share of investments in joint ventures is as follows: Financial position Current assets 706 327 Non-current assets 2,757 3,386
Net profit (loss) 54 60 * The 2010 amounts include the Group’s share of PruHealth’s results for the seven months ended 31 July 2010. On 1 August 2010, the Group’s interest in PruHealth was diluted and the Group’s investment was reclassified as an associate.
Investment properties are classified as held for sale when contracts have been exchanged but the sale has not been completed at the period end. At 31 December 2011 the value of assets held for sale was £3 million (2010: £257 million). Gains on disposal of held for sale assets are recorded in ‘investment return’ within the income statement.
Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, treasury bills and other short-term highly liquid investments with less than 90 days maturity from the date of acquisition. Cash and cash equivalents included in the cash flow statement comprise the following statement of financial position amounts: Total cash and cash equivalents 7,257 6,631
Share capital and share premium Share capital 127 127 Share premium 1,873 1,856 Reserves Retained earnings 5,839 4,982 Translation reserve 354 454 Available-for-sale reserve 924 612
Issued shares of 5p each fully paid: At 1 January 2010 2,532,227,471 127 1,843 Shares issued under share option schemes 2,455,227 – 13 Shares issued in lieu of cash dividends 10,911,808 – 62 Reserve movements in respect of shares issued in lieu of cash dividends – – (62)
Amounts recorded in share capital represent the nominal value of the shares issued. The difference between the proceeds received on issue of shares, net of issue costs, and the nominal value of shares issued is credited to the share premium account. Shares issued in lieu of cash dividends in 2010 were considered to take the legal form of bonus issue shares and were accounted for as such. At 31 December 2011, there were options outstanding under SAYE schemes to subscribe for shares as follows: Share price range
Transactions by Prudential plc and its subsidiaries in Prudential plc shares The Group buys and sells Prudential plc (‘own shares’) either in relation to its employee share schemes or via transactions undertaken by authorised investment funds that the Group is deemed to control. Further information about these transactions is set out below. The cost of own shares of £109 million as at 31 December 2011 (2010: £75 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. At 31 December 2011, 8.1 million (2010: 4.5 million) Prudential plc shares with a market value of £52 million (2010: £30 million) were held in such trusts. Of this total, 8.0 million (2010: 4.4 million) shares were held in trusts under employee incentive plans. In 2011, the Company purchased the following number of shares in respect of employee incentive plans.
Of the total shares held in trust, 0.1 million (2010: 0.1 million) shares were held by a qualifying employee share ownership trust. These shares are expected to be fully distributed in the future on maturity of savings-related share option schemes. The shares purchased each month are as follows: Share price
Notes B5, D2c, D3c and D4c provide further analysis of the movement in the year of the Group’s policyholder liabilities and unallocated surplus of the with-profits funds.
Securitiesnote (iii) 193 193 192 US$750m 11.75% Perpetual Subordinated Capital Securities 477 477 472 US$550m 7.75% Perpetual Subordinated Capital
The Group has designated US$2.85 billion (2010: US$2.3 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.
(ii) 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.
In addition, other borrowings include senior debt issued through the Federal Home Loan Bank of Indianapolis and was secured on collateral posted with FHLB by Jackson.
(iii) Maturity analysis The following table sets out the contractual maturity analysis of the Group’s borrowings attributable to with-profits operations: Less than 1 year 297 96 1 to 2 years 75 635 2 to 3 years 30 99 3 to 4 years 110 74 4 to 5 years 31 1 Over 5 years 429 617
Provision in respect of defined benefit pension schemes:I3 Deficit, gross of deferred tax, based on scheme assets held, including investments in Prudential insurance policies: Attributable to PAC with-profits fund (ie absorbed by the liability for unallocated surplus) 41 106 Attributable to shareholder-financed operations (ie to shareholders’ equity) 23 114 64 220 Add back: Investments in Prudential insurance policies 165 227
Comprising: Legal provisions 14 20 Restructuring provisions 23 26 Other provisions 263 236
Legal provisions The movement in legal provisions is summarised in the table below: Jackson* £m
Total at 31 December 2010 19 1 20 Charged to income statement: Used during the year (6) – (6)
* 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. The provision has been established to cover potential litigation and is expected to be utilised over the next five years.
Total at 31 December 2010 200 28 8 236 Charge to income statement: Additional provisions 120 19 – 139 Unused amounts released (15) (6) (3) (24) Used during the year (88) – – (88)
* Benefits will generally be paid out within the next three years.
Pension mis-selling review The pensions review by the UK insurance regulator of past sales of personal pension policies required all UK life insurance companies to review their cases of potential mis-selling and record a provision for the estimated costs. The Group met the requirement of the FSA to issue offers to all cases by 30 June 2002. The table below summarises the change in the pension mis-selling provision for the years ended 31 December 2011 and 2010. The change in the provision is included in benefits and claims in the income statement and the movement in unallocated surplus of with-profits funds has been determined accordingly.
At 1 January 314 322 Changes to actuarial assumptions and method of calculation 97 37 Discount unwind 1 2 Redress to policyholders (49) (46) Payment of administrative costs (1) (1)
* The pension mis-selling provision is included within the liabilities in respect of investment contracts with discretionary participation features under IFRS 4.
This review was completed on 30 June 2002. The assurance will continue to apply to any policy in force at 31 December 2003, both for premiums paid before 1 January 2004, and for subsequent regular premiums (including future fixed, RPI or salary related increases and Department of Work and Pensions rebate business). The assurance has not applied to new business since 1 January 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The maximum amount of capital support available under the terms of the assurance will reduce over time. The bonus and investment policy for each type of with-profits policy is the same irrespective of whether or not the assurance applies and this is expected to continue for the foreseeable future. Hence removal of the assurance for new business has had no impact on policyholder returns.
Mortgage endowment products review In common with several other UK insurance companies, the Group used to sell low-cost endowment products related to repayment of residential mortgages. At sale, the initial sum assured is set at a level such that the projected benefits, including an estimate of the annual bonus receivable over the life of the policy, will equal or exceed the mortgage debt. Because of a decrease in expected future investment returns since these products were sold, the FSA is concerned that the maturity value of some of these products will be less than the mortgage debt. The FSA has worked with insurance companies to devise a programme whereby the companies write to customers indicating whether they may have a possible shortfall and outline the actions that the customers can take to prevent this possibility. The Group is exposed to mortgage endowment products in respect of policies issued by Scottish Amicable Life plc (SAL) and the Scottish Amicable Life Assurance Society (SALAS) which were transferred into SAIF. At 31 December 2011, provisions of £2 million (2010: £2 million) in respect of the SAL policies and £15 million (2010: £20 million) in SAIF were held within policyholder liabilities to cover potential compensation in respect of mortgage endowment product mis-selling claims. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, wholly attributable to the policyholders of the fund, this provision has no impact on shareholders. In addition, in the year ended 31 December 2010 Prudential Assurance’s main with-profits fund paid compensation of £1 million (2010: £2 million) in respect of mortgage endowment products mis-selling claims and at 31 December 2011 held a provision of £26 million (2010: £32 million) in respect of further compensation. The movement in this provision has no impact on the Group’s profit before tax. In May 2006, the Group introduced a deadline for both Prudential and Scottish Amicable mortgage endowment complaints. Impacted customers have three years to lodge a mis-selling complaint in line with the time limit prescribed by the FSA and the ABI.
Guaranteed annuities Prudential Assurance used to sell guaranteed annuity products in the UK and at 31 December 2011 held a provision of £90 million (2010: £24 million) within the main with-profits fund within policyholder liabilities to honour guarantees on these products. The Group’s main exposure to guaranteed annuities in the UK is through SAIF and at 31 December 2011 a provision of £370 million (2010: £336 million) was held in SAIF to honour the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, wholly attributable to the policyholders of the fund, the movement in this provision has no impact on shareholders.
Guarantees and commitments Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume and types of business. The Group estimated its reserve for future guarantee fund assessments for Jackson, included within other liabilities to be £17 million at 31 December 2011 (2010: £16 million). Similar assessments for the UK businesses were not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies. At 31 December 2011, Jackson has unfunded commitments of £341 million (2010: £363 million) related to its investments in limited partnerships and of £77 million (2010: £88 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them. Jackson owns debt instruments issued by securitisation trusts managed by PPM America. At 31 December 2011, the support provided by certain forbearance agreements Jackson entered into with the counterparty to certain of these trusts could potentially expose Jackson to maximum losses of £71 million (2010: £332 million), if circumstances allowed the forbearance period to cease. Jackson believes that, so long as the forbearance period continues, the risk of loss under the agreements is remote. The Group has provided other guarantees and commitments to third-parties entered into in the normal course of business but the Company does not consider that the amounts involved are significant.
Creditors arising from direct insurance and reinsurance operations 970 821 Interest payable 67 66 Other items 212 242
I1: Acquisition of United Overseas Bank Life Assurance Limited in 2010
On 1 February 2010, the Group acquired from United Overseas Bank (UOB) its 100 per cent interest in UOB Life Assurance Limited in Singapore for total cash consideration, after post-completion adjustments of SGD67 million (£32 million), of SGD495 million (£220 million). As part of the transaction the Group also entered into a long-term strategic partnership to develop a major regional bancassurance business with UOB.
Assets: Intangible assets attributable to shareholders: present value of acquired in-force business 12 Other non-investment and non-cash assets 16 Investments of long-term business and other operations 1,004 Cash and cash equivalents 89
Total assets include loans and receivables with a fair value of £15 million. This value represents the gross contractual amount and all amounts have been collected.
The consolidated statement of cash flows contains a £133 million net cash outflow in respect of this acquisition representing cash consideration of £220 million, acquisition related costs paid of £2 million less cash and cash equivalents acquired of £89 million.
On 1 August 2010, Discovery Holdings of South Africa, the Group’s joint venture partner in its investment in PruHealth, completed the acquisition of the entire share capital of Standard Life Healthcare, a wholly-owned subsidiary of the Standard Life Group, for £138 million. Discovery funded the purchase of the Standard Life Healthcare transaction, and contributed Standard Life Healthcare to PruHealth as a capital investment on completion. As a result of the transaction, Discovery increased their shareholding in PruHealth from the previous level of 50 per cent to 75 per cent, and Prudential’s shareholding was reduced from 50 per cent of the previous joint venture structure to 25 per cent of the new structure with the much enlarged business.
Allowance for future improvements to post retirement mortality For males (females) 100 per cent (75 per cent) of Medium Cohort subject to a minimum rate of improvement of 1.75 per cent (1 per cent) up to the age of 90, decreasing linearly to zero by age of 120. The last completed actuarial valuation of the Scottish Amicable Pension Scheme as at 31 March 2008 by Jonathan Seed, Fellow of the Faculty of Actuaries, of Xafinity Consulting, demonstrated the scheme to be 91 per cent funded. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a seven year period were made from July 2009 of £7.3 million per annum. During 2010, the Group agreed to pay additional funding of £5.8 million per annum from October 2010 until the conclusion of the next formal valuation, or until the funding level reaches 90 per cent, whichever is the earlier. The actuarial valuation as at 31 March 2011 will be finalised later in 2012. The IAS 19 deficit of the Scottish Amicable Pension Scheme at 31 December 2011 of £55 million (2010: £146 million) has been allocated approximately 50 per cent to the PAC with-profits fund and 50 per cent to the shareholders’ fund. The last completed actuarial valuation of the M&G pension scheme as at 31 December 2008 by Paul Belok, Fellow of the Institute of Actuaries, of AON Hewitt Limited (previously AON Consulting Limited), was finalised in January 2010, and demonstrated the scheme to be 76 per cent funded. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a five year period have been made from January 2010 of £14.1 million per annum for the first two years and £9.3 million per annum for the subsequent three years. During 2011, the Group agreed to pay an additional funding of £1.2 million per annum from January 2012, until the conclusion of the next formal valuation as at 31 December 2011, which is currently in progress. The IAS 19 surplus of the M&G pension scheme on an economic basis at 31 December 2011 was £10 million (2010: deficit of £27 million). As described above, as at 31 December 2011, the M&G pension scheme has invested £165 million in Prudential policies (2010: £227 million). After excluding these investments that are offset against liabilities to policyholders, the IAS 19 basis position of the scheme is a deficit of £155 million (2010: £254 million).
2 Corporate governance The rules of the Group’s largest pension arrangement, the defined benefit section of PSPS, a final salary scheme, specify that, in exercising its investment powers, the Trustee’s objective is to achieve the best overall investment return consistent with the security of the assets of the scheme. In doing this, consideration is given to the nature and duration of the scheme’s liabilities. The Trustee sets the benchmark for the asset mix, following analysis of the liabilities by the Scheme’s Actuary and, having taken advice from the Investment Managers, then selects benchmark indices for each asset type in order to measure investment performance against a benchmark return. The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the Actuarial Valuation, or earlier if the Scheme Actuary recommends. Interim reviews are conducted annually based on changing economic circumstances and financial market levels. The Trustee sets the general investment policy and specifies any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegates the responsibility for selection and realisation of specific investments to the Investment Managers. In carrying out this responsibility, the Investment Managers are required by the Pensions Act 1995 to have regard to the need for diversification and suitability of investments. Subject to a number of restrictions contained within the relevant asset management agreements, the Investment Managers are authorised to invest in any class of investment asset. However, the Investment Managers will not invest in any new class of investment asset without prior consultation with the Trustee. The Trustee consults the Principal Employer, the Prudential Assurance Company, on these investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustee. The investment policies and strategies for the other two UK defined benefit schemes, the M&G Group Pension Scheme and the Scottish Amicable Staff Pension Scheme, which are both final salary schemes, follow similar principles, but have different target allocations reflecting the particular requirements of the schemes.
‡ The rates of 2.5 per cent are those for PSPS. Assumed rates of increase of pensions in payments for inflation for all other schemes are 2.9 per cent in 2011 (2010: 3.55 per cent).
The calculations are based on current actuarially calculated mortality estimates with a specific allowance made for future improvements in mortality. The specific allowance for 2011 and 2010 is in line with a custom calibration of the 2009 mortality model from the CMI bureau of the Institute and Faculty of Actuaries.
The tables used for PSPS immediate annuities in payment at 31 December 2011 and 2010 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 Female: 103.4 per cent PNFA00 with improvements in line with a custom calibration of the CMI’s 2009 mortality model, with a long-term mortality improvement rate of 1.00 per cent per annum.
The assumed life expectancies on retirement at age 60, based on the mortality table used were: 2011 years 2010 years
Retiring today 27.8 29.0 27.7 29.0 Retiring in 20 years’ time 30.5 31.1 30.3 31.1
Deficit under IAS 19 included in Provisions in the statement of financial position – as explained in note 7 below (229) (447)
Shareholders’ share: Gross of tax (deficit) (162) (67) (254) – (483) Related tax 44 16 63 – 123
Shareholders’ share: Gross of tax (deficit) surplus (114) 18 21 52 (23) Related tax 31 (6) (5) (14) 6
All schemes Underlying position (without the effect of IFRIC 14) Surplus (deficit) 338 (7) (109) 90 312 Less: amount attributable to PAC with-profits fund (285) (11) 71 (39) (264)
Effect of IFRIC 14 Derecognition of surplus and set-up of additional funding obligation (588) (38) 94 – (532) Less: amount attributable to PAC with-profits fund 407 29 (66) – 370
Shareholders’ share: Gross of tax surplus (deficit) (181) (9) 28 – (162) Related tax 51 2 (9) – 44
With the effect of IFRIC 14 Surplus (deficit) (250) (45) (15) 90 (220) Less: amount attributable to PAC with-profits fund 122 18 5 (39) 106
Shareholders’ share: Gross of tax surplus (deficit) (128) (27) (10) 51 (114) Related tax 36 7 2 (14) 31
Notes (a) The components of the credit (charge) to operating results (comprising amounts attributable to the PAC with-profits fund and shareholder-backed operations) are as follows: Current service cost (35) (38) Negative past service cost – RPI to CPI inflation measure changenote (i) 282 – Finance (expense) income: Interest on pension scheme liabilities (299) (294) Expected return on assets 308 325
Total credit (charge) after the effect of IFRIC 14 as shown above, reflected in the Group’s operating profit based on longer-term investment returnsnote (ii) 27 (45)
Notes (i) RPI to CPI inflation measure change The £282 million credit shown above comprises £216 million for PSPS and £66 million for other schemes. As noted earlier, the PSPS
Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of PSPS, the charge to operating profit based on longer-term investment returns for PSPS reflects the cash cost of contributions for ongoing service of active members. In addition, the charge to the operating results also includes a charge for the unwind of discount on the opening provision for deficit funding for PSPS.
(b) The components of the credit (charge) for actuarial and other gains and losses (comprising amounts attributable to the PAC with-profits fund and shareholder-backed operations) are as follows: Actual less expected return on assets 982 306 Losses on changes of assumptions for plan liabilities (414) (411) Experience gains (losses) on liabilities 314 (4)
Total credit (charge) without the effect of IFRIC 14 882 (109) Effect of IFRIC 14 for pension schemes (846) 94
Actuarial and other gains and losses after the effect of IFRIC 14 36 (15)
Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of PSPS, the actuarial gains and losses do not include those of PSPS. In addition, as a result of applying IFRIC 14, the Group has recognised a provision for deficit funding in respect of PSPS. The change in 2011 in relation to this provision was £(4) million (2010: £nil), and is recognised as other gains and losses within the £36 million of actuarial and other gains and losses shown above.
(c) On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the underlying statements of financial position of the schemes at 31 December were: PSPS
Equities 210 273 483 7 548 277 825 14 Bonds 5,547 407 5,954 83 3,864 339 4,203 70 Properties 297 20 317 4 199 29 228 4 Cash-like investmentsnote (i) 378 31 409 6 740 8 748 12
Notes (i) The PSPS 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 cash-like investments 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 that match a proportion of its liabilities. As at 31 December 2011, the nominal value of the interest and inflation-linked swaps amounted to £0.9 billion (2010: £1.1 billion) and £2.0 billion (2010: £1.8 billion) respectively.
The movements in the deficit on the ‘economic basis’ between scheme assets and liabilities were: Current service cost (13) (13) Negative past service cost (RPI to CPI inflation measure change) 66 – Other finance income (4) (5) Cash costs and unwind of discount on opening provision for deficit funding for PSPS (22) (27) Contributions 93 90 Actuarial and other gains and losses 36 (15)
Net decrease in deficit 156 30 6 Movement in IAS 19 basis financial position The change in the present value of the benefit obligation and the change in fair value of the assets for the total of the PSPS, Scottish Amicable, M&G and Taiwan schemes, and the provision for deficit funding of PSPS over the period, were as follows: 2011 £m
Fair value of plan assets, beginning of year 426 227 653 653 Present value of benefit obligation, beginning of year (826) (826) Provision for deficit funding for PSPS (47) (47)
Service cost – current charge only (13) (13) Negative past service cost – RPI to CPI inflation measure change 66 66 Interest cost (45) (45) Expected return on plan assets 26 15 41 41
Service cost – current charge only (13) (13) Interest cost (43) (43) Expected return on plan assets 25 13 38 38 Employee contributions 1 1 (1) – Employer contributions 55 15 20 35 90 Actuarial gains (losses) 20 11 31 (46) (15)
Cash costs and unwind of discount on the opening provision for deficit funding for PSPS (27) (27)
7 IAS 19 basis financial position as consolidated The IAS 19 basis pensions deficit can be summarised as follows: Fair value of plan assets, end of year (excluding investments in Prudential policies) 6,886 5,659 5,224 5,057 5,150
Funded status (wholly or partly funded) 1,266 221 273 564 324 Present value of unfunded obligations on Group
Components of net periodic pension cost Current service cost (35) (38) Negative past service cost (RPI to CPI inflation measure change) 282 – Interest cost (299) (294) Expected return on assets – economic basis 308 325 Less: expected return on investments of scheme assets in Prudential insurance policies (25) (21) Expected return on assets – IAS 19 basis† 283 304
Actuarial gains and losses – IAS 19 basis* (as referred to in note I3a) 37 (26)
Net periodic pension cost (included within acquisition and other operating expenditure in the income statement) 49 (84)
Fair value of scheme assets, end of year (IAS 19 basis) 6,886 5,659 5,224 5,057 5,150 Present value of the benefit obligation, end of year (5,620) (5,692) (5,174) (4,673) (5,015)
Experience adjustments on scheme liabilities 314 (4) 76 145 (14) Percentage of scheme liabilities at 31 December (5.59%) (0.07%) 1.47% 3.10% 0.28% Experience adjustments on scheme assets (IAS 19 basis) 998 287 100 (277) (7) Percentage of scheme assets at 31 December 14.49% 5.07% 1.91% (5.48%) (0.14%)
The experience adjustments on scheme liabilities in 2011 of £314 million related mainly to the ‘true up’ reflecting improvements in data consequent upon the ongoing 2011 triennial valuations of PSPS and the Scottish Amicable pension scheme. The experience adjustments on scheme liabilities in 2008 of a gain of £145 million related mainly to the ‘true up’ reflecting improvements in data consequent upon the 2008 triennial valuation of PSPS. Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2012 amounts to £89 million (2011: £94 million). However, this is subject to a reassessment when the 2011 valuations of the schemes are completed.
8 Sensitivity of the pension scheme liabilities to key variables The total underlying Group pension scheme liabilities of £5,620 million (2010: £5,692 million) comprise £4,844 million (2010: £4,866 million) for PSPS and £776 million (2010: £826 million) for the other schemes. The table below shows the sensitivity of the underlying PSPS and the other scheme liabilities at 31 December 2011 and 2010 to changes in discount rates, inflation rates and mortality rates.
CPI: Decrease by 0.2% from 1.9% to 1.7% with consequent reduction in salary increases
Decrease in scheme liabilities by: PSPS 0.6% Other schemes 4.1% Mortality rate Increase life expectancy by 1 year Increase in scheme liabilities by: PSPS 2.7% Other schemes 2.4%
Assumption Change in assumption Impact on scheme liabilities in IAS 19 basis
with consequent reduction in salary increases Decrease in scheme liabilities by: PSPS 1.0% Other schemes 4.9% Mortality rate Increase life expectancy by 1 year Increase in scheme liabilities by: PSPS 2.1% Other schemes 2.6%
9 Transfer value of PSPS scheme At 31 December 2011, it is estimated that the assets of the scheme are broadly sufficient to cover the liabilities of PSPS on a ‘buyout’ basis, including an allowance for expenses. The ‘buyout’ basis refers to a basis that might apply in the circumstance of a transfer to another appropriate financial institution. In making this assessment, it has been assumed that a more conservative investment strategy applies together with a more prudent allowance for future mortality improvements and no allowance for discretionary pension increases.
ii Other pension plans The Group operates various defined contribution pension schemes including schemes in Jackson and Asia. The cost of the Group’s contributions for continuing operations to these schemes in 2011 was £40 million (2010: £37 million).
The Group maintains four share option schemes satisfied by the issue of new shares. UK-based executive directors and eligible employees are eligible to participate in the Prudential HM Revenue & Customs (HMRC)-approved UK Savings Related Share Option Scheme (SAYE scheme) and the Asia-based executive directors and eligible employees can participate in the equivalent International SAYE scheme. Dublin-based employees are eligible to participate in the Prudential International Assurance Sharesave Plan, and Hong Kong-based agents can participate in the Non-employee Savings Related Share Option Scheme. The schemes allow participants to save towards the exercise of options over Prudential plc shares, at an option price set at the beginning of the savings period as determined by reference to the average market price of the ordinary shares on the three business days immediately preceding the invitation, at a discount of 20 per cent. Participants may save up to £250 per month for three or five years. On maturity at the end of the set term, participants may exercise their options within six months of the end of the savings period and purchase Prudential plc shares. If an option is not exercised within six months, participants are entitled to a refund of their cash contributions plus interest if applicable under the rules. The exercise period of the options granted may be advanced to an earlier date in certain circumstances, for example on retirement, and may be extended in certain circumstances, for example on the death of the participant the personal representative may exercise the options beyond the normal exercise period. Shares are issued to satisfy options that are exercised. No options may be granted under the schemes if the grant would cause the number of shares which have been issued, or which remain issuable pursuant to options granted in the preceding 10 years under the scheme and other share option schemes operated by the Company, or which have been issued under any other share incentive scheme of the Company, to exceed 10 per cent of the Company’s ordinary share capital at the proposed date of grant. UK-based executive directors and employees are also eligible to participate in the Company’s HMRC-approved Share Incentive Plan, which allows all UK-based employees to purchase shares of Prudential plc (partnership shares) on a monthly basis out of gross salary. For every four partnership shares bought, an additional matching share is awarded, purchased on the open market. Dividend shares accumulate while the employee participates in the plan. Partnership shares may be withdrawn from the scheme at any time. If the employee withdraws from the plan within five years, the matching shares are forfeit, and if within three years, dividend shares are forfeit.
Beginning of year: 23.9 19.2 Granted 10.3 11.2 Exercised (4.2) (4.7)
Between £2 and £3 8.2 1.6 2.88 – – Between £3 and £4 – 0.8 3.73 – 3.43 Between £4 and £5 5.0 3.1 4.58 0.3 4.40 Between £5 and £6 0.1 0.9 5.58 0.1 5.53
Between £2 and £3 9.0 2.6 2.88 – – Between £3 and £4 0.1 1.3 3.59 – 3.67 Between £4 and £5 3.3 3.3 4.51 – 4.07 Between £5 and £6 0.4 1.0 5.59 0.2 5.63
Dividend yield (%) 3.33 3.33 3.43 3.43 Expected volatility (%) 28.90 62.67 42.69 64.65 Risk-free interest rate (%) 1.32 0.89 1.70 1.07 Expected option life (years) – 3.48 – 3.49 Weighted average exercise price (£) – 4.66 – 4.61 Weighted average share price (£) 7.32 6.06 5.70 6.38
Compensation costs for all share-based compensation plans are determined using either the Black-Scholes model or the Monte Carlo model. Share options and awards are valued using the share price at the date of grant. 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 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 SAYE options, the expected volatility is measured as the standard deviation of expected share price returns based on statistical analysis of daily share prices over a period up to the grant date equal to the expected life of options. In recent years, this calculation has been influenced by the extreme market volatility experienced in 2008/2009. Risk-free interest rates are UK gilt rates with projections for three- and five-year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over the year of grant. For the GPSP, volatility and correlation between Prudential and an index constructed from a simple average of the TSR growth of 10 companies is required. For grants in 2011, an average index volatility and correlation of 32 per cent and 78 per cent respectively, were used. For the GPSP, market implied volatilities are used for both Prudential and the components of the index. Changes to the subjective input assumptions could materially affect the fair value estimate. When options are granted or awards made to employees, an estimate is made of what percentage is more than likely to vest, be forfeited, lapse or cancelled based on historical information. Based on these estimates, compensation expense to be accrued at that date is calculated and amortised over the vesting period. For early exercises of options or release of awards due to redundancy, death or resignation, the compensation expense is immediately recognised, and for forfeitures due to employees leaving the Group, any previously recognised expense is reversed. However, if an employee loses their award because of the Group’s failure to meet the performance criteria, previously recognised expense is not reversed. During the year, the Group granted share options to certain non-employee independent financial advisors. Those options were measured using the Black-Scholes option pricing model with assumptions consistent with those of other share options. These transactions were measured using an option model because the Group does not receive a separate and measurable benefit from those non-employees in exchange for the options granted. As such, the fair value of the options themselves is more readily determinable than the services received in return.
Total share-based payment expense Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows: Share-based compensation expense 48 47 Amount accounted for as equity-settled 44 37 Carrying value at 31 December of liabilities arising from share-based payment transactions 15 17 Intrinsic value of above liabilities for which rights had vested at 31 December 6 6
Key management constitutes the directors of Prudential plc as they have authority and responsibility for planning, directing and controlling the activities of the Group. Total key management remuneration can be broken down in the following table: Salaries and short-term benefits 12,192,000 9,594,000 Post-employment benefits 1,189,000 926,000 Share-based payments 9,734,000 11,157,000
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts 2.1 1.9 Fees payable to the Company’s auditor and its associates for other services: Audit of subsidiaries pursuant to legislation 6.1 6.1 Audit-related assurance services 2.6 2.5 Tax compliance services 0.6 0.4 Other assurance services 0.5 0.6 Services relating to corporate finance transactions excluding the AIA transaction 0.5 0.1 All other services 0.3 0.4 Services relating to the AIA transaction – 5.5
In addition, there were fees incurred of £0.1 million (2010: £0.1 million) for the audit of pension schemes. The above audit fees for 2011 and 2010 reflect the new disclosure requirements of SI2011/2198 – The Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) (Amendment) Regulations 2011.
All services were specifically approved by the Prudential Group Audit Committee. The Audit Committee regularly monitors the non-audit services provided to the Group by its auditor and has developed a formal Auditor Independence Policy, which sets out the types of services that the auditor may provide, consistent with the guidance in Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’ and with the provisions of the US Sarbanes-Oxley Act. The Audit Committee annually reviews the auditor’s objectivity and independence. More information on these issues is given in the corporate governance report within this Annual Report.
In 2011 and 2010, 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. As indicated above, all of these transactions are on terms broadly equivalent to those that prevail in arm’s length transactions.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for PRIL, which operates mainly in England and Wales. Details of all Prudential subsidiaries, joint ventures and associates will be annexed to the next Annual Returns of Prudential plc filed with the UK Registrar of Companies.
ii Dividend restrictions and minimum capital requirements Certain Group subsidiaries are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company. UK insurance companies are required to maintain solvency margins, which must be supported by capital reserves and other resources, including unrealised gains on investments. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, without the prior regulatory approval, dividends cannot be distributed if all dividends made within the preceding 12 months exceed the greater of Jackson’s statutory net gain from operations or 10 per cent of Jackson’s statutory surplus for the prior year. In 2012, the maximum amount of dividends that could be paid by Jackson, subject to the availability of earned surplus, without prior regulatory approval is US$411 million (£264 million) (in 2011: US$770 million (£495 million)). The Group’s subsidiaries in Asia may remit dividends to the Group, in general, provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations. The Group capital position statement for life assurance businesses is set out in note D5, 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 D5 of the local capital requirement of each of the fund or group of companies.
During 2010, the Group acquired a 100 per cent interest in United Overseas Bank Life Assurance Limited (UOB) in Singapore. Further details are set out in note I1. On 1 October 2010, the PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, acquired control of Meterserve (North West) Limited and Meterserve (North East) Limited (together referred to as ‘Meterserve’), increasing its 50 per cent stake to 100 per cent. As this transaction is within the with-profits fund, it has no impact on shareholders’ profit or equity for the period ended 31 December 2010. The impact on the Group’s consolidated revenue, including investment returns, is not material. Had the acquisition been effected at 1 January 2010, the revenue and profit of the Group from continuing operations for the year ended 31 December 2010 would not have been materially different. A summary of the consideration, goodwill and net assets acquired relating to Meterserve is provided in the table below: Cash consideration paid 22 Fair value of existing stake 25
Net assets acquired: Property, plant and equipment 219 Derivative assets (35) Other non-investment and non-cash assets 11 Cash and cash equivalents 10 Borrowings attributable to with-profits funds (194) Other non-insurance liabilities (6)
Total goodwill arising on acquisition attributable to the with-profits fund 42
Fixed assets Investments: Shares in subsidiary undertakings 5 10,902 9,410 Loans to subsidiary undertakings 5 1,200 849
Current assets Debtors: Amounts owed by subsidiary undertakings 6,122 4,244 Deferred tax 6 364 345 Other debtors 11 6 Derivative assets 8 3 112 Cash at bank and in hand 152 162
Less liabilities: amounts falling due after more than one year Subordinated liabilities 7 (2,652) (2,718)
Capital and reserves Share capital 10 127 127 Share premium 10 1,873 1,856 Profit and loss account 11 5,357 2,284
The financial statements of the parent company on pages 371 to 382 were approved by the Board of directors on 12 March 2012 and signed on its behalf.
Prudential plc (the Company) is a parent holding company. The Company together with its subsidiaries (collectively, the Group) is an international financial services group with its principal operations in Asia, the US and the UK. In Asia, the Group has operations in Hong Kong, Malaysia, Singapore, Indonesia and other Asian countries. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company (Jackson). In the UK, the Group operates 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. The Company is responsible for the financing of each of its subsidiaries.
The financial statements of the Company, which comprise the balance sheet and related notes, are prepared in accordance with Part 15 of the Companies Act 2006, which applies to companies generally. The Company has taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profit and loss account. The financial statements are prepared in accordance with applicable accounting standards under UK Generally Accepted Accounting Practice (UK GAAP), including Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP). The Company has not prepared a cash flow statement on the basis that its cash flow is included within the cash flow statement in the consolidated financial statements. The Company has also taken advantage of the exemption within FRS 29, ‘Financial Instruments: Disclosures’, from the requirements of this standard on the basis that the Company’s results are included in the publicly available consolidated financial statements of the Group that include disclosures that comply with IFRS 7, ‘Financial Instruments: Disclosures’, which is equivalent to FRS 29. The Company adopted the ‘Improvements to Financial Reporting Standards 2010’ in 2011 which included minor changes to FRS 29 ‘Financial Instruments: Disclosures’ and FRS 8 ‘Related Party Disclosures’. These changes closely reflect the requirements of International Financial Reporting Standards (IFRS) and form part of the continuing convergence of UK GAAP to IFRS requirements in the UK. Their adoption did not have an impact on the financial statements of the Company.
Share premium The difference between the proceeds received on issue of shares and the nominal value of the shares issued is credited to the share premium account.
Foreign currency translation Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas subsidiaries are translated at year-end exchange rates. The impact of these currency translations is recorded within the profit and loss account for the year. Other assets and liabilities denominated in foreign currencies are also converted at year end exchange rates with the related foreign currency exchange gains or losses reflected in the profit and loss account for the year.
A pension surplus or deficit is recorded as the difference between the present value of the scheme liabilities and the fair value of the scheme assets. The Company’s share of pension surplus is recognised to the extent that the Company is able to recover a surplus either through reduced contributions in the future or through refunds from the scheme. The assets and liabilities of the defined benefit pension schemes of the Prudential Group are subject to a full triennial actuarial valuation using the projected unit method. Estimated future cash flows are then discounted at a high quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine its present value. These calculations are performed by independent actuaries. 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. Actuarial gains and losses as a result of the changes in assumptions, the difference between actual and expected investment return on scheme assets and experience variances are recorded in the statement of total recognised gains and losses. Actuarial gains and losses also include adjustment for unrecognised pension surplus as described above.
Notes on the parent company financial statements continued 4 Reconciliation from UK GAAP to IFRS
Profit after tax Profit for the financial year of the Company in accordance with UK GAAP 3,720 881 IFRS adjustment (5) (8)
Profit for the financial year of the Company (including dividends from subsidiaries) in accordance with IFRS 3,715 873 Share in the IFRS result of the Group, net of distributions to the Company (2,225) 558
Profit after tax of the Group attributable to shareholders in accordance with IFRS 1,490 1,431
Net equity Shareholders’ equity of the company in accordance with UK GAAP 7,357 4,267 IFRS adjustment (44) (51)
The principal subsidiary undertakings of the Company at 31 December 2011, all wholly-owned, were: Main activity Country of incorporation
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for PRIL which operates mainly in England and Wales. Details of all Prudential subsidiaries, joint ventures and associates will be annexed to the Company’s next Annual Returns filed with the UK Registrar of Companies and the Registrar of Companies in Hong Kong.
Short-term timing differences 6 10 Unused deferred tax losses 358 335
Capital Securities 644 639 – – 644 639 US$250m 6.75% Perpetual Subordinated
Capital Securitiesnote (iii) 193 192 – – 193 192 US$750m 11.75% Perpetual Subordinated
Total core structural borrowings 3,201 3,267 – – 3,201 3,267 Other borrowings: Commercial paper note (iv) – – 2,706 2,311 2,706 2,311 Floating Rate Notes 2012note (v) – – 200 200 200 200 Medium-Term Notes 2013note (iv) – – 250 249 250 249
Borrowings are repayable as follows: Within 1 year or on demand – – 2,906 2,511 2,906 2,511 Between 1 and 5 years – – 250 249 250 249 After 5 years 3,201 3,267 – – 3,201 3,267
Recorded in the balance sheet as: Subordinated liabilitiesnote (vi) 2,652 2,718 Debenture loans 549 549
(ii) The €20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These borrowings have been swapped into borrowings of £14 million with interest payable at three month £LIBOR plus 1.2 per cent.
(iii) The US$250 million 6.75 per cent borrowings, the US$300 million 6.5 per cent borrowings and the US$550 million 7.75 per cent 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.
(iv) These borrowings support a short-term fixed income securities programme. (v) The Company issued £200 million Floating Rate Notes in 2011 which mature in April 2012. All Notes have been subscribed to by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements. These Notes were originally issued in October 2008 and have been reissued upon their maturity.
(vi) The interests of the holders of the Subordinated Notes and the Subordinated Capital Securities are subordinate to the entitlements of other creditors of the Company.
in a n cia l state m e n ts P
aren t co m p an y 8 Derivative financial instruments
Interest rate swaps – – 13 – Cross-currency swaps 3 – 99 – Inflation-linked swap – 207 – 146
Derivative financial instruments are held to manage interest rate and currency profiles. The change in fair value of the derivative financial instruments of the Company was a loss before tax of £75 million (2010: loss before tax of £33 million). The Company’s derivative which swapped the interest rate and the currency profile of the ¤500 million subordinated notes settled in December 2011. The derivative financial instruments are valued internally using standard market practices. In accordance with the Company’s risk management framework, all internally generated valuations are subject to independent assessment against external counterparties’ valuations.
The majority of UK Prudential staff are members of the Group’s pension schemes. The largest scheme is the Prudential Staff Pension Scheme (the ‘Scheme’) which is primarily a closed defined benefit scheme. At 31 December 2011, on the FRS 17, ‘Retirement Benefits’ basis of valuation, the underlying pension liabilities of the Scheme accounted for 86 per cent (2010: 86 per cent) of the liabilities of the Group’s defined benefit schemes. For the purpose of preparing consolidated financial statements, the Group applies IFRS basis accounting including IAS 19, ‘Employee Benefits’. However, the individual accounts of the Company continue to follow UK GAAP including FRS 17. The FRS 17 disclosures are aligned with IAS 19. Under IFRS, the Group applies IFRIC 14, interpretation guidance to IAS 19 with the effect of derecognising the Group’s interest in the Scheme’s surplus and recognising an additional liability for the deficit funding obligation for the Scheme in the Group financial statements. Further details are described in note I3 ‘Staff and pension plans’ of the Group financial statements. At 31 December 2005, the allocation of surpluses and deficits attaching to the Scheme between the Company and the unallocated surplus of the PAC with-profits funds was apportioned in the ratio 30/70 between the Company and the PAC with-profits fund following detailed consideration of the sourcing of previous contributions. This ratio was applied to the base deficit position at 1 January 2006 and for the purpose of determining the allocation of the movements in that position up to 31 December 2011. The FRS 17 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity. Defined benefit schemes are generally required to be subject to full actuarial valuation every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. The last completed actuarial valuation of the Scheme was as at 5 April 2008. This valuation demonstrated the Scheme to be 106 per cent funded by reference to the Scheme Solvency Target that forms the basis of the Scheme’s statutory funding objective. Accordingly, no formal deficit plan was required. However, in recognition of the fall in value of the Scheme’s investments between 5 April 2008 and the completion of the actuarial valuation in 2009, an additional funding akin to deficit funding was agreed by the Trustees. The total contributions currently being made by the Group into the Scheme, representing the annual accrual cost and deficit funding, are £50 million per annum. The current contributions will continue to be made until the next valuation as at 5 April 2011 is finalised later in 2012. In 2011, total employer contributions for the year, including expenses and augmentations, were £54 million (2010: £55 million). Using external actuarial advice provided by the professionally qualified actuaries, Towers Watson, for the valuation of the Scheme, the most recent full valuations have been updated to 31 December 2011 applying the principles prescribed by FRS 17.
Equities 6.8 8.2 8.5 Bonds 3.0 4.6 5.3 Properties 5.55 6.9 6.75 Other assets 2.0 4.75 4.75
The long-term expected rates of return have been determined after applying due consideration to the requirements of paragraph 54 of FRS 17, in particular, taking account of the values of the assets. In July 2010, the UK government announced plans to use the CPI in place of the RPI in its determination of the statutory minimum pension increases for private sector occupational pension schemes. In December 2010, the government published the statutory revaluation order for 2011 which confirms the change to use CPI. Further, in December 2010, the government consulted on the impact of the switch from RPI to CPI on the private sector occupational pension schemes. In its response following the consultation published in June 2011, the government confirmed that it would not introduce legislation to override scheme rules which provide for pension increases/revaluation on a basis that is higher than the statutory minimum. Only those tranches of the Scheme which are subject to statutory increases in accordance with the Scheme rules were affected by the government’s decision to change the indexation from RPI to CPI. Other tranches of the Scheme were unaffected. During 2011, the Scheme communicated to its members the changes in basis from RPI to CPI in light of the government announcement. The change has the impact of reducing the Scheme liabilities by £216 million, of which £65 million is attributable to the Company. However, as the Company is only able to recognise a restricted FRS 17 surplus for the Scheme, this reduction in the Scheme liabilities has no effect on the profit or shareholders’ funds of the Company. Further details of the Scheme, including mortality assumptions, are shown in note I3 ‘Staff and pension plans’ of the Group financial statements.
Equities 210 3.3 548 10.3 830 16.8 823 17.1 1,278 26.1 Bonds 5,547 86.2 3,864 72.2 3,406 68.8 2,430 50.6 1,134 23.2 Properties 297 4.6 199 3.7 272 5.5 283 5.9 545 11.2 Cash-like investments 378 5.9 740 13.8 441 8.9 1,267 26.4 1,932 39.5
Surplus in the Scheme recognised by the Company 52 56 52 50 163
The surplus in the Scheme recognised in the balance sheet of the Company represents the element of 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 4,866 4,436 Current service costs 22 25 Negative past service cost – RPI to CPI inflation measure change (216) – Interest costs 254 251 Employee contributions 1 1 Actuarial losses 131 369 Benefit payments (214) (216)
Operating charge: Current service costs (22) (25) Negative past service cost – RPI to CPI inflation measure change 216 – Finance income (expense): Interest on Scheme liabilities (254) (251) Expected return on Scheme assets 267 287 13 36
The pension charge attributable to the Company is net of the apportionment to the PAC with-profits fund and is related to the surplus recognised on the balance sheet of the Company. In 2011, an amount of £65 million was applied to extinguish the negative past service cost attributable to the Company from the unrecognised portion of the pension surplus at 31 December 2011.
Actuarial (losses) gains attributable to the Company before tax (16) (14) (3) (143) 91
The total actual return on Scheme assets was a gain of £1,240 million (2010: £562 million). The experience gains on Scheme liabilities in 2011 of £295 million related mainly to the ‘true-up’ reflecting improvements in data consequent upon the ongoing 2011 triennial valuation of the Scheme. Similarly, the experience gains of £127 million in 2008 were related mainly to the improvements in the data consequent to the 2008 triennial valuation. 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 2011, the actuarial losses attributable to the Company included an amount charged of £268 million (2010: amount credited of £14 million) for the adjustment to the unrecognised portion of surplus which has not been deducted from the pension charge. The actuarial losses before tax of £16 million (2010: £14 million) attributable to the Company are recorded in the statement of total recognised gains and losses. Cumulative actuarial gains as at 31 December 2011 amount to £58 million (2010: £74 million). Total employer contributions expected to be paid into the Scheme for the year ending 31 December 2012 amount to £54 million, reflecting the annual accrual cost and deficit funding, and expenses. However, this is subject to a reassessment when the valuation as at 5 April 2011 is completed later in 2012.
At 1 January 2,545,594,506 127 1,856 Shares issued under share option schemes 2,444,824 – 17
The profit after tax of the Company for the year was £3,720 million (2010: £881 million). After dividends of £642 million (2010: £511 million), actuarial losses net of tax in respect of the pension scheme of £12 million (2010: £10 million), share-based payment credits of £7 million (2010: £6 million) and scrip dividends of £nil (2010: £62 million), retained profit at 31 December 2011 amounted to £5,357 million (2010: £2,284 million). During the year, the Company received dividends from its subsidiary undertakings of £4,002 million. Included within this amount was £2,734 million relating to gains made by an intermediate holding company following the transfer at fair value of certain of its subsidiaries to other parts of the Group as part of an internal restructuring exercise. Because the gains relate to intragroup transactions, the amount of £2,734 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 2011, the UK GAAP retained earnings of the holding company from which distributable reserves may be derived were £5,357 million. A reconciliation of the movement in shareholders’ funds of the Company for the years ended 31 December 2011 and 2010 is given below: Profit for the yearnote 4 3,720 881 Dividends (642) (511)
3,078 370 Actuarial losses recognised in respect of the pension scheme net of related taxnote 9 (12) (10) Share-based paymentsnote 5 7 6 New share capital subscribednote 10 17 75
Net increase in shareholders’ funds 3,090 441 Shareholders’ funds at beginning of year 4,267 3,826
In January 2012, as part of an internal restructuring, the Company transferred at fair value interests of £3,889 million in shares in a central subsidiary and £2,007 million in loans to a second such subsidiary to another central subsidiary in exchange for shares issued by that subsidiary. No profit or loss arose on the transfers. Subject to shareholders’ approval, a final dividend for 2011 of 17.24 pence per ordinary share will be paid on 24 May 2012 in sterling to shareholders on the principal and Irish branch registers at 6.00pm BST on Friday, 30 March 2012 (the ‘Record Date’), and in Hong Kong dollars to shareholders on the Hong Kong branch register at 4.30pm Hong Kong time on the Record Date (‘HK Shareholders’). Holders of US American Depositary Receipts will be paid their dividend in US dollars on or about five days after the payment date of the dividend to shareholders on the principal register. The dividend will be paid on or about 31 May 2012 in Singapore dollars to shareholders with shares standing to the credit of their securities accounts with The Central Depository (Pte) Limited (CDP) at 5.00pm Singapore time on the Record Date (‘SG Shareholders’). The dividend payable to the HK Shareholders will be translated at the exchange rate ruling at the close of business on 12 March 2012. The exchange rate at which the dividend payable to the SG Shareholders will be translated will be determined by the CDP.
The dividend will distribute an estimated £439 million of shareholders’ funds. In line with 2010, shareholders on the principal register and Irish branch register will be able to participate in a Dividend Reinvestment Plan.
• 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 are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
The directors of Prudential plc, whose names and positions are set out on pages 108 to 112 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
This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed.
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 383, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors.
Opinion on financial 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 2011 and of the Group’s profit for the year then ended; • the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the EU; • the parent company financial statements have been properly prepared in accordance with UK Generally Accepted Accounting Practice; • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006; and, as regards the Group financial statements, Article 4 of the IAS Regulation.
G Bainbridge Senior Statutory Auditor for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants London
b asis su p p lem en tary in fo rm atio n Financial statements | European Embedded Value (EEV) basis supplementary information
Long-term business 1,764 1,450 Eastspring Investments 80 72 Development expenses (5) (4)
US operations New business 2 815 761 Business in force 3 616 697
Analysed as profits (losses) from: New business: Excluding Japan 2 2,151 2,028 Japannote (v) – (1)
(iii) In 2011 the Group altered its inflation measure basis for future statutory increases to pension payments for certain tranches of its UK defined benefit pension schemes. This reflects the UK Government’s decision to replace the basis of indexation from RPI with CPI. This resulted in a credit to operating profit for 2011 on an IFRS basis of £42 million and an additional £3 million recognised on the EEV basis.
(iv) Restructuring costs comprise the charge of £(16) million recognised on an IFRS basis and an additional £(3) million recognised on the EEV basis for the shareholders’ share of restructuring costs incurred by the PAC with-profits fund. Solvency II implementation costs comprise the charge of £(55) million recognised on an IFRS basis and an additional £(1) million recognised on the EEV basis.
(vi) The comparative results have been prepared using previously reported average exchange rates for the year.
Other income and expenditure (536) (494) RPI to CPI inflation measure change on defined benefit pension schemes 45 – Solvency II implementation costs (56) (46) Restructuring costs (19) (28)
Operating profit based on longer-term investment returns 3,978 3,696 Short-term fluctuations in investment returns 5 (907) (30) Mark to market value movements on core borrowings 9 (14) (164) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 23 (11) Effect of changes in economic assumptions 6 (158) (10) Costs of terminated AIA transaction 4 – (377) Gain on dilution of Group holdings 13 – 3
Based on profit after tax and non-controlling interests of £2,142 million (2010: £2,573 million) 12 84.6p 101.9p * Operating earnings per share for 2010 has been determined after excluding an exceptional tax credit of £158 million which primarily related to the impact of a settlement agreed with the UK tax authorities – see note 11.
Dividends declared and paid in reporting year: Current year interim dividend 7.95p 6.61p Final/second interim dividend for prior year 17.24p 13.56p
US operations: Net assets of operations 5,082 113 5,195 4,799 106 4,905 Acquired goodwill – 16 16 – 16 16
Based on EEV basis shareholders’ equity of £19,637 million (2010: £18,207 million) 771p 715p Number of issued shares at year end (millions) 2,548 2,546
a Covered business The EEV results for the Group are prepared for ‘covered business’, as defined by the EEV Principles. Covered business represents the Group’s long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The EEV basis results for the Group’s covered business are then combined with the IFRS basis results of the Group’s other operations. The definition of long-term business operations is consistent with previous practice and comprises those contracts falling under the definition of long-term insurance business for regulatory purposes together with, for US operations, contracts that are in substance the same as guaranteed investment contracts (GICs) but do not fall within the technical definition. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management. With two principal exceptions, covered business comprises the Group’s long-term business operations. The principal exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and for the presentational treatment of the financial position of the Group’s principal defined benefit pension scheme, the Prudential Staff Pension Scheme (PSPS). A small amount of UK group pensions business is also not modelled for EEV reporting purposes. SAIF is a ring-fenced sub-fund of the Prudential Assurance Company (PAC) long-term fund, established by a Court approved Scheme of Arrangement in October 1997. SAIF is closed to new business and the assets and liabilities of the fund are wholly attributable to the policyholders of the fund. The PSPS deficit funding liability attaching to the shareholder-backed business is included in the total for Other operations, reflecting the fact that the deficit funding is being paid for by the parent company, Prudential plc. The changes in financial position of the Scottish Amicable and M&G pension scheme are reflected in the EEV results for UK insurance operations and Other operations respectively.
The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results (as explained in note 1(c)(iv)) no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profit before tax. Separately, the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items, as explained in note 1(c)(i).
New business The contribution from new business represents profits determined by applying operating assumptions as at the end of the year. In determining the new business contribution for UK immediate annuity business, which is interest rate sensitive, it is appropriate to use assumptions reflecting point of sale market conditions, consistent with how the business is priced. For other business within the Group, end of period economic assumptions are used.
UK insurance operations The only significant financial options and guarantees in the UK insurance operations arise in the with-profits fund and SAIF. With-profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses: annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The with-profits fund also held a provision on the Pillar I Peak 2 basis of £90 million at 31 December 2011 (2010: £24 million) to honour guarantees on a small amount of guaranteed annuity option products. Beyond the generic features and the provisions held in respect of guaranteed annuities described above, there are very few explicit options or guarantees of the with-profits fund such as minimum investment returns, surrender values, or annuity values at retirement and any granted have generally been at very low levels. At 31 December 2011, guarantees on certain with-profits deferred annuity business were in the money as a result of the low level of interest rates at that date. The Group’s main exposure to guaranteed annuity options in the UK is through SAIF and a provision on the Pillar I Peak 2 basis of £370 million (2010: £336 million) was held in SAIF at 31 December 2011 to honour the guarantees. As SAIF is a separate sub-fund of the PAC long-term fund which is attributable to policyholders of the fund, the movement in the provision has no direct impact on shareholders.
Time value The value of financial options and guarantees comprises two parts. One is given by a deterministic valuation on best estimate assumptions (the intrinsic value). The other part arises from the variability of economic outcomes in the future (the time value). Where appropriate, a full stochastic valuation has been undertaken to determine the time value of the financial options and guarantees. The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations. Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of long-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for correlation between the various asset classes. Details of the key characteristics of each model are given in note 17(a).
• UK insurance operations: the capital requirements are set at the higher of Pillar I and Pillar II requirements for shareholder-backed business of UK insurance operations as a whole, which for 2011 and 2010 was Pillar I.
Market risk allowance The allowance for market risk represents the beta multiplied by an equity risk premium. Except for UK shareholder-backed annuity business (as explained below) such an approach has been used for all of the Group’s businesses. The beta of a portfolio or product measures its relative market risk. The risk discount rates reflect the market risk inherent in each product group and hence the volatility of product cash flows. These are determined by considering how the profits from each product are affected by changes in expected returns on various asset classes. By converting this into a relative rate of return it is possible to derive a product specific beta. Product level betas reflect the most recent product mix to produce appropriate betas and risk discount rates for each major product grouping.
Additional credit risk allowance The Group’s methodology is to allow appropriately for credit risk. The allowance for total credit risk is to cover: • expected long-term defaults, • credit risk premium (to reflect the volatility in downgrade and default levels), and • short-term downgrades and defaults.
• Policyholder benefits for Jackson fixed annuity business are not fixed. It is possible in adverse economic scenarios to pass on a component of credit losses to policyholders (subject to guarantee features) through lower crediting rates. Consequently, it is only necessary to allow for the balance of the credit risk in the risk discount rate.
(3) With-profit fund holdings of debt securities The UK with-profits fund holds debt securities as part of its investment portfolio backing policyholder liabilities and unallocated surplus. The assumed earned rate for with-profit holdings of corporate bonds is defined as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
(v) With-profits business and the treatment of the estate The proportion of surplus allocated to shareholders from the PAC with-profits fund has been based on the present level of 10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing final bonus rates (and related shareholder transfers) so as to exhaust the estate over the lifetime of the in-force with-profits business. In any scenarios where the total assets of the life fund are insufficient to meet policyholder claims in full, the excess cost is fully attributed to shareholders. Similar principles apply, where appropriate, for other with-profit funds of the Group’s Asian operations.
(vi) Pension costs The Group operates three defined benefit schemes in the UK. The largest scheme is the PSPS. The other two, smaller schemes are the Scottish Amicable and M&G scheme.
Under IFRS the surpluses or deficits attaching to these schemes are accounted for in accordance with the provisions of IAS 19 that apply the principles of IFRIC 14, providing guidance on assessing the limit in IAS 19 on the amount of surplus in a defined benefit pension scheme that can be recognised as an asset. Under the EEV basis the IAS 19 basis surpluses (to the extent not restricted under IFRIC 14) or deficits are initially allocated in the same manner. The shareholders’ 10 per cent interest in the PAC with-profits fund estate is determined after inclusion of the portion of the IAS 19 basis surpluses or deficits attributable to the fund. Adjustments under EEV in respect of accounting for surpluses or deficits on the Scottish Amicable Pension Scheme are reflected as part of UK long-term business operations and for other defined benefit schemes the adjustments are reflected as part of Other operations, as shown in note 7. Separately, the projected cash flows of in-force covered business include the cost of contributions to the defined benefit schemes for future service based on the contribution basis applying to the schemes at the time of the preparation of the results.
Non-operating results comprise the recurrent items of short-term fluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, the mark to market value movements on core borrowings and the effect of changes in economic assumptions. In addition, for 2010 the Company incurred costs associated with the terminated AIA transaction and the Group’s holding in PruHealth was diluted. The effect of both of these items has been shown separately from operating profits based on longer-term investment returns.
(v) Operating experience variances Operating profits include the effect of experience variances on non-economic assumptions, which are calculated with reference to the embedded value assumptions at the end of the reporting year, such as persistency, mortality and morbidity, expenses and other factors. Further details are shown in note 17(b).
Actuarial and other gains and losses For pension schemes in which the IAS 19 position reflects the difference between the assets and liabilities of the scheme, actuarial and other gains and losses comprise: • the difference between actual and expected return on the scheme assets, • experience gains and losses on scheme liabilities, • the impact of altered economic and other assumptions on the discounted value of scheme liabilities, and • for pension schemes where the IAS 19 position reflects a deficit funding obligation, actuarial and other gains and losses includes the movement in estimates of deficit funding requirements.
(viii) Taxation The profit for the year for covered business is in most cases calculated initially at the post-tax level. The post-tax profit for covered business is then grossed up for presentation purposes at the rates of tax applicable to the countries and periods concerned. In the UK the rate applied for 2011 is 25 per cent (2010: 27 per cent). For Jackson, the US federal tax rate of 35 per cent is applied to gross up movements on the value of in-force business. The overall tax rate includes the impact of tax effects determined on a local regulatory basis. For Asia, similar principles apply subject to the availability of taxable profits. Tax payments and receipts included in the projected cash flows to determine the value of in-force business are calculated using rates that have been substantively enacted by the end of the reporting period. Possible future changes of rate are not anticipated.
Financial statements | European Embedded Value (EEV) basis supplementary information 1 Basis of preparation, methodology and accounting presentation continued
Asian operations 1,456 1,514 1,660 8,910 1,076 65 12.1 US operations 12,562 19 1,275 12,720 815 64 6.4 UK insurance operationsnote (vii) 4,871 259 746 6,111 260 35 4.3
(iii) New business contributions represent profits determined by applying operating assumptions as at the end of the year. In general, the use of point of sale or end of period economic assumptions is not significant in determining the new business contribution for different types of business and across financial reporting periods. However, to obtain proper measurement of the new business contribution for business which is interest rate sensitive, it is appropriate to use assumptions reflecting point of sale market conditions, consistent with how the business was priced. In practice, the only area within the Group where this has a material effect is for UK shareholder-backed annuity business. For other business within the Group end of period economic assumptions are used.
(iv) The amounts shown in the tables are translated at average exchange rates for the year. (v) The tables for 2010 exclude new business sales and contributions for Japanese insurance operations in which the Company ceased selling new business from 15 February 2010.
(vii) The new business margin for UK operations for 2010 of 45 per cent reflects the signing of bulk annuity buy-in insurance agreements with an APE of £93 million and new business profit of £106 million. In 2011 the new business margin of 35 per cent includes bulk annuity agreements with an APE of £33 million and new business profit of £28 million.
The credit of £89 million in 2010 for mortality and morbidity assumption changes mainly arose in Indonesia of £72 million comprising £36 million for relaxation of morbidity assumptions and £36 million to reflect recent experience in relation to protection benefits provided by unit-linked policies.
The charge of £(62) million in 2010 for expense assumption changes includes a charge in Korea of £(40) million to reflect higher policy maintenance costs and a charge of £(16) million in Malaysia relating to altered maintenance expense assumptions.
(d) The charge of £(140) million in 2011 for persistency and withdrawals assumption changes arises as follows: 2011 £m
(1) The charge of £(106) million in Malaysia includes £(108) million for the effect of strengthening partial withdrawal assumptions on PruSaver product riders to reflect recent experience. Policyholders’ pattern and frequency of withdrawals from this savings rider is different from that of the underlying ‘host’ contract, where both persistency and premium payment experience remains in line with assumptions.
(f) The favourable effect of mortality and morbidity experience in 2011 of £58 million and in 2010 of £45 million reflects better than expected experience, principally arising in Hong Kong, Indonesia, Singapore and Malaysia.
(g) The negative expense experience variance of £(31) million in 2011 (2010: £(39) million) comprises a charge of £(26) million (2010: £(18) million) for expense overruns for operations which are at a relatively early stage of development, for which actual expenses are in excess of those factored into the product pricing, together with £(6) million (2010: £(9) million) in Taiwan and £1 million (2010: £(12) million) of variance for other operations.
(h) The positive persistency and withdrawals experience variance of £10 million in 2011 reflects a combination of favourable experience in Hong Kong and Indonesia, partially offset by individually small negative variances in other territories.
The negative persistency and withdrawals experience variance of £(48) million in 2010 mainly arises in India of £(27) million relating to higher paid-ups and surrenders on unit-linked business and in Malaysia of £(26) million for higher partial withdrawals on unit-linked business as customers sought to monetise a proportion of their funds following two years of exceptional returns.
(i) The credit of £28 million in 2011 for other experience and other items primarily arises in Indonesia of £24 million. The credit of £41 million in 2010 includes a credit of £24 million arising in Indonesia for the impact of additional riders being added to in-force policies during the year, funded from the policyholder unit-linked account balances.
(j) The in-force operating profit for 2010 of £549 million reflects the effect of setting economic assumptions on an ‘active’ basis rather than the previously applied ‘passive’ basis as described in note 17a(v), the impact of which was to lower in-force operating profits in 2010 by £(58) million, principally for altered unwind of discount.
Unwind of discount and other expected returnsnote (a) 349 369 Effect of changes in operating assumptions: Persistencynote (b) 29 4 Variable Annuity (VA) feesnote (c) 24 27 Mortalitynote (d) (36) 10 Othernote (e) (3) (38)
(b) The credit of £29 million for the effect of changes in persistency assumptions in 2011 arises on variable annuity business of a credit of £15 million and £14 million on other business. The credit of £15 million for VA business represents a credit of £32 million to reflect a decrease in lapse rates for selected product and policy duration combinations, partially offset by a charge of £(17) million to increase partial withdrawal rates in line with experience. The credit of £14 million for other business reflects updated persistency assumptions for life and fixed annuity business.
(c) The effect of the change of assumption for VA fees represents the capitalised value of the change in the projected level of policyholder advisory fees, which vary according to the size and mix of VA funds. The credit of £24 million for 2011 (2010: £27 million) reflects an increase in the projected level of fees paid by policyholders, according to the current fund size and mix.
(e) The charge of £(38) million for other operating assumption changes in 2010 includes the net effect of a number of items including a charge of £(19) million for the altered projection of life reserves run-off.
(h) Other experience variances and other items arise as follows: Mortality experience variancenote (1) (6) 21 Expense experience variancenote (2) 12 32 Persistency experience variancenote (3) 21 23 Other (10) 9
(1) The negative mortality experience variance of £(6) million in 2011 includes a provision of £(16) million in respect of unclaimed property for deceased policyholders. The positive mortality experience variance of £21 million in 2010 primarily relates to life products.
(2) The positive expense experience variances of £12 million in 2011 and £32 million in 2010 primarily represents favourable experience variance relating to marketing expenses.
(3) The positive persistency experience variance of £21 million in 2011 mainly arises on annuity business and in 2010, the favourable experience variance of £23 million primarily arises on annuity and institutional business.
Notes (a) The decrease in unwind of discount and other expected returns from £550 million for 2010 to £485 million for 2011 mainly arises from lower unwind on with-profits business, reflecting a decrease in both the risk discount rate and opening in-force value (as adjusted for the effects of changes in operating and economic assumptions).
(b) In 2011 a change to reduce the UK corporate tax rate to 25 per cent with effect from 1 April 2012 was enacted. The effect of the change in tax rate of £79 million in 2011 represents the pre-tax benefit of the reduction in tax rate from 27 per cent to 25 per cent, arising from the increase in the present value of the post-tax projected cash flows of the in-force business, grossed up for notional tax. The effect of the change in tax rate of £41 million for 2010 represents the pre-tax benefit of the reduction in the tax rate from 28 per cent to 27 per cent.
Short-term fluctuations in investment returns, net of the related change in the time value of cost of options and guarantees, arise as follows: Group summary
Notes Analysis by business unit (i) Asian operations For 2011, short-term fluctuations in investment returns in Asian operations of £(155) million are driven by lower equity markets reducing future expected fee income, mainly arising in Singapore £(105) million and Korea £(22) million. The 2011 short-term fluctuations in investment returns also include £(28) million of adverse variance arising in other territories. This principally comprises fluctuations arising in India of £(53) million reflecting lower equity market returns, in Vietnam of £(33) million for unrealised losses on bonds and equities and Taiwan of £(30) million for losses on bonds and CDOs, partially offset by a credit in Hong Kong of £96 million primarily relating to positive returns on bonds backing participating business.
Notes on the EEV basis results continued 5 Short-term fluctuations in investment returns continued
(ii) US operations The short-term fluctuations in investment returns for US operations comprise the following items: Debt securities investment return related experiencenote (a) (74) (351) Investment return related impact due primarily to changed expectation of profits on in-force variable annuity business in future periods based on current period equity returns, net of related hedging activity for equity related productsnote (b) (418) (332)
Actual less long-term return on equity based investments and other items 1 5
(2) related hedging activity. In 2011 there was a negative 0.5 per cent rate of return for the variable annuity separate account assets. This compared with an assumed longer-term rate of return of 5.4 per cent. Consequently the asset values, and therefore projected future fees at 31 December 2011, were lower than assumed. As a consequence of this lower level of return, net of the impact of relating hedging effects, there was a short-term fluctuation of £(418) million.
In 2010 there was a 14.5 per cent return which compared with an assumed longer-term rate of return of 6.8 per cent. However, despite this excess return, there was an overall charge of £(332) million which arose from the effects of related hedging activity.
(iii) UK insurance operations The short-term fluctuations in investment returns for UK insurance operations represents: With-profitsnote (a) (201) 218 Shareholder-backed annuitynote (b) 56 84 Unit-linked and other note (c) 4 34
Notes (a) For with-profits business the amounts reflect the excess (deficit) of the actual investment return on the investments of the PAC with-profits fund (covering policyholder liabilities and unallocated surplus) against the assumed long-term rate for the year. For 2011 the charge of £(201) million reflects the actual investment return of 3.2 per cent against the assumed long-term rate of 5.1 per cent, primarily reflecting the fall in equity markets and widening of corporate bond credit spreads, partially offset by the increase in asset values as a result of the reduction in bond yields. For 2010 the credit of £218 million reflects the actual investment return of 12.0 per cent against the assumed long-term rate of 6.7 per cent.
b asis su p p lem en tary in fo rm atio n 6 Effect of changes in economic assumptions
Notes Analysis by business unit (i) Asian operations The effect of changes in economic assumptions for Asian operations in 2011 of a credit of £279 million principally arises in Singapore £160 million, Malaysia £97 million and Indonesia £94 million, primarily reflecting the positive impact of discounting health and protection profits at lower rates, driven by the decrease in risk-free rates as shown in note 17a. There is a partial offset arising in Hong Kong of £(57) million, primarily reflecting the reduction in fund earned rates for participating business.
For 2010, the effect of changes in economic assumptions in Asian operations of £(71) million primarily represents the effect of derisking certain asset portfolios in Hong Kong and Singapore totalling £(73) million, together with the effects of routine adjustments for changes in economic factors and the effect of altering the basis of setting economic assumptions to the ‘active’ basis as described in note 17a(v).
(ii) US operations The effect of changes in economic assumptions for US operations reflects the following: Effect of changes in 10-year treasury rates, beta and equity risk premium:note (a) Fixed annuity and other general account business 282 111 Variable Annuity (VA) business (333) (112) Increase in risk margin allowance for credit risknote (b) (93) –
Notes (a) For Jackson, the charge for the effect of changes in economic assumptions represents the aggregate of the effects of changes to projected returns and the risk discount rate. The risk discount rate, as discussed in note 1(b)(iii), represents the aggregate of the risk-free rate and margin for market risk, credit risk and non-diversifiable non-market risk.
(b) For 2011 the effect of £(93) million for the increase in the risk margin allowance within the risk discount rate for credit risk represents 50 basis points increase in the risk discount rate for spread business (from 150 basis points in 2010 to 200 basis points in 2011), and 10 basis points for VA business (from 30 basis points in 2010 to 40 basis points in 2011), representing the proportion of business invested in the general account, as described in note 1b(iii).
(iii) UK insurance operations The effect of changes in economic assumptions of a charge of £(293) million for UK insurance operations for 2011 comprises the effect of: Shareholderbacked
Effect of changes in risk discount rates 240 627 867 55 183 238 Other changes (20) (85) (105) (6) 12 6
(b) For with-profits and other business the charge in 2011 of £(1,113) million for the effect of changes in expected long-term rates of return arises from the reduction in fund earned rates as shown in note 17a, driven by the (1.5) per cent decrease in gilt rates and reduction in additional returns assumed on corporate bonds, reflecting changes in asset mix. The credit in 2011 of £627 million for the effect of changes in risk discount rates reflects the (1.35) per cent reduction in the risk discount rate as shown in note 17(a), driven by the (1.5) per cent decrease in gilt rates, partly offset by the impact of an increase in beta for with-profits business.
b asis su p p lem en tary in fo rm atio n 7 Shareholders’ equity (excluding non-controlling interests) – segmental analysis
Asian operations Long-term business: Net assets of operations – EEV basis shareholders’ equitynote (iii) 8,510 7,445 Acquired goodwillnote (i) 235 236 8,745 7,681 Eastspring Investments:note (i) Net assets of operations 211 197 Acquired goodwill 61 61
US operations Jackson – EEV basis shareholders’ equity (net of surplus note borrowings of £177 million (2010: £172 million) 5,082 4,799 Broker-dealer and asset management operations:note (i) Net assets of operations 113 106 Acquired goodwill 16 16
M&G:note (i) Net assets of operations 229 254 Acquired goodwill 1,153 1,153
Other operations Holding company net borrowings at market value 9 (2,188) (2,212) Other net assetsnote (i) 128 149
Notes on the EEV basis results continued 7 Shareholders’ equity (excluding non-controlling interests) – segmental analysis continued
Notes (i) With the exception of the share of the Prudential Staff Pension Scheme (PSPS) deficit (as explained below), the amounts shown for net assets of non-covered business, together with acquired goodwill, have been determined on the statutory IFRS basis. The share of the PSPS deficit attributable to the PAC with-profits fund is included in ‘other operations’ net assets. The overall pension scheme deficit, net of tax, attributable to shareholders relating to PSPS is determined as shown below: IFRS basis deficit (relating to shareholder-backed operations) (5) (10) Additional EEV deficit (relating to shareholders’ 10 per cent share of the IFRS basis deficit attributable to the PAC
(ii) The additional retained profit on an EEV basis for Other operations primarily represents the mark to market value difference on holding company net borrowings of a charge of £(187) million (2010: £(177) million), as shown in note 9.
Free surplus is the excess of the net worth over the capital required to support the covered business. Where appropriate, adjustments are made to the regulatory basis net worth from the local regulatory basis so as to include backing assets movements at fair value rather than cost, so as to comply with the EEV Principles. Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements, as described in note 1(b)(ii).
Underlying movement: New business (553) – (553) Business in force: Expected in-force cash flows (including expected return on net assets) 1,972 363 2,335 Effects of changes in operating assumptions, operating experience variances and other operating items 168 – 168 RPI to CPI inflation measure change on defined benefit pension schemes 20 13 33 1,607 376 1,983 Changes in non-operating itemsnote (iii) (507) (24) (531)
Net movement in free surplus 91 (8) 83 Balance at 1 January 2011 2,748 590 3,338
Balance at 1 January 2011 Representing: Asian operations 1,045 197 1,242 US operations 1,163 106 1,269 UK operations 540 287 827
basis shareholders’ equity as shown in note 7. (iii) Changes in non-operating items This represents short-term fluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes and the effect of changes in economic assumptions for long-term business operations. Short-term fluctuations in investment returns primarily reflect temporary market movements on the portfolio of investments held by the
Notes on the EEV basis results continued 8 Analysis of movement in free surplus continued
Mark to market value movements on Jackson assets backing surplus and required capitalnote 14 62 – 62 Othernote (vi) (227) (82) (309)
Core structural borrowings – central fundsnote (i) 3,201 187 3,388 3,267 177 3,444
In accordance with the EEV Principles, core borrowings are carried at market value. As the liabilities are generally held to maturity or for the long-term, no deferred tax asset or liability has been established on the market value adjustment above.
Beginning of year 190 30 Change: Income statement 14 164 Foreign exchange effects – (4)
(iii) The core structural borrowing by Prudential Capital of £250 million represents a bank loan taken out in 2010 which was made in two tranches: £135 million maturing in June 2014, and £115 million maturing in December 2012.
Long-term business: New businessnote 2 1,076 815 260 2,151 – 2,151 Business in forcenote 3 688 616 593 1,897 – 1,897
Operating profit based on longer-term investment returns 1,759 1,427 853 4,039 (61) 3,978
Short-term fluctuations in investment returnsnote 5 (155) (491) (141) (787) (120) (907) Mark to market value movements on core
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes – – 20 20 3 23
Effect of changes in economic assumptionsnote 6 279 (144) (293) (158) – (158)
Profit (loss) for the year 1,433 508 320 2,261 (119) 2,142
in a n cia l state m e n ts E
Net increase (decrease) in shareholders’ equity 1,065 283 88 1,436 (6) 1,430 Shareholders’ equity at 1 January 2011notes (ii) and 7 7,445 4,799 5,970 18,214 (7) 18,207
Shareholders’ equity at 31 December 2011notes (ii) and 7 8,510 5,082 6,058 19,650 (13) 19,637
Intragroup dividends (including statutory transfers)note (a) (302) (330) (218) (850) 850 –
Notes (a) Intragroup dividends (including statutory transfers) represent dividends that have been declared in the year and amounts accrued in respect of statutory transfers.
(b) Investment in operations reflects increases in share capital. (c) For long-term business operations, the difference between the total above of £814 million for intragroup dividends (including statutory transfers) and investment in operations and the net cash flows to parent company of £829 million (as shown in note 8) primarily relates to timing differences arising on statutory transfers, intragroup loans and other non-cash items.
(iv) Other transfers from long-term business operations to Other operations in 2011 represent: Asian operations £m
The tax charge comprises: Tax charge on operating profit based on longer-term investment returns: Long-term business: Asian operationsnote (i) 402 329 US operations 487 509 UK insurance operationsnote (i) 221 260
Total tax charge on operating profit based on longer-term investment returns, excluding exceptional tax credit 1,044 992
Total tax credit on items not included in operating profit (268) (304)
Operating EPS: Operating profit before tax 3,978 3,696 Tax excluding exceptional tax credit (1,044) (992) Non-controlling interests (4) (4)
Operating profit after tax and non-controlling interests including exceptional tax credit 2,930 2,858 Operating EPS (pence) excluding exceptional tax credit 115.7p 106.9p Exceptional tax credit (pence) – 6.3p Operating EPS (pence) including exceptional tax credit 115.7p 113.2p
Total profit after tax and non-controlling interests 2,142 2,573 Total EPS (pence) including exceptional tax credit 84.6p 101.9p
On 1 August 2010, Discovery Holdings of South Africa, the Group’s joint venture partner in its investment in PruHealth, completed the acquisition of the entire share capital of Standard Life Healthcare, a wholly-owned subsidiary of the Standard Life Group, for £138 million. Discovery funded the purchase of the Standard Life Healthcare transaction, and contributed Standard Life Healthcare to PruHealth as a capital investment on completion. As a result of the transaction, Discovery increased their shareholding in PruHealth from the previous level of 50 per cent to 75 per cent, and Prudential’s shareholding was reduced from 50 per cent of the previous joint venture structure to 25 per cent of the new structure with the much enlarged business. A gain of £3 million arose in 2010 upon the dilution, representing the difference between the fair value of the enlarged 25 per cent investment still held and the book value of the original 50 per cent investment holding.
Intragroup dividends (including statutory transfers) and investment in operationsnote (ii) (1,028) – (1,028) 214 (814) Mark to market value movements on Jackson assets backing surplus and required capital 62 – 62 – 62 Other transfers from net worth (28) – (28) – (28)
b asis su p p lem en tary in fo rm atio n
US operations Shareholders’ equity at 1 January 2011 1,163 1,505 2,668 2,131 4,799 New business contributionnote (v) (202) 232 30 500 530 Existing business – transfer to net worth 754 (288) 466 (466) – Expected return on existing business 42 46 88 139 227 Changes in operating assumptions and experience variances 154 2 156 27 183 Changes in non-operating assumptions and
UK insurance operations Shareholders’ equity at 1 January 2011 540 1,120 1,660 4,310 5,970 New business contributionnote (v) (54) 77 23 172 195 Existing business – transfer to net worth 511 (72) 439 (439) – Expected return on existing business 10 38 48 317 365 Changes in operating assumptions and experience variances (38) (4) (42) 94 52 RPI to CPI inflation measure change on defined benefit pension schemes 20 – 20 – 20 Changes in non-operating assumptions and
(including statutory transfers) and investment in operations include the repayment of contingent loan funding. Contingent loan funding represents amounts whose repayment to the lender is contingent upon future surpluses 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.
Free surplus invested in new business (297) (202) (54) (553) – (553)
(vi) New business contribution and free surplus invested in new business for the Group’s Japanese insurance subsidiary, which ceased selling new business with effect from 15 February 2010, have been presented separately from those of the remainder of the Group.
The discounted value of in-force business and required capital can be reconciled to the 2011 and 2010 totals in the tables below for the emergence of free surplus as follows: Required capitalnote 14 3,447 3,415 Value of in-force (VIF)note 14 13,364 12,051 Add back: deduction for cost of time value of guaranteesnote 14 685 369 Other itemsnote (1,214) (845)
Note Other items represent amounts incorporated into VIF where there is no definitive timeframe for when the payments will be made or receipts received. In particular, other items includes the deduction of the value of the shareholders’ interest in the estate, the value of which is derived by increasing final bonus rates so as to exhaust the estate over the lifetime of the in-force with-profits business. This is an assumption to give an appropriate valuation. To be conservative this item is excluded from the expected free surplus generation profile below.
Financial statements | European Embedded Value (EEV) basis supplementary information 15 Expected transfer of value of in-force business to free surplus continued
Cash flows are projected on a deterministic basis and are discounted at the appropriate risk discount rate. The modelled cash flows use the same methodology underpinning the Group’s embedded value reporting and so is subject to the same assumptions and sensitivities. The table below shows how the VIF generated by the in-force business and the associated required capital is modelled as emerging into free surplus over future years.
Asian operations 6,329 2,304 1,407 866 591 1,009 152 US operations 4,078 2,358 1,007 421 173 119 – UK insurance operations 4,583 1,792 1,173 755 468 389 6
b asis su p p lem en tary in fo rm atio n 16 Sensitivity of results to alternative assumptions a Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2011 (31 December 2010) and the new business contribution after the effect of required capital for 2011 and 2010 to: • 1 per cent increase in the discount rates, • 1 per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates), • 1 per cent rise in equity and property yields, • 10 per cent fall in market value of equity and property assets (embedded value only), • holding company statutory minimum capital (by contrast to required capital), (embedded value only), • 5 basis point increase in UK long-term expected defaults, and • 10 basis point increase in the liquidity premium for UK shareholder-backed annuities.
Interest rates – 1% decrease 253 58 400 711 Equity/property yields – 1% rise 329 185 205 719 Equity/property market values – 10% fall (159) 16 (326) (469) Statutory minimum capital 114 92 4 210 Long-term expected defaults – 5 bps increase – – (98) (98) Liquidity premium – 10 bps increase – – 196 196
• 10 per cent proportionate decrease in lapse rates (a 10 per cent sensitivity on a base assumption of 5 per cent would represent a lapse rate of 4.5 per cent per annum), and
• 5 per cent proportionate decrease in base mortality and morbidity rates (ie increased longevity).
Maintenance expenses – 10% decrease 26 11 7 44 Lapse rates – 10% decrease 92 24 10 126 Mortality and morbidity – 5% decrease 60 9 (9) 60 Change representing effect on: Life business 60 9 3 72 UK annuities – – (12) (12)
Maintenance expenses – 10% decrease 27 9 5 41 Lapse rates – 10% decrease 81 31 8 120 Mortality and morbidity – 5% decrease 50 7 (20) 37 Change representing effect on: Life business 50 7 1 58 UK annuities – – (21) (21)
Maintenance expenses – 10% decrease 117 44 52 213 Lapse rates – 10% decrease 342 157 65 564 Mortality and morbidity – 5% decrease 289 92 (227) 154 Change representing effect on: Life business 289 92 12 393 UK annuities – – (239) (239)
b asis su p p lem en tary in fo rm atio n a Principal economic assumptions Deterministic assumptions The tables below summarise the principal financial assumptions: Assumed investment returns reflect the expected future returns on the assets held and allocated to the covered business at the valuation date. Equity risk premiums in Asia range from 3.25 per cent to 8.7 per cent for both years. In the US and the UK, the equity risk premium is 4.0 per cent for both years.
Risk discount rate: New business 10.45 5.1 13.1 13.0 4.9 7.9 7.0 13.2 5.4 5.0 10.5 18.85 In-force 10.45 5.1 13.1 13.0 4.9 8.1 7.1 13.2 6.1 5.2 10.5 18.85 Expected long-term
Weighted risk discount rate:note (i) New business (excluding Japan) 7.4 8.4 In-force 6.9 8.1
(ii) For Hong Kong the assumptions shown are for US dollar denominated business which comprises the largest proportion of the in-force business. For other territories, the assumptions are for local currency denominated business which reflects the largest proportion of the in-force business.
(iv) The mean equity return assumptions for the most significant equity holdings in the Asian operations were: To obtain the mean, an average over all simulations of the accumulated return at the end of the projection period is calculated. The annual average return is then calculated by taking the root of the average accumulated return minus one.
‘active’ basis. For other Asian countries the investment return assumptions and risk discount rates were based on an assessment of longer-term economic conditions (the ‘passive’ basis). The altered approach with effect from full year 2010 to determine the EEV basis results for all Asian territories on an ‘active basis’ of economic assumption setting is in line with the Group’s other operations, and reflects the fact that markets in a number of Asian countries are becoming increasingly developed.
Pre-tax operating profits from: New businessnote 2 5 Business in forcenote 3 (58)
Total (53) Short-term fluctuations in investment returns and changes in economic assumptions 16
Fixed Annuity business*note (i) 1.75 to 2.0 2.0 Fixed Index Annuity business 2.25 2.5 Institutional business 1.0 –
(ii) The weighted average risk discount rates reflect the mix of business between variable annuity and non-variable annuity business. The decrease in the weighted average risk discount rates from 2010 to 2011 primarily reflects the decrease in the US 10-year Treasury bond rate of 140 basis points, partly offset by the effect of the increase in additional allowance for credit risk (as described in note (iii) below) and the impact of the increase in allowance for market risk.
Risk discount rate: New businessnote (i) 7.7 7.3 In-forcenote (ii) 8.6 9.9 Pre-tax expected long-term nominal rate of return for shareholder-backed annuity business: New business: Fixed annuities 4.95 4.9 Inflation-linked annuities 4.4 5.1 In-force:note (ii) Fixed annuities 4.5 5.1 Inflation-linked annuities 4.1 5.2 Other business:note (iv) Risk discount rate:note (iii) New business 5.3 6.9 In-force 5.65 7.0 Pre-tax expected long-term nominal rates of investment return: UK equities 6.5 8.0 Overseas equities 5.9 to 9.9 7.3 to 10.2 Property 5.2 6.7 Gilts 2.5 4.0 Corporate bonds 4.0 5.7 Expected long-term rate of inflation 3.0 3.55 Post-tax expected long-term nominal rate of return for the PAC with-profits fund: Pension business (where no tax applies) 5.1 6.7 Life business 4.4 5.9
Notes (i) The new business risk discount rate for shareholder-backed annuity business incorporates a default allowance for best estimate defaults in respect of assets purchased with new business monies received in 2011. The increase in the risk discount rate from 2010 to 2011 reflects the profile of the release of additional credit risk provisions, appropriate to the new business assets, over the projected lifetime of this business. These additional provisions comprise of a credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults.
(iv) Credit spread treatment For with-profits business, the embedded value reflects the discounted value of future shareholder transfers. These transfers are directly affected by the level of projected rates of return on investments, including debt securities. The assumed earned rate for with-profit holdings of corporate bonds is defined as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
For UK shareholder-backed annuity business, different dynamics apply both in terms of the nature of the business and the EEV methodology applied. For this type of business the assets are generally held to maturity to match long duration liabilities. It is therefore appropriate under EEV methodology to include a liquidity premium in the economic basis used. The appropriate EEV risk discount rate is set in order to equate the EEV with a ‘market consistent embedded value’ including liquidity premium. The liquidity premium in the ‘market consistent embedded value’ is derived from the yield on the assets held after deducting an appropriate allowance for credit risk. For PRIL, which has approximately 90 per cent of UK shareholder-backed annuity business, the allowance for credit risk for the in-force business at 31 December 2011 is made up of: (a) 15 basis points for fixed annuities and 14 basis points for inflation-linked annuities in respect of long-term expected defaults. This is derived by applying Moody’s data from 1970 to 2009 and the definition of the credit rating used is the second highest credit rating published by Moody’s, Standard and Poor’s and Fitch; and
Credit risk allowance: Long-term expected defaults 15 16 Additional provisions 51 52
Notes (1) The new business liquidity premium is based on the weighted average of the point of sale liquidity premium. (2) Specific assets are allocated to the new business for the year with the appropriate allowance for credit risk which was 35 basis points
UK insurance operations • Interest rates are projected using a two-factor model calibrated to the initial market yield curve; • The risk premium on equity assets is assumed to follow a log-normal distribution; • The corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and • Property returns are modelled in a similar fashion to corporate bonds, namely as the return on a risk-free bond, plus a risk premium, plus a process representative of the change in residual values and the change in value of the call option on rents.
Notes on the EEV basis results continued 17 Assumptions continued b Demographic assumptions Persistency, mortality and morbidity assumptions are based on an analysis of recent experience but also reflect expected future experience. Where relevant, when calculating the time value of financial options and guarantees, policyholder withdrawal rates vary in line with the emerging investment conditions according to management’s expectations.
Corporate expenditure comprises: • Expenditure for group head office, to the extent not allocated to the PAC with-profits funds, together with Solvency II implementation and restructuring costs, which are charged to the EEV basis results as incurred; and
V b asis su p p lem en tary in fo rm atio n 18 New business premiums and contributionsnotes (i), (ii)
Group insurance operations Asia – excluding Indianote (iii) 1,321 1,019 1,426 1,211 1,559 1,313 8,444 6,911 India 135 85 88 180 101 188 466 582
Corporate pensions 184 228 215 198 233 221 1,224 1,099 Onshore bonds 1,779 1,660 – – 178 166 1,781 1,660 Other products 780 774 44 56 122 133 978 1,089 Wholesale 336 945 – – 34 95 336 945
Total UK and Europe insurance operationsnote (v) 4,871 5,656 259 254 746 820 6,111 6,842
Prudential plc Annual Report 2011 18 New business premiums and contributionsnotes (i), (ii) continued
(ii) For 2010, the table above excludes new business sales for the Group’s Japanese insurance subsidiary, which ceased selling new business with effect from 15 February 2010.
in a n cia l state m e n ts A
II. IFRS profit and loss information 439 (a) Analysis of long-term insurance business pre-tax IFRS
III. IFRS balance sheet information 446 (a) Adoption of altered US GAAP requirements to Group
IFRS reporting in 2012 451 (b) IFRS shareholders’ fund summary by business unit and net asset value per share
The following table sets forth Prudential’s selected consolidated financial data for the periods indicated. Certain data is derived from Prudential’s audited consolidated financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and as adopted by the European Union (EU) and European Embedded Value (EEV). This table is only a summary and should be read in conjunction with Prudential’s consolidated financial statements and the related notes included elsewhere in this document.
IFRS basis results Gross premium earned 25,706 24,568 20,299 18,993 18,359 Outward reinsurance premiums (429) (357) (323) (204) (171)
Tax credit (charge) attributable to policyholders’ returns 17 (611) (818) 1,624 5
Profit (loss) before tax attributable to shareholders 1,943 1,461 746 (450) 1,063 Tax (charge) credit attributable to shareholders’ returns (449) (25) (55) 59 (354)
Profit (loss) from continuing operations after tax 1,494 1,436 691 (391) 709 Discontinued operations (net of tax) – – (14) – 241
Profit (loss) from continuing operations before tax attributable to shareholders(note 2) 1,943 1,461 746 (450) 1,063
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and including 2010 exceptional tax credit) (in pence) 63.9p 68.3p 47.5p 38.1p 31.3p
Operating earnings per share (reflecting operating profit based on longer-term investment returns after related tax and non-controlling interests and including 2010 exceptional tax credit) (in pence) 115.7p 113.2p 88.8p 85.1p 69.2p
Annual premium equivalent (APE) sales: EEV new business profit (NBP) 2,151 2,028 1,619 1,205 1,103
As of and for the Year Ended 31 December 2011 £bn 2010 £bn 2009 £bn 2008 £bn 2007 £bn
Funds under management(note 4) 351 340 290 249 267 EEV shareholders’ equity, excluding non-controlling interests 19.6 18.2 15.3 15.0 14.6 Insurance Groups Directive capital surplus (as adjusted)(note 5) 4.0 4.3 3.4 1.5 1.9
(3) Asia comparative APE new business sales prior to 2011 exclude the Japanese insurance operations, which ceased writing new business from 15 February 2010.
(5) The surpluses shown are before allowing for the final dividends for each year, which are paid in the following year. The 2011 surplus is estimated. Since 2007, following the sale of Egg Banking, Prudential has been subject to the capital adequacy requirements of the Insurance Groups Directive (IGD) which applies to groups whose activities are mainly in the insurance sector. Prior to the sale of Egg Banking, Prudential was subject to the capital adequacy requirements of the Financial Conglomerates Directive (FCD) which applies to groups with significant cross-sector activities in insurance and banking/investment services. Prudential was classified as an insurance conglomerate under the FCD. As the requirements for insurance conglomerates under the FCD are closely aligned to the requirements for insurance groups under the IGD, the move for Prudential from FCD to IGD did not result in a significant impact.
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver
This classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: i Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to policyholder accounts. It excludes the longer-term investment return on assets in excess of those covering shareholder-backed policyholder liabilities, which has been separately disclosed as expected return on shareholder assets.
vi Acquisition costs and administration expenses represent expenses incurred in the period attributable to shareholders. It excludes items such as restructuring costs and Solvency II costs, which are not included in the segment profit for insurance, as well as items that are more appropriately included in other source of earnings lines (eg investment expenses are netted off investment income as part of spread income or fee income as appropriate).
Spread income 70 692 251 – 1,013 Fee income 122 506 60 – 688 With-profits 32 – 310 – 342 Insurance margin 392 188 12 – 592 Margin on revenues 1,018 – 194 – 1,212 Expenses: Acquisition costs (656) (851) (138) – (1,645)
DAC adjustments 2 517 (1) – 518 Expected return on shareholder assets 19 125 98 – 242
Margin analysis of long-term insurance business The following analysis expresses certain of the Group’s sources of operating profit as a margin of policyholder liabilities or other suitable driver. Details of the Group’s average policyholder liability balances are given in D2(c), D3(c) and D4(c).
DAC adjustments 280 518 Expected return on shareholder assets 200 242 * The average liability balance is generally calculated as the average of the opening and closing liability balances as this is seen as a good proxy for average balances throughout the year. Given the volatility in the year, the calculation of average liabilities has been refined for Jackson in two ways: (i) the average for both the general and the separate account balances is now derived from month-end balances throughout the year as opposed to opening and closing balances only, and (ii) liabilities held in the general account for variable annuity living and death guaranteed benefits have been excluded from the calculation of the average as no spread income is earned on these balances. The 2010 balances for Jackson have been amended for consistency albeit impacts are minimal.
• Spread income has increased by £18 million from £70 million in 2010 to £88 million in 2011, an increase of 26 per cent that predominantly reflects the growth of the Asian non-linked policyholder liabilities; • Fee income has increased by £9 million from £122 million in 2010 to £131 million in 2011, broadly in line with the movement in unit-linked liabilities following continued positive net flows into unit-linked business; • Insurance margin has increased by £85 million from £392 million in 2010 to £477 million in 2011, predominantly reflecting the continued growth of the in-force book, which contains a relatively high proportion of risk-based products. 2011 includes £38 million (2010: £19 million) of non-recurring items, reflecting assumption changes and other items that are not expected to reoccur in future periods; • Margin on revenues has increased by £181 million to £1,199 million in 2011, reflecting the ongoing growth in the size of the portfolio. During the year the new business mix has moved towards those countries that levy higher premium charges (eg Indonesia); • Acquisition costs have increased by 17 per cent from £656 million in 2010 to £766 million in 2011, ahead of the 10 per cent increase in sales. This trend is distorted by the changes in country mix, particularly by the reduction of sales in India. Excluding India, acquisition costs were 21 per cent higher compared to a 18 per cent increase in sales. The analysis above uses shareholder acquisition costs as a proportion of total APE. If with-profits sales were excluded from the denominators, the acquisition cost ratio would become 59 per cent (2010: 53 per cent). (Excluding India 2011: 61 per cent, 2010: 58 per cent); • Administration expenses have increased from £467 million in 2010 to £503 million in 2011. The administration expense ratio has improved from 299 bps in 2010 to 280 bps in 2011 as we continue to see the benefits of operational leverage; and
• Expected return on shareholder assets has increased by £7 million to £26 million, principally reflecting higher shareholder assets and lower investment expenses in the period.
DAC adjustments 271 517 Expected return on shareholder assets 83 125 * The average liability balance is generally calculated as the average of the opening and closing liability balances as this is seen as a good proxy for average balances throughout the year. Given the volatility in the year, the calculation of average liabilities has been refined for Jackson in two ways: (i) the average for both the general and the separate account balances is now derived from month-end balances throughout the year as opposed to opening and closing balances only, and (ii) liabilities held in the general account for variable annuity living and death guaranteed benefits have been excluded from the calculation of the average as no spread income is earned on these balances. The 2010 balances have been amended for consistency, albeit impacts are minimal.
† The ratio for acquisition costs is calculated as a percentage of total APE.
• Spread income benefited by £113 million in 2011 from the effect of transactions entered into in 2011 and 2010 to more closely match the overall asset and liability duration (2010: £108 million). Excluding this effect, the spread margin would have been 218 bps (2010: 205 bps). The reported spread margin increased from 243 bps in 2010 to 258 bps in 2011. This is despite the downward pressure on yields caused by the low interest rate environment, the effect of which continues to be mitigated by reductions in crediting rates; • Fee income has increased by 34 per cent to £680 million in 2011, broadly in line with the growth in separate account balances. The growth in account balances during 2011 reflected the strong net flows from variable annuity business; • Insurance margin represents operating profits from insurance risks, including variable annuity guarantees and other sundry items. Positive net flows into variable annuity business with life contingent and other guarantee fees have primarily resulted in an improvement in the margin from £188 million in 2010 to £232 million in 2011; • Acquisition costs have increased in absolute terms compared to 2010, due largely to the significant increase in sales volumes. However, acquisition costs as a percentage of total APE is slightly lower at 70 per cent in 2011, with the decrease attributable to a reduced rate of marketing costs and lower average commissions; • Administration expenses increased to £412 million in 2011, compared to £344 million in 2010, primarily as a result of higher asset based commission paid on the larger 2011 separate account balance. These asset based commissions paid upon policy anniversary dates are treated as an administration expense in this analysis as opposed to a cost of acquisition, and are offset by higher fees. The administration cost was marginally higher at 66 bps (2010: 64 bps). Excluding trail commission amounts, the resulting administration expense ratio would be 46 bps (2010: 48 bps); and
Spread income 247 23,520 105 251 20,969 120 Fee income 59 21,476 27 60 20,353 29 With-profits 293 81,281 36 310 79,558 39 Insurance margin 27 12 Margin on revenues 226 194 Expenses: Acquisition costs* (127) 746 (17)% (138) 820 (17)%
DAC adjustments (5) (1) Expected return on shareholder assets 91 98 * The ratio for acquisition costs is calculated as a percentage of APE including with-profits sales. Acquisition costs include only those relating to shareholders.
† Following the reduction in 2010 of the Group’s interest in the PruHealth and PruProtect businesses from 50 per cent to 25 per cent, the profits of these businesses have been shown as a single line in the insurance margin line in 2011, consistent with associate accounting priciples. 2010 has been amended in light of this change.
II(b): Asian operations – analysis of IFRS operating profit by territory
Total long-term business operating profit 704 532 Eastspring Investments 80 72
New business strain (including Japan) (54) (57) Business in force 763 593
The IFRS new business strain corresponds to approximately 3 per cent of new business APE premiums for 2011 (2010: approximately 4 per cent of new business APE).
The strain reflects the aggregate of the pre-tax regulatory basis strain to net worth after IFRS adjustments for deferral of acquisition costs and deferred income where appropriate.
II(c): Analysis of asset management operating profit based on longer-term investment returns 2011 £m
Operating income before performance-related fees 706 196 122 249 1,273 Performance-related fees 21 6 – – 27
Average funds under management (FUM)† 199.8 bn 51.1 bn Margin based on operating income† 36 bps 40 bps Cost/income ratio‡ 60% 62%
Average funds under management (FUM)† 186.5 bn 47.2 bn Margin based on operating income† 34 bps 40 bps Cost/income ratio‡ 63% 64%
Note (i) M&G and Eastspring Investments can be further analysed as follows: M&G
bps * Operating income is net of commissions and includes performance-related fees, and for M&G carried interest on private equity investments. † Margin represents operating income as a proportion of the related funds under management (FUM). Opening and closing internal and external funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations which are managed by third parties outside of the Prudential Group are excluded from these amounts.
‡ Cost/income ratio is calculated as cost as a percentage of income excluding performance-related fees. § As noted above, the margins on operating income are based on the average of the opening and closing FUM balances. For M&G, if a monthly average FUM had been used, the retail margins would have been 95 bps for 2011 and 2010. ¶ Institutional includes internal funds.
III(a): Adoption of altered US GAAP requirements to Group IFRS reporting in 2012
Under the Group’s IFRS reporting, Prudential has the option to either continue with its current basis of measurement or improve its accounting policy under IFRS 4 to acknowledge the issuance of the Update. Prudential has chosen to continue with its current basis of measurement for reporting of its 2011 results and improve its policy in 2012 to apply the US GAAP update on the retrospective basis to the results of its US insurance operation, Jackson. The reason and timing for the change is to achieve consistency with the basis expected to be applied by peer competitor companies in the US market in their US GAAP financial statements. To ensure consistency, it is also intended to make the change on the retrospective basis in 2012 for the Asian operations that historically have effectively applied US GAAP for measuring insurance assets and liabilities.
Asian insurance operations(note (a)) 704 – 704 324 (2) 322 532 (10) 522 US insurance operations(note (b)) 694 (43) 651 368 (28) 340 833 (105) 728 Other operations 672 – 672 366 – 366 576 – 576
Tax attributable to shareholders – operating profit excluding, for 2010, exceptional tax credit: Exceptional 2010 tax credit related primarily to the impact of settlement agreed with the UK tax authorities – – – – – – 158 – 158
non-operating profit (1) 25 24 (61) 7 (54) 188 26 214 Non-controlling interests – operating profit (4) – (4) (2) – (2) (5) – (5)
III(a): Adoption of altered US GAAP requirements to Group IFRS reporting in 2012 continued
Notes on effect of change on operating profit based on longer-term investment returns (a) Asian insurance operations
New business Acquisition costs on new contracts not able to be deferred (156) (80) (159) Business in force at beginning of period Reduction in amortisation on reduced DAC balance 113 52 54
Profit for the year net of non-controlling interests 1,490 (75) 1,415 861 (32) 829 1,431 (125) 1,306
Exchange movements on foreign operations and net investment hedges, net of related tax (32) (5) (37) (75) 13 (62) 251 (14) 237
Total comprehensive income for the year net of non-controlling interests 1,770 (43) 1,727 877 (1) 876 2,160 (84) 2,076
Net increase in equity 1,086 (43) 1,043 470 (1) 469 1,760 (84) 1,676 At beginning of year 8,031 (510) 7,521 8,031 (510) 7,521 6,271 (426) 5,845
Equity Shareholders’ equity Asian insurance operations 2,349 (43) 2,306 2,269 (45) 2,224 2,149 (45) 2,104 US insurance operations 4,271 (510) 3,761 3,764 (466) 3,298 3,815 (465) 3,350 Rest of Group 2,497 – 2,497 2,468 – 2,468 2,067 – 2,067
III(b): IFRS shareholders’ funds summary by business unit and net asset value per share i Shareholders’ fund summary
Total of all operations 9,117 8,031 ii Net asset value per share
IV(a): Reconciliation of expected transfer of fair value of in-force (VIF) and required capital business of free surplus
The above amounts can be reconciled to the new business amounts as follows: 2011 £m
Undiscounted expected free surplus generation for years 2012 to 2051 2,702 1,253 602 4,557 Less: discount effect (1,611) (377) (355) (2,343)
Add: Expected free surplus to be generated in year 2051* – – – – – – 230 230
2011 expected free surplus generation for years 2012 to 2051 – 1,777 1,634 1,556 1,512 1,502 26,081 34,062
Asia £m £m £m £m £m £m Other £m Total £m 2010 expected free surplus generation for years 2011 to 2050 635 598 573 558 554 554 14,472 17,944
2011 expected free surplus generation for years 2012 to 2051 – 674 647 634 595 590 14,562 17,702 * Excluding 2011 new business.
£m £m £m £m £m £m Other £m Total £m 2010 expected free surplus generation for years 2011 to 2050 852 546 490 440 449 380 3,219 6,376
Less: Amounts expected to be realised in the current year (852) – – – – – – (852)
Foreign exchange differences – 4 4 3 4 3 23 41 New business – 245 103 96 16 102 691 1,253 Operating movements – (8) (2) 7 4 16 Non-operating and other movements – (107) (110) (96) 7 (17) (499) (805)
£m £m £m £m £m £m Other £m Total £m 2010 expected free surplus generation for years 2011 to 2050 436 407 516 451 443 433 8,847 11,533
Less: Amounts expected to be realised in the current year (436) – – – – – – (436)
New business – 20 21 23 18 20 500 602 Operating movements – 23 18 15 14 8 Non-operating and other movements – (27) (53) (17) (38) (33) (1,300) (1,390)
2011 expected free surplus generation for years 2012 to 2051 – 423 502 472 437 428 8,085 10,347 * Excluding 2011 new business.
Transfer to free surplus in 2011 597 754 511 1,862 Expected return on free assets 58 42 10 110 Operating variances 52 154 (38) 168 RPI to CPI inflation measure change on defined benefit pension schemes – – 20 20
Total discounted free surplus expected to emerge in the next 40 years 7,184 4,267 4,620 16,071 1,091 876 247 2,214
Discounted expected generation from all in-force business for years 2012 to 2051 16,071 Discounted expected generation from all in-force business for years after 2051 211
Discounted expected generation from all in-force business at 31 December 2011 16,282 Add: Free surplus of life operations held at 31 December 2011 2,839 Less: Time value of guarantees (685) Other non-modelled items* 1,214
Total EEV of life operations 19,650 * These relate to items where there is no definitive timeframe for when the payments will be made or receipts received and are, consequently, excluded from the amounts incorporated into the tables above showing the expected generation of free surplus from in-force business at 31 December 2011. In particular, it excludes the value of the shareholders’ interest in the estate.
Business area: Asian operations 32.6 30.9 US operations 71.9 63.6 UK operations 146.3 145.2
Note (i) External funds shown above for 2011 of £99.8 billion (2010: £100.4 billion) comprise £111.2 billion (2011: £111.4 billion) in respect of investment products, as published in the New Business schedules (see schedule 7) less £11.4 billion (2010: £11.0 billion) that are classified within internal funds.
Note (i) As included in the investments section of the consolidated statement of financial position at 31 December 2011, except for £0.2 billion
(2010: £0.4 billion) investment properties which are held-for-sale or occupied by the Group and, accordingly under IFRS, are included in other statement of financial position captions.
IV(c): Effect of foreign currency rate movements on results i Rates of exchange The profit and loss accounts of foreign subsidiaries are translated at average exchange rates for the year. Assets and liabilities of foreign subsidiaries are translated at closing exchange rates. Foreign currency borrowings that have been used to provide a hedge against Group equity investments in overseas subsidiaries are also translated at closing exchange rates. The impact of these translations is recorded as a component of the movement in shareholders’ equity.
Hong Kong 12.07 12.48 12.17 12.01 Indonesia 14,091.80 14,049.41 14,106.51 14,033.41 Malaysia 4.93 4.90 4.83 4.97 Singapore 2.02 2.02 2.01 2.11 India 82.53 74.80 70.01 70.66 Vietnam 32,688.16 33,139.22 30,526.26 29,587.63 USA 1.55 1.60 1.57 1.55
IV(c): Effect of foreign currency rate movements on results continued ii Effect of rate movement on results IFRS basis results
US operations: Jackson 694 803 Broker-dealer, asset management and Curian operations 24 21
UK operations: Long-term business 683 673 General insurance commission 40 46
Other income and expenditure (483) (449) RPI to CPI inflation measure change on defined benefit pension schemes 42 – Solvency II implementation costs (55) (45) Restructuring costs (16) (26)
Note (i) The ‘as published’ operating profit for 2011 and ‘memorandum’ operating profit for 2010 have been calculated by applying average 2011 exchange rates (CER).
Jackson 1,431 1,406 Broker-dealer, asset management and Curian operations 24 21
UK operations: New business 260 365 Business in force 593 571
The ‘as published’ shareholders’ funds for 2011 and memorandum’ shareholders’ funds for 2010 have been calculated by applying closing period end 2011 exchange rates.
d d itio n al u n au d ited fin an cial in fo rm atio n
The total number of securities available for issue under the scheme is 6,351,563, which represents 0.249 per cent of the issued share capital at 31 December 2011. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £6.65. The fair value of options granted under the Plan in the period was £2.63.
The total number of securities available for issue under the scheme is 2,792,355, which represents 0.110 per cent of the issued share capital at 31 December 2011. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £6.61. The fair value of options granted under the Plan in the period was £2.63.
End of period 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 1,520 – – – – 829 691 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 30,320 – – – – – 30,320 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 6,567 – – – – – 6,567 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 2,426 – – – – – 2,426
End of period 28 Sep 2006 4.75 01 Dec 2011 31 May 2012 8,577 – 3,191 – – – 5,386 26 Apr 2007 5.72 01 Jun 2010 30 Nov 2010 13,533 – – – – 13,533 – 26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 15,557 – – – – – 15,557 27 Sep 2007 5.52 01 Dec 2010 31 May 2011 19,595 – 11,988 – – – 7,607 27 Sep 2007 5.52 01 Dec 2012 31 May 2013 5,748 – – 2,778 – – 2,970 25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 20,951 – 14,723 1,639 – – 4,589 25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 4,195 – – 361 – – 3,834 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 42,741 – 666 1,587 – – 40,488 25 Sep 2008 4.38 01 Dec 2013 31 May 2014 17,135 – – 3,427 – – 13,708 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 897,848 – – 23,647 – – 874,201 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 749,908 – – 35,582 – – 714,326 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 50,612 – – 4,166 – – 46,446 25 Sep 2009 4.25 01 Dec 2014 31 May 2015 11,717 – – – – – 11,717 28 Sep 2010 4.61 01 Dec 2013 31 May 2014 1,136,477 – – 17,902 – – 1,118,575 28 Sep 2010 4.61 01 Dec 2015 31 May 2016 379,253 – – 3,901 – – 375,352 16 Sep 2011 4.66 01 Dec 2014 31 May 2015 – 649,598 – 5,191 – – 644,407 16 Sep 2011 4.66 01 Dec 2016 31 May 2017 – 266,624 – – – – 266,624
A number of factors (risk factors) affect Prudential’s operating results and financial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, is not updated, and any forward looking statements are made subject to the reservations specified below under ‘Forward Looking Statements’.
Prudential’s approaches to managing risks are explained in the ‘Business review’ section under ‘Risk and capital management’.
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profitability. Since 2008 Prudential has had to operate against a challenging background of periods of unprecedented volatility in global capital and equity markets, interest rates and liquidity, and widespread economic uncertainty. Government interest rates have also fallen to historic lows in the US and UK. These factors have, at times during this period, had a material adverse effect on Prudential’s business and profitability.
In the future, the adverse effects of such factors would be felt principally through the following items: • Investment impairments or reduced investment returns, which could impair Prudential’s ability to write significant volumes of new business and would have a negative impact on its assets under management and profit; • Higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses; • Prudential in the normal course of business enters into a variety of transactions with counterparties, including derivative transactions. Failure of any of these counterparties to discharge their obligations, or where adequate collateral is not in place, could have an adverse impact on Prudential’s results; and
• Estimates of the value of financial instruments being difficult because in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain value and estimates of value require substantial elements of judgement, assumptions and estimates (which may change over time). Increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline.
For some non-unit-linked investment products, in particular those written in some of the Group’s Asian operations, it may not be possible to hold assets which will provide cash flows to match exactly those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets where regulated surrender values are set with reference to the interest rate environment prevailing at the time of policy issue. This results in a mismatch due to the duration and uncertainty of the liability cash flows and the lack of sufficient assets of a suitable duration. While this residual asset/liability mismatch risk can be managed, it cannot be eliminated. Where interest rates in these markets remain lower than interest rates used to calculate surrender values over a sustained period, this could have an adverse impact on Prudential’s reported profit.
A significant part of the profit from Prudential’s UK insurance operations is related to bonuses for policyholders declared on with-profits products, which are broadly based on historical and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns.
Prudential is subject to the risk of potential sovereign debt credit deterioration owing to the amounts of sovereign debt obligations held in its investment portfolio Prudential is subject to the risk of potential sovereign debt credit deterioration and default. During 2011 and 2012, this risk has heightened, particularly in relation to European and US sovereign debt. Investing in such instruments creates exposure to the direct or indirect consequences of political, social or economic changes (including changes in governments, heads of states or monarchs) in the countries in which the issuers are located and the creditworthiness of the sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject. Periods of economic uncertainty may affect the volatility of market prices of sovereign debt to a greater extent than the volatility inherent in debt obligations of other types of issues. If a sovereign were to default on its obligations, this could have a material adverse effect on Prudential’s financial condition and results of operations.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due to their geographical diversity, Prudential’s businesses are subject to the risk of exchange rate fluctuations. Prudential’s operations in the US and Asia, which represent a significant proportion of operating profit and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon translation of results into pounds sterling. The currency exposure relating to the translation of reported earnings is not currently separately managed. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within other comprehensive income. Consequently, this could impact on Prudential’s gearing ratios (defined as debt over debt plus shareholders’ funds).
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates Changes in government policy, legislation (including tax) or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. Also, regulators in jurisdictions in which Prudential operates may change the level of capital required to be held by individual businesses or could introduce possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of the recent interventions by governments in response to global economic conditions, it is widely expected that there will be a substantial increase in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure and enhanced supervisory powers.
Current EU directives, including the EU Insurance Groups Directive (‘IGD’), require European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a somewhat higher amount of regulatory capital at the group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. The EU is also developing a new solvency framework for insurance companies, referred to as ‘Solvency II’. The new approach will be based on the concept of three pillars – minimum capital requirements, supervisory review of firms’ assessment of risk, and enhanced disclosure requirements – and will cover valuations, the treatment of insurance groups, the definition of capital and the overall level of capital requirements. A key aspect of Solvency II is that the assessment of risks and capital requirements will be aligned more closely with economic capital methodologies, and may allow Prudential to make use of its internal economic capital models, if approved by the Financial Services Authority (FSA) or other relevant supervisory authority. The Solvency II Directive was formally approved by the Economic and Financial Affairs Council in November 2009. The European Parliament is currently discussing the Omnibus II Directive which, once approved, will amend the Solvency II Directive. In addition, the European Commission is continuing to develop the detailed rules that will complement the high-level principles of the Directive, referred to as ‘implementing measures’. The Omnibus II Directive is expected to be finalised during 2012, with the implementing measures expected to be finalised later in 2012. There is significant uncertainty regarding the final outcome of this process. As a result there is a risk that the effect of the measures finally adopted could be adverse for Prudential, including potentially a significant increase in capital required to support its business and that Prudential may be placed at a competitive disadvantage to other European and non-European financial services groups.
The Group’s accounts are prepared in accordance with current International Financial Reporting Standards (‘IFRS’) applicable to the insurance industry. The International Accounting Standards Board (‘IASB’) introduced a framework that it described as Phase I, which permitted insurers to continue to use the statutory basis of accounting for insurance assets and liabilities that existed in their jurisdictions prior to January 2005. In July 2010, the IASB published an Exposure Draft for its Phase II on insurance accounting, which would introduce significant changes to the statutory reporting of insurance entities that prepare accounts according to IFRS. The IASB continues its deliberation on the exposure draft principles but it remains uncertain whether the proposals in the Exposure Draft will become the final IASB standard and when changes might take effect.
Within the UK, Prudential’s principal competitors in the life market include many of the major retail financial services companies including, in particular, Aviva, Legal & General, Lloyds Banking Group and Standard Life.
Jackson’s competitors in the US include major stock and mutual insurance companies, mutual fund organisations, banks and other financial services companies such as AIG, AXA Financial Inc., Hartford Life Inc., Prudential Financial, Lincoln National, MetLife and TIAA-CREF.
Prudential’s long-term senior debt is rated as A2 by Moody’s, A+ by Standard & Poor’s and A by Fitch. These ratings have a stable outlook.
The Prudential Assurance Company Limited’s financial strength is rated Aa2 by Moody’s, AA by Standard & Poor’s and AA by Fitch. These ratings have a stable outlook.
In addition, changes in methodologies and criteria used by rating agencies could result in downgrades that do not reflect changes in the general economic conditions, or Prudential’s financial condition.
Further, because of the long-term nature of much of the Group’s business, accurate records have to be maintained for significant periods. Prudential’s systems and processes incorporate controls which are designed to manage and mitigate the operational risks associated with its activities. For example, any weakness in the administration systems or actuarial reserving processes could have an impact on its results of operations during the effective period. Prudential has not experienced or identified any operational risks in its systems or processes during 2011, which have subsequently caused, or are expected to cause, a significant negative impact on its results of operations.
Adverse experience against the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations Prudential needs to make assumptions about a number of factors in determining the pricing of its products and setting reserves, and for reporting its capital levels and the results of its long-term business operations. For example, the assumption that Prudential makes about future expected levels of mortality is particularly relevant for its UK annuity business. In exchange for a premium equal to the capital value of their accumulated pension fund, pension annuity policyholders receive a guaranteed payment, usually monthly, for as long as they are alive. Prudential conducts rigorous research into longevity risk, using data from its substantial annuitant portfolio. As part of its pension annuity pricing and reserving policy, Prudential’s UK business assumes that current rates of mortality continuously improve over time at levels based on adjusted data from the Continuous Mortality Investigations (CMI), as published by the Institute and Faculty of Actuaries. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
Prudential operates in a number of markets through joint ventures and other arrangements with third parties (including in China and India), involving certain risks that Prudential does not face with respect to its consolidated subsidiaries Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures (including in China and India). For the Group’s joint venture operations, management control is exercised jointly with the venture participants. The level of control exercisable by the Group depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants. Prudential may also face financial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture, or encounters financial difficulty. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could adversely affect the results of operations of Prudential.
Actual exchange rate (AER) Actual exchange rates are actual historical exchange rates for the specific accounting period, being the average rates over the period for the income statement and the closing rates for the balance sheet at the balance sheet date.
Asset backed security (ABS) A security whose value and income payments are derived from and collateralised (or ‘backed’) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually.
Available-for-sale (AFS) Securities that have been acquired neither for short-term sale nor to be held to maturity. Shown at fair value on the statement of financial position and changes in value are taken straight to equity instead of the income statement.
Bancassurance The distribution of insurance products through bank branches and/or joint ventures with banks.
• Final bonus – an additional bonus expected to be paid when policyholders take money from the policies. If investment return has been low over the lifetime of the policy, a final bonus may not be paid. Final bonuses may vary and are not guaranteed.
Discretionary participation features or DPF A contractual right to receive, as a supplement to guaranteed benefits, additional benefits: • that are likely to be a significant portion of the total contractual benefits,
Duration The number of years required to receive the present value of a stream of future cash flow, which is often used as an indicator of a bond’s price volatility resulting from changes in interest rates.
First year premiums These are premiums received in the first year of a recurring premium policy.
Fixed annuities Fixed annuity contracts written in the US which allow for tax-deferred accumulation of funds, are used for asset accumulation in retirement planning and for providing income in retirement and offer flexible payout options. The contract holder pays the insurer a premium, which is credited to the contract holders account. Periodically, interest is credited to the contract holders account and administrative charges are deducted, as appropriate.
Fixed indexed annuities These are similar to fixed annuities, in that the contract holder pays the insurer a premium, which is credited to the contract holder’s account, and periodically, interest is credited to the contract holders account and administrative charges are deducted, as appropriate. An annual minimum interest rate may be guaranteed, although actual interest credited may be higher and is linked to an equity index over its indexed option period.
Guaranteed minimum income benefit (GMIB) (US) A guarantee that ensures, under certain conditions, that the owner may annuitise the variable annuity contract based on the greater of (a) the actual account value or (b) a payout base equal to premiums credited with some interest rate, or the maximum anniversary value of the account prior to annuitisation.
Investment grade Investments rated BBB- or above for S&P or Baa3 or above for Moodys. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.
Investment-linked products or contracts Insurance products where the surrender value of the policy is linked to the value of underlying investments (such as collective investment schemes, internal investment pools or other property) or fluctuations in the value of underlying investment or indices. Investment risk associated with the product is usually borne by the policyholder. Insurance coverage, investment and administration services are provided for which the charges are deducted from the investment fund assets. Benefits payable will depend on the price of the units prevailing at the time of surrender, death or the maturity of the product, subject to surrender charges. These are also referred to as unit-linked products or unit linked contracts.
Investment property Property (land and/or a building or part of a building) held to earn rentals or for capital appreciation or both, rather than for use by the Prudential Group’s operations.
Medium term note (MTN) A general obligation of a company, sold through investment banks, with maturities generally in the three to 10-year range.
Net asset value per share Shareholders equity divided by the number of ordinary shares in issue.
Net worth Regulatory basis net assets for EEV reporting purposes. These net assets are sometimes subject to minor adjustment to achieve consistency with the IFRS treatment of certain items.
New business contribution The profits, calculated in accordance with European Embedded Value Principles, from business sold in the financial reporting period under consideration.
New business margin The value of new business on an EEV basis, expressed as a percentage of the present value of new business premiums expected to be received from the new business.
• EEV basis – similar to as described under IFRS but under EEV basis, where additional profit and loss effects arise, operating profit based on longer-term investment returns also excludes the mark to market value movements on core structural borrowings and the effect in changes in economic assumptions and changes in the time value of cost of options and guarantees arising from changes in economic factors.
Participating funds Distinct portfolios where the policyholders have a contractual right to receive, at the discretion of the insurer, additional benefits based on factors such as the performance of a pool of assets held within the fund, as a supplement to any guaranteed benefits. The insurer may either have discretion as to the timing of the allocation of those benefits to participating policyholders, or may have discretion as to the timing and the amount of the additional benefits. For Prudential the most significant participating funds are with-profits funds for business written in the UK, Hong Kong, Malaysia and Singapore.
Renewal premiums Premiums receivable in subsequent years of a multi-year insurance policy.
Sarbanes-Oxley The Sarbanes-Oxley Act, officially named the Public Company Accounting Reform and Investor Protection Act of 2002, became law on 30 July 2002 in response to high-profile business failures, in order to reinforce investor confidence and protect investors by improving the accuracy and reliability of corporate disclosure. All companies (both foreign and domestic in the US), including Prudential, that have registered equity or debt securities under the Securities Exchange Act of 1934 are subject to the Sarbanes-Oxley Act.
Scottish Amicable Insurance Fund (SAIF) SAIF is a ring-fenced sub-fund of the Prudential Assurance Company’s long-term fund following the acquisition of the mutually owned Scottish Amicable Life Assurance Society in 1997. The fund is solely for the benefit of policyholders of SAIF. Shareholders of Prudential plc have no interest in the profits of this fund, although they are entitled to asset management fees on this business.