Net increase in shareholders’ equity 4,763 2,318 854 7,935 100 (953) 7,082 Shareholders’ equity at beginning of year: Effect of implementation of Solvency II note 2 – – (473) (473) – – (473) Other opening adjustments note (v) 66 – 279 345 – (345) –
Notes (i) Other operations of £(4,070) million represents the shareholders’ equity of £(4,315) million for other operations as shown in the movement in shareholders’ equity and includes goodwill of £245 million (2015: £233 million) related to Asia long-term operations.
(iv) The additional retained loss on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of £(357) million (2015: £(353) million), as shown in note 8.
Loss attaching to held for sale Korea life business note 9 (86) – (86) (309) (395)
Profit for the year from long-term business 2,062 425 2,487 2,380 4,867 Exchange movements on foreign operations and
Profit for the year from long-term business 557 224 781 1,868 2,649
Note The net value of in-force business comprises the value of future margins from current in-force business less the cost of holding required capital as shown below: Asia operations
Cost of time value of guarantees (87) (911) – (998) (88) (1,012) – (1,100)
Net value of in-force business 14,807 7,354 2,776 24,937 10,754 6,114 2,330 19,198 * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results in the table above are presented after the adjustments for the impact of Solvency II for UK insurance operations at 1 January 2016, together with the effect of a classification change, as discussed in note 9(v).
For EEV covered business, free surplus is the excess of the regulatory basis net assets for EEV reporting purposes (net worth) over the capital required to support the covered business. Where appropriate, adjustments are made to the net worth so that backing assets are included at fair value rather than cost so as to comply with the EEV Principles. Free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis post-tax earnings and shareholders’ equity, net of goodwill. Free surplus for other operations is taken to be EEV basis post-tax earnings and shareholders’ equity for central operations, net of goodwill, with subordinated debt recorded as free surplus to the extent that it is classified as available capital under Solvency II.
Free surplus for insurance and asset management operations and Group total free surplus, including other operations, are shown in the tables below.
Asia operations Underlying free surplus generated from in-force life business 1,210 951 1,064 27% 14% Investment in new business note (iii)(a) (476) (386) (426) (23)% (12)%
Broker-dealer and asset management note (iii)(b) (3) 7 8 (143)% (138)%
UK insurance operations Underlying free surplus generated from in-force life business 907 878 878 3% 3% Investment in new business note (iii)(a) (129) (65) (65) (98)% (98)%
Underlying free surplus generated from insurance and asset management operations 3,588 3,043 3,276 18% 10%
Asset management and general insurance commission note (iii)(b) 508 506 518 0% (2)%
* The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year.
(iii) Movement in free surplus – long-term business and asset management operations 2016 £m
Loss attaching to held for sale Korea life business note 10 (86) – (86) – (86) Other non-operating items note (c) (932) (38) (970) (169) (1,139)
Disposal of Japan life business 23 – 23 – 23 Results of the held for sale Korea life business note 17 15 – 15 – 15 Other non-operating items note (c) (415) (53) (468) 29 (439)
Balance at end of year 5,642 1,124 6,766 1,224 7,990 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details).
Mark to market value movements on Jackson assets backing surplus and required capital note 9 (11) – (11) – (11)
(iii) Movement in free surplus – long-term business and asset management operations continued
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) basis results 12 Expected transfer of value of in-force business and required capital to free surplus
* In order to show the cash flows for UK insurance operations on a comparable basis, the 2015 comparative results for UK insurance operations reflect the impact of the implementation of Solvency II at 1 January 2016 (see note 2 for details).
Note ‘Other items’ represent amounts incorporated into VIF where there is no definitive time frame for when the payments will be made or receipts received. In particular, other items include the deduction 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.
(a) Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2016 and 31 December 2015 and the new business contribution after the effect of required capital for 2016 and 2015 to: — 1 per cent increase in the discount rates; — 1 per cent increase in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); — 0.5 per cent decrease in interest rates* (1 per cent decrease for 2015), 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); — The statutory minimum capital level by contrast to EEV basis required capital for (embedded value only); and — 5 basis points increase in UK long-term expected defaults.
* To reflect the current level of low interest rates, the sensitivity of new business contribution and embedded value to a 0.5 per cent reduction in interest rates is shown for 2016.
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long-term business operations and include the combined effect on the value of in-force business and net assets at the balance sheet dates indicated. If the change in assumptions shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year. These are for the effect of economic assumption changes and short-term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition for changes in interest rates, the effect shown above for Jackson would also be recorded within the fair value movements on assets backing surplus and required capital, which are taken directly to shareholders’ equity.
(ii) Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency, mortality and morbidity, as described in note 15. These assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the non-diversifiable risks associated with the cash flows that are not otherwise allowed for.
New business profitability is a key metric for the Group’s management of the development of the business. In addition, post-tax new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP). These margins are calculated as the percentage of the value of new business profit to APE and PVNBP. APE is calculated as the aggregate of regular premiums and one-tenth of single premiums. PVNBP is calculated as equalling single premiums plus the present value of expected premiums of regular premium new business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
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Valuation movements on investments With the exception of debt securities held by Jackson, investment gains and losses during the year (to the extent that changes in capital values do not directly match changes in liabilities) are included directly in the profit for the year and shareholders’ equity as they arise.
Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for Jackson securities classified as available-for-sale, movements in unrealised appreciation (depreciation) on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.
(iii) Cost of capital A charge is deducted from the embedded value for the cost of locked-in required capital supporting the Group’s long-term business. The cost is the difference between the nominal value of the capital and the discounted value of the projected releases of this capital, allowing for post-tax investment earnings on the capital.
US operations (Jackson) The principal financial options and guarantees in Jackson are associated with the fixed annuity (FA) and variable annuity (VA) lines of business.
Jackson also issues fixed index annuities (FIA) that enable policyholders to obtain a portion of an equity-linked return while providing a guaranteed minimum return. The guaranteed minimum returns are of a similar nature to those described above for fixed annuities.
The Group’s main exposure to guaranteed annuity options in the UK is through the non-covered business of SAIF. A provision on the Solvency II basis of £571 million was held in SAIF at 31 December 2016 (Pillar I Peak 2 basis at 31 December 2015: £412 million) to honour the guarantees. As described in note 14(a)(i), the assets and liabilities are wholly attributable to the policyholders of the fund. Therefore the movement in the provision has no direct impact on shareholders’ funds.
Time value The value of financial options and guarantees comprises two parts: — The first part arises from a deterministic valuation on best estimate assumptions (the intrinsic value); and — The second part arises from the variability of economic outcomes in the future (the time value).
(v) Level of required capital In adopting the EEV Principles, Prudential has based required capital on its internal targets subject to it being at least the local statutory minimum requirements.
(vii) Internal asset management The in-force and new business results from long-term business include the projected value of profits or losses from asset management and service companies that support the Group’s covered insurance businesses. The results of the Group’s asset management operations include the current year profits from the management of both internal and external funds. EEV basis shareholders’ other income and expenditure is adjusted to deduct the unwind of the expected internal asset management profit margin for the year. The deduction is on a basis consistent with that used for projecting the results for covered insurance business. Group operating profit accordingly includes the variance between actual and expected profit in respect of management of the assets for covered business.
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 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.
The risk discount rate incorporates an additional allowance for credit risk premium and short-term downgrades and defaults as shown in note 15(ii). In determining this allowance a number of factors have been considered. These factors, in particular, include: — How much of the credit spread on debt securities represents an increased credit risk not reflected in the RMR long-term default assumptions, and how much is liquidity premium (which is the premium required by investors to compensate for the risk of longerterm investments which cannot be easily converted into cash, and converted at the fair market value). In assessing this effect, consideration has been given to a number of approaches to estimating the liquidity premium by considering recent statistical data; and
— 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 investment return rates credited to policyholders. Consequently, it is only necessary to allow for the balance of the credit risk in the risk discount rate.
The level of the additional allowance is assessed at each reporting period to take account of prevailing credit conditions and as the business inforce alters over time. The additional allowance for variable annuity business has been set at one-fifth of the non-variable annuity business to reflect the proportion of the allocated holdings of general account debt securities.
In 2015, the allowance for liquidity premium was based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for expected long-term defaults, a credit risk premium, an allowance for a 1-notch downgrade of the asset portfolio subject to credit risk; and an allowance for short-term downgrades and defaults.
(3) With-profits 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 risk-free, 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.
A base level allowance of 50 basis points is applied to cover the non-diversifiable non-market risks associated with the Group’s businesses. For the Group’s Asia operations in China, Indonesia, the Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points. For the Group’s US business and UK business, no additional allowance is necessary.
In 2015, for UK shareholder-backed annuity business, a further allowance of 50 basis points was used to reflect the longevity risk, which is covered by the solvency capital requirements following the implementation of Solvency II from 1 January 2016.
(x) Taxation In determining the post-tax profit for the year for covered business, the overall tax rate includes the impact of tax effects determined on a local regulatory basis. Tax payments and receipts included in the projected cash flows to determine the value of in-force business are calculated using rates that have been announced and substantively enacted by the end of the reporting period.
(xi) Inter-company arrangements The EEV results for covered business incorporate annuities established in the PAC non-profit sub-fund from vesting pension policies in SAIF (which is not covered business). The EEV results also incorporate the effect of the reinsurance arrangement of non-profit immediate pension annuity liabilities of SAIF to the PAC non-profit sub-fund.
(b) Accounting presentation (i) Analysis of post-tax profit To the extent applicable, the presentation of the EEV post-tax profit for the year is consistent in the classification between operating and non-operating results with the basis that the Group applies for the analysis of IFRS basis results. Operating results reflect underlying results including longer-term investment returns (which are determined as described in note 14(b)(ii)) and incorporate the following: — New business contribution, as defined in note 14(a)(ii); — Unwind of discount on the value of in-force business and other expected returns, as described in note 14(b)(iii); — The impact of routine changes of estimates relating to operating assumptions, as described in note 14(b)(iv); and — Operating experience variances, as described in note 14(b)(v).
(ii) Investment returns included in operating profit For the investment element of the assets covering the net worth of long-term insurance business, investment returns are recognised in operating results at the expected long-term rate of return. These expected returns are calculated by reference to the asset mix of the portfolio. For the purpose of calculating the longer-term investment return to be included in the operating result of the PAC with-profits fund of UK operations, where assets backing the liabilities and unallocated surplus are subject to market volatility, asset values at the beginning of the reporting period are adjusted to remove the effects of short-term market movements as explained in note 14(b)(iii).
UK operations In applying this general approach, the unwind of discount included in operating profit is determined by reference to the following: — The unwind is determined by reference to an implied single risk discount rate for 2016. Following the implementation of Solvency II the EEV risk-free rate is based on a yield curve (as set out in note 14a(viii)), which is used to derive a single implied discount rate which, if this rate had been used, would reproduce the same embedded value as that calculated by reference to the yield curve. The difference between the operating profit determined using the single implied discount rate and that derived using the yield curve is included within non-operating profit; and
Principal economic assumptions The EEV basis results for the Group’s operations have been determined using economic assumptions where the long-term expected rates of return on investments and risk discount rates are set by reference to year-end risk-free rates of return (defined below for each of the Group’s insurance operations). Expected returns on equity and property asset classes and corporate bonds are derived by adding a risk premium, based on the Group’s long-term view, to the risk-free rate.
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long-term inflation %New business In-force business 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Total weighted risk discount rate note (a) 5.3 5.9 6.1 6.4 Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each country’s risk discount rates by reference to the post-tax EEV basis new business contribution and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in 10-year government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
(b) For Hong Kong the assumptions shown are for US dollar denominated business. For other territories, the assumptions are for local currency denominated business. (c) Equity risk premiums in Asia range from 3.5 per cent to 8.7 per cent (2015: from 3.5 per cent to 8.6 per cent). (d) The mean equity return assumptions for the most significant equity holdings of the Asia operations are: Hong Kong 6.5 6.3
(ii) US operations The risk-free rates of return for US operations are defined as 10-year treasury bond yield at the end of the year.
January to June issues 1.25 1.25 July to December issues 1.25 1.50
Fixed index annuity business: January to June issues 1.50 1.50 July to December issues 1.50 1.75
Non-variable annuity: Risk discount rate 4.1 3.9 Additional allowance for credit risk included in risk discount ratenote 14(a)(viii) 1.0 1.0
Weighted average total: New business 6.8 6.7 In-force business 6.5 6.2
(iii) UK insurance operations Effective from 1 January 2016, following the implementation of Solvency II, the EEV risk-free rate is based on the full term structure of interest rates, ie a yield curve, which is used to determine the embedded value at the end of the reporting period. For 2016, these yield curves are used to derive pre-tax expected long-term nominal rates of investment return and risk discount rates. For the purpose of determining the unwind of discount in the analysis of operating profit, these yield curves are used to derive a single implied risk discount rate, as explained in note 14(a)(viii).
For 2015, risk-free rates of return and risk discount rates were based on a flat 15-year gilt yield at the end of the year. The key economic assumptions are shown below for both years, for 2016 the single implied risk discount rate is shown, along with the 15-year nominal rate of return based on the yield curve. For 2015 the long-term nominal rates of return are shown.
Risk discount rate: New business 3.9 5.7 In-force business 4.5 7.4
Expected 15-year/long-term rate of inflation 3.6 3.1 Equity risk premium 4.0 4.0 * The risk discount rates for with-profits and other business shown above represents a weighted average total of the rates applied to determine the present value of future cash flows, including a portion of future with-profits business shareholders’ transfers recognised in net worth.
(b) The table below shows the pattern of the UK risk-free Solvency II spot yield curve at the end of 31 December 2016: Stochastic assumptions Details are given below of the key characteristics of the models used to determine the time value of the financial options and guarantees as referred to in note 14(a)(iv).
(v) US operations (Jackson) — Interest rates and equity returns are projected using a log-normal generator reflecting historical market data; — Corporate bond returns are based on treasury yields plus a spread that reflects current market conditions; and — The volatility of equity returns ranges from 18 per cent to 27 per cent for both years, and the standard deviation of interest rates ranges from 2.3 per cent to 2.6 per cent (2015: from 2.2 per cent to 2.5 per cent).
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Operating assumptions Best estimate assumptions Best estimate assumptions are used for the cash flow projections, where best estimate is defined as the mean of the distribution of future possible outcomes. The assumptions are reviewed actively and changes are made when evidence exists that material changes in future experience are reasonably certain.
Tax rates The assumed long-term effective tax rates for operations reflect the incidence of taxable profits and losses in the projected cash flows as explained in note 14(a)(x).
Notes on the EEV basis results Continued 16 New business premiums and contributions note (i)
US insurance operations Variable annuities 10,653 11,977 – – 1,065 1,198 10,653 11,977 Elite Access (variable annuity) 2,056 3,144 – – 206 314 2,056 3,144 Fixed annuities 555 477 – – 55 48 555 477 Fixed index annuities 508 458 – – 51 46 508 458 Wholesale 1,836 1,230 – – 184 123 1,836 1,230
Total UK and Europe insurance operations 9,836 8,463 177 179 1,160 1,025 10,513 9,069
Group total excluding UK bulk annuities† 27,841 26,179 3,536 2,697 6,320 5,315 45,392 39,275 * For 2016, the risk discount rates used to calculate PVNBP for UK insurance operations are on a basis that reflects the Solvency II regime effective on 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year.
† The new business premiums and contributions exclude the results attributable to the held for sale Korea life business (see note 17 for details). The 2015 comparatives have been similarly adjusted.
(ii) New business in China is included at Prudential’s 50 per cent interest in the China life operation. (iii) New business in India is included at Prudential’s 26 per cent interest in the India life operation.
Notes on the EEV basis results Continued 17 Agreement to sell Korea life business
Consistent with the classification of the business as held for sale for IFRS reporting, the EEV carrying value has been set to £105 million at 31 December 2016, representing the estimated proceeds, net of £9 million of related expenses.
Operating profit New business contribution 3 8 Profit from business in force 3 33
Underlying free surplus generated New business contribution (9) (27) Profit from business in force 3 34
The directors have chosen to prepare supplementary information in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (the EEV Principles) using the methodology and assumptions set out in the Notes on the EEV basis results.
In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2016 has been properly prepared, in all material respects, in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (the EEV Principles) using the methodology and assumptions set out in the Notes on the EEV basis results.
Respective responsibilities of directors and auditor As explained more fully in the Directors’ responsibilities statement set out on page 361, the Directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
07 A dditional inform ation 07 Additional information 364 Index to the additional unaudited financial information 392 Risk factors 402 Shareholder information 405 How to contact us
I. IFRS profit and loss information 365 a Analysis of long-term insurance business pre-tax IFRS
operating profit based on longer-term investment returns by driver 372 b Asia operations – analysis of IFRS operating profit by territory 373 c Analysis of asset management operating profit based on longer-term investment returns 374 d Contribution to UK Life financial metrics from specific management actions undertaken to position the balance sheet more efficiently under the new Solvency II regime
I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: — Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets.
— With-profits business represents the gross of tax shareholders’ transfer from the with-profits fund for the year. — Insurance margin primarily represents profits derived from the insurance risks of mortality and morbidity. — Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses. — Acquisition costs and administration expenses represent expenses incurred in the year attributable to shareholders. 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 sources of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate).
Margin on revenues 1,919 – 207 2,126 Expenses: Expected return on shareholder assets 99 12 110 221
Longevity reinsurance and other management actions to improve solvency 332 332 Provision for review of past annuity sales (175) (175)
Longevity reinsurance and other management actions to improve solvency 400 400
Margin on revenues 1,919 1,643 1,821 Expenses: DAC adjustments note (v) 148 97 108
— Fee income increased by 2 per cent on a constant exchange rate basis to £174 million in 2016 (AER: 13 per cent), broadly in line with the increase in movement in average unit-linked liabilities.
Analysis of US operating profit drivers: — Spread income declined on a constant exchange rate basis by 5 per cent to £802 million in 2016 (AER increased by 8 per cent). The reported spread margin decreased to 217 basis points from 241 basis points in 2015, primarily due to lower investment yields. Spread income benefited from swap transactions previously entered into to more closely match the asset and liability duration. Excluding this effect, the spread margin would have been 153 basis points (2015 CER: 167 basis points and AER: 166 basis points).
— Fee income increased on a constant exchange rate basis by 3 per cent to £1,942 million in 2016 (AER: 16 per cent), primarily due to positive net inflows from variable annuity business and fund appreciation during the second half of the year. Fee income margin has remained broadly in line with the prior year at 190 basis points (2015 CER and AER: 192 basis points).
— Acquisition costs, which are commissions and expenses incurred to acquire new business, including those that are not deferrable, have decreased by 17 per cent at a constant exchange rate basis, largely due to lower sales in 2016.
— Administration expenses increased to £959 million in 2016 compared to £934 million for 2015 at constant exchange rates (AER £828 million), primarily as a result of higher asset-based commissions . These are paid on policy anniversary dates and are treated as an administration expense in this analysis. Excluding these trail commissions, the resulting administration expense ratio would be 34 basis points (2015 CER and AER: 36 basis points).
Analysis of pre-tax operating profit before and after acquisition costs and DAC adjustments 2015 CER £m note (iii)
Analysis of operating profit based on longer-term investment returns for US operations by product
Life and other business note (c) 206 197 223 5% (8)%
The analysis of operating profit based on longer-term investment returns for US operations by product represents the net profit generated by each line of business after allocation of costs. Broadly: a) Spread business is the net operating profit for fixed annuity, fixed indexed annuity and guaranteed investment contracts and largely comprises spread income less costs.
Longevity reinsurance and other management actions to improve solvency 332 400 Provision for review of past annuity sales (175) –
– A contribution from in-force annuity and other business, which was broadly in line with last year at £136 million (2015: £135 million), equivalent to 42 basis points of average reserves (2015: 43 basis points).
— Fee income principally represents asset management fees from unit-linked business, including direct investment only business to group pension schemes, where liability flows are driven by a small number of large single mandate transactions and fee income mostly arises within our UK asset management business. Excluding these schemes, the fee margin on the remaining balances was 40 basis points (2015: 43 basis points).
(iv) For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as a proxy for average balances throughout the year. The calculation of average liabilities for Jackson is generally derived from month end balances throughout the year, as opposed to opening and closing balances only. In 2016, given the significant equity market fluctuations in certain months during the year, average liabilities for fee income in Jackson have been calculated using daily balances instead of month end balances in order to provide a more meaningful analysis of the fee income, which is charged on the daily account balance. The 2015 average liabilities for fee income in Jackson have been calculated based on average of month end balances. The alternative use of the daily balances to calculate the average would have resulted in no change to the margin on the CER basis. Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administration expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson. Average liabilities are adjusted for business acquisitions and disposals in the year.
South-east Asia operations including Hong Kong 1,292 1,018 1,136 27% 14%
Notes (i) Analysis of operating profit between new and in-force business. The result for insurance operations comprises amounts in respect of new business and business in force as follows: AER CER
New business strain* (29) 5 7 Business in force 1,469 1,108 1,234 Non-recurrent items note (ii) 67 62 66 * The IFRS new business strain corresponds to approximately (0.8) per cent of new business APE premiums for 2016 (2015: approximately 0.2 per cent of new business APE).
I(c) Analysis of asset management operating profit based on longer-term investment returns 2016 £m
Share of associate’s results 13 – – – 13 Group’s share of tax on joint ventures’ operating profit – (21) – – (21)
Operating profit based on longer-term investment returns 425 141 27 (4) 589
Operating income (net of commission) note (i) 961 307 118 321 1,707
Share of associate’s results 14 – – 14 Group’s share of tax on joint ventures’ operating profit – (16) – (16)
bps * Margin represents operating income before performance-related fees as a proportion of the related funds under management (FUM). Monthly 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 that are managed by third parties outside of the Prudential Group are excluded from these amounts.
Other management actions to improve solvency 41 69 110 75 Provision for the review of past annuity sales – (145) (145) –
Operating profit from in-force business 259 116 375 545 New business profit: Total post-tax Life EEV operating profit 384 259 643 863 *The 2016 results for the UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016. The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year.
Net cash remitted by business units: UK life net remittances to the Group
Net remittances to the Group from business units1 1,718 1,625 Net interest paid (333) (290) Tax received 132 145 Corporate activities (215) (209)
Total holding company cash flow 370 673 Cash and short-term investments at beginning of year 2,173 1,480 Foreign exchange movements 83 20
1 Net cash remittances comprise dividends and other transfers from business units that are reflective of emerging earnings and capital generation. 2 Non-operating net cash flow principally relates to the issue of subordinated debt less the repayment of debt and payments for distribution rights. 3 Including central finance subsidiaries.
Notes (i) Prudential Group funds under management comprise: 2016 £bn 2015 £bn
Total investments per the consolidated statement of financial position 421.7 352.0 Less: investments in joint ventures and associates accounted for using the equity method (1.2) (1.0) Investment properties which are held for sale or occupied by the Group (included in other IFRS captions) 0.4 0.4 Internally managed funds held in joint ventures 7.0 5.6
Note The £182.5 billion (2015: £162.7 billion) investment products comprise £174.8 billion (2015: £156.7 billion) plus Asia Money Market Funds of £7.7 billion (2015: £6.0 billion).
Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2016 of £7.7 billion (2015: £6.0 billion).
II(c) Solvency II capital position at 31 December 2016 The estimated Group shareholder Solvency II surplus at 31 December 2016 was £12.5 billion, before allowing for payment of the 2016 second interim ordinary dividend and after allowing for recalculation of transitional measures as at 31 December 2016.
The Group shareholder Solvency II capital position excludes: — A portion of Solvency II surplus capital (£1.4 billion at 31 December 2016) relating to the Group’s Asian life operations, including due to ‘contract boundaries’; — The contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds in surplus (representing £3.7 billion of surplus capital from UK with-profits funds at 31 December 2016) and from the shareholders’ share of the estate of with-profits funds; and
It also excludes unrealised gains on certain derivative instruments taken out to protect Jackson against declines in long-term interest rates. At Jackson’s request, the Department of Insurance Financial Services renewed its approval to carry these instruments at book value in the local statutory returns for the period 31 December 2016 to 1 October 2017. At 31 December 2016, this approval had the effect of decreasing local statutory capital and surplus (and by extension Solvency II Own Funds and Solvency II surplus) by £0.3 billion, net of tax. This arrangement reflects an elective long-standing practice first put in place in 2009, which can be unwound at Jackson’s discretion.
Korea is included in the Solvency II results above, pending local regulatory approval for the sale, which once complete will increase the shareholder Solvency II ratio by around 1 percentage point.
Reconciliation of IFRS equity to Group Solvency II Shareholder Own Funds
The key items of the reconciliation as at 31 December 2016 are: — £2.2 billion represents the adjustment required to the Group’s shareholders’ funds in order to convert Jackson’s contribution from an IFRS basis to the local statutory valuation basis. This item also reflects a derecognition of Own Funds of £0.9 billion, equivalent to the value of 100 per cent of Risk Based Capital requirements (Company Action Level), as agreed with the Prudential Regulation Authority; — £3.8 billion due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £6.3 billion due to the addition of subordinated debt which is treated as available capital under Solvency II but as a liability under IFRS; — £3.4 billion due to the inclusion of a risk margin for UK and Asia non-hedgeable risks, net of £2.5 billion transitionals, all of which are not applicable under IFRS; — £4.0 billion due to the inclusion of the value of future shareholder transfers from with-profits business (excluding the shareholders’ share of the with-profits estate, for which no credit is given under Solvency II), which is excluded from the determination of the Group’s IFRS shareholders’ funds; — £10.5 billion due to differences in insurance valuation requirements between Solvency II and IFRS, with Solvency II Own Funds partially capturing the value of in-force business which is excluded from IFRS; and
— £1.3 billion due to the impact on the valuation of deferred tax assets and liabilities resulting from the other valuation differences noted above.
Sensitivity analysis The estimated sensitivity of the Group shareholder Solvency II capital position to significant changes in market conditions is as follows: Impact of market sensitivities
Impact of: 20% instantaneous fall in equity markets 0.0 3% (1.0) (7)%
Notes 1 Where hedges are dynamic, rebalancing is allowed for by assuming an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four-week period. 2 Subject to a floor of zero. 3 Allowing for further transitional recalculation after the interest rate stress. 4 US Risk Based Capital solvency position included using a stress of 10 times expected credit defaults.
* The UK shareholder capital position excludes the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position at 31 December 2016 includes the impact of recalculated transitionals at the valuation date which has reduced the UK shareholder surplus from £5.0 billion to £4.6 billion.
While the surplus position of the UK with-profits funds remains strong on a Solvency II basis, it is ring-fenced from the shareholder balance sheet and is therefore excluded from both the Group and the UK shareholder Solvency II surplus results. The estimated UK with-profits funds Solvency II surplus at 31 December 2016 was £3.7 billion, after allowing for recalculation of transitional measures as at 31 December 2016.
Reconciliation of UK with-profits IFRS unallocated surplus to Solvency II Own Funds2
Annual regulatory reporting The Group will publish its Solvency and Financial Condition Report and related quantitative templates no later than 1 July 2017. The templates will require us to combine the Group shareholder solvency position with those of all other ring-fenced funds across the Group. In combining these solvency positions, the contribution to own funds from these ring-fenced funds will be set equal to their aggregate solvency capital requirements, estimated at £6.2 billion (ie the solvency surplus in these ring-fenced funds will not be captured in the templates). There will be no impact on the reported Group Solvency II surplus.
Notes 1 The UK shareholder capital position represents the consolidated capital position of the shareholder funds of The Prudential Assurance Company Ltd (PAC) and all its subsidiaries. 2 The UK with-profits capital position includes the PAC with-profits sub-fund, the Scottish Amicable Insurance Fund and the Defined Charge Participating Sub-Fund.
II(d) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus The tables below show how the value of in-force business (VIF) generated by the in-force long-term business and the associated required capital is modelled as emerging into free surplus over the next 40 years. Although a small amount (less than 3 per cent) of the Group’s embedded value emerges after this date, analysis of cash flows emerging in the years shown in the tables is considered most meaningful. The modelled cash flows use the same methodology underpinning the Group’s embedded value reporting and so are subject to the same assumptions and sensitivities used to prepare our 2016 results.
Expected period of emergence Asia† US UK Total Asia† US UK Total
Total free surplus expected to emerge in the next 40 years 34,280 15,970 13,783 64,033 5,350 2,101 639 8,090 * The analysis excludes amounts incorporated into VIF at 31 December 2016 where there is no definitive timeframe for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the estate. It also excludes any free surplus emerging after 2056.
The above amounts can be reconciled to the new business amounts as follows: 2016 £m
Undiscounted expected free surplus generation for years 2017 to 2056 5,350 2,101 639 8,090
Discounted expected free surplus generation for years 2017 to 2056 2,382 1,355 380 4,117 Discounted expected free surplus generation for years 2056+ 292 – 1 293 Less: Free surplus investment in new business (476) (298) (129) (903)
Less: Amounts expected to be realised in the current year (2,667) – – – – – – (2,667) Less: Contribution from the held for sale
Operating movements – 11 18 (16) 5 (36) Non-operating and other movements – 97 128 69 (11) (18) (521) (274)
2016 expected free surplus generation for years 2017 to 2056 – 3,441 3,195 3,111 3,070 3,030 48,186 64,033
Asia 2016 £m £m £m £m £m £m Other £m Total £m 2015 expected free surplus generation for years 2016 to 2055 1,015 962 926 905 871 889 20,640 26,208
Less: Amounts expected to be realised in the current year (1,015) – – – – – – (1,015)
Less: Contribution from the held for sale Korea life business‡ – (40) (40) (37) (35) (33) (537) (722)
Add: Expected free surplus to be generated in year 2056* – – – – – – 358 358
2016 expected free surplus generation for years 2017 to 2056 – 1,320 1,247 1,202 1,167 1,142 28,202 34,280
£m £m £m £m £m £m Other £m Total £m 2015 expected free surplus generation for years 2016 to 2055: 1,120 991 951 970 1,018 982 6,665 12,697
Non-operating and other movements – (1) 34 8 (54) (33) 153 60 2016 expected free surplus generation for years 2017 to 2056 – 1,446 1,279 1,273 1,281 1,282 9,409 15,970
At 31 December 2016, the total free surplus expected to be generated over the next five years (2017 to 2021 inclusive), using the same assumptions and methodology as those underpinning our 2016 embedded value reporting was £15.8 billion, an increase of £3.3 billion from the £12.5 billion expected over an equivalent period from the end of 2015, after allowing for the effect of the implementation of Solvency II on the opening balance sheet.
This increase primarily reflects the new business written in 2016, which is expected to generate £1,788 million of free surplus over the next five years.
At 31 December 2016, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £64.0 billion, up from the £52.4 billion expected at the end of 2015, after allowing for the effect of the implementation of Solvency II on the opening balance sheet, reflecting the effect of new business written across all three business operations of £8.1 billion and a positive foreign exchange translation effect of £6.8 billion. These positive effects have been offset by the negative impact of £(0.7) billion for the removal of the contribution from the Korea life business following its reclassification as held for sale and a £(0.3) billion net effect reflecting operating, market assumption changes and other items. In Asia, these include the negative impact from movements in long-term interest rates and other regular operating assumption changes. In the US, these mainly reflect the positive effect of higher future separate account growth due to the increase in interest rates and the impact of an increase in equity market returns in 2016, partially offset by the negative effect from the acceleration of free surplus from the contingent financing of specific US statutory reserves. In the UK, these mainly arise from the positive effect of higher than assumed investment returns on with-profits funds, partially offset by the negative effect of longevity reinsurance transactions entered into during the year. The longevity reinsurance transactions executed this year had the effect of accelerating the generation of future free surplus into 2016. The overall growth in the Group’s undiscounted value of free surplus reflects our ability to write both growing and profitable new business.
Actual underlying free surplus generated in 2016 from life business in-force at the end of 2016 was £4.0 billion including £0.8 billion of changes in operating assumptions and experience variances. This compares with the expected 2016 realisation at the end of 2015 of £2.7 billion. This can be analysed further as follows: Asia £m
Underlying free surplus generated from in-force life business in 2016 1,210 1,866 907 3,983 2016 free surplus expected to be generated at 31 December 2015 1,015 1,120 532 2,667
Total discounted free surplus expected to emerge in the next 40 years 15,314 10,556 7,740 33,610 2,382 1,355 380 4,117
The above amounts can be reconciled to the Group’s financial statements as follows: 2016 £m
Discounted expected generation from all in-force business for years 2017 to 2056 33,610 Discounted expected generation from all in-force business for years after 2056 1,115
(ii) Expected emergence of risk margin release and amortisation of transitional The 31 December 2016 Solvency II own funds included £2.5 billion of transitional relief (recalculated at the valuation date), the majority of which relates to UK annuity business in force on 1 January 2016, established to substantially mitigate the impact of recognising the related risk margin on transition to Solvency II. The following table sets out the expected UK annuity business risk margin release net of the related transitional amortisation over the next 15 years.
UK free surplus expected to emerge by 2031 1,876 (1,740) 7,999 8,135 Total UK free surplus expected to emerge from 2032 to 2056 5,648
Annuity in-force business: – Risk margin release less amortisation of transitional expected to emerge by 2031 1.9 (1.7) – Risk margin release expected to emerge after 2031 and gross up for tax 1.1 (0.4)
II(e) Foreign currency source of key metrics The tables below show the Group’s key free surplus, IFRS and EEV metrics analysis by contribution by currency group: Free surplus and IFRS 2016 results
II(f) Option schemes The Group presently grants share options through four schemes, and exercises of the options are satisfied by the issue of new shares. Executive directors and eligible employees based in the UK may participate in the UK savings-related share option scheme. Executives and eligible employees based in Asia as well as eligible employees based in Europe can participate in the international savings-related share option scheme, while agents based in certain regions of Asia can participate in the international savings-related share option scheme for non-employees. Employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan, which currently has no outstanding options in issue. Further details of the schemes and accounting policies are detailed in Note B3.2 of the IFRS basis consolidated financial statements.
The options schemes will terminate as follows, unless the directors resolve to terminate the plans at an earlier date: — UK savings-related share option scheme: 16 May 2023; — International savings-related share option scheme: 31 May 2021; — Prudential International Assurance sharesave plan: 3 August 2019; and — International savings-related share option scheme for non-employees 2012: 17 May 2022.
The weighted average share price of Prudential plc for the year ended 31 December 2016 was £13.56 (2015: £15.49). Particulars of options granted to directors are included in the Directors’ remuneration report on page 109. The closing price of the shares immediately before the date on which the options were granted during the year was £13.71. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2016.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £14.80.
The weighted average fair value of options granted under the plan in the period was £2.96.
Prudential International Assurance sharesave plan There are no securities available for issue under the scheme at 31 December 2016.
The total number of securities available for issue under the scheme is 3,330,661 which represents 0.129 per cent of the issued share capital at 31 December 2016.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £15.01.
The weighted average fair value of options granted under the plan in the period was £3.09.
Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance (59,366) (29,656) (50,169) (43,154) (45,144)
Remeasurement of carrying value of Korea life business classified as held for sale (238) – – – Disposal of Japan life business: Cumulative exchange loss recycled from other comprehensive income – (46) – – –
Share of profits from joint ventures and associates, net of related tax 182 238 303 147 135
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)note 1 3,212 3,321 3,154 2,082 3,117
Tax charges attributable to policyholders’ returns (937) (173) (540) (447) (370)
Profit before tax attributable to shareholders 2,275 3,148 2,614 1,635 2,747 Tax credit (charge) attributable to shareholders’ returns (354) (569) (398) (289) (584)
Based on profit for the year attributable to the equity holders of the Company: Basic earnings per share (in pence) 75.0p 101.0p 86.9p 52.8p 85.1p Diluted earnings per share (in pence) 75.0p 100.9p 86.8p 52.7p 85.0p
Dividend per share declared and paid in reporting period (in pence) 49.40p 38.05p 35.03p 30.52p 25.64p Interim ordinary dividend/final ordinary dividend 39.40p 38.05p 35.03p 30.52p 25.64p Special dividend 10.00p
Operating profit based on longer-term investment returnsnote 2 4,256 3,969 3,154 2,937 2,504
Profit before tax attributable to shareholders 2,275 3,148 2,614 1,635 2,747
Core structural borrowings of shareholder-financed operations 6,798 5,011 4,304 4,636 3,554
EEV shareholders’ equity, excluding non-controlling interests 39.0 32.4 29.2 24.9 22.4 Group shareholder Solvency II surplusnote 4 12.5 9.7 n/a n/a n/a Insurance Groups Directive capital surplus before final dividend n/a 5.5 4.7 5.1 5.1
3 Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations. 4 The 2016 surplus is estimated.
(b) Other adjustments represent asset and liability valuation differences between IFRS and the local regulatory reporting basis used to value net worth for long-term insurance operations. It also includes the mark to market of the Group’s core borrowings which are fair valued under EEV but not IFRS. The most significant valuation differences relate to changes in the valuation of insurance liabilities. For example, in Jackson where IFRS liabilities are higher than the local regulatory basis as they are principally based on policyholder account balances (with a deferred acquisition costs recognised as an asset) whereas the local regulatory basis used for EEV is based on future cash flows due to the policyholder on a prudent basis with consideration of an expense allowance as applicable, but with no separate deferred acquisition cost asset.
(c) The 2016 EEV results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime, effective from 1 January 2016. The 2015 EEV results for UK insurance operations were prepared on a basis reflecting the Solvency I regime. As noted in (b) above, ‘other adjustments’ represent asset and liability valuation differences between IFRS and the local regulatory basis used to value net worth for long-term insurance operations. At 31 December 2016 for the UK this would be the difference between IFRS and Solvency II, and at 31 December 2015 the difference between IFRS and Solvency I.
II(i) Reconciliation of APE new business sales to earned premiums The Group reports annual premium equivalent (APE) new business sales as a measure of the new policies sold in the period. This differs from the IFRS measure of premiums earned as shown below: Annual premium equivalents (APE) as published 6,320 5,466 Adjustment to include 100% of single premiums on new business sold in the period note (a) 25,057 24,918 Contribution from the held for sale Korea life business 192 305 Premiums from in-force business and other adjustments note (b) 7,412 5,974
Prudential’s approaches to managing risks are explained in the ‘Group Chief Risk Officer’s report on the risks facing our business and how these are managed’ section of this document.
In the future, the adverse effects of such factors would be felt principally through the following items: — Investment impairments and/or reduced investment returns, which could reduce Prudential’s capital and impair its ability to write significant volumes of new business, increase the potential adverse impact of product guarantees, or have a negative impact on its assets under management and profit; — Higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses; — Failure of counterparties who have transactions with Prudential (eg banks and reinsurers) to meet commitments that could give rise to a negative impact on Prudential’s financial position and on the accessibility or recoverability of amounts due or, for derivative transactions, adequate collateral not being in place; — Estimates of the value of financial instruments 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 such values require substantial elements of judgement, assumptions and estimates (which may change over time); and
On 23 June 2016, the UK held a referendum in which a majority of the voting population voted in favour of the UK leaving the European Union (EU). The UK is expected to submit a formal notification of its intention to withdraw from the EU by the end of March 2017. Once this notification has been submitted, the UK will have a period of a maximum two years to negotiate the terms of its withdrawal from the EU. If no formal withdrawal agreement is reached between the UK and the EU, then it is expected the UK’s membership of the EU will automatically terminate two years after the submission of the notification of the UK’s intention to withdraw from the EU. The vote in favour of the UK leaving the EU will have political, legal and economic ramifications for both the UK and the EU, although these are expected to be more pronounced for the UK. The Group has several UK domiciled operations, including Prudential UK and M&G, and these may be impacted by a UK withdrawal from the EU. The potential outcome of the negotiations on UK withdrawal and any subsequent negotiations on trade and access to the country’s major trading markets, including the single EU market is currently unknown. The ongoing uncertainty of when the UK will leave the EU, whether any form of transitional arrangements will be agreed between the UK and the EU, and the possibility of a lengthy period before negotiations are concluded may increase volatility in the markets where the Group operates and create the potential for a general downturn in economic activity and for further or prolonged interest rate reductions in some jurisdictions due to monetary easing and investor sentiment.
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 those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets where regulated premium and claim 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 those used to calculate premium and claim values over a sustained period, this could have a material adverse effect on Prudential’s reported profit.
In the US, fluctuations in prevailing interest rates can affect results from Jackson which has a significant spread‑based business, with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates. Declines in spread from these products or other spread businesses that Jackson conducts, and increases in surrender levels arising from interest rate rises, could have a material impact on its businesses or results of operations.
Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. The value of these guarantees is affected by market factors (such as interest rates, equity values, bond spreads and realised volatility) and policyholder behaviour. There could be market circumstances where the derivatives that Jackson enters into to hedge its market risks may not fully cover its exposures under the guarantees. The cost of the guarantees that remain unhedged will also affect Prudential’s results.
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 Investing in sovereign debt 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.
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 and legislation (including in relation to tax and
The Dodd‑Frank Act represents a comprehensive overhaul of the financial services industry within the US that, among other reforms to financial services entities, products and markets, may subject financial institutions designated as systemically important to heightened prudential and other requirements intended to prevent or mitigate the impact of future disruptions in the US financial system. The full impact of the Dodd‑Frank Act on Prudential’s businesses remains unclear, as many of its provisions are primarily focused on the banking industry, have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years.
The IAIS has various initiatives which are detailed in this section. On 18 July 2013, it published a methodology for identifying G‑SIIs, and a set of policy measures that will apply to them, which the FSB endorsed. An updated methodology for identifying G‑SIIs was published by the IAIS on 16 June 2016. Groups designated as a G‑SII are subject to additional regulatory requirements, including enhanced group‑wide supervision, effective resolution planning, development of a Systemic Risk Management Plan, a Recovery Plan and a Liquidity Risk Management Plan. Prudential’s designation as a G‑SII was reaffirmed on 21 November 2016. Prudential is monitoring the development and potential impact of the policy measures and is continuing to engage with the PRA on the implications of the policy measures and Prudential’s designation as a G‑SII.
The G‑SII regime also introduces two types of capital requirements. The first, a Basic Capital Requirement (BCR), is designed to act as a minimum group capital requirement and the second, a Higher Loss Absorption (HLA) requirement reflects the drivers of the assessment of G‑SII designation. The IAIS intends for these requirements to take effect from January 2019, but G‑SIIs will be expected to privately report to their group‑wide supervisors in the interim.
The IAIS is also developing ComFrame which is focused on the supervision of Internationally Active Insurance Groups (IAIGs). ComFrame will establish a set of common principles and standards designed to assist regulators in addressing risks that arise from insurance groups with operations in multiple jurisdictions. As part of this, work is underway to develop a global Insurance Capital Standard (ICS) that is intended to apply to IAIGs. Once the development of the ICS has been concluded, it is intended to replace the BCR as the minimum group capital requirement for G‑SIIs. A consultation on the ICS was concluded in 2016 and the IAIS intends to publish an interim version of the ICS in 2017. Further field testing, consultations and private reporting to group‑wide supervisors on the interim version are expected over the coming years, and the ICS is expected to be adopted as part of ComFrame by the IAIS in late 2019.
Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event
The resolution of several issues affecting the financial services industry could have a negative impact on Prudential’s reported results or on its relations with current and potential customers Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the UK and internationally. These actions could involve a review of types of business sold in the past under acceptable market practices at the time, such as the requirement in the UK to provide redress to certain past purchasers of pensions and mortgage endowment policies, changes to the tax regime affecting products, and regulatory reviews on products sold and industry practices, including, in the latter case, lines of business it has closed. Current regulatory actions include the UK business’s undertaking to the Financial Conduct Authority to review annuities sold without advice after 1 July 2008 to its contract‑based defined contribution pension customers and potentially provide redress to certain such customers.
In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. New requirements could be introduced in these and other regulatory regimes that challenge legal structures, current sales practices, or could retrospectively be applied to sales made prior to their introduction, which could have a negative impact on Prudential’s business or reported results.
In Asia, the Group’s principal competitors in the region are international financial companies, including global life insurers such as Allianz, AXA, AIA and Manulife, and multinational asset managers such as J.P.Morgan Asset Management, Schroders, HSBC Global Asset Management, and Franklin Templeton. In a number of markets, local companies have a very significant market presence.
Risk factors Continued companies, mutual fund organisations, banks and other financial services companies such as AIG, AXA Financial Inc., Allianz, Prudential Financial, Lincoln National, MetLife, and Aegon.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and damage its relationships with creditors or trading counterparties Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings, as a result of, for example, decreased profitability, increased costs, increased indebtedness or other concerns, could have an adverse effect on its ability to market products; retain current policyholders; and on the Group’s financial flexibility. In addition, the interest rates Prudential pays on its borrowings are affected by its credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations.
Prudential plc’s long‑term senior debt is rated as A2 by Moody’s, A+ by Standard & Poor’s, and A by Fitch. These ratings are all on a stable outlook.
Prudential plc’s short‑term debt is rated as P‑1 by Moody’s, A‑1 by Standard & Poor’s, and F1 by Fitch.
The Prudential Assurance Company Limited’s financial strength is rated Aa3 (negative outlook) by Moody’s, AA (stable outlook) by Standard & Poor’s, and AA (stable outlook) by Fitch.
Adverse experience in the operational risks inherent in Prudential’s business could disrupt its business functions and have a negative impact on its results of operations Operational risks are present in all of Prudential’s businesses, including the risk (from both Prudential and its outsourcing partners) of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential also employs a large number of models and user‑developed applications in its processes. Further, because of the long‑term nature of much of the Group’s business, accurate records have to be maintained for significant periods.
These factors, among others, result in significant reliance on and require significant investment in information technology (IT), compliance and other operational systems, personnel and processes. In addition, Prudential outsources several operations, including a significant part of its UK back office and customer‑facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
Such events could, among other things, harm Prudential’s ability to perform necessary business functions, result in the loss of confidential or proprietary data (exposing it to potential legal claims and regulatory sanctions) and damage its reputation and relationships with its customers and business partners. Similarly, any weakness in administration systems (such as those relating to policyholder records or meeting regulatory requirements) or actuarial reserving processes could have a material adverse effect on its results of operations during the effective period.
Attempts by third parties to disrupt Prudential’s IT systems could result in loss of trust from Prudential’s customers, reputational damage and financial loss Being part of the financial services sector, Prudential and its business partners are increasingly exposed to the risk that third parties may attempt to disrupt the availability, confidentiality and integrity of its IT systems, which could result in disruption to the key operations, make it difficult to recover critical services, damage assets and compromise data (both corporate or customer). This could result in loss of trust from Prudential’s customers, reputational damage and direct or indirect financial loss. The cyber‑security threat continues to evolve globally in sophistication and potential significance. As a result of Prudential’s increasing market profile, the growing interest by customers to interact with their insurance provider and asset manager through the internet and social media, improved brand awareness and the classification of Prudential as a G‑SII, there is an increased likelihood of Prudential being considered a target by cyber criminals. To date, Prudential has not identified a failure or breach which has had a material impact in relation to its legacy and other IT systems and processes. However, it has been, and likely will continue to be, subject to potential damage from computer viruses, attempts at unauthorised access and cyber‑security attacks such as ‘denial of service’ attacks (which, for example, can cause temporary disruption to websites and IT networks), phishing and disruptive software campaigns.
Adverse experience relative to the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations In common with other life insurers, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity levels and trends, policy surrenders and take‑up rates on guarantee features of products, investment performance and impairments, unit cost of administration and new business acquisition expenses.
Another example is the impact of epidemics and other effects that give rise to a large number of deaths or additional sickness claims. Significant influenza epidemics have occurred a number of times over the past century but the likelihood, timing, or the severity of future epidemics cannot be predicted. The effectiveness of external parties, including governmental and non‑governmental organisations, in combating the spread and severity of any epidemics could have a material impact on the Group’s loss experience.
Prudential may face financial, reputational and other exposure (including regulatory censure) in the event that any of its partners fails to meet its obligations under the arrangements, encounters financial difficulty, or fails to comply with local or international regulation and standards such as those pertaining to the prevention of financial crime. In addition, a significant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements, such as through significant deterioration in the reputation, financial position or other circumstances of the third party or material failure in controls (such as those pertaining to the prevention of financial crime) could adversely affect the results of operations of Prudential.
Prudential’s Articles of Association contain an exclusive jurisdiction provision Under Prudential’s Articles of Association, certain legal proceedings may only be brought in the courts of England and Wales. This applies to legal proceedings by a shareholder (in its capacity as such) against Prudential and/or its Directors and/or its professional service providers. It also applies to legal proceedings between Prudential and its Directors and/or Prudential and Prudential’s professional service providers that arise in connection with legal proceedings between the shareholder and such professional service provider. This provision could make it difficult for US and other non‑UK shareholders to enforce their shareholder rights.
Changes in tax legislation may result in adverse tax consequences Tax rules, including those relating to the insurance industry, and their interpretation may change, possibly with retrospective effect, in any of the jurisdictions in which Prudential operates. Significant tax disputes with tax authorities, and any change in the tax status of any member of the Group or in taxation legislation or its scope or interpretation could affect Prudential’s financial condition and results of operations.
Annual Exchange Rates (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.
Bonuses Bonuses refer to the non-guaranteed benefit added to participating life insurance policies and are the way in which policyholders receive their share of the profits of the policies. There are normally two types of bonus: — Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and
Deferred acquisition costs or DAC Acquisition costs are expenses of an insurer which are incurred in connection with the acquisition of new insurance contracts or the renewal of existing insurance policies. They include commissions and other variable sales inducements and the direct costs of issuing the policy, such as underwriting and other policy issue expenses. Typically, under IFRS, an element of acquisition costs are deferred, ie not expensed in the year incurred, and instead amortised in the income statement in line with the emergence of surpluses on the related contracts.
www.prudential.co.uk� Annual�Report�2016 Prudential plc 399 07 A dditional inform ation 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 holder’s 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.
Group free surplus Group free surplus at the end of the period comprises free surplus for the insurance businesses, representing the excess of the net worth over the required capital included in the EEV results, and IFRS net assets for the asset management businesses excluding goodwill. The free surplus generated during the period comprises the movement in this balance excluding foreign exchange, capital and other reserve movements. Specifically, it includes amounts maturing from the in-force operations during the period less the investment in new business, the effect of market movements and other one-off items.
Guaranteed investment contract (GIC) (US) An investment contract between an insurance company and an institutional investor, which provides a stated rate of return on deposits over a specified period of time. They typically provide for partial or total withdrawals at book value if needed for certain liquidity needs of the plan.
Guaranteed minimum withdrawal benefit (GMWB) (US) A guarantee in a variable annuity that promises that the owner may make annual withdrawals of a defined amount for the life of the owner or until the total guaranteed amount is recovered, regardless of market performance or the actual account balance.
Liquidity coverage ratio Prudential calculates this as assets and resources available to us that are readily convertible to cash to cover corporate obligations in a prescribed stress scenario. We calculate this ratio over a range of time horizons extending to 12 months.
Non-participating business A life insurance policy where the policyholder is not entitled to a share of the company’s profits and surplus, but receives certain guaranteed benefits. Also known as non-profit in the UK. Examples include pure risk policies (eg fixed annuities, term insurance, critical illness) and unit-linked insurance contracts.
Operational borrowings Borrowings which arise in the normal course of the business.
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.
Regular premium product A life insurance product with regular periodic premium payments.
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.
Communication with shareholders The Group maintains a corporate website containing a wide range of information relevant for private and institutional investors, including the Group’s financial calendar www.prudential.co.uk
Details of the 2016 AGM, including the major items discussed at the meeting and the results of the voting, can be found on the Company’s website.
Prudential has maintained a sufficiency of public float throughout the reporting period as required by the Hong Kong Listing Rules.
As at 13 March 2017, no notifications have been received since the year end.
As at 13 March 2017, Trustees held 0.47 per cent of the issued share capital under the various plans in operation.
All Directors are required to hold a minimum number of shares under guidelines approved by the Board, which they would also be expected to retain as described on page 131 of the Directors’ remuneration report.
Details of shares issued during 2015 and 2016 are given in note C10 on page 275.
In accordance with the terms of a waiver granted by the Hong Kong Stock Exchange, Prudential confirms that it complies with the applicable law and regulation in the UK in relation to the holding of shares in treasury and with the conditions of the waiver in connection with the purchase of own shares and any treasury shares it may hold.
Shareholder enquiries For enquiries about shareholdings, including dividends and lost share certificates, please contact the Company’s registrars: Register By post By telephone
Principal UK register Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA.
Textel 0371 384 2255 (for hard of hearing). Lines are open from 8.30am to 5.30pm (UK), Monday to Friday. International shareholders Tel +44 (0)121 415 7026
Tel +1 800 990 1135 or from outside the US +1 651 453 2128 or log on to www.adr.com
Phuong Lan holds PRUmultiple care and PRU-Wealth Assured policies from Prudential Vietnam. These products provide financial protection against critical illness during Phuong Lan’s lifetime, ensure availability of funds to help realise her goals in her later years, and enhance her family’s prosperity.
Providing financial security since 1848 Successive generations have looked to Prudential to safeguard their financial security – from industrial workers and their families in Victorian Britain, to around 24 million insurance customers worldwide today. Our financial strength, heritage, prudence and focus on our customers’ long‑term needs ensure that people continue to turn to our trusted brands to help them plan for today and tomorrow.
Prudential Corporation Asia is formed in Hong Kong as a regional head office to expand operations beyond an existing presence in Malaysia, Singapore and Hong Kong.
Prudential and CITIC launch the first Sino‑British life insurance joint venture in China.
Prudential acquires businesses in Ghana and Kenya, marking its entry into the fast‑growing African life insurance industry.
In June 1949, an article describing the life and work of a long‑serving Prudential agent, Fred Sawyer, appeared in the Weekly Illustrated magazine. One of the pictures was so striking that it prompted Prudential’s publicity department to use it in their next advertising campaign, and the figure of Fred Sawyer came to represent a typical agent.
‘“Service,” says Pru agent Sawyer, “is the secret of success”. He has 1,500 clients and collects in the morning and evening, fitting in clerical work in the afternoon. But he still finds time to be a special constable, a school manager and a district councillor. “I know the people,” says Mr Sawyer, “I wouldn’t change my job for any other.”’
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