The 2014 final dividend of 25.74 pence per ordinary share will be paid on 21 May 2015 in sterling to shareholders on the principal register and the Irish branch register at 6.00pm BST on 27 March 2015 (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 (US Shareholders) will be paid their dividends in US dollars on or about 29 May 2015. The final dividend will be paid on or about 28 May 2015 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 using the exchange rate quoted by the WM Company at the close of business on 9 March 2015. The exchange rate at which the dividend payable to the SG Shareholders will be translated into Singapore dollars, will be determined by CDP.
Intangible assets attributable to withprofits funds: Goodwill in respect of acquired subsidiaries for venture fund and other investment purposes C5.2(a) – – 186 186 – – – 186
Total policyholder liabilities and unallocated surplus of with-profits funds C4 42,170 126,746 154,436 323,352 – – (1,363) 321,989
Core structural borrowings of shareholder-financed operations: Subordinated debt – – – – – 3,320 – 3,320
Operational borrowings attributable to shareholder-financed operations C6.2 – 179 74 253 6 2,004 – 2,263
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 2,161 22 5,174 7,357 – – – 7,357
Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method D6 268 – 449 717 92 – – 809
Assets held for sale D1 916 – – 916 – – – 916 Cash and cash equivalents note (iii) 1,522 604 2,586 4,712 1,562 511 – 6,785
Liabilities held for sale D1(b) 868 – – 868 – – – 868
(ii) Included within other non-investment and non-cash assets are accrued investment income of £2,667 million (2013: £2,609 million) and other debtors of £1,852 million (2013: £1,746 million).
Of the total cash and cash equivalents, £304 million (31 December 2013: £511 million) is held centrally and considered to be available for general use by the Group. The remaining funds are considered not to be available for general use by the Group, and include funds held for the benefit of policyholders.
C1: Analysis of Group position by segment and business type continued
C1.2 Group statement of financial position – analysis by business type
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes 186 – – – – – 186 177
Deferred acquisition costs and other intangible assets 61 – – – – – 61 72
Assets held for sale D1(b) – 286 538 – – – 824 916
Unallocated surplus of with-profits funds 12,450 – – – – – 12,450 12,061
Total policyholder liabilities and unallocated surplus of with-profits funds C4.1(a) 118,039 118,915 85,035 – – – 321,989 286,014
Core structural borrowings of shareholder-financed operations: Subordinated debt – – – – 3,320 – 3,320 3,662
Borrowings attributable to with-profits operations C6.2 1,093 – – – – – 1,093 895
Intangible assets attributable to with-profits funds: Deferred acquisition costs and other intangible assets 54 – – 54 66
Unallocated surplus of with-profits funds note (ii) 2,102 – – 2,102 77
Notes (i) The statement of financial position for with-profits business comprises the with-profits assets and liabilities of the Hong Kong, Malaysia and Singapore with-profits operations. Assets and liabilities of other participating business are included in the column for ‘Other business’.
Deferred tax assets – 2,343 2,343 2,042 Other non-investment and non-cash assets note (iv) – 6,617 6,617 6,710
Liabilities Policyholder liabilities: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) note (v) 81,741 45,005 126,746 107,411
Notes (i) These amounts are for separate account assets and liabilities for all variable annuity products comprising those with and without guarantees. Assets and liabilities attaching to variable annuity business that are not held in the separate account, eg, in respect of guarantees are shown within other business. (ii) Other investments comprise: Derivative assets* 916 766 Partnerships in investment pools and other† 754 791 * After taking account of the derivative liabilities of £251 million (2013: £515 million), which are also included in other non-insurance liabilities, the derivative position for US operations is a net asset of £665 million (2013: £251 million).
(v) In addition to the policyholder liabilities above, Jackson has entered into a programme of funding arrangements under contracts, which, in substance are almost identical to GICs. The liabilities under these funding agreements totalled, £844 million (2013: £485 million) and are included in other non-insurance liabilities in the statement of financial position above.
(vi) Changes in shareholders’ equity: Operating profit based on longer-term investment returns B1.1 1,431 1,243 Short-term fluctuations in investment returns B1.2 (1,103) (625) Amortisation of acquisition accounting adjustments arising from the purchase of REALIC (71) (65)
alan ce sh eet n o tes 175 Prudential plc Annual Report 2014
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) 6,690 82,389 23,300 31,709 55,009 144,088 134,632 Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds) C4.1(d) – 10,348 – – – 10,348 11,984
Notes (i) The PAC with-profits sub-fund (WPSF) mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). Included in the PAC with-profits fund is £11.7 billion (2013: £12.2 billion) of non-profits annuities liabilities. The WPSF’s profits are apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution is determined via the annual actuarial valuation. For the purposes of this table and subsequent explanation, references to the WPSF also include, for convenience, the amounts attaching to the Defined Charges Participating Sub-fund which comprises 3.8 per cent of the total assets of the WPSF and includes the with-profits annuity business transferred to Prudential from the Equitable Life Assurance Society on 1 December 2007 (with assets of approximately £1.7 billion). Profits to shareholders on this with-profits annuity business emerge on a ‘charges less expenses’ basis and policyholders are entitled to 100 per cent of the investment earnings.
alan ce sh eet n o tes 177 Prudential plc Annual Report 2014
Other non-investment and non-cash assets 1,308 228 69 1,605 1,475 Investments in joint ventures and associates accounted for using the equity method 35 – 72 107 92 Financial investments: Equity securities and portfolio holdings in unit trusts 61 – 18 79 65
Liabilities Core structural borrowing of shareholder-financed operations 275 – – 275 275 Operational borrowings attributable to shareholder-financed operations 6 – – 6 – Intra-group debt represented by operational borrowings at Group level note (ii) 2,004 – – 2,004 1,933 Other non-insurance liabilities note (iii) 2,757 217 92 3,066 3,512
Total intra-group debt represented by operational borrowings at Group level 2,004 1,933
Intangible assets attributable to shareholders: Goodwill – – 1,463 1,463 Deferred acquisition costs and other intangible assets – – 7,261 7,261
Investment properties 12,764 – – 12,764 12,764 Investments accounted for using the equity method – – 1,017 1,017 Loans note (iv) 2,291 – 10,550 12,841 13,548 Equity securities and portfolio holdings in unit trusts 144,862 – – 144,862 144,862 Debt securities note (v) 112,354 32,897 – 145,251 145,251 Other investments note (vi) 7,623 – – 7,623 7,623 Deposits – – 13,096 13,096 13,096
Assets held for sale note (vii) 824 – – 824 824 Cash and cash equivalents – – 6,409 6,409 6,409
alan ce sh eet n o tes 179 Prudential plc Annual Report 2014 2014 £m
Core structural borrowings of shareholder-financed operations – – 4,304 4,304 4,925 Other borrowings: Operational borrowings attributable to shareholder-
C3: Assets and liabilities – Classification and Measurement continued 2013 £m
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities – – 218,185 218,185 Investment contract liabilities with discretionary participation features note (iii) – – 35,592 35,592 Investment contract liabilities without discretionary participation features 17,736 – 2,440 20,176 20,177 Unallocated surplus of with-profits funds – – 12,061 12,061
(ii) Realised gains and losses on the Group’s investments for 2014 recognised in the income statement amounted to a net gain of £2.9 billion (2013: £2.5 billion). (iii) The carrying value of investment contracts with discretionary participation features is on IFRS 4 basis. It is impractical to determine the fair value of these contracts due to the lack of a reliable basis to measure participation features.
(iv) Loans and receivables are reported net of allowance for loan losses of £21 million (2013: £62 million). (v) As at 31 December 2014, £477 million (2013: £495 million) of convertible bonds were included in debt securities and £1,148 million (2013: £1,078 million) were included in borrowings.
The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange-quoted investments, or by using quotations from independent third parties, such as brokers and pricing services or by using appropriate valuation techniques.
alan ce sh eet n o tes 183 Prudential plc Annual Report 2014
Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts 108,392 336 21 108,749
Total financial investments, net of derivative liabilities 112,895 6,728 32 119,655
Total financial instruments at fair value 144,560 86,549 3,385 234,494 * Loans in the above table are those classified as fair value through profit or loss in note C3.1.
Liabilities Investment contract liabilities without discretionary participation features – – (2,441) (2,441) Core structural borrowings of shareholder-financed operations – (4,878) (188) (5,066) Operational borrowings attributable to shareholder-financed operations – (2,010) (142) (2,152) Borrowings attributable to the with-profits funds – (798) (93) (891) Obligations under funding, securities lending and sale and repurchase
The fair value included for the subordinated and senior debt issued by the parent company is determined using the quoted prices from independent third parties.
Of the total level 2 debt securities of £107,731 million at 31 December 2014 (2013: £100,687 million), £10,093 million are valued internally (2013: £8,556 million). The majority of such securities are valued using matrix pricing, which is based on assessing the credit quality of the underlying borrower to derive a suitable discount rate relative to government securities of a comparable duration. Under matrix pricing, the debt securities are priced taking the credit spreads on comparable quoted public debt securities and applying these to the equivalent debt instruments factoring in a specified liquidity premium. The majority of the parameters used in this valuation technique are readily observable in the market and, therefore, are not subject to interpretation.
d Fair value measurements for level 3 fair valued assets and liabilities Reconciliation of movements in level 3 assets and liabilities measured at fair value The following table reconciles the value of level 3 fair valued assets and liabilities at 1 January 2014 to that presented at 31 December 2014.
alan ce sh eet n o tes 187 Prudential plc Annual Report 2014
Total financial investments, net of derivative liabilities 6,763 589 149 446 (693) (175) 194 – 13 (34) 7,252
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,327) (14) – (18) 18 123 (73) – – – (1,291)
Equity securities and portfolio holdings in unit trusts 568 50 (3) 26 (73) – – – 84 (3) 649
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,224) (57) (1) – 2 94 (141) – – – (1,327)
Of the total net gains and losses in the income statement of £565 million (2013: £480 million), £344 million (2013: £415 million) relates to net unrealised gains of financial instruments still held at the end of the year, which can be analysed as follows: Investment properties Equity securities 70 46 Debt securities 149 30 Other investments 284 397 Derivative liabilities (137) (8) Net asset value attributable to unit holders of consolidated unit trusts and similar funds (14) (57) Other financial liabilities (8) 7
At 31 December 2014, the Group held £3,760 million (2013: £3,385 million) of net financial instruments at fair value within level 3. This represents 1 per cent (2013: 2 per cent) of the total fair valued financial assets net of fair valued financial liabilities.
Included within these amounts were loans of £2,025 million at 31 December 2014 (2013: £1,887 million), measured as the loan outstanding balance, attached to REALIC and held to back the liabilities for funds withheld under reinsurance arrangements. The funds withheld liability of £2,201 million at 31 December 2014 (2013: £2,051 million) was also classified within level 3, accounted for on a fair value basis being equivalent to the carrying value of the underlying assets.
alan ce sh eet n o tes 189 Prudential plc Annual Report 2014
(c) Liabilities of £(1,269) million (2013: £(1,301) million) for the net asset value attributable to external unit holders in respect of the consolidated investment funds, which are non-recourse to the Group. These liabilities are valued by reference to the underlying assets.
(d) Derivative liabilities of £(23) million (2013: £nil) which are valued internally using standard market practices but are subject to independent assessment against external counterparties’ valuations.
Other assets at fair value – investment properties The investment properties of the Group are principally held by the UK insurance operations which are externally valued by professionally qualified external valuers using the Royal Institution of Chartered Surveyors (RICS) valuation standards. An ‘income capitalisation’ technique is predominantly applied for these properties. This technique calculates the value through the yield and rental value depending on factors such as the lease length, building quality, covenant and location. The variables used are compared to recent transactions with similar features to those of the Group’s investment properties. As the comparisons are not with properties which are virtually identical to Group’s investment properties, adjustments are made by the valuers where appropriate to the variables used. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of the properties.
During 2014, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to 2 of £618 million and transfers from level 2 to level 1 of £223 million. These transfers which relate to equity securities and debt securities arose to reflect the change in the observability of the inputs used in valuing these securities.
Debt securities are carried at fair value. The amounts included in the statement of financial position are analysed as follows, with further information relating to the credit quality of the Group’s debt securities at 31 December 2014 provided in the notes below.
Insurance operations: Asia note (a) 23,629 18,554 US note (b) 32,980 30,292 UK note (c) 86,349 82,014
Government bonds 174 387 Corporate bonds* 654 491 * Rated as investment grade by local external ratings agencies.
alan ce sh eet n o tes 191 Prudential plc Annual Report 2014 b US insurance operations i Overview
Corporate and government security and commercial loans: Publicly traded and SEC Rule 144A securities* 20,745 18,875 Non-SEC Rule 144A securities 3,745 3,395
Residential mortgage-backed securities (RMBS) 1,567 1,760 Commercial mortgage-backed securities (CMBS) 2,343 2,339 Other debt securities 608 593
Total US debt securities† 32,980 30,292 * A 1990 SEC rule that facilitates the resale of privately placed securities under Rule 144A that are without SEC registration to qualified institutional investors. The rule was designed to develop a more liquid and efficient institutional resale market for unregistered securities.
† Debt securities for US operations included in the statement of financial position comprise: Available-for-sale 32,897 30,205 Fair value through profit or loss: Securities held to back liabilities for funds withheld under reinsurance arrangement 83 87 ii Valuation basis, presentation of gains and losses and securities in an unrealised loss position Under IAS 39, unless categorised as ‘held to maturity’ or ‘loans and receivables’ debt securities are required to be fair valued. Where available, quoted market prices are used. However, where securities do not have an externally quoted price based on regular trades or where markets for the securities are no longer active as a result of market conditions, IAS 39 requires that valuation techniques be applied. IFRS 13 requires classification of the fair values applied by the Group into a three level hierarchy. At 31 December 2014, 0.1 per cent of Jackson’s debt securities were classified as level 3 (31 December 2013: 0.1 per cent) comprising of fair values where there are significant inputs which are not based on observable market data.
Movements in unrealised gains and losses on available-for-sale securities There was a movement in the statement of financial position value for debt securities classified as available-for-sale from a net unrealised gain of £781 million to a net unrealised gain of £1,840 million as analysed in the table below. This increase reflects the effects of decreasing long-term interest rates.
Assets fair valued at below book value Book value* 5,899 10,825
Fair value (as included in statement of financial position) 5,719 9,976
Assets fair valued at or above book value Book value* 25,158 18,599
More than 10 years (54) (558) Mortgage-backed and other debt securities (31) (62)
alan ce sh eet n o tes 193 Prudential plc Annual Report 2014 iii Ratings The following table summarises the securities detailed above by rating using S&P, Moody’s, Fitch and implicit ratings of mortgage-backed securities based on National Association of Insurance Commissioners (NAIC) valuations.
S&P – AAA 164 132 S&P – AA+ to AA- 6,067 5,252 S&P – A+ to A- 8,640 7,728 S&P – BBB+ to BBB- 10,308 9,762 S&P – Other 1,016 941
Moody’s – Aaa 84 65 Moody’s – Aa1 to Aa3 29 13 Moody’s – A1 to A3 27 65 Moody’s – Baa1 to Baa3 72 70 Moody’s – Other 8 10
Total debt securities (see overview table in note (i) above) 32,980 30,292 * The Securities Valuation Office of the NAIC classifies debt securities into six quality categories range from Class 1 (the highest) to Class 6 (the lowest). Performing securities are designated as Classes 1 to 5 and securities in or near default are designated Class 6.
C3: Assets and liabilities – Classification and Measurement continued c UK insurance operations 2014 £m
The majority of unrated debt security investments were held in SAIF and the PAC with-profits fund and relate to convertible debt and other investments which are not covered by ratings analysts nor have an internal rating attributed to them. The non-linked shareholder-backed business of PRIL and other annuity and long-term business includes £3,750 million which are not externally rated. The internal ratings for these securities consists of £1,082 million AA+ to AA-, £1,336 million A+ to A-, £1,183 million BBB+ to BBB-, £60 million BB+ to BB- and £89 million that were rated B+ and below or unrated.
alan ce sh eet n o tes 195 Prudential plc Annual Report 2014 e Asset-backed securities The Group’s holdings in Asset-Backed Securities (ABS), which comprise Residential Mortgage-Backed Securities (RMBS), Commercial Mortgage-Backed Securities (CMBS), Collateralised Debt Obligations (CDO) funds and other asset-backed securities, at 31 December 2014 is as follows: Shareholder-backed operations: Asia insurance operations note (i) 104 139 US insurance operations note (ii) 4,518 4,692 UK insurance operations (2014: 25% AAA, 42% AA) note (iii) 1,864 1,727 Other operations note (iv) 875 667
With-profits operations: Asia insurance operations note (i) 228 200 UK insurance operations (2014: 57% AAA, 17% AA) note (iii) 5,126 5,765
(2013: 94 per cent) are investment graded. (ii) US insurance operations US insurance operations’ exposure to asset-backed securities at 31 December 2014 comprises: RMBS Sub-prime (2014: 7% AAA, 11% AA, 8% A) 235 255
CDO funds (2014: 21% AAA, 1% AA, 23% A), including £nil exposure to sub-prime 53 46 Other ABS (2014: 27% AAA, 17% AA, 45% A), including £72 million exposure to sub-prime 555 547
Other Eurozone (principally Belgium) 5 29 5 28 * Including bonds guaranteed by the federal government. † The exposure to the United States sovereign debt comprises holdings of Jackson, the UK and Asia insurance operations.
The exposure is well diversified by issuer, sub-sector and geography with 138 issuers across the five sub-sectors. The average holding is £25 million.
BB or below 280* 31 9 320 * Total exposure to the more directly impacted sub-segments of Exploration and Production and Oil and Gas services is £779 million.
The tables above exclude assets held to cover linked liabilities and those of the consolidated unit trusts and similar funds. In addition, the table above excludes the proportionate share of oil and gas debt holdings of the Group’s joint venture operations.
The amounts included in the statement of financial position are analysed as follows: Insurance operations: Asia note (a) 1,014 922 US note (b) 6,719 6,375 UK note (c) 4,254 4,173
Asset management operations: a Asia insurance operations The loans of the Group’s Asia insurance operations comprise: Mortgage loans* 88 57 Policy loans* 672 611 Other loans† 254 254
Total Asia insurance operations loans 1,014 922 * The mortgage and policy loans are secured by properties and life insurance policies respectively. † The majority of the other loans are commercial loans held by the Malaysia operation and which are all investment graded by two local rating agencies.
Total US insurance operations loans 2,025 4,694 6,719 1,887 4,488 6,375 * All of the mortgage loans are commercial mortgage loans which are collateralised by properties. The property types are industrial, multi-family residential, suburban office, retail and hotel.
At 31 December 2014, Jackson had mortgage loans with a carrying value of £13 million (2013: £47 million) where the contractual terms of the agreements had been restructured.
c UK insurance operations The loans of the Group’s UK insurance operations comprise: SAIF and PAC WPSF Mortgage loans* 1,145 1,183 Policy loans 10 12 Other loans† 1,510 1,629
d Asset management operations The M&G loans relate to loans and receivables managed by Prudential Capital. These assets are generally secured but most have no external credit ratings. Internal ratings prepared by the Group’s asset management operations, as part of the risk management process, are: Loans and receivables internal ratings: AAA 101 108 AA+ to AA- – 28 A+ to A- 161 – BBB+ to BBB- 244 516 BB+ to BB- 49 174 B and other 299 270
alan ce sh eet n o tes 199 Prudential plc Annual Report 2014
C3.5 Financial instruments – additional information a Market risk i Liquidity analysis Contractual maturities of financial liabilities on an undiscounted cash flow basis 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 2,347 2,347 – – – – – – 2,347
Obligations under funding, securities lending and sale and repurchase agreements 2,074 2,074 – – – – – – 2,074
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,278 5,278 – – – – – – 5,278
Most investment contracts have options to surrender early, often subject to surrender or other penalties. Therefore, most contracts can be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts mean these are unlikely to be exercised in practice and the more useful information is to present information on expected payment. The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of £13 billion (2013: £13 billion) which have no stated maturity but which are repayable on demand.
Of these financial liabilities, 47 per cent (2013: 28 per cent) are held by the PAC with-profits fund, mainly relating to foreign currency borrowings.
The derivative assets are included in ‘other investments’ in the statement of financial position and are used for efficient portfolio management to obtain cost effective and efficient management of exposure to various markets in accordance with the Group’s investment strategies and to manage exposure to interest rate, currency, credit and other business risks. The Group also uses interest rate derivatives to reduce exposure to interest rate volatility. In particular: — UK with-profits funds use derivatives for efficient portfolio management or reduction in investment risks. For UK annuity business derivatives are used to assist with asset and liability cash flow matching; — US operations and some of the UK operations hold large amounts of interest-rate sensitive investments that contain credit risks on which a certain level of defaults is expected. These businesses have purchased some swaptions to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets; and
At 31 December 2014, the Group had lent £4,578 million (2013: £3,791 million) of securities of which £3,129 million (2013: £2,910 million) was lent by the PAC with-profits fund and held cash and securities collateral under such agreements of £4,887 million (2013: £3,930 million) of which £3,400 million (2013: £3,012 million) was held by the PAC with-profits fund.
In addition, at 31 December 2014, the Group had entered into repurchase transactions for which the fair value of the collateral pledged was securities of £186 million (2013: cash pledged of £17 million and securities pledged of £524 million).
Financial liabilities: Notes (i) The Group has not offset any of the amounts presented in the consolidated statement of financial position. (ii) Represents the amount that could be offset under master netting or similar arrangements where Group does not satisfy the full criteria to offset on the consolidated statement of financial position.
alan ce sh eet n o tes 203 Prudential plc Annual Report 2014
Net credit for impairment net of reversals 37 17 * Relates to loans held by the UK with-profits fund and mortgage loans held by Jackson.
Reclassification of Japan life business as held for sale† (1,026) – – (1,026) Net flows: Shareholders' transfers post tax (38) – (192) (230) Investment-related items and other movements 462 8,219 7,812 16,493 Foreign exchange translation differences (2,231) (2,704) (117) (5,052) Acquisition of Thanachart Lifenote D1 487 – – 487
Net flows: Shareholders' transfers post tax (40) – (200) (240) Investment-related items and other movements 3,480 3,712 14,310 21,502 Foreign exchange translation differences 1,372 7,360 (90) 8,642
Comprising: Policyholder liabilities on the consolidated statement of financial position§ 38,705 126,746 144,088 309,539 Unallocated surplus of with-profits funds on the consolidated statement of financial position 2,102 – 10,348 12,450 Group's share of policyholder liabilities of joint ventures* 4,215 – – 4,215
† Liabilities of £1,026 million in respect of the Japan life operation at 1 January 2013 were removed from policyholder liabilities following its reclassification as held for sale at 31 December 2013. No further amounts are shown within the 2014 or 2013 analysis above in respect of Japan life business.
‡ Up until 31 December 2013 for the purposes of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance was reported within the unallocated surplus of the PAC WPSF of the UK insurance operations.
On 1 January 2014, following consultation with the policyholders of PAC and regulators and court approval, the Hong Kong branch of PAC was transferred to separate subsidiaries established in Hong Kong. From this date, the unallocated surplus of the Hong Kong with-profits business is reported within the Asia insurance operations segment.
¶ Averages have been based on opening and closing balances and adjusted for acquisitions, disposals and corporate transactions in the year and exclude unallocated surplus of with-profits funds.
Notes (a) The £1,026 million liabilities of the Japan life operation at 1 January 2013 were removed from policyholder liabilities following its reclassification as held for sale at 31 December 2013. No further amounts are shown within 2014 or 2013 analysis above in respect of Japan life business.
C4: Policyholder liabilities and unallocated surplus of with-profits funds continued iii Movement in insurance contract liabilities and unallocated surplus of with-profits funds Further analysis of the movement in the year of the Group’s insurance contract liabilities, gross and reinsurance share, and unallocated surplus of with-profits funds is provided below: Insurance contract liabilities Unallocated surplus of
Reclassification of Japan life business as held for sale (1,026) – – Income and expense included in the income statement and other comprehensive income 18,133 56 1,507 Acquisition of Thanachart Life 487 – – Foreign exchange translation differences (4,893) (114) (35)
Reclassification of Japan life business as held for sale† – (366) (660) (1,026) Premiums
Shareholders' transfers post tax (38) – – (38) Investment-related items and other movementsnote (f) (160) 369 253 462 Acquisition of Thanachart Lifenote (g) – – 487 487 Foreign exchange translation differencesnote (a) (517) (1,241) (473) (2,231)
Comprising: Policyholder liabilities on the consolidated statement of financial position 13,138 11,918 6,854 31,910 Unallocated surplus of with-profits funds on the consolidated statement of financial position 77 – – 77 Group's share of policyholder liabilities relating to joint ventures* – 1,847 1,312 3,159
Shareholders' transfers post tax (40) – – (40) Investment-related items and other movementsnote (f) 1,621 1,336 523 3,480 Foreign exchange translation differencesnote (a) 689 375 308 1,372
Notes (a) Movements in the year have been translated at the average exchange rates for the year ended 31 December 2014. The closing balance has been translated at the closing spot rates as at 31 December 2014. Differences upon retranslation are included in foreign exchange translation differences. (b) Up until 31 December 2013 for the purposes of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance was reported within the unallocated surplus of the PAC WPSF of the UK insurance operations.
(f) Investment-related items and other movements for 2014 principally represents unrealised gains on bonds, following the fall in bond yields and positive investment gains from the Asia equity market.
(g) The acquisition of Thanachart Life reflects the liabilities acquired at the date of acquisition.
ii Duration of liabilities The table below shows the carrying value of policyholder liabilities and the maturity profile of the cash flows on a discounted basis for 2014 and 2013, taking account of expected future premiums and investment returns: Policyholder liabilities 38,705 31,910
Total Asia operations 40,319 31,736 * The significant increase for Hong Kong compared to the prior year is primarily due to the effect of transferred unallocated surplus from the PAC WPSF at 1 January 2014 on the domestication of the Hong Kong branch business as discussed in note D2.
alan ce sh eet n o tes 209 Prudential plc Annual Report 2014
Transfers from general to separate account 1,395 (1,395) – Investment-related items and other movementsnote (c) 1,963 1,749 3,712 Foreign exchange translation differencesnote (a) 4,728 2,632 7,360
(c) Positive investment-related items and other movements in variable annuity separate account liabilities of £1,963 million for 2014 primarily reflects the increase in the US equity market during the year. Fixed annuity, GIC and other business investment and other movements of £1,749 million primarily reflect the increase in interest credited to the policyholder accounts in the year and an increase in other guarantee reserves.
ii Duration of liabilities The table below shows the carrying value of policyholder liabilities and maturity profile of the cash flows on a discounted basis for 2014 and 2013: Fixed annuity and
Shareholders' transfers post tax (200) – – (200) Switches (167) 167 – – Investment-related items and other movements note (c) 9,637 1,597 3,076 14,310 Foreign exchange translation differences (90) – – (90)
* Averages have been based on opening and closing balances and exclude unallocated surplus of with-profits funds.
(b) Net outflows improved from £5,325 million in 2013 to £4,510 million in 2014, due primarily to higher premium flows (up £2,068 million to £3,546 million) into our annuity and other long-term business following an increase in the number of bulk annuity transaction in the year. The levels of inflows/outflows for unit-linked business is driven by corporate pension schemes with transfers in or out from only a small number of schemes influencing the level of flows in the year.
(c) Investment-related items and other movements of £14,310 million reflect both growth in equity markets and fall in long-term bond yields in 2014.
alan ce sh eet n o tes 211 Prudential plc Annual Report 2014 ii Duration of liabilities With the exception of most unitised with-profits bonds and other whole of life contracts the majority of the contracts of the UK insurance operations have a contract term. In effect, the maturity term of the other contracts reflects the earlier of death, maturity, or lapsation. In addition, as described in note A3.1, with-profits contract liabilities include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
Expected maturity: — The cash flow projections of expected benefit payments used in the maturity profile table above are from value of in-force business and exclude the value of future new business, including future vesting of internal pension contracts; — Benefit payments do not reflect the pattern of bonuses and shareholder transfers in respect of the with-profits business; — Investment contracts under ‘Other’ comprise certain unit-linked and similar contracts accounted for under IAS 39 and IAS 18; — For business with no maturity term included within the contracts, for example with-profits investment bonds such as Prudence Bonds, an assumption is made as to likely duration based on prior experience; and
— The maturity tables shown above have been prepared on a discounted basis.
In general terms, the Asia participating products provide savings and protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund as determined at the discretion of the insurers. The Asia operations’ non-participating term, whole life and endowment products offer savings and/or protection where the benefits are guaranteed, or determined by a set of defined market-related parameters. Unit-linked products combine savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. Health and Protection policies provide mortality or morbidity benefits and include health, disability, critical illness and accident coverage. Health and Protection products are commonly offered as supplements to main life policies but can be sold separately.
Non-participating long-term products are the only ones where the Group is contractually obliged to provide guarantees on all benefits. Unit-linked products have the lowest level of guarantee.
Whole of life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions are written in the Korea life operations though this is not to a significant extent as Korea has a much higher proportion of linked and health business. The Korea business has non-linked liabilities and linked liabilities at 31 December 2014 of £596 million and £2,109 million respectively (2013: £547 million and £1,905 million respectively).
For the shareholder-backed non-linked business, the future policyholder benefit provisions for Asia businesses in the Group’s IFRS accounts, are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with the modified statutory basis or where local GAAP is not well established and in which the business written is primarily non-participating and linked business, US GAAP principles are used as the most appropriate reporting basis.
alan ce sh eet n o tes 213 Prudential plc Annual Report 2014
The other Asia operations principally adopt a net premium valuation method to determine the future policyholder benefit provisions. The effect of changes in assumptions used to measure insurance assets and liabilities for Asia insurance operations is as disclosed in note B4(a).
Immediate annuities At 31 December 2014, immediate annuities accounted for 1 per cent (2013: 1 per cent) of Jackson’s policy and contract liabilities. Immediate annuities guarantee a series of payments beginning within a year of purchase and continuing over either a fixed period of years and/or the life of the policyholder. If the term is for the life of the policyholder, then Jackson’s primary risks are mortality and reinvestment. The implicit interest rate on these products is based on the market conditions that exist at the time the policy is issued and is guaranteed for the term of the annuity.
ii Variable annuities At 31 December 2014, variable annuities accounted for 69 per cent (2013: 65 per cent) of Jackson’s policy and contract liabilities. Variable annuities are deferred annuities that have the same tax advantages and payout options as fixed interest rate and fixed index annuities. They are also used for asset accumulation in retirement planning and to provide income in retirement.
Jackson issues variable annuity contracts where it contractually guarantees to the contractholder either a) a return of no less than total deposits made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial withdrawals plus a minimum return, or c) the highest contract value on a specified anniversary date adjusted for any withdrawals following the contract anniversary. These guarantees include benefits that are payable in the event of death (guaranteed minimum death benefit (GMDB)), at annuitisation (guaranteed minimum income benefit (GMIB)), at specified dates during the accumulation period (guaranteed minimum withdrawal benefit (GMWB)) or at the end of a specified period (guaranteed minimum accumulation benefit (GMAB)). Jackson hedges these risks using equity options and futures contracts as described in note C7.3. The GMAB and GMIB are no longer offered, with the existing GMIB coverage being substantially reinsured.
Jackson launched Elite Access in March 2012. Elite Access is a variable annuity which has no guaranteed benefits and provides tax efficient access to alternative investments. At 31 December 2014, Jackson had in force Elite Access variable annuity contracts with liability balance of £6.8 billion (2013: £3.4 billion).
iv Institutional products Jackson’s institutional products consist of traditional guaranteed investment contracts (‘GICs’), funding agreements (including agreements issued in conjunction with Jackson’s participation in the US Federal Home Loan Bank programme) and Medium Term Note funding agreements. At 31 December 2014, institutional products accounted for 3 per cent of policy and contract liabilities (2013: 3 per cent). Under a traditional GIC, the policyholder makes a lump sum deposit. The interest rate paid is fixed and established when the contract is issued. If deposited funds are withdrawn earlier than the specified term of the contract, an adjustment is made that approximates a market value adjustment.
Under a funding agreement, the policyholder either makes a lump sum deposit or makes specified periodic deposits. Jackson agrees to pay a rate of interest, which may be fixed but is usually a floating short-term interest rate linked to an external index. The average term of the funding agreements is one to two years. In 2014 and 2013, there were no funding agreements terminable by the policyholder with less than 90 days’ notice.
Determining contract liabilities As permissible under IFRS 4 and consistent with the basis explained in note A3.1, in the case of Jackson the carrying values of insurance assets and liabilities are consolidated into the Group accounts based on US GAAP. An overview of the deferral and amortisation of acquisition costs for Jackson is provided in note C5.1(b).
Capitalised acquisition costs and deferred income for these contracts are amortised over the life of the book of contracts. The present value of the estimated gross profits is generally computed using the rate of interest that accrues to policyholder balances (sometimes referred to as the contract rate). Estimated gross profits include estimates of the elements, each of which will be determined based on the best estimate of amounts of the elements over the life of the book of contracts without provision for adverse deviation: — Amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances; — Amounts expected to be assessed for contract administration less costs incurred for contract administration; — Amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances; — Amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender charges); and
Guaranteed Minimum Income Benefits are essentially fully reinsured, subject to a modest deductible and annual claim limits. As this reinsurance benefit is net settled, it is considered to be a derivative under IAS 39, and is therefore recognised at fair value with the change in fair value included as a component of short-term fluctuations. The direct GMIB liability is not considered a derivative instrument under IAS 39 and, as such, an accounting difference arises from this one-sided mark to market.
Guaranteed Minimum Withdrawal Benefit ‘not for life’ features are considered to be embedded derivatives under IAS 39. Therefore, provisions for these benefits are recognised at fair value. The change in these guaranteed benefit reserves, along with claim payments and associated fees included in reserves are included along with the hedge results in short-term fluctuations, resulting in removal of the market impact from the operating profit based on longer-term investment returns.
For Guaranteed Minimum Withdrawal Benefit and Guaranteed Minimum Income Benefit reinsurance embedded derivatives that are fair valued under IAS 39, Jackson bases its volatility assumptions on implied market volatility for periods ranging from 5 to 10 years period, where sufficient market liquidity is assumed to exist, followed by grading to long-term historical volatility levels beyond that point, where such long-term historical volatility levels contain an explicit margin for conservatism.
The effect of any non-recurrent changes of assumptions used to measure insurance assets and liabilities of Jackson is shown in note B4(b).
Regular bonus rates For regular bonuses, the bonus rates are determined for each type of policy primarily by targeting the bonus level at a prudent proportion of the long-term expected future investment return on underlying assets. The expected future investment return is reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers. However, the rates declared may differ by product type, or by the date of payment of the premium, or date of issue of the policy, or if the accumulated regular bonuses are particularly high or low, relative to a prudent proportion of the achieved investment return.
Net income of the fund before movement in unallocated surplus 2,096 3,236 Movement in unallocated surplus (84) (1,294)
Determining contract liabilities i Overview The calculation of the contract liabilities involves the setting of assumptions for future experience. This is done following detailed review of the relevant experience including in particular mortality, expenses, tax, economic assumptions and, where applicable, persistency.
Tax assumptions are set equal to current rates of taxation. For non-profit business excluding unit-linked business, the valuation interest rates used to discount the liabilities are based on the yields as at the valuation date on the assets backing the technical provisions. For fixed interest securities the gross redemption yield is used except for the non-profit annuities within PAC and PRIL annuity business where the internal rate of return of the assets backing the liabilities is used. Properties are valued using the rental yield, and for equities it is the greater of the dividend yield and the average of the dividend yield and the earnings yield. An adjustment is made to the yield on non-risk-free fixed interest securities and property to reflect credit risk. To calculate the non-unit reserves for linked business, assumptions have been set for the gross unit growth rate and the rate of inflation of maintenance expenses, as well as for the valuation interest rate as described above.
The process of determining policyholder liabilities of SAIF is similar to that for the with-profits policies of the WPSF.
iii Annuity business Credit risk provisions For IFRS reporting, the results for UK shareholder-backed annuity business are particularly sensitive to the allowances made for credit risk. Further details on credit risk allowance are provided in note B4(c).
PCFA00 2013 CMI 2012 For females: with a long-term improvement rate of 1.50% pa.
For annuities in deferment, the tables used by both the non-profit annuities within the WPSF and PRIL were AM92 – 4 years (males) and AF92 – 4 years (females) for 2014 and 2013.
Other assumption changes The effect of other assumption changes and modelling adjustments for the shareholder-backed business is set out in note B4(c).
For the with-profits sub-fund, the aggregate effect of assumption changes and modelling adjustments in 2014 was a net charge to unallocated surplus of £86 million (2013: net credit of £200 million), relating to changes in mortality assumptions, offsetting releases of margins, and altered expense, persistency and economic assumptions, where appropriate in the two periods.
Goodwill attributable to shareholders comprises: Other goodwill represents amounts allocated to entities in Asia and the US operations. These goodwill amounts by acquired operations are not individually material.
Total of deferred acquisition costs and other intangible assets 7,261 5,295
Note PVIF and other intangibles comprise PVIF, distribution rights and other intangibles such as software rights. Distribution rights relate to amounts that have been paid or have become unconditionally due for payment as a result of past events in respect of bancassurance partnership arrangements in Asia. These agreements allow for bank distribution of Prudential’s insurance products for a fixed period of time. Additions of £865 million in 2014 principally relate to fees paid and due to extend the term and expand the geographic scope of the agreement with Standard Chartered Bank and other fees on current distribution deals.
US insurance operations Summary balances The DAC amount in respect of US insurance operations comprises amounts in respect of: Variable annuity business 5,002 3,716 Other business 759 868 Cumulative shadow DAC (for unrealised gains booked in other comprehensive income)* (584) (463)
Overview of the deferral and amortisation of acquisition costs for Jackson Under IFRS 4, the Group applies ‘grandfathered’ US GAAP for measuring the insurance assets and liabilities of Jackson. In the case of Jackson term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest-sensitive life business, acquisition costs are deferred and amortised in line with a combination of historical and future expected gross profits on the relevant contracts. For fixed interest rate and fixed index annuity and interest-sensitive life business, the key assumption is the long-term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual spread analysis. Expected gross profits also depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual mortality, lapse and expense experience is performed using internally developed experience studies.
Under the mean reversion technique applied by Jackson, the projected level of return for each of the next five years is adjusted from period to period so that in combination with the actual rates of return for the preceding two years and the current period, the 7.4 per cent (2013: 7.4 per cent) annual return is realised on average over the entire eight-year period. Projected returns after the mean reversion period revert back to the 7.4 per cent (2013: 7.4 per cent) assumption.
However, to ensure that the methodology does not over anticipate a reversion to the long-term level of returns following adverse markets, the mean reversion technique has a cap and floor feature whereby the projected returns in each of the next five years can be no more than 15 per cent per annum and no less than 0 per cent per annum (after deduction of net fund management fees) in each year.
Furthermore, in those periods where the cap or floor is relevant, the mean reversion technique provides no further dampening and additional volatility may result.
In 2014, the DAC amortisation charge for operating profit was determined after including a charge for accelerated amortisation of £13 million (2013: credit for decelerated amortisation of £82 million). The 2014 amount primarily reflects the separate account performance of 6 per cent, which is lower than the assumed level for the year.
As noted above, the application of the mean reversion formula has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. It would take a significant movement in equity markets in 2015 (outside the range of negative 34 per cent to positive 36 per cent) for the mean reversion assumption to move outside the corridor.
Exchange differences 315 – (138) – Change in shadow DAC related to movement in unrealised appreciation of
Note (i) All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts: Gross amount 234 224 Accumulated amortisation (147) (128)
M&G for which the goodwill is shown in the table above. Goodwill is tested for impairment of these investments by comparing the investment’s carrying value including goodwill with its recoverable amount (fair value less costs to sell). The fair value is determined by using a discounted cash flow valuation based on cash flow projections to 2016 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 which were from 10 to 14 per cent. The discount rates were derived by reference to risk-free rates and an equity premium risk. In 2014 and 2013, there was no impairment of goodwill.
Note (i) The above costs relate to non-participating business written by the PAC with-profits sub-fund. As the with-profits contracts are accounted for under the
UK regulatory ‘realistic basis’, no deferred acquisition costs are established for this type of business.
Amortisation charge (20) (9) Exchange differences 3 (1) Disposals and transfers 4 –
Perpetual Subordinated Capital Securities (Innovative Tier 1) note (i) 1,789 2,133
¤20m Medium Term Subordinated Notes 2023 note (viii) 16 17 £435m 6.125% Subordinated Notes 2031 429 429 £400m 11.375% Subordinated Notes 2039 391 388 £700m 5.7% Subordinated Notes 2063 note (v) 695 695
(ii) The senior debt ranks above subordinated debt in the event of liquidation. (iii) The Prudential Capital bank loan of £275 million has been made in two tranches: a £160 million loan maturing on 20 December 2017 and a £115 million loan also maturing on 20 December 2017. These two tranches are currently drawn at a cost of 12 month £LIBOR plus 0.40 per cent. (iv) In January 2013, the Company issued core structural borrowings of US$700 million 5.25 per cent Tier 1 Perpetual Subordinated Capital Securities primarily to retail investors in Asia. The proceeds, net of costs, were US$689 million.
(v) In December 2013, the Company issued core structural borrowings of £700 million Lower Tier 2 Subordinated Notes primarily to UK institutional investors.
The proceeds, net of costs, were £695 million. (vi) On 23 December 2014, the Company exercised its right to redeem early the US$750 million 11.75 per cent Tier 1 perpetual subordinated capital securities at their aggregate nominal amount together with accrued interest. (vii) These borrowings can be converted, in whole or in part, at the Company’s option and subject to certain conditions, on any interest payment date, into one or more series of Prudential preference shares.
Borrowings in respect of short-term fixed income securities programmes 2,004 1,933 Non-recourse borrowings of US operations 19 18
Bank loans and overdrafts 6 3 Obligations under finance leases 4 – Other borrowings note (ii) 230 198
These Notes have been wholly subscribed to 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.
(iii) In January 2015, the Company issued £300 million Medium Term Notes which will mature in January 2018. The proceeds, net of costs, were £299 million. (iv) In all instances the holders of the debt instruments issued by these subsidiaries and funds do not have recourse beyond the assets of those subsidiaries and funds.
C7.1 Group overview The Group’s risk framework and the management of the risk including those attached to the Group’s financial statements including financial assets, financial liabilities and insurance liabilities, together with the inter-relationship with the management of capital have been included in the audited sections of ‘Group Chief Risk Officer’s report on the risks facing our business and our capital strength’ within the Strategic Report.
Type of business Market and credit risk Insurance and lapse risk
Derivative hedge programme to the extent not fully hedged against liability
Detailed analyses of sensitivity of IFRS basis profit or loss and shareholders’ equity to key market and other risks by business unit are provided in notes C7.2, C7.3, C7.4 and C7.5. The sensitivity analyses provided show the effect on profit or loss and shareholders’ equity to changes in the relevant risk variables, all of which are reasonably possible at the relevant balance sheet date. In the equity risk sensitivity analysis shown below, the Group has considered the impact of an instantaneous 20 per cent fall in equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous fall but rather this would be expected to occur over a period of time during which the Group would be able to put mitigating management actions in place. In addition, the equity risk sensitivity analysis provided assumed that all equity indices fall by the same percentage.
Impact of diversification on risk exposure The Group enjoys significant diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations through a broad mix of product types. This arises because not all risk scenarios are likely to happen at the same time and across all geographic regions. Relevant correlation factors include: Correlation across geographic regions: — Financial risk factors; and — Non-financial risk factors.
C7.2 Asia insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The Asia operations sell with-profits and unit-linked policies and, although the with-profits business generally has a lower terminal bonus element than in the UK, the investment portfolio still contains a proportion of equities. Non-participating business is largely backed by debt securities or deposits. The Group’s exposure to market risk arising from its Asia operations is therefore at modest levels. This reflects the fact that the Asia operations have a balanced portfolio of with-profits, unit-linked and other types of business.
Unit-linked business As for the UK insurance operations, for unit-linked business, the main factor affecting the profit and shareholders’ equity of the Asia operations is investment performance through asset management fees. The sensitivity of profits and shareholders’ equity to changes in insurance risk, interest rate risk and credit risk are not material.
alan ce sh eet n o tes 229 Prudential plc Annual Report 2014
For the purposes of analysing sensitivity to variations in interest rates, reference has been made to the movements in the 10-year government bond rates of the territories. At 31 December 2014, 10-year government bond rates vary from territory to territory and range from 1.6 per cent to 8.0 per cent (2013: 1.7 per cent to 9.0 per cent).
The estimated sensitivity to the decrease and increase in interest rates at 31 December 2014 and 2013 is as follows: Decrease
Net effect on profit and shareholders’ equity (59) (113) 277 (175)
Equity price risk The non-linked shareholder business has limited exposure to equity and property investment (31 December 2014: £932 million). Generally changes in equity and property investment values are not directly offset by movements in policyholder liabilities.
Interest rate risk — Related to meeting guaranteed rates of accumulation on fixed annuity products following a sharp and sustained fall in interest rates; — Related to the guarantee features attached to the Company’s products and to policyholder withdrawals following a sharp and sustained increase in interest rates; and
alan ce sh eet n o tes 231 Prudential plc Annual Report 2014
Value movements on the derivatives are reported within the income statement. In preparing Jackson’s segment profit as shown in note B1.1 value movements on Jackson’s derivative contracts, are included within short-term fluctuations in investment returns and excluded from operating results based on longer-term investment returns.
Interest rate swap These generally involve the exchange of fixed and floating payments over the period for which Jackson holds the instrument without an exchange of the underlying principal amount. These agreements are used for hedging purposes.
These derivatives (including various call and put options and interest rate contingent options) are used to hedge Jackson’s obligations associated with its issuance of fixed index deferred annuities and certain VA guarantees. Some of these annuities and guarantees contain embedded options which are fair valued for financial reporting purposes.
GMAB – Premium only 0% 53 – Highest specified anniversary account value minus withdrawals post-anniversary
As a result of this hedging programme, if the equity markets were to increase further in the future, the net effect of Jackson’s free-standing derivatives would decrease in value. However, over time, this movement would be broadly offset by increased separate account fees and reserve decreases, net of the related changes to amortisation of deferred acquisition costs. Due to the nature of the free-standing and embedded derivatives, this hedge, while highly effective on an economic basis, may not completely mute in the financial reporting the immediate impact of equity market movements as the free-standing derivatives reset immediately while the hedged liabilities reset more slowly and fees are recognised prospectively. The opposite impact would be observed if the equity markets were to decrease.
The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2014 and 2013.
C7: Risk and sensitivity analysis continued ii Sensitivity to interest rate risk Notwithstanding the market risk exposure previously described, except in the circumstances of interest rate scenarios where the guarantee rates included in contract terms are higher than crediting rates that can be supported from assets held to cover liabilities, the accounting measurement of fixed annuity liabilities of Jackson products is not generally sensitive to interest rate risk. This position derives from the nature of the products and the US GAAP basis of measurement. The Guaranteed Minimum Withdrawal Benefit features attached to variable annuity business (other than ‘for-life’) are accounted for as embedded derivatives which are fair valued and so will be sensitive to changes in interest rate.
Profit and loss: Pre-tax profit effect (net of related changes in
Related effect on charge for deferred tax 489 242 (173) (306) 45 23 18 56
(net of related changes in amortisation of DAC) 2,979 1,663 (1,663) (2,979) 2,624 1,477 (1,477) (2,624) Related effect on movement in deferred tax (1,043) (582) 582 1,043 (918) (517) 517 918
These sensitivities are shown only for interest rates in isolation and do not include other movements in credit risk that may affect credit spreads and valuations of debt securities. Similar to sensitivity to equity risk, the sensitivity movements provided in the table above are at a point in time and reflects the hedging programme in place on the balance sheet date, while the actual impact on financial results would vary contingent upon a number of factors.
iii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2014, the average and closing rates were US$1.65 (2013: US$1.56) and US$1.56 (2013: US$1.66) to £1.00 sterling, respectively. A 10 per cent increase (weakening of the dollar) or decrease (strengthening of the dollar) in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows: A 10% increase in US$:£ exchange rates
alan ce sh eet n o tes 235 Prudential plc Annual Report 2014 iv Other sensitivities Total profit of Jackson is very sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts.
Except to the extent of mortality experience, which primarily affects profits through variations in claim payments and Guaranteed Minimum Death Benefit reserves, the profits of Jackson are relatively insensitive to changes in insurance risk.
Jackson is sensitive to lapse risk and other types of policyholder behaviour, such as the take-up of its Guaranteed Minimum Withdrawal Benefit product features. Jackson has extensive derivative programme to seek to manage the exposure for altered equity markets and interest rates. For example, Jackson uses derivatives to ameliorate the effect of a sharp rise in interest rates, which would be the most likely cause of a sudden change in policyholder behaviour.
For variable annuity business, the key assumption is the expected long-term level of separate account returns, which for 2014 was 7.4 per cent (2013: 7.4 per cent). The impact of using this return is reflected in two principal ways, namely: — Through the projected expected gross profits which are used to determine the amortisation of deferred acquisition costs. This is applied through the use of a mean reversion technique which is described in more detail in note C5.1(b) above; and
Shareholder-backed annuity business The principal items affecting the IFRS results of the UK shareholder-backed annuity business are mortality experience and assumptions, and credit risk. The assets covering the liabilities are principally debt securities and other investments that are held to match the expected duration and payment characteristics of the policyholder liabilities. These liabilities are valued for IFRS reporting purposes by applying discount rates that reflect the market rates of return attaching to the covering assets.
i Sensitivity to interest rate risk and other market risk By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK insurance operations are, except annuity business, not generally exposed to interest rate risk. At 31 December 2014 annuity liabilities accounted for 98 per cent (2013: 98 per cent) of UK shareholder-backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure to the Prudential Assurance Company with-profits sub-fund (for its non-profit annuity business) and shareholders (for annuity liabilities of Prudential Retirement Income Limited and the non-profit sub-fund) is very substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mis-matching profits or losses to arise.
Carrying value of debt securities and derivatives 11,559 5,063 (4,085) (7,457) 8,602 3,843 (3,170) (5,827)
alan ce sh eet n o tes 237 Prudential plc Annual Report 2014
In addition the shareholder-backed portfolio of UK non-linked insurance operations covering liabilities and shareholders’ equity includes equity securities and investment properties. Excluding any second order effects on the measurement of the liabilities for future cash flows to the policyholder, a fall in their value would have given rise to the following effects on pre-tax profit, profit after tax and shareholders’ equity.
Net sensitivity of profit after tax and shareholders’ equity (272) (136) (237) (118)
A 10 per cent increase in the relevant exchange rates would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Eastspring Investments and US asset management operations, by £9 million (2013: £12 million) and £33 million (2013: £29 million) respectively.
ii Sensitivities to other financial risks for asset management operations The principal sensitivities to other financial risk of asset management operations are credit risk on the bridging loan portfolio of the Prudential Capital operation and the indirect effect of changes to market values of funds under management. Due to the nature of the asset management operations there is limited direct sensitivity to movements in interest rates. Total debt securities held at 31 December 2014 by asset management operations were £2,293 million (2013: £2,045 million), the majority of which are held by the Prudential Capital’s operation. Debt securities held by Prudential Capital are in general variable rate bonds and so market value is limited in sensitivity to interest rate movements and consequently any change in interest rates would not have a material impact on profit or shareholders’ equity. The Group’s asset management operations do not hold significant investments in property or equities.
b Other operations The Group holds certain derivatives that are used to manage foreign currency movements and macroeconomic exposures. The fair value of these derivatives is sensitive to the combined effect of movements in exchange rates, interest rates and inflation rates. The possible permutations cover a wide range of scenarios. For indicative purposes, a reasonably possible range of fair value movements could be plus or minus £150 million.
Unrealised losses or gains on investments 83 315 (1,697) (1,450) Balances relating to investment and insurance contracts 4 8 (499) (451) Short-term temporary differences 2,607 2,050 (2,065) (1,861)
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 2014 full year results and financial position at 31 December 2014 the possible tax benefit of approximately £110 million (2013: £127 million), which may arise from capital losses valued at approximately £0.5 billion (2013: £0.6 billion), is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset of £47 million (2013: £61 million), which may arise from trading tax losses and other potential temporary differences totalling £0.2 billion (2013: £0.4 billion) is sufficiently uncertain that it has not been recognised. Of these, losses of £32 million will expire within the next seven years. Of the remaining losses £1 million will expire within 20 years and the rest have no expiry date.
Under IAS 12, ‘Income Taxes’, deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled, based on the tax rates (and laws) that have been enacted or are substantively enacted at the end of the reporting period.
The current tax liability increased to £617 million (2013: £395 million) reflecting the increase in shareholder profits.
alan ce sh eet n o tes 239 Prudential plc Annual Report 2014
Economic surplus (deficit) (including investment in Prudential insurance policies) 130 (144) 60 (1) 45 124 (115) 36 (1) 44
Attributable to: Consolidation adjustment against policyholder liabilities for investment in Prudential insurance policies note (iii) – – (132) – (132) – – (114) – (114)
are included within ‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position.
Triennial actuarial valuations All of the schemes are required to carry out a full actuarial valuation every three years in order to assess the appropriate level of funding for schemes in relation to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds.
Last completed actuarial valuation date 5 April 2011 31 March 2011 31 December 2011
Valuation actuary, all Fellow of the Institute and Faculty of Actuaries
No deficit or other funding required. Future ongoing contributions for active members were reduced to the minimum level required under the scheme rules from July 2012 (approximately £6 million per annum excluding expenses)
The next triennial valuations for the PSPS, SASPS and M&GGPS as at 5 April 2014, 31 March 2014 and 31 December 2014, respectively are currently in progress.
alan ce sh eet n o tes 241 Prudential plc Annual Report 2014
Risks to which the defined benefit schemes expose the Group Responsibility of making good of any deficit that may arise in the schemes lies with the employers of the schemes, which are subsidiaries of the Group. Accordingly, the pension schemes expose the Group to a number of risks and the most significant of which are detailed below: — Interest rate and investment risk – this risk arises because the schemes are not invested wholly in assets that most closely match the expected future cash flows. Therefore, falling equity markets and bond yields may lead to higher deficits in the schemes. Details of the investment portfolio of the schemes are provided in section (c); — Inflation risk – the majority of the benefit obligations of all three schemes are linked to inflation, and higher inflation will lead to higher liabilities; and
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 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.
The majority of the scheme liabilities are linked to inflation. The assets that would most closely match the liabilities are a combination of index-linked government bonds or investment grade derivatives to match these inflation-linked liabilities and fixed interest gilts to match the fixed liabilities of the schemes. These ‘matching assets’ generally are expected to generate lower future returns than asset classes such as equities. The risk that must be traded off against investing in higher expected returns assets is increased volatility of the schemes’ return and higher risk of default.
The SASPS and M&GGPS use very limited or no derivatives to hedge their risks. The risks arising from these schemes are managed through well diversified investments with a portion of the scheme assets invested in inflation-indexed bonds to provide a partial hedge against inflation. The M&G pension scheme also invests in leveraged gilts as part of its asset liability management.
C9: Defined benefit pension schemes continued b Assumptions The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended 31 December were as follows: Discount rate* 3.5 4.4 Rate of increase in salaries 3.0 3.3 Rate of inflation†
Retail prices index (RPI) 3.0 3.3 Consumer prices index (CPI) 2.0 2.3
The calculations are based on current actuarially calculated mortality estimates with a specific allowance made for future improvements in mortality. The specific allowance made is in line with a custom calibration and has been updated in 2014 to reflect the 2012 mortality model from the Continuous Mortality Investigation Bureau of the Institute and Faculty of Actuaries (CMI). The tables used for PSPS immediate annuities in payment at 31 December 2014 were: Male: 114.0 per cent PNMA00 with improvements in line with a custom calibration of the CMI’s 2012 mortality model, with a long-term mortality improvement rate of 1.75 per cent per annum; and
Female: 108.5 per cent PNFA00 with improvements in line with a custom calibration of the CMI’s 2012 mortality model, with a long-term mortality improvement rate of 1.25 per cent per annum.
The underlying pension position on an economic basis reflects the assets (including investments in Prudential policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. The IAS 19 basis excludes the investments in Prudential policies. At 31 December 2014, the investments in Prudential insurance policies comprise £131 million (2013: £143 million) for PSPS and £132 million (2013: £114 million) for the M&GGPS. In principle, on consolidation the investments are eliminated against policyholder liabilities of UK insurance operations, so that the formal IAS 19 position for the scheme in isolation excludes these items. This treatment applies to the M&GGPS investments. However, as a substantial portion of the Company’s interest in the underlying surplus of PSPS is not recognised, the adjustment is not necessary for the PSPS investments.
Movements on the pension scheme deficit determined on the economic basis are as follows, with the effect of the application of IFRIC 14 being shown separately: 2014 £m
Shareholders' share: Gross of tax surplus (deficit) (174) (8) (22) – (204)
Less: amount attributable to PAC with-profits fund (29) 14 11 (15) (19)
Bonds*: * 94 per cent of the bonds are investment graded (2013: 97 per cent).
Net deficit, beginning of year 6,944 (6,298) 646 (602) 44 (114) (70)
alan ce sh eet n o tes 245 Prudential plc Annual Report 2014
Plan assets Equities: Bonds: Fair value of plan assets, end of year* 7,575 229 7,804 6,360 327 6,687 Present value of benefit obligation (7,312) (6,298)
(ii) Maturity profile of the benefit obligations The weighted average duration of the benefit obligations of the schemes is 18.4 years (2013: 18.2 years).
The following table provides an expected maturity analysis of the benefit obligations as at 31 December: All schemes £m 1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over
(iii) The adjustments for investments in Prudential insurance policies are consolidation adjustments for intra-group assets and liabilities with no impact to operating results.
C9: Defined benefit pension schemes continued d Sensitivity of the pension scheme liabilities to key variables The total underlying Group pension scheme liabilities of £7,312 million (2013: £6,298 million) comprise £6,157 million (2013: £5,316 million) for PSPS and £1,155 million (2013: £982 million) for the other schemes. The table below shows the sensitivity of the underlying PSPS and the other scheme liabilities at 31 December 2014 and 2013 to changes in discount rate, inflation rates and mortality rates. The sensitivity information below is based on the core scheme liabilities and assumptions at the balance sheet date. The sensitivity is calculated based on a change in one assumption with all other assumptions being held constant. As such, interdependencies between the assumptions are excluded.
Rate of inflation 3.0% RPI: 3.3% RPI: Decrease by 0.2% Decrease in scheme liabilities by: 2.0% CPI: 2.3% CPI: Decrease by 0.2% PSPS 0.6% 0.7%
At 31 December 2014, there were options outstanding under Save As You Earn schemes to subscribe for shares as follows: Number of shares to
alan ce sh eet n o tes 247 Prudential plc Annual Report 2014
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. The cost of own shares of £195 million as at 31 December 2014 (2013: £141 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans. At 31 December 2014, 10.3 million (2013: 7.1 million) Prudential plc shares with a market value of £153.1 million (2013: £94.5 million) were held in such trusts all of which are for employee incentive plans. The maximum number of shares held during 2014 was 10.3 million which was in December 2014.
The Group has consolidated a number of authorised investment funds where it is deemed to control these funds under IFRS. Some of these funds hold shares in Prudential plc. The total number of shares held by these funds at 31 December 2014 was 7.5 million (2013: 7.1 million) and the cost of acquiring these shares of £67 million (2013: £60 million) is included in the cost of own shares. The market value of these shares as at 31 December 2014 was £112 million (2013: £95 million). During 2014, these funds made net additions of 405,940 Prudential shares (2013: net additions of 2,629,816) for a net increase of £7 million to book cost (2013: net increase of £33 million).
All share transactions were made on an exchange other than the Stock Exchange of Hong Kong. Other than set out above the Group did not purchase, sell or redeem any Prudential plc listed securities during 2014 or 2013.
This statement sets out the estimated capital position of the Group’s subsidiaries, by life assurance and asset management operations by reference to the local regulations as at 31 December 2014.
C11.1 Life assurance business a Summary statement The Group’s estimated capital position for its life assurance subsidiaries with reconciliations to shareholders’ equity is shown below. In addition, the statement provides an analysis of available capital for Group’s life assurance operations, determined by reference to the local regulations, to meet risks and regulatory requirements.
Group shareholders' equity Held outside long-term funds: Held in long-term funds note (iii) – – – 2,438 – – 2,438 2,064
Jackson surplus notes note (iv) – – – – 160 – 160 151 Investment and policyholder liabilities valuation differences between IFRS and regulatory basis for Jackson note (vii) – – – – 3,710 – 3,710 2,610
Valuation difference on non-profit annuity liabilities within WPSF between IFRS basis and regulatory basis – (251) (251) – – – (251) (241)
alan ce sh eet n o tes 249 Prudential plc Annual Report 2014
Notes (i) Up until 31 December 2013, the PAC WPSF unallocated surplus included amounts related to the Hong Kong branch, while the related policyholder liabilities are included in the Asia life assurance subsidiaries but classified as being part of the UK regulated with-profit funds. Following the completion of the process of domestication of the Hong Kong branch (see note D2 for further information ) on 1 January 2014, the unallocated surplus of the Hong Kong with-profits business is reported within the Asia insurance operations segment from this date. In addition, the related policyholder liabilities are classified as being part of the non-UK regulated funds. The shareholders’ share of realistic liabilities adjustment to the regulatory basis is only applicable to the UK regulated with-profits fund.
(iv) For regulatory purposes the Jackson surplus notes are accounted for as capital. (v) Other adjustments to shareholders’ equity and unallocated surplus include amounts for the value of non-participating business for UK regulated with-profits funds, deferred tax, admissibility and other items measured differently on the regulatory basis. For Jackson the principal reconciling item is deferred tax related to the differences between IFRS and regulatory basis as shown in the table above and other methodology differences.
(vi) Principally includes unit-linked and similar contracts in the UK and GIC liabilities of Jackson. (vii) The investment and policyholder liabilities valuation difference between IFRS and regulatory bases for Jackson is mainly due to not all investments being carried at fair value under the regulatory basis and also due to the valuation difference on annuity reserves.
Group shareholders' equity Held outside long-term funds: Held in long-term funds 2,438 – – 2,438
c Movement in total available capital on local regulatory bases Total available capital for the Group’s life assurance operations has changed as follows: £m
Notes (i) With-profits sub-fund The decrease in 2014 of £800 million reflects primarily the transfer of the available capital for the Hong Kong with-profits business to Asia life assurance subsidiaries following the completion of the Hong Kong branch domestication on 1 January 2014 and the negative impact of decreasing yields, partially offset by the positive impact of investment returns earned on the opening available capital.
(ii) Jackson The increase of £238 million in 2014 reflects an underlying increase of £57 million (applying the 2014 year end exchange rate of US$1.56: £1.00) and £181 million of exchange translation gain.
(iii) Other UK life assurance subsidiaries and funds The increase in 2014 of £589 million includes the effect of the transfer of the available capital for the Hong Kong non-participating business to the Asia life assurance subsidiaries. Excluding this effect, the increase principally comprises value movement on assets backing surplus capital due to reduction in interest rates and other investment related profits.
(v) Other factors comprise the effect of changes in new business, valuation interest rate, investment return, foreign exchange and other factors. In 2014, the net movement of £3,244 million includes the effect of the difference between the regulations in the UK and Hong Kong as applied to the calculation of the amounts of the available capital for the Hong Kong business transferred between the two operations on 1 January 2014.
Policy reserves for traditional business are determined on a gross premium reserve basis using prudent best estimate assumptions. For linked business, the value of the units are maintained with a non-unit reserve which is calculated in accordance with standard actuarial methodology.
For non-participating business, gross premium reserves are determined using best estimate assumptions along with provisions for risk margin for adverse deviations. For linked business the value of units is held together with a non-unit reserve calculated in accordance with standard actuarial methodology.
alan ce sh eet n o tes 251 Prudential plc Annual Report 2014
Life insurers are required by law to maintain capital funds which are not less than the greater of (i) the sum of capital for all risks and asset as prescribed in the regulation and (ii) a minimum amount of 50 million Thai Baht.
ii US insurance operations The regulatory framework for Jackson is governed by the requirements of the US NAIC approved Risk-Based Capital standards. Under these requirements life insurance companies report using a formula-based capital standard that they calculate by applying factors to various asset, premium and reserve items and separate model based calculations of risk associated primarily with variable annuity products. The Risk-Based Capital formula takes into account the risk characteristics of a company, including asset risk, insurance risk, interest rate risk, market risk and business risk.
Available capital of the with-profits sub-fund and Scottish Amicable Insurance Fund of £7.2 billion (2013: £8.0 billion) represents the excess of assets over liabilities on the PRA realistic basis. Unlike the previously discussed FRS 27 basis, realistic liabilities on the regulatory basis include the shareholders’ share of future bonuses. These amounts are shown before deduction of the risk capital margin which is estimated to be £1.0 billion at 31 December 2014 (2013: £0.9 billion).
iv Group capital requirements In addition to the requirements at individual Company level, PRA requirements under the IGD apply additional prudential requirements for the Group as a whole. Discussion of the Group’s estimated IGD position at 31 December 2014, together with market risk sensitivity disclosure provided to key management, is provided in the Strategic Report section of the Group’s 2014 Annual Report. Following ratification of the Solvency II Omnibus II Directive on 16 April 2014, Solvency II is expected to come into force on 1 January 2016 and will replace the existing IGD capital requirements.
e Transferability of available capital For PAC and all other UK long-term insurers, long-term business assets and liabilities must, by law, be maintained in funds separate from those for the assets and liabilities attributable to non-life insurance business or to shareholders. Only the ‘established surplus’, the excess of assets over liabilities in the long-term fund determined through a formal valuation, may be transferred so as to be available for other purposes. Distributions from the with-profits sub-fund to shareholders reflect the shareholders’ one-ninth share of the cost of declared policyholders’ bonuses.
For Asia subsidiaries, the amounts retained within the companies are at levels that provide an appropriate level of capital strength in excess of the local regulatory minimum. For ring-fenced with-profits funds, the excess of assets over liabilities is retained with distribution tied to the shareholders’ share of bonuses through declaration of actuarially determined surplus. The businesses in Asia may, in general, remit dividends to the UK, provided the statutory insurance fund meets the local regulatory solvency targets.
g Intra-group arrangements in respect of the Scottish Amicable Insurance Fund Should the assets of the Scottish Amicable Insurance Fund be inadequate to meet the guaranteed benefit obligations of the policyholders of the Scottish Amicable Insurance Fund, the PAC long-term fund would be liable to cover any such deficiency in the first instance.
C11.2 Asset management operations – regulatory and other surplus Certain asset management subsidiaries of the Group are subject to regulatory requirements. The movement in the year of the surplus regulatory capital position of those subsidiaries, combined with the movement in the IFRS basis shareholders’ funds for unregulated asset management operations, is as follows: Asset management operations
Distributions made to the parent company (342) (5) (62) (409) (365)
Charged to income statement: Notes (i) Restructuring provisions primarily relate to restructuring activities of UK insurance operations. The provisions pertain to property liabilities resulting from the closure of regional sales centres and branches and staff terminations and other transformation costs to enable streamlining of operations. (ii) Other provisions comprise staff benefits provisions of £395 million (2013: £332 million), provisions for onerous contracts of £35 million (2013: £41 million) and regulatory and other provisions of £57 million (2013: £41 million). Staff benefits are generally expected to be paid out within the next three years.
Tangible assets Of the £646 million of tangible assets, £521 million were held by the Group’s with-profits operations, primarily by the consolidated subsidiaries for venture fund and other investment purposes of the PAC with-profits fund.
The 2014 income statement includes rental income from investment properties of £729 million (2013: £606 million) and direct operating expenses including repairs and maintenance arising from these properties of £41 million (2013: £46 million).
The Group’s policy is to let investment properties to tenants through operating leases. Minimum future rentals to be received on non-cancellable operating leases of the Group’s freehold investment properties are receivable in the following periods: Less than 1 year 314 351
The total minimum future rentals to be received on non-cancellable sub-leases for the Group’s investment properties held under finance leases at 31 December 2014 are £2,600 million (2013: £2,315 million).
b Held for sale Japan life business On 5 February 2015, the Group announced that it had completed the sale of its closed book life insurance business in Japan, PCA Life Insurance Company Limited to SBI Holdings, Inc. following regulatory approvals. The transaction was announced on 16 July 2013. Of the agreed US$85 million cash consideration, the Group received US$68 million on completion of the transaction, and a further payment of up to US$17 million will be received contingent upon the future performance of the Japan life business.
Adjustment for remeasurement of the carrying value to fair value less costs to sell (124) (120)
c Bancassurance partnership with Standard Chartered Bank On 12 March 2014, the Group announced that it had entered into an agreement expanding the term and geographic scope of its strategic pan-Asian bancassurance partnership with Standard Chartered Bank. Under the new 15-year agreement, which commenced on 1 July 2014, a wide range of Prudential life insurance products are exclusively distributed through Standard Chartered Bank branches in nine markets – Hong Kong, Singapore, Indonesia, Thailand, Malaysia, the Philippines, Vietnam, India and Taiwan – subject to applicable regulations in each country. In China and South Korea, Standard Chartered Bank distributes Prudential’s life insurance products on a preferred basis. Prudential and Standard Chartered Bank have also agreed to explore additional opportunities to collaborate in due course elsewhere in Asia and in Africa, subject to existing exclusivity arrangements and regulatory restrictions.
The consideration for the transaction was THB 18.981 billion (£412 million), of which THB 17.500 billion (£380 million) was settled in cash on completion in May 2013 with a further payment of THB 0.946 billion (£20 million), for adjustments to reflect the net asset value as at completion date, paid in July 2013. In addition a deferred payment of THB 0.535 billion (£12 million) was paid 12 months after completion. Included in the total consideration of THB 18.981 billion (£412 million) was the cost of the distribution rights associated with the exclusive 15-year bancassurance partnership agreement with Thanachart Bank.
The Group is involved in a number of litigation and regulatory issues. These include civil proceedings involving Jackson, 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. Whilst the outcome of such litigation and regulatory issues cannot be predicted with certainty, the Company believes that their ultimate outcome will not have a material adverse effect on the Group’s financial condition, results of operations, or cash flows.
In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment policy and it gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. This review was completed on 30 June 2002 with the assurance continuing 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, retail price index or salary related increases and Department of Work and Pensions rebate business). The assurance has not applied to new business since 1 January 2004.
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.
: O th er n o tes 259 Prudential plc Annual Report 2014
D5: Subsidiary undertakings a Principal subsidiaries The principal subsidiary undertakings (those undertakings whose results or financial position, in the opinion of the directors, principally affected the Group’s results or financial position) of the Group at 31 December 2014 are disclosed in note 5 ‘Investments of the Company’ of the parent company financial statements.
b Dividend restrictions and minimum capital requirements Certain Group subsidiaries and joint ventures are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company.
The Group’s subsidiaries and joint ventures 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 and has sufficient distributable reserves.
The Group capital position statement for life assurance businesses is set out in note C11.1, showing the available capital reflecting the excess of regulatory basis over liabilities for each fund or group of companies determined by reference to the local regulation of the subsidiaries. In addition, disclosure is also provided in note C11.1 of the local capital requirement of the principal funds and companies.
Joint ventures represent arrangements where the controlling parties through contractual or other agreement have the rights to the net assets of the arrangements. The Group has shareholder-backed joint venture insurance and asset management businesses in China with CITIC Group, and in India with ICICI Bank. In addition, there is an asset management joint venture in Hong Kong with Bank of China International Holdings Limited (BOCI) and Takaful general and life insurance joint venture in Malaysia.
The Group’s associates, which are also accounted for under the equity method, include PPM South Africa and PruHealth (until its sale in 2014, see note D1). In addition, the Group has investments in Open-Ended Investment Companies (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. As allowed under IAS 28, these investments are accounted for on a fair value through profit or loss basis. The aggregate fair value of associates accounted for at fair value through profit or loss where there are published price quotations is approximately £1.2 billion at 31 December 2014 (2013: £0.5 billion).
The Group’s share of the profits, net of related tax, and carrying amount of interest in joint ventures and associates, which are equity accounted as shown in the consolidated income statement comprises the following: Joint ventures Associates
Further, following the adoption of IFRS 11 in 2013, the Group’s investments in joint ventures are now accounted for on an equity method basis. There are no material transactions between these joint ventures and other Group companies.
In addition, the Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. The contractual obligations to purchase or develop investment properties at 31 December 2014 were £232 million (2013: £92 million).
Current assets Debtors: Amounts owed by subsidiary undertakings 3,785 3,706 Other debtors 3 3
Amounts owed to subsidiary undertakings (1,108) (2,462) Tax payable (55) (60) Sundry creditors (3) (4) Accruals and deferred income (39) (40)
Other borrowings 7 – (299) Amounts owed to subsidiary undertakings 5 – (7,227)
Total net assets (excluding pension) 7,914 7,322 Pension asset (net of related deferred tax) 9 31 30
The financial statements of the parent company on pages 261 to 269 were approved by the Board of Directors on 9 March 2015 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, Indonesia, Malaysia, Singapore and other countries. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company. In the UK, the Group operates through its subsidiaries, primarily The Prudential Assurance Company Limited, Prudential Retirement Income Limited and M&G Investment Management Limited.
Derivatives Derivative financial instruments are held to manage certain macroeconomic exposures. Derivative financial instruments are carried at fair value with changes in fair value included in the profit and loss account.
Tax Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year, they can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
The Group’s UK subsidiaries each file separate tax returns. In accordance with UK tax legislation, where one domestic UK company is a 75 per cent owned subsidiary of another UK company, or both are 75 per cent owned subsidiaries of a common parent, the companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses arising in the same accounting period may be offset for the purposes of determining current and deferred taxes.
Under FRS 20 ‘Share-based Payment’, where the Company, as the parent company, has the obligation to settle the options or awards of its equity instruments to employees of its subsidiary undertakings, and such share-based payments are accounted for as equitysettled in the Group financial statements, the Company records an increase in the investment in subsidiary undertakings for the value of the share options and awards granted with a corresponding credit entry recognised directly in equity. The value of the share options and awards granted is based upon the fair value of the options and awards at the grant date, the vesting period and the vesting conditions.
Profit for the financial year of the Company (including dividends from subsidiaries) in accordance with IFRS 1,463 1,595 Share in the IFRS result of the Group, net of distributions to the Company† 753 (249)
Profit after tax of the Group attributable to shareholders in accordance with IFRS 2,216 1,346
P aren t co m p an y 265 Prudential plc Annual Report 2014 5 Investments of the Company 2014 £m
Other movements comprise £6 million in respect of share-based payments, reflecting the value of payments settled by the Company for employees of its subsidiary undertakings, offset by cash of £58 million received from those subsidiaries in respect of share awards.
The Prudential Assurance Company Limited Insurance England and Wales Prudential Retirement Income Limited (PRIL)* Insurance Scotland M&G Investment Management Limited* Asset management England and Wales Jackson National Life Insurance Company* Insurance US Prudential Assurance Company Singapore (Pte) Limited* Insurance Singapore PT Prudential Life Assurance* Insurance Indonesia Prudential Hong Kong Limited* Insurance Hong Kong * Owned by a subsidiary undertaking of the Company.
Short-term timing differences 1 2 Unused deferred tax losses 7 7
The reduction in the UK corporation tax rate from 21 per cent to 20 per cent from 1 April 2015 was substantively enacted on 2 July 2013. Accordingly, the effect of this change was included in the financial statements for the year ended 31 December 2014. The change did not have a material impact on the Company’s deferred tax balances as at 31 December 2014.
Other borrowings: Floating Rate Notesnote (iii) – – 200 200 200 200 Medium Term Notes 2015note (ii) – – 300 299 300 299
Borrowings are repayable as follows: Within 1 year or on demand – – 2,204 1,834 2,204 1,834
Notes (i) Further details on the core structural borrowings of the Company are provided in note C6.1 of the Group financial statements. (ii) These borrowings support a short-term fixed income securities programme. (iii) The Company issued £200 million Floating Rate Notes in October 2014 which will mature in October 2015. These Notes have been wholly subscribed to by a
(iv) The interests of the holders of the subordinated liabilities are subordinate to the entitlements of other creditors of the Company. (v) In January 2015, the Company issued £300 million Medium Term Notes which will mature in January 2018. The proceeds, net of costs, were £299 million.
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.
P aren t co m p an y 267 Prudential plc Annual Report 2014 9 Pension scheme financial position
At 31 December 2005, the allocation of surpluses and deficits attaching to the Scheme between the Company and the unallocated surplus of The Prudential Assurance Company Limited (‘PAC’) with-profits fund was apportioned in the ratio 30/70 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 2014. The FRS 17 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity.
Total value of assets 6,997 100.0 6,042 100.0 6,400 100.0 6,432 100.0 5,351 100.0 Present value of
Surplus in the Scheme recognised by the Company 39 37 49 52 56
Underlying Scheme liabilities and assets The change in the present value of the underlying Scheme liabilities and the change in the fair value of the underlying Scheme assets are as follows: Present value of Scheme liabilities, at 1 January 5,316 5,226 Current service cost 17 17 Past service cost 4 3 Interest cost 229 225 Employee contributions 1 1 Actuarial gains 830 78 Benefit payments (240) (234)
Fair value of Scheme assets, at 1 January 6,042 6,400 Expected return on Scheme assets 219 182 Employee contributions 1 1 Employer contributions* 11 11 Actuarial gains (losses) 964 (318) Benefit payments (240) (234)
Pension charge and actuarial gains (losses) of the Scheme and attributable to the Company The pension charge of the Scheme and the charge recognised in the Company’s profit and loss account are as follows: Pension charge: 2014 £m 2013 £m
Operating charge: Current service cost (17) (17) Past service cost (4) (3)
Finance (expense) income: Interest on Scheme liabilities (229) (225) Expected return on Scheme assets 219 182
Changes in assumptions underlying the present value of Scheme liabilities (796) (76) (233) (426) (370)
The actuarial gains before tax of £11 million (2013: £8 million) attributable to the Company are recorded in the statement of total recognised gains and losses. Cumulative actuarial gains as at 31 December 2014 amount to £112 million (2013: £101 million).
Total employer contributions expected to be paid into the Scheme for the year ending 31 December 2015 amount to £11 million, comprising ongoing service contributions and expenses. This is subject to reassessment when the 2014 triennial valuation is finalised in 2015.
The profit after tax of the Company for the year was £1,460 million (2013: £1,579 million). After dividends of £895 million (2013: £781 million), actuarial gains net of tax in respect of the pension scheme of £9 million (2013: £6 million) and share-based payment credits of £6 million (2013: £6 million), retained profit at 31 December 2014 amounted to £5,909 million (2013: £5,329 million). The retained profit includes distributable reserves of £3,435 million and non-distributable reserves of £2,474 million. The non-distributable reserves comprise £2,405 million relating to gains made by intermediate holding companies following the transfer at fair value of certain subsidiaries to other parts of the Group as part of internal restructuring exercises, and £69 million of share-based payment reserves. The amount of £2,405 million is not able to be regarded as part of the distributable reserves of the parent company because the gains relate to intra-group transactions. 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 non-distributable 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.
Actuarial gains recognised in respect of the pension scheme, net of related taxnote 9 9 6 Share-based paymentsnote 5 6 6 New share capital subscribed 13 6
Net increase in shareholders’ funds 593 816 Shareholders’ funds at beginning of year 7,352 6,536
Shareholders’ funds at end of yearnote 4 7,945 7,352 12 Other information a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note B3.3 of the Group financial statements.
b Information on transactions of the directors with the Group is given in note D7 of the Group financial statements. c The Company employs no staff. d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2013: £0.1 million) and for other services were £0.1 million (2013: £0.1 million). e In certain instances, the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
Subject to shareholders’ approval, in May 2015 the Company will pay a final dividend for the year ended 31 December 2014. Further details are provided in note B7 of the Group financial statements.
— Prepare the financial statements on the going-concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business.
The directors of Prudential plc, whose names and positions are set out on pages 72 to 75 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; — The strategic report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face; and
— The Annual Report and financial statements, taken as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy.
in an cial statem en ts Statem en t o f d irecto rs’ resp o n sib ilities In d ep en d en t au d ito r’s rep o rt
The risk – The Group’s investment portfolio represents 91 per cent of the Group’s total assets.
Our response – We used our own valuation specialists and pricing services to assist us in performing our audit procedures in this area, which included: — Assessing whether the valuation process is appropriately designed and captures relevant valuation inputs; — Testing associated controls in respect of the valuation process; — Performing our own independent price checks from our own pricing services using external quotes for liquid positions and, where available, for illiquid positions; — Assessing pricing model methodologies and assumptions against industry practice and valuation guidelines; — Evaluating the testing performed by the Group in order to identify any impairment in relation to loans; and performing our own assessment of loan files to understand the performance of the loans. We obtained an understanding of existing and prospective investee company cash flows to understand whether loans can be serviced or refinancing may be required and considered the impact on impairment testing performed.
We also assessed whether the Group’s disclosures in relation to the valuation of investments are compliant with the relevant accounting requirements, in particular the sensitivity of the valuations adopted to alternative outcomes.
Other key audit procedures included assessing the Group’s methodology for calculating the insurance liabilities and their analysis of the movements in insurance liabilities during the year, including consideration of whether the movements are in line with the assumptions adopted by the Group, our understanding of developments in the business and our expectation derived from market experience. We considered the validity of management’s liability adequacy testing which is a key test performed to check that the liabilities are adequate in the context of expected experience. Our work on the liability adequacy test includes assessing the reasonableness of the projected cash flows and challenging the assumptions adopted in the context of company and industry experience data and specific product features.
We considered whether the Group’s disclosures in relation to the assumptions used in the calculation of insurance liabilities are compliant with the relevant accounting requirements, in particular the sensitivities of these assumptions to alternative scenarios and inputs.
Deferred Acquisition Costs (‘DAC’) (£5,930 million) Refer to page 81 (Audit Committee report), page 135 (accounting policy) and pages 220 to 224 (financial disclosures)
Our response – We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included
We report to the Group audit committee any corrected or uncorrected identified misstatements exceeding £15 million in addition to other identified misstatements that warrant reporting on qualitative grounds.
The Group audit team visited 10 component locations in insurance operations in UK, US, Hong Kong, Indonesia, Singapore, Malaysia, Korea and Vietnam, fund management operations in M&G and Prudential Capital. This included an assessment of the audit risk and strategy. Video and telephone conference meetings were also held with these component auditors and certain others that were not physically visited. At these visits and meetings, the findings reported to the Group audit team were discussed in more detail, and any further work required by the Group audit team was then performed by the component auditor
The Senior Statutory Auditor, in conjunction with other senior staff in the Group team, also regularly attended Business Unit audit committee meetings (at a regional level for Asia) and participated in meetings with local management to understand at first hand the key risks and audit issues at a component level which may affect the Group financial statements.
In particular, we are required to report to you if: — We have identified material inconsistencies between the knowledge we acquired during our audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy; or
— The Audit Committee Report does not appropriately address matters communicated by us to the audit committee.
Under the Listing Rules we are required to review: — The directors’ statement, set out on page 90, in relation to going concern; and
— The part of the Corporate Governance Statement on page 88 relating to the Company’s compliance with the ten provisions of the 2012 UK Corporate Governance Code specified for our review.
We have nothing to report in respect of the above responsibilities.
for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants London
In broad terms, IFRS profits for long-term business reflect the aggregate of results on a traditional accounting basis. By contrast, embedded value is a way of reporting the value of the life insurance business.
Results prepared under the EEV principles capture the discounted value of future profits expected to arise from the current book of long-term business. The results are prepared by projecting cash flows, by product, using best estimate assumptions for all relevant factors. Furthermore, in determining these expected profits, full allowance is made for the risks attached to their emergence and the associated cost of capital, and takes into account recent experience in assessing likely future persistency, mortality, morbidity and expenses. Further details are explained in notes 16 and 17.
Index to European Embedded Value (EEV) basis results 277 Post-tax operating profit based on longer-term investment returns 278 Post-tax summarised consolidated income statement 278 Movement in shareholders’ equity 279 Summary statement of financial position
Notes on the EEV basis results 280 1 Basis of preparation 280 2 Results analysis by business area 282 3 Analysis of new business contribution 283 4 Operating profit from business in force 285 5 Short-term fluctuations in investment returns 286 6 Effect of changes in economic assumptions 287 7 Sale of PruHealth and PruProtect businesses 287 8 Held for sale Japan life business 288 9 Domestication of the Hong Kong branch business 288 10 Net core structural borrowings of shareholderfinanced operations 289 11 Analysis of movement in free surplus 291 12 Reconciliation of movement in shareholders’ equity 292 13 Reconciliation of movements in net worth and value of in-force for long-term business 294 14 Expected transfer of value of in-force business to free surplus 295 15 Sensitivity of results to alternative assumptions 297 16 Methodology and accounting presentation 307 18 New business premiums and contributions
Analysed as profits (losses) from: Business in force 4 2,049 2,168
* The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis. This approach has been adopted throughout this supplementary information.
Notes (i) EEV basis other income and expenditure represents the post-tax IFRS basis result, less the unwind of expected margins on the internal management of the assets of the covered business (as explained in note 16(a)(vii)). (ii) Solvency II and restructuring costs comprise the net of tax charge recognised on an IFRS basis and the additional amount recognised on the EEV basis for the shareholders’ share incurred by the PAC with-profits fund. (iii) The comparative results have been prepared using previously reported average exchange rates for the year. For memorandum disclosure purposes, note 2 presents the 2013 results on both actual exchange rates (AER) and constant exchange rates (CER) bases.
Post-tax operating profit based on longer-term investment returns Asia operations 1,978 1,955 US operations 1,534 1,565 UK operations 1,151 1,200 Other income and expenditure (531) (482) Solvency II and restructuring costs (36) (34)
Post-tax operating profit based on longer-term investment returns 4,096 4,204 Short-term fluctuations in investment returns 5 763 (564) Effect of changes in economic assumptions 6 (369) 629 Mark to market value movements on core borrowings (187) 152 Gain on sale of PruHealth and PruProtect 7 44 – Loss attaching to held for sale Japan life business 8 – (35) Costs of domestication of Hong Kong branch 9 (4) (28) Total post-tax non-operating profit 247 154
Profit for the year attributable to equity holders of the Company 4,343 4,358 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
New share capital subscribed 13 6 Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes (11) (53) Reserve movements in respect of share-based payments 106 98 Treasury shares: Movement in own shares in respect of share-based payment plans (48) (10) Movement in own shares purchased by unit trusts consolidated under IFRS (6) (31)
Shareholders’ equity at end of year 12 29,161 24,856 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
Total assets less liabilities, before deduction for insurance funds 326,633 288,826 Less insurance funds:*
Total EEV basis shareholders’ equity (excluding non-controlling interests) 12 29,161 24,856 * Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.
* Annualised return on embedded value is based on EEV post-tax operating profit, as a percentage of opening EEV basis shareholders’ equity.
Paul Manduca Tidjane Thiam Nic Nicandrou Chairman Group Chief Executive Chief Financial Officer
The EEV basis results have been prepared in accordance with the EEV Principles issued by the European Insurance CFO Forum in May 2004 and subsequently supplemented by Additional Guidance on EEV Disclosure issued in October 2005. Where appropriate, the EEV basis results include the effects of adoption of International Financial Reporting Standards (IFRS). The EEV results are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis.
The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles. The auditors have reported on the 2014 EEV basis results supplement to the Company’s statutory accounts for 2014. Their report was (i) unqualified, (ii) did not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying their report and (iii) did not contain a statement under section 498(2) or (3) of the Companies Act 2006. Except for the change in presentation of EEV results from pre-tax to post-tax, as described in the additional unaudited financial information for the 2013 annual report, the 2013 results have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2013.
Analysed as profits from: Post-tax operating profit based on longer-term investment returns 4,096 4,204 3,933 (3)% 4%
Short-term fluctuations in investment returns 5 763 (564) (529) 235% 244% Effect of changes in economic assumptions 6 (369) 629 623 (159)% (159)%
Based on post-tax profit 170.4p 171.0p 161.7p 0% 5% Average number of shares (millions) 2,549 2,548 2,548
Asia operations(note ii) 2,125 11,375 1,139 54 10.0 US operations 1,573 15,723 706 45 4.5 UK insurance operations 725 5,978 237 33 4.0
Note The movements in operating profit from business in force of £(119) million from £2,168 million in 2013 to £2,049 million for 2014 comprises: 2014 £m
Reduction in unwind of discount and other expected returns: Foreign exchange effects (80) Effect of changes in interest rates (187) Effect of growth in opening value and other items 207
Non-recurrent benefit in 2013 of reduction in UK corporate tax rates (98) Year-on-year change in effects of other operating assumptions, experience variances and other items 39
Unwind of discount and other expected returnsnote (a) 648 668 Effect of changes in operating assumptions: Mortality and morbiditynote (b) 27 19 Persistency and withdrawalsnote (c) (17) (23)
(g) The expense experience variance at 2014 is negative £(27) million (2013: negative £(17) million). The variance arises in operations which are currently sub-scale (China, Malaysia Takaful and Taiwan), and from short-term overruns in India and Korea.
Total US operations 834 820 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(c) The effect of other changes in operating assumptions of £31 million reflects a number of offsetting items and includes the capitalised effect of changes in projected policyholder variable annuity fees of £46 million (2013: £33 million) which vary depending on the size and mix of variable annuity funds.
(d) The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults (see note 17 (ii)). The spread experience variance in 2014 of £192 million (2013: £217 million) includes the positive effect of transactions undertaken to more closely match the overall asset and liability duration.
(e) The amortisation of interest-related gains and losses reflects the fact that when bonds that are neither impaired nor deteriorating are sold and reinvested, there will be a consequent change in the investment yield. The realised gain or loss is amortised into the result over the year when the bonds would have otherwise matured to better reflect the long-term returns included in operating profits.
Total UK insurance operations 476 595 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
Notes (a) The decrease in unwind of discount and other expected returns of £(27) million from £437 million for 2013 to £410 million for 2014 reflects a £(59) million adverse impact of the 130 basis point reduction in gilt yields partially offset by £32 million mainly for the underlying growth in the in-force book. (b) For 2013, the positive contribution from the change in UK corporate tax rates of £98 million reflected the combined effect of the reductions in corporate rates from 23 per cent to 21 per cent from April 2014 and 21 per cent to 20 per cent from April 2015.
basis resu lts 285 Prudential plc Annual Report 2014 5 Short-term fluctuations in investment returns
Insurance operations: Asianote (ii) 439 (308) USnote (iii) (166) (280) UKnote (iv) 583 28
* The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(ii) Asia operations The short-term fluctuations in investment returns for Asia operations comprise amounts in respect of: 2014 £m 2013* £m
These fluctuations mainly arise from decreases (2014) and increases (2013) in long-term interest rates as they affect the value of bonds in the portfolios backing liabilities and related capital. The £134 million credit for other operations in 2014 principally arises in Taiwan of £23 million and in Thailand of £49 million for unrealised gains on bonds.
Notes (a) The credit relating to fixed income securities comprises the following elements: – The excess of actual realised gains and losses over the amortisation of interest-related realised gains and losses recorded in the profit and loss account; – Credit loss experience (versus the longer-term assumption); and – The impact of changes in the asset portfolio. (b) This item reflects the net impact of: – Variances in projected future fees and future benefit costs arising from the effect of market fluctuations on the growth in separate account asset values in the current reporting period; and – Related hedging activity arising from realised and unrealised gains and losses on equity-related hedges and interest rate options. (c) For 2013, other items of £84 million primarily reflected a beneficial impact of the excess of actual over assumed return from investments in limited partnerships.
(iv) UK insurance operations The short-term fluctuations in investment returns for UK insurance operations comprise: 2014 £m 2013* £m
Shareholder-backed annuitynote (a) 310 (58) With-profits, unit-linked and othernote (b) 273 86 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(v) Other operations Short-term fluctuations in investment returns of other operations were negative £(93) million (2013: negative £(4) million) representing unrealised value movements on investments and foreign exchange items.
The effects of changes in economic assumptions for in-force business included in profit for the year, arise as follows: (i) Group summary 2014 £m 2013* £m
Total Asia operations (269) 255 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(iii) US operations The effect of changes in economic assumptions for US operations comprises: 2014 £m 2013* £m
Notes (a) For fixed annuity and other general account business, the credit of £151 million in 2014 principally arises from the effect on the future projected spread income of applying a lower discount rate on the opening value of the in-force book, arising from the 90 basis points reduction in the 10-year treasury rates (2013: charge of £(244) million reflecting the 130 basis points increase).
(d) The overall credit in 2013 of £242 million included a charge of £(13) million for the effect of a change in required capital on the EEV basis from 235 per cent to 250 per cent of risk-based capital.
(iv) UK insurance operations The effect of changes in economic assumptions for UK insurance operations comprises the following: 2014 £m 2013* £m
Notes (a) For shareholder-backed annuity business, the overall positive effect reflects the effect on the present value of projected spread income arising from the reduction in expected long-term rates of return and risk discount rates, following the swap rate decline in 2014.
(b) For with-profits and other business, the total charge in 2014 of £(375) million (2013: credit of £188 million) includes the net effect of the reduction in fund earned rates and risk discount rates (as shown in note 17(iii)), arising from the 130 basis points decrease (2013: increase of 120 basis points) in the 15-year government bond rate and portfolio changes.
On 5 February 2015, the Group announced that it had completed the sale of its closed book life insurance business in Japan, PCA Life Insurance Company Limited to SBI Holdings, Inc. following regulatory approvals. The loss of Japan life business in the 2013 results includes the reduction in EEV carrying value to reflect the completion of sale.
The net EEV basis effect of £(11) million represents the cost of holding higher required capital levels in the stand-alone Hong Kong shareholder-backed long-term insurance business. The post-tax costs incurred to enable the domestication in 2014 were £4 million (2013: £28 million).
Core structural borrowings – central funds 3,869 579 4,448 4,211 392 4,603
Net core structural borrowings of shareholder- * Including central finance subsidiaries.
basis resu lts 289 Prudential plc Annual Report 2014 11 Analysis of movement in free surplus
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.
US operations Underlying free surplus generated from in-force life business 1,191 1,129 1,072 5% 11% Investment in new businessnote (ii)(a) (187) (298) (283) 37% 34%
Representing: Long-term business: Expected in-force cash flows (including expected return on net assets) 2,382 2,150 2,037 11% 17%
Underlying free surplus generated from in-force life business 2,696 2,628 2,494 3% 8% Investment in new businessnotes (ii)(a), (ii)(g) (606) (637) (597) 5% (2)%
Net cash flows to parent companynote (d) (1,170) (312) (1,482) (1,341) Bancassurance agreement and purchase of Thanachart Life – – – 365 Exchange movements, timing differences and other itemsnote (e) 210 (80) 130 (352)
Net movement in free surplus 1,008 83 1,091 314 Balance at 1 January: Effect of domestication of Hong Kong branch on 1 January 2014note 9 (35) – (35) –
(c) Non-operating items are principally short-term fluctuations in investment returns and the effect of changes in economic assumptions for long-term business operations. (d) Net cash flows to parent company for long-term business operations reflect the flows as included in the holding company cash flow at transaction rates. (e) Exchange movements, timing differences and other items represent: 2014 £m
Mark to market value movements on Jackson assets backing surplus and required capitalnote 12 77 – 77 Shareholders' share of actuarial and other gains and losses on defined benefit pension schemes (17) (1) (18)
(f) Other primarily reflects the effect of intra-group loans, contingent loan funding as shown in note 13(i), timing differences and other non-cash items. (g) Investment in new business includes the annual amortisation charge of amounts incurred to secure exclusive distribution rights through our bancassurance partners at a rate that reflects the pattern in which the future economic benefits are expected to be consumed by reference to new business levels. Included within the overall free surplus balance of the Asia life entities is £304 million representing unamortised amounts incurred to secure exclusive distribution rights through bancassurance partners. These amounts exclude £883 million of Asia distribution rights intangibles that are financed by loan arrangements from central companies, the costs of which are allocated to the Asia life segment as the amortisation cost is incurred.
Post-tax operating profit based on longer-term investment returns 1,900 1,528 726 4,154 (58) 4,096
Other items taken directly to equity Exchange movements on foreign operations and
Mark to market value movements on Jackson assets backing surplus and required capital – 77 – 77 – 77
Shareholders’ equity at 31 December note (i) 12,312 8,379 8,433 29,124 37 29,161
Balance at 31 December 2013 Representing: Statutory IFRS basis shareholders’ equity: Total IFRS basis shareholders’ equity 2,564 3,446 2,976 8,986 664 9,650 Additional retained profit (loss) on an EEV
(iii) Investment in operations reflects increases in share capital. (iv) Included in other movements was a charge of £(11) million (2013: £(53) million) for the shareholders’ share of actuarial and other gains and losses on the defined benefit schemes.
Post-tax operating profit based on longer-term investment returns 2,090 254 2,344 1,810 4,154
Post-tax profit from long-term business 1,968 442 2,410 2,269 4,679 Exchange movements on foreign operations and net
Representing: Asia operations Shareholders’ equity at 1 January: Effect of domestication of Hong Kong branch
New business contributionnotes (ii) and 3 (346) 130 (216) 1,378 1,162 Existing business – transfer to net worth 828 (23) 805 (805) – Expected return on existing businessnote 4 62 – 62 586 648 Changes in operating assumptions and experience variancesnote 4 (29) 44 15 76 91
basis resu lts 293 Prudential plc Annual Report 2014 2014 £m
Post-tax operating profit based on longer-term investment returns 572 45 617 109 726
Post-tax profit from long-term business 601 218 819 507 1,326 Intra-group dividends (including statutory transfers)note (i) (279) – (279) 79 (200)
Notes on the EEV basis results continued 13 Reconciliation of movement in net worth and value of in-force for long-term business continued
Notes (i) The amounts shown in respect of free surplus and the value of in-force business for UK insurance operations for intra-group dividends (including statutory transfers) 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.
Post-tax new business contributionnote 3 1,162 694 270 2,126 1,139 706 237 2,082 Free surplus invested in new business (346) (187) (73) (606) (310) (298) (29) (637)
Cost of time value of guaranteesnote (iv) (113) (462) – (575) (50) (146) – (196)
US operations 7,471 3,867 2,298 873 334 99 – UK insurance operations 5,771 2,111 1,464 973 606 604 13
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2013 total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years
(a) Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2014 (31 December 2013) and the post-tax new business contribution after the effect of required capital for 2014 and 2013 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); — The statutory minimum capital level (by contrast to EEV basis required capital), (for embedded value only); — 5 basis point increase in UK long-term expected defaults; and — 10 basis point increase in the liquidity premium for UK annuities.
Notes on the EEV basis results continued 15 Sensitivity of results to alternative assumptions continued
Post-tax new business contributionnote 3 1,162 694 270 2,126 1,139 706 237 2,082
Long-term expected defaults – 5bps increase – – (10) (10) – – (6) (6) Liquidity premium – 10bps increase – – 20 20 – – 12 12 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
Interest rates – 1% decrease 211 16 452 679 200 (12) 443 631 Equity/property yields – 1% rise 435 365 282 1,082 370 250 210 830 Equity/property market values – 10% fall (221) (129) (380) (730) (183) (90) (238) (511) Statutory minimum capital 129 139 4 272 109 153 4 266 Long-term expected defaults – 5bps increase – – (139) (139) – – (114) (114)
Change representing effect on: * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2013 results are shown on a comparable basis – see note 1.
(a) Methodology Overview The embedded value is the present value of the shareholders’ interest in the earnings distributable from assets allocated to covered business after sufficient allowance has been made for the aggregate risks in that business. The shareholders’ interest in the Group’s long-term business comprises: — The present value of future shareholder cash flows from in-force covered business (value of in-force business), less deductions for: – The cost of locked-in required capital; and – The time value of cost of options and guarantees; — Locked-in required capital; and — The shareholders’ net worth in excess of required capital (free surplus).
(i) 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 post-tax EEV basis results for the Group’s covered business are then combined with the post-tax IFRS basis results of the Group’s other operations. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management, as described in note 16(a)(vii).
— The presentational treatment of the Group’s principal defined benefit pension scheme, the Prudential Staff Pension Scheme (PSPS). The partial recognition of the surplus for PSPS is recognised in ‘Other’ operations.
The results for any covered business conceptually reflect the aggregate of the IFRS results and the movements on the additional shareholders’ interest recognised on the EEV basis. Thus the start point for the calculation of the EEV results for Jackson, as for other businesses, reflects the market value movements recognised on the IFRS basis.
(iii) Cost of capital A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as required capital. The cost is the difference between the nominal value of the capital and the discounted value of the projected releases of this capital allowing for investment earnings (post-tax) on the capital.
Where required capital is held within a with-profits long-term fund, the value placed on surplus assets in the fund is already discounted to reflect its release over time, and no further adjustment is necessary in respect of required capital.
Fixed annuities provide that, at Jackson’s discretion, it may reset the interest rate credited to policyholders’ accounts, subject to a guaranteed minimum. The guaranteed minimum return varies from 1.0 per cent to 5.5 per cent for 2014 and 2013, depending on the particular product, jurisdiction where issued, and date of issue. For 2014, 86 per cent (2013: 86 per cent) of the account values on fixed annuities are for policies with guarantees of 3 per cent or less. The average guarantee rate is 2.7 per cent (2013: 2.8 per cent).
(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. For with-profits business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is sufficient to meet the required capital requirements. For shareholder-backed business the following capital requirements apply: — Asia operations: the level of required capital has been set to an amount at least equal to the higher of local statutory requirements and the internal target; — US operations: the level of required capital has been set at 250 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL); and
In the annuity MCEV calculations, as the assets are generally held to maturity to match long duration liabilities, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for: (a) Expected long-term defaults derived as a percentage of historical default experience based on Moody’s data for the period 1970 to 2009 and the definition of the credit rating assigned to each asset held is the second highest credit rating published by Moody’s, Standard & Poor’s and Fitch; (b) A credit risk premium, which is derived as the excess over the expected long-term defaults, of the 95th percentile of historical cumulative defaults based on Moody’s data for the period 1970 to 2009, and subject to a minimum margin over expected long-term defaults of 50 per cent; (c) An allowance for a 1-notch downgrade of the asset portfolio subject to credit risk; and (d) An allowance for short-term downgrades and defaults.
(2) With-profits fund non-profit annuity business For UK non-profit annuity business including that attributable to the PAC with-profits fund, the basis for determining the aggregate allowance for credit risk is consistent with that applied for UK shareholder-backed annuity business (as described previously). The allowance for credit risk for this business is taken into account in determining the projected cash flows to the with-profits fund, which are in turn discounted at the risk discount rate applicable to all of the projected cash flows of the fund.
A base level allowance of 50 basis points is applied to cover the non-diversifiable non-market risks associated with the Group’s businesses. For the Group’s US business and UK business, other than shareholder-backed annuity, no additional allowance is necessary. For UK shareholder-backed annuity business, a further allowance of 50 basis points is used to reflect the longevity risk which is of particular relevance. For the Group’s Asia operations in China, India, Indonesia, the Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points.
(ix) Foreign currency translation Foreign currency profits and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange. The principal exchange rates are shown in note A1 of the IFRS statements.
(xi) Intercompany arrangements The EEV results for covered business incorporate annuities established in the PAC non-profit sub-fund from vesting pension polices in SAIF (which is not covered business). The EEV results also incorporate the effect of the reinsurance arrangement of non-profit immediate pension annuity liabilities of SAIF to PRIL. In addition, the free surplus and value of in-force business are calculated after taking account of the impact of contingent loan arrangements between Group companies (movements in the contingent loan liability are reflected via the projected cash flows in the value of in-force and the related funding is reflected in free surplus).
(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 16(b)(ii) opposite) and incorporate the following: — New business contribution, as defined in note 16(a)(ii); — Unwind of discount on the value of in-force business and other expected returns, as described in note 16(b)(iii) opposite; — The impact of routine changes of estimates relating to non-economic assumptions, as described in note 16(b)(iv) opposite; and — Non-economic experience variances, as described in note 16(b)(v) opposite.
(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 16(b)(iii) below.
For UK annuity business, rebalancing of the asset portfolio backing the liabilities to policyholders may, from time to time, take place to align it more closely with the internal benchmark of credit quality that management applies. Such rebalancing will result in a change in the projected yield on the asset portfolio and the allowance for default risk. The net effect of these changes is included in the result for the year.
(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 period, such as persistency, mortality and morbidity, expenses and other factors.
(vi) Effect of changes in economic assumptions Movements in the value of in-force business at the beginning of the period caused by changes in economic assumptions, net of the related change in the time value of cost of options and guarantees, are recorded in non-operating results.
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 period end rates of return on government bonds. 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.
(c) The mean equity return assumptions for the most significant equity holdings of the Asia operations were: Hong Kong 6.2 7.1
Risk discount rate: New business 6.5 6.8 In forcenote (a) 6.9 8.3
Other business: Risk discount rate: New business 5.3 6.1 In force 5.9 6.8
Pre-tax expected long-term nominal rates of investment return: UK equities 6.2 7.5 Overseas equities 6.2 to 9.0 7.1 to 9.2 15-year gilt rate 2.2 3.5 Corporate bonds 3.8 5.1
Bond spread over swap rates 108 117 143 133 Total credit risk allowance 29 37 58 62 * The new business liquidity premium is based on the weighted average of the point-of-sale liquidity premia.
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 16(a)(iv).
Exceptional expenses are identified and reported separately. For mature business, it is Prudential’s policy not to take credit for future cost-reduction programmes until the savings have been delivered. For businesses which are currently sub-scale (China, Malaysia Takaful and Taiwan), and India (where the business model is being adapted as the industry continues to adjust to regulatory changes), expense overruns are reported where these are expected to be short-lived.
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 16(a)(x).
The local standard corporate tax rates applicable for the most significant operations for 2014 and 2013, are as follows: Standard corporate tax rates %
US operations 35.0 UK operations 20.0 * 16.5 per cent on 5 per cent of premium income.
SE Asia operations including Hong Kong 1,710 1,575 1,615 1,551 1,786 1,709 10,350 9,473 Chinanote (ii) 239 114 81 71 105 83 550 409 Korea 212 311 92 82 113 113 609 641 Taiwan 83 102 116 107 124 117 462 491 Indianote (iii) 28 34 106 100 109 103 360 361
US insurance operations Variable annuities 10,899 10,795 – – 1,090 1,079 10,899 10,795 Elite access (variable annuity) 3,108 2,585 – – 311 259 3,108 2,585 Fixed annuities 527 555 – – 53 55 527 555 Fixed index annuities 370 907 – – 37 91 370 907 Life – 1 – 2 – 2 – 12 Wholesale 651 869 – – 65 87 651 869
UK and Europe insurance operations Direct and partnership annuities 162 284 – – 16 28 162 284 Intermediated annuities 139 488 – – 14 49 139 488 Internal vesting annuities 764 1,305 – – 76 131 764 1,305
Notes (i) The tables shown above are provided as an indicative volume measure of transactions undertaken in the reporting period that have the potential to generate profits for shareholders. The amounts shown are not, and not intended to be, reflective of premium income recorded in the IFRS income statement. (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.
— Described the basis on which business that is not covered business has been included in the supplementary information, including any material departures from the accounting framework applicable to the Group’s financial statements.
Our opinion on the EEV basis supplementary information is unmodified We have audited the EEV basis supplementary information of Prudential plc (the Company) for the year ended 31 December 2014 set out in the EEV basis results and Notes on the EEV basis results pages. The EEV basis supplementary information should be read in conjunction with the Group financial statements.
In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2014 has been properly prepared, in all material respects, in accordance with the European Embedded Value Principles issued in May 2004 by the European CFO Forum as supplemented by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 (together ‘the EEV Principles’) using the methodology and assumptions set out in the Notes on the EEV basis results.
Our responsibility is to audit, and express an opinion on, the supplementary information in accordance with the terms of our engagement and in accordance with International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
Scope of an audit of financial statements performed in accordance with ISAs (UK and Ireland) A description of the scope of an audit of financial statements is provided on our website at www.kpmg.com/uk/ auditscopeother2013 This report is made subject to important explanations regarding our responsibilities, as published on that website, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
I. IFRS profit and loss information 313 a Analysis of long-term insurance business pre-tax
A d d itio n al in fo rm atio n 313 Prudential plc Annual Report 2014
Margin on revenues 1,545 – 176 1,721 Expenses: Expected return on shareholder assets 64 14 137 215
Margin on revenues 1,545 1,562 1,413 Expenses: DAC adjustmentsnote (vi) 92 35 32
Analysis of Asia operating profit drivers — Spread income has increased by 17 per cent at constant exchange rate (AER 9 per cent) to £125 million in 2014, predominantly reflecting the growth of the Asia non-linked policyholder liabilities; — Fee income has increased by 11 per cent at constant exchange rates (AER 1 per cent) from £140 million in 2013 to £155 million in 2014, broadly in line with the increase in movement in average unit-linked liabilities; — Insurance margin has increased by £59 million at constant exchange rates to £675 million in 2014, predominantly reflecting the continued growth of the in-force book, which contains a relatively high proportion of risk-based products. 2014 insurance margin includes non-recurring items of £27 million (2013: £52 million at AER; £48 million on CER); — Excluding the adverse impact of currency fluctuations, margin on revenues has increased by £132 million from £1,413 million in 2013 to £1,545 million in 2014, primarily reflecting higher premium income recognised in the period; — Acquisition costs have increased by 12 per cent at constant exchange rates (AER 2 per cent) to £1,031 million in 2014, compared to the 15 per cent increase in sales (AER 5 per cent increase), resulting in a modest decrease in the acquisition costs ratio. The analysis above uses shareholder acquisition costs as a proportion of total APE. If with-profits sales were excluded from the denominator the acquisition cost ratio would become 66 per cent (2013: 65 per cent at CER), broadly consistent with the prior year; — Administration expenses have increased by 7 per cent at constant exchange rates (AER 3 per cent decrease) to £618 million in 2014 as the business continues to expand. On constant exchange rates, the administration expense ratio has reduced from 279 basis points in 2013 to 256 basis points in 2014; and
A d d itio n al in fo rm atio n 315 Prudential plc Annual Report 2014
— DAC adjustments decreased to £191 million during 2014 compared to £297 million at a constant exchange rate (AER £313 million) during 2013, with 2013 benefiting from a £78m (AER £82 million) deceleration in DAC amortisation due to strong equity market returns in that year. This was not repeated in 2014, which experienced an accelerated DAC amortisation charge of £13 million.
Other DAC adjustments – amortisation of previously deferred acquisition costs: Normal (474) (474) (485) (485) (461) (461) (Accelerated)/
Insurance margin 96 89 Margin on revenues 176 187 Expenses: DAC adjustments (6) (14)
Analysis of UK operating profit drivers: — Spread income has increased from £228 million in 2013 to £272 million in 2014 following an increase in bulk annuity sales that contributed £105 million (2013: £25 million) in the year partially offset by lower individual annuity sales; — Fee income has reduced from £65 million in 2013 to £61 million in 2014 due to a change in product mix towards those with lower asset management charges, partly offset by an increase in funds under management; — Insurance margin has increased from £89 million for 2013 to £96 million for 2014, primarily due to improved profits from protection business; — Margin on revenues represents premium charges for expenses and other sundry net income received by the UK. 2014 income was £176 million, £11 million lower than in 2013; — Acquisition costs as a percentage of new business sales for 2014 decreased to 11 per cent from 2013 at 15 per cent, principally driven by the effect on this percentage ratio of business mix. The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. It is therefore impacted by the level of with-profit sales in the year. Acquisition costs as a percentage of shareholder-backed new business sales, excluding the bulk annuity transactions, were 36 per cent in 2014 (2013: 35 per cent); and
— Administration expenses have increased from £124 million in 2013 to £143 million in 2014 largely due to increased investment spend to realign our business following the pension reforms announced in the UK Budget.
(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 derived from month end balances throughout the year as opposed to opening and closing balances only. Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administrative expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson. Average liabilities are adjusted for business acquisitions and disposals in the period.
I: IFRS profit and loss information continued b Asia operations – analysis of IFRS operating profit by territory Operating profit based on longer-term investment returns for Asia operations are analysed as follows: 2014 £m AER
SE Asia Operations inc. Hong Kong 903 873 785 3% 15%
(ii) Other non-recurrent items of £49 million in 2014 (2013: £44 million) represent a number of items, none of which are individually significant that are not anticipated to re-occur in future.
A d d itio n al in fo rm atio n 319 Prudential plc Annual Report 2014 c Analysis of asset management operating profit based on longer-term investment returns 2014 £m
Operating income (net of commission)note (i) 987 241 130 303 1,661
Share of associate’s results 13 – – – 13 Group's share of tax on joint ventures’ operating profit – (11) – – (11)
Operating profit based on longer-term investment returns 446 90 42 12 590
Operating income before performance-related fees 863 215 121 362 1,561 Performance-related fees 25 1 – – 26
Average funds under management £233.8bn £61.9bn Margin based on operating income* 37bps 35bps Cost/income ratio† 59% 62%
Notes (i) Operating income and expense includes the Group’s share of contribution from joint ventures (but excludes any contribution from associates). In the income statement as shown in note B2 of the IFRS financial statements, these amounts are netted and tax deducted and shown as a single amount. (ii) M&G and Eastspring Investments can be further analysed as follows: M&G
Net cash remitted by business units: UK net remittances to the Group UK Life fund paid to the Group 193 206 Shareholder-backed business: Other UK paid to the Group 132 149
M&G remittances to the Group 285 235 PruCap remittances to the Group 57 57
Cash and short-term investments at end of year 1,480 2,230 * Including central finance subsidiaries. † Non-operating net cash flow is principally for corporate transactions for distribution rights and acquired subsidiaries and issue and repayment of subordinated debt.
A d d itio n al in fo rm atio n 321 Prudential plc Annual Report 2014 b Funds under management (a) Summary note (i)
Prudential Group funds under managementnote (i) 341.6 299.6 External fundsnote (ii) 154.3 143.3
Solvency II adopts the concept of market consistency as a valuation framework for both assets and liabilities as well as a one year value at risk methodology (with certain modifications) for evaluating solvency. While the majority of assets held by insurers can be fair valued based on market observable prices (albeit such market based valuations can be distorted at times of market stress), the same is not true of insurance liabilities which are not traded in liquid markets. Solvency II seeks to create a proxy market value for insurance liabilities, by valuing best-estimate cash flows at market levels of risk-free interest rates and allowing for an additional risk margin to ensure these liabilities are sufficient to cover the amount another insurance company would be prepared to pay for these liabilities.
As an indication of the range of uncertainty, we have produced the following sensitivities to reflect various possible Solvency II outcomes. For example, relative to the £9.7 billion of economic capital surplus at 31 December 2014: — 20 per cent haircut in the contribution recognised for Asia in the Group available capital, reflecting Solvency II fungibility tests, would reduce Group surplus by £1.9 billion (-23 percentage points of cover ratio); — Transitional relief may be applied in relation to the UK business, which subject to regulatory approval is expected to bring overall UK surplus in line with current Solvency I (Pillar II) levels. Applying this transitional relief for UK annuities is estimated to increase Group surplus by £1.3 billion (+16 percentage points of cover ratio); and
These sensitivities are intended to provide examples and should not be considered indicative of the adjustments that the Prudential Regulation Authority may ultimately require.
Alongside developing the above economic capital based on outputs from our Solvency II internal model, we have developed an alternative ‘multi-term’ economic capital model, which seeks to evaluate our ability to meet obligations to customers as these fall due and which in our view is the best way to assess our economic solvency. This ‘multi-term’ approach is designed to both overcome the artificial one year timeframe of the Solvency II methodology and remove areas of known excessive prudence that for us do not reflect economic reality, such as the imposition of an additional risk margin that a theoretical buyer may demand to take over the liabilities in one year’s time. Removing this risk margin alone would increase the estimated surplus referred to above to £13.6 billion, equivalent to an economic capital ratio of 265 per cent. This confirms the strong capital position of the Group and its ability to withstand severe market shocks, when assessed through appropriately risk-sensitive measures.
Detail relating to the economic capital position – based on outputs from our Solvency II internal model Our economic capital results are based on outputs from our Solvency II internal model. Although the Solvency II and Omnibus II Directives, together with the Level 2 ‘Delegated Act’ published on 17 January 2015, provide a framework for the calculation of Solvency II results, there remain material areas of policy uncertainty and the methodology and assumptions are subject to review and approval by the Prudential Regulation Authority, the Group’s lead supervisor.
We remain on track to submit our internal model to the Prudential Regulation Authority for approval in 2015. However, given the degree of uncertainty, these economic capital results should not be interpreted as representing the Pillar I output from an approved Solvency II internal model and are not intended to provide a forecast of the eventual position.
At 31 December 2014, the Group had an economic capital surplus of £9.7 billion (2013: £11.3 billion) and an economic capital ratio of 218 per cent before taking into account the 2014 final dividend. A summary of the capital position on this basis is shown in the table below: Economic capital positionnote
As a general principle, both assets and liabilities are recognised at the value at which they could theoretically be transferred to a third party in an arm’s length transaction. On the asset side of the balance sheet, assets are mostly held at IFRS fair value. However, adjustments are required to IFRS values to eliminate intangible items such as goodwill and deferred acquisition costs and to take account of economic assets which are excluded from the current IFRS balance sheet such as the present value of future with-profits shareholder transfers.
The best estimate liability is calculated by taking the average of future risk-adjusted best estimate cash flows, taking into account the time value of money. An economic definition of contract boundaries has been applied in determining the cash flows to include in the best estimate liability. The best estimate liability also allows for the value of options and guarantees embedded in existing contracts as well as the value of future discretionary benefits payable to policyholders. Realistic management actions and policyholder behaviour are allowed for where relevant. In addition, since capital requirements are only derived to cover risks over a one year horizon, a risk margin is added to the best estimate liability to cover the cost of ceding liabilities to a third party after one year, assuming a 6 per cent per annum cost of capital and with no diversification between legal entities, in line with Solvency II requirements.
In addition to the assumption of US equivalence, no transferability restrictions have been applied to the economic value of overseas surplus. Other key elements of Prudential’s methodology relating to areas that are presently unclear for Solvency II Pillar I calculations, relate to: (i) The liability discount rate for UK annuities, which includes an initial estimate of the Solvency II ‘matching adjustment’ in addition to the risk-free rate, but where there remains a range of possible outcomes pending further policy clarity; (ii) The impact of transitional arrangements on technical provisions, for which no allowance has been made in the economic capital position, but which may apply under Solvency II (although the use of this transitional is subject to regulatory approval and the extent to which it is permitted is likely to depend on the final Solvency II capital position); and
The 2013 results were prepared using a liquidity premium methodology, before the matching adjustment had been included in our internal model. Under this previous basis, credit reserves were set as a proportion of credit spreads. The 2013 results have not been restated for the effect of adopting the matching adjustment methodology, with the difference between the two approaches being recorded within the 2014 model changes.
Assumptions The key assumptions required for the economic capital calibration are: (i) Assumptions used to derive non-market related best estimate liability cash flows, which are based on EEV best estimate assumptions; (ii) Assumptions used to derive market related best estimate liability cash flows, which are based on market data at the valuation date where this data is reliable and comes from a deep and liquid market, or on appropriate extrapolation methodologies where markets are not sufficiently liquid to be reliable; (iii) Assumptions underlying the calculation of the best estimate liability in respect of dynamic management actions and policyholder behaviour; (iv) Assumptions underlying the risk models used to calculate the 1-in-200 level capital requirements for the Economic Capital Requirement which are set using a combination of historic market, demographic and operating experience data and expert judgement; and
Aside from UK annuities, no matching adjustment allowance or any other form of liquidity premium has been assumed for any other lines of business.
Other business developments On 5 February 2015 Prudential announced the completion of the sale of its closed book business in Japan. The contribution of Japan to the Group surplus has been set equal to the ‘held for sale’ accounting value of £49 million. On 10 November 2014, Prudential announced an agreement to sell its 25 per cent equity stake in the PruHealth and PruProtect businesses for £155 million, which is allowed for in these results. On 1 July 2014 Prudential renewed its distribution agreement with Standard Chartered Bank to 2029. The amount of these distribution fees is allowed for in these economic capital results and has had a negative impact on the Group solvency ratio of -10 percentage points. The impact of the domestication of the Hong Kong branch, which became effective on 1 January 2014, is also allowed for and is estimated to have had a negative impact on the Group solvency ratio of -4 percentage points, mainly due to a loss of diversification in the risk margin following separation of the Hong Kong business into a subsidiary.
Analysis of movement in the economic capital surplus The table below shows the movement during the financial year in the Group’s economic capital surplus.
Model changes (0.3) 0.1 Economic capital surplus as at 31 December 9.7 11.3
Analysis of Group Economic Capital Requirements The table below shows the split of the Group Economic Capital Requirement by risk type1.
US RBC Company Action Level. 2 Based on outputs from the Group’s Solvency II internal model which has not been reviewed or approved by the Prudential Regulation Authority.
Reconciliation of IFRS equity to economic available capital To aid understanding, the amount representing the Group’s available capital under the economic capital basis is reconciled to the Group’s IFRS shareholders’ equity in the table below: Reconciliation of IFRS equity to economic available capital1 2014 £bn 2013 £bn
IFRS shareholders' equity at 31 December 11.8 9.7 Adjustment to restate US insurance entities onto a US Risk Based Capital basis (1.1) (0.6) Remove DAC, goodwill and intangibles (3.5) (2.7) Add subordinated-debt treated as economic available capital 3.7 3.8 Impact of risk margin (4.7) (3.5) Add value of shareholder-transfers 4.0 4.1 Other liability valuation differences 9.0 9.3 Increase in value of net deferred tax liabilities (resulting from valuation differences above) (0.9) (1.3)
Sensitivity analysis Stress testing this economic capital position gives the following results as at 31 December 2014: — An instantaneous 20 per cent fall in equity markets would reduce surplus by £0.6 billion and reduce the economic solvency ratio to 214 per cent; — An instantaneous 40 per cent fall in equity markets would reduce surplus by £2.2 billion and reduce the economic solvency ratio to 195 per cent; — A 50 basis points reduction in interest rates (subject to a floor of zero) would reduce surplus by £1.4 billion and reduce the economic solvency ratio to 195 per cent; — A 100 basis points increase in interest rates would increase surplus by £1.8 billion and increase the economic solvency ratio to 254 per cent; and
— A 100 basis points increase in credit spreads with 15 per cent downgrades in the UK annuity portfolio1 would reduce surplus by £2.1 billion and reduce the economic solvency ratio to 190 per cent.
In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in-force business at 31 December 2014, the tables also present the expected future free surplus to be generated from the investment made in new business during 2014 over the same 40-year period.
Total free surplus expected to emerge in the next 40 years 24,577 10,530 12,035 47,142 3,582 1,594 773 5,949 * The analysis excludes amounts incorporated into VIF at 31 December 2014 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 2054. Following their sale, the cash flows exclude any cash flows in respect of Japan and PruHealth and PruProtect.
Undiscounted expected free surplus generation for years 2015 to 2054 3,582 1,594 773 5,949
Discounted expected free surplus generation for years 2015 to 2054 1,471 1,062 322 2,855 Discounted expected free surplus generation for years 2054+ 91 – 2 93 PruHealth and PruProtect free surplus generation for new business not included above† – – 19 19 Less: Free surplus investment in new businessnote 13 (346) (187) (73) (606)
The undiscounted expected free surplus generation from all in-force business at 31 December 2014 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2013 as follows: Group £m £m £m £m £m Other £m Total £m 2013 expected free surplus generation for years 2014 to 2053* 2,165 2,109 2,025 1,911 1,884 1,814 31,638 43,546
Less: Amounts expected to be realised in the current year (2,165) – – – – – – (2,165)
Foreign exchange differences – 77 73 67 65 63 850 1,195 New business – 390 274 290 170 255 4,570 5,949 Sale of PruHealth and PruProtect – (2) (2) (5) (7) (7) (48) (71) Operating movements – 9 (9) 18 47 58 Non-operating and other movements – (70) (25) (53) (18) (4) (1,632) (1,679)
Foreign exchange differences – 25 26 23 22 21 548 665 New business – 124 144 149 119 118 2,928 3,582 Operating movements – – (29) (1) 7 13 Non-operating and other movements – (17) (19) (23) (7) (15) (1,115) (1,206)
Foreign exchange differences – 52 47 44 43 42 302 530 New business – 241 108 118 29 114 984 1,594 Operating movements – (10) 7 10 37 35 Non-operating and other movements – (46) (20) (37) (17) 9 (48) (80)
2014 expected free surplus generation for years 2015 to 2054 – 506 514 501 503 494 9,517 12,035 * Excluding 2014 new business.
At 31 December 2014, the total free surplus expected to be generated over the next five years (years 2015 to 2019 inclusive), using the same assumptions and methodology as those underpinning our embedded value reporting was £11.4 billion, an increase of £1.7 billion from the £9.7 billion expected over the same period at the end of 2013.
Actual underlying free surplus generated in 2014 from life business in force at the end of 2014 was £2.7 billion including £0.3 billion of changes in operating assumptions and experience variances. This compares with the expected 2014 realisation at the end of 2013 of £2.2 billion. This can be analysed further as follows: Asia £m
Transfer to free surplus in 2014 828 883 565 2,276 Expected return on free assets 62 30 14 106 Changes in operating assumptions and experience variances (30) 278 66 314
Underlying free surplus generated from in-force life business in 2014 860 1,191 645 2,696 2014 free surplus expected to be generated at 31 December 2013 801 902 462 2,165
A d d itio n al in fo rm atio n 331 Prudential plc Annual Report 2014
The equivalent discounted amounts of the undiscounted totals shown previously are shown below: 2014 £m
Discounted expected generation from all in-force business for years 2015 to 2054 23,631 Discounted expected generation from all in-force business for years after 2054 470
US$ linkednote 1 36 35 29 Other Asia currencies 18 13 15
f Option schemes The Group 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, while employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan. Executives based in Asia, and eligible employees, can participate in the international savings-related share option scheme, while agents based in Hong Kong can participate in the international savings-related share option scheme for non-employees. Further details of the schemes and accounting policies are detailed in note B3.2 of the IFRS basis consolidated financial statements.
The option 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.
A d d itio n al in fo rm atio n 333 Prudential plc Annual Report 2014
End Beginning of year Granted Exercised Cancelled Forfeited Lapsed End of year 28 Sep 06 4.75 01 Dec 13 31 May 14 148 – (148) – – – – 26 Apr 07 5.72 01 Jun 14 30 Nov 14 503 – (503) – – – – 27 Sep 07 5.52 01 Dec 14 31 May 15 1,668 – (1,000) – – (5) 663 25 Sep 08 4.38 01 Dec 13 31 May 14 12,317 – (12,317) – – – – 25 Sep 08 4.38 01 Dec 15 31 May 16 10,873 – (307) – – (25) 10,541 27 Apr 09 2.88 01 Jun 14 30 Nov 14 1,655,947 – (1,644,907) (1,417) (2,713) (6,910) – 27 Apr 09 2.88 01 Jun 16 30 Nov 16 171,125 – (5,292) (227) – (278) 165,328
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current year was £14.08.
End Beginning of year Granted Exercised Cancelled Forfeited Lapsed End of year 25 Apr 08 5.51 01 Jun 13 30 Nov 13 1,453 – (1,453) – – – – 25 Sep 08 4.38 01 Dec 13 31 May 14 3,503 – (3,503) – – – – 27 Apr 09 2.88 01 Jun 14 30 Nov 14 75,573 – (75,573) – – – – 25 Sep 09 4.25 01 Dec 12 31 May 13 5,349 – (5,349) – – – – 25 Sep 09 4.25 01 Dec 14 31 May 15 2,682 – – – – – 2,682 28 Sep 10 4.61 01 Dec 13 31 May 14 29,097 – (29,097) – – – – 28 Sep 10 4.61 01 Dec 15 31 May 16 6,130 – – – – – 6,130
The total number of securities available for issue under the scheme is 1,442,807 which represents 0.056 per cent of the issued share capital at 31 December 2014.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current year was £14.58.
End Beginning of year Granted Exercised Cancelled Forfeited Lapsed End of year
There are no securities available for issue under the scheme at 31 December 2014. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current year was £13.70.
Date of grant Exercise price £ Beginning End Beginning of year Granted Exercised Cancelled Forfeited Lapsed End of year 25 Apr 08 5.51 01 Jun 13 30 Nov 13 1,997 – – – – (1,997) – 25 Sep 08 4.38 01 Dec 13 31 May 14 9,186 – (4,798) – – (4,388) – 27 Apr 09 2.88 01 Jun 12 30 Nov 12 27,532 – – – – (27,532) – 27 Apr 09 2.88 01 Jun 14 30 Nov 14 686,366 – (686,366) – – – – 25 Sep 09 4.25 01 Dec 14 31 May 15 11,717 – (11,717) – – – – 28 Sep 10 4.61 01 Dec 13 31 May 14 341,803 – (341,803) – – – –
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current year was £14.16.
A d d itio n al in fo rm atio n 335 Prudential plc Annual Report 2014 g Selected historical financial information of Prudential The following table sets forth Prudential’s selected consolidated financial data for the periods indicated. Certain data is derived from Prudential’s audited consolidated financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and as adopted by the European Union (EU) and European Embedded Value (EEV).
Acquisition costs and other expenditure (6,752) (6,861) (6,032) (4,717) (4,692) Finance costs: interest on core structural borrowings of
Remeasurement of carrying value of Japan life business classified as held for sale (13) (120) – – –
Based on profit for the year attributable to the equity holders of the Company: Basic earnings per share (in pence) 86.9p 52.8p 85.1p 57.1p 52.4p Diluted earnings per share (in pence) 86.8p 52.7p 85.0p 57.0p 52.3p Dividend per share declared and paid in reporting period
Operating profit based on longer-term investment returnsnote 2 3,186 2,954 2,520 2,017 1,823
Profit before tax attributable to shareholdersnote 2 2,614 1,635 2,747 1,866 1,283
Operating earnings per share (excluding 2010 exceptional tax credit) (in pence) 96.6p 90.9p 76.9p 62.7p 58.8p
Operating profit based on longer-term investment returnsnote 2 4,096 4,204 3,174 2,942 2,697
Operating earnings per share (excluding 2010 exceptional tax credit) (in pence) 160.7p 165.0p 124.9p 116.0p 107.4p
Operating earnings per share (including 2010 exceptional tax credit) (in pence) 160.7p 165.0p 124.9p 116.0p 113.7p * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2010 to 2013 results are shown on a comparable basis.
Annual premium equivalent (APE) sales 4,650 4,423 4,195 3,681 3,485 EEV new business profit (NBP) (post-tax)* 2,126 2,082 1,791 1,536 1,433 * The 2014 EEV results of the Group are presented on a post-tax basis and, accordingly, the 2010 to 2013 results are shown on a comparable basis.
As of and for the year ended 31 December 2014 £m 2013 £m 2012 £m 2011 £m 2010 £m
A d d itio n al in fo rm atio n 337 Prudential plc Annual Report 2014
h Results of sold PruHealth and PruProtect businesses The tables below show the results of the sold PruHealth and PruProtect businesses which were included in the Group’s results for full year and half year 2014.
Prudential’s approaches to managing risks are explained in the ‘Group Chief Risk Officer’s report on the risks facing our business and our capital strength’ section of this document.
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profitability. Since 2008, Prudential has operated against a challenging background of periods of significant volatility in global capital and equity markets, interest rates (which in some jurisdictions have become negative) and liquidity, and widespread economic uncertainty. For example, government interest rates remain at or near historic lows in the US, the UK and some Asian countries in which Prudential operates. These factors have, at times during this period, had a material adverse effect on Prudential’s business and profitability.
Global financial markets are subject to uncertainty and volatility created by a variety of factors, including concerns over sovereign debt, general slowing in world growth, the timing and scale of quantitative easing programmes of central banks and socio-political events. Upheavals in the financial markets may affect general levels of economic activity, employment and customer behaviour. For example, insurers may experience an elevated incidence of claims, lapses, or surrenders of policies, and some policyholders may choose to defer or stop paying insurance premiums. The demand for insurance products may also be adversely affected. In addition, there may be a higher incidence of counterparty failures. If sustained, this environment is likely to have a negative impact on the insurance sector over time, and may consequently have a negative impact on Prudential’s business and its balance sheet and profitability. For example, this could occur if the recoverable value of intangible assets for bancassurance agreements and deferred acquisition costs are reduced. New challenges related to market fluctuations and general economic conditions may continue to emerge.
For some non-unit-linked investment products, in particular those written in some of the Group’s Asia 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 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 those used to calculate surrender values over a sustained period, this could have a material adverse effect on Prudential’s reported profit.
In particular, fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully reflected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities, and the amounts that are credited to policyholders in the form of benefit increases, subject to minimum crediting rates. Declines in spread from these products or other spread businesses that Jackson conducts, and increases in surrenders arising from interest rate rises, could have a material impact on its businesses or results of operations.
Moreover, governments may use a variety of techniques, such as intervention by their central banks or imposition of regulatory controls or taxes, to devalue their currencies’ exchange rates, or may adopt monetary and other policies (including to manage their debt burdens) that have a similar effect, all of which could adversely impact the value of an investment in sovereign debt even in the absence of a technical default. Periods of economic uncertainty may affect the volatility of market prices of sovereign debt to a greater extent than the volatility inherent in debt obligations of other types of issuers.
Risk factors continued equivalents. These detailed rules and guidelines are not currently expected to be finalised until mid to late 2015. Further, the effective application of a number of key measures incorporated in the Omnibus II Directive, including the provisions for third-country equivalents, is subject to supervisory judgement and approval. 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 the capital required to support its business, and that Prudential may be placed at a competitive disadvantage to other European and non-European financial services groups.
In July 2013 the FSB announced the initial list of nine insurance groups that have been designated as G-SIIs of which Prudential was one. Designation as a G-SII has led to additional policy measures being applied to the designated group. Based on the policy framework released by the IAIS, and subsequent guidance papers, these additional policy measures include enhanced Group-wide supervision, effective resolution measures of the Group in the event of failure, loss absorption, and higher loss absorption capacity. Prudential is monitoring the development, and potential impact, of the framework of 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), designed to act as a minimum Group capital requirement; and the second, a Higher Loss Absorption (HLA) requirement that should reflect the drivers of the assessment of G-SII designation. G-SIIs will be required to report on their BCR to Group-wide supervisors on a confidential basis from 2015. The HLA requirement will apply from January 2019 to the insurance groups identified as G-SIIs in November 2017.
Regulators’ interest may include the approach that product providers use to select third-party distributors and to monitor the appropriateness of sales made by them. In some cases, product providers can be held responsible for the deficiencies of third-party distributors.
In the US, there has been significant attention on the different regulatory standards applied to investment advice delivered to retail customers by different sectors of the industry. As a result of reports relating to perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms. This includes focus on the suitability of sales of certain products, alternative investments and the widening of the circumstances under which a person or entity providing investment advice, with respect to certain employee benefit and pension plans, would be considered a fiduciary – and would subject the person or entity to certain regulatory requirements. There is a risk that new regulations introduced may have a material adverse effect on the sales of the products by Prudential and increase Prudential’s exposure to legal risks.
A d d itio n al in fo rm atio n 341 Prudential plc Annual Report 2014 actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations (including tax) or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provided in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are sufficient. Given the large or indeterminate amounts of damages sometimes sought, other sanctions that might be applicable, and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s reputation, results of operations or cash flows.
In Asia, the Group’s principal competitors in the region are international financial companies, including global life insurers such as Allianz, AXA, AIA, and Manulife, and multinational asset managers such as J P Morgan Asset Management, Schroders, HSBC Global Asset Management and Franklin Templeton. In a number of markets, local companies have a very significant market presence.
Within the UK, Prudential’s principal competitors include many of the major retail financial services companies and fund management companies including, in particular, Aviva, Legal & General, Lloyds Banking Group, Standard Life,
Schroders, Invesco Perpetual and Fidelity. 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, Allianz, Prudential Financial, Lincoln National, MetLife and Aegon.
Prudential believes competition will intensify across all regions in response to consumer demand, technological advances, the impact of consolidation, regulatory actions and other factors. Prudential’s ability to generate an appropriate return depends significantly upon its capacity to anticipate and respond appropriately to these competitive pressures.
Although Prudential’s IT, compliance and other operational systems and processes incorporate controls designed to manage and mitigate the operational risks associated with its activities, there can be no assurance that such controls will always be effective. Due to human error, among other reasons, operational incidents do happen periodically and no system or process can entirely prevent them – although there have not been any material such events to date. For example, although Prudential has not identified a material failure or breach in relation to its legacy and other IT systems and processes to date, it has been, and likely will continue to be, subject to computer viruses, attempts at unauthorised access and cyber-security attacks. Prudential’s legacy and other IT systems and processes, as with operational systems and processes generally, may be susceptible to failure or breaches.
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. This could result in loss of trust from Prudential’s customers, reputational damage and financial loss. The cyber-security threat continues to evolve globally in sophistication and potential significance as Prudential increasingly moves to digitalise its business
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 relationships with its business partners and customers. 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.
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 expense.
Prudential needs to make assumptions about a number of factors in determining the pricing of its products, setting reserves, 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 and models from the Continuous Mortality Investigations (CMI) as published by the Institute and Faculty of Actuaries. Assumptions about future expected levels of mortality are similarly relevant to the Guaranteed Minimum
Withdrawal Benefit (GMWB) of Jackson’s variable annuity business. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its UK annuity business, especially Jackson’s portfolio of traditional and variable annuities. Prudential’s persistency assumptions reflect recent past experience for each relevant line of business. Any expected change in future persistency is also reflected in the assumption. If actual levels of future persistency are significantly different than assumed, the Group’s results of operations could be adversely affected. Furthermore, Jackson’s variable annuity products are sensitive to other types of policyholder behaviour, such as the take-up of its GMWB product features.
A d d itio n al in fo rm atio n 343 Prudential plc Annual Report 2014
Asset-backed security 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.
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
— 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.
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 holders’ account and, periodically, interest is credited to the contract holders’ account and administrative charges are deducted, as appropriate. An annual minimum interest rate may be guaranteed, although actual interest credited may be higher and is linked to an equity index over its indexed option period.
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.
Inherited estate For life insurance proprietary companies, surplus capital available on top of what is necessary to cover policyholders’ reasonable expectations. An inherited (orphan) estate is effectively surplus capital on a realistic basis built over time, and not allocated to policyholders or shareholders.