In 1997, the business of Scottish Amicable Life Assurance Society (SALAS), a mutual society, was transferred to PAC. In effecting the transfer, a separate sub-fund, Scottish Amicable Insurance Fund (SAIF), was established within PAC’s long-term business fund. This sub-fund contains all the with-profi ts business and all other pension business that was transferred. No new business has been or will be written in the sub-fund and the sub-fund is managed to ensure that all the invested assets are distributed to SAIF policyholders over the lifetime of SAIF policies. With the exception of certain amounts in respect of the unitised with-profi ts life business, all future earnings arising in SAIF are retained for SAIF policyholders. Any excess (defi ciency) of revenue over expense within SAIF during a period is attributable to the policyholders of the fund. Shareholders have no interest in the profi ts of SAIF but are entitled to the asset management fees paid on this business.
Jackson has received regulatory enquiries on an industry-wide matter relating to claims settlement practices and compliance with unclaimed property laws. Concurrently, some regulators and state legislatures have required and others are considering proposals that would require life insurance companies to take additional steps to identify unreported deceased policy and contract holders. Additionally, numerous states are contracting with independent fi rms to perform specifi c unclaimed property audits or targeted market conduct examinations covering claims settlement practices and procedures for escheating unclaimed property. One such fi rm has been contracted by treasury departments of 26 states to perform an examination of the Jackson’s practices for handling unclaimed property. Any regulatory audits, related examination activity and internal reviews may result in additional payments to benefi ciaries, escheatment of funds deemed abandoned under state laws, administrative penalties and changes in the Jackson’s procedures for the identifi cation of unreported claims and handling of escheatable property.
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 signifi cant.
Creditors arising from direct insurance and reinsurance operations 1,134 970 Interest payable 62 67 Other items* 2,258 212 * Of the £2,258 million other items as at 31 December 2012, £2,021 million related to liabilities for funds withheld under reinsurance arrangement of the Group’s US operations from the purchase of REALIC, as discussed in note I1.
295Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
The purchase consideration paid is equivalent to the fair value of the identifi able acquired assets and liabilities assumed and accordingly no goodwill is recognised under IFRS on the date of completion of the acquisition.
Investments of long-term business and other operations: Loans 2,204 Equity securities and portfolio holdings in unit trusts 69 Debt securities 7,177
At the date the fi nancial statement were approved, the fair value of the identifi able acquired assets and liabilities and the consideration were subject to fi nalisation. In accordance with accounting guidance for business combinations, the Company will continue to review the balance sheet and record required adjustments, for up to a 12 month period following the acquisition close date, in order to refl ect updated information on certain accruals, related expenses, or other potential valuation adjustments, if further information becomes available about facts and circumstances that existed as of the acquisition date. Any measurement period adjustments determined to be material will be applied retrospectively to the acquisition date in the Company’s consolidated fi nancial statements and depending on the nature of the adjustment, the Company’s results subsequent to the acquisition period could be affected.
Reserves were initially valued consistent with existing IFRS guidance. Accordingly, as for the Group’s measurement of Jackson’s insurance assets and liabilities, under IFRS 4, a ‘grandfathered’ US GAAP basis has been applied. For instance the traditional products were valued using standard modeling techniques with assumptions updated to match current interest rate environment or be consistent with Jackson’s assumptions where appropriate. Base reserves on interest sensitive products were set equal to the account value and the reserves accounted for under FASB ASC Subtopic 944-80 Financial Services – Insurance – Separate Accounts (formerly SOP 03-1) were adjusted to refl ect Jackson’s assumptions where appropriate. In addition, provision has been made for the effects of fair valuing the acquired policyholder liabilities and value of in force business in accordance with IFRS 3.
Notes (i) Estimation of the REALIC business’ contribution to the Group’s consolidated revenue and profi t before tax for the year if the acquisition had occurred on 1 January 2012. In determining these amounts, it has been assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2012.
(ii) The profi t of £61 million for the period has been determined aft er a charge of £(19) million for amortisation of acquisition accounting adjustments. This charge refl ects the net eff ect of: (a) The diff erence between the yield on the acquired debt securities (excluding those held to back funds withheld for reinsurance contracts) determined by reference to their market value at acquisition as required by the IFRS 3 purchase GAAP purposes and the book yield on a historic GAAP basis; (b) Amortisation of the fair value adjustments on policyholder liabilities; and (c) Amortisation of the acquired value of in-force business. This charge has been shown separately within Group’s supplementary analysis of profi t, as explained in note B1.
As part of the deal, Prudential Thailand and Thanachart Bank have entered into an agreement to establish an exclusive 15-year partnership to develop jointly their bancassurance business in Thailand. This transaction builds on Prudential’s strategy of focusing on the highly attractive markets of South-east Asia and is in line with the Group’s multichannel distribution strategy.
A summary of the consideration, goodwill and net assets acquired relating to these four acquisitions is provided in the table below: Total £m
† Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of Prudential Staff Pension Scheme (PSPS) as described in note (b)(i)1 below, the other pension costs for PSPS represents the cash cost of contributions for ongoing service of active members and the unwind of discount on the opening provision for defi cit funding for PSPS.
The Group asset (liability) in respect of defi ned benefi t pension schemes is as follows: PSPS Other schemes Total Total
Underlying economic surplusnote 4(i) 1,174 (36) 1,138 1,543 Less: unrecognised surplus and adjustment for obligation under IFRIC 14 for defi cit funding (2011 only)note 4(i) (1,010) – (1,010) (1,607)
The Group also operates two smaller defi ned benefi t schemes for UK employees in respect of Scottish Amicable and M&G. For all three schemes, the projected unit method was used for the most recent full actuarial valuations. There is also a small defi ned benefi t scheme in Taiwan with a negligible defi cit.
Triennial actuarial valuations Defi ned benefi t schemes in the UK are generally required to be subject to 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.
Excluding expenses, the contributions fell to approximately £6 million per annum from the £50 million per annum paid previously. The new contributions are only for ongoing service of current employees that are active members of the scheme. No defi cit type funding is required. Defi cit funding for PSPS, where applicable, as applied in 2011, is apportioned in the ratio of 70/30 between the PAC with-profi ts fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant to current activity. In 2012, total contributions paid in the year including expenses were £36 million (2011: £54 million).
The market value of PSPS scheme assets as at the 5 April 2011 valuation was £5,255 million. The actuarial assumptions used in determining benefi t obligations and the net periodic benefi t costs for the purposes of the 2011 valuation were as follows: Rate of increase in salaries Nil Rate of infl ation: Retail Prices Index (RPI) 3.7 Consumer Prices Index (CPI) 3.0 Rate of increase of pensions in payment for infl ation: Guaranteed (maximum 5%) 3.0 Guaranteed (maximum 2.5%) 2.5 Discretionary Nil Expected returns on plan assets 4.2
Summary economic and IAS 19 fi nancial positions Under the IAS 19 ‘Employee Benefi ts’ valuation basis, the Group applies IFRIC 14, ‘IAS 19 – The Limit on a Defi ned Benefi t Asset, Minimum Funding Requirements and their Interaction’. Under IFRIC 14, a surplus is only recognised to the extent that the Company is able to access the surplus either through an unconditional right of refund to the surplus or through reduced future contributions relating to ongoing service, which have been substantively enacted or contractually agreed. Further, the IFRS fi nancial position recorded, refl ects the higher of any underlying IAS 19 defi cit and any obligation for committed defi cit funding where applicable.
For PSPS, the Group does not have an unconditional right of refund to any surplus of the scheme. Accordingly, prior to the fi nalisation of the 5 April 2011 triennial valuation, the Group had not recognised the underlying surplus of PSPS (31 December 2011: £1,588 million gross of deferred tax) and had recognised an economic liability for defi cit funding (31 December 2011: £19 million gross of deferred tax).
The IAS 19 defi cit of the Scottish Amicable Pension Scheme at 31 December 2012 was £74 million (31 December 2011: defi cit of £55 million) and has been allocated approximately 50 per cent to the PAC with-profi ts fund and 50 per cent to the shareholders’ fund.
The rules of the Group’s largest pension arrangement, the defi ned benefi t section of PSPS, a fi nal salary scheme, specify that, in exercising its investment powers, the Trustee’s objective is to achieve the best overall investment return consistent with the security of the assets of the scheme. In doing this, consideration is given to the nature and duration of the scheme’s liabilities. The Trustee sets the benchmark for the asset mix, following analysis of the liabilities by the Scheme’s Actuary and, having taken advice from the Investment Managers, then selects benchmark indices for each asset type in order to measure investment performance against a benchmark return.
The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the Actuarial Valuation, or earlier if the Scheme Actuary recommends. Interim reviews are conducted annually based on changing economic circumstances and fi nancial market levels.
The Trustee sets the general investment policy and specifi es any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegates the responsibility for selection and realisation of specifi c investments to the Investment Managers. In carrying out this responsibility, the Investment Managers are required by the Pensions Act 1995 to have regard to the need for diversifi cation and suitability of investments. Subject to a number of restrictions contained within the relevant asset management agreements, the Investment Managers are authorised to invest in any class of investment asset. However, the Investment Managers will not invest in any new class of investment asset without prior consultation with the Trustee.
The investment policies and strategies for the other two UK defi ned benefi t schemes, the M&G Group Pension Scheme and the Scottish Amicable Staff Pension Scheme, which are both fi nal salary schemes, follow similar principles, but have different target allocations refl ecting the particular requirements of the schemes.
301Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
Retail prices index (RPI) 2.7 2.9 Consumer prices index (CPI) 2.0 1.9 Rate of increase of pensions in payment for infl ation: Guaranteed (maximum 5%) 2.5 2.5 Guaranteed (maximum 2.5%)‡ 2.5 2.5 Discretionary‡ 2.5 2.5 Expected returns on plan assets 3.1 5.1 * The discount rate has been determined by reference to an ‘AA’ corporate bond index, adjusted where applicable, to allow for the diff erence in duration between the index and the pension liabilities.
Female: 103.4 per cent PNFA00 with improvements in line with a custom calibration of the CMI’s 2009 mortality model, with a long-term mortality improvement rate of 1.00 per cent per annum.
Consulting for SAPS and Aon Hewitt Limited for the M&G scheme, the most recent full valuations have been updated to 31 December 2012, applying the principles prescribed by IAS 19.
(i) Estimated pension scheme defi cit – economic basis Movements on the pension scheme defi cit (determined on the economic basis) are as follows, with the effect of the application of IFRIC 14 being shown separately: 2012 £m
Less: amount attributable to PAC with-profi ts fund 1,124 (93) (322) – 709
Shareholders' share: Gross of tax defi cit (483) 43 139 – (301)
(ii) IAS 19 basis fi nancial position as consolidated The movements in the pension schemes’ surplus and defi cit between scheme assets and liabilities as consolidated in the fi nancial statements were: 2012 £m
Cash costs and unwind of discount on opening provision for defi cit funding for PSPS (17) (17) (17)
Net defi cit, end of year (19) 731 (776) (64) (165) (229)
Defi cit recognised in the statement of fi nancial position (41) (229) (447) (437) (306)
Experience adjustments: Experience adjustments on scheme liabilities‡ (4) 314 (4) 76 145 Percentage of scheme liabilities at
Percentage of scheme assets at 31 December (0.57)% 14.49% 5.07% 1.91% (5.48)%
† The M&G pension scheme invests in Prudential insurance policies. On Prudential Group consolidation these assets are eliminated against liabilities in the statement of fi nancial position of UK insurance operations. Up until 2011 all of the M&G scheme assets were invested in this way thus giving rise to an unfunded status on a Prudential Group consolidated basis. At 31 December 2012 and 2011, only £169 million (2011: £165 million) out of the M&G scheme assets of £297 million (2011: £257 million) was invested in Prudential insurance policies, thereby switching its status to a partly funded scheme.
‡ The experience adjustments on scheme liabilities in 2011 of £314 million related mainly to the ‘true-up’ refl ecting improvements in data consequent upon the ongoing 2011 triennial valuations of PSPS and the Scottish Amicable pension scheme. The experience adjustments on scheme liabilities in 2008 of a gain of £145 million related mainly to the ‘true up’ refl ecting improvements in data consequent upon the 2008 triennial valuation of PSPS.
The long-term expected rate of return has been taken to be the weighted average (by market value) of the long-term expected rates of return on each major asset class shown above.
Long-term expected rate of return: Equity 6.8 8.2 Bonds 3.0 4.6 Properties 5.6 6.9 Other assets 2.0 4.8
The actual return on scheme assets was a gain of £189 million (gain of 2011: £1,290 million) on an IAS 19 basis. None of the scheme assets included shares in Prudential plc or property occupied by the Prudential Group.
Pension cost – economic basisnote (i) above and note (b) (30) 27 Adjustment for investments in Prudential insurance policiesnote (d) (8) (15)
Pension cost – IAS 19 basis (as recognised in the income statement and referred to in note I3a) (38) 12
Actuarial and other gains and losses Actual less expected return on assets (34) 982 Losses on changes of assumptions for plan liabilities (273) (414) Experience (losses) gains on liabilities (4) 314 Total (charge) credit without the effect of IFRIC 14 (311) 882 Effect of the application of IFRIC 14 461 (846)
Actuarial gains and losses – economic basisnote (i) above and note (c) 150 36 Adjustment for investments in Prudential insurance policiesnote (d) (5) 1
307Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
– Exceptional discretionary pension increase for PSPS in 2012 During the fi rst half of 2012, an exceptional discretionary increase to pensions in payment of PSPS was awarded which resulted in a past service cost of £106 million. As the PSPS scheme surplus is substantially not recognised for accounting purposes, these two items had negligible impact on the Group’s results. (b) Consistent with the derecognition of a substantial portion of the Company’s interest in the underlying IAS 19 surplus of PSPS, the charge to operating profi t based on longer-term investment returns for PSPS refl ects the cash cost of contributions for ongoing service of active members (2012: £17 million; 2011: £20 million). In addition, the charge to the operating results also includes a charge for the unwind of discount on the opening provision for defi cit funding for PSPS (2012: £nil; 2011:£2 million).
(c) The net credit (charge) for actuarial and other gains and losses is recorded within the income statement. Within the Group’s supplementary analysis of profi t, the shareholders’ share of actuarial and other gains and losses (ie net of allocation of the share to the PAC with-profi ts funds) of £50 million as shown in note ii above (2011:£21 million) is excluded from operating profi t based on longer-term investment returns as shown in note B1.
(d) The adjustments for investments in Prudential insurance policies are consolidation adjustments with no net impact to the operating results.
The total underlying Group pension scheme liabilities of £6,059 million (2011: £5,620 million) comprise £5,226 million (2011: £4,844 million) for PSPS and £833 million (2011: £776 million) for the other schemes. The table below shows the sensitivity of the underlying PSPS and the other scheme liabilities at 31 December 2012 and 2011 to changes in discount rates, infl ation rates and mortality rates.
Discount rate 4.4% 4.7% Decrease by 0.2% Increase in scheme liabilities by: Other schemes 4.9% 4.8%
I3: Staff and pension plans continued 6 Transfer value of PSPS scheme
I4: Share-based payments a Description of the plans The Group maintains a number of main share award and share option plans relating to Prudential plc shares, which are described below.
(i) Group Performance Share Plan, previously Restricted Share Plan The Group Performance Share Plan (GPSP) is the incentive plan in which all executive directors and other senior executives within the Group can participate. This scheme was established as a replacement for the Restricted Share Plan (RSP) under which no further awards could be made after March 2006. Awards are granted either in the form of a nil cost option, conditional right over shares, or such other form that shall confer to the participant an equivalent economic benefi t, with a vesting period of three years. The performance measure for the awards is that Prudential’s Total Shareholder Return (TSR) outperforms an index comprising of peer companies. Vesting of the awards between each performance point is on a straight-line sliding-scale basis. Participants are entitled to the value of reinvested dividends that would have accrued on the shares that vest. Beginning in 2010, newly issued shares have been used in settling the awards that vest and are released.
The RSP was, until March 2006, the Group’s long-term incentive plan for executive directors and other senior executives designed to provide rewards linked to shareholder return. Each year participants were granted a conditional option to receive a number of shares. There was a deferment period of three years, at the end of which the award vested to an extent that depended on the performance of the Group’s shares including notional reinvested dividends and on the Group’s underlying fi nancial performance. After vesting, the option may be exercised at zero cost at any time, subject to closed period rules, in the balance of a 10-year period. Shares are purchased in the open market by a trust for the benefi t of qualifying employees.
(iv) Share Incentive Plan UK-based executive directors and employees are also eligible to participate in the Company’s HMRC-approved Share Incentive Plan (SIP), which allows all UK-based employees to purchase shares of Prudential plc (partnership shares) on a monthly basis out of gross salary. For every four partnership shares bought, an additional matching share is awarded, purchased on the open market. Dividend shares accumulate while the employee participates in the plan. Partnership shares may be withdrawn from the scheme at any time. If the employee withdraws from the plan within fi ve years, the matching shares are forfeit, and if within three years, dividend shares are forfeit.
(vii) Annual Incentive Plan Certain senior executives have Annual Incentive Plans (AIP) with awards paid in cash up to the target level of their plan. The portion of any award for above-target performance is made in the form of awards of shares deferred for three years, with the release of shares subject to close periods. The shares are held in the employee share trust and shares equivalent to dividends otherwise payable will accumulate for the benefi t of award holders during the deferral period up to the release date.
Movements in share awards outstanding under the Group’s share-based compensation plans relating to Prudential plc shares at 31 December 2012 and 2011 were as follows: Awards outstanding under incentive plans including conditional options
Beginning of year: 26.7 23.9 Granted 8.8 10.3 Exercised (9.4) (4.2)
c Fair value of options and awards The weighted average fair values of Prudential plc options and awards granted during the period are as follows: Weighted average fair value Weighted average fair value
The fair value amounts estimated on the date of grant relating to all options including conditional nil cost options above were determined using the Black-Scholes and the Monte Carlo option-pricing models using the following assumptions: GPSP SAYE
Dividend yield (%) – 3.63 – 3.33 Expected volatility (%) 33.03 34.33 28.90 62.67 Risk-free interest rate (%) 0.31 0.39 1.32 0.89 Expected option life (years) – 3.24 – 3.48 Weighted average exercise price (£) – 6.29 – 4.66 Weighted average share price (£) 6.78 8.26 7.32 6.06
Compensation costs for all share-based compensation plans are determined using the Black-Scholes model, Monte Carlo model or other market consistent valuation methods. The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black-Scholes model to value all options and awards other than the GPSP and UK BUPP, for which the Group uses a Monte Carlo model in order to allow for the impact of the TSR performance conditions. These models are used to calculate fair values for share options and awards at the grant date based on the quoted market price of the stock at the measurement date, the amount, if any, that the employees are required to pay, the dividend yield, expected volatility, risk-free interest rates and exercise prices.
For the SAYE options, the expected volatility is based on the market implied volatilities for Prudential shares as quoted on Bloomberg. This change (from an estimate based on historic volatility) brings the methodology into line with the approach used to determine the volatility for the GPSP and UK BUPP awards. The Prudential specifi c at-the-money implied volatilities are adjusted to allow for the different term and discounted exercise price on SAYE options by using information on the volatility surface of the FTSE 100.
Post-employment benefi ts comprise the change in the transfer value of the accrued benefi t relating to directors’ defi ned benefi t pension schemes in the year and the total contributions made to directors’ other pension arrangements.
The share-based payments charge is the sum of £7,992,000 (2011: £6,571,000), which is determined in accordance with IFRS 2, ‘Share-based payments’ (see note I4) and £3,795,000 (2011: £3,163,000) of deferred share awards.
Total key management remuneration includes total directors’ emoluments of £18,505,000 (2011: £16,212,000) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report, and additional amounts in respect of pensions and share-based payments. Further information on directors’ remuneration is given in the directors’ remuneration report.
The Audit Committee annually reviews the auditor’s objectivity and independence. More information on these issues is given in the corporate governance report within this Annual Report.
(OEICs), collateralised debt obligations and similar entities which are not consolidated and where a Group company acts as manager. These entities are regarded as related parties for the purposes of IAS 24. The balances are included in the Group’s statement of fi nancial position sheet at fair value or amortised cost in accordance with their IAS 39 classifi cations. The transactions are included in the income statement and include amounts paid on issue of shares or units, amounts received on cancellation of shares or units and paid in respect of the periodic charge and administration fee. Further details of the aggregate assets, liabilities, revenues, profi ts or losses and reporting dates of entities considered to be associates under IFRS are disclosed in note H8.
In 2012 and 2011, other transactions with directors were not deemed to be signifi cant both by virtue of their size and in the context of the directors’ fi nancial positions. As indicated above, all of these transactions are on terms broadly equivalent to those that prevail in arm’s length transactions.
313Notes on the Group fi nancial statements Prudential plc Annual Report 2012 F
ii Dividend restrictions and minimum capital requirements Certain Group subsidiaries are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company. UK insurance companies are required to maintain solvency margins which must be supported by capital reserves and other resources, including unrealised gains on investments. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, without the prior regulatory approval, dividends cannot be distributed if all dividends made within the preceding 12 months exceed the greater of Jackson’s statutory net gain from operations or 10 per cent of Jackson’s statutory surplus for the prior year. In 2013, the maximum amount of dividends that could be paid by the US insurance sub-group, subject to the availability of earned surplus, without prior regulatory approval is US$352 million (£216 million) (in 2012: US$411 million (£264 million)). The Group’s subsidiaries in Asia may remit dividends to the Group, in general, provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations and has suffi cient distributable reserves. The Group capital position statement for life assurance businesses is set out in note D5, showing the available capital refl ecting the excess of regulatory basis over liabilities for each fund or group of companies determined by reference to the local regulation of the subsidiaries. In addition, disclosure is also provided in note D5 of the local capital requirement of each of the fund or group of companies.
ii Capital commitments 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 2012 were £5 million (2011: £9 million).
in an cial statem en ts Parent company fi nancial statements Prudential plc Annual Report 2012
Fixed assets Investments: Shares in subsidiary undertakings 5 11,929 10,902 Loans to subsidiary undertakings 5 1,164 1,200
Current assets Debtors: Amounts owed by subsidiary undertakings 3,208 6,122 Deferred tax 6 47 364 Other debtors 3 11
Less liabilities: amounts falling due aft er more than one year
Capital and reserves Share capital 10 128 127 Share premium 10 1,889 1,873 Profi t and loss account 11 4,519 5,357
The fi nancial statements of the Company, which comprise the balance sheet and related notes, are prepared in accordance with Part 15 of the Companies Act 2006, which applies to companies generally. The Company has taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profi t and loss account.
Borrowings Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profi t and loss account to the date of maturity, or, for hybrid debt, over the expected life of the instrument.
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 indefi nitely to be offset against profi ts arising from the same company.
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19, ’Deferred tax’. The Company has chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to refl ect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
Pensions The Company assumes a portion of the pension surplus or defi cit of the Group’s main pension scheme, the Prudential Staff Pension Scheme (PSPS) and applied the requirements of FRS 17, ‘Retirement Benefi ts’ (as amended in December 2006) to its interest in the PSPS surplus or defi cit. Further details are disclosed in note 9.
The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of the discount on liabilities at the start of the period, gains and losses on settlements and curtailments, less the expected investment return on the scheme assets at the start of the period, is recognised in the profi t and loss account. To the extent that part or all of the Company’s interest in the pension surplus is not recognised as an asset, the unrecognised surplus is initially applied to extinguish any past service costs, losses on settlements or curtailments that would otherwise be included in the profi t and loss account. Next, the expected investment return on the scheme’s assets is restricted so that it does not exceed the total of the current service cost, interest cost and any increase in the recoverable surplus. Any further adjustment for the unrecognised surplus is treated as an actuarial gain or loss.
Notes on the parent company fi nancial statements continued 4 Reconciliation from UK GAAP to IFRS
The Company fi nancial statements are prepared in accordance with UK GAAP and the consolidated fi nancial statements are prepared in accordance with IFRS as issued by the IASB and endorsed by the EU. The tables below provide a reconciliation between UK GAAP and IFRS.
(Loss) profi t for the fi nancial year of the Company (including dividends from subsidiaries) in accordance with IFRS (145) 3,715
Net equity Shareholders’ equity of the Company in accordance with UK GAAP 6,536 7,357 IFRS adjustment* – (44)
The (loss) profi t for the fi nancial year of the Company in accordance with UK GAAP and IFRS includes dividends declared in the year from subsidiary undertakings of £501 million and £4,002 million for the years ended 31 December 2012 and 2011, respectively.
In January 2012, as part of an internal restructuring, the Company transferred at fair value, interests of £3,889 million in shares in a central subsidiary undertaking and £2,007 million of loans to a second such subsidiary to another central subsidiary in exchange for shares issued by that subsidiary of £4,930 million, and settlement of an amount owed to that subsidiary of £966 million. No profi t or loss arose on the transfer.
Other movements comprise £6 million in respect of share-based payments refl ecting the value of payments settled by the Company for employees of its subsidiary undertakings in 2012 offset by cash of £20 million received from those subsidiaries.
The principal subsidiary undertakings of the Company at 31 December 2012 are disclosed in note I8(i) ‘Subsidiary undertakings – Principal subsidiaries’ of the Group fi nancial statements.
Short-term timing differences 3 6 Unused deferred tax losses 44 358
For each category of deferred tax asset recognised, its recoverability against forecast taxable profi ts is not signifi cantly impacted by expected changes to accounting standards.
The UK government’s tax rate change to 23 per cent has had the effect of reducing the Company’s net deferred tax balance at 31 December 2012 by £3 million. The change to 23 per cent is effective from 1 April 2013 but is substantively enacted as at 31 December 2012. The subsequent proposed rate change to 21 per cent by 1 April 2014 is not expected to have a material effect on the deferred tax balance recognised at 31 December 2012.
Group fi nancial statements. (ii) These borrowings support a short-term fi xed income securities programme. (iii) The Company issued £200 million Floating Rate Notes in 2012 which mature in April 2013. All Notes have been subscribed to by a Group subsidiary and accordingly have been eliminated on consolidation in the Group fi nancial statements. These Notes were originally issued in October 2008 and have been reissued upon their maturity.
The proceeds, net of costs, were US$689 million. Also in January 2013, the Company repaid the £250 million Medium-Term Notes 2013 on maturity.
Derivative fi nancial instruments are held to manage interest rate and currency profi les. The change in fair value of the derivative fi nancial instruments of the Company was a gain before tax of £17 million (2011: loss before tax of £75 million).
The derivative fi nancial instruments are valued internally using standard market practices. In accordance with the Company’s risk management framework, all internally generated valuations are subject to independent assessment against external counterparties’ valuations.
The majority of UK Prudential staff are members of the Group’s pension schemes. The largest scheme is the Prudential Staff Pension Scheme (the ‘Scheme’) which is primarily a closed defi ned benefi t scheme.
For the purpose of preparing consolidated fi nancial statements, the Group applies IFRS basis accounting including IAS 19, ‘Employee Benefi ts’ as described further in note I3 ‘Staff and pension plans’ of the Group fi nancial statements (note I3). Although the individual accounts of the Company continue to follow UK GAAP, the disclosures under FRS 17, ‘Retirement Benefi ts’ are aligned with IAS 19.
At 31 December 2005, the allocation of surpluses and defi cits attaching to the Scheme between the Company and the unallocated surplus of the The Prudential Assurance Company Limited (PAC) with-profi ts fund was apportioned in the ratio 30/70 following detailed consideration of the sourcing of previous contributions. This ratio was applied to the base defi cit position at 1 January 2006 and for the purpose of determining the allocation of the movements in that position up to 31 December 2012. The FRS 17 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity.
The last completed triennial actuarial valuation of the Scheme was as at 5 April 2011. Further details on the results of this valuation and the total employer contributions to the Scheme for the year are provided in note I3, together with the key assumptions adopted, including mortality assumptions.
Equities 6.7 6.8 8.2 Bonds 2.8 3.0 4.6 Properties 5.5 5.55 6.9 Other assets 2.0 2.0 4.75
in an cial statem en ts Notes on the parent company fi nancial statements Prudential plc Annual Report 2012
The assets and liabilities of the Scheme were: 31 Dec 2012 31 Dec 2011 31 Dec 2010 31 Dec 2009 31 Dec 2008
The surplus in the Scheme recognised in the balance sheet of the Company represents the element of the amount which is recoverable through reduced future contributions and is net of the apportionment to the PAC with-profi ts fund.
Present value of Scheme liabilities, at 31 December 5,226 4,844 * The past service cost in 2012 of £106 million resulted from an exceptional discretionary increase to pensions in payment of the Scheme awarded during the year. The negative past service cost in 2011 of £216 million related to the eff ect of the change of the basis of indexation from Retail Price Index to Consumer Price Index.
Fair value of Scheme assets, at 1 January 6,432 5,351 Expected return on Scheme assets 201 267 Employee contributions 1 1 Employer contributions† 36 54 Actuarial (losses) gains (45) 973 Benefi t payments (225) (214)
Notes on the parent company fi nancial statements continued 9 Pension scheme fi nancial position continued
Operating charge: Current service cost (21) (22) Past service cost (106) 216
The pension charge attributable to the Company is net of the apportionment to the PAC with-profi ts fund and is related to the surplus recognised on the balance sheet of the Company. In 2011, an amount of £65 million was applied to extinguish the negative past service cost attributable to the Company from the unrecognised portion of the pension surplus at 31 December 2011. No adjustment was made to the pension charge in 2012 relating to the unrecognised portion of the Scheme’s surplus.
Experience (losses) gains on Scheme liabilities (0% (2011: 6%) (2010: 0%) (2009: 1%) (2008: 3%) of liabilities) (19) 295 1 59 127
Actuarial gains (losses) attributable to the Company before tax 35 (16) (14) (3) (143)
The actuarial gains (losses) attributable to the Company are net of the apportionment to the PAC with-profi ts fund and are related to the surplus recognised in the balance sheet of the Company. In 2012, the actuarial losses attributable to the Company included an amount credited of £124 million (2011: amount charged of £268 million) for the adjustment to the unrecognised portion of surplus which has not been deducted from the pension charge.
The actuarial gains before tax of £35 million (2011: losses of £16 million) attributable to the Company are recorded in the statement of total recognised gains and losses. Cumulative actuarial gains as at 31 December 2012 amount to £93 million (2011: £58 million).
Total employer contributions expected to be paid into the Scheme for the year ending 31 December 2013 amount to £11 million, refl ecting the annual accrual cost and expenses.
A summary of the ordinary shares in issue and the options outstanding to subscribe for the Company’s shares at 31 December 2012 is set out in note H11 ‘Shareholders’ equity: share capital, share premium and reserves’ of the Group fi nancial statements.
A reconciliation of the movement in shareholders’ funds of the Company for the years ended 31 December 2012 and 2011 is given below: (Loss) profi t for the year note 4 (216) 3,720 Dividends (655) (642)
(871) 3,078 Actuarial gains (losses) recognised in respect of the pension scheme, net of related taxnote 9 27 (12) Share-based paymentsnote 5 6 7 New share capital subscribed 17 17
Shareholders' funds at end of year note 4 6,536 7,357 12 Other information a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note I5 ‘Key management remuneration’ of the Group fi nancial statements.
b Information on transactions of the directors with the Group is given in note I7 ‘Related party transactions’ of the Group fi nancial 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 (2011: £0.1 million) and for other services were £0.6 million (2011: £nil). 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 2013 the Company will pay a fi nal dividend for the year ended 31 December 2012. Further details are provided in note B3 ‘Dividends’ of the Group fi nancial statements.
Statement of directors’ responsibilities in respect of the annual report and the fi nancial statements
Company law requires the directors to prepare Group and parent company fi nancial statements for each fi nancial year. Under that law the directors are required to prepare the Group fi nancial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and applicable law and have elected to prepare the parent company fi nancial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice).
Under company law the directors must not approve the fi nancial statements unless they are satisfi ed that they give a true and fair view of the state of affairs of the Group and parent company and of their profi t or loss for that period. In preparing each of the Group and parent company fi nancial statements, the directors are required to: AAAAAAAAAAAAAAAA Select suitable accounting policies and then apply them consistently; AAAAAAAAAAAAAAAA Make judgements and estimates that are reasonable and prudent; AAAAAAAAAAAAAAAA For the Group fi nancial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; AAAAAAAAAAAAAAAA For the parent company fi nancial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company fi nancial statements; and
The directors are responsible for keeping adequate accounting records that are suffi cient to show and explain the parent company’s transactions and disclose with reasonable accuracy at any time the fi nancial position of the parent company and enable them to ensure that its fi nancial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.
The directors are responsible for the maintenance and integrity of the corporate and fi nancial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of fi nancial statements may differ from legislation in other jurisdictions.
The directors of Prudential plc, whose names and positions are set out on pages 88 to 92 confi rm that to the best of their knowledge: AAAAAAAAAAAAAAAAA The fi nancial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, fi nancial position and profi t or loss of the Company and the undertakings included in the consolidation taken as a whole; and
in an cial statem en ts Statement of directors’ responsibilities/Independent auditor’s report Prudential plc Annual Report 2012
D irecto rs’ resp o n sib ilities/au d ito r’s rep o rt
Scope of the audit of the fi nancial statements A description of the scope of an audit of fi nancial statements is provided on the APB’s website at www.frc.org.uk/apb/scope/ private.cfm
Opinion on fi nancial statements In our opinion: AAAAAAAAAAAAAAAAAAA The fi nancial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2012 and of the Group’s profi t for the year then ended; AAAAAAAAAAAAAAAAAAA The Group fi nancial statements have been properly prepared in accordance with IFRSs as adopted by the EU; AAAAAAAAAAAAAAAAAAA The parent company fi nancial statements have been properly prepared in accordance with UK Generally Accepted Accounting Practice; and
AAAAAAAAAAAAAAAAAA The information given in the Directors’ Report for the fi nancial year for which the fi nancial statements are prepared is consistent with the fi nancial statements.
AAAAAAAAAAAAAAAAAA The parent company fi nancial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or
AAAAAAAAAAAAAAAAAA Certain disclosures of directors’ remuneration specifi ed by law are not made; or
Long-term business 1,960 1,764 Eastspring Investments 75 80 Development expenses (7) (5)
Operating profi t based on longer-term investment returnsnote (i) 4,321 3,978
Notes (i) EEV basis operating profi t based on longer-term investment returns excludes the recurrent items of short-term fl uctuations in investment returns, the mark to market value movements on core borrowings, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes, and the eff ect of changes in economic assumptions. In addition for 2012, operating profi t excludes the gain arising on the acquisition of REALIC and the dilution of the Group’s holding in PPM South Africa. The amounts for these items are included in total EEV profi t attributable to shareholders. The Company believes that operating profi t, as adjusted for these items, better refl ects underlying performance. Profi t before tax and basic earnings per share include these items together with actual investment returns.
(iv) Restructuring costs comprise the charge of £(19) million recognised on an IFRS basis and an additional £(3) million recognised on the EEV basis for the shareholders’ share of restructuring costs incurred by the PAC with-profi ts fund. Solvency II implementation costs comprise the charge of £(48) million recognised on an IFRS basis and an additional £(2) million recognised on the EEV basis.
Operating profi t based on longer-term investment returns Asia operations 2,028 1,839 US operations 1,649 1,455 UK operations: 1,270 1,250 Other income and expenditure (554) (536) RPI to CPI infl ation measure change on defi ned benefi t pension schemes – 45 Solvency II implementation costs (50) (56) Restructuring costs (22) (19)
Attributable to: Equity holders of the Company 3,813 2,142 Non-controlling interests – 4
New share capital subscribed 17 17 Reserve movements in respect of share-based payments 42 44 Treasury shares: Movement in own shares in respect of share-based payment plans (13) (30) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS 36 (5) Mark to market value movements on Jackson assets backing surplus and required capital: Mark to market value movements arising during the year 53 96 Related tax (18) (34)
US operations: Net assets of operations 6,032 108 6,140 5,082 113 5,195 Acquired goodwill – 16 16 – 16 16
Other operations: Holding company net borrowings at market value – (2,282) (2,282) – (2,188) (2,188)
Representing: Net assets (liabilities) 22,266 (1,292) 20,974 19,650 (1,478) 18,172 Acquired goodwill 239 1,230 1,469 235 1,230 1,465
* Return on embedded value is based on EEV operating profi t aft er related tax and non-controlling interests, as shown in note 13, as a percentage of opening EEV basis shareholders’ equity.
Total assets less liabilities, before deduction for insurance funds 274,863 243,207 Less insurance funds:*
Share capital 128 127 Share premium 1,889 1,873 IFRS basis shareholders’ reserves 8,342 6,564
The supplementary information on pages 326 to 362 was approved by the Board of directors on 12 March 2013 and signed on its behalf.
The EEV basis results have been prepared in accordance with the EEV Principles issued by the European Insurance CFO Forum in May 2004 and expanded by the Additional Guidance on EEV disclosures published in October 2005. Where appropriate, the EEV basis results include the effects of adoption of International Financial Reporting Standards (IFRS).
a Covered business The EEV results for the Group are prepared for ‘covered business’, as defi ned by the EEV Principles. Covered business represents the Group’s long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The EEV basis results for the Group’s covered business are then combined with the IFRS basis results of the Group’s other operations. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management.
With two principal exceptions, covered business comprises the Group’s long-term business operations. The principal exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and for the presentational treatment of the fi nancial position of the Group’s principal defi ned benefi t pension scheme, the Prudential Staff Pension Scheme (PSPS), as described in note 1(c)(vi). A small amount of UK group pensions business is also not modelled for EEV reporting purposes.
Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency and mortality. These assumptions are used to project future cash fl ows. The present value of the future cash fl ows is then calculated using a discount rate which refl ects both the time value of money and the non-diversifi able risks associated with the cash fl ows that are not otherwise allowed for.
Best estimate assumptions Best estimate assumptions are used for the cash fl ow projections, where best estimate is defi ned as the mean of the distribution of future possible outcomes. The assumptions are reviewed actively and changes are made when evidence exists that material changes in future experience are reasonably certain.
Assumptions required in the calculation of the value of options and guarantees, for example relating to volatilities and correlations, or dynamic algorithms linking liabilities to assets, have been set equal to the best estimates and, wherever material and practical, refl ect any dynamic relationships between the assumptions and the stochastic variables.
In determining the EEV basis value of new business, premiums are included in projected cash fl ows on the same basis of distinguishing annual and single premium business as set out for statutory basis reporting.
New business premiums refl ect those premiums attaching to covered business, including premiums for contracts classifi ed as investment products for IFRS basis reporting. New business premiums for regular premium products are shown on an annualised basis. Internal vesting business is classifi ed as new business where the contracts include an open market option.
The contribution from new business represents profi ts determined by applying operating assumptions as at the end of the year. For UK immediate annuity business and single premium Universal Life products in Asia, primarily Singapore, the new business contribution is determined by applying economic assumptions refl ecting point of sale market conditions. This is consistent with how the business is priced as crediting rates are linked to yields on specifi c assets and the yield locked-in when the assets are purchased at the point of sale of the policy. For other business within the Group, end of period economic assumptions are used.
New business profi tability is a key metric for the Group’s management of the development of the business. In addition, new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP) and are calculated as the ratio of the value of new business profi t to APE and PVNBP. APE are calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts. PVNBP are calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for Jackson securities classifi ed as available-for-sale, movements in unrealised appreciation on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.
The annual result is affected by the movement in this cost from year-to-year which comprises a charge against new business profi t and generally a release in respect of the reduction in capital requirements for business in force as this runs off.
Where required capital is held within a with-profi ts long-term fund, the value placed on surplus assets in the fund is already discounted to refl ect its release over time and no further adjustment is necessary in respect of required capital.
There are also various non-participating long-term products with guarantees. The principal guarantees are those for whole of life contracts with fl oor levels of policyholder benefi ts that accrue at rates set at inception and do not vary subsequently with market conditions.
in an cial statem en ts Notes on the EEV basis results Prudential plc Annual Report 2012
UK insurance operations For covered business the only signifi cant fi nancial options and guarantees in the UK insurance operations arise in the with-profi ts fund.
The Group’s main exposure to guaranteed annuity options in the UK is through the non-covered business of SAIF. A provision on the Pillar I Peak 2 basis of £371 million was held in SAIF at 2012 (2011: £370 million) to honour the guarantees. As described in note 1(a) above, the assets and liabilities are wholly attributable to the policyholders of the fund. Therefore the movement in the provision has no direct impact on shareholders.
(ii) Level of required capital In adopting the EEV Principles, Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements. Economic capital is assessed using internal models but, when applying the EEV Principles, Prudential does not take credit for the signifi cant diversifi cation benefi ts that exist within the Group. For with-profi ts business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is suffi cient to meet the required capital requirements. For shareholder-backed business the following capital requirements apply: AAAAAAAAAAAAAAAAA Asia operations: the level of required capital has been set at the higher of local statutory requirements and the economic capital requirement; AAAAAAAAAAAAAAAAA US operations: the level of required capital has been set to an amount at least equal to 235 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL); and
The risk margin represents the aggregate of the allowance for market risk, additional allowance for credit risk where appropriate, and allowance for non-diversifi able non-market risk. No allowance is required for non-market risks where these are assumed to be fully diversifi able.
The allowance for market risk represents the beta multiplied by an equity risk premium. Except for UK shareholder-backed annuity business (as explained below) such an approach has been used for all of the Group’s businesses.
In 2012, the basis of determining projected rates of return for holdings of corporate bonds was refi ned so as to comprise the risk-free rate plus an assessment of long-term spread over the risk-free rate. Previously, market spreads at the reporting date, rather than long-term spreads, were applied. The main effects of this change are for holdings in Hong Kong, Korea, Malaysia and Singapore. The new basis aligns with the approach for UK with-profi t holdings of corporate bonds and, more generally, is consistent with the use of long-term risk premiums for holdings of other categories of investments across the Group’s operations.
US operations (Jackson) For Jackson business, the allowance for long-term defaults is refl ected in the risk margin reserve (RMR) charge which is deducted in determining the projected spread margin between the earned rate on the investments and the policyholder crediting rate.
After taking these and related factors into account and based on market conditions, the risk discount rate for general account business includes an additional allowance of 150 basis points (2011: 200 basis points) for credit risk. For VA business, the additional allowance has been set at one-fi fth (equivalent to 30 basis points (2011: 40 basis points)) of the non-VA business to refl ect the proportion of the VA business that is allocated to holdings of general account debt securities. The level of the additional allowance is assessed at each reporting period to take account of prevailing credit conditions and as the business in force alters over time.
UK operations (1) Shareholder-backed annuity business For Prudential’s UK shareholder-backed annuity business, Prudential has used a market consistent embedded value (MCEV) approach to derive an implied risk discount rate which is then applied to the projected best estimate cash fl ows.
A base level allowance of 50 basis points is applied to cover the non-diversifi able 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 refl ect 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.
(iv) With-profi ts business and the treatment of the estate The proportion of surplus allocated to shareholders from the PAC with-profi ts fund has been based on the present level of 10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing fi nal bonus rates (and related shareholder transfers) so as to exhaust the estate over the lifetime of the in-force with-profi ts business. In any scenarios where the total assets of the life fund are insuffi cient to meet policyholder claims in full, the excess cost is fully attributed to shareholders. Similar principles apply, where appropriate, for other with-profi ts funds of the Group’s Asia operations.
(vi) Foreign currency translation Foreign currency profi ts 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 purpose of translating the profi ts and losses at average exchange rates, notwithstanding the fact that EEV profi t represents the incremental value added on a discounted cash fl ow basis, is to maintain consistency with the methodology applied for IFRS basis reporting.
c Accounting presentation (i) Analysis of profi t before tax To the extent applicable, the presentation of the EEV profi t for the year is consistent with the basis that the Group applies for analysis of IFRS basis profi ts before shareholder taxes between operating and non-operating results. Operating results refl ect the underlying results including longer-term investment returns (which are determined as described in note 1(c)(ii) below) and incorporate the following: AAAAAAAAAAAAAAAAA New business contribution, as defi ned in note 1(b)(i); AAAAAAAAAAAAAAAAA Unwind of discount on the value of in-force business and other expected returns, as described in note 1(c)(iv) below; AAAAAAAAAAAAAAAAA The impact of routine changes of estimates relating to non-economic assumptions, as described in note 1(c)(iii) below; and AAAAAAAAAAAAAAAAA Non-economic experience variances, as described in note 1(c)(v) below.
(ii) Operating profi t 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-profi ts 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 1(c)(iv) below.
For UK insurance operations the amount included within operating results based on longer-term investment returns represents the unwind of discount on the value of in-force business at the beginning of the period (adjusted for the effect of current period assumption changes), the unwind of discount on additional value representing the shareholders’ share of smoothed surplus assets retained within the PAC with-profi ts fund (as explained in note 1(c)(ii) above), and the expected return on shareholders’ assets held in other UK long-term business operations. Surplus assets retained within the PAC with-profi ts fund are smoothed for this purpose to remove the effects of short-term investment volatility from operating results. In the summary statement of fi nancial position and for total profi t reporting, asset values and investment returns are not smoothed. At 31 December 2012, the shareholders’ interest in the smoothed surplus assets used for this purpose only, were £121 million lower (31 December 2011: £39 million higher) than the surplus assets carried in the statement of fi nancial position.
(vii) Eff ect 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 option and guarantees, are recorded in non-operating results.
(ix) Inter-company arrangements The EEV results for covered business incorporate the effect of the reinsurance arrangement of non-profi t immediate pension annuity liabilities of SAIF (which is not covered business) to PRIL. In addition, the analysis of free surplus and value of in-force business takes account of the impact of contingent loan arrangements between Group companies.
China 10.13 10.00 9.78 10.37 10.32 Hong Kong 12.60 12.29 12.07 12.48 12.17 India 89.06 84.70 82.53 74.80 70.01 Indonesia 15,665.76 14,842.01 14,091.80 14,049.41 14,106.51 Korea 1,740.22 1,785.07 1,790.32 1,775.98 1,776.86 Malaysia 4.97 4.89 4.93 4.90 4.83 Singapore 1.99 1.98 2.02 2.02 2.01 Taiwan 47.20 46.88 47.06 47.12 45.65 Vietnam 33,875.42 33,083.59 32,688.16 33,139.22 30,526.26 US 1.63 1.58 1.55 1.60 1.57
Notes on the EEV basis results continued 2 Analysis of new business contribution
Unwind of discount and other expected returns 599 412 482 1,493 Effect of changes in operating assumptions* 20 35 87 142 Experience variances and other items 75 290 (16) 349 2011 £m
Unwind of discount and other expected returns 613 349 485 1,447 Effect of changes in operating assumptions* 10 14 79 103 Experience variances and other items 65 253 29 347 * As shown below.
20 10 Experience variance and other items: Mortality and morbiditynote (e) 57 58 Persistency and withdrawalsnote (f) 50 10 Expensenote (g) (30) (31)
(d) The charge of £(48) million for expense assumption changes in 2012 principally arises in Malaysia and refl ects changes to the pension entitlements of agents.
(f) The positive persistency and withdrawals experience variance of £50 million in 2012 (2011: £10 million) refl ects a combination of favourable experience in Hong Kong and Indonesia.
Notes on the EEV basis results continued 3 Operating profi t from business in force continued
Unwind of discount and other expected returnsnote (a) 412 349 Effect of changes in operating assumptions: Persistencynote (b) 45 29 Variable annuity (VA) feesnote (c) (19) 24 Mortalitynote (d) 33 (36)
In 2011, the charge of £(36) million for updated mortality assumptions primarily arose on variable annuity business. (e) The charge of £(24) million in 2012 for other operating assumption changes includes a charge of £(12) million for the impact of altered assumptions for
Unwind of discount and other expected returnsnote (a) 482 485 Effect of change in UK corporate tax ratenote (b) 87 79 Other itemsnote (c) (16) 29
Notes (a) The decrease in unwind of discount and other expected returns of £(3) million from £485 million in 2011 to £482 million for 2012 refl ects the £(17) million eff ect of lower risk discount rates driven by the reduction in interest rates, partly off set by the £14 million eff ect of an increase in the opening in-force value (aft er economic assumption changes) on which the discount rates are applied.
(b) The eff ect of the change in tax rate of £87 million in 2012 represents the benefi t of the reduction in tax rate from 25 per cent to 23 per cent. Consistent with the Group’s approach of grossing up the movement in the net of tax value of in-force for shareholder tax, the £87 million benefi t is presented gross (2011: £79 million, 27 per cent to 25 per cent).
(c) Other items in 2012 of £(16) million includes a charge of £(52) million for the strengthening of mortality assumptions, net of reserve releases and the eff ects of portfolio rebalancing for annuity business.
PPM South Africa On 22 February 2012, M&G completed transactions to (i) exchange bonus share rights for equity holdings with the employees of PPM South Africa, and (ii) the sale of a 10 per cent holding in the majority of the business to Thesele Group, a minority shareholder, for cash. Following these transactions M&G’s majority holding in the business reduced from 75 per cent to 49.99 per cent. Under IFRS requirements, the divestment is accounted for as the disposal of the 75 per cent holding and an acquisition of a 49.99 per cent holding at fair value resulting in a reclassifi cation of PPM South Africa from a subsidiary to an associate. As a consequence of the IFRS application, the transactions gave rise to a gain on dilution of £42 million. Consistent with the Group’s treatment for IFRS reporting, this amount has been treated as a gain on dilution of holdings which is shown separately from operating profi t based on longer-term investment returns in the Group’s supplementary analysis of profi t.
The gain arising from the acquisition of REALIC is excluded from the Group’s EEV operating profi t based on longer-term investment returns and is calculated as follows: Total EEV 2012 £m note (ii)
Short-term fl uctuations in investment returns, net of the related change in the time value of cost of options and guarantees, arise as follows: (i) Group summary
Insurance operations: Asianote (ii) 395 (155) USnote (iii) (254) (491) UKnote (iv) 315 (141)
Other operations: Economic hedge value movementnote (v) (32) – Other note (vi) 114 (120)
(iii) US operations The short-term fl uctuations in investment returns for US operations comprise the following items: Investment return related experience on fi xed income securitiesnote (a) (99) (74) Investment return related impact due primarily to changed expectation of profi ts on in-force variable annuity business in future periods based on current period equity returns, net of related hedging activity for equity related productsnote (b) (183) (418)
In 2011, there was a negative 0.5 per cent rate of return for the variable annuity separate account assets. This compared with an assumed longer-term rate of return of 5.4 per cent. Consequently, the asset values and therefore projected future fees at 31 December 2011 were lower than assumed.
For 2011, the charge of £(201) million refl ects the actual investment return of 3.2 per cent against the assumed long-term rate of 5.1 per cent, primarily refl ecting the fall in equity markets and widening of corporate bond credit spreads, partially off set by the increase in asset values as a result of the reduction in bond yields.
(vi) Other Short-term fl uctuations of Other operations in 2012 of £114 million primarily represent unrealised fair value movements on Prudential Capital’s bond portfolio. Short-term fl uctuations of Other operations in 2011 of £(120) million represent unrealised value movements on investments, including centrally held swaps to manage foreign exchange and certain macroeconomic exposures of the Group.
The credit for the shareholders’ share of actuarial and other gains and losses comprises: IFRS basis 50 21 Additional shareholders’ interest note (1(c)(vi)) 12 2
EEV basis total 62 23 8 Eff ect of changes in economic assumptions
(iii) US operations The effect of changes in economic assumptions for US operations refl ects the following: Effect of changes in 10-year treasury rates, beta and equity risk premium:note (a)
Decrease (increase) in additional allowance for credit risknote (b) 148 (93)
Notes (a) For Jackson, the eff ect of changes in economic assumptions represents the aggregate of the eff ects of changes to projected returns and the risk discount rate.
(iv) UK insurance operations The effect of changes in economic assumptions of a credit of £48 million for UK insurance operations for 2012 comprises the effect of: Shareholder-backed annuity businessnote (a)
Notes (a) For shareholder-backed annuity business the overall eff ect of changes in expected long-term rates of return and risk discount rates for the years shown above refl ect the combined eff ects of the changes in economic assumptions, which incorporate a default allowance for both best estimate defaults and in respect of the additional credit risk provisions (as shown in note 17(iii)).
V b asis su p p lem en tary in fo rm atio n 9 Analysis of movement in free surplus
Free surplus is the excess of the net worth over the capital required to support the covered business. Where appropriate, adjustments are made to the regulatory basis net worth from the local regulatory basis so as to include backing assets movements at fair value rather than cost so as to comply with the EEV Principles.
Underlying movement: Investment in new businessnote (ii) (618) – (618) Business in force: Expected in-force cash fl ows (including expected return on net assets) 2,019 386 2,405 Effects of changes in operating assumptions, operating experience variances and other operating items 295 – 295 1,696 386 2,082 Changes in non-operating itemsnote (iv) (163) 84 (79)
Gain on dilution of Group’s holdingsnote 4 – 42 42 Effect of acquisition of REALICnotes 5 and (v) (169) – (169)
Net movement in free surplus 118 150 268 Balance at 1 January 2012 2,839 582 3,421
Representing: Asia operations 974 207 1,181 US operations 1,211 108 1,319 UK operations 772 417 1,189
This represents short-term fl uctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes and the eff ect of changes in economic assumptions for long-term business operations.
(v) The eff ect on free surplus of the purchase of REALIC refl ects the diff erence between the consideration of £370 million and the free surplus of REALIC at the acquisition date.
(vi) Net cash fl ows to parent company for long-term business operations refl ect the fl ows as included in the holding company cash fl ow at transaction rates.
(vii) Exchange movements, timing diff erences and other items represent: 2012 £m
Holding company*cash and short-term investments (1,380) – (1,380) (1,200) – (1,200)
Core structural borrowings – central funds 3,126 536 3,662 3,201 187 3,388
Holding company net borrowings 1,746 536 2,282 2,001 187 2,188 Core structural borrowings –
Note The movement in the mark to market value adjustment represents: Mark to market movement in balance sheet: 2012 £m 2011 £m
Beginning of year 204 190 Change refl ected in: Income statement 380 14 Foreign exchange effects (5) –
V b asis su p p lem en tary in fo rm atio n 11 Reconciliation of movement in shareholders’ equity (excluding non-controlling interests)
Operating profi t based on longer-term investment returns 1,953 1,608 837 4,398 (77) 4,321
Short-term fl uctuations in investment returnsnote 6 395 (254) 315 456 82 538 Mark to market value movements on core
Profi t before tax (including actual investment returns) 2,199 1,864 1,184 5,247 (227) 5,020
Tax on short-term fl uctuations in investment returns (60) 91 (72) (41) (3) (44) Tax on shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes – – 4 4 (18) (14)
Tax on effect of changes in economic assumptions 36 (29) (11) (4) – (4)
Profi t (loss) for the year 1,755 1,413 937 4,105 (292) 3,813
Other movements Exchange movements on foreign operations and net investment hedges, net of tax (271) (252) – (523) 54 (469) Intra-group dividends (including statutory transfers)note (ii) (544) (252) (207) (1,003) 1,003 – Investment in operationsnote (ii) 4 – – 4 (4) – External dividends – – – – (655) (655) Reserve movements in respect of share-based payments – – – – 42 42 Other transfers 8 6 (16) (2) 2 – Treasury shares movements – – – – 23 23 New share capital subscribed – – – – 17 17 Mark to market value movements on Jackson assets backing surplus and required capital net of tax – 35 – 35 – 35
Net increase in shareholders’ equity 952 950 714 2,616 190 2,806 Shareholders’ equity at 1 January 2012note (i) 8,510 5,082 6,058 19,650 (13) 19,637
11 Reconciliation of movement in shareholders’ equity (excluding non-controlling interests) continued
Balance at 1 January 2012 Representing: Statutory IFRS basis shareholders’ equity 2,071 3,761 2,552 8,384 180 8,564 Additional retained profi t (loss) on an EEV
(iii) The additional retained profi t on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of £(536) million (2011: £(187) million) (as shown in note 10).
Total tax charge on operating profi t based on longer-term investment returns 1,145 1,044
Average number of shares (millions) 2,541 2,541 2,533 2,533 * Total profi t in 2012 includes a gain of £453 million relating to the acquisition of REALIC – see note 5.
Group Shareholders’ equity at 1 January 2012 2,839 3,447 6,286 13,364 19,650 New business contributionnotes (iii), (iv) (618) 454 (164) 1,955 1,791 Existing business – transfer to net worth 1,923 (324) 1,599 (1,599) – Expected return on existing business 96 85 181 929 1,110 Changes in operating assumptions and experience variances 295 50 345 51 396 Changes in non-operating assumptions and experience variances (163) 109 (54) 409 355 Gain on acquisition of REALICnotes 5 and (v) (169) 169 – 453 453
Intra-group dividends (including statutory transfers) and investment in operationsnote (ii) (1,187) – (1,187) 188 (999) Mark to market value movements on Jackson assets backing surplus and required capital 35 – 35 – 35 Other transfers from net worth (2) – (2) – (2)
and investment in operationsnote (ii) (656) – (656) 116 (540) Other transfers to net worth 8 – 8 – 8
Gain on acquisition of REALICnotes 5 and (v) (169) 169 – 453 453
Profi t aft er tax from long-term business 256 296 552 861 1,413 Exchange movements on foreign operations and net
UK insurance operations Shareholders’ equity at 1 January 2012 552 1,216 1,768 4,290 6,058 New business contributionnote (iv) (45) 86 41 200 241 Existing business – transfer to net worth 511 (79) 432 (432) – Expected return on existing business – 37 37 336 373 Changes in operating assumptions and experience variances (4) 6 2 53 55 Changes in non-operating assumptions and experience
Profi t aft er tax from long-term business 515 112 627 310 937 Intra-group dividends (including statutory transfers)note (ii) (279) – (279) 72 (207) Other transfers from net worth (16) – (16) – (16)
Notes on the EEV basis results continued 14 Reconciliation of net worth and value of in-force for long-term businessnote(i) continued
Notes (i) All fi gures are shown net of tax. (ii) The amounts shown in respect of free surplus and the value of in-force business for Asia and UK insurance operations for intra-group dividends (including statutory transfers) and investment in operations include the repayment of contingent loan funding. Contingent loan funding represents amounts whose repayment to the lender is contingent upon future surpluses emerging from certain contracts specifi ed under the arrangement. If insuffi cient 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.
(iii) The movements arising from new business contribution are as follows: Free surplus invested in new business (618) (553) Increase in required capital 454 406
Reduction in total net worth (164) (147) Increase in the value associated with new business 1,955 1,683
Pre-tax new business contributionnote 2 1,266 873 313 2,452 1,076 815 260 2,151 Tax (284) (305) (72) (661) (265) (285) (65) (615)
Post-tax new business contribution 982 568 241 1,791 811 530 195 1,536
Post-tax new business contribution per £1 million free surplus invested 3.4 2.0 5.4 2.9 2.7 2.6 3.6 2.8
(v) The eff ect on free surplus of the purchase of REALIC refl ects the diff erence between the consideration of £370 million and the free surplus of REALIC at the acquisition date. The REALIC free surplus represents the excess of net worth over required capital. The incremental value of in-force of £453 million represents the amount which is recognised on the EEV reporting basis over and above the net worth.
(vi) The value of in-force business includes the value of future margins from current in-force business less the cost of holding required capital and represents: Asia operations
Value of in-force business before deduction of cost of capital and time value of guarantees 7,903 3,992 4,916 16,811 6,922 3,222 4,598 14,742
Net value of in-force business 7,518 3,221 4,672 15,411 6,583 2,491 4,290 13,364
Note A provision for the cost of time value of options and guarantees for UK insurance operations is no longer required.
The discounted value of in-force business and required capital can be reconciled to the 2012 and 2011 totals in the tables below for the emergence of free surplus as follows: Required capitalnote 14 3,898 3,447 Value of in-force (VIF)note 14 15,411 13,364 Add back: deduction for cost of time value of guaranteesnote 14 683 685 Other itemsnote (1,401) (1,214)
Expected period of conversion of future post-tax distributable earnings and required capital fl ows to free surplus 2011 total as shown above 1-5 years 6 -10 years 11-15 years 16 -20 years 21-40 years 40+ years
Notes on the EEV basis results continued 16 Sensitivity of results to alternative assumptions
(a) Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2012 (31 December 2011) and the new business contribution after the effect of required capital for 2012 and 2011 to: AAAAAAAAAAAAAAAA 1 per cent increase in the discount rates; AAAAAAAAAAAAAAAA 1 per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fi xed interest assets, risk discount rates); AAAAAAAAAAAAAAAA 1 per cent rise in equity and property yields; AAAAAAAAAAAAAAAA 10 per cent fall in market value of equity and property assets (embedded value only); AAAAAAAAAAAAAAAA Holding company statutory minimum capital (by contrast to required capital), (embedded value only); AAAAAAAAAAAAAAAA 5 basis point increase in UK long-term expected defaults; and AAAAAAAAAAAAAAAA 10 basis point increase in the liquidity premium for UK annuities.
V b asis su p p lem en tary in fo rm atio n
Deterministic assumptions The tables below summarise the principal fi nancial assumptions: Assumed investment returns refl ect the expected future returns on the assets held and allocated to the covered business at the valuation date.
Risk discount rate: New business 10.1 3.8 13.2 9.4 – 7.4 5.8 11.1 3.6 3.25 10.3 17.2 In force 10.1 3.5 13.2 9.4 4.5 7.2 5.8 11.1 4.3 3.4 10.3 17.2 Expected long-term rate of infl ation 2.5 2.25 4.0 5.0 0.0 3.0 2.5 4.0 2.0 1.0 3.0 5.5 Government bond
Risk discount rate: New business 10.0 3.85 13.75 11.15 – 7.1 6.4 12.2 3.9 5.0 10.1 19.6 In force 10.0 3.7 13.75 11.15 4.7 7.1 6.5 12.2 4.65 5.0 10.1 19.6 Expected long-term rate of infl ation 2.5 2.25 4.0 5.0 0.0 3.0 2.5 4.0 2.0 1.0 3.0 6.5 Government bond
(b) For Hong Kong the assumptions shown are for US dollar denominated business. For other territories, the assumptions are for local currency denominated business.
(c) The risk discount rate for Malaysia refl ects both the Malaysia life and Takaful operations. (d) The mean equity return assumptions for the most signifi cant equity holdings in the Asia operations were:
Fixed annuity business*: January to June issues 1.4† 1.75† July to December issues 1.1† 1.75† Fixed index annuity business: January to June issues 1.75† 2.25 July to December issues 1.35† 2.25 Institutional business 1.25 1.0
New business 6.3 6.5 In force 5.6 6.0 US 10-year treasury bond rate at end of year 1.8 1.9 Pre-tax expected long-term nominal rate of return for US equities 5.8 5.9 Equity risk premium 4.0 4.0 Expected long-term rate of infl ation 2.5 2.0 * Including the proportion of variable annuity business invested in the general account. † Grading up linearly by 25 basis points to a long-term assumption over fi ve years.
(b) The weighted average risk discount rates refl ect the mix of business between variable annuity and non-variable annuity business. The decrease in the weighted average risk discount rates from 2011 to 2012 primarily refl ects the decrease in the US 10-year treasury bond rate of 10 basis points together with the eff ect of the decrease in additional allowance for credit risk (as described in note (d) below).
(c) Credit risk treatment The projected cash fl ows incorporate the expected long-term spread between the earned rate and the rate credited to policyholders. The projected earned rates refl ect book value yields which are adjusted over time to refl ect projected reinvestment rates. Positive net cash fl ows are assumed to be reinvested in a mix of corporate bonds, commercial mortgages and limited partnerships. The yield on those assets is assumed to grade from the current level to a yield that allows for a long-term assumed credit spread on the reinvested assets of 1.25 per cent over 10 years. The yield also refl ects an allowance for a risk margin reserve which for 2012 is 28 basis points (2011: 27 basis points) for long-term defaults (as described in note 1(b)(iii)), which represents the allowance as at the valuation date applied in the cash fl ow projections of the value of the in-force business.
(d) For US operations, the risk discount rates shown above include an additional allowance for a combination of credit risk premium and short-term downgrade and default allowance for general account business of 150 basis points (2011: 200 basis points) and for variable annuity business of 30 basis points (2011: 40 basis points) to refl ect the fact that a proportion of the variable annuity business is allocated to the general account (as described in note 1(b)(iii)).
(b) For shareholder-backed annuity business, the movements in the pre-tax long-term nominal rates of return and the risk discount rates for in-force business mainly refl ect the eff ect of changes in asset yields.
(c) The risk discount rates for new business and business in force for UK insurance operations other than shareholder-backed annuities refl ect weighted rates based on the type of business.
(d) Credit spread treatment For with-profi ts business, the embedded value refl ects the discounted value of future shareholder transfers. These transfers are directly aff ected by the level of projected rates of return on investments, including debt securities. The assumed earned rate for with-profi t holdings of corporate bonds is defi ned as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defi ned as the risk-free rate plus a long-term risk premium.
(2) 50 basis points in respect of additional provisions which comprise a credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults.
The credit assumptions used and the residual liquidity premium element of the bond spread over swap rates is as follows: New business*
Stochastic assumptions The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations described above. Assumptions specifi c to the stochastic calculations, such as the volatilities of asset returns, refl ect local market conditions and are based on a combination of actual market data, historic market data and an assessment of longer-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with allowance for correlation between the various asset classes.
(iv) Asia operations AAAAAAAAAAAAAAAAAAA The same asset return models as described for UK insurance operations below, appropriately calibrated, have been used for Asia operations. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK whilst property holdings do not represent a signifi cant investment asset; AAAAAAAAAAAAAAAAAAA The stochastic cost of guarantees is primarily only of signifi cance for the Hong Kong, Korea, Malaysia and Singapore operations; and
(vi) UK insurance operations AAAAAAAAAAAAAAAAAAA Interest rates are projected using a two-factor model calibrated to the initial market yield curve; AAAAAAAAAAAAAAAAAAA The risk premium on equity assets is assumed to follow a log-normal distribution; AAAAAAAAAAAAAAAAAAA The corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and AAAAAAAAAAAAAAAAAAA Property returns are modelled in a similar fashion to corporate bonds, namely as the return on a risk-free bond, plus a risk premium, plus a process representative of the change in residual values and the change in value of the call option on rents.
For Asia operations, the expenses comprise costs borne directly and recharged costs from the Asia regional head offi ce, that are attributable to covered business. The assumed future expenses for these operations also include projections of these future recharges. Development expenses are charged as incurred.
implementation and restructuring costs, which are charged to the EEV basis results as incurred; and AAAAAAAAAAAAAAAA Expenditure of the Asia regional head offi ce that is not allocated to the covered business or asset management operations, and is charged as incurred. These costs are primarily for corporate related activities and included within corporate expenditure.
(ix) Taxation and other legislation Current taxation and other legislation have been assumed to continue unaltered except where changes have been announced and substantively enacted in the year.
Asia insurance operations Hong Kong 157 180 380 313 396 331 2,316 2,023 Indonesia 359 250 410 338 446 363 2,097 1,435 Malaysia 98 79 208 215 218 223 1,388 1,225 Philippines 172 95 28 20 45 30 254 153 Singapore 399 371 261 198 301 235 2,314 1,855 Thailand 12 11 36 26 37 27 140 102 Vietnam 1 1 44 42 45 42 159 143
SE Asia operations including Hong Kong 1,198 987 1,367 1,152 1,488 1,251 8,668 6,936 Chinanote (ii) 37 46 53 54 56 59 277 294 Korea 94 71 86 94 95 101 438 542 Taiwan 172 217 138 126 156 148 723 672 Indianote (iii) 67 135 96 88 102 101 438 466
US insurance operations Fixed annuities 581 472 – – 58 47 581 472 Fixed index annuities 1,094 934 – – 109 93 1,094 934 Life 6 10 12 19 12 20 102 168 Variable annuities 12,445 10,909 – – 1,245 1,091 12,445 10,909 Wholesale 378 237 – – 38 24 378 237
in an cial statem en ts Notes on the EEV basis results/Statement of directors’ responsibilities Prudential plc Annual Report 2012
In preparing the EEV supplementary information, the directors have: AAAAAAAAAAAAAAAAAAA Prepared the supplementary information in accordance with the EEV Principles; AAAAAAAAAAAAAAAAAAA Identifi ed and described the business covered by the EVM; AAAAAAAAAAAAAAAAAAA Applied the EVM consistently to the covered business; AAAAAAAAAAAAAAAAAAA Determined assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then applied them consistently; AAAAAAAAAAAAAAAAAAA Made estimates that are reasonable and consistent; and AAAAAAAAAAAAAAAAAAA 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 fi nancial statements.
Scope of the audit of the supplementary information An audit involves obtaining evidence about the amounts and disclosures in the supplementary information suffi cient to give reasonable assurance that the supplementary information is free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to Group’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of signifi cant accounting estimates made by the directors; and the overall presentation of the supplementary information. In addition, we read all the fi nancial and nonfi nancial information in the annual report and accounts to identify material inconsistencies with the audited supplementary information. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Respective responsibilities of directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 363, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
In d ep en d en t au d ito r’s rep o rt/ A
I. Selected historical fi nancial information of Prudential 366 Selected historical fi nancial information of Prudential
II. IFRS profi t and loss information 369 a Analysis of long-term insurance business pre-tax IFRS
I II. Other information 376 a Funds under management 378 b Reconciliation of expected transfer of value of in-force
Earned premiums, net of reinsurance 29,404 25,277 24,211 19,976 18,789 Investment return 24,051 9,360 21,769 26,889 (30,202)
Profi t (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) note (1) 3,188 1,811 1,882 1,380 (2,072)
Tax (charge) credit attributable to policyholders’ returns (378) 17 (611) (818) 1,624
Profi t (loss) for the year 2,197 1,419 1,311 558 (390)
Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes 50 21 (10) (74) (13) Costs of terminated AIA transaction – – (377) – – Gain on dilution of Group's holdings 42 – 30 – – Amortisation of acquisition accounting adjustments arising on the purchase of REALIC (19) – – – – Loss on sale and results of Taiwan agency business – – – (621) 1
Profi t (loss) from continuing operations before tax attributable to shareholders note (2) 2,810 1,828 1,271 562 (448)
Operating earnings per share (refl ecting operating profi t based on longer-term investment returns after related tax and non-controlling interests and excluding 2010 exceptional tax credit) (in pence) 76.8p 62.8p 59.0p 44.0p 39.0p
Operating earnings per share (refl ecting operating profi t based on longer-term investment returns after related tax and non-controlling interests and including 2010 exceptional tax credit) (in pence) 76.8p 62.8p 65.3p 44.0p 39.0p * The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2008 to 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied.
Operating profi t based on longer-term investment returns note (2) 4,321 3,978 3,696 3,090 2,865 Short-term fl uctuations in investment returns
Mark to market value movements on core borrowings (380) (14) (164) (795) 656 Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes 62 23 (11) (84) (14) Effect of changes in economic assumptions (16) (158) (10) (910) (398) Costs of terminated AIA transaction – – (377) – – Gain on dilution of Group's holdings 42 – 3 – – Gain on acquisition of REALIC 453 – – – – Profi t on sale and results of Taiwan agency business – – – 91 (248)
Profi t (loss) from continuing operations before tax attributable to shareholders 5,020 2,922 3,107 1,743 (2,106)
Annual premium equivalent (APE) sales: Total APE sales 4,195 3,681 3,485 2,844 2,837 EEV new business profi t (NBP) 2,452 2,151 2,028 1,619 1,205
Total assets 310,253 272,745 260,040 227,103 214,858 Total policyholder liabilities and unallocated surplus of with-profi ts funds 271,363 236,290 224,980 196,417 182,391 Core structural borrowings of shareholder-fi nanced operations 3,554 3,611 3,676 3,394 2,958 Total liabilities 299,889 264,138 252,475 221,230 210,193 Total equity 10,364 8,607 7,565 5,873 4,665 * The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2008 to 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied.
As of and for the year ended 31 December 2012 £bn 2011 £bn 2010 £bn 2009 £bn 2008 £bn
Notes 1 This measure is the formal profi t (loss) before tax measure under IFRS but is not the result attributable to shareholders. 2 Operating profi ts are determined on the basis of including longer-term investment returns. EEV and IFRS operating profi ts are stated aft er excluding the eff ect of short-term fl uctuations in investment returns against long-term assumptions, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes, gain on dilution of the Group’s holdings and in 2010 costs associated with the terminated AIA transaction. In addition, for EEV basis results, operating profi t excludes the eff ect of changes in economic assumptions, the market value movement on core borrowings and in 2012, the gain arising on the acquisition of REALIC. Separately, on the IFRS basis, operating profi t also excludes amortisation of accounting adjustments on the acquisition of REALIC.
II(a): Analysis of long-term insurance business pre-tax IFRS operating profi t based on longer-term investment returns by driver
Spread income 106 702 266 – 1,074 Fee income 141 875 61 – 1,077 With-profi ts result 39 – 272 – 311 Insurance margin 594 399 39 – 1,032 Margin on revenues 1,453 – 216 – 1,669 Expenses: Expected return on shareholder assets 43 55 107 – 205 Gain on China Life (Taiwan) shares 51 – – – 51
Long-term business operating profi t 913 964 703 – 2,580 Asset management operating profi t 75 39 371 – 485 GI commission – – 33 – 33 Other income and expenditu re* – – – (565) (565)
II(a): Analysis of long-term insurance business pre-tax IFRS operating profi t based on longer-term investment returns by driver continued 2011 £m
Total operating profi t based on longer-term investment returns 784 675 1,080 (512) 2,027 * DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in note A5 of the IFRS fi nancial statements. † Including restructuring and Solvency II implementation costs.
Margin analysis of long-term insurance business The following analysis expresses certain of the Group’s sources of operating profi t as a margin of policyholder liabilities or other suitable driver. Details of the Group’s average policyholder liability balances are given in D2(b), D3(b), D4(b).
Spread income 1,074 62,174 173 1,065 57,417 185 Fee income 1,077 78,807 137 870 68,298 127 With-profi ts result 311 95,681 33 331 93,056 36 Insurance margin 1,032 736 Margin on revenues 1,669 1,425 Expenses: DAC adjustments note (ii) 406 237
Expected return on shareholder assets 205 200 Gain on China Life (Taiwan) shares 51 –
Spread income 106 6,720 158 88 5,623 157 Fee income 141 13,022 108 131 12,370 106 With-profi ts result 39 12,990 30 38 11,775 32 Insurance margin 594 477 Margin on revenues 1,453 1,199 Expenses: DAC adjustments note (ii) (28) 14
Notes (i) The ratio for acquisition costs is calculated as a percentage of APE including with-profi ts sales. Acquisition costs include only those relating to shareholders. (ii) DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in note A5 of the IFRS fi nancial statements. (iii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. (iv) For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as this is seen as a good 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. Liabilities held in the general account for variable annuity living and death guaranteed benefi ts together with other amounts on which no spread income is earned (eg REALIC liabilities) are excluded from the calculation of the average. In addition for REALIC, which are included in the average liability to calculate the administration expense margin, the calculation excludes the liabilities reinsured to (and in essence retained by) Swiss Re immediately prior to the acquisition by Jackson.
AAAAAAAAAAAAAAAAAAA Fee income has increased from £131 million in 2011 to £141 million in 2012, broadly in line with the increase in movement in average unit-linked liabilities, following the recovery in equity markets in 2012. AAAAAAAAAAAAAAAAAAA Insurance margin has increased by £117 million from £477 million in 2011 to £594 million in 2012 predominantly refl ecting the continued growth of the in-force book, which contains a relatively high proportion of risk-based products. Insurance margin includes non-recurring items of £48 million (2011: £38 million), refl ecting assumption changes and other items that are not expected to reoccur in the future.
AAAAAAAAAAAAAAAAAAA Margin on revenues has increased by £254 million from £1,199 million in 2011 to £1,453 million in 2012 primarily refl ecting the on-going growth in the size of the portfolio and higher premium income recognised in the year.
AAAAAAAAAAAAAAAAAAA Administration expenses have increased from £503 million in 2011 to £583 million in 2012 as the business continues to expand. Expressed as a ratio of policyholder liabilities, administration costs have increased from 280 basis points to 295 basis points due to changes in business mix.
AAAAAAAAAAAAAAAAAAA Expected return on shareholder assets has increased from £26 million in 2011 to £43 million in 2012 primarily due to higher income from increased shareholder assets.
II(a): Analysis of long-term insurance business pre-tax IFRS operating profi t based on longer-term investment returns by driver continued
Spread income 702 29,416 239 730 28,274 258 Fee income 875 44,046 199 680 34,452 197 Insurance margin 399 232 Expenses: DAC adjustments note (ii) 442 228
AAAAAAAAAAAAAAAA Fee income has increased by 29 per cent to £875 million in 2012, compared to £680 million in 2011 as a result of the growth in separate account balances primarily due to positive net fl ows from variable annuity business. Fee income margin has increased slightly to 199 basis points (2011: 197 basis points) primarily refl ecting changes to business mix.
AAAAAAAAAAAAAAAA Acquisition costs, which are commissions and general expenses incurred to acquire new business, have increased in absolute terms compared to 2011 due largely to an increase in sales volumes. However, acquisition costs as a percentage of APE have decreased to 66 per cent for 2012, compared to 70 per cent in 2011, due to the continued increase in producers selecting asset based commission which is treated as an administrative expense in this analysis, rather than front end commissions.
AAAAAAAAAAAAAAAA Administration expenses increased to £537 million in 2012 compared to £412 million in 2011, primarily as a result of higher asset based commissions paid on the larger 2012 separate account balance. Asset based commissions are paid upon policy anniversary dates and are treated as an administration expense in this analysis as opposed to a cost of acquisition and are offset by higher fee income. The administration expense margin was higher at 71 basis points (2011: 66 basis points). Excluding these trail commission amounts, the resulting administration expense margin would be 48 basis points (2011: 46 basis points ). The increase arises as a result of the effect of the REALIC acquisition on the administration expense margin together with the impact in 2012 of non -recurring expenditures.
AAAAAAAAAAAAAAAA DAC adjustments increased to £442 million in 2012 compared to £228 in 2011. 2011 was lowered by £190 million of accelerated DAC amortisation as a result of the reversal of the benefi t received in 2008 from the mean reversion formula. Market movements in 2012 resulted in deceleration of DAC amortisation of £56 million which was offset by higher amortisation as a result of higher gross profi ts. Following the adoption of the updated US GAAP principles for deferred acquisition costs, as described in note A5 of the IFRS fi nancial statements, certain acquisition costs are no longer fully deferrable resulting in new business strain of £174 million for 2012 (2011: £156 million).
Total operating profi t before acquisition costs and DAC adjustments 1,494 1,494 1,313 1,313
Note The ratio for acquisition costs is calculated as a percentage of APE including with-profi ts sales. Acquisition costs include only those relating to shareholders.
Analysis of UK IFRS operating profi t drivers AAAAAAAAAAAAAAAAAAA Spread income has increased from £247 million in 2011 to £266 million in 2012 principally due to increased new business profi ts from higher annuity sales. The margin has fallen slightly from 105 basis points to 102 basis points. AAAAAAAAAAAAAAAAAAA Fee income has increased in line with the growth in unit-linked liabilities. Expressed as an asset management charge it is equivalent to 28 basis points (2011: 27 basis points). AAAAAAAAAAAAAAAAAAA With-profi ts income has decreased by £21 million from £293 million in 2011 to £272 million in 2012 principally due to a 50 basis point reduction in annual bonus rates. This has contributed to the reduction in the with-profi ts margin from 36 basis points in 2011 to 33 basis points in 2012.
AAAAAAAAAAAAAAAAAAA Insurance margin has increased by £12 million from £27 million in 2011 to £39 million in 2012, mainly due to increased profi ts from our protection business.
AAAAAAAAAAAAAAAAAAA Acquisition costs as a percentage of new business sales have improved from 17 per cent in 2011 to 15 per cent in 2012. 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-profi t sales in the year. Acquisition costs as a percentage of shareholder -backed new business sales were 33 per cent for 2012 (2011: 33 per cent).
AAAAAAAAAAAAAAAAAAA Expected return on shareholder has increased from £91 million in 2011 to £107 million in 2012 principally due to higher IFRS shareholders’ funds.
Gain on China Life (Taiwan) shares 51 – Other non-recurrent items 48 38
(ii) During 2012, the Group sold its 7.74 per cent stake in China Life (Taiwan) for £97 million crystallising a gain of £51 million. Other non-recurrent items of £48 million in 2012 (2011: £38 million) represent a small number of items that are not anticipated to re occur in subsequent periods.
II(c): Analysis of asset management operating profi t based on longer-term investment returns 2012 £m
Operating income before performance-related fees 734 201 120 296 1,351 Performance-related fees 9 2 – – 11
Average funds under management (FUM), including 49.99% proportional share of PPM South Africa† £209.0 bn
Operating income before performance-related fees 666 196 122 249 1,233 Performance-related fees 13 6 – – 19
Margin based on operating income† 35 bps 38 bps Cost/income ratio‡ 61% 62%
Notes (i) Following the divestment in the fi rst half of 2012 of M&G’s holding in PPM South Africa from 75 per cent to 49.99 per cent and its treatment from 2012 as an associate, M&G’s operating income and expense no longer includes any element from PPM South Africa. In order to avoid period on period distortion, in the table above the 2011 operating income, margin and cost/income ratio refl ect the retrospective application of this basis of presentation for the 2011 results.
II(c): Analysis of asset management operating profi t based on longer-term investment returns continued
‡ Cost/income ratio represents cost as a percentage of operating income before performance related fees. In order to avoid period -on -period distortion, M&G’s operating income and expense excludes any contribution from M&G’s associate, PPM South Africa.
Internal funds under management 283.6 250.8 External funds note 121.4 99.8
Investment propertiesnote – – 0.1 0.1 11.0 10.9 11.1 11.0 Equity securities 14.3 12.0 49.6 38.1 36.1 37.3 100.0 87.4 Debt securities 21.4 17.7 33.0 27.0 85.7 79.8 140.1 124.5 Loans and receivables 1.0 1.2 6.2 4.1 4.6 4.4 11.8 9.7 Other investments and deposits 2.2 1.7 2.5 2.6 15.9 13.9 20.6 18.2
Note As included in the investments section of the consolidated statement of fi nancial position at 31 December 2012 except for £0.2 billion (2011: £0.2 billion) investment properties which are held for sale or occupied by the Group and, accordingly under IFRS, are included in other statement of fi nancial position captions.
III(b): Reconciliation of expected transfer of value of in-force (VIF) and required capital business to free surplus
Expected transfer of value of in-force (VIF) and required capital business to free surplus 2012 £m
The above amounts can be reconciled to the new business amounts as follows: 2012 £m
Discounted expected free surplus generation for years 2013 to 2052 1,210 1,000 274 2,484 Discounted expected free surplus generation for years 2052+ 41 – 3 44 Less: free surplus investment in new business (292) (281) (45) (618)
Pre-tax EEV new business profi t 1,266 873 313 2,452 * Other items represent the impact of the time value of options and guarantees on new business, foreign exchange eff ects and other non-modelled items. Foreign exchange eff ects arise as EEV new business profi t amounts are translated at average exchange rates and the expected free surplus generation uses year end closing rates.
Asia £m £m £m £m £m £m Other £m Total £m 2011 expected free surplus generation for years 2012 to 2051 674 647 634 595 590 564 13,998 17,702
Less: amounts expected to be realised in the current year (674) – – – – – – (674)
2012 expected free surplus generation for years 2013 to 2052 – 719 761 724 686 654 13,697 17,241
Less: amounts expected to be realised in the current year (680) – – – – – – (680)
Add: expected free surplus to be generated in year 2052* – – – – – – – –
New business – 269 108 113 37 115 764 1,406 Acquisition of REALIC – 45 35 44 38 41 738 941 Operating movements – (4) 7 14 20 18 Non-operating and other movements – 11 (8) (30) – (5) 84 107 2012 expected free surplus generation for years 2013 to 2052 – 785 572 600 557 587 4,448 7,549 * Excluding 2012 new business.
III(b): Reconciliation of expected transfer of value of in-force (VIF) and required capital business to free surplus continued
£m £m £m £m £m £m Other £m Total £m 2011 expected free surplus generation for years 2012 to 2051 423 502 472 437 428 412 7,673 10,347
New business – 27 23 23 20 23 506 622 Operating movements – 23 21 9 4 5 Non-operating and other movements† – (106) (33) (5) (8) (10) (124) (224)
2012 expected free surplus generation for years 2013 to 2052 – 446 483 464 444 430 8,095 10,362 * Excluding 2012 new business. † Includes an adjustment of £102 million to the cash fl ows for which there is no defi nitive timeframe for their emergence and therefore which have been removed from the cash fl ows presented at 31 December 2012.
Underlying free surplus generated from in-force life business in 2012 771 1,036 507 2,314 2012 free surplus expected to be generated at 31 December 2011 674 680 423 1,777
Total EEV for life operations 22,266 * These relate to items where there is no defi nitive timeframe for when the payments will be made or receipts received and are, consequently, excluded from the amounts incorporated into the tables above showing the expected generation of free surplus from in-force business at 31 December 2012. In particular it excludes the value of the shareholders’ interest in the estate.
The Group maintains four share option schemes satisfi ed by the issue of new shares. UK-based executive directors are eligible to participate in the UK savings-related share option scheme, and executives based in Asia can participate in the International savings -related share option scheme. Dublin-based employees are eligible to participate in the Prudential International Assurance sharesave plan, and Hong Kong based agents can participate in the Non-employee savings-related share option scheme. Further details of the schemes and accounting policies are detailed in note I4 of the IFRS basis consolidated fi nancial statements. All options were granted at £nil consideration. No options have been granted to substantial shareholders, suppliers of goods or services (excluding options granted to agents under the Non-employee savings-related share option scheme) or in excess of the individual limit for the relevant scheme. The options schemes will terminate as follows, unless the directors resolve to terminate the plans at an earlier date: AAAAAAAAAAAAAAAA UK savings-related share option scheme: 8 May 2013; AAAAAAAAAAAAAAAA International savings-related share option scheme: 31 May 2021; AAAAAAAAAAAAAAAA Prudential International Assurance sharesave plan: 3 August 2019; and AAAAAAAAAAAAAAAA Prudential International savings-related share option scheme for non-employees 2012: 17 May 2022.
The weighted average share price of Prudential plc for the year ended 31 December 2012 was £7.69 (2011: £6.86). Particulars of options granted to directors are included in the Directors’ Remuneration Report on page 113. The closing price of the shares immediately before the date on which the options were granted during the current period was £8.22. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2012.
Date of grant Exercise price £ Beginning End Beginning of period Granted Exercised Cancelled Forfeited Lapsed End of period 30 Sep 2004 3.43 01 Dec 2011 31 May 2012 3,852 – (3,852) – – – – 12 Apr 2005 3.87 01 Jun 2012 30 Nov 2012 8,528 – (8,528) – – – – 29 Sep 2005 4.07 01 Dec 2012 31 May 2013 9,072 – (5,292) – – – 3,780 20 Apr 2006 5.65 01 Jun 2013 30 Nov 2013 7,322 – – – – – 7,322 28 Sep 2006 4.75 01 Dec 2011 31 May 2012 11,029 – (11,029) – – – – 28 Sep 2006 4.75 01 Dec 2013 31 May 2014 13,325 – – – – – 13,325 26 Apr 2007 5.72 01 Jun 2010 30 Nov 2010 2,865 – – – – (2,865) – 26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 7,191 – (7,191) – – – – 26 Apr 2007 5.72 01 Jun 2014 30 Nov 2014 503 – – – – – 503 27 Sep 2007 5.52 01 Dec 2012 31 May 2013 17,264 – (12,156) – – – 5,108 27 Sep 2007 5.52 01 Dec 2014 31 May 2015 1,668 – – – – – 1,668 25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 27,099 – (453) – – (137) 26,509 25 Apr 2008 5.51 01 Jun 2015 30 Nov 2015 1,544 – – – – – 1,544 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 40,617 – (38,162) – – (2,455) – 25 Sep 2008 4.38 01 Dec 2013 31 May 2014 47,353 – (2,674) – – (1,305) 43,374 25 Sep 2008 4.38 01 Dec 2015 31 May 2016 11,371 – (90) – – (76) 11,205 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 2,767,654 – (2,738,947) (4,694) (10,783) (7,521) 5,709 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 1,789,848 – (27,164) (6,944) (16,820) (19,715) 1,719,205 27 Apr 2009 2.88 01 Jun 2016 30 Nov 2016 178,968 – (352) (795) – (329) 177,492 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 224,295 – (173,784) (5,721) (2,433) (1,372) 40,985 25 Sep 2009 4.25 01 Dec 2014 31 May 2015 90,865 – (2,027) – (117) (2,070) 86,651 28 Sep 2010 4.61 01 Dec 2013 31 May 2014 271,969 – (1,408) (7,644) (4,875) (1,322) 256,720 28 Sep 2010 4.61 01 Dec 2015 31 May 2016 134,304 – (1,569) (1,339) (5,021) (2,514) 123,861 16 Sep 2011 4.66 01 Dec 2014 31 May 2015 485,420 – (2,373) (12,818) (4,516) (7,514) 458,199 16 Sep 2011 4.66 01 Dec 2016 31 May 2017 197,637 – (15) (5,357) (7,580) (115) 184,570 21 Sep 2012 6.29 01 Dec 2015 31 May 2016 – 995,343 – (3,148) (5,294) – 986,901 21 Sep 2012 6.29 01 Dec 2017 31 May 2018 – 152,281 – (4,772) – – 147,509
The total number of securities available for issue under the scheme is 4,302,140 which represents 0.168 per cent of the issued share capital at 31 December 2012. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £7.13. The weighted average fair value of options granted under the plan in the period was £2.28.
Date of grant Exercise price £ Beginning End Beginning of period Granted Exercised Cancelled Forfeited Lapsed End of period 20 Apr 2006 5.65 01 Jun 2011 30 Nov 2011 820 – – – – (820) – 28 Sep 2006 4.75 01 Dec 2011 31 May 2012 709 – – – – (709) – 26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 17,847 – (2,778) – (580) – 14,489 27 Sep 2007 5.52 01 Dec 2010 31 May 2011 22,185 – – – – (22,185) – 25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 8,928 – – – – (8,928) – 25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 4,192 – – – – – 4,192 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 195,889 – (28,952) (418) (85) (166,434) – 25 Sep 2008 4.38 01 Dec 2013 31 May 2014 6,951 – – – – – 6,951 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 1,740,780 – (1,652,468) (20,966) (3,454) (418) 63,474 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 81,218 – – (1,748) (1,337) – 78,133 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 110,422 – (59,246) (5,541) (3,945) (149) 41,541 25 Sep 2009 4.25 01 Dec 2014 31 May 2015 2,682 – – – – – 2,682 28 Sep 2010 4.61 01 Dec 2013 31 May 2014 157,107 – (699) (17,743) (19,502) – 119,163 28 Sep 2010 4.61 01 Dec 2015 31 May 2016 6,130 – – – – – 6,130 16 Sep 2011 4.66 01 Dec 2014 31 May 2015 410,756 – (52) (20,880) (36,983) – 352,841 16 Sep 2011 4.66 01 Dec 2016 31 May 2017 25,739 – – – – – 25,739 21 Sep 2012 6.29 01 Dec 2015 31 May 2016 – 691,531 – (3,228) (6,935) – 681,368 21 Sep 2012 6.29 01 Dec 2017 31 May 2018 – 34,701 – – – – 34,701
The total number of securities available for issue under the scheme is 1,431,404 which represents 0.056 per cent of the issued share capital at 31 December 2012. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £7.01. The weighted average fair value of options granted under the plan in the period was £2.28.
Date of grant Exercise price £ Beginning End Beginning of period Granted Exercised Cancelled Forfeited Lapsed End of period 25 Sep 2008 4.38 01 Dec 2011 31 May 2012 691 – (691) – – – – 27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 30,320 – (26,516) – – (158) 3,646 27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 6,567 – – – – – 6,567 25 Sep 2009 4.25 01 Dec 2012 31 May 2013 2,426 – (1,627) – – (160) 639
Additional information 386 Risk factors 392 Glossary 396 Shareholder information 398 How to contact us
A number of factors (risk factors) affect Prudential’s operating results and fi nancial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, is not updated, and any forwardlooking statements are made subject to the reservations specifi ed below under ‘Forward-looking statements’.
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fl uctuations and general economic conditions Prudential’s businesses are inherently subject to market fl uctuations and general economic conditions. Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profi tability. Since 2008, Prudential has had to operate against a challenging background of periods of signifi cant volatility in global capital and equity markets, interest rates and liquidity, and widespread economic uncertainty. Government interest rates have also fallen to historic lows in the US and UK and some Asia countries in which Prudential operates. These factors have, at times during this period, had a material adverse effect on Prudential’s business and profi tability.
A signifi cant part of the profi t from Prudential’s UK insurance operations is related to bonuses for policyholders declared on with-profi ts products, which are broadly based on historical and current rates of return on equity, real estate and fi xed income securities, as well as Prudential’s expectations of future investment returns. This profi t could be lower in a sustained low interest rate environment.
Current EU directives, including the EU Insurance Groups Directive (IGD) require European fi nancial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a higher amount of regulatory capital at the group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. The EU is also developing a regulatory framework for insurance companies, referred to as ‘Solvency II’. The approach is based on the concept of three pillars. Pillar 1 consists of the quantitative requirements, for example, the amount of capital an insurer should hold. Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers. Pillar 3 focuses on disclosure and transparency requirements.
The Group’s accounts are prepared in accordance with current International Financial Reporting Standards (IFRS) applicable to the insurance industry. The International Accounting Standards Board (IASB) introduced a framework that it described as Phase I, which permitted insurers to continue to use the statutory basis of accounting for insurance assets and liabilities that existed in their jurisdictions prior to January 2005. In July 2010, the IASB published an Exposure Draft for its Phase II on insurance accounting, which would introduce signifi cant changes to the statutory reporting of insurance entities that prepare accounts according to IFRS. The IASB continues its deliberation on the exposure draft principles but it remains uncertain whether the proposals in the Exposure Draft will become the fi nal IASB standard. The timing of the changes taking effect is uncertain but not expected to be before 2017.
Any changes or modifi cation of IFRS accounting policies may require a change in the future results or a restatement of reported results.
Prudential’s businesses are conducted in highly competitive environments with developing demographic trends and continued profi tability depends on management’s ability to respond to these pressures and trends The markets for fi nancial services in the UK, US and Asia are highly competitive, with several factors affecting Prudential’s ability to sell its products and continued profi tability, including price and yields offered, fi nancial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance, historical bonus levels, developing demographic trends and customer appetite for certain savings products. In some of its markets, Prudential faces competitors that are larger, have greater fi nancial resources or a greater market share, offer a broader range of products or have higher bonus rates or claims-paying ratios. Further, heightened competition for talented and skilled employees and agents with local experience, particularly in Asia, may limit Prudential’s potential to grow its business as quickly as planned.
In Asia, the Group’s principal competitors in the region are international fi nancial companies, including Allianz, AXA, ING, AIA and Manulife. In a number of markets, local companies have a very signifi cant market presence.
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 signifi cantly upon its capacity to anticipate and respond appropriately to these competitive pressures.
Litigation, disputes and regulatory investigations may adversely aff ect Prudential’s profi tability and fi nancial condition Prudential is, and may be in the future, subject to legal actions, disputes and regulatory investigations in various contexts, including in the ordinary course of its insurance, investment management and other business operations. These legal actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specifi c 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 suffi cient. 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 fl ows.
Although Prudential’s 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. For example, although the business has not experienced a material failure or breach in relation to IT systems and processes to date, failures or breaches of this sort, including a cyber-security attack, could harm its ability to perform necessary business functions and hurt its relationships with its business partners and customers. Similarly, any weakness in the administration systems or actuarial reserving processes could have an impact on its results of operations during the effective period. Prudential has not experienced or identifi ed any operational risks in its systems or processes during 2012, which have subsequently caused, or are expected to cause, a signifi cant negative impact on its results of operations.
Adverse experience relative to the assumptions used in pricing products and reporting business results could signifi cantly aff ect Prudential’s results of operations 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. If mortality improvement rates signifi cantly 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. Prudential’s persistency assumptions refl ect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also refl ected in the assumption. If actual levels of future persistency are signifi cantly lower than assumed (that is, policy termination rates are signifi cantly higher than assumed), the Group’s results of operations could be adversely affected.
In addition, changes in methodologies and criteria used by rating agencies could result in downgrades that do not refl ect changes in the general economic conditions or Prudential’s fi nancial condition.
In common with other life insurers, the profi tability of the Group’s businesses depends on a mix of factors including mortality and morbidity trends, policy surrender rates, investment performance and impairments, unit cost of administration and new business acquisition expense.
Prudential operates in a number of markets through joint ventures and other arrangements with third parties (including in China and India), involving certain risks that Prudential does not face with respect to its consolidated subsidiaries Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures (including in China and India). For the Group’s joint venture operations, management control is exercised jointly with the venture participants. The level of control exercisable by the Group depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued cooperation between, the joint venture participants. Prudential may also face fi nancial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encounters fi nancial diffi culty. In addition, a signifi cant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could adversely affect the results of operations of Prudential.
Prudential’s Articles of Association contain an exclusive jurisdiction provision Under Prudential’s Articles of Association, certain legal proceedings may only be brought in the courts of England and Wales. This applies to legal proceedings by a shareholder (in its capacity as such) against Prudential and/or its directors and/or its professional service providers. It also applies to legal proceedings between Prudential and its directors and/or Prudential and Prudential’s professional service providers that arise in connection with legal proceedings between the shareholder and such professional service provider. This provision could make it diffi cult for US and other non-UK shareholders to enforce their shareholder rights.
AER Actual Exchange Rates are actual historical exchange rates for the specifi c accounting period, being the average rates over the period for the income statement and the closing rates for the balance sheet at the balance sheet date.
Bonuses Bonuses refer to the non-guaranteed benefi t added to participating life insurance policies and are the way in which policyholders receive their share of the profi ts of the policies. There are normally two types of bonus: AAAAAAAAAAAAA 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
AAAAAAAAAAAAA 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 fi nal bonus may not be paid. Final bonuses may vary and are not guaranteed.
CER Constant Exchange Rate – Prudential plc reports its results at both actual exchange rates (AER) to refl ect actual results and also constant exchange rates so as to eliminate the impact from exchange translation.
Deferred annuities Annuities or pensions due to be paid from a future date or when the policyholder reaches a specifi ed age.
Guaranteed investment contract (GIC) (US) An investment contract between an insurance company and an institutional investor, which provides a stated rate of return on deposits over a specifi ed period of time. They typically provide for partial or total withdrawals at book value if needed for certain liquidity needs of the plan.
Guaranteed minimum death benefi t (GMDB) (US) The basic death benefi t offered under variable annuity contracts, which specifi es that if the owner dies before annuity income payments begin, the benefi ciary will receive a payment equal to the greater of the contract value or purchase payments less withdrawals.
Guaranteed minimum income benefi t (GMIB) (US) A guarantee that ensures, under certain conditions, that the owner may annuitise the variable annuity contract based on the greater of (a) the actual account value or (b) a payout base equal to premiums credited with some interest rate, or the maximum anniversary value of the account prior to annuitisation.
Guaranteed minimum withdrawal benefi t (GMWB) (US) A guarantee in a variable annuity that promises that the owner may make annual withdrawals of a defi ned amount for the life of the owner or until the total guaranteed amount is recovered, regardless of market performance or the actual account balance.
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 movements, and other reserve movements. Specifi cally, 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.
Health and protection These comprise health and personal accident insurance products, which provide morbidity or sickness benefi ts and include health, disability, critical illness and accident coverage. Health and protection products are sold both as standalone policies and as riders that can be attached to life insurance products. Health and Protection riders are presented together with ordinary individual life insurance products for purposes of disclosure of fi nancial information.
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.
Investment-linked products or contracts Insurance products where the surrender value of the policy is linked to the value of underlying investments (such as collective investment schemes, internal investment pools or other property) or fl uctuations in the value of underlying investment or indices. Investment risk associated with the product is usually borne by the policyholder. Insurance coverage, investment and administration services are provided for which the charges are deducted from the investment fund assets. Benefi ts payable will depend on the price of the units prevailing at the time of surrender, death or the maturity of the product, subject to surrender charges. These are also referred to as unit-linked products or unit-linked contracts.
Market value reduction (MVR) A reduction applied to the payment on with-profi ts bonds when policyholders surrender in adverse market conditions.
New business contribution The profi ts, calculated in accordance with European Embedded Value Principles, from business sold in the fi nancial reporting period under consideration.
New business margin The value of new business on an EEV basis expressed as a percentage of the present value of new business premiums expected to be received from the new business.
Non-participating business A life insurance policy where the policyholder is not entitled to a share of the Company’s profi ts and surplus, but receives certain guaranteed benefi ts. Also known as non-profi t in the UK. Examples include pure risk policies (eg fi xed annuities, term insurance, critical illness) and unit-linked insurance contracts.
d d itio n al in fo rm atio n G
Separate account A separate account is a pool of investments held by an insurance company not in, or ‘separate’ from, its general account. The returns from the separate account generally accrue to the policyholder. A separate account allows an investor to choose an investment category according to his individual risk tolerance, and desire for performance.
Stochastic techniques Stochastic techniques incorporate results from repeated simulations using key fi nancial parameters which are subject to random variations and are projected into the future.
Subordinated debt A fi xed interest issue or debt that ranks below other debt in order of priority for repayment if the issuer is liquidated. Holders are compensated for the added risk through higher rates of interest. Under EU insurance regulation, subordinated debt is not treated as a liability and counts towards the coverage of the required minimum margin of solvency, with limitations.
Unallocated surplus Unallocated surplus is recorded wholly as a liability and represents the excess of assets over policyholder liabilities for Prudential’s with-profi ts funds. The balance retained in the unallocated surplus represents cumulative income arising on the with-profi ts business that has not been allocated to policyholders or shareholders.
Payment date 23 May 2013 23 May 2013 On or about 3 June 2013
d d itio n al in fo rm atio n Sh areh o ld er in fo rm atio n
American Depositary Receipts (ADRs) The Company’s ordinary shares are listed on the New York Stock Exchange in the form of American Depositary Shares, evidenced by ADRs and traded under the symbol PUK. Each American Depositary Share represents two ordinary shares. All enquiries regarding ADR holder accounts should be directed to JP Morgan, the authorised depositary bank, at JPMorgan Chase & Co, PO Box 64504, St. Paul, MN 55164-0504, USA. Telephone: +1 800 990 1135 or from outside the US: +1 651 453 2128 or log on to www.adr.com
Singapore shareholder enquiries Shareholders who have shares standing to the credit of their securities accounts with CDP in Singapore may refer queries to the CDP at 4 Shenton Way, #02-01, SGX Centre 2, Singapore 068807. Telephone: +65 6535 7511. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker.
ShareGift Shareholders who have a only small number of shares, the value of which makes them uneconomic to sell, may wish to consider donating them to ShareGift (Registered Charity 1052686). The relevant share transfer form may be downloaded from our website www.prudential.co.uk/prudential-plc/ investors/shareholder_services/forms or from Equiniti. Further information about ShareGift may be obtained on +44 (0)20 7930 3737 or from www.ShareGift.org There are no implications for capital gains tax purposes (no gain or loss) on gifts of shares to charity and it is also possible to obtain income tax relief.
o w to co n tact u s How to contact us
Forward-looking statements This document may contain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future fi nancial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations and including, without limitation, statements containing the words ‘may’, ‘will’, ‘should’, ‘continue’, ‘aims’, ‘estimates’, ‘projects’, ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward-looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward-looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future fi nancial condition or performance or other indicated results to differ materially from those indicated in any forward-looking statement. Such factors include, but are not limited to: future market conditions, including fl uctuations in interest rates and exchange rates and the potential for a sustained low-interest rate environment, and the performance of fi nancial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives related to the fi nancial crisis and the effect of the European Union’s ‘Solvency II’ requirements on Prudential’s capital maintenance requirements; the impact of competition, economic growth, infl ation, and defl ation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards, accounting standards or relevant regulatory frameworks, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affi liates operate; and the impact of legal actions and disputes. These, and other important factors may, for example, result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefi ts. Further discussion of these and other important factors that could cause Prudential’s actual future fi nancial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the ‘Risk factors’ heading in this document.
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