BUSINESS REVIEW 24 Chief Financial Officer’s overview 40 Risk and capital management 46 Business unit review: • Insurance operations: Asia, US, UK • Asset management: M&G, Asia, US
GOVERNANCE 76 Board of directors 79 Governance report 93 Additional disclosures 94 Index to principal Directors’ Report disclosures
115 Summary of statutory and supplementary International Financial Reporting Standards (IFRS) basis and EEV basis results 118 Index to Group financial statements 119 Consolidated income statement 120 Consolidated statement of comprehensive income 121 Consolidated statement of changes in equity 123 Consolidated statement of financial position 125 Consolidated statement of cash flows 126 Notes on the Group financial statements 292 Balance sheet of the parent company 293 Notes on the parent company financial statements 302 Statement of directors’ responsibilities in respect of the Annual Report and the financial statements 303 Independent auditor’s report to the members of
In 2009 we delivered an outstanding performance during a year of unprecedented economic uncertainty.
International Financial Reporting Standards operating profit based on longer-term investment returns £1,405m £1,283m
Understanding and responding to our customers’ needs is at the heart of our business. It is something we have been doing for over 160 years. We generate sustainable value for our shareholders through a relentless focus on meeting our customers’ savings, income and protection needs and a disciplined approach to investing in the most profitable growth opportunities.
The Group is structured around four main business units: Prudential Corporation Asia, Jackson National Life Insurance Company, Prudential UK and M&G. Our operating model allows each of our businesses to stay close to their customers within the framework of a consistent, Group-wide global approach to managing risk, capital, cash, reputation and leadership development and succession.
PRUDENTIAL CORPORATION ASIA Through its life insurance and asset management operations, Prudential has 28 businesses in 13 countries across Asia.
Prudential is a leading life insurer in Asia with a presence in 12 markets and a top three position in seven key locations: Hong Kong, India, Indonesia, Malaysia, Singapore, the Philippines and Vietnam. We provide a comprehensive range of savings, protection and investment products that are specifically designed to meet the needs of customers in each of our local markets.
Founded nearly 50 years ago, Jackson has a long and successful record of providing advisers with the products, tools and support to design effective retirement solutions for their clients.
It has a number of major competitive advantages including significant longevity experience, multi-asset investment capabilities, a strong investment track record, a highly respected brand and financial strength. Prudential UK continues to focus on its core strengths including its annuities, pensions and investment products where it can maximise the advantage it has in offering with-profits and other multi-asset investment funds.
M&G has been investing money for individual and institutional clients for nearly 80 years. Today it is one of the largest investors in the UK stock market, as well as being a powerhouse in fixed income.
% of Group new business profit 45% Asia 14% UK 41% US
* % of Group EEV long-term operating profits † % of Group IFRS operating profits
IFRS operating profits based on longer-term investment returns before restructuring costs and other income and expenditure.
• Top five provider of variable and fixed index annuities in US
• Ranked top insurance company for sales support satisfaction in the Financial Research Corporate Adviser Insights study on Marketing Effectiveness
• Rated as a ‘World Class’ service provider for five successive years by Service Quality Measurement Group
• ‘Highest Customer Satisfaction by Industry’ award from Service Quality Measurement Group
• Record total APE retail sales of £912 million – highest level in Jackson’s history
• Internal Rate of Return (IRR) of over 20 per cent in 2009
• The strength and performance of our With-Profits Fund has once again allowed us to deliver strong annualised returns for policyholders
• Award-winning, widely-recognised, trusted brand – named Asia-Pacific’s Health Insurer of Year in 2009 by Frost and Sullivan
• 89 per cent of active institutional funds delivered returns ahead of their benchmarks over three years
During 2009, our clear and consistent strategy delivered a strong rise in profits in very challenging and rapidly changing conditions. All our businesses performed extremely well, enabling the Group to deliver exceptional growth in shareholder value.
From our origins in the UK, and for over 160 years, our mission has been to meet our customers’ changing needs for savings, income and protection.
Throughout the year, Tidjane has demonstrated his ability to drive performance and build value, and has consistently proven his ability to lead Prudential to the next level.
In April 2009, we announced the appointment of Nic Nicandrou as Chief Financial Officer in succession to Tidjane. Nic, who joined from Aviva, combines technical depth and experience with high-quality leadership skills, making him the ideal person to maintain our commitment to leading best-in-class disclosure and transparency.
I would particularly like to highlight the contribution of our employees who volunteer their time supporting local communities and good causes. During 2009, over 6,400 employees signed up as volunteers – amounting to approximately one in four of our workforce – with nearly half of them participating in our flagship programme, The Chairman’s Award. This programme has gone from strength to strength, bringing together employees as volunteers on key projects working with our global charity partners. Our volunteering programme is a demonstration of our brand values in action.
After an outstanding year for Prudential, I remain extremely confident about the prospects for our business. I believe our strategy, skills and powerful brands uniquely position us in the sector to drive profitable growth and create sustainable value.
We have consistently said our strategy is a formula for outperformance, and these results demonstrate that we have been able to execute it with discipline and effectiveness.
On 1 March 2010 we announced our agreement with AIG for the combination of Prudential and AIA Group Limited, a wholly owned subsidiary of AIG. The strength of AIA’s business, its market-leading positions in South-East Asia and the potential for accelerated growth of the combined business in the future present a compelling and unique opportunity for Prudential.
Group performance Turning to our performance in 2009, our total Group operating profit before tax from continuing operations, on the European Embedded Value (EEV) basis, rose to £3,090 million, an increase of 8 per cent. Our EEV new business profit increased by £407 million, or 34 per cent to £1,607 million. Margins improved across the Group rising from 42 per cent to 56 per cent, an exceptional level of performance given the market conditions prevailing in 2009. We achieved our objective of increased profitability while consuming less capital, through investing our free surplus in those markets and products which deliver the highest returns within our new business strain targets. In 2009 our investment in new business was 16 per cent lower at £675 million (2008: £806 million).
On the statutory International Financial Reporting Standards (IFRS) basis, operating profit based on longer-term investment returns increased by 10 per cent to £1,405 million. IFRS operating profit increased across all three life operations: in Asia it increased 62 per cent to £416 million; in the US it increased 13 per cent to £459 million; and in the UK it increased 11 per cent to £606 million, a very strong performance. Operating profit at M&G decreased 17 per cent to £238 million, reflecting the impact of the volatility in equity and property markets during the year, while our asset management business in Asia increased operating profits by 6 per cent to £55 million. We saw a change in other income and expenditure to negative £395 million (2008: negative £260 million), as a result of lower returns on central funds and an increase in interest payable on core structural borrowings.
Importantly, we also succeeded in significantly strengthening our Group capital position, making us one of the best-capitalised insurers and underpinning our ability to exploit growth opportunities. Using the regulatory measure of the Insurance Groups Directive (IGD), the Group’s capital surplus was estimated at £3.4 billion at the 2009 year-end, more than double its level of £1.5 billion at the end of 2008, with a solvency ratio of 270 per cent, or 2.7 times our regulatory requirement.
Given the Group’s outstanding financial performance in 2009 and increasingly robust financial position, the Board has recommended a final dividend of 13.56 pence per share, bringing the full-year dividend to 19.85 pence per share, an increase of 5 per cent. The dividend is covered 2.2 times by post-tax IFRS operating profit based on longer-term investment returns.
Our strategy Our strategy is to profitably meet our customers’ changing needs for savings, income and protection in our chosen markets. By maintaining our focus and discipline in the implementation of this strategy, and by allocating capital to the most attractive opportunities, we believe we are able to generate sustainable and differentiated value for our shareholders. Over the last year our strategy has proven its worth under the most testing conditions, delivering a significant outperformance in Total Shareholder Return (TSR) in 2009.
Our financial strength is fundamental to our strategy and as a result of our disciplined risk management approach and targeted Group-wide actions to grow and protect our capital, we are emerging stronger from the global economic downturn. This capital strength has been instrumental in our ability to invest in profitable growth opportunities in 2009, especially in our chosen markets in Asia and the US.
In the US, which remains the world’s largest retirement market, we continued to focus on building our share of the expanding and cash-generative annuities market. We have emerged from the crisis with a significantly stronger position in the variable annuities market, a key product for baby boomers as they reach retirement. We have continued to grow our share of the fixed index annuities market, while limiting our appetite for fixed annuities in order to conserve capital and maximise profits.
We believe that our strategy, and the consistency and discipline with which we execute it, is what differentiates us.
As a Group we have a portfolio of highly trusted brands including Prudential, M&G and Jackson and we remain committed to this successful multi-brand strategy. This approach gives us the flexibility to tailor our brands to our different businesses and the customers these businesses serve. We believe the strength of our brands was a significant differentiator in 2009, as many customers looked for companies with a heritage and history that they knew and trusted, as safe havens for their assets amid the widespread financial uncertainty.
We believe that our strategy, and the consistency and discipline with which we execute it, is what differentiates us. In 2010 we intend to continue our disciplined execution of this strategy, amplifying and accelerating it to deliver continued profitable growth and increased shareholder value.
Product and distribution strategy Our operating model enables each of our business units to stay close to its customers, allowing them to be flexible in identifying and developing the specific product and distribution mix that is right for each market.
In the US, the volatility in US equity markets in 2009 saw customers seek safer, but lower, returns by buying fixed annuities, fixed index annuities or variable annuities with guaranteed living benefits. Jackson responded quickly and was able to capitalise on this shift in demand across all its annuity product lines. Supported by our core skills in product manufacturing and distribution, our purposeful focus on variable annuities and maintaining capital strength enabled us to gain significant market share while achieving a strong rise in margins and profitability.
PRUDENTIAL CORPORATION ASIA • Expand the agency force and continue to improve productivity • Maximise the potential from non-agency distribution and add new partners • Further develop direct marketing channels and up-sell and cross-sell • Increase focus on retirement services and health products
M&G • Maintain superior investment performance for both internal and external funds • Continue growth in third-party retail and institutional businesses
PRUDENTIAL UK • Build on our strengths in the retirement market and risk products • Make the most of our core capabilities and assets including our longevity experience, multi-asset investment expertise, brand, financial strength and large customer base
Jackson market position • Write profitable business and conserve IGD capital • Grow existing retail distribution through organic growth of National Planning Holdings (NPH), Jackson’s independent broker-dealer network
In the UK we continued to focus on the retail market, with an emphasis on our market-leading with-profits and annuities products. We restricted our appetite for the capital intensive bulk annuity market and ceased to offer lifetime mortgages. These decisions reflect our focus on higher margin products, with shorter payback periods. In the UK, we have a diverse multi-channel approach including direct sales, financial advisers and partnerships. We continue to use our strong foundation, brand heritage and customer franchise to support our business.
• Record results across a number of metrics in challenging markets
• Launched a new Income Choice Annuity product • The With-Profits Fund has consistently outperformed the market for our long-term investors
• Gained over 50 new panel positions across 24 key accounts, meaning our products are more widely available to intermediaries
• Won two Five-Star awards at the Financial Adviser Service Awards as well as the award for best annuity provider at the Professional Adviser Awards 2010
• Compete selectively in areas of the retirement income and savings market where we can play to our core strengths and generate attractive returns on capital employed
• Maximise the opportunities arising from our significant competitive advantages including our financial strength, significant longevity experience, multi-asset investment capabilities, strong investment track record, brand and large customer base
• New business was written at an aggregate after-tax IRR of more than 20 per cent on fully allocated ‘AA’ capital
• Prudent but dynamic management of capital • Deliver growing dividend, determined after taking into account the Group’s financial flexibility and opportunities to invest in areas of business offering attractive returns
• Targeting dividend cover of 2 times over time 2009 achievements
During the course of the year we enhanced the strength and flexibility of our capital base, increasing our IGD capital surplus from £1.5 billion at year-end 2008 to £3.4 billion at 31 December 2009, equivalent to approximately 270 per cent cover of the required capital. This increase resulted from a series of measures that clearly demonstrated our disciplined approach to capital management.
In addition to internal capital generation of £1.1 billion, we transferred the assets and liabilities of our agency distribution business in Taiwan to China Life of Taiwan, which boosted our IGD capital surplus by approximately £0.8 billion. A further £0.9 billion was contributed by issues of subordinated and hybrid debt, and £0.9 billion by financial restructuring and internal reorganisation of Group capital. These gains of some £3.7 billion, were partially offset by about £0.4 billion of credit impacts in Jackson, £0.6 billion of debt interest and other central costs, £0.3 billion of dividends net of scrip, £0.2 billion from regulatory changes and £0.3 billion of foreign exchange movements.
Going forward, we are increasingly positive on the outlook for Asia and this is reflected in our announcement concerning AIA. We remain cautious on the major Western economies, because of a number of imbalances threatening their return to higher growth, including high levels of consumer and government debt, budget deficits and unemployment. In Asia we enjoy a unique combination of market-leading positions in the fastest growing, most profitable markets; strong brands; unrivalled multi-channel distribution and well-designed products. Asia, with its GDP growth rates, saving habits and low penetration, remains the primary focus of our growth and investment. This is the most attractive opportunity in our industry today and the agreement we announced on 1 March 2010 demonstrates that I have every intention of ensuring that the Group makes the most of it, while also capitalising on our strong presence in the US, the UK and our market leading asset management platform.
I am committed to managing the Group with discipline and a relentless focus on execution and operational delivery. I am confident that the quality of our teams, coupled with our culture of discipline and focus, will position us well to continue to outperform our industry, not only through the current economic cycle but also through those yet to come.
The main engine of our growth strategy is our unique presence in Asia, which includes 28 businesses, spread over 13 countries.
We have top three positions in the fast-growing markets of Hong Kong, India, Indonesia, Malaysia, the Philippines, Singapore and Vietnam. We will accelerate our investment in the region to capture future growth, fuelled by our unrivalled distribution, products, customer service and brands.
Our business in the UK provides the foundation and fuel for the Group’s strategy.
Our results, as summarised below, show that we have achieved our dual objectives of higher profitability and lower levels of investment in new business at a time when market conditions remained challenging for the insurance industry. This highlights our focus on value over volume as we manage investment in new business to meet our capital management targets. In addition we have been able to strengthen our capital position and have continued to generate a positive Group operating holding company cash flow.
In 2009, in a difficult economic and market environment, Prudential produced a strong performance across all of its key performance indicators. We believe this performance demonstrates the success of our strategy and the resilience and strength of Prudential’s business model.
On long-term business notes 2, 3 3,202 2,810 14 3,080 4
EEV basis shareholders’ funds per share 603p 599p 1 563p 7
Dividend per share relating to the reporting year 19.85p 18.9p 5 n/a n/a
In 2009, total EEV basis operating profits based on longer-term investment returns of £3,090 million were up eight per cent from 2008, primarily from an increase in the profitability from the Group’s long-term business operations which was up 14 per cent to £3,202 million comprising new business profit of £1,607 million, in-force profits of £1,601 million and development expenses of £6 million. New business profit increased by £407 million to £1,607 million, driven principally by the US and Asia. Overall, there was a two per cent decrease in the contribution from in-force business (before development expenses), down by £35 million to £1,601 million. The movement reflects a growing level of unwind of discount, up by £210 million, reflecting the increased in-force business offset by a reduction in the level of contribution from changes to operating assumptions, experience variances and other items of, in aggregate, £245 million. The growth in the Group’s EEV operating profit was held back by a lower contribution from the asset management businesses (down £48 million to £297 million) reflecting reduced market values in 2009. There was also a negative impact on Group EEV operating profit from other income and expenditure of £131 million due to lower returns on central funds and higher interest payable on core structural borrowings.
The total EEV profit before tax for 2009 of £1,743 million compares to a loss of £2,106 million for 2008. The increase of £3,849 million reflects the growth in operating profit of £225 million and an increase in the aggregate effect of non-operating items of £3,624 million which mostly arise from the net effects of improved financial markets. Within the non-operating items of negative £1,347 million there were positive contributions of £351 million for short-term fluctuations in investment returns and the £91 million from the profit on sale and results of the Taiwan agency business that was sold in June 2009. However, these amounts were offset by reductions of £795 million for the change in the mark-to-market value of the Group’s borrowings as credit spreads normalised, a charge of £910 million for the effect of changes in economic assumptions and time value of cost of options and guarantees arising from increasing interest rates and the application of higher risk discount rates across our businesses and an £84 million charge for actuarial and other losses for the Group’s defined benefit pension schemes.
The total IFRS profit before disposal of Taiwan agency business was £1,367 million in 2009, significantly higher than for 2008 (loss of £451 million) reflecting increased operating profits and more favourable short-term fluctuations partially offset by a charge for the costs of hedging the Group IGD capital surplus. Total profit before tax from continuing operations on the IFRS basis was £746 million in 2009 after allowing for the loss on disposal of the Taiwan agency business of £621 million which was completed in June 2009.
Since the beginning of the year, management actions have led to a very material increase in the Group’s IGD surplus position to £3.4 billion including the issuance of £400 million subordinated debt in May to part replace maturing senior debt, the net proceeds of the Tier 1 hybrid debt of US$750 million (circa £455 million) issued in July, the beneficial impact of the sale of Taiwan agency business of £800 million, with other capital initiatives and capital generation through operating earnings net of impairments, financing costs, effects of currency and rule changes accounting for the balance. We believe this level of IGD acts as a prudent regulatory buffer whilst there remains a degree of uncertainty in the future economic environment in which we operate.
In the volatile economic environment experienced during 2009, we maintained our strong focus on risk, capital and cash management. Our commitment to focusing on value over volume has been demonstrated by the strong growth in both EEV and IFRS operating profit. We have also been able to continue to be cash flow positive at the holding company level, with a positive contribution of £38 million before exceptional items.
Long-term profits generated by the Group in 2009 increased by 14 per cent to £3,202 million. These profits comprise new business profits of £1,607 million (2008: £1,200 million), in-force profits of £1,601 million (2008: £1,636 million) and development expenses of £6 million (2008: £26 million).
The contribution from in-force operating profit decreased by £35 million to £1,601 million, including unwind of discount and other expected returns that increased by £210 million to £1,421 million, primarily reflecting the growth in Asia’s in-force book and the increase in risk discount rates in the US. In-force profit in 2009 also includes the effects of operating assumption changes and experience variances and other items which had an aggregate impact of £180 million. This primarily reflects the positive impact of altered assumptions for Guaranteed Minimum Withdrawal Benefits in the US of £156 million where our expectation of the utilisation of the withdrawal feature available to policyholders on Variable Annuity contracts has been modified to take account of the more recent experience of policyholder behaviour when benefits are “in the money”. Also included are the broadly offsetting effects of favourable experience and other items in the US and UK against the impact of adverse persistency in Asia.
Asset management business: US broker-dealer and asset management 10 10 – 12 (17)
EEV basis profit after tax and minority interests AER8 £m £m
Operating profit from the asset management business decreased to £297 million, down 14 per cent from £345 million in 2008, reflecting reduced market values in 2009 compared to 2008.
For our UK business, the short-term fluctuations in investment returns were positive £445 million (versus negative £2,407 million in 2008), including positive £430 million relating to with-profits business, primarily reflecting the difference between the 15.5 per cent investment return arising in the year on the investments of the with-profits life fund (covering policyholder liabilities and unallocated surplus) and the long-term assumed return of 6.9 per cent.
For other operations, the principal component of short-term fluctuations in investment returns is a one-off £235 million cost arising from the hedge temporarily put in place during the first quarter, to protect the Group IGD capital surplus in the light of exceptional market conditions. During the severe equity market conditions experienced in the first quarter of 2009, coupled with historically high equity volatility, the Group entered into exceptional short-dated hedging contracts to protect against potential tail-events on the IGD capital position, in addition to our regular operational hedging programmes. The residual short-term fluctuations in investment returns for other operations of positive £105 million includes £66 million for unrealised appreciation on Prudential Capital’s debt securities portfolio and £28 million on swaps held centrally to manage Group assets and liabilities.
Mark-to-market movement on core borrowings The mark-to-market movement on core borrowings was a negative £795 million, as credit spreads incorporated in the market value of the debt narrowed to more normal levels.
Our larger markets of Malaysia, Hong Kong, Singapore and Indonesia continue to show strong increases in operating profit. In Indonesia, the results increased from £55 million to £102 million, reflecting the strong underlying growth of the business and further improvements to the impact of new business on operating profits. In Malaysia, IFRS operating profit of £65 million, excluding the oneoff credit, was up 41 per cent on 2008, driven mainly by the growth in the profits from the in-force business. Hong Kong recorded increased operating profit up 45 per cent to £48 million, due mainly to increased profits from the in-force non-participating business, both as a result of growth and the non-recurrence of one-off costs in 2008. This has been offset by reduced participating fund profits following lower bonus payments to policyholders in 2009 reducing the corresponding transfer to shareholders from the with-profits fund. Singapore saw an increase in operating profit of £29 million (35 per cent) to £112 million reflecting growth in the in-force business. Aside from Japan, where on 15 February 2010 the operation suspended writing new business, Taiwan, which is focusing on its bancassurance business following the disposal of its agency business in June 2009, and Thailand, all the Asian life operations are generating operating profits on the IFRS basis.
The Asian asset management operations reported operating profits of £55 million, up by six per cent from £52 million in 2008. This reflects favourable exchange rates and management’s focus on profitability during the period. Profit in 2009 was adversely impacted by a one-off loss in India of £6 million.
Asset management fees have increased by 14 per cent to £458 million in 2009, with growth in our Asian and US businesses and favourable exchange rate movements more than offsetting the impact of falling asset values on fees earned.
The significant decrease in Jackson’s DAC amortisation principally reflects the improvements in equity markets in the period and the non-recurrence of the DAC acceleration of circa £140 million that occurred in 2008.
Net insurance margin has grown by 53 per cent to £472 million in 2009 principally reflecting the strong growth in our Asian in-force book (up £55 million to £253 million in 2009), improved mortality experience in the US and UK and a one-off benefit of £34 million in the UK relating to a longevity swap on certain aspects of the UK’s annuity back-book liabilities.
Profits from with-profits business were £310 million in 2009 compared with £425 million in 2008, reflecting lower bonus rates, and hence lower transfers to shareholders, which are calculated as one-ninth of the cost of policyholders’ bonus, due to market falls.
Other of negative £218 million is primarily as a result of increased hedging costs in the US. This negative impact is before allowing for VA guarantee fees of £137 million included within net insurance margin and reflects the economic nature of Jackson’s hedging programme, with derivative losses arising from increasing equity markets and interest rates not being fully offset by the release of policyholder reserves (which are not economically valued under US GAAP, the grandfathered accounting basis under IFRS 4). After allowing for VA guarantee fees earned in the period the cumulative impact of VA hedging activities for 2008 and 2009 is a small net operating loss of £7 million.
The positive short-term fluctuations of £31 million for our Asian operations primarily reflect strong market performance in Taiwan and Japan partially offset by the impact of unrealised losses on the debt securities portfolio in Vietnam.
IFRS basis results – Analysis of life insurance pre-tax IFRS operating profit based on longer-term investment returns by driver
Non-recurrent release of reserves for Malaysian life operation 63 – – – –
Profit (loss) before loss on sale and results of Taiwan agency business 1,367 (451)
Profit (loss) for the year attributable to equity holders of the Company 676 (396)
The positive short-term fluctuations of £27 million for our US operations comprise positive £385 million for market value movements on the free standing derivatives used to manage the fixed annuity and other general account business, negative £414 million in respect of debt securities, and positive £56 million of other items. The negative £414 million for debt securities reflects the levels of realised gains and losses (including writedowns ) in excess of the allowance for longer-term defaults and amortisation of interest-related gains included in the operating result adjusted for associated deferred acquisition costs.
Short-term fluctuations for other operations, in addition to the previously discussed IGD hedge costs of £235 million, were £105 million positive, which includes £66 million for unrealised appreciation on Prudential Capital’s debt securities portfolio and £28 million on swaps held centrally to manage Group assets and liabilities.
Sale of Taiwan agency business On 20 February 2009 we announced our agreement to transfer the assets and liabilities of the agency distribution business in Taiwan, including the capital consuming in-force book, to China Life Insurance Limited (Taiwan). We completed the transaction on 19 June 2009 following regulatory approval being given on that day. The transfer has resulted in a one-off negative pre-tax impact of £621 million. After allowing for tax, and other adjustments, the effect on shareholders’ equity was negative £607 million. The overall size of loss reflects the carrying value of the IFRS equity of the business as applied in the calculation of the loss on sale and the application of ‘grandfathered’ US GAAP under IFRS 4 for insurance assets and liabilities. US GAAP does not and is not designed to include the costs of holding economic capital to support the legacy interest rate guaranteed products, as recognised under the Company’s supplementary reporting basis under European Embedded Value principles. The loss on sale reflects this element of the economic value. Separately, it is to be noted that under IFRS there is no recognition of the enhanced IGD capital surplus position arising on completion.
Unrealised gains and losses on Jackson securities classified as available for salenote 1 – – 1,043 (831)
2 The increase in free surplus of £1.6 billion arises primarily from £0.9 billion being generated by the long-term businesses, and an increased of £1 billion from the disposal of Taiwan off-set by cash paid to the holding company and other items. 3 The reduction in required capital from £4,117 million at 31 December 2008 to £2,994 million at 31 December 2009, principally reflects the sale of the
EEV On an EEV basis, which recognises the shareholders’ interest in long-term business, shareholder funds at 31 December 2009 were £15.3 billion, an increase of £0.3 billion from the 2008 year-end level. This increased level of shareholders’ funds reflects the profit after tax of £1.2 billion, the adverse effects of exchange movements of £0.7 billion and dividend payments of £0.5 billion, which are partially offset by new share capital subscribed of £0.1 billion and other movements of £0.2 billion.
For Prudential’s other Asian markets, following the sale of the Taiwan agency business, the embedded value was £848 million in aggregate.
In 2009 the net unrealised gains/losses within the statement of financial position value for debt securities classified as availablefor -sale moved from a net unrealised loss of £2,897 million to a net unrealised gain of £4 million. After allowing for DAC and tax effects this reduction in the level of unrealised gains/losses has led to a £1.0 billion increase in shareholders’ funds during the year. The reduction in unrealised gains/losses reflects the benefits of some normalisation in credit markets with spreads tightening.
In June 2009 we completed the sale of the Taiwan agency business. As anticipated, this gave rise to an increase in free surplus of £987 million, representing the release of negative free surplus that previously applied. This compares to an increase in IGD capital of £800 million. The difference arises predominantly because the calibrations underpinning the capital requirements on a regulatory (IGD) basis are different from those applied on an economic capital (EEV) basis.
The total movement in free surplus net of tax in the period can be analysed as follows: AER8 £m £m
Expected in-force cash flows (including expected return on net assets) 1,914 1,623
Comprised of: Free surplus relating to long-term insurance business 2,065 447
Free surplus generation Sources and uses of free surplus generation from the Group’s life and asset management operations 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. Specifically, it includes amounts maturing from the in-force operations during the period less the investment in new business, the effect of market movements and other one-off items.
For asset management operations we have defined free surplus generation to be total post tax IFRS profit for the period. Group free surplus generated also includes the general insurance commission earned during the period and excludes restructuring and shareholders’ centrally arising other income and expenditure.
During 2009 we generated total free surplus from the retained businesses of £1,216 million (2008: negative £707 million).
Underlying free surplus generated from the in-force book increased 34 per cent from £1,558 million in 2008 to £2,089 million in 2009, reflecting favourable exchange rates, the underlying growth of the portfolio, and positive changes in operating assumptions and variances of £175 million for our life businesses (2008: negative £65 million). These positive changes include £158 million arising in the UK (2008: £118 million) and £115 million arising in the US (2008: negative £1 million), consistent with management’s on-going focus on capital preservation, and were offset by the negative changes in Asia of £98 million (2008: negative £182 million) principally arising from adopting higher required capital level assumptions in a number of businesses.
In the UK, investment in new business decreased by 65 per cent from £293 million in 2008 to £103 million in 2009, and for each £1 million of free surplus invested we generated £1.6 million of post-tax new business contribution to embedded value (2008: £0.7 million). This reflects the UK’s focus on capital preservation with an increase in with-profits bonds sales and minimal bulk annuity transactions in 2009 and its disciplined approach to individual annuity pricing. The average free surplus undiscounted payback period for business written in the 12 months to 31 December 2009 was five years (12 months to 31 December 2008: six years).
In Asia, investment in new business was £246 million, which was flat compared to 2008 on a CER basis (£250 million). For each £1 million of free surplus invested we generated £2.2 million of post-tax new business contribution to embedded value (2008: £2.1 million). This increase arises predominantly from the benefit derived from a change in sales mix from the lower margin markets of Korea and India to higher margin territories in the region. The average free surplus undiscounted payback period for business written in the 12 months to 31 December 2009 was three years (12 months to 31 December 2008: four years).
Asia US UK Group Asia* US UK Group £m £m £m £m £m £m £m £m
Free surplus invested in new business (246) (326) (103) (675) (224) (289) (293) (806)
Net worth invested in new business (177) (26) (21) (224) (182) (24) (128) (334)
Post tax new business profit for the year 526 224 197 947
Net remittances to Group from Business Units 688 515 Net interest paid (214) (128)
Operating holding company* cash flow after dividend 38 54 Exceptional Items: Cash flow arising from sale of Taiwan agency business (125) –
Receipts (payments) arising from foreign exchange movements on US$ hedging instruments 60 (352)
Cash and short-term investments at 31 December 1,486 1,165 * Including central finance subsidiaries. †Costs in respect of IGD hedge taken out in Q1 2009 to mitigate against further adverse movement in market indices from the lows experienced at that time.
Holding company cash flow We continue to manage cash flows across the Group with a view to achieving a balance between ensuring sufficient net remittances from the businesses to cover the progressive dividend (after corporate costs) and maximising value for shareholders through the reinvestment of the free surplus generated at business unit level in the particularly profitable opportunities available to the Group given its established position in key life insurance markets. On this basis, the holding company cash flow statement at an operating level should generally balance to close to zero before exceptional cash flows.
After corporate costs, there was a net cash inflow before dividend of £382 million in 2009 compared to £340 million for 2008. The dividend paid net of scrip, was £344 million in 2009 compared to £286 million in 2008. The take-up of scrip dividends in 2009 continued to be significant at £137 million (2008: £157 million).
As a consequence, overall, we reported a positive underlying cash inflow before exceptional items of £38 million in 2009. There were also two exceptional payments. We paid £125 million in connection with the sale of the Taiwan agency business to China Life Insurance Company Ltd of Taiwan, which comprised of £45 million to purchase a 9.99 per cent stake in that company and £80 million for transaction related expenditure including restructuring costs.
In the first quarter of 2009, we incurred one-off exceptional costs in relation to an IGD hedge taken out in 2009 to mitigate against further adverse movement in market indices from the lows experienced at that time, with the transaction being executed by Jackson where the specialist skills reside for the particular types of instruments utilised and we have injected £235 million of capital into Jackson.
Of the £58.7 billion investments related to shareholder-backed operations, £3.9 billion was held by Asia long-term business, £28.9 billion by Jackson and £22.8 billion by the UK long-term business respectively.
Policyholder liabilities and unallocated surplus of with-profits funds Policyholder liabilities related to shareholder-backed business grew by £ 7.9 billion from £ 92.2 billion at 31 December 2008 to £100.1 billion at 31 December 2009.
The increase reflects positive net cash flows (premiums less surrenders and maturities/deaths) of £7.2 billion in 2009, predominantly driven by strong inflows in the US (£5.2 billion) and Asia (£2.1 billion), as well as positive investment-related items of £10.8 billion, primarily reflecting the growth in global equity and bond markets during the year.
Shareholders’ net borrowings and ratings The Group’s core structural borrowings at 31 December 2009 totalled £3.4 billion on an IFRS basis, compared with £3.0 billion at the end of 2008. In May 2009, senior debt of £0.3 billion was repaid on maturity and new hybrid debt of £0.4 billion was issued.
In July 2009 a further £0.5 billion of new hybrid debt was issued. In addition there were exchange translation gains of £0.2 billion on foreign currency denominated borrowings in the period.
In addition to our core structural borrowings set out above, we also have in place an unlimited global commercial paper programme. As at 31 December 2009, we had issued commercial paper under this programme totalling £409 million, US$1,976 million, and EUR 449 million. The central treasury function also manages our £5,000 million medium-term note (MTN) programme covering both core and non-core borrowings, under which the outstanding subordinated debt at 31 December 2009 was £835 million, US$750 million and EUR 520 million, while the senior debt outstanding was £200 million and US$12 million. In addition, our holding company has access to £1,600 million of committed revolving credit facilities, provided by 15 major international banks, and renewable between September 2011 and March 2012; and an annually renewable £500 million committed securities lending liquidity facility. Apart from small drawdowns to test the process, these facilities have never been drawn, and there were no amounts outstanding at 31 December 2009. The commercial paper programme, the MTN programme, the committed revolving credit facilities and the committed securities lending liquidity facility are all available for general corporate purposes and to support the liquidity needs of our holding company and are intended to maintain a strong and flexible funding capacity.
We manage the Group’s core debt within a target level consistent with our current debt ratings. At 31 December 2009, the gearing ratio (debt, net of cash and short-term investments, as a proportion of EEV shareholders’ funds plus debt) was 11.1 per cent, compared with 10.7 per cent at 31 December 2008.
Prudential plc has strong debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential’s long-term senior debt is rated A+ (negative outlook), A2 (negative outlook) and A+ (negative outlook) from Standard & Poor’s, Moody’s and Fitch, while short-term ratings are A-1, P-1 and F1+ respectively.
Investment related items and other movements 2,811 2,986 5,023 10,820 Disposal of Taiwan agency business (3,508) – – (3,508)
The actuarial valuation of the M&G pension scheme as at 31 December 2008 demonstrated the scheme to be 76 per cent funded, representing a deficit of £51 million. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit over a five year period are being made from January 2010 of £14.1 million per annum for the first two years and £9.3 million per annum for the subsequent three years.
The valuation basis under IAS 19 for the Group financial statements differs markedly from the full triennial actuarial valuation basis. For PSPS, the terms of the trust deed restrict shareholders’ access to any underlying surplus in the scheme.
As at 31 December 2009, on the Group IFRS statement of financial position, the shareholders’ share of the liabilities for these UK schemes amounted to a £92 million liability net of related tax relief. The total share attributable to the PAC with-profits fund amounted to a liability of £110 million net of related tax relief.
Financial instruments The Group is exposed to financial risk through our financial assets, financial liabilities, and policyholder liabilities. The key financial risk factors that affect us include market risk, credit risk and liquidity risk. Information on our Group’s exposure to financial risk factors, and our financial risk management objectives and policies, is provided both in our Risk and Capital Management section of the Business Review and the financial statements.
Jackson surplus notes (Lower Tier 2) 154 4 158 173 (19) 154
Risk oversight Group risk appetite We define and monitor aggregate risk limits for our earnings volatility and our capital requirements based on financial and non-financial stresses: a Earnings volatility: the objectives of the limits are to ensure that (a) the volatility of our earnings is consistent with our stakeholders’ expectations, (b) the Group has adequate earnings (and cash flows) to service debt, expected dividends and to withstand unexpected shocks, and (c) earnings (and cash flows) are managed properly across geographies and are consistent with our funding strategies. The two measures we apply to monitor the volatility of our earnings are European Embedded Value (EEV) operating profit and International Financial Reporting Standards (IFRS) operating profit, although EEV and IFRS total profits are also considered.
Local limits are agreed with each of the business units to ensure that the aggregate risk exposure remains within the defined Group-level risk appetite. Each business unit determines its own individual risk position by calculating the impacts (on earnings and capital measures) of a shock to its market, credit, insurance and operational risk exposures and agrees them with Group Risk and the Group Executive Risk Committee (GERC).
We use a two-tier approach to apply the limits at business unit level. Firstly, we calculate business unit risk limits. These ensure that, provided each business unit keeps within its limits, the Group risk position will remain within the Group limits. Secondly, the impact on the risk position is considered as part of Group Risk’s scrutiny of large transactions or departures from plans proposed by individual business units.
1 Financial risks a Market risk i Equity risk In the UK business, most of our equity exposure is incurred in the with-profits fund which includes a large inherited estate estimated at £6.4 billion as at 31 December 2009 (2008: £5.4 billion), which can absorb market fluctuations and protect the fund’s solvency. The inherited estate itself is partially protected against falls in equity markets through an active hedging policy. In the course of 2009 we have reduced the with-profit fund’s exposure to UK equities whilst increasing the proportion of fixed income assets.
In the US, where we are a leading provider of variable annuities, there are well-understood risks associated with the guarantees embedded in our products. We provide guarantees for minimum death benefits (GMDB) on all policies in this class, minimum withdrawal benefits (GMWB) on 47 per cent of the book, and minimum income benefits (GMIB) on only eight per cent. To protect the shareholders against the volatility induced by these embedded options, we use both a comprehensive hedging programme and reinsurance. Due to the inability to economically reinsure or hedge the GMIB, Jackson ceased offering this benefit in 2009.
In the US there is interest rate risk across the portfolio. We manage fixed annuity interest rate exposure through a combination of interest rate swaps and interest rate options, to protect capital against rates rising quickly, and through the contractual ability to reset crediting rates annually.
Category Risk type Definition 1 Financial a) Market risk The risk that arises from adverse changes in the value of, or income from, assets and risks changes in interest rates or exchange rates.
b) Credit risk The risk of loss if another party fails to meet its obligations, or fails to do so in a timely fashion.
d) Liquidity risk The risk that a business, though solvent on a balance sheet basis, either does not have the financial resources to meet its obligations as they fall due or can secure them only at excessive cost.
On a statutory (Pillar 1) basis we have held prudent credit reserves within the UK shareholder annuity funds of £1.6 billion to allow for future credit risk. For Prudential Retirement Income Limited (PRIL) this allowance is set at 71bps at 31 December 2009 (2008: 80bps). This now represents 41 per cent of the portfolio spread over swaps compared to 31 per cent as at 30 June 2009 and 25 per cent as at 31 December 2008. A low level of new defaults (£11 million) were reported on the debt portfolio held by the UK shareholder backed annuity business in 2009.
Within the RMBS portfolio of £3.3 billion, the agency guaranteed portion is 60 per cent. Another 21 per cent of the portfolio is non-agency prime and Alt-A investments with pre-2006/2007 vintages, where experience has been much more positive than later vintages. Our exposure to the 2006/2007 vintages totals £466 million of which £373 million is invested in the senior part of the capital structure, thereby significantly reducing the risk of defaults and the magnitude of loss if a shortfall does occur. The actual exposure to non-senior 2006/2007 Prime and Alt-A RMBS is only £93 million. The total RMBS portfolio has an average fair value price of 78 cents in the dollar.
In Jackson total amounts charged to profits relating to debt securities was £631 million (2008: £624 million). This is net of recoveries/reversals recognised in the year of £5 million (2008: £3 million).
In 2009, Jackson’s total defaults were less than £1 million (2008: £78 million). In addition, as part of our active management of the book, we incurred net losses of £6 million (2008: £130 million) on the sale of impaired bonds.
IFRS write-downs excluding defaults for the year were £630 million compared to £419 million in 2008. Of this amount £509 million (2008: £167 million) was in respect of RMBS securities.
The impairment process reflects a rigorous review of every single bond and security in our portfolio. The accounting requires us to book full mark-to-market losses on impaired securities through our income statement. However we would expect only a proportion of these losses eventually to turn into defaults, and some of the impaired securities to recover in price over time.
In considering potential future losses for Jackson, it is essential to examine the key components of the debt portfolio. As at 31 December 2009, 93 per cent of Jackson’s total debt portfolio of £22.8 billion consisted of investment grade securities and seven per cent were non-investment grade.
Asset management The debt portfolio of the Group’s asset management operations of £1.2 billion principally comprises £1.1 billion related to Prudential Capital operations. Of this amount, debt securities of £1.1 billion were rated AAA to A- by S&P or Aaa by Moody’s.
Loans Of the total Group loans of £8.8 billion at 31 December 2009, £6.9 billion are held by shareholder-backed operations comprising of £4.5 billion commercial mortgage loans and £2.4 billion of other loans.
Of this total held by shareholder-backed operations, the Asian insurance operations held £0.4 billion of other loans, the majority of which are commercial loans held by the Malaysian operation that are investment graded by two local rating agencies. The US insurance operations held £4.3 billion of loans, comprising £3.8 billion of commercial mortgage loans, all of which are collateralised by properties, and £0.5 billion of policy loans. The US commercial mortgage loan portfolio does not include any single-family residential mortgage loans and therefore is not exposed to the risk of defaults associated with residential sub-prime mortgage loans. The UK insurance operations held £0.8 billion of loans, the majority of which are mortgage loans collateralised by properties.
Unrealised credit losses in the US Jackson’s net unrealised position moved from a loss of £2,897 million at 31 December 2008 to a net gain of £4 million at 31 December 2009 as the markets rebounded from the historically wide spreads at the end of 2008. The gross unrealised loss position moved from £3,178 million at 31 December 2008 to £966 million at 31 December 2009. Gross unrealised losses on securities priced at less than 80 per cent of face value totalled £594 million at 31 December 2009 compared to £1.9 billion at 31 December 2008.
We use the qualitative and quantitative analysis of operational risk exposures material to the Group to support business decisions, to inform overall levels of capital held and to assess the adequacy of the corporate insurance programme.
Capital management Regulatory capital (IGD) Prudential is subject to the capital adequacy requirements of the European Union (EU) Insurance Groups Directive (IGD) as implemented by the Financial Services Authority (FSA) in the UK. The IGD capital adequacy requirements involves aggregating surplus capital held in our regulated subsidiaries, from which Group borrowings, except those subordinated debt issues that qualify as capital, are deducted. No credit for the benefit of diversification is permitted under this approach.
Our capital position has been further strengthened during 2009, driven by our prudent but proactive risk management. Our IGD capital surplus is estimated at £3.4 billion at 31 December 2009 (before allowing for the 2009 final dividend) giving an estimated solvency ratio of 270 per cent. This compares to a surplus at 31 December 2008 (before allowing for the 2008 final dividend) of £1.5 billion and a solvency ratio of 152 per cent. The positive movement of £1.9 billion during 2009 mainly comprises: • Net capital generation mainly through operating earnings (in-force releases less investment in new business) of £1.1 billion
• The impact of the sale of our agency distribution business in Taiwan of £0.8 billion
• Hybrid debt issues in May and July 2009, totalling £0.9 billion • Additional recognition of £0.4 billion of surplus in respect of part of the shareholders’ interest in the future transfers from the PAC with-profit fund, recognition of £0.2 billion of future profits in the UK and Hong Kong and other intra-group capital efficiencies of £0.3 billion.
Offset by: • Final 2008 dividends, net of scrip, of £0.2 billion and interim 2009 dividends, net of scrip, of £0.1 billion
• External financing costs and other central costs of £0.6 billion • Credit related impairments and default losses in the US of £0.4 billion • Impacts arising from regulatory changes of £0.2 billion • Foreign exchange movements of £0.3 billion.
We have strengthened our IGD capital position in challenging markets. We continue to have further options available to us to manage available and required capital. These could take the form of either increasing available capital (for example, through financial reinsurance or debt issuance) or reducing required capital (for example, through the level and the mix of new business, notably by maintaining pricing discipline and through the use of other risk mitigation strategies such as hedging and reinsurance).
In addition to this strong capital position, the total credit reserve for the UK shareholder annuity funds, which protects our capital position in excess of the IGD surplus, has been strengthened to £1.6 billion (from £1.5 billion at 30 September 2009). This reserve is equivalent to 71 bps per annum over the lifetime of the assets.
During the severe equity market conditions experienced in the first quarter of 2009 the Group entered into exceptional overlay short-dated hedging contracts to protect against potential tailevents on the IGD capital position, in addition to the regular operational hedging programmes. The hedge contracts have expired and have not been renewed.
• A 40 per cent fall in equity markets (comprising an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four week period) would reduce the IGD surplus by £500 million.
We believe that the results of these stress tests, together with our Group’s strong underlying earnings capacity, our established hedging programmes and our additional areas of financial flexibility, demonstrate that we are in a position to withstand possible significant further deterioration in market conditions.
Many of the issues being actively debated have received considerable focus both within the industry and from national bodies. However, the application of Solvency II to international groups is still unclear and there remains a risk of inconsistent application, which may place Prudential at a competitive disadvantage to other European and non-European financial services groups. There is also a risk that the effect of the measures finally adopted could be adverse for the Group including potentially a significant increase in the capital required to support the UK annuity business.
Having assessed the high-level requirements of Solvency II, an implementation programme was initiated with dedicated teams to manage the required work across the Group. The activity of the local Solvency II teams is being coordinated by Group Head Office to achieve consistency in the understanding and application of the requirements.
Risk mitigation and hedging We manage our actual risk profile against our tolerance of risk. To do this, we maintain risk registers that include details of the risks we have identified and of the controls and mitigating actions we employ in managing them. Any mitigation strategies involving large transactions – such as a material derivative transaction – are subject to review at Group level before implementation.
Asia is home to 60 per cent of the world’s population and, given its impressive economic transformation over the last few years, the region now has an increasingly significant role in the global economy. This is translating into the rapid emergence of an increasingly urbanised and wealthy mass affluent sector that generates outstanding growth potential in retail financial services as people look to protect their financial well being and manage their savings in more sophisticated and efficient ways.
The concept that Asian economies are decoupling from Western economies is a point for continued debate, but external indicators suggest that Asia is recovering more quickly from the recent global financial crisis. Sound fundamentals coupled with aggressive stimuli have enabled most Asian economies to outperform the developed Western markets over the course of 2009. So long as inflation remains under control, we expect the Asian central banks are likely to resist currency appreciation and maintain low interest rates. We anticipate that capital flows into Asia should increase as Asia’s GDP growth continues to outpace the rest of the world.
Market overview Asia’s life insurance industry saw a sharp decline in new business premiums during the first half of 2009 with investment linked and single premium products particularly impacted. However, balance sheets have generally remained robust and there have been no significant failures of insurance companies in the region.
The region’s life insurance regulators are generally inherently conservative and have watched the collapse of purportedly sophisticated Western models of risk and capital management in the banking sector with interest. They are under pressure to ensure these ‘mis-steps’ are not replicated in their markets and so although regulators have been raising standards for quality of sales advice, product transparency and service for several years, this emphasis has generally increased post-crisis. Prudential views any measures taken to improve standards and enhance the reputation of the industry positively as we believe we already manage our businesses to a market-leading standard.
Prudential is one of the pioneers in partnership distribution in Asia. Our unique model includes locating Prudential employed and managed sales people, known as Financial Service Consultants (FSC), in key branches of our bank distribution partners. Despite challenging market conditions, FSC sales for 2009 totalled £181 million, representing an increase of 26 per cent over 2008. Prudential has distribution relationships with over 75 institutions across Asia including Standard Chartered Bank, E.Sun Bank and our joint venture partners ICICI in India and CITIC in China. On 6 January 2010 we announced an important distribution agreement with UOB Group covering Singapore, Indonesia and Thailand.
Our focus on health and protection products has been particularly successful in a number of respects. Health and protection products are important for the customers who buy them and the distributors who sell them. The proportion of health and protection products in our total APE mix increased to 29 per cent in 2009, up from 24 per cent in 2008. Higher average new business margins for health business translated into solid returns for shareholders, and health products accounted for over 50 per cent of the total new business profit generated in 2009. Prudential was honoured as Asia Pacific’s Health Insurer of Year in 2009 by Frost and Sullivan.
Health and protection products are important for the customers who buy them and the distributors who sell them.
Prudential currently insures over 10 million life insurance customers in Asia. While we continue to focus aggressively on the acquisition of new customers given the generally low penetration rates, we are equally focused on strengthening and deepening our relationships with our existing customers. We are developing advanced data mining and profiling capabilities which provide us with a better understanding of which customers need which products and when. Around 40 per cent of new business came from existing customers in 2009 (excluding India), up from 25 per cent in 2008. Our customer retention rate was 90 per cent in 2009, a one per cent improvement over 2008.
We have maintained strict pricing and value disciplines and have not succumbed to the temptation to drive sales results with low margin products. New business market share statistics for full year 2009 are not yet available but based on our estimates and market intelligence we expect to have retained our top three positions in seven out of our 11 life markets.
As reported at the interims, during the first half of 2009 we did see a deterioration of persistency, principally in Korea, and we reported adverse assumption changes and experience variances to reflect this. During the second half of 2009, the situation has improved as a result of management actions and an improvement in market conditions. During the second half only an additional £47 million of assumption changes and experience variances relating to persistency were incurred, resulting in a full year charge of £154 million. Overall assumption changes and experience variances for 2009 netted out at a charge of £97 million, representing an improvement from the charge of £124 million reported at the half year. Given the scale of the EV shareholder funds of the long-term business at £5.8 billion, these experience variances and assumption changes remain small. The contribution to in-force earnings arising from the unwind of the discount rate and other operating investment returns amounted to £489 million, up 20 per cent on prior year, reflecting the growing scale of the business.
Prudential Asia Life reported record IFRS profits of £416 million for 2009, an increase of 62 per cent over 2008.
New business strain on the IFRS basis is 6.2 per cent of APE compared to 8.0 per cent reported in 2008. The main driver is change in country mix with lower proportions of new business from India and Korea. IFRS profits from the in-force book of £494 million are 22 per cent ahead of 2008 excluding the impact of the reserve release in Malaysia.
Following a slow start to 2009, given the impacts of the market turbulence on customer confidence in India, ICICI-Prudential has seen an encouraging resurgence in new business volumes during the fourth quarter. Prudential’s fourth quarter new business volumes of £52 million (reflecting our 26 per cent ownership) is up 30 per cent on the third quarter. Agency recruitment has slowed as our branch expansion programme has now been successfully completed. The proportion of business derived from bank distribution continues to increase and now stands at 30 per cent for 2009 compared to 25 per cent for 2008. The operation remains India’s leading private sector life insurer.
Growth in Indonesia remains on track with the fourth quarter of £64 million of new business volumes up 49 per cent on the third quarter of 2009 and up 36 per cent on the equivalent quarter of last year. Full year new business in Indonesia of £190 million represented an increase of 8 per cent on 2008. Agency manpower continues to be the main driver of growth with over 20,000 new agents added during the year. Takaful linked products remain a significant contributor at 25 per cent of the new business mix. Prudential is the market leader in Indonesia in the life insurance industry.
Singapore also had a very strong finish to 2009 closing the year with new business volumes up 14 per cent at £128 million. Fourth quarter new business sales of £48 million were up 66 per cent on the third quarter and 85 per cent higher than the equivalent quarter of last year. Improved sentiment, plus increases in agency productivity and new non-participating products drove this very strong result. We anticipate holding our market leading position in Singapore.
The scale and reach of our Asia franchise is unparalleled, with top three market share positions in seven fast-growing markets.
The United States is the world’s largest retirement savings market, and is continuing to grow rapidly. As 78 million baby boomers1 reach retirement age, their retirement assets will shift from asset accumulation to income distribution. There are already US$2 trillion of assets generating retirement income in the US – and this amount is forecast to rise to some US$7 trillion by 2029.2
Prudential’s US business, Jackson, benefited significantly from this flight to quality in the US annuity market. Our strategy continues to target increasing volumes in variable annuities in line with the goal of capital preservation. As Jackson focused on optimising the balance between new business profits and capital consumption, no institutional sales were made during the full year of 2009.
Notes 1 Source: US Census Bureau 2 Source: Tiburon Strategic Advisers, LLC
Initiatives in 2009 Distribution The success in the marketplace of Prudential’s US business, Jackson, continues to be driven by our industry-leading distribution organisation and product innovation, coupled with our sound evaluation of product economics. Our long-term goals for Jackson include the continued and profitable expansion of our share of the US annuities and retail asset management markets, which we plan to achieve by building on our advantaged position in the advice-based distribution channels. Ongoing profitable growth in Jackson’s share of the US annuities market largely depends on the continued enhancement and expansion of our existing product offering, increased penetration of existing distribution channels and entry into new distribution channels, as well as opportunistic inorganic growth.
The success in the marketplace of Prudential’s US business, Jackson, continues to be driven by our industry-leading distribution organisation and product innovation, coupled with our sound evaluation of product economics.
The annuity industry is consolidating to the strongest players, and this consolidation has contributed to a substantial increase in Jackson’s distribution relationships. We have experienced a large influx of new advisers this year, increasing our licensed agent and registered representative count by more than 30,000 to 117,453, which has driven significant increases in market share for Jackson, particularly in variable annuities. Jackson signed a distribution agreement with Merrill Lynch, which began selling Jackson products in late 2009.
Many baby boomers are increasingly seeking advice to help them recover the losses suffered during the crisis. With strong growth in our distribution relationships in advice-based channels, Jackson is well positioned to benefit from this trend.
During 2009, Jackson maintained its track record of continued product innovation by enhancing our variable annuity product line by offering a bonus variable annuity and six new portfolio investment options. We also continued to modify our Guaranteed Minimum Withdrawal Benefits (GMWBs).
Customer service The significant increase in new business in 2009, following the difficult market conditions in 2008, resulted in higher call volume to our service centres. Despite this increased workload, we continued to demonstrate the ability to service investors’ and advisers’ needs accurately and efficiently, by once again earning recognition as a World Class service provider in the Service Quality Measurement Group’s (SQM) latest benchmarking study of North American service centres. Historically, only 5 per cent of service centres receive World Class designation, but 2009 marked the fifth year that Jackson has achieved World Class status. We also earned SQM’s ‘Highest Customer Satisfaction by Industry’ award for having the highest rate of customer satisfaction in the financial services industry. During 2009, Jackson created a series of educational presentations and materials designed to address the concerns that advisers were facing in such a challenging economic environment. In Financial Research Corporation’s 2009 Advisor Insight study, Jackson ranked number one in overall adviser satisfaction with marketing effectiveness.
Total EEV basis operating profit* 1,233 586 110 693 78 *Based on longer-term investment returns and excludes broker-dealer, fund management and Curian
Business unit review > Insurance operations > United States > continued
Jackson ranked 4th in total annuity sales with a market share of 5.3 per cent in the first nine months of 2009, up from 11th and a market share of 4.0 per cent for 20083.
Industry FIA sales have increased due to higher customer demand for products which offer guaranteed rates of return with additional upside potential linked to stock market index performance. Additionally, Jackson’s FIA sales have benefited from the company’s consistent financial strength ratings and further disruptions among some of the top FIA sellers. Jackson ranked fifth in sales of FIAs during the first three quarters of 2009, with a market share of 7.1 per cent, up from 9th with a market share of 3.5 per cent at the end of 20085.
Total retail annuity net flows of £5.0 billion for 2009 represent a 115 per cent increase on the same period in 2008 at actual exchange rates, reflecting the impacts of record sales and continued low levels of surrender activity.
The variable annuity new business margin increased from 43 per cent in 2008 to 81 per cent in 2009, arising from updated assumptions, revised benefits and higher take-up rates on the higher margin guaranteed withdrawal benefits.
Total EEV basis operating profit for the long-term business in 2009 was £1,233 million, compared to £586 million in 2008.
IFRS operating profit for the long-term business was £459 million in 2009, up 13 per cent over the £406 million in 2008. The expected charge from the negative accounting effect of rising equity markets and interest rates on derivative instruments supporting Jackson’s variable annuity business has been more than offset by the absence of the accelerated DAC amortisation experienced in 2008 and the effect of movements in exchange rates. Since Jackson hedges the economics of the product rather than the accounting result, there will naturally be some volatility in the reported results due to equity market and interest rate movements. As evidence of the effectiveness of Jackson’s hedging programme, over the cumulative 24 month period of 2008 and 2009, which included a historic decline and partial recovery of equity markets as well as significant interest rate movements, Jackson’s variable annuity guaranteed benefits and related hedges resulted in a net operating loss of £7 million.
Gross unrealised losses moved from £3,178 million at 31 December 2008 to £966 million at 31 December 2009 as the markets rebounded from the historically wide spreads at the end of 2008. The net unrealised position moved from an unrealised loss of £2,897 million at 31 December 2008 to a net unrealised gain of £4 million at 31 December 2009.
Our outstanding performance in the US is driven by our success in meeting the needs of the babyboomer generation – the 78 million Americans now approaching retirement and looking to turn their retirement savings into income.
During 2009, a period of unprecedented financial turmoil, savers began to seek greater certainty. Jackson was quick to respond through offering a comprehensive product portfolio that could be customised to meet the needs of individual customers.
As a result, Jackson moved from eleventh in total annuity sales to become a top-five provider, while simultaneously achieving a dramatic increase in margins.
Prudential UK continues to focus on realising value from the opportunities created by the increasing need for retirement solutions. Prudential UK competes in selected areas of the UK’s retirement savings and income markets where it believes that it can generate attractive returns from capital employed. In line with the Group’s strategy, the business continues to place great emphasis on the disciplined deployment of capital to seize opportunities that play to the core strengths of the business and this focus enabled us to deliver a strong relative performance in 2009.
Business unit review > Insurance operations > United Kingdom > continued
Prudential UK management concluded that this is not sustainable and that cash and capital can be deployed more effectively across other parts of the business. Prudential UK’s existing lifetime mortgage customers are unaffected by this decision.
EEV total operating profit based on longer-term investment returns of £921 million was down 15 per cent on 2008. This was mainly due to the £118 million benefit arising in 2008 from rebalancing the credit portfolio that supports the shareholderbacked annuity business compared with £22 million in 2009. The 2009 in-force operating result includes £588 million from the unwind of the discount rate on the value in-force business which is three per cent higher than 2008.
Prudential UK continues to manage actively the retention of the in-force book. During 2009, the experience at an aggregate level has been in line with long-term assumptions.
Prudential UK writes with-profits annuity, with-profits bond and with-profits corporate pensions business in its life fund, with other products backed by shareholder capital. The weighted average post-tax IRR on the shareholder capital allocated to new business growth in the UK was in excess of 15 per cent. The average free surplus undiscounted payback period for shareholder-backed business written in 2009 was five years.
The Group’s asset management businesses operate different models and under different brands tailored to their markets and strengths. However, they continue to work together by managing money for each other with clear regional specialism, distributing each others’ products and sharing knowledge and expertise, such as credit research.
Each business and its performance in 2009 is summarised on the following pages.
M&G’s asset management business M&G is an investment-led business which aims to deliver superior long-term performance for third-party clients and the internal funds of the Prudential Group.
Our strategy is to recruit and nurture leading investment talent. We seek to create an environment in which this talent will thrive and so deliver the level of returns that our clients expect of us.
As at 31 December 2009, M&G’s total funds under management were £174 billion, including £70 billion of assets managed on behalf of third-party retail and institutional clients.
In the retail market, we aim to offer high-performing funds which are managed from our London headquarters and distributed in the UK and across Europe, mainly through intermediaries. The diversity of our retail product range proved its worth in the recent market turmoil, as investors bought both our equity and fixed income funds.
In the institutional market, we provide third-party clients such as pension funds with a range of traditional and specialist investment strategies, some of which have originally been developed for the Prudential internal funds.
M&G had an exceptional year in 2009, delivering record net fund inflows of £13.5 billion.
Gross fund inflows rose 54 per cent to £24.9 billion. These record inflows and the recovery of equity markets in the latter half of 2009 led to a 23 per cent increase in M&G’s funds under management to a total of £174 billion. As at 31 December 2009, 40 per cent of M&G’s funds under management were for third-party clients.
The UK Retail Business had an especially good year, with net inflows rising by 216 per cent to £6.0 billion from £1.9 billion in 2008. This compared with total UK retail net sales of £25.8 billion for the year (source, IMA, 12 months to end of 2009).
Similarly, the Institutional Business attracted an exceptionally high level of net new business. Net inflows were £6.0 billion, a rise of 354 per cent on 2008. They included the award of a single fixed income mandate valued at £4 billion and £0.8 billion of net new money into our leveraged loan funds. Gross fund sales were up 59 per cent at £11.3 billion.
Funds Under Management (FUM) (£ billion) 174 141 23 141 23
Prudential Capital has a diversified earnings base derived from its portfolio of secured loans, debt investments and the provision of wholesale markets services. The business delivered a good financial result in 2009, considering prevailing market conditions. As a result of sustained revenue and maintaining a low cost/income ratio, IFRS operating profits increased by five per cent to £61 million, resulting in a cash remittance to the Group holding company of £82 million.
In 2009, M&G attracted record net and gross fund inflows, at £13.5 billion and £24.9 billion respectively. This outstanding achievement was the result of excellent long-term investment performance combined with a deeply-trusted brand and a high standard of client communications.
Total funds under management for both internal and third-party clients reached £174 billion by the end of 2009. M&G’s goal is to deliver the level of investment performance its clients expect by nurturing and retaining some of the best talent in the fund management industry.
Introduction Prudential’s asset management business in Asia manages investments for Prudential UK and the Asian life companies and has also successfully leveraged these investment capabilities to build a market leading third-party funds management business.
Initiatives in 2009 Investment performance is one of the key drivers of success for Asia Asset Management. In 2009, 64 per cent of its funds outperformed their peer benchmarks or were ranked within the top-two performance quartiles among peers1.
Fund launches were curtailed during 2009 given the market conditions; however Asia Asset Management did successfully raise new funds in 2009 including £300 million (US$469 million) from a Qatar Fixed Maturity Plan Series in Dubai, £220 million (US$345 million) from an equity fund in China and £109 million (US$170 million) from a target return fund in India. A new innovation was the Brazil Fund, launched in Taiwan that raised £94 million (US$147 million).
Asia Asset Management has continued to build its retail distribution network across Asia. For example, in Japan, the business has successfully established distribution relationships with mega distributors.
Financial performance Asia Asset Management total funds under management as at 31 December 2009 is £42.4 billion and includes £4.2 billion of assets from the Group, £18.7 billion from Prudential Corporation Asia’s life funds and £19.5 billion from third-party customers. Compared to 2008, the overall FUM increased by 22 per cent (excluding the FUM related to the sold Taiwan agency business).
IFRS profit from fund management is £55 million, up six per cent on the prior year. Lower management fees were more than offset by stringent cost control. The asset management business requires very little capital to support its growth and in 2009 it remitted a net £33 million to the Group holding company.
PPM America (PPMA) manages assets for Prudential’s US, UK and Asian affiliates. PPMA also provides other affiliated and unaffiliated institutional clients with investment services including collateralised debt obligations (CDOs), private equity funds, institutional accounts, and mutual funds. PPMA’s strategy is focused on managing existing assets effectively, maximising the benefits gleaned from synergies with our international asset management affiliates, and leveraging investment management capabilities across the Prudential Group. PPMA also pursues third-party mandates on an opportunistic basis.
Financial performance IFRS operating profit in 2009 was £6 million, up from £2 million in 2008, primarily due to performance driven income.
National Planning Holdings (NPH) is Jackson’s affiliated independent broker-dealer network. The business comprises four broker-dealer firms, including National Planning Corporation, SII Investments, INVEST Financial Corporation and Investment Centers of America.
Financial performance NPH generated record revenues of £390 million during the year, up from £328 million in 2008, on gross 2009 product sales of £9 billion. NPH’s 2009 IFRS operating profit of £4 million declined from £8 million in 2008. NPH increased the number of registered advisers in the network by nearly 10 per cent to approximately 3,478 at the end of 2009.
In 2009, the new business profit mix in our Asian insurance business was derived 56 per cent (2008: 49 per cent) from health and protection products, 31 per cent (2008: 41 per cent) from unit-linked products and 13 per cent (2008: 10 per cent) from non-linked products.
Accident and health products provide mortality or morbidity benefits and include health, disablement, critical illness and accident cover. These products are commonly offered as supplements to main life policies, but can also be sold separately.
Unit-linked products tend to have higher profits on the EEV basis of reporting than traditional non-linked products, as expenses and charges are better matched and solvency capital requirements are lower. At the end of 2009, we were offering unit-linked products in 11 of the 12 countries in Asia in which we operate, with the only exception being Thailand.
United States Jackson’s product offerings include variable, fixed and fixed index annuities, as well as life insurance, and institutional products.
Annuities Annuity products are long-term individual retirement products, which offer tax-deferred accumulation on the funds invested until proceeds are withdrawn from the policy.
Periodically, interest is credited to the contract holder’s account and administrative charges are deducted. The interest rate may be reset on each contract anniversary, subject to a guaranteed minimum, in line with state regulations. When the annuity matures, the contract holder is paid either the amount in the contract holder account, or staggered payments in the form of an immediate annuity product – similar to a UK annuity in payment.
Fixed annuity policies are subject to early surrender charges for the first six to nine years of the contract. In addition, the contract may be subject to a market value adjustment at the time of surrender. During the surrender charge period, the contract holder may cancel the contract for the surrender value. Our profits on fixed annuities come primarily from the spread between the return earned on investments and the interest credited to the contract holder’s account (net of any surrender charges or market value adjustment) less expenses. Fixed annuities continue to be a profitable book of business, benefiting from favourable spread income in recent years. However, the continued low interest rate environment could have an impact on the fixed annuity portfolio as lower crediting rates could result in increased surrenders and lower sales as customers seek alternative investment opportunities. Alternatively, it is also the case that recent equity market volatility may have the effect of making customers more risk averse, and so they may view fixed annuities as an attractive alternative to variable annuities.
Variable annuities are tax-advantaged, deferred annuities where the rate of return depends upon the performance of the underlying portfolio, similar in principle to UK unit-linked products. They are also used for asset accumulation in retirement planning and to provide income in retirement. The contract holder can allocate the premiums between a variety of variable subaccounts with a choice of fund managers and/or guaranteed fixed-rate options. As with a unit-linked fund, the contract holder’s premiums allocated to the variable accounts are held separately from Jackson’s general account assets. The value of the portion of the separate account allocated to variable sub-accounts fluctuates with the underlying investments. Variable annuity policies are subject to early surrender charges for the first four to seven years of the contract. During the surrender charge period, the contract holder may cancel the contract for the surrender value. Jackson offers one variable annuity that has no surrender charges and also offers a choice of guaranteed benefit options within their variable annuity product portfolio, which customers can elect and pay for. These options include the guaranteed minimum death benefit (GMDB), which guarantees that, upon death of the annuitant, the contract holder or beneficiary receives a minimum value regardless of past market performance. These guaranteed death benefits might be expressed as the return of original premium, the highest past anniversary value of the contract, or as the original premium accumulated at a fixed rate of interest. In addition, there are three other types of guarantee: guaranteed minimum withdrawal benefits (GMWB), guaranteed minimum accumulation benefits (GMAB) and guaranteed minimum income benefits (GMIB). Due to the lack of availability to economically reinsure or hedge new issues of GMIB, Jackson discontinued offering it in 2009.
Life insurance Jackson also sells several types of life insurance including term life, universal life and variable universal life. Term life provides protection for a defined period of time and a benefit that is payable to a designated beneficiary upon the insured’s death. Universal life provides permanent individual life insurance for the life of the insured and includes a savings element. Variable universal life is a life insurance policy that combines death benefit protection and the important tax advantages of life insurance with the long-term growth potential of professionally managed investments. The Jackson life insurance book has also delivered consistent profitability, driven primarily by positive mortality and persistency experience.
Institutional products Jackson’s institutional products division markets institutional products such as traditional Guaranteed Investment Contracts (GICs), Funding Agreements and Medium Term Note (MTN) funding agreements. The institutional product offerings also include Jackson’s funding agreements issued to the Federal Home Loan Bank. Institutional products are distributed directly to investors, through investment banks, or through funding agreement brokers.
Mutual funds During 2007, Jackson launched a line of retail mutual funds as a complement to the broad product offering. Due to the significant disruption in the mutual fund market in the fourth quarter of 2008 and first quarter of 2009, Jackson determined that its line of retail mutual funds were subscale and, accordingly, exited this market and allocated the capital to the more profitable variable annuity market.
The primary with-profits sub-fund is part of The Prudential Assurance Company Limited (PAC)’s long-term fund. The return to shareholders on virtually all with-profits products is in the form of a statutory transfer to PAC shareholders’ funds. This is analogous to a dividend from PAC’s long-term fund, and is dependent upon the bonuses credited or declared on policies in that year. In this context, there are two types of bonuses – ‘regular’ and ‘final’. Regular bonuses are declared regularly, usually once a year, and are determined as a prudent proportion of the long-term expected future investment return on the underlying assets. Once credited, regular bonuses are guaranteed in accordance with the terms of the particular product. In contrast, ‘final’ bonuses are only guaranteed until the next bonus declaration, and are primarily determined on the actual smoothed investment return achieved over the life of the policy. Prudential’s with-profits policyholders currently receive 90 per cent of the distribution from the main with-profits sub-fund as bonus additions to their policies, while shareholders receive 10 per cent as a statutory transfer.
The profits from almost all of the new non-participating business accrue solely to shareholders. Such business is written in the non-profit sub-fund within PAC’s long-term fund, or in various shareholder-owned direct or indirect subsidiaries. The most significant of these is Prudential Retirement Income Limited (PRIL), which also writes all new immediate annuities arising from vesting deferred annuity policies in the with-profits sub-fund of PAC.
(ii) Asset management fees – represents profits driven by investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses.
(iii) Net expense margin – represents expenses charged to the profit and loss account (excluding those borne by the withprofits fund and those products where earnings are purely protection driven) including amounts relating to movements in deferred acquisition costs, net of any fees or premium loadings related to expenses. Jackson DAC amortisation (net of hedging effects), which is intended to be part of the expense margin, has been separately highlighted in the table below.
Long-term Non long-term Group business business total £m £m £m £m
Analysis of pre-tax IFRS profit by driver by long-term business unit 2009 £m
Description of EEV basis reporting Prudential’s results are prepared on two accounting bases – the supplementary EEV basis, and the IFRS basis for the financial statements. Over the life of any given product, the total profit recognised will be the same under either the IFRS or the EEV basis. However, the two methods recognise the emergence of that profit in different ways, with profits emerging earlier under the EEV basis than under IFRS. This section explains how EEV differs from IFRS and why it is used.
In broad terms, IFRS profits for long-term business reflect the aggregate of statutory transfers from UK-style with-profits funds and profit on a traditional accounting basis for other long-term business. By their nature, the products sold by the life insurance industry are long-term, as insurance companies commit to service these products for many years into the future. The profit on these insurance sales is generated over this long-term period. In our view, the result under IFRS does not properly reflect the inherent value of these future profits, as it focuses instead on the amounts accruing to shareholders in the current year.
In May 2004 the CFO Forum, representing the Chief Financial Officers of 19 European insurers, published the European Embedded Value Principles (expanded by the Additional Guidance of EEV Disclosures published in October 2005), that provide consistent definitions, a framework for setting actuarial assumptions, and a more explicit approach to the underlying methodology and disclosures. So for example: • The allowance for risk is explicit for EEV through: (i) an allowance for the cost of capital (at the higher of economic capital and the local statutory minimum) (ii) stochastic or other appropriate modelling of financial options and guarantees to ensure that an allowance for their cost is irrespective of their value at the balance sheet date, and (iii) an explicit allowance in the risk discount rate for financial and non-financial risks; • EEV specifically allows for the look-through into profits arising in shareholder service companies, most notably the profit arising in investment management companies from managing the insurance companies funds for covered business; • There are extensive disclosures required for EEV on all aspects of the calculations, including the methodology adopted and the analysis of return.
The assumptions used for the EEV basis of accounting are set out in the notes that accompany the supplementary EEV basis information. An indication of the sensitivity of the results to changes in key assumptions is also provided within that information.
Harvey McGrath, Chairman, Prudential plc is the Board sponsor for corporate responsibility (CR).
In 2009, financial institutions came under continued scrutiny as a result of the market turmoil. Insurance companies are, however, fundamentally different from banks because we invest in assets for the long-term. During the financial turmoil we played a significant role to help stabilise the market by providing liquidity during difficult times to the benefit of the whole economy.
Insurance companies have a unique role in society by helping people manage uncertainty and plan for a more secure future. In this way, our commercial value is linked to the social value of what we offer to our customers.
Fair and transparent products meeting customer needs Understanding and responding to our customers’ needs is at the heart of our business. It is something we have been doing for over
In the US, there are approximately 78 million people who will move from the workforce into retirement during the next decade. Jackson, our US business, is focused on understanding and meeting customers’ post-retirement needs. During 2009, a period of unprecedented financial turmoil, savers began to seek greater certainty. Jackson was quick to respond through making its variable annuity products more widely available. It also provided customers with the flexibility to select, and only pay for, those benefits that met their unique financial requirements. During 2009, Jackson also introduced a bespoke educational series for advisors to help them respond to customer concerns about the impact of the economic climate on their savings and income.
The UK is characterised by an ageing population. Low savings rates and high levels of consumer debt, coupled with an increasing shift in responsibility for providing retirement income away from government and employers towards individuals, have resulted in people being inadequately provided for during increasingly long periods of retirement. As a result, there is a growing need for financial advice and financial products, including guarantees and longevity protection.
At M&G, our UK and European asset manager, we believe in offering clients straightforward products together with clear and balanced information, helping them make the right investment decisions for their needs. At M&G, our strategy is to invest in companies and not just chase share prices. We are informed shareholders, not traders, which means taking a long-term approach to investment opportunities and, provided our investment case remains intact, maintaining our conviction in the companies we hold.
In response to the significant reduction in bank lending in 2009, M&G created the M&G UK Companies Financing Fund. This fund seeks to offer valuable finance to medium to large-sized (mid cap) companies and has attracted some £1.6 billion in commitments from clients.
A number of our customer-focused initiatives deliver wider benefits across other areas of our CR agenda. For example, in the US, Jackson’s customer e-delivery strategy – via its new website – is providing customers with information ‘on-demand’, while also helping to protect the environment by conserving resources and generating cost savings for our business.
In the US, we once again earned recognition as a World Class service provider in the latest benchmarking study of North American service centres by the Service Quality Measurements Group (SQM). This marked the fifth year that Jackson has achieved World Class status. Jackson also earned SQM’s ‘Highest Customer Satisfaction by Industry’ award for having the highest rate of customer satisfaction in the financial services industry.
Our businesses participate actively in industry efforts to serve customers better. In the UK, the Financial Services Authority (FSA) has established Treating Customers Fairly principles. In support of this, Prudential is a member of the Association of British Insurers’ (ABI) Customer Impact Scheme that seeks to drive continuous improvement through the monitoring of customers’ experiences. In 2009, Prudential UK saw an increase in the number of customers rating it ‘very good’ or ‘excellent’ for the time taken to arrange an annuity – from 45 per cent in 2008 to 62 per cent in 2009. Prudential UK also won two five-star awards at the Financial Adviser Service Awards as well as receiving the award for the best annuity provider at the Professional Adviser Awards 2010.
We always try to resolve any problems for our customers as quickly and smoothly as possible. In 2009, the Financial Ombudsman Service (FOS) in the UK first published its complaints data showing the number of cases upheld by FOS in favour of the consumer. Prudential was well above the industry norm, ranking 4th in the list of almost 150 financial services companies.
Diversity We are committed to integrating diversity into our business practices. Our policies are guided by the principles of the UN’s Universal Declaration of Human Rights and the International Labour Organisation’s core labour standards.
In addition, our businesses worldwide continued to drive initiatives in 2009, reflecting our commitment to diversity. For example, our Korean life insurance business, together with our Asian fund management operation, introduced employee training on aspects of our diversity policies. In the UK, M&G, our asset management business, runs annual workshops for all managers to support our diversity agenda. This includes ‘Respect in the Workplace’ and ‘The Employment Life Cycle’. Employees of our property investment management business, PRUPIM, participate in an on-line learning programme on age discrimination legislation.
In 2009, we also participated in the Financial Services Inquiry into the sex discrimination and gender pay gap report of the Equality and Human Rights Commission.
Building and rewarding performance We believe that employees should be rewarded according to the contribution they make to our business, as a whole. We reward our people based on both the results they achieve as well as their behaviours and competencies. Our remuneration policies are regularly reviewed to ensure that our reward structure keeps pace with the markets in which we operate, and that they remain relevant to the growth of our business.
Growing a strong talent pipeline We recognise that the talent and knowledge of our people is key to our continued success. In 2009, we implemented strategic resourcing programmes for country CEOs in Asia, and for the Finance function globally, to improve our medium and long-term talent pipeline.
Our flagship Momentum Programme, operating since 2007, aims to recruit high-potential individuals early in their careers and to provide them with a fast-track development plan. Through business placements and training modules, the candidates gain the management skills and experience required in international business. Momentum has a strong diversity focus and is open to people both within and outside of Prudential. In 2009 the Momentum website received more than 33,000 visits from 131 countries, and over 1,700 people from 49 countries applied. This is the highest number of applicants since the launch of the programme, and double the number of applications received in 2008. The 17 successful applicants increased the total number of participants in the programme to 37, who are in roles across all four of our businesses.
Developing an organisation that works We are committed to effective communication to support employee engagement and commitment. We conduct regular employee surveys in our businesses around the world to monitor our people’s level of engagement with Prudential as an employer, identify the effectiveness of our organisation’s structures and practices, and highlight areas for improvement.
At Group Head Office, a dedicated team provides regular communication to employees across the Group from the Group Leadership Team. This enables employees to understand the Group strategy, direction and performance.
Prudential participates in the Carbon Disclosure Project – an annual commitment to disclose information on carbon emissions and strategies for managing the risks posed by climate change.
Full details of our environmental policy can be found on our website at: www.prudential.co.uk/prudential-plc/cr/managementpolicies
Our corporate property team has identified a three-year Group-wide environmental strategy for all occupied buildings, with roll-out scheduled to commence in 2010.
Our property investment portfolio PRUPIM’s vision as a leading sustainable real estate manager is to deliver superior investment performance through integrating sustainability into its business culture, activities and decision making. It seeks not only to address its own impacts but also to influence the property sector through innovation and thoughtleadership.
PRUPIM was the first UK property company to achieve the International Environmental Management Standard ISO 14001 for the management of its real estate investment portfolio. In 2009, PRUPIM achieved ISO 14001 certification for an additional six managed investment properties and achieved PAS99 – the world’s first integrated management system which includes ISO 14001 – at 10 managed shopping centres, taking the total to 52 PRUPIM properties that have been accredited to date.
PRUPIM’s strategic approach and progress to date can be found in their sixth annual Sustainability Report published in 2009. For more details please visit www.PRUPIM.com
Employee volunteering Our approach to community investment is to support charitable organisations and appropriate NGOs, not just through funding, but with the experience and expertise of our employees. In 2009, approximately one in four employees volunteered in their community.
In 2006, we launched our flagship volunteering programme, The Chairman’s Award, supporting our global charity partners. This programme has gone from strength to strength and, in 2009, over 30 projects around the world were supported.
Each year, a shortlist of volunteering programmes is chosen by a judging panel and employees are asked to vote for the project they believe has made the greatest impact. All of the projects included in the Chairman’s Award receive a financial donation from the Group for each employee who signs up as a volunteer, and the top five short-listed projects receive additional funding.
Building financial capability We began developing our financial capability programme in the UK in 2001, and are continuing to see significant progress, both in the UK and, increasingly, internationally.
Prudential also partnered with the Chinese Ministry of Education, the Chinese Academy of Social Sciences (CASS) and the Chinese Insurance Regulatory Commission (CIRC) to develop and introduce an insurance education curriculum in schools across the country. This programme has reached over 5,000 students from 26 schools in seven provinces since its launch in 2007.
Donations In 2009 the Group spent £6.5 million in support of its community investment strategy. Direct donations to charitable organisations amounted to £5.6 million, of which approximately £2.7 million came from EU operations.
It is the Group’s policy not to make donations to political parties nor to incur political expenditure, within the meaning of those expressions as defined in the Political Parties, Elections and Referendums Act 2000. The Group did not make any such donations or incur any such expenditure in 2009.
Responsibility committee Below the Board, the Responsibility Committee comprises senior representatives from relevant Group functions and each of our core businesses. This committee is responsible for monitoring the Group’s CR activities and for raising issues that need to be addressed.
In the UK we strengthened this policy in 2009 by signing up to the Prompt Payment Code, launched in December 2008 by the UK Department for Business, Enterprise and Regulatory Reform. In 2009, our trade creditor days, based on the ratio of amounts which were owed to trade creditors at the year-end to the aggregate of the amounts invoiced by trade creditors during the year were 22 days.
Tidjane Thiam has been an executive director of Prudential since 25 March 2008. He was the Chief Financial Officer until 30 September 2009, and became Group Chief Executive with effect from 1 October 2009. Tidjane was previously Chief Executive Officer, Europe at Aviva, where he also held successively the positions of Group Strategy and Development Director and Managing Director, Aviva International. Tidjane spent the first part of his professional career with McKinsey & Company in Paris, London and New York, serving insurance companies and banks. He then spent a number of years in Africa where he was Chief Executive and then Chairman of the National Bureau for Technical Studies and Development in Côte d’Ivoire and a cabinet member as Secretary of Planning and Development. Tidjane returned to France to become a partner with McKinsey & Company as one of the leaders of their Financial Institutions practice before joining Aviva in 2002.
Nic Nicandrou has been an executive director of Prudential and Chief Financial Officer since 28 October 2009. Before joining Prudential, he worked at Aviva, where he held a number of senior finance roles, including Norwich Union Life Finance Director and Board Member, Aviva Group Financial Control Director, Aviva Group Financial Management and Reporting Director and CGNU Group Financial Reporting Director. Nic started his career at PriceWaterhouse Coopers, where he worked in both London and Paris.
Rob Devey has been an executive director of Prudential and Chief Executive, Prudential UK and Europe since 16 November 2009. Rob joined Prudential from Lloyds Banking Group where he worked from 2002 in a number of senior leadership roles across insurance and retail banking including Managing Director, Direct Channels UK Retail Banking, Managing Director of HBOS Financial Services and Managing Director of HBOS General Insurance. Prior to joining HBOS, Rob was a consultant with the Boston Consulting Group (BCG) in the UK, US and Europe, working in financial services.
Michael McLintock has been an executive director of Prudential since September 2000. He is also Chief Executive of M&G, a position he held at the time of M&G’s acquisition by Prudential in 1999. Michael joined M&G in 1992. He previously also served on the board of Close Brothers Group plc as a non-executive director (2001-2008). Since October 2008, he has been a Trustee of the Grosvenor Estate.
Barry Stowe has been an executive director of Prudential since November 2006, and Chief Executive, Prudential Corporation Asia since October 2006. He has also been a director of the Life Insurance Marketing Research Association (LIMRA) and the Life Office Management Association (LOMA) since October 2008, and a member of the Board of Visitors of Lipscomb University since May 2009. Previously, Barry was President, Accident & Health Worldwide for AIG Life Companies. He joined AIG in 1995, and prior to that was President and CEO of Nisus, a subsidiary of Pan-American Life, from 1992-1995. Before joining Nisus, Barry spent 12 years at Willis Corroon in the US.
Keki Dadiseth has been an independent non-executive director of Prudential since April 2005. During 2006, he was appointed as a nonexecutive director of ICICI Prudential Life Assurance Company Limited and ICICI Prudential Trust Limited. Keki is also a director of Britannia Industries Limited, Piramal Healthcare Limited, Siemens Limited, The Indian Hotels Company Limited and Godrej Properties Limited, all of which are quoted on the Bombay Stock Exchange. In addition, he acts as advisor to Goldman Sachs, Fleishman-Hillard Inc and Oliver Wyman Limited, and as a trustee for a number of Indian charities. Keki is the non-executive Chairman of Omnicom India Marketing Advisory Services Private Limited, an unquoted Indian company, and is also a board member of various other unquoted Indian companies, including his recent appointment as Chairman of Sony India Pvt Ltd and Senior Advisor to Sony Group in India.
Michael Garrett Independent non-executive director and member of the Remuneration Committee
Ann is also a non-executive director of Rio Tinto plc, Rio Tinto Limited, UBS AG, Ariel Holdings Limited, Atrium Underwriting Group Limited and Atrium Underwriters Limited. In 2008 and until January 2009, Ann was Chief Financial Officer and an executive director of Northern Rock.
Bridget Macaskill has been an independent non-executive director of Prudential since September 2003. Bridget rejoined the Board of Prudential having previously resigned due to a potential conflict of interest in 2001. She has been a member of the Remuneration Committee since 2003 and became its Chairman in May 2006.
Bridget joined First Eagle Investment Management, LLC, (formerly Arnhold and S. Bleichroeder Advisers, LLC), a US based investment management firm, as President and Chief Operating Officer in February 2009. She is a trustee of the TIAA-CREF funds and was previously also a non-executive director of the Federal National Mortgage Association – Fannie Mae (2005-2008), Scottish & Newcastle PLC (2004-2008) and J Sainsbury Plc (2002-2006). Prior to that, she spent 18 years at OppenheimerFunds Inc, a major New York based investment management company, the final 10 years of which she was Chief Executive Officer.
Kathleen O’Donovan ACA Independent non-executive director and member of the Audit Committee
Previously, Kathleen was a non-executive director and Chairman of the Audit Committees of Great Portland Estates PLC, EMI Group plc and the Court of the Bank of England, and a non-executive director of O
From 1991 to 2002, Kathleen was Chief Financial Officer of BTR and Invensys, and prior to that she was a partner at Ernst & Young.
James Ross has been an independent non-executive director of Prudential since May 2004 and the Senior Independent Director since May 2006. He is also a non-executive director of Schneider Electric in France, and Chairman of the Leadership Foundation for Higher Education and of the Liverpool School of Tropical Medicine. James was previously a nonexecutive director of McGraw-Hill and Datacard Inc in the United States, and prior to that, Chairman of National Grid plc and Littlewoods plc. He was also Chief Executive of Cable and Wireless plc and Chairman and Chief Executive of BP America Inc., and a Managing Director of the British Petroleum Company plc.
Lord Turnbull KCB CVO Independent non-executive director and member of the Audit Committee
As a UK company listed on the Main Market of the London Stock Exchange, Prudential is subject to the governance rules set out in the Combined Code on Corporate Governance (the Combined Code). The Board has approved a governance framework which maps out the internal approvals processes and those matters which may be delegated. These principally relate to the operational management of the Group’s businesses and include pre-determined authority limits delegated by the Board to the Group Chief Executive for further delegation by him in respect of matters which are necessary for the effective day-to-day running and management of the business. The chief executive of each business unit has authority for the management of that business unit and has established a management board comprising its most senior executives.
The Board has overall responsibility for the system of internal control and risk management and for reviewing its effectiveness. The framework setting out the Group’s approach to internal control, risk management and corporate responsibility comprises the following: • Group governance framework: Documents the Group’s internal control policies and processes in an online manual, including the Group’s risk framework, code of business conduct and detailed policies on key operational and financial risks. Business units are also required to follow any additional processes necessary to comply with local statutory and regulatory requirements.
• Group risk framework: Provides an overview of the Groupwide philosophy and approach to risk management, and sets out the key risk management processes which support the Group’s compliance with internal, statutory and regulatory requirements.
Corporate governance and the role of the Board Combined Code compliance The corporate governance rules applicable to all UK companies admitted to the Official List of the UK Listing Authority are set out in the Combined Code, published by the Financial Reporting Council, the latest version of which can be viewed at www.frc.org.uk/corporate/combinedcode.cfm
The principles of the Combined Code have been applied as set out below and in the Directors’ Remuneration Report.
Board composition, appointments and election/re-election As at 31 December 2009, the Board comprised the Chairman, six executive directors and seven independent non-executive directors. The biographies of all current directors are set out on pages 77 and 78.
Non-executive directors are typically expected to serve for two terms of three years from their initial election by shareholders, although the Board may invite them to serve for an additional period. Both Bridget Macaskill and Kathleen O’Donovan have been invited to serve another three-year term, having served for six years as non-executive directors since their initial election by shareholders.
The Board is actively engaged in succession planning for both executive and non-executive roles to ensure that Board composition is periodically renewed, and that the Board retains its effectiveness at all times. This is delivered through an established review process that is applied across all businesses and covers both director and senior management succession and development, and through the work of the Nomination Committee, as described more fully on page 87. The Board considers the outcome of the review annually and actions arising from the review are implemented as part of the management development agenda. We believe that our non-executive directors bring a wide range of business, financial and international experience to the Board and its committees. Our executive directors, who head up the main businesses of the Group, each bring an in-depth understanding to the Board of their particular business, its markets and its challenges, ensuring coverage of the breadth and depth of the Group’s principal activities.
Board and committee meetings and attendance During 2009, the Board met nine times and held one separate strategy event. A detailed forward agenda has been in operation for a number of years, which is kept updated to reflect not only scheduled regular items of business but also any topical matters arising during the year. Each year, at least one of the Board meetings is held at one of the Group’s business operations to facilitate a fuller understanding of that business. In June 2009, a Board meeting was held in Chicago, where the Board met with senior members of the US management team and attended a series of presentations on the US business. In November 2009, a Board meeting was held in Kuala Lumpur where the directors met senior members of the Asian management team and received presentations on the Asian business.
The table below details the number of Board and Committee meetings attended by each director throughout the year. Where directors were not able to attend a meeting, their views were canvassed by the Chairman prior to the meeting. A further nine ad hoc Board Committee meetings took place during the year, which had been convened to finalise arrangements for matters discussed by the Board, such as final approvals of periodic financial reports, or finalising corporate transactions.
Executive directors Tidjane Thiam (Group Chief Executive) 9 (9) – – –
4 Ceased to be a director with effect from 30 September 2009. 5 Ceased to be a director with effect from 15 September 2009.
Board independence The Company follows the Combined Code when determining the independence of its non-executive directors, and in addition to that guidance Prudential is required to affirm annually the independence of its Audit Committee members under the United States Sarbanes-Oxley legislation. Where necessary, the Board ensures that appropriate processes are in place to manage any potential conflicts of interest.
In line with the provisions of the Combined Code, the Chairman in office during the year was independent on appointment. Throughout the year all non-executive directors were considered by the Board to be independent in character and judgement, and independent in accordance with the Combined Code.
Keki Dadiseth and Barry Stowe also serve as non-executive directors of ICICI Prudential Life Insurance Company Limited, an Indian company which is owned 26 per cent by Prudential, and in addition Keki serves at Prudential’s request as a non-executive director of ICICI Prudential Trust Limited, an Indian company which is owned 49 per cent by Prudential. The Board does not consider that these appointments in any way affect Keki’s status as an independent director of Prudential.
Other commitments and conflicts of interest Other commitments The Board was satisfied during 2009 that the Chairman’s other commitments did not interfere with the day-to-day performance of his duties for the Group, and that he had the commitment and capability to make himself available under unforeseen circumstances, should the need arise. The major commitments of the Chairman, including changes during the year where applicable, are detailed in his biography on page 77.
Directors may, from time to time, hold directorships or other significant interests with companies outside of the Prudential Group, which may have business relationships with the Group.
Non-executive directors may serve on a number of other boards, provided that they are able to demonstrate satisfactory time commitment to their role at Prudential, and that they discuss any new appointment with the Chairman prior to accepting. This ensures that they do not compromise their independence and that any potential conflicts of interest and any possible issues arising out of the time commitments required by the new role can be identified and addressed appropriately. The major commitments of our non-executive directors are detailed in their biographies set out on page 78.
In addition, the performance of the non-executive directors and the Group Chief Executive was evaluated by the Chairman in individual meetings. The non-executive directors, led by the Chairman, evaluated the performance of the executives, and, led by the Senior Independent Director, will evaluate the performance of the Chairman in March.
Internal and external support All directors have direct access to the services of the Company Secretary who advises them on all corporate governance matters, on Board procedures, and on compliance with applicable rules and regulations. In order to ensure good information flows, full Board and Committee papers are provided to the directors by the Company Secretary in the ordinary course approximately one week before each Board or Committee meeting.
The chief executive and chief financial officer of each business unit certified compliance with the Group’s governance, internal control and risk management requirements. The risk management function reviewed any matters identified by business units in their certification, and also assessed the risk and control issues that arose and were reported during the year. This included routine and exception-based risk reporting, matters identified and reported by other Group Head Office oversight functions, and the findings from the work of the internal audit function, who execute risk-based audit plans throughout the Group. The results were reported to and reviewed by the Group Audit Committee, the role of which is described on pages 84 to 87 and by the Board where appropriate.
Disclosure of information to auditor The directors who held office at the date of approval of this directors’ report confirm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditor is unaware; and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act 2006.
Board Committees The Board has established audit, remuneration and nomination committees as standing committees of the Board with written terms of reference, which are kept under regular review. Following recent reviews of the governance of UK companies, the Board intends to establish a separate risk committee responsible for monitoring and overseeing risk, which will become operational in 2010. These committees are key elements of the Group’s corporate governance framework, and reports on each committee currently in operation are included below: Audit Committee Report This report sets out the responsibilities of the Group Audit Committee (the Committee) and the activities carried out by the Committee during the year to meet its objectives.
Full biographical details of the members of the Committee, including their relevant experience are set out in their biographies on page 78.
In addition, the Committee received in-depth presentations on a range of topics.
Internal control and risk management The Committee reviewed the Group’s statement on internal control systems prior to its endorsement by the Board. It also reviewed the policies and processes for identifying, assessing and managing business risks. Throughout the year, the Committee received the minutes of the Disclosure Committee and the Group Operational Risk Committee and noted their activities. Further information on the Disclosure Committee and on risk governance appears on pages 89 and 90 to 91 respectively.
The Committee assesses the effectiveness of the internal audit function by means of regular reviews, some of them carried out by external advisers, and through ongoing dialogue with the Groupwide Internal Audit Director. External reviews of internal audit arrangements and standards were last conducted in 2006 and 2007 to ensure that the activities and resources of internal audit are most effectively organised to support the oversight responsibilities of the Committee. These reviews, performed by Deloitte, confirmed that the internal audit function complies with the Institute of Internal Auditors’ international standards for the professional practice of internal auditing and was operating effectively. An internal assessment of the internal audit function was performed by the Group-wide Internal Audit Director in 2008 and 2009, based on internal audit’s ongoing self-assessment processes and using a maturity model derived from the review criteria used by Deloitte. The assessment confirmed that the internal audit function conforms to the Institute of Internal Auditors’ international standards and continues to operate effectively in all areas of professional practice. The results of the assessment were reported in detail to the Committee in February 2010.
Auditor performance and independence As part of its work during 2009, the Committee assessed the performance of the external auditor, its independence and objectivity, and the effectiveness of the audit process. In addition to questioning the external auditor and the Chief Financial Officer, which is a regular feature of meetings, the review of the effectiveness of the external audit process was conducted through a questionnaire-based exercise administered by Group-wide Internal Audit, supplemented by interviews with senior finance staff and Committee members. The Committee reviewed the external audit strategy and received reports from the auditor on its own policies and procedures regarding independence and quality control, including an annual confirmation of its independence in line with industry standards.
Following its review of the external auditor’s effectiveness and independence, the Committee has recommended to the Board that KPMG Audit Plc be re-appointed as auditor of the Company, and a resolution for the re-appointment of KPMG Audit Plc as auditor of the Company to hold office until the end of the 2011 Annual General Meeting will be put to a shareholder vote at the Annual General Meeting on 19 May 2010.
Review of Committee effectiveness During the year, the Committee undertook an in-depth performance assessment in-house by way of a detailed questionnaire, administered by the Secretariat, addressing both compliance with various regulations and codes of conduct, and qualitative aspects of the Committee’s performance during the year. The results were discussed at a Committee meeting in December 2009 and reported to the Board in February 2010. Recommendations to improve processes identified by the review are being implemented, and the Committee is satisfied, based on the findings of this review, that it had been operating as an effective audit committee throughout the year, meeting all applicable legal and regulatory requirements. Further reviews of the effectiveness of the Committee will be undertaken regularly and will, from time to time, be conducted by external consultants.
Remuneration Committee Report Role of the Committee The Remuneration Committee (the Committee) determines the remuneration packages of the Chairman and executive directors.
It also agrees the principles and monitors the level and structure of remuneration for a defined population of senior management as determined by the Board. In framing its remuneration policy, the Committee has given full consideration to the provisions of Schedule A to the Combined Code. The Directors’ Remuneration Report prepared by the Board is set out in full on pages 96 to 114. In preparing the report, the Board has followed the provisions of the Combined Code, the Listing Rules of the Financial Services Authority, and the Companies Act 2006.
The terms of reference comply with all significant aspects of relevant investor guidelines, and require the Committee to ensure that when setting remuneration policy, the Company provides reward for enhancing shareholder value responsibly in relation to executive directors’ individual contributions, which we believe is the appropriate policy to support our business.
Membership The Committee is comprised of independent non-executive directors and the Chairman, as set out below: Harvey McGrath (Chairman) Bridget Macaskill James Ross
During 2009, the Committee met six times and recommended to the Board the appointments of Tidjane Thiam as Group Chief Executive as of 1 October 2009, Nic Nicandrou as executive director and Chief Financial Officer as of 28 October 2009 and Rob Devey as executive director and Chief Executive, Prudential UK and Europe, as of 16 November 2009. Full biographical details of those directors are set out on page 77. Details of Committee members’ attendance at meetings are set out on page 81.
Any change to the Articles must be approved by special resolution of the shareholders in accordance with the provisions of the Companies Act.
Where, under an employee share plan operated by the Company, participants are the beneficial owners of the shares but not the registered owners, the voting rights are normally exercisable by the registered owner, in accordance with the relevant plan rules. Trustees may vote at their discretion, but do not vote on any unawarded shares held as surplus assets.
Some of the Company’s employee share plans include restrictions on transfer of shares while the shares are subject to the plan. As described in the Directors’ Remuneration Report, non-executive directors use a proportion of their fees to purchase shares in the Company which may not normally be transferred during a director’s period of office. In addition, all directors are required to obtain a number of qualification shares within one year of appointment, which they would also be expected to retain during their tenure of office.
Powers of directors to issue shares The directors require authority from shareholders in relation to the issue of shares by the Company. Whenever shares are issued, the Company has to offer the shares to existing shareholders pro rata to their holdings, unless it has been given authority by shareholders to issue shares without offering them first to existing shareholders. The Company seeks authority from its shareholders on an annual basis to issue shares, up to a maximum amount, and to issue up to five per cent of its issued share capital without observing pre-emption rights, in line with relevant regulations and best practice. Dis-application of statutory pre-emption procedures is also sought for rights issues. The Company’s existing authorities to issue shares and to do so without observing pre-emption rights are due to expire at the end of this year’s Annual General Meeting. An ordinary resolution and a special resolution to approve the renewal of these authorities respectively will be put to shareholders at the Annual General Meeting on 19 May 2010.
Details of shares issued during 2008 and 2009 are given in Note H11 on page 264. No shares were issued in 2007 dis-applying preemption rights, and the total number of shares issued dis-applying pre-emption rights by the Company over the last three years amounted to less than 7.5 per cent of the Company’s aggregate issued share capital over that period.
Powers of directors to buy back shares The directors also require authority from shareholders in relation to the buying back of shares by the Company. The Company seeks authority by special resolution on an annual basis for the buyback of its own shares in accordance with the relevant provisions of the Companies Act 2006 and other related guidance. The Company has not made use of that authority since it was last granted at its Annual General Meeting in 2009. This existing authority is due to expire at the end of this year’s Annual General Meeting. A special resolution to approve the renewal of this authority will be put to shareholders at the Annual General Meeting on 19 May 2010.
In particular in relation to the provisions of section 302 of that Act, which covers disclosure controls and procedures, a Disclosure Committee has been established reporting to the Group Chief Executive, chaired by the Chief Financial Officer and comprising members of senior management. The objectives of this committee are to: • assist the Group Chief Executive and the Chief Financial Officer in designing, implementing and periodically evaluating the Company’s disclosure controls and procedures; • monitor compliance with the Company’s disclosure controls and procedures; • review and provide advice to the Group Chief Executive and Chief Financial Officer with regard to the scope and content of all public disclosures made by the Company which are of material significance to the market or investors; and
• review and consider, and where applicable follow up on, matters raised by other components of the disclosure process. These may include, to the extent they are relevant to the disclosure process, any matters to be raised with the Group Audit Committee, the internal auditors or the external auditor of the Company’s internal controls.
The provisions of section 404 of the Act require the Company’s management to report on the effectiveness of internal controls over financial reporting in its annual report on Form 20-F, which is filed with the US Securities and Exchange Commission. To comply with this requirement to report on the effectiveness of internal control, the Group has documented and tested its internal controls over financial reporting in the format required by the Act. The annual assessment and related report from the external auditor will be included in the Group’s annual report on Form 20-F, which will be published in the coming months.
In addition, the Disclosure Committee has regard to the UK Listing Regime, and evaluates whether or not a particular matter requires disclosure to the market.
Organisation Prudential’s risk governance framework requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group. The framework is based on the concept of ‘three lines of defence’: risk management, risk oversight and independent assurance.
Material risks will only be retained where this is consistent with Prudential’s risk appetite framework, i.e.: • The retention of the risk contributes to value creation. • The Group is able to withstand the impact of an adverse outcome.
The Group has five objectives for risk and capital management: a Framework: design, implement and maintain a capital management and risk oversight framework consistent with the Group’s risk appetite and Risk-Adjusted Profitability (RAP) model.
b Monitoring: establish a ‘no surprises’ risk management culture by identifying the risk landscape, assessing and monitoring risk exposures and understanding change drivers.
c Control: implement risk mitigation strategies and remedial actions where exposures are deemed inappropriate and manage the response to extreme events.
e Culture: foster a risk management culture, providing quality assurance and facilitating the sharing of best practice risk measurement and management across the Group and industry.
The Group Audit Committee is provided with minutes of the Group Operational Risk Committee, and regular updates on financial and operational risk exposures.
The Board is committed to achieving the highest standards of corporate responsibility in directing and controlling the business. In terms of the governance of our corporate responsibility strategy, Harvey McGrath, Chairman, has Board level responsibility for social, environmental and ethical risk management. The Board discusses Prudential’s performance in these areas at least once a year and also reviews and approves Prudential’s corporate responsibility report and strategy on an annual basis.
Company law requires the directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and of the Group. The criteria applied in the preparation of the financial statements are set out in the statement of directors’ responsibilities on page 302.
Directors in office during the year Board of directors 76–78, 80
Future developments of the business of the Company Group Chief Executive’s report 11-12
Rules governing changes to the articles of association Corporate governance 88
Significant agreements impacted by a change of control Additional disclosures 93
Agreements for compensation for loss of office or Additional disclosures 93 employment on takeover
The primary objectives of our remuneration policy remain unchanged: to attract high calibre executives, to encourage them to contribute to the success of Prudential by achieving our business plans and returns for shareholders and to reward them based on the Company’s success and their individual contributions. The policy supports the Company’s strategy and goals, and aims to comply with good practice in the UK, whilst not losing sight of the need to take account of competitive conditions in local markets.
During 2009 there were a number of changes to the executive director team. Tidjane Thiam was appointed as Group Chief Executive, succeeding Mark Tucker; Nic Nicandrou was appointed as Chief Financial Officer, succeeding Tidjane Thiam; and Rob Devey was appointed as Chief Executive UK & Europe, succeeding Nick Prettejohn. These individuals bring with them a richly deserved reputation for delivering performance and value, and their talents and experience are well-suited to lead Prudential in the next stage of its development. In conjunction with the changes made to the executive team, we took the opportunity to make some adjustments to the balance of the remuneration elements for the executive director roles to reflect the current needs of our business. In line with our remuneration policy, as our team of executive directors develop and demonstrate measurable success, we would expect to pay them at an appropriate level against their peers to reflect their contributions to the Group.
The Remuneration Committee is mindful of the commentary around pay in the financial services sector. While there are a number of important differences between the banking and insurance sectors, the principles around ensuring good remuneration governance and avoiding a focus on short-term results at the expense of the long-term have broad relevance across all sectors.
We will continue to review the implications of the emerging guidelines and regulation on our current remuneration governance structures, policies and practices and implement any changes where appropriate.
I hope that you will endorse the policies outlined in our report.
The Directors’ Remuneration Report has been prepared by the Remuneration Committee (the ‘Committee’) and has been approved by the Board. Shareholders will be given the opportunity to approve the report at the Annual General Meeting on 19 May 2010.
The report has been drawn up in accordance with the Combined Code on Corporate Governance, Schedule 8 of the Large and Medium sized Companies and Groups (Accounts and Reports) Regulations 2008 and the UK Listing Authority Listing Rules. KPMG Audit Plc has audited the sections contained on pages 107 to 114.
During the year, the Company has complied with the provisions of Section 1 and Schedule A of the Combined Code on Corporate Governance then in force regarding directors’ remuneration.
The Remuneration Committee is responsible for: • Determining the remuneration policy for the Chairman and the executive directors of the Company; • Monitoring the remuneration of a defined population of senior management; and
Each business unit also has its own remuneration committee with similar terms of reference to ensure effective remuneration governance in all our businesses.
The members of the Committee during 2009, listed below, are all independent non-executive directors: Bridget Macaskill (Chairman) Keki Dadiseth Michael Garrett James Ross
Provide part of the fixed element of remuneration set at an appropriate level compared with peers.
Consideration is also given to remuneration arrangements and levels for other Prudential employees.
Required to defer a portion of annual bonus into Prudential shares for three years.
The structure of plans are determined by market practice and local legislation.
Market data is considered from the FTSE 50 for UK roles, UK-based asset management companies for M&G, Asia general industry and insurance sector for the executive director with responsibility for Asia, and US insurers for the executive director with responsibility for the US.
The Remuneration Committee reviews salaries annually. Any changes in basic salaries are effective from 1 January.
Details of the approach taken for base salaries in 2010 is set out on page 100.
Executive directors have annual bonus plans based on the achievement of financial performance measures and individual contribution. Bonuses awarded are not pensionable.
The Chief Executives of the UK & Europe, Asia and Jackson also participate in the Business Unit Performance Plan. For Asia and Jackson, awards are based on the growth in Shareholder Capital Value on an European Embedded Value (EEV) basis. For the UK & Europe, awards to be made in 2010 will be based on relative TSR as per the Group plan above.
Executive directors receive certain benefits, for example participation in medical insurance schemes, the use of a car and driver and security arrangements. No benefits are pensionable.
Executive directors are also entitled to participate in certain M&G investment products on the same basis as other members of staff.
Encourage executives to build up an interest in the Company’s shares and support alignment with shareholder interests.
It is the Company’s policy to provide efficient pension vehicles to allow executive directors to save for their retirement and to make appropriate contributions to their retirement savings plans.
In 2010, the Long Term Savings Plan (LTSP) and the Alternative Retirement Benefit Scheme (ARBS) will be established as long-term savings vehicles for executive directors and other employees.
The Group Chief Executive and Chief Executive of M&G are required to hold shares equal to 200% of salary.
Base salary at Maximum Deferral Maximum Maximum Maximum Director Role 1 January 2010 % of salary requirement % of salary % of salary % of salary
Clark Manning Chief Executive Jackson $1,050,000 c.320% 1 30% of total bonus 230% 230% 460%
Nic Nicandrou Chief Financial Officer £550,000 160% 40% of total bonus 200% – 200%
Tidjane Thiam Group Chief Executive £900,000 180% 50% of total bonus 300% – 300%
Notes 1 Clark Manning’s annual bonus figure includes a notional figure for his 10 per cent share of the Jackson senior management bonus pool based on the performance of Jackson. 2 Michael McLintock’s annual bonus and long-term incentive opportunity under the M&G Executive LTIP are based on M&G’s performance both in absolute terms and relative to its peers. The annual bonus and long-term incentive opportunities are determined by an assessment of market competitive rewards for median and superior performance. In line with practice in the asset management sector, there is no specified maximum incentive award. Michael’s total remuneration is subject to an overriding cap such that his total remuneration should not be greater than three per cent of M&G’s annual IFRS profits.
• Superior performance leads to maximum annual bonus and maximum long-term incentive vesting.
No increases to base salaries were made for executive directors or senior executives in 2009.
Michael McLintock’s salary has been increased from £320,000 to £350,000. Michael’s last increase in base salary was in January 2004. Michael’s remuneration structure and quantum is determined annually on a total compensation basis and therefore the increase to base salary will not increase his annual or long-term incentive opportunity.
No adjustment has been made to the base salaries for Clark Manning, Rob Devey or Nic Nicandou at 1 January 2010.
The base salaries for executive directors for 2010 are set out on page 99.
The proportions of financial and individual performance for each executive director are: Individual Financial measures strategic goals
Note 1 The proportions for Clark Manning’s annual bonus include a Jackson senior management bonus pool which is based on Jackson financial performance. The proportions shown in the table incorporate a notional level for this pool.
The proportions and measures for the 2010 bonus plans will be as set out above.
In addition to IFRS profit, M&G’s annual bonus plan performance measures include growth in third party funds under management and comparative fund investment performance. Performance achieved against IFRS profit was lower than in 2008, primarily due to a lower FTSE All Share index in 2009. This result was partially offset by additional income earned on the higher than anticipated inflows as well as an improved return on the Corporate Bond and investment book. Performance achieved against both the growth in third party funds and investment performance measures was strong.
The annual bonus payments included in the table on page 107 are summarised in the table below: % of 2009 salary*
Executive directors with regional responsibility also participate in plans linked to the relevant business unit’s success.
The companies in the index for 2010 include Aegon, Allianz, Aviva, Axa, Generali, ING, Legal & General, Manulife, Old Mutual and Standard Life. The companies in the index for awards made in 2008 and 2009 included the companies above and also Friends Provident, which was removed from the comparator group for both set of awards with effect from November 2009 as a result of its delisting.
The vesting schedule for awards under the GPSP is set out in the table below.
Prudential’s TSR relative to the index % of award at the end of the performance period which vests*
Business Unit Performance Plan (BUPP) – executive directors with regional responsibilities For executive directors with regional responsibilities, the BUPP delivers shares subject to performance over a three year performance period.
For outstanding awards, the performance measure under the BUPP is Shareholder Capital Value (SCV) which is shareholders’ capital and reserves on a European Embedded Value (EEV) basis for each regional business unit. Vesting depends on the increase in SCV over the performance period, and the required growth rates are different for each of Prudential’s business regions in order to reflect the relative maturity of each market and business environment.
% of award which vests* UK & Europe Jackson Asia *Straight line vesting occurs between the performance levels provided above.
The value of the vested phantom shares will be paid in cash after the end of the three year performance period.
All-employee plans Save As You Earn (SAYE) schemes UK based executive directors are eligible to participate in the Prudential HMRC approved SAYE scheme and the Asia based executive director can participate in the equivalent International SAYE scheme. These schemes allow employees to save towards the exercise of options over Prudential plc shares, at an option price set at the beginning of the savings period at a discount of up to 20 per cent to the market price.
Share Incentive Plan (SIP) UK-based executive directors are also eligible to participate in the Company’s HMRC approved 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, which is purchased by Prudential on the open market. Dividend shares accumulate while employees participate in the plan. Partnership shares may be withdrawn from the scheme at any time. If the employee withdraws from the plan within five years, the matching shares are forfeited and if within three years, dividend shares are also forfeited.
Pensions and long-term savings policy It is the Company’s policy to provide efficient pension vehicles to allow executive directors to save for their retirement and to make appropriate contributions to their retirement savings plans.
Michael McLintock participates in a contributory defined benefit scheme that provides a target pension of two thirds of final pensionable earnings on retirement at age 60. Participation is on the same basis as other employees who joined at the same date. Benefits under the plan are subject to a notional scheme earnings cap, set at £117,600 and £123,600 for the 2008/09 and 2009/10 tax years respectively. Michael is entitled to supplements based on his salary above the notional earnings cap.
Tidjane Thiam The 2008 Directors’ Remuneration Report provided details of the remuneration arrangements that would apply to Tidjane Thiam on appointment as Group Chief Executive from 1 October 2009. To reflect the transition of responsibilities from Mark Tucker, the Committee decided that it was appropriate that Tidjane’s arrangements be implemented with effect from 1 July 2009.
• The long-term incentive plan awards for 2007, 2008 and 2009 will vest at the end of each relevant three year performance period pro-rated based on service, i.e. 33/36ths, 21/36ths and 9/36ths respectively. Vesting will remain dependent on performance achieved over the relevant performance periods and any shares released will occur at the same time as for all other participants in the GPSP and BUPP.
Rob Devey Rob Devey’s remuneration structure on appointment to Chief Executive UK & Europe is summarised on page 99. Rob’s deferred share and long-term incentive award buyout arrangements, that were approved by the Committee in order to compensate him for losses incurred as a result of leaving his previous employer, can be found under ‘Other share awards’ on page 111.
In order for Rob to take up the position with Prudential, he was required to relocate. To facilitate this move, the Committee approved the payment of stamp duty and other incidental moving costs of £131,310. Should Rob leave the Group within two years, or give notice of intention to leave, these payments would be clawed back. Further details of these benefits can be found on page 107.
Subject to the Group Chief Executive’s or Chairman’s approval, executive directors are able to accept external appointments as non-executive directors of other organisations. Any fees paid may be retained by the executive director. In 2009, Tidjane Thiam earned 15,000 euros and Michael McLintock earned £42,500 from external companies. Other directors served as non-executive directors on the boards of companies in the educational and cultural sectors without receiving a fee for such services.
Non-executive directors are not eligible to participate in annual bonus plans, long-term incentive plans or pension arrangements. Their fees are determined by the Board and reflect their individual responsibilities, including committee membership as appropriate. The Board reviews fees annually and the last fee change was effective 1 July 2008.
The annual fees which were paid in 2009 for non-executive directors’ board and committee membership are detailed in the table below.
Annual fee as at Annual 1 January 2009 fee as at (or on appointment if later) 1 January 2010
Notice period Notice period Date of contract to the Company from the Company
Date of initial Commencement Expiry date appointment date of of current by the Board current term term
Executive directors should have a substantial shareholding which should be built up over a period of five years. Shares earned and deferred under the annual bonus plan are included in calculating the executive director’s shareholding.
Receipts (ADR’s). One ADR is equivalent to two Prudential plc shares.
Directors’ shareholdings The interests of directors in ordinary shares of the Company are set out below. This includes deferred annual bonus awards and interests in shares awarded on appointment detailed in the table on ‘Other Share Awards’ on page 111.
Note 1 Part of Barry Stowe’s interests in shares are made up of 30,339 ADRs
Cash including cash of performance supplements Total supplements periods ending for pension Other cash Emoluments for pension 31 December Salary/Fees Bonus Benefits* purposes† payments 2009 purposes‡ 2009§
Nic Nicandrou (from 28 October 2009)note 4 98 550 5 1 654
Total non-executive directors 696 696 833 * Benefits include where provided the use of a car and driver, medical insurance, security arrangements and expatriate benefits. † Pension supplements that are paid in cash are included in the table. The policy on pensions is described in the section on ‘Pensions and long-term savings policy’ on page 103. The pension and long-term savings arrangements for current executive directors are described in the section on ‘Directors’ pensions and life assurance’ on page 113.
Notes 1 As part of Rob Devey’s appointment terms, it was agreed that any bonus award for Rob would be assessed as if he had been in employment for the whole of 2009. It is anticipated that a deferred share award from the 2009 annual bonus valued at £240,000 will be made to Rob. This is included in the 2009 bonus figure. Actual costs reimbursed to Rob as part of his relocation arrangements as detailed on page 104 are included in the benefits figure. It should be noted that Rob elected not to receive his cash supplement for pension purposes in full during 2009. It is anticipated that the Company will make a request to the Trustees of the Alternative Retirement Benefit Scheme during 2010 to accept a contribution for an amount equivalent to this supplement.
Notes continued 4 As part of Nic Nicandrou’s appointment terms, it was agreed that any bonus award for Nic would be assessed as if Nic had been in employment for the whole of 2009. It is anticipated that a deferred share award from the 2009 annual bonus valued at £220,000 will be made to Nic. This is included in the 2009 bonus figure. As detailed on page 104, Nic has not yet been reimbursed for any relocation expenses. It should be noted that Nic elected not to receive his cash supplement for pension purposes in full during 2009. It is anticipated that the Company will make a request to the Trustees of the Long Term Savings Plan during 2010 to accept a contribution for an amount equivalent to this supplement.
6 It is anticipated that for Barry Stowe a deferred share award from the 2009 annual bonus valued at HK$2,248,852 will be made. This is included in the 2009 bonus figure. Barry’s benefits primarily relate to his expatriate status including costs of £148,051 for housing, £41,528 for children’s education and £32,607 for home leave.
Notes 1 2009 awards made under the GPSP and the BUPP have a performance period from 1 January 2009 to 31 December 2011. In determining the 2009 conditional share awards the shares were valued at the average share price for the 30 days immediately following the announcement of Prudential’s 2008 results, and the price used to determine the number of shares was 347.74 pence.
3 At 31 December 2009, Shareholder Capital Value performance under the 2007 BUPPs was as follows: % compound No. of shares released from Anticipated value of growth in SCV 2007 BUPP share award 2007 BUPP cash award release
Face value Face value of conditional of conditional awards awards outstanding Conditionally Payments outstanding at Date of
Year of at 1 January awarded made 31 December end of initial 2009 in 2009 in 2009 2009 performance
For the 2005 phantom option award of 367,800 units, the option price at the end of the performance period was £1.07. This resulted in a payment of £393,546 to Michael McLintock. For the 2006 award, the phantom share price at the end of the performance period was £1.69 and the phantom option price was £0.69. This resulted in a payment from the phantom share award of £380,250 and the phantom option award of £253,782.
Other share awards The table below sets out the share awards that have been made to executive directors under their appointment terms and those deferred from annual bonus plan payouts. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the awards from the 2008 annual bonus, made in 2009, the average share price was 308.63 pence.
Conditional Conditional share share awards out- Condi- Scrip awards out- Market Market standing tionally dividends Shares standing at price at price at at 1 January awarded accumu- released 31 December Date of original date of Year of 2009 in 2009 lated in 2009 2009 end of date of vesting or initial (Number (Number (Number (Number (Number restricted Date of award release grant of shares) of shares) of shares) of shares) of shares) period release (pence) (pence)
Year of 2009 in 2009 lated in 2009 2009 end of date of vesting or initial (Number (Number (Number (Number (Number restricted Date of award release grant of shares) of shares) of shares) of shares) of shares) period release (pence) (pence)
Notes 1 In order to secure the appointment of Rob Devey and to compensate him for the loss of outstanding long-term remuneration, Rob was awarded rights to Prudential shares as set out in the table.
2 Under the terms agreed on his leaving the Company, the outstanding deferred awards to Nick Prettejohn have been released to him. 3 In order to secure the appointment of Nic Nicandrou and to compensate him for the loss of outstanding long-term remuneration, Nic was awarded rights to Prudential shares as set out in the table.
4 Under the terms agreed on his leaving the Company, the outstanding deferred awards to Mark Tucker have been released to him.
Exercise Options Options Market price out- Market out- price adjusted standing price on standing at Original for 2004
Notes 1 Gains of £0 were made by directors in 2009 on the exercise of share options (2008: £15,420). 2 No price was paid for the award of any option. 3 The highest and lowest share prices during 2009 were 650.5 pence and 207 pence respectively.
Clark Manning participates in a US tax-qualified defined contribution plan (a 401K plan). He is also provided with life assurance cover of two times salary. Company matching contributions of six per cent of base salary up to a maximum of $14,700 were made in 2009. In addition, an annual profit sharing contribution of $14,700 was made in 2009.
Additional pension Transfer value of accrued earned during year benefit at 31 December ended 31 December 2009 note 3
Ignoring Allowing Amount of Years of inflation for inflation (B-A) less Contributions pensionable Accrued on pension on pension contributions to pension Age at service at benefit at earned to earned to made by and life 31 December 31 December 31 December 31 December 31 December directors assurance note 1 note 2 note 4
The following tables and referenced disclosure notes show the results reported in the statutory financial statements on pages 119 to 301 and supplementary EEV basis results on pages 304 to 340. This page does not form part of the statutory financial statements.
Profit (loss) after tax attributable to equity holders of the Company IFRS income statement 119 £676m £(396)m
Dividends per share declared and paid in reporting period IFRS note B3 149 19.20p 18.29p
Shareholders’ equity, excluding minority interests IFRS statement of financial position 124 £6,271m £5,058m
Shareholders’ share of actuarial and other gains and losses on IFRS note B1 defined benefit pension schemes 144 £(74)m £(13)m
Loss on sale and results for Taiwan agency business 144 £(621)m £1m
Operating earnings per share after related tax and minority interests IFRS note B2 148 43.4p 39.9p
Effect of changes in economic assumptions and time value of cost of options and guarantees 305 £(910)m £(398)m
Basic earnings (loss) per share EEV earnings per share 305 49.8p (54.1)p
Results bases With the exception of the presentation of the results for the Taiwan agency business, for which (as described below) the sale process was completed in June 2009, the basis of preparation of statutory IFRS basis results and supplementary IFRS basis information is consistent with that applied for the 2008 results and financial statements. The EEV basis results have been prepared in accordance with the European Embedded Value Principles issued by the CFO Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance on European Embedded Values Disclosures issued in October 2005.
Life insurance products are, by their nature, long-term and the profit on this business is generated over a significant number of years. Accounting under IFRS alone does not, in Prudential’s opinion, fully reflect the value of future profit streams. Prudential considers that embedded value reporting provides investors with a measure of the future profit streams of the Groups long-term businesses and is a valuable supplement to statutory accounts.
Operating profit based on longer-term investment returns Consistent with previous reporting practice, the Group provides supplementary analysis of the IFRS profit before tax attributable to shareholders analyses its EEV basis results so as to distinguish operating profit based on longer-term investments returns from other elements of total profit. On both the IFRS and EEV bases, operating earnings per share are calculated using operating profits based on longer-term investment returns, after related tax and minority interests. These profits exclude short-term fluctuations in investment returns and the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes. Under the EEV basis, where additional profit and loss effects arise, operating profit based on longer term investment returns also excludes the mark to market value movements on core borrowings and the effect of changes in economic assumptions and changes in the time value of cost of options and guarantees arising from changes in economic factors.
In 2009, as a result of the exceptional dislocated market conditions, the Group incurred non-recurrent cost of £235 million for hedging its Insurance Group’s Directive (IGD) capital surplus. These costs have been shown separately from operating profit based on longer-term investment returns as part of the short-term fluctuations in investment returns.
Section D: Life assurance businesses 166 D1: Group overview 173 D2: UK insurance operations 189 D3: US insurance operations 206 D4: Asian insurance operations 214 D5: Capital position statement for life assurance businesses
Section H: Other information on statement of financial position items 253 H1: Intangible assets attributable to shareholders 256 H2: Intangible assets attributable to with-profits funds 257 H3: Reinsurers’ share of insurance contract liabilities 258 H4: Tax assets and liabilities 259 H5: Accrued investment income and other debtors 259 H6: Property, plant and equipment 260 H7: Investment properties 261 H8: Investments in associates and joint ventures 263 H9: Properties held for sale 263 H10: Cash and cash equivalents 264 H11: Shareholders’ equity: Share capital, share premium and reserves 265 H12: Insurance contract liabilities and unallocated surplus of with-profits funds 266 H13: Borrowings 268 H14: Provisions and contingencies 272 H15: Other liabilities
Parent company financial statements 292 Balance sheet of the parent company 293 Notes on the parent company financial statements
Statement of directors’ responsibilities and independent auditor’s report 302 Statement of directors’ responsibilities in respect of the Annual Report and the financial statements 303 Independent auditor’s report to the members of Prudential plc
European Embedded Value (EEV) basis supplementary information 304 Operating profit based on longer-term investment returns 305 Summarised consolidated income statement – EEV basis 305 Earnings per share – EEV basis 305 Dividends per share 306 Movement in shareholders’ equity (excluding minority interests) – EEV basis 307 Summary statement of financial position – EEV basis 308 Notes on the EEV basis supplementary information 341 Statement of directors’ responsibilities in respect of the European Embedded Value (EEV) basis supplementary information 342 Independent auditor’s report to Prudential plc on the European Embedded Value (EEV) basis supplementary information
Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns)* 1,564 (2,074)
Based on loss from discontinued operations attributable to the equity holders of the Company B2 (0.6)p –
* This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders.
Other comprehensive income (loss): Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year B4 (206) 391
Unrealised valuation movements, net of related change in amortisation of deferred income and acquisition costs and related tax – – – – 1,043 1,043 – 1,043
Treasury shares Movement in own shares held in respect of share-based payment plans – – 3 – – 3 – 3 Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – (3) – – (3) – (3)
Reserves Loss for the year – – (396) – – (396) 5 (391) Other comprehensive income (loss): Exchange movements on foreign operations and net investment hedges, net of related tax – – – 510 – 510 – 510
Unrealised valuation movements, net of related change in amortisation of deferred income and acquisition costs and related tax – – – – (831) (831) – (831)
Total other comprehensive income (loss) – – – 510 (831) (321) – (321)
Share capital and share premium New share capital subscribed H11 2 168 – – – 170 – 170 Transfer to retained earnings in respect of shares issued in lieu of cash dividends H11 – (156) 156 – – – – –
Treasury shares Movement in own shares held in respect of share-based payment plans – – 3 – – 3 – 3 Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – (25) – – (25) – (25)
Net increase (decrease) in equity 2 12 (697) 510 (831) (1,004) (47) (1,051)
Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets H1(b) 4,049 5,349
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes H2(a) 124 174
Other non-investment and non-cash assets: Property, plant and equipment H6 367 635
Investments of long-term business and other operations: Investment properties H7 10,905 11,992
Cash flows from operating activities Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns)* 1,564 (2,074)
Cash flows from investing activities Purchases of property, plant and equipment H6 (91) (240)
Cash flows from financing activities Structural borrowings of the Group: I10
Effect of exchange rate changes on cash and cash equivalents (218) 550
Cash and cash equivalents at end of year H10 5,307 5,955 * This measure is the formal profit (loss) before tax measure under IFRS but it is not the result attributable to shareholders. † Reclassification adjustments have been made in respect of the 2008 comparatives for these line items as explained in note I10. ‡ Cash movements in respect of equity capital exclude scrip dividends.
Notes on the Group financial statements > A: Background and accounting policies
a Critical accounting policies Prudential’s discussion and analysis of its financial condition and results of operations are based upon Prudential’s consolidated financial statements, which have been prepared in accordance with IFRS adopted for use in the EU. Were the Group to apply IFRS as published by the IASB, as opposed to EU-adopted IFRS, no additional measurement adjustments or disclosures would be required.
In 2005 the Group chose to improve its IFRS accounting for UK regulated with-profits funds by the voluntary application of the UK accounting standard FRS 27, ‘Life Assurance’. Under this standard, the main accounting changes that were required for UK with-profits funds were: • derecognition of deferred acquisition costs and related deferred tax; and • replacement of MSB liabilities with adjusted realistic basis liabilities.
The results included in the financial statements for 2009 and 2008 reflect this basis. Unallocated surplus represents the excess of assets over policyholder liabilities for the Group’s with-profits funds that have yet to be appropriated between policyholders and shareholders. The Group has opted to account for unallocated surplus wholly as a liability with no allocation to equity. This treatment reflects the fact that shareholders’ participation in the cost of bonuses arises only on distribution. Shareholder profits on with-profits business reflect one-ninth of the cost of declared bonus.
Taking account of these considerations the Group has decided that, except for certain minor categories of derivatives, it is not appropriate to seek to achieve hedge accounting under IAS 39. As a result of this decision the total income statement results are more volatile as the movements in the value of Jackson’s derivatives are reflected within it.
For shareholder-backed business, with the exception of debt securities held by Jackson and assets classified as loans and receivables, all financial investments and investment property are designated as assets at fair value through profit and loss. Short-term fluctuations in investment returns on such assets held by with-profits funds, do not affect directly reported shareholder results. This is because (i) the unallocated surplus of with-profits funds is accounted for as liabilities and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from unallocated surplus. However, for shareholder-backed businesses the short-term fluctuations affect the result for the year and the Group provides additional analysis of results to provide information on results before and after short-term fluctuations in investment returns.
b Critical accounting estimates and judgements Investments Determining the fair value of financial investments when the markets are not active The Group holds certain financial investments for which the markets are not active. These can include financial investments which are not quoted on active markets and financial investments for which markets are no longer active as a result of market conditions e.g. market illiquidity. When the markets are not active, there is generally no or limited observable market data to account for financial investments at fair value. The determination of whether an active market exists for a financial investment requires management’s judgement.
The financial investments measured at fair value are classified into the following three level hierarchy on the basis of the lowest level of inputs that is significant to the fair value measurement of the financial investment concerned: Level 1: Quoted prices (unadjusted) in active markets for identical assets and liabilities Level 2: Inputs other than quoted prices included within level 1 that are observable either directly or indirectly (i.e. derived from prices).
Determining impairments relating to financial assets Available-for-sale securities Financial investments carried on an available-for-sale basis are represented by Jackson’s debt securities portfolio. The consideration of evidence of impairment requires management’s judgement. In making this determination the factors considered include, for example,
• Whether the decline of the financial investment’s fair value is substantial. A substantial decline in fair value might be indicative of a credit loss event that would lead to a measurable decrease in the estimated future cash flows.
• The duration and extent to which the amortised cost exceeds fair value. This factor provides an indication of how the contractual cash flows and effective interest rate of a financial asset compares with the implicit market estimate of cash flows and the risk attaching to a ‘fair value’ measurement. The length of time for which that level of difference has been in place may also provide further evidence as to whether the market assessment implies an impairment loss has arisen.
For Jackson’s residential mortgage-backed and other asset-backed securities, all of which are classified as available-for-sale, the model used to analyse cash flows, begins with the current delinquency experience of the underlying collateral pool for the structure, by applying assumptions about how much of the currently delinquent loans will eventually default, and multiplying this by an assumed loss severity. Additional factors are applied to anticipate ageing effect. After applying a cash flow simulation an indication is obtained as to whether or not the security has suffered, or is anticipated to suffer, contractual principal or interest payment shortfall. If a shortfall applies an impairment charge is recorded. The difference between the fair value and book cost for unimpaired securities accounted for as available-for-sale, falls to be accounted for as unrealised gains or losses, with the movements in the accounting period being accounted for in other comprehensive income.
A detailed explanation of the basis of liability measurement is contained in note D2(f)(ii). The Group’s other with-profits contracts are written in with-profits funds that operate in some of the Group’s Asian operations.
ii Other contracts Contracts, other than those of with-profits funds, are written in shareholder-backed operations of the Group. The significant shareholder-backed product groupings and the factors that may significantly affect IFRS results due to experience against assumptions or changes of assumptions vary significantly between business units. For some types of business the effect of changes in assumptions may be significant, whilst for others, due to the nature of the product, assumption setting may be of less significance. The nature of the products and the significance of assumptions are discussed in notes D2, D3 and D4. From the perspective of shareholder results the key sensitivity relates to the assumption for allowance for credit risk for UK annuity business. Prior to its disposal of the Taiwan agency business in the first half of 2009, the Group’s financial results were also sensitive to the assumed future investment returns for that business.
Jackson For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For interest-sensitive business, the key assumption is the long-term spread between the earned rate and the rate credited to policyholders, which is based on the annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of Jackson’s actual industry experience and future expectations. A detailed analysis of actual experience is measured by internally developed mortality studies.
Pensions The Group applies the requirements of IAS 19, ‘Employee benefits’ and associated interpretations including IFRIC 14 ’IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’, to its defined benefit pension schemes. The principal deferred benefit pension scheme is the Prudential Staff Pension Scheme (PSPS). For PSPS the terms of the trust deed restrict shareholders’ access to any underlying surplus. Accordingly, applying the interpretation of IFRIC 14, any underlying IAS 19 basis surplus is not recognised for IFRS reporting. The financial position for PSPS recorded in the IFRS financial statements reflects the higher of any underlying IAS 19 deficit and any obligation for deficit funding.
The economic participation in the surplus or deficits attaching to the PSPS and the smaller Scottish Amicable Pensions Scheme (SAPS) are shared between the PAC with-profits sub-fund (WPSF) and shareholder operations. The economic interest reflects the source of contributions over the scheme life, which in turn reflects the activity of the members during their employment.
In the case of PSPS, movements in the apportionment of the financial position for PSPS between the WPSF and shareholders’ funds in 2009 reflect the 70/30 ratio applied to the base deficit position as at 31 December 2005 but with service cost and contributions for ongoing service apportioned by reference to the cost allocation for activity of current employees. For SAPS the ratio is estimated to be 50/50 between the WPSF and shareholders’ funds.
iii Loans and receivables – this comprises non-quoted investments that have fixed or determinable payments and are not designated as fair value through profit and loss or available-for-sale. These investments include loans collateralised by mortgages, deposits, loans to policyholders and other unsecured loans and receivables. These investments are carried at amortised cost using the effective interest method.
Derivatives and hedge accounting Derivative financial instruments are used to reduce or manage investment, interest rate and currency exposures, to facilitate efficient portfolio management and for investment purposes.
The Group may designate certain derivatives as hedges. This includes fair value hedges, cash flow hedges and hedges of net investments in foreign operations. If the criteria for hedge accounting are met then the following accounting treatments are applied from the date at which the designation is made and the accompanying requisite documentation is in place: i Hedges of net investments in foreign operations – the effective portion of any change in fair value of derivatives or other financial instruments designated as net investment hedges are recognised in other comprehensive income (i.e. outside of the income statement). The ineffective portion of changes in the fair value of the hedging instrument is recorded in the income statement. The gain or loss on the hedging instrument recognised directly in other comprehensive income, is recognised in the income statement on disposal of the foreign operation.
iii Cash flow hedges – the effective portion of changes in the fair value of derivatives designated as cash flow hedges is recognised in other comprehensive income (i.e. outside of the income statement). Movements in fair value relating to the ineffective portion are booked in the income statement. Amounts recognised in other comprehensive income are recorded in the income statement in the periods in which the hedged item affects profit or loss.
For UK with-profits funds the derivative programme is undertaken as part of the efficient management of the portfolio as a whole. As noted in section D2 value movements on the with-profits funds investments are reflected in changes in asset-share liabilities to policyholders or the liability for unallocated surplus. Shareholders’ profit and equity are not affected directly by value movements on the derivatives held.
Securities lending including repurchase agreements The Group is party to various securities lending agreements under which securities are loaned to third-parties on a short-term basis. The loaned securities are not derecognised; rather, they continue to be recognised within the appropriate investment classification. The Group’s policy is that collateral in excess of 100 per cent of the fair value of securities loaned is required from all securities’ borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
Borrowings Although initially recognised at fair value, net of transaction costs, borrowings, excluding liabilities of consolidated collateralised debt obligations, are 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 related issue costs) is amortised through the income statement to the date of maturity or for hybrid debt, over the expected life of the instrument.
For investment contracts which do not contain discretionary participating features, the accounting is carried out in accordance with IAS 39 to reflect the deposit nature of the arrangement, with premiums and claims reflected as deposits and withdrawals and taken directly to the statement of financial position as movements in the financial liability balance.
Acquisition costs With the exception of costs incurred in respect of with-profits contracts valued on a realistic basis, costs of acquiring new insurance business, principally commissions, marketing and advertising costs and certain other costs associated with policy issuance and underwriting that are not reimbursed by policy charges, are specifically identified and capitalised as part of deferred acquisition costs (DAC), which are included as an asset in the statement of financial position. The DAC asset in respect of insurance contracts is amortised against margins in future revenues on the related insurance policies, to the extent that the amounts are recoverable out of the margins. Recoverability of the unamortised DAC asset is assessed at the time of policy issue and reviewed if profit margins have declined.
Under IFRS, investment contracts (excluding those with discretionary participation features) accounted for as financial liabilities in accordance with IAS 39 which also offers investment management services, require the application of IAS 18 for the revenue attached to these services. The Group’s investment contracts primarily comprise certain unit-linked savings contracts in the UK and Asia and contracts with fixed and guaranteed terms in the US (such as guaranteed investment contracts and annuity-certains) all of which offer an investment service.
UK regulated with-profits funds Prudential’s long-term business written in the UK comprises predominantly life insurance policies with discretionary participating features under which the policyholders are entitled to participate in the returns of the funds supporting these policies. Business similar to this type is also written in certain of the Group’s Asian operations subject to local market and regulatory conditions. Such policies are called with-profits policies. Prudential maintains with-profits funds within the Group’s long-term business funds, which segregate the assets and liabilities and accumulate the returns related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and final, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profits with respect to bonuses declared on with-profits business correspond to the shareholders’ share of the cost of bonuses as declared by the board of directors. The shareholders’ share currently represents one-ninth of the cost of bonuses declared for with-profits policies.
Annual bonuses are declared and credited each year to with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account in the year declared. Final bonuses are declared each year and accrued for all policies scheduled to mature and for death benefits expected to be paid during the next financial year. Final bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or final bonus declarations.
The policyholders’ liabilities of the regulated with-profits funds are accounted for under FRS 27. Under FRS 27 for the UK with-profits funds: • no deferred acquisition costs and related deferred tax are recognised; and • adjusted realistic basis liabilities instead of MSB liabilities are recognised.
Jackson The future policyholder benefit provisions for Jackson’s conventional protection-type policies are determined using the net level premium method under US GAAP principles and assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviations. For non-conventional protection-type policies, the policyholder benefit provision included within policyholder liabilities in the consolidated statement of financial position is the policyholder account balance.
For the business of Jackson, the determination of the expected emergence of margins, against which the amortisation profile of the DAC asset is established, is dependent on certain key assumptions. For single premium deferred annuity business, the key assumption is the expected long-term spread between the earned rate and the rate credited to policyholders. For variable annuity business, the key assumption is the expected long-term level of equity market returns which, for 2009 and 2008, was 8.4 per cent per annum, implemented using a mean reversion methodology. These returns affect the level of future expected profits through their effects on fee income and the required level of provision for guaranteed minimum death benefit claims.
For the operations in Taiwan, Vietnam and Japan, countries where local GAAP is not appropriate in the context of the previously applied MSB, accounting for insurance contracts is based on US GAAP. For these three operations the business written is primarily nonparticipating and linked business. The future policyholder benefit provisions for non-linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claim expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business. Where appropriate, liabilities for participating business for these three operations include provisions for the policyholders’ interest in realised investment gains and other surpluses that have yet to be declared as bonuses.
The Group holds investments in internally and externally managed open-ended investment companies (OEICs) and unit trusts. These are consolidated where the Group’s percentage ownership level is 50 per cent or greater. The Group’s percentage ownership levels in these entities can fluctuate from day to day according to changes in the Group’s and third-party participation in the funds. In instances where the Group’s ownership of internally managed funds declines marginally below 50 per cent and, based on historical analysis and future expectations the decline in ownership is expected to be temporary, the funds continue to be consolidated as subsidiaries under IAS 27.
Other interests in entities, where significant influence is not exercised, are carried as investments at fair value through profit and loss. The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2009 except where entities have non-coterminous year ends. In such cases, the information consolidated is based on the accounting period of these entities and is adjusted for material changes up to 31 December. Accordingly, the information consolidated is deemed to cover the same period for all entities throughout the Group. The results of subsidiaries are included in the financial statements from the date control commences to the date control ceases. All inter-company transactions are eliminated on consolidation. Results of asset management activities include those for managing internal funds.
Contributions to the Group’s defined contribution schemes are expensed when due. Once paid, the Group has no further payment obligations. Any prepayments are reflected as an asset on the statement of financial position.
The compensation expense charged to the income statement is primarily based upon the fair value of the options granted, the vesting period and the vesting conditions. Vesting conditions exclude the ability of an employee to voluntarily exit a scheme and such exits are treated as an acceleration of vesting and hence a shortening of the period over which the expense is charged. The Group revises its estimate of the number of options likely to be exercised at each statement of financial position date and adjusts the charge to the income statement accordingly. Where the share-based payment depends upon vesting outcomes attaching to market-based performance conditions, additional modelling is performed to estimate the fair value of the awards. No subsequent adjustment is then made to the fair value charge for awards that do not vest on account of these performance conditions not being met.
Deferred taxes are provided under the liability method for all relevant temporary differences, being the difference between the carrying amount of an asset or liability in the statement of financial position and its value for tax purposes. IAS 12, ‘Income Taxes’ does not require all temporary differences to be provided for, in particular, the Group does not provide for deferred tax on undistributed earnings of subsidiaries where the Group is able to control the timing of the distribution and the temporary difference created is not expected to reverse in the foreseeable future. The tax effects of losses available for carry forward are recognised as an asset. Deferred tax assets are only recognised when it is more likely than not, that future taxable profits will be available against which these losses can be utilised. Deferred tax related to charges or credits taken to other comprehensive income is also credited or charged to other comprehensive income and is subsequently recognised in the income statement together with the deferred gain or loss.
Basis of presentation of tax charges Tax charges in the income statement reflect the aggregate of the shareholder tax on the long-term business result and on the Group’s other results.
For life insurance company acquisitions, the adjusted net assets include an identifiable intangible asset for the present value of inforce business which represents the profits that are expected to emerge from the acquired insurance business. The present value of inforce business is calculated using best estimate actuarial assumptions for interest, mortality, persistency and expenses and is amortised over the anticipated lives of the related contracts in the portfolio. The net carrying amount of insurance liabilities acquired less the value of in-force business, represents the fair value of the insurance liabilities acquired. An intangible asset may also be recognised in respect of acquired investment management contracts representing the fair value of contractual rights acquired under these contracts.
Goodwill Goodwill arising on acquisitions of subsidiaries and businesses is capitalised and carried on the Group statement of financial position as an intangible asset at initial value less any accumulated impairment losses. Goodwill impairment testing is conducted annually and when there is an indication of impairment. For the purposes of impairment testing, goodwill is allocated to cash generating units. These cash generating units reflect the smallest group of assets that includes the goodwill and generates cash flows that are largely independent of the cash inflows from other groups of assets. If the carrying amount of the cash generating unit exceeds its recoverable amount then the goodwill is considered impaired. Impairment losses are recognised immediately in the income statement and may not be reversed in future periods.
Segments Under IFRS 8, adopted in 2009, the Group determines and presents operating segments based on the information that is internally provided to the Group Executive Committee (‘GEC’), which is the Group’s chief operating decision maker.
Prudential Capital has been incorporated into the M&G operating segment for the purposes of segment reporting.
The performance measure of operating segments utilised by the Company is IFRS operating profit attributable to shareholders based on longer-term investment returns. This measure excludes the recurrent items of short-term fluctuations in investment returns and the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes. In addition, for 2009 this measure excludes the non-recurrent cost of hedging the Group IGD capital surplus included within short-term fluctuations in investment returns (see note B1). In 2009 the Company sold its Taiwan agency business. In order to facilitate comparisons on a like for like basis, the loss on sale and the results of the Taiwan agency business during the period of ownership (including those for the 2008 comparatives) are shown separately within the segmental analysis of profit. Further details on the determination of the performance measure of “operating profit based on longer-term investment returns” is provided below in note A4 (d).
Segment results that are reported to the GEC include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items are mainly in relation to the Group Head Office and Asia Regional Head Office.
Foreign exchange The Group’s consolidated financial statements are presented in pounds sterling, the Group’s presentation currency. Accordingly, the results and financial position of foreign subsidiaries must be translated into the presentation currency of the Group from their functional currencies, i.e. the currency of the primary economic environment in which the entity operates. All assets and liabilities of foreign subsidiaries are converted at year end exchange rates whilst all income and expenses are converted at average exchange rates where this is a reasonable approximation of the rates prevailing on transaction dates. The impact of these currency translations is recorded as a separate component in the Statement of comprehensive income.
The Group uses operating profit based on longer-term investment returns to measure the performance of its operational segments. For the purposes of measuring operating profit, investment returns on shareholder-financed business are based on the expected longerterm rates of return. This reflects the particular features of long-term insurance business where assets and liabilities are held for the longterm and for which the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying performance for life businesses exclusive of changes in market conditions. In determining profit on this basis the following key elements are applied to the results of the Group’s shareholder-financed operations.
i Debt and equity securities Longer-term investment returns comprise income and longer-term capital returns. For debt securities the longer-term capital returns comprise two elements. These are a risk margin reserve (RMR) based charge for expected defaults, which is determined by reference to the credit quality of the portfolio, and amortisation of interest-related realised gains and losses to operating results based on longer-term investment returns to the date when sold bonds would have otherwise matured. The shareholder-backed operation for which the risk margin reserve charge is most significant is Jackson National Life. The RMR charge for Jackson is based on long-term average default and recovery data as published by Moody’s. During 2009 refinements were made to the RMR process following the National Association of Insurance Commissioners (NAIC) issuing RBC valuation data for more than 20,000 RMBS securities. Note B1 provides further detail. Longer-term equity returns comprise aggregate long-term income and capital returns.
ii Derivative value movements Value movements for Jackson’s equity-based derivatives and variable annuity product embedded derivatives are included in operating profits based on longer-term investment returns. The inclusion of these movements is so as to broadly match with the results on the Jackson variable annuity book that pertain to equity market movements, subject to some limitations for GMDB products where US GAAP does not fully reflect the economic features being hedged. These accounting mis-matches are magnified in periods of significant market movements.
Other derivative value movements are excluded from operating results based on longer-term investment returns. These derivatives are primarily held by Jackson as part of a broadly-based hedging programme for features of Jackson’s bond portfolio (for which value movements are booked in the statement of comprehensive income rather than income statement) and product liabilities (for which US GAAP accounting does not reflect the economic features being hedged).
For such business the policyholder liabilities are directly reflective of the asset value movements. Accordingly, all asset value movements are recorded in the operating results based on longer-term investment returns.