Infracapital Greenfield Partners I GP LLP LPI 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
Infracapital Greenfield Partners I LP LPI 26.52% Laurence Pountney Hill, London, EC4R 0HH, UK
Infracapital Long Term Income Partners GP LLP LPI 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Infracapital Partners III GP SARL OS 100.00% 6, rue Eugène Ruppert, L‑245, Luxembourg
Infracapital RF GP Limited OS 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
Infracapital SLP Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Investment Centers of America, Inc OS 100.00% 314 East Thayer Avenue, Bismarck, ND 58501, USA
Jackson Charitable Foundation, Inc NSB 100.00% 1 Corporate Way, Lansing, MI 48951, USA
LIPP SARL (In liquidation) OS 100.00% 5, rue Guillaume Kroll, L‑1882, Luxembourg
London Stone Investments F3 Employee Feeder GP LLP LPI 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
M&G European Credit Investment Fund OS 99.98% 80, route d’Esch, L‑1470, Luxembourg
M&G European Select Fund OS 39.97% Laurence Pountney Hill, London, EC4R 0HH, UK
M&G General Partner Inc OS 100.00% Walker House, 87 Mary Street, Grand Cayman, KY1‑9002, Cayman Islands
M&G Gilt & Fixed Interest Income Fund OS 45.22% Laurence Pountney Hill, London, EC4R 0HH, UK
M&G International Investments Switzerland AG OS 100.00% Talstrasse 66, 8001 Zurich, Switzerland
M&G Investment Funds (10) ‑ M&G Global Listed Infrastructure Fund OS 64.83%
M&G Investments Japan Co., Ltd. OS 100.00% 3‑1 Toranomon, 4 Chome, Minato‑ku, Tokyo, Japan
M&G Managed Growth Fund OS 26.14% Laurence Pountney Hill, London, EC4R 0HH, UK
M&G PFI Carry Partnership 2016 LP LPI 25.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
M&G RE Espana 2016 S.L. OS 100.00% Plaza de Colon, Torre II, Planta 14, 28046, Madrid, Spain
M&G Real Estate Debt Fund LP LPI 29.20% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT
www.prudential.co.uk Annual Report 2017 Prudential plc 293 01 G roup overview 02 Strategic report 03 G
M&G Real Estate Japan Co., Ltd. OS 100.00% 9th Floor, Shiroyama Trust Tower, 4‑3‑1 Toranomon, Minato‑ku, Tokyo, 105‑ 6009, Japan
M&G Real Estate Korea Co., Ltd. OS 100.00% 17th Floor, Kyobo Building 1, Jongno, Jongno ‑Gu, Seoul, Korea
M&G RED II GP Limited OS 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey, GY1 1WG
M&G RED II SLP GP Limited OS 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
M&G RED III GP Limited OS 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey, GY1 1WG
M&G RED III SLP GP Limited OS 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
M&G SIF Management Company (Ireland) Limited OS 100.00% 78 Sir John Rogerson’s Quay, Dublin 2, D02 RK57, Ireland
M&G UKEV (SLP) LP LPI 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
Manchester Nominee (1) Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Mission Plans of America, Inc OS 100.00% 1999 Bryan Street, Suite 900, Dallas, TX 75201, USA
National Planning Corporation OS 100.00% 1209 Orange Street, Wilmington, DE 19801, USA
North Sathorn Holdings Company Limited OS 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn Road, Yannawa Subdistrict, Sathorn District, Bangkok, Thailand
Oaktree Business Park Limited OS 12.50% Laurence Pountney Hill, London, EC4R 0HH, UK
Old Kingsway, LP LPI 100.00% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA
Pacus (UK) Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
PCA Life Assurance Co. Ltd. OS 99.79% 8th Floor, No.1 Songzhi Road, Taipei 11047, Taiwan
PCA Reinsurance Co. Ltd. OS 100.00% Unit Level 13(A), Main Office Tower, Financial Park Labuan, Jalan Merdeka, 87000 Federal Territory of Labuan, Malaysia
PPM Finance, Inc OS 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA
PPM Managers GP Limited OS 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
PPM Ventures (Asia) Limited (In liquidation) OS 100.00% Gloucester Tower, 15 Queens Road, Central, Hong Kong
Prudential (Cambodia) Life Assurance Plc OS 100.00% 20th Floor, #445, Monivong Blvd, Boeung Prolit, 7 Makara, Phnom Penh Tower, Phnom Penh, Cambodia
Prudential Assurance Company Singapore (Pte) Limited OS 100.00% 30 Cecil Street, #30‑01 Prudential Tower, Singapore 049712
Prudential Assurance Malaysia Berhad OS 51.00% Level 3, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia
Prudential BSN Takaful Berhad OS 49.00% Level 8A, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia
Prudential Capital plc OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Corporation Australasia Holdings Pty Limited OS 100.00% c/o Highgate Legal Pty Limited, 33 Lexington Drive, Bella Vista, NSW 2153, Australia
Prudential Corporation Holdings Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Credit Opportunities 1 SARL OS 100.00% 1, Rue Hildegard von Bingen, L‑1282 Luxembourg
Prudential Hong Kong Limited OS 100.00% 59th Floor, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong
Prudential Life Assurance (Lao) Company Limited OS 100.00% Unit A, 6th Floor, Vientiane Plaza Hotel Office Building, Sailom Road, Hatsady Neua Village, Chanthabouly District, Vientiane Capital, Lao PDR
Prudential Life Assurance (Thailand) Public Company Limited OS 99.93% 9/9 Sathorn Building, 20th– 27th Floor, South Sathorn Road, Yannawa, Sahtorn, Bangkok 10120, Thailand
Prudential Life Assurance Kenya Limited OS 100.00% 5th Ngong Avenue, Nairobi, Kenya
Prudential Life Assurance Zambia Limited OS 100.00% Prudential House, Thabo Mbeki Road, Lusaka, Zambia
Prudential Mortgages Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Polska sp. z.o.o OS 100.00% 02‑670 Warszawa, Pulawska 182, Poland
Prudential Portfolio Management Group Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Properties Trusty Pty Limited OS 100.00% Darling Park Tower 2, 201 Sussex Street, Sydney, NSW 2000, Australia
Suite 1005, 10th Floor, Wisma Hamzah‑Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia
Prudential Services Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Services Singapore Pte. Ltd. OS 100.00% 1 Wallich Street, #19‑01 Guoco Tower, Singapore 078881
Prudential Singapore Holdings Pte. Limited OS 100.00% 30 Cecil Street, #30‑01 Prudential Tower, Singapore 049712
Prudential UK Services Limited OS 100.00% Craigforth, Stirling, FK9 4UE, UK
Prudential Unit Trusts Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Prudential Vietnam Assurance Private Limited OS 100.00% 25th Floor, Saigon Trade Centre, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam
Prudential Vietnam Finance Company Limited OS 100.00% 23rd Floor, Saigon Trade Centre, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam
Prudential/M&G UK Companies Financing Fund LP LPI 34.42% Laurence Pountney Hill, London, EC4R 0HH, UK
PVM Partnerships Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
REALIC of Jacksonville Plans, Inc OS 100.00% 1999 Bryan Street, Suite 900, Dallas, TX 75201, USA
Rift GP 1 Limited OS 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK
ScotAm Pension Trustees Limited OS 100.00% Craigforth, Stirling, FK9 4UE, UK
Scottish Amicable Life Assurance Society No share capital 100.00% Craigforth, Stirling, FK9 4UE, UK
Scotts Spazio Pte. Ltd. OS 45.00% 30 Cecil Street, #23‑02, Prudential Tower, Singapore 049712
Sectordate Limited OS 32.60% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham, B2 5PP, UK
Selly Oak Shopping Park (General Partner) Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
SII Investments, Inc OS 100.00% 5555, Grande Market Drive, Appleton, WI 54912, USA
Silverfleet Capital 2004 LP LPI 100.00% 1 Royal Plaza, St Peters Port, Guernsey, GY1 2HL
Squire Capital I, LLC MI 100.00% 1 Corporate Way, Lansing, MI 48951, USA
Squire Reassurance Company, LLC OS 100.00% 1 Corporate Way, Lansing, MI 48951, USA
Suite 1005, 10th Floor Wisma Hamzah‑Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia
Thanachart Life Assurance Public Company Limited (In liquidation) OS 99.93% 9/9 Sathorn Building, 25th Floor, South Sathorn Road, Yannawa, Sathorn, Bangkok 10120, Thailand
The Car Auction Unit Trust OS 50.00% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT
The St Edward Homes Partnership OS 49.95% Berkeley House, 19 Portsmouth Road, Cobham, Surrey, KT11 1JG, UK
The Strand Property Unit Trust LPI 50.00% Liberte house, 19‑23 La Motte Street, St Helier, Jersey, JE2 4SY
Two Rivers LP LPI 50.00% Bow Bells House, 1 Bread Street, London, EC4M 9HH, UK
Wessex Gate Limited OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK
Wynnefield Private Equity Partners I, LP LPI 99.00% 1105 North Market Street, Suite 1300, Wilmington, DE 19801, USA
Significant accounting policies In addition to the critical accounting polices presented in note A3.1, the following detailed accounting policies are adopted by the Group to prepare the consolidated financial statements. These accounting policies are applied consistently for all years presented and normally are not subject to change unless new accounting standards, interpretations or amendments are introduced by the IASB.
(a) Basis of consolidation The Group consolidates those investees it is deemed to control. The Group has control over an investee if all three of the following are met: (1) it has power over an investee; (2) it is exposed to, or has rights to, variable returns from its involvement with the investee; and (3) it has ability to use its power over the investee to affect its own returns.
The Group performs a re‑assessment of consolidation whenever there is a change in the substance of the relationship between the Group and an investee. Where the Group is deemed to control an entity it is treated as a subsidiary and its results, assets and liabilities are consolidated. Where the Group holds a minority share in an entity, with no control over the entity, the investments are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position.
Where the Group’s asset manager sets up OEICs and UTs as part of asset management operations, the Group’s interest is limited to the administration fees charged to manage the assets of such entities. With no participation in these entities, the Group does not retain risks associated with OEICs and UTs. For these open‑ended investment companies and unit trusts, the Group is not deemed to control the entities but to be acting as an agent.
The majority of such vehicles are not consolidated. In these cases the Group is not the sponsor of the vehicles in which it holds investments and has no administrative rights over the vehicles’ activities. The Group generates returns and retains the ownership risks commensurate to its holding and its exposure to the investments. Accordingly the Group does not have power over the relevant activities of such vehicles and all are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position.
(c) Earned premiums, policy fees and claims paid Premiums for conventional with‑profits policies and other protection type insurance policies are recognised as revenue when due. Premiums and annuity considerations for linked policies, unitised with‑profits and other investment type policies are recognised as revenue when received or, in the case of unitised or unit‑linked policies, when units are issued. These amounts exclude premium taxes and similar duties where Prudential collects and settles taxes borne by the customer.
The Group uses the trade date method to account for regular purchases and sales of financial assets. See note A3.1 for further details of valuation of financial investments.
www.prudential.co.uk Annual Report 2017 Prudential plc 301 01 G roup overview 02 Strategic report 03 G
The Group may designate certain derivatives as hedges. For 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 is recognised in other comprehensive income. The ineffective portion of changes in the fair value of the hedging instrument is recorded in the income statement.
In addition, the Group applies the option under IFRS 4 to not separate and fair value surrender options embedded in host contracts and with‑profits investment contracts whose strike price is either a fixed amount or a fixed amount plus interest.
The operating segments identified by the Group reflect the Group’s organisational structure, which, following a reorganisation during the year, is by business units Asia, US and UK and Europe. All business units contain both insurance and asset management operations.
(g) 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.
The Group utilises the projected unit credit method to calculate the defined benefit obligation. This method sees each period of service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation. Estimated future cash flows are then discounted at a high‑quality corporate bond rate, adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine its present value. These calculations are performed by independent actuaries.
(n) Intangible assets Intangible assets acquired on the purchase of a subsidiary or portfolio of contracts are measured at fair value on acquisition. Deferred acquisition costs are accounted for as described in note A3.1(c). Other intangible assets, such as distribution rights and software, are valued initially at the price paid to acquire them and are subsequently carried at cost less amortisation and any accumulated impairment losses. Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contract. Amounts for distribution rights are amortised on a basis to reflect the pattern in which the future economic benefits are expected to be consumed by reference to new business production levels. The same principles apply to determining the amortisation method for other intangible assets unless the pattern cannot be determined reliably, in which case a straight line method is applied. Amortisation of intangible assets is charged to the ‘acquisition costs and other expenditure’ line in the consolidated income statement. Impairment testing is conducted when there is an indication of impairment.
(o) Cash and cash equivalents Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, treasury bills and other short‑term highly liquid investments with less than 90 days maturity from the date of acquisition.
(q) Share capital Shares are classified as equity when their terms do not create an obligation to transfer assets. The difference between the proceeds received on issue of the shares, net of share issue costs, and the nominal value of the shares issued, is credited to share premium. Where the Company purchases shares for the purposes of employee incentive plans, the consideration paid, net of issue costs, is deducted from retained earnings. Upon issue or sale any consideration received is credited to retained earnings net of related costs.
For diluted earnings per share, the weighted average number of shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Group’s only class of potentially dilutive ordinary shares are those share options granted to employees where the exercise price is less than the average market price of the Company’s ordinary shares during the year. No adjustment is made if the impact is anti‑dilutive overall.
Fixed assets Investments in subsidiary undertakings 5 10,798 10,859 Current assets Debtors: Amounts owed by subsidiary undertakings 4,732 5,798 Other debtors 5 11
Amounts owed to subsidiary undertakings (715) (773) Tax payable (10) (10) Deferred tax liability 9 (12) (9) Accruals and deferred income (79) (72)
The financial statements of the parent company on pages 305 to 313 were approved by the Board of Directors on 14 March 2018 and signed on its behalf.
Total comprehensive income for the year Profit for the year – – 840 840 Actuarial gains recognised in respect of the defined benefit pension scheme – – 4 4
alue (EEV ) basis results 07 A dditional inform ation 1 Nature of operations
In these financial statements, the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: — A cash flow statement and related notes; — Disclosures in respect of transactions with wholly‑owned subsidiaries within the Prudential Group; — Disclosure in respect of capital management; and — The effects of new but not yet effective IFRSs.
In 2017, the Company adopted Amendments to IAS 12, ‘Income Taxes’ (recognition of deferred tax assets) and Annual Improvements to IFRSs 2014‑2016 Cycle. Their adoption had no material impact on the financial statements of the Company.
Derivatives Derivative financial instruments are held to manage certain macro‑economic exposures. Derivative financial instruments are carried at fair value with changes in fair value included in the profit and loss account.
Borrowings Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profit and loss account to the date of maturity or, for subordinated debt, over the expected life of the instrument.
Notes on the parent company financial statements continued 3 Significant accounting policies continued
Pensions The Company assumes a portion of the pension surplus or deficit of the Group’s main pension scheme, the Prudential Staff Pension Scheme (‘PSPS’). The Company applies the requirements of IAS 19 ‘Employee Benefit’ (as revised in 2011) for the accounting of its interest in the PSPS surplus or deficit. Further details are disclosed in note 7.
The assets and liabilities of the defined benefit pension schemes of the Prudential Group are subject to a full triennial actuarial valuation using the projected unit method. Estimated future cash flows are then discounted at a high quality corporate bond yield, adjusted to allow for the difference in duration between the bond index and the pension liabilities, where appropriate, to determine their present value. These calculations are performed by independent actuaries.
www.prudential.co.uk Annual Report 2017 Prudential plc 309 01 G roup overview 02 Strategic report 03 G
FRS 101 and IFRS 1,235 840 Share in the IFRS result of the Group, net of distributions to the Company* 1,155 1,081
Profit after tax of the Group attributable to shareholders in accordance with IFRS 2,390 1,921
Subsidiary undertakings of the Company at 31 December 2017 are listed in note D6 of the Group financial statements.
A description of the regulatory framework in which the Scheme operates, the governance of the Scheme, and the risks to which the Scheme exposes the Company is provided in note C9. The most recent full valuation has been updated to 31 December 2017, applying the principles prescribed by IAS 19. The actuarial assumptions used in determining the IAS 19 benefit obligations and the net periodic costs and sensitivity of IAS 19 benefit obligation to changes in the actuarial assumptions are also provided in note C9.
The assets and liabilities of the Scheme were: Quoted prices in an active market Other Total
Underlying surplus in the Scheme 721 717 Effect of the application of IFRIC 14 for de‑recognition of surplus (485) (558)
www.prudential.co.uk Annual Report 2017 Prudential plc 311 01 G roup overview 02 Strategic report 03 G
Actuarial gains (losses) note (ii) 40 (33) 7 87 94 Contributions paid by the employer note (iii) 11 – 11 – 11 Contributions paid by the employee – – – – – Benefits paid (391) 391 – – –
Total actuarial gains (losses) without the effect of IFRIC 14 7 (277)
Actuarial gains attributable to the Company before tax† 34 4 * The total return on Scheme assets in 2017 was a gain of £233 million (2016: £1,199 million). † Actuarial gains attributable to the Company are net of the apportionment to the PAC with‑profits fund and are related to the surplus recognised in the balance sheet of the
A summary of the ordinary shares in issue and the options outstanding to subscribe for the Company’s shares at 31 December 2017 is set out in note C10 of the Group financial statements.
www.prudential.co.uk Annual Report 2017 Prudential plc 313 01 G roup overview 02 Strategic report 03 G
Under English company law, Prudential may pay dividends only if sufficient distributable reserves of the Company are available for the purpose and if the amount of its net assets is greater than the aggregate of its called up share capital and non‑distributable reserves (such as the share premium account) and the payment of the dividend does not reduce the amount of its net assets to less than that aggregate.
The retained profit of the Company is substantially generated from dividend income received from subsidiaries. The Group segmental analysis illustrates the generation of profit across the Group (see note B1 of the Group financial statements). The Group and its subsidiaries are subject to local regulatory minimum capital requirements, as set out in note C12 of the Group financial statements. A number of the principal risks set out in the ’Report on the risks facing our business and how these are managed’ could impact the generation of profit in the Group’s subsidiaries in the future and hence impact their ability to pay dividends in the future.
b Information on transactions of the directors with the Group is given in note D4 of the Group financial statements. c The Company employs no staff. d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2016: £0.1 million) and for other services were £0.1 million (2016: £0.1 million). e In certain instances, the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment.
The second interim ordinary dividend for the year ended 31 December 2017, which was approved by the Board of Directors after 31 December 2017, is described in note B6 of the Group financial statements.
Intention to demerge the Group’s UK businesses In March 2018, the Group announced its intention to demerge its UK and Europe business (‘M&G Prudential’) from Prudential plc, resulting in two separately listed companies. In preparation for the UK demerger process, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019.
* Relates to £12.0 billion of IFRS shareholder annuity liabilities, valued as at 31 December 2017.
Company law requires the Directors to prepare Group and parent company financial statements for each financial year. Under that law the Directors are required to prepare the Group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU) and applicable law and have elected to prepare the parent company financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice) including FRS 101 Reduced Disclosure Framework.
The Directors of Prudential plc, whose names and positions are set out on pages 83 to 87 confirm that to the best of their knowledge: — The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; — The strategic report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face; and
We were appointed as auditor by the shareholders in October 1999. The period of total uninterrupted engagement is the 19 years ended 31 December 2017. We have fulfilled our ethical responsibilities under, and we remain independent of the Group in accordance with, UK ethical requirements including the Financial Reporting Council (‘FRC’) Ethical Standard as applied to listed public interest entities. No non‑audit services prohibited by that standard were provided.
2 Key audit matters: Our assessment of risks of material misstatement Key audit matters are those matters that, in our professional judgement, were of most significance in the audit of the financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. We summarise below the key audit matters, in decreasing order of audit significance, in arriving at our audit opinion above, together with our key audit procedures to address those matters and, as required for public interest entities, our results from those procedures. These matters were addressed, and our results are based on procedures undertaken, in the context of, and solely for the purpose of, our audit of the financial statements as a whole, and in forming our opinion thereon, and consequently are incidental to that opinion, and we do not provide a separate opinion on these matters.
The Group has significant policyholder liabilities representing 86 per cent of the Group’s total liabilities.
We used our own actuarial specialists to assist us in performing our procedures in this area.
Our procedures included: Methodology choice We have assessed the methodology for selecting assumptions and calculating the policyholder liabilities. This included: — Applying our understanding of developments in the business and the impact of changes in methodology on the selection of assumptions; — Comparing changes in methodology to our expectations derived from market experience; and
— Assessing the assumptions relating to policyholder behaviour by comparing to relevant company and industry historical experience data.
— Evaluating the evidence used to prepare the mortality experience investigation by reference to actual mortality experience of the policyholders in order to assess whether this supported the year‑end assumptions adopted; and
— Assessing whether the expense assumptions appropriately reflect the expected future costs of administering the underlying policies by analysing current year unit costs and the likely impact of planned actions.
Benchmarking assumptions and sector experience — Comparing mortality experience to industry data on current mortality and expectations of future mortality improvements; — Evaluating the credit risk assumptions by reference to industry practice and our expectation derived from market experience; and
— Used the results of our industry benchmarking of assumptions and actuarial market practice to inform our challenge of the assumptions in relation to the mortality, credit risk and expense assumptions.
Valuation of policyholder liabilities (2017: £411,243 million, 2016: £388,996 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 168 (accounting policy) and pages 230 to 252 (financial disclosures)
Valuation of investments (2017: £422,230 million, 2016: £393,584 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 174 (accounting policy) and pages 209 to 229 (financial disclosures)
The Group’s investment portfolio represents 91 per cent of the Group’s total assets.
The valuation of the portfolio involves judgement depending on the observability of the inputs into the valuation and further judgement in determining the appropriate valuation methodology for harder to value investments where external pricing sources are either not readily available or are unreliable.
For quoted investments: Tests of details We performed independent price checks using external quoted prices and by agreeing the observable inputs that were used in the Group’s valuation techniques to external data.
Benchmarking assumptions We assessed a sample of the valuation assumptions with reference to the Group’s own valuation guidelines as well as industry practice.
Assessing transparency We assessed whether the disclosures in relation to the valuation of investments are compliant with the relevant accounting requirements and appropriately present the sensitivities in the valuations based on alternative outcomes.
Subjective valuation DAC involves judgements in respect of the identification of the acquisition costs that may be deferred, the appropriateness of the deferral methodology adopted and the assessment of the recoverability of the asset.
The amortisation and recoverability assessment of the DAC asset in the US component is related to the achieved and projected future profit profile. This involves making assumptions about future investment returns and the consequential impact on fee income; therefore there is a greater level of subjectivity involved in relation to the US DAC.
We used our own actuarial specialists to assist us in performing our audit procedures in this area.
Our procedures included: Methodology choice We evaluated the appropriateness of the deferral methodology by reference to the requirements of relevant accounting standards.
Assessing application We evaluated the judgements involved in determining whether the costs incurred are deferred appropriately by reference to the adopted deferral methodology.
Tests of detail We verified the accuracy of the calculations performed including the extent of the amortisation adjustment determined based on an assessment of the future profit profiles.
Assessing transparency We assessed whether the disclosures in relation to the valuation and amortisation of DAC are compliant with the relevant accounting requirements.
Our result We found the valuation and amortisation of DAC to be acceptable (2016: acceptable).
Determination of pension asset (restricted surplus) in respect of the defined benefit pension scheme (Pension asset (restricted surplus) – 2017: £71 million, 2016: £48 million). The risk relates to the parent company financial statements. Refer to page 105 (Audit Committee Report), page 308 (accounting policy) and pages 271 to 276 (financial disclosures)
The parent company assumes a portion of the surplus of the Group’s main defined benefit pension scheme.
Subjective valuation Where an entity does not have a right to a refund the asset ceiling is determined by reference to the present value of the difference between the estimated future service cost and the contributions payable by the entity over the future working lives of the active members. Assumptions are made over the future service costs.
Our procedures included: Methodology choice We assessed, with the support of our pension specialists, the methodology for selecting assumptions underpinning the calculation of the defined benefit pension obligation and the estimated future service cost including the consequent calculation of the restricted surplus by reference to the relevant accounting standards.
We also considered whether the movements in the defined benefit pension obligation and the estimated future service cost, including the consequential calculation of the restricted surplus, were consistent with the changes made in the assumptions from the prior year.
Our result We found the pension asset (restricted surplus) recognised in respect of the defined benefit pension scheme to be acceptable (2016: acceptable).
3 Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £350 million (2016: £350 million) determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 2.2 per cent (2016: 2.4 per cent)). We consider IFRS shareholders’ equity to be the most appropriate benchmark as it represents the residual interest that can be ascribed to shareholders after policyholder assets and corresponding liabilities have been accounted for; we consider that this is the most appropriate measure for the size of the business and that it provides a stable measure year on year. We compared our materiality against other relevant benchmarks, such as total assets, total revenue and profit before tax to ensure the materiality selected was appropriate for our audit.
B £80 to £186 million Range of materiality at 14 components
Materiality for the parent company financial statements as a whole was set at £186 million (2016: £ 186 million), determined with reference to a benchmark of parent company’s net assets, of which it represents 2.4 per cent (2016: 2.5 per cent).
We subjected the Group’s operations to audits for group reporting purposes as follows: Of the 14 (2016: 15) reporting components scoped in for the Group audit, we subjected 10 (2016: 10) to full scope audits for group reporting purposes and 4 (2016: 5) to an audit of account balances. The latter were not individually financially significant enough to require a full scope audit for group reporting purposes, but did present specific individual audit risks that needed to be addressed.
The components subjected to full scope audits included the parent company; the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, and Thailand; and the fund management operations of M&G and Eastspring Singapore. Additionally, the components subjected to an audit of account balances included Prudential Capital and the insurance operations in China, Taiwan and Vietnam.
The account balances audited were policyholder liabilities, investments and deferred acquisition costs. For the remaining operations, we performed analysis at an aggregated Group level to re‑examine our assessment that there were no significant risks of material misstatement within these operations.
The Senior Statutory Auditor, in conjunction with other senior staff in the Group and component audit teams, also regularly attended Business Unit audit committee meetings (these were held at a regional level for Asia) and participated in meetings with local components to obtain additional understanding first hand, of the key risks and audit issues at a component level which may affect the Group financial statements.
4 We have nothing to report on going concern We are required to report to you if: — We have anything material to add or draw attention to in relation to the Directors’ statement on page 120 to the financial statements on the use of the going concern basis of accounting with no material uncertainties that may cast significant doubt over the Group and Company’s use of that basis for a period of at least 12 months from the date of approval of the financial statements; or
— The related statement under the Listing Rules set out on page 120 is materially inconsistent with our audit knowledge.
Strategic report and Directors’ report Based solely on our work on the other information: — We have not identified material misstatements in the strategic report and the Directors’ report; — In our opinion the information given in those reports for the financial year is consistent with the financial statements; and
— In our opinion those reports have been prepared in accordance with the Companies Act 2006.
— The Directors’ explanation in the viability statement of how they have assessed the prospects of the Group, over what period they have done so and why they considered that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.
— The section of the annual report describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee.
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— The parent company financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or
7 Respective responsibilities Directors’ responsibilities As explained more fully in their statement set out on page 314, the Directors are responsible for the preparation of the financial statements including being satisfied that they give a true and fair view. They are also responsible for: such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; assessing the Group and Parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and using the going concern basis of accounting unless they either intend to liquidate the Group or the parent Company or to cease operations, or have no realistic alternative but to do so.
In addition we considered the impact of laws and regulations in the specific areas of regulatory capital recognising the financial and regulated nature of the Group’s activities. With the exception of any known or possible non‑compliance, and as required by auditing standards, our work in respect of these was limited to enquiry of the Directors and other management and inspection of regulatory and legal correspondence. We considered the effect of any known or possible non‑compliance in these areas as part of our procedures on the related financial statements items.
We communicated identified laws and regulations throughout our team and remained alert to any indications of non‑compliance throughout the audit. This included communication from the Group to component audit teams of relevant laws and regulations identified at Group level, with a request to report on any indications of potential existence of non‑compliance with relevant laws and regulations (irregularities) in these areas, or other areas directly identified by the component teams.
As with any audit, there remained a higher risk of non‑detection of irregularities, as these may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls.
8 The purpose of our audit work and to whom we owe our responsibilities This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed.
Post‑tax operating profit based on longer‑term investment returns 327 Post‑tax summarised consolidated income statement 328 Movement in shareholders’ equity 329 Summary statement of financial position 330
Description of EEV basis reporting In broad terms, IFRS profit for long‑term business reflects the aggregate of results on a traditional accounting basis. By contrast, EEV is a way of reporting the value of the life insurance business.
Results prepared under the EEV Principles capture the discounted value of future profits expected to arise from the current book of long‑term business. The results are prepared by projecting cash flows, by product, using best estimate assumptions for all relevant factors. Furthermore, in determining these expected profits, full allowance is made for the risks attached to their emergence and the associated cost of capital, taking into account recent experience in assessing likely future persistency, mortality, morbidity and expenses. Further details are explained in notes 14 and 15.
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Other income and expenditure note (i) (746) (682) Restructuring costs note (ii) (97) (32) Interest received from tax settlement – 37
Asia operations 3,860 3,199 US operations 2,150 1,968 UK and Europe operations 1,431 1,007 Other income and expenditure (746) (682) Restructuring costs (97) (32) Interest received from tax settlement – 37
Operating profit based on longer-term investment returns 6,598 5,497 Short‑term fluctuations in investment returns 5 2,111 (507) Effect of changes in economic assumptions 6 (102) (60) Mark to market value movements on core structural borrowings (326) (4) Impact of US tax reform 7 390 – Profit (loss) attaching to disposal of businesses 17 80 (410) Total non‑operating profit (loss) 2,153 (981)
Attributable to: Equity holders of the Company 8,750 4,516 Non‑controlling interests 1 –
Based on post‑tax profit attributable to equity holders of the Company (in pence) 340.9p 176.4p Weighted average number of shares (millions) 2,567 2,560
Net increase in shareholders’ equity 9 5,730 7,082 Shareholders’ equity at beginning of year 9 38,968 31,886
Shareholders’ equity at end of year 46,161 (1,463) 44,698 40,842 (1,874) 38,968
Holding company net borrowings at market value note 8 – (4,239) (4,239) – (4,052) (4,052)
Total IFRS basis shareholders’ equity 9 16,087 14,666 Additional EEV basis retained profit 9 28,611 24,302
Total EEV basis shareholders’ equity 9 44,698 38,968 * Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.
Based on EEV basis shareholders’ equity of £44,698 million (2016: £38,968 million) (in pence) 1,728p 1,510p Number of issued shares at year end (millions) 2,587 2,581
The supplementary information on pages 327 to 358 was approved by the Board of Directors on 14 March 2018.
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The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles. Except for the reclassification of results to reflect the reassessment of the Group’s operating segments as described in the note in B1.3 of the IFRS financial statements, the 2016 results have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2016.
Based on post‑tax operating profit including longer‑term investment returns after non‑controlling interests (in pence) 257.0p 214.7p 224.3p 20% 15%
Based on post‑tax profit attributable to equity holders of the Company (in pence) 340.9p 176.4p 182.5p 93% 87%
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Note After allowing for foreign exchange effects of £133 million, the new business contribution increased by £395 million on a CER basis. This increase is driven by higher sales volumes (a contribution of £188 million), a beneficial effect of changes in long‑term interest rates (£48 million) and pricing, product mix and other actions of £159 million. The £159 million impact reflects the beneficial impact of our strategic emphasis on increasing sales from health and protection business in Asia, together with a positive £76 million effect arising in the US for the impact of US tax reform (see note 7).
Unwind of discount and other expected returns 1,007 694 465 2,166 Effect of changes in operating assumptions 241 196 195 632 Experience variances and other items 89 347 13 449 2016 £m
Unwind of discount and other expected returns 866 583 445 1,894 Effect of changes in operating assumptions 54 170 25 249 Experience variances and other items 124 428 (95) 457
Unwind of discount and other expected returns note (a) 694 583 Effect of changes in operating assumptions note (b) 196 170 Experience variances and other items: Spread experience variance 71 119 Amortisation of interest‑related realised gains and losses 91 88 Other note (c) 185 221
(after allowing for the benefit of US tax reform) and a net £24 million effect for foreign exchange and interest rate movements. (b) The effect of assumption changes of £196 million in 2017 mainly relates to assumption updates for persistency, mortality and policyholder utilisation. (c) Other experience variances of £185 million in 2017 include the effects of positive mortality and persistency experience in the period, together with the benefit of tax credits relating to the dividend received deduction for variable annuity business.
Unwind of discount and other expected returns note (a) 465 445 Change in longevity assumptions basis note (b) 195 – Reduction in corporate tax rate – 25 Other items note (c) 13 (95)
(d) In response to the findings of the FCA’s Thematic Review of Annuities Sales Practices, the UK business has agreed to review all internally vesting annuities sold without advice after 1 July 2008. The FCA formally released its redress calculation methodology in early 2018 and Prudential reassessed the provision held. Reflecting this, the UK 2017 result includes a £(187) million (post‑tax) increase in the provision held for the estimated cost of the review and any appropriate customer redress. The provision held continues to exclude any potential for insurance recoveries. For more information, see note B3 of the IFRS financial statements.
alue (EEV ) basis results 07 A dditional inform ation 5 Short-term fluctuations in investment returns
Short‑term fluctuations in investment returns included in profit for the year arise as follows: (i) Group summary
Asia operations note (ii) 887 (100) US operations note (iii) 582 (1,102) UK and Europe operations note (iv) 621 876 Other operations 21 (181)
(ii) Asia operations The short‑term fluctuations in investment returns for Asia operations comprise: Hong Kong 531 (105)
Note For 2017, the credit of £887 million mainly reflects unrealised gains on bonds driven by the decrease in bond yields across many of the business units (see note 15(i)), together with higher equity returns than assumed for Hong Kong with‑profits business and higher investment returns than assumed in Singapore for with‑profits and unit‑linked businesses.
(iii) US operations The short‑term fluctuations in investment returns for US operations comprise: Investment return related experience on fixed income securities note (a) (46) (85) Investment return related impact due to changed expectation of profits on in‑force variable annuity business in future periods based on current year separate account return, net of related hedging activity and other items note (b) 628 (1,017)
Notes (a) The net result relating to fixed income securities reflects a number of offsetting items as follows: – the impact on portfolio yields of changes in the asset portfolio in the year; – the difference between actual realised gains and losses and the amortisation of interest‑related realised gains and losses that is recorded within operating profit; and – credit experience (versus the longer‑term assumption).
(b) This item reflects the net impact of: – changes in projected future fees and future benefit costs arising from the difference between the actual growth in separate account asset values of 17.5 per cent and that assumed of 5.9 per cent for the year (2016: actual growth of 8.9 per cent compared to assumed growth of 6.0 per cent); and – related hedging activity arising from realised and unrealised gains and losses on equity‑related hedges and interest rate options, and other items.
(b) The positive £229 million fluctuation in 2017 for with‑profits and other business represents the impact of achieving a 9 per cent pre‑tax return on the with‑profits fund (including unallocated surplus) compared to the assumed rate of return of 5 per cent for the year (2016: achieved return of 14 per cent compared to assumed rate of 5 per cent), partially offset by the effect of a partial hedge of future shareholder transfers expected to emerge from the UK’s with‑profits sub‑fund entered into to protect future shareholder with‑profit transfers from movements in the UK equity market.
Notes on the EEV basis results continued 6 Effect of changes in economic assumptions
For 2017, the charge of £(136) million mainly reflects the decrease in the assumed separate account return and reinvestment rates, following the 10 basis points decrease in the US 10‑year treasury yield in the year, resulting in lower projected fee income and an increase in projected benefit costs for variable annuity business. For fixed annuity and other general account business, the impact reflects the effect on the present value of future projected spread income from the combined movement in interest rates and credit spreads.
The credit of £129 million mainly reflects the movement in expected long‑term rates of return and risk discount rates as shown in note 15 (iii).
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alue (EEV ) basis results 07 A dditional inform ation 7 Impact of US tax reform
Holding company (including central finance subsidiaries) cash and short‑term investments (2,264) – (2,264) (2,626) – (2,626)
Long‑term business: Asset management and general insurance commission 155 7 416 – 578
Other items taken directly to equity: Exchange movements on foreign operations and net
Intra‑group dividends and investment in operations note (ii) (842) (466) (678) 1,986 – External dividends – – – (1,159) (1,159) Mark to market value movements on Jackson assets backing surplus and required capital – 40 – – 40
(2016: £245 million) related to Asia long‑term operations. (ii) Intra‑group dividends represent dividends that have been declared in the year and investment in operations reflect increases in share capital. The amounts included in note 11 for these items are as per the holding company cash flow at transaction rates. The difference primarily relates to intra‑group loans, foreign exchange and other non‑cash items. (iii) Other movements include reserve movements in respect of the shareholders’ share of actuarial gains and losses on defined benefit pension schemes, share capital subscribed, share‑based payments and treasury shares and intra‑group transfers between operations which have no overall effect on the Group’s embedded value. (iv) Group total EEV basis shareholders’ equity can be further analysed as follows: Total long-term business operations note 10
Total EEV basis shareholders’ equity 45,917 2,550 (3,769) 44,698 40,597 2,432 (4,061) 38,968
Existing business – transfer to net worth 3,279 (742) 2,537 (2,537) – Expected return on existing business note 4 138 201 339 1,827 2,166 Changes in operating assumptions and
Operating profit based on longer-term investment returns 3,101 42 3,143 3,672 6,815
Operating profit based on longer-term investment returns 923 205 1,128 2,577 3,705
Operating profit based on longer-term investment returns 1,321 150 1,471 672 2,143
Existing business – transfer to net worth 675 (377) 298 (298) – Expected return on existing business note 4 31 100 131 334 465 Changes in operating assumptions and
Operating profit based on longer-term investment returns 857 (313) 544 423 967
US operations Underlying free surplus generated from in‑force life business 1,575 1,866 1,961 (16)% (20)% Investment in new business note (iii)(a) (254) (298) (313) 15% 19%
Underlying free surplus generated from insurance and asset management operations before restructuring costs 3,717 3,582 3,707 4% 0%
Underlying free surplus generated from insurance and asset management operations 3,640 3,566 3,691 2% (1)%
Effects of changes in operating assumptions, operating experience variances and other items before restructuring costs 635 840 879 (24)% (28)%
Net cash flows to parent company note (c) (645) (475) (668) (1,788) 1,788 – External dividends – – – – (1,159) (1,159) Exchange rate movements, timing differences
Underlying free surplus generated before restructuring costs 859 1,565 1,158 3,582 (628) 2,954
Net cash flows to parent company note (c) (516) (420) (782) (1,718) 1,718 – External dividends – – – – (1,267) (1,267) Exchange rate movements, timing differences
(e) Other items include the effect of movements in subordinated debt for other operations, intra‑group loans and other intra‑group transfers between operations, non‑cash items.
Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years 13 Sensitivity of results to alternative assumptions
(a) Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2017 and 31 December 2016 and the new business contribution after the effect of required capital for 2017 and 2016 for long‑term business operations to: — 1 per cent increase in the discount rates; — 1 per cent increase in interest rates and risk discount rates, including consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets); — 0.5 per cent decrease in interest rates and risk discount rates, including consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets); — 1 per cent rise in equity and property yields; — 10 per cent fall in market value of equity and property assets (embedded value only); — The statutory minimum capital level in contrast to EEV basis required capital (for embedded value only); and — 5 basis points increase in UK long‑term expected defaults.
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long‑term business operations and include the combined effect on the value of in‑force business and net assets at the balance sheet dates indicated. If the change in assumptions shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year, namely the effect of economic assumption changes and short‑term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition, for changes in interest rates, the effect shown above for Jackson would also be recorded within the fair value movements on assets backing surplus and required capital, which are taken directly to shareholders’ equity.
(b) Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2017 and 31 December 2016 and the new business contribution after the effect of required capital for 2017 and 2016 for long‑term business operations to: — 10 per cent proportionate decrease in maintenance expenses (a 10 per cent sensitivity on a base assumption of £10 per annum would represent an expense assumption of £9 per annum); — 10 per cent proportionate decrease in lapse rates (a 10 per cent sensitivity on a base assumption of 5 per cent would represent a lapse rate of 4.5 per cent per annum); and
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Covered business comprises the Group’s long‑term business operations, with two exceptions: — The closed Scottish Amicable Insurance Fund (SAIF) which is excluded from covered business. SAIF is a ring‑fenced sub‑fund of The Prudential Assurance Company Limited (PAC) long‑term fund, established by a Court Approved Scheme of Arrangement in October 1997. SAIF is closed to new business and the assets and liabilities of the fund are wholly attributable to the policyholders of the fund.
(ii) Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency, mortality and morbidity, as described in note 15(vii). These assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the non‑diversifiable risks associated with the cash flows that are not otherwise allowed for.
The post‑tax contribution from new business represents profits determined by applying operating and economic assumptions as at the end of the year. New business profitability is a key metric for the Group’s management of the development of the business. In addition, post‑tax new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP). These margins are calculated as the percentage of the value of new business profit to APE and PVNBP. APE is calculated as the aggregate of regular premiums and one‑tenth of single premiums. PVNBP is calculated as equalling single premiums plus the present value of expected premiums of regular premium new business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
There are also various non‑participating long‑term products with guarantees. The principal guarantees are those for whole‑of‑life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions.
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Jackson also issues fixed index annuities (FIA) that enable policyholders to obtain a portion of an equity‑linked return while providing a guaranteed minimum return. The guaranteed minimum returns are of a similar nature to those described above for fixed annuities.
With‑profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses: annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The PAC with‑profits fund also held a provision of £53 million at 31 December 2017 (31 December 2016: £62 million) to honour guarantees on a small number of guaranteed annuity option products.
The Group’s main exposure to guaranteed annuity options in M&G Prudential is through the non‑covered business of SAIF. A provision of £503 million was held in SAIF at 31 December 2017 (31 December 2016: £571 million) to honour the guarantees. As described in note 14(a)(i), the assets and liabilities are wholly attributable to the policyholders of the fund. Therefore the movement in the provision has no direct impact on shareholders’ funds.
Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market data, historic market data and an assessment of long‑term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for correlation between the various asset classes. Details of the key characteristics of each model are given in notes 15(iv), (v) and (vi).
— UK and Europe: the capital requirements are set at the Solvency II Solvency Capital Requirement (SCR) for shareholder‑backed business as a whole.
(vi) With-profits business and the treatment of the estate The proportion of surplus allocated to shareholders from the PAC with‑profits fund has been based on the present level of 10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing final bonus rates (and related shareholder transfers) so as to exhaust the estate over the lifetime of the in‑force with‑profits business. In any scenarios where the total assets of the life fund are insufficient to meet policyholder claims in full, the excess cost is fully attributed to shareholders. Similar principles apply, where appropriate, for other with‑profits funds of the Group’s Asia operations.
The projected rates of return for holdings of corporate bonds comprise the risk‑free rate plus an assessment of long‑term spread over the risk‑free rate.
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In the annuity MCEV calculations, as the assets are generally held to maturity to match liabilities, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on the Solvency II allowance for credit risk. The Solvency II allowance is set by European Insurance and Occupational Pensions Authority (EIOPA) using a prudent assumption that all future downgrades will be replaced annually, and allowing for the credit spread floor.
For the purposes of presentation in the EEV results, the results on this basis are reconfigured. Under this approach the projected earned rate of return on the debt securities held is determined after allowing for a best estimate credit risk allowance. The remaining elements of prudence within the Solvency II allowance are incorporated into the risk margin included in the discount rate, shown in note 15(iii).
(2) With-profits fund non-profit annuity business For non‑profit annuity business attributable to the PAC with‑profits fund, the basis for determining the aggregate allowance for credit risk is consistent with that applied for UK shareholder‑backed annuity business (as described above). The allowance for credit risk for this business is taken into account in determining the projected cash flows from the with‑profits fund, which are in turn discounted at the risk discount rate applicable to all of the projected cash flows from the fund.
Allowance for non-diversifiable non-market risks The majority of non‑market and non‑credit risks are considered to be diversifiable. An allowance for non‑diversifiable non‑market risks is estimated as set out below: A base level allowance of 50 basis points is applied to cover the non‑diversifiable non‑market risks associated with the Group’s businesses. For the Group’s Asia operations in China, Indonesia, the Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points. The level of these allowances are reviewed and updated based on an assessment of a range of pre‑defined emerging market risk indicators, as well as the Group’s exposure and experience in the business units. During 2017, the China allowance for non‑market risk was reduced reflecting the growth in the size of the business, increasing management exposure and experience in the country and an improvement in our risk assessment of the market. For the Group’s US business and UK and Europe business, no additional allowance is necessary.
(xi) Inter-company arrangements The EEV results for covered business incorporate annuities established in the PAC non‑profit sub‑fund from vesting pension policies in SAIF (which is not covered business). The EEV results also incorporate the effect of the reinsurance arrangement of non‑profit immediate pension annuity liabilities of SAIF to the PAC non‑profit sub‑fund.
Non‑operating results comprise the recurrent items of: — Short‑term fluctuations in investment returns; — The mark to market value movements on core structural borrowings; and — The effect of changes in economic assumptions.
(iii) Unwind of discount and other expected returns The Group’s methodology in determining the unwind of discount and other expected returns is by reference to: — The value of in‑force business at the beginning of the year (adjusted for the effect of current year economic and operating assumption changes); and
M&G Prudential The unwind is determined by reference to an implied single risk discount rate. The EEV risk‑free rate is based on a yield curve (as set out in note 14(a)(viii)), which is used to derive a single implied discount rate which, if this rate had been used, would reproduce the same embedded value as that calculated by reference to the yield curve. The difference between the operating profit determined using the single implied discount rate and that derived using the yield curve is included within non‑operating profit.
(iv) Effect of changes in operating assumptions Operating profit includes the effect of changes to non‑economic assumptions on the value of in‑force at the end of the year. For presentational purposes the effect of changes is delineated to show the effect on the opening value of in‑force as operating assumption changes, with the experience variances subsequently being determined by reference to the end‑of‑year assumptions (see note 14(b)(v)).
(vi) Effect of changes in economic assumptions Movements in the value of in‑force business at the beginning of the year caused by changes in economic assumptions, net of the related change in the time value of cost of options and guarantees, are recorded in non‑operating results. For M&G Prudential, the embedded value incorporates Solvency II transitional measures, which are recalculated using management’s estimate of the impact of operating and market conditions at the valuation date. The effect of changes in economic assumptions is after allowing for this recalculation.
Total weighted risk discount rate note (a) 5.3 5.3 5.7 6.1
Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each market’s risk discount rates by reference to the post‑tax EEV basis new business contribution and the closing value of in‑force business. The changes in the risk discount rates for individual Asia business units reflect: – the movements in 10‑year government bond yields; – changes in product mix; and – the effect of changes in the economic basis (see note 14(a)(viii) and above).
(ii) US The risk‑free rates of return for the US are defined as 10‑year treasury bond yield at the end of the year.
Fixed index annuity business: January to June issues 1.75 1.50 July to December issues 1.50 1.50
Non‑variable annuity: Risk discount rate 4.1 4.1 Additional allowance for credit risk included in risk discount rate note 14(a)(viii) 1.0 1.0
US 10‑year treasury bond yield 2.4 2.5 Pre‑tax expected long‑term nominal rate of return for US equities 6.4 6.5 Expected long‑term rate of inflation 3.0 3.0 Equity risk premium 4.0 4.0 S&P equity return volatility note (v) 18.0 18.0 * Including the proportion of variable annuity business invested in the general account and fixed index annuity business, the assumed spread margin grades up linearly by 25 basis points to a long‑term assumption over five years.
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Risk discount rate 4.0 4.5 Pre‑tax expected 15‑year nominal rates of investment return note (c) 2.6 2.8 With-profits and other business: Risk discount rate: note (b)
Expected 15‑year rate of inflation 3.5 3.6 Equity risk premium 4.0 4.0
Notes (a) For shareholder‑backed annuity business, the movements in the pre‑tax long‑term nominal rates of return and risk discount rates reflect the effect of changes in asset yields. (b) The risk discount rates for with‑profits and other business shown above represents a weighted average total of the rates applied to determine the present value of future cash flows, including a portion of future with‑profits business shareholders’ transfers recognised in net worth. (c) The table below shows the pattern of the UK risk‑free Solvency II spot yield curve at the end of both years: 1 year 5 year 10 year 15 year 20 year
Stochastic assumptions Details are given below of the key characteristics of the models used to determine the time value of the financial options and guarantees as referred to in note 14(a)(iv).
(iv) Asia — The stochastic cost of guarantees is primarily of significance for the Hong Kong, Malaysia, Singapore and Taiwan operations; — The principal asset classes are government and corporate bonds; — The asset return models are similar to the models as described for M&G Prudential below; and — The volatility of equity returns ranges from 18 per cent to 35 per cent, and the volatility of government bond yields ranges from 1.1 per cent to 2.0 per cent (2016: from 0.9 per cent to 2.3 per cent) following a number of modelling changes at full year 2017 in respect of future bond returns.
(vi) UK and Europe (M&G Prudential) — Interest rates are projected using a stochastic interest rate model calibrated to the current market yields; — Equity returns are assumed to follow a log‑normal distribution; — The corporate bond return is calculated based on a risk‑free return plus a mean‑reverting spread; — Property returns are also modelled on a risk‑free return plus a risk premium with a stochastic process reflecting total property returns; and
Operating assumptions (vii) Best estimate assumptions Best estimate assumptions are used for the cash flow projections, where best estimate is defined as the mean of the distribution of future possible outcomes. The assumptions are reviewed actively and changes are made when evidence exists that material changes in future experience are reasonably certain.
Corporate expenditure, which is included in other income and expenditure, comprises: — Expenditure for Group Head Office, to the extent not allocated to the PAC with‑profits funds, together with restructuring costs; and — Expenditure of the Asia Regional Head Office that is not allocated to the covered business or asset management operations which is charged as incurred. These costs are primarily for corporate related activities and are included within corporate expenditure.
The local statutory corporate tax rates applicable for the most significant operations for 2016 and 2017 are as follows: Statutory corporate tax rates %
Asia operations: Hong Kong 16.5 per cent on 5 per cent of premium income Indonesia 25.0 Malaysia 24.0 Singapore 17.0
US operations* 2016 and 2017: 35.0; from 1 January 2018: 21.0 UK operations 2016: 20.0; from 1 April 2017: 19.0; from 1 April 2020: 17.0 * The US tax reform changes included a reduction in the corporate income tax rate from 35 per cent to 21 per cent effective from 1 January 2018 (see note 7).
www.prudential.co.uk Annual Report 2017 Prudential plc 357 01 G roup overview 02 Strategic report 03 G
SE Asia operations including Hong Kong 2,011 2,186 2,857 2,856 3,058 3,075 17,508 17,224
Notes on the EEV basis results continued 17 Disposal of businesses
Intention to demerge the Group’s UK businesses In March 2018, the Group announced its intention to demerge its UK & Europe business (‘M&G Prudential’) from Prudential plc, resulting in two separately‑listed companies. In preparation for the UK demerger process, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019.
The Directors have chosen to prepare supplementary information in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (‘the EEV Principles’) using the methodology and assumptions set out in the Notes on the EEV basis results.
Opinions and conclusions arising from our audit Our opinion on the EEV basis supplementary information is unmodified We have audited the EEV basis supplementary information of Prudential plc (the Company) for the year ended 31 December 2017 set out in the EEV basis results and Notes on the EEV basis results pages. The EEV basis supplementary information should be read in conjunction with the Group financial statements.
In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2017 has been properly prepared, in all material respects, in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (‘the EEV Principles’) using the methodology and assumptions set out in the Notes on the EEV basis results.
Respective responsibilities of directors and auditor As explained more fully in the Directors’ responsibilities statement set out on page 359, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Scope of an audit of financial statements performed in accordance with ISAs (UK and Ireland) A description of the scope of an audit of financial statements is provided on our website at www.kpmg.com/uk/ auditscopeukco2014a. This report is made subject to important explanations regarding our responsibilities, as published on that website, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.
Philip Smart for and on behalf of KPMG LLP Chartered Accountants London
www.prudential.co.uk Annual Report 2017 Prudential plc 363 01 G roup overview 02 Strategic report 03 G
I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre‑tax operating earnings from long‑term insurance operations into the underlying drivers of those profits, using the following categories: — Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets.
— DAC adjustments comprise DAC amortisation for the year, excluding amounts related to short‑term fluctuations in investment returns, net of costs deferred in respect of new business.
Analysis of pre-tax IFRS operating profit by source and margin analysis of Group long-term insurance business The following analysis expresses certain of the Group’s sources of operating profit as a margin of policyholder liabilities or other relevant drivers. Details on the calculation of the Group’s average policyholder liability balances are given in note (iv) at the end of this section.
Longevity reinsurance and other management actions to improve solvency 276 276 Changes in longevity assumption basis 204 204 Provision for review of past annuity sales (225) (225)
Long‑term business operating profit based on longer‑term investment returns 1,799 2,214 861 4,874
Long‑term business operating profit based on longer‑term investment returns 1,571 2,155 799 4,525
www.prudential.co.uk Annual Report 2017 Prudential plc 365 01 G roup overview 02 Strategic report 03 G
— Fee income has increased by 10 per cent at constant exchange rates (AER: 14 per cent) to £199 million in 2017, broadly in line with the increase in movement in average unit‑linked liabilities.
— Insurance margin has increased by 21 per cent to £1,310 million in 2017 on a constant exchange rate basis (AER: 26 per cent), primarily reflecting the continued growth of the in‑force book, which contains a relatively high proportion of risk‑based products.
— Insurance margin represents operating profits from insurance risks, including variable annuity guarantees and other sundry items. Insurance margin decreased to £906 million in 2017 from £933 million in 2016 on a constant exchange rate basis, with higher income from the variable annuity guarantees being more than offset by a decline in the contribution from the closed books of business.
— Acquisition costs, which are commissions and expenses incurred to acquire new business, including those that are not deferrable, have decreased by 5 per cent at a constant exchange rate basis, largely due to the continued increase in producers selecting asset‑based commissions, which are paid upon policy anniversary dates and are treated as an administration expense in this analysis, rather than front end commissions.
— Administration expenses increased to £1,174 million during 2017, compared to £1,007 million for 2016 at a constant exchange rate (AER: £959 million), primarily as a result of higher asset based commissions. Excluding these asset‑based commissions, the resulting administration expense ratio was relatively flat at 35 basis points (2016: 34 basis points at CER and AER).
www.prudential.co.uk Annual Report 2017 Prudential plc 367 01 G roup overview 02 Strategic report 03 G
Other DAC adjustments – amortisation of previously deferred acquisition costs: Analysis of operating profit based on longer-term investment returns for US operations by product
The analysis of operating profit based on longer‑term investment returns for US operations by product represents the net profit generated by each line of business after allocation of costs. Broadly: a) Spread business is the net operating profit for fixed annuity, fixed indexed annuity and guaranteed investment contracts and largely comprises spread income less costs.
b) Fee business represents profits from variable annuity products. As well as fee income, revenue for this product line includes spread income from investments directed to the general account and other variable annuity fees included in insurance margin.
Analysis of UK and Europe operating profit drivers: — Spread income reduced from £177 million in 2016 to £137 million in 2017, mainly due to lower annuity sales. Spread income has two components: – A contribution from new annuity business which was lower at £9 million in 2017 compared to £41 million in 2016, reflecting our effective withdrawal from this market.
– A contribution from in‑force annuity and other business, which was broadly in line with last year at £128 million (2016: £136 million), equivalent to 38 basis points of average reserves (2016: 42 basis points).
— The £204 million favourable longevity assumption changes reflect the adoption of the Continuous Mortality Investigation 2015 model. Further information on changes to mortality assumptions is given in note C4.1 (d).
Notes to sources of earnings tables (i) The ratio for acquisition costs is calculated as a percentage of APE sales including with‑profits sales. Acquisition costs include only those relating to shareholder‑backed business. (ii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. (iii) The 2016 comparative information has been presented at AER and CER so as to eliminate the impact of exchange translation. CER results are calculated by translating prior year results using the current year foreign exchange rates. All CER profit figures have been translated at current year average rates. For Asia CER average liability calculations, the policyholder liabilities have been translated using current year opening and closing exchange rates. For the US CER average liability calculations, the policyholder liabilities have been translated at the current year month end closing exchange rates. See also note A1.
(iv) For UK and Europe and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as a proxy for average balances throughout the year. The calculation of average liabilities for Jackson is generally derived from month end balances throughout the year, as opposed to opening and closing balances only. The average liabilities for fee income in Jackson have been calculated using daily balances instead of month end balances in order to provide a more meaningful analysis of the fee income, which is charged on the daily account balance. Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administration expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson. Average liabilities are adjusted for business acquisitions and disposals in the year.
(v) The DAC adjustments contain a credit of £43 million in respect of joint ventures and an associate in 2017 (2016: AER credit of £28 million).
I(b) Asia operations – analysis of IFRS operating profit by business unit Operating profit based on longer‑term investment returns for Asia operations is analysed as follows: 2017 £m AER
Notes (i) Analysis of operating profit between new and in‑force business The result for insurance operations comprises amounts in respect of new business and business in force as follows: AER CER
The new business result reflects the aggregate of the pre‑tax regulatory basis result to net worth after IFRS adjustments for deferral of acquisition costs and deferred income where appropriate.
I(c) Analysis of asset management operating profit based on longer-term investment returns 2017 £m
Operating income before performance‑related fees 1,034 421 Performance‑related fees 53 17
Average funds under management £275.9bn £128.4bn Margin based on operating income* 37bps 33bps Cost/income ratio† 58% 56%
Operating income before performance‑related fees 923 353 Performance‑related fees 33 7
Operating income (net of commission) note (i) 956 360 Operating expense note (i) (544) (198) Share of associate’s results 13 – Group’s share of tax on joint ventures’ operating profit – (21)
Notes (i) Operating income and expense includes the Group’s share of contribution from joint ventures (but excludes any contribution from associates). In the income statement as shown in note B1.6 of the IFRS financial statements, these amounts are netted and tax deducted and shown as a single amount. (ii) M&G Prudential asset management and Eastspring Investments can be further analysed as follows: M&G Prudential asset management
bps * Margin represents operating income before performance‑related fees as a proportion of the related funds under management (FUM). Monthly closing internal and external funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations that are managed by third parties outside the Prudential Group are excluded from these amounts.
I(d) Contribution to UK life financial metrics from specific management actions undertaken to position the balance sheet more efficiently under the Solvency II regime In 2017, further management actions were taken to improve the solvency of the UK and Europe insurance operations and to mitigate market risks. These actions included extending the reinsurance of longevity risk to cover a further £0.5 billion of IFRS annuity liabilities. As at 31 December 2017, the total IFRS annuity liabilities subject to longevity reinsurance were £14.4 billion. Management actions also repositioned the fixed income asset portfolio to improve the trade‑off between yield and credit risk.
The effect of these actions on the UK’s long‑term IFRS operating profit, underlying free surplus generation and EEV operating profit before restructuring costs is shown in the tables below.
Shareholder‑backed annuity new business 9 41 In‑force business: Longevity reinsurance transactions 31 197 Other management actions to improve solvency 245 135 Changes in longevity assumption basis 204 – Provision for the review of past annuity sales (225) (175)
Expected in‑force and return on net worth 706 693 Longevity reinsurance transactions 15 126 Other management actions to improve solvency 385 225 Changes in longevity assumption basis 179 – Provision for the review of past annuity sales (187) (145)
Underlying free surplus generated from in‑force business 1,070 923 New business strain (175) (129)
Unwind of discount and other expected return 465 445 Longevity reinsurance transactions (6) (90) Other management actions to improve solvency 127 110 Changes in longevity assumption basis 195 – Provision for the review of past annuity sales (187) (145)
www.prudential.co.uk Annual Report 2017 Prudential plc 373 01 G roup overview 02 Strategic report 03 G
Net cash remitted by business units: Total Asia net remittances to the Group 645 516
Net remittances to the Group from business units1 1,788 1,718 Net interest paid (415) (333) Tax received 152 132 Corporate activities (207) (215)
Total holding company cash flow (352) 370 Cash and short‑term investments at beginning of year 2,626 2,173 Foreign exchange movements (10) 83
1 Net cash remittances comprise dividends and other transfers from business units that are reflective of emerging earnings and capital generation. 2 Non‑operating net cash flow principally relates to the repayment of subordinated debt net of the proceeds from that issued in the year, and payments for distribution rights and acquisition of subsidiaries.
II(b) Funds under management (a) Summary For our asset management businesses, funds managed on behalf of third parties are not recorded on the balance sheet. They are, however, a driver of profitability. We therefore analyse the movement in the funds under management each period, focusing on those which are external to the Group and those primarily held by the insurance businesses. The table below analyses, by segment, the funds of the Group held in the statement of financial position and the external funds that are managed by Prudential’s asset management operations.
Business area: Asia operations: Internal funds 81.4 69.6 Eastspring Investments’ external funds 55.9 45.7
M&G Prudential: Internal funds, including PruFund‑backed products 186.8 174.0 External funds 163.9 136.8
Notes 1 The results exclude contribution from PruFund products (net inflows of £9.0 billion in 2017; funds under management of £35.9 billion as at 31 December 2017, £24.7 billion as at 2 The £219.7 billion (2016: £182.5 billion) investment products comprise £210.4 billion (2016: £174.8 billion) plus Asia Money Market Funds of £9.3 billion (2016: £7.7 billion).
(c) M&G and Eastspring Investments – total funds under management M&G, the asset management business of M&G Prudential and Eastspring Investments, the Group’s asset management business in Asia, manage funds from external parties and also funds for the Group’s insurance operations. The table below analyses the total funds under management managed by M&G and Eastspring Investments respectively.
Investments 2017 £bn 2016 £bn 2017 £bn note 2016 £bn note
External funds under management 163.9 136.8 55.9 45.7 Internal funds under management 134.6 128.1 83.0 72.2
Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2017 of £9.3 billion (2016: £7.7 billion).
II(c) Return on IFRS shareholders’ funds Return on IFRS shareholders’ funds is calculated as operating profit based on longer‑term investment returns net of tax and non‑ controlling interests divided by opening shareholders’ funds. Operating profit based on longer‑term investment returns is reconciled to IFRS profit before tax in note B1 to the IFRS financial statements.
Operating profit based on longer‑term investment returns, net of tax and non‑controlling interests B5 3,727 3,362
II(d) IFRS gearing ratio Gearing ratio is calculated as net core structural borrowings of shareholder‑financed operations divided by closing IFRS shareholders’ funds plus net core structural borrowings.
Core structural borrowings of shareholder‑financed operations C6.1 6,280 6,798 Less holding company cash and short‑term investments II(a) (2,264) (2,626)
Net core structural borrowings of shareholder-financed operations 4,016 4,172 Closing shareholders’ funds 16,087 14,666
* The Group shareholder capital position excludes the contribution to Own Funds and the Solvency Capital Requirement from ring‑fenced with‑profit funds and staff pension schemes in surplus. The solvency positions include management’s estimates of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority.
In accordance with Solvency II requirements, these results allow for: — Capital in Jackson in excess of 250 per cent of the US local Risk Based Capital requirement. As agreed with the Prudential Regulation Authority, this is incorporated in the result above as follows: – Own funds: represents Jackson’s local US Risk Based available capital less 100 per cent of the US Risk Based Capital requirement (Company Action Level); – Solvency Capital Requirement: represents 150 per cent of Jackson’s local US Risk Based Capital requirement (Company Action Level); and
It also excludes unrealised gains on certain derivative instruments taken out to protect Jackson against declines in long‑term interest rates. At Jackson’s request, the Department of Insurance Financial Services renewed its approval to carry these instruments at book value in the local statutory returns for the period 31 December 2017 to 1 October 2018. At 31 December 2017, this approval had the effect of decreasing local statutory capital and surplus (and by extension Solvency II Own Funds and Solvency II surplus) by £0.4 billion, net of tax. This arrangement reflects an elective long‑standing practice first put in place in 2009, which can be unwound at Jackson’s discretion.
The 31 December 2017 Solvency II results above allow for the completion of the sale of the Korea life business and sale of the US broker‑dealer network in 2017, which contributes £0.1 billion to the Group Solvency II surplus. The results also allow for the impact of US tax reforms enacted in December 2017, which reduce the Group Solvency II surplus by £0.6 billion.
Further information on the Solvency II capital position for the Group and The Prudential Assurance Company Limited is published annually in the Solvency and Financial Condition Reports. These were last published on the Group’s website on 18 May 2017.
www.prudential.co.uk Annual Report 2017 Prudential plc 377 01 G roup overview 02 Strategic report 03 G
Analysis of movement in Group shareholder surplus Full year 2017 Full year 2016
The estimated movement in Group Solvency II surplus over 2017 is driven by: — Operating experience of £3.6 billion: generated by in‑force business and new business written in 2017, after allowing for amortisation of the UK transitional and the impact of one‑off management optimisations implemented over the period; — Non-operating experience of £(0.6) billion: resulting mainly from the impact of US tax reform and market movements during 2017, after allowing for the recalculation of the UK transitional at the valuation date; — Other capital movements: comprising a loss from foreign currency translation, the net impact of debt raised offset by debt redeemed during 2017 and a reduction in surplus from payment of dividends; and
— Model changes: reflecting minor calibration changes made to the internal model during 2017.
Analysis of Group Solvency Capital Requirements The split of the Group’s estimated Solvency Capital Requirement by risk type including the capital requirements in respect of Jackson’s risk exposures based on 150 per cent of US Risk Based Capital requirements (Company Action Level) but with no diversification between Jackson and the rest of the Group, is as follows: Split of the Group’s estimated Solvency Capital Requirements
The key items of the reconciliation as at 31 December 2017 are: — £3.0 billion represents the adjustment required to the Group’s shareholders’ funds in order to convert Jackson’s contribution from an IFRS basis to the local statutory valuation basis. This item also reflects a derecognition of Own Funds of £0.8 billion, equivalent to the value of 100 per cent of Risk Based Capital requirements (Company Action Level), as agreed with the Prudential Regulation Authority; — £4.0 billion due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £5.8 billion due to the addition of subordinated debt which is treated as available capital under Solvency II but as a liability under IFRS; — £3.9 billion due to the inclusion of a risk margin for UK and Asia non‑hedgeable risks, net of £2.3 billion from transitional measures (after allowing for recalculation of the transitional measures as at 31 December 2017) which are not applicable under IFRS; — £5.3 billion due to the inclusion of the value of future shareholder transfers from with‑profits business (excluding the shareholders’ share of the with‑profits estate, for which no credit is given under Solvency II), which is excluded from the determination of the Group’s IFRS shareholders’ funds; — £12.1 billion due to differences in insurance valuation requirements between Solvency II and IFRS, with Solvency II Own Funds partially capturing the value of in‑force business which is excluded from IFRS; — £1.6 billion due to the impact on the valuation of net deferred tax liabilities resulting from the liability valuation differences noted above; and
— £0.4 billion due to other items, including the impact of revaluing loans, borrowings and debt from IFRS to Solvency II.
Notes 1 Where hedges are dynamic, rebalancing is allowed for by assuming an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four‑week period. 2 Subject to a floor of zero. 3 Allowing for further transitional recalculation after the interest rate stress. 4 US Risk Based Capital solvency position included using a stress of 10 times expected credit defaults.
* The UK shareholder capital position excludes the contribution to Own Funds and the Solvency Capital Requirement from ring‑fenced with‑profit funds and staff pension schemes in surplus. The solvency positions include management’s estimate of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority.
A reconciliation between the IFRS unallocated surplus and Solvency II Own Funds for UK with‑profits business is as follows: Reconciliation of UK with-profits funds £bn £bn
Value of shareholder transfers (2.7) (2.3) Risk margin (net of transitional) (0.7) (0.7) Other valuation differences (0.5) (0.3)
Annual regulatory reporting The Group will publish its Solvency and Financial Condition Report and related quantitative templates no later than 17 June 2018. The templates will require us to combine the Group shareholder solvency position with those of all other ring‑fenced funds across the Group. In combining these solvency positions, the contribution to own funds from these ring‑fenced funds will be set equal to their aggregate Solvency Capital Requirements, estimated at £6.6 billion (ie the solvency surplus in these ring‑fenced funds will not be captured in the templates). There will be no impact on the reported Group Solvency II surplus.
Notes 1 The UK with‑profits capital position includes the PAC with‑profits sub‑fund, the Scottish Amicable Insurance Fund and the Defined Charge Participating Sub‑Fund. 2 The insurance subsidiaries of PAC are Prudential General Insurance Hong Kong Limited, Prudential Hong Kong Limited, Prudential International Assurance plc and Prudential
(i) Expected transfer of value of in-force business (VIF) and required capital to free surplus
Undiscounted expected free surplus generation for years 2018 to 2057 5,507 2,017 861 8,385
www.prudential.co.uk Annual Report 2017 Prudential plc 381 01 G roup overview 02 Strategic report 03 G
Add: Expected free surplus to be generated in year 2057* – – – – – – 578 578
Asia £m £m £m £m £m £m Other £m Total £m 2016 expected free surplus generation for years 2017 to 2056 1,320 1,247 1,202 1,167 1,142 1,122 27,080 34,280
Less: Amounts expected to be realised in the current year (1,320) – – – – – – (1,320)
Non‑operating and other movements – 7 19 16 24 33 501 601 2017 expected free surplus generation for years 2018 to 2057 – 1,393 1,352 1,299 1,256 1,239 31,231 37,770
Non‑operating and other movements – 142 197 197 201 203 2,467 3,360 2017 expected free surplus generation for years 2018 to 2057 – 1,464 1,425 1,483 1,551 1,441 11,280 18,644
Non‑operating and other movements – 35 74 67 61 44 (300) (301)
At 31 December 2017, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £70.1 billion, up from the £64.0 billion expected at the end of 2016, reflecting the effect of new business written across all three business operations of £8.4 billion, a negative foreign exchange translation effect of £(3.1) billion and a £3.7 billion net effect reflecting operating, market assumption changes and other items. In Asia, these include the effect of changes in operating assumptions reflecting the net benefit arising from annual review of experience, together with the benefit of management actions. In the US, these mainly reflect the positive effect from persistency assumption updates and increase in equity market returns, together with the benefits from US tax reform, partially offset by lower future separate account return due to the decrease in interest rates. In the UK and Europe, these reflect the impact of management actions which had the effect of accelerating the generation of future free surplus into 2017, partially offset by higher than assumed investment returns on with‑profits funds. The overall growth in the Group’s undiscounted value of free surplus reflects our ability to write both growing and profitable new business.
Actual underlying free surplus generated in 2017 from life business in force before restructuring costs at the end of 2017 was £4.1 billion including £0.6 billion of changes in operating assumptions and experience variances. This compares with the expected 2017 realisation at the end of 2016 of £3.4 billion. This can be analysed further as follows: Asia £m
II(g) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued
www.prudential.co.uk Annual Report 2017 Prudential plc 383 01 G roup overview 02 Strategic report 03 G
The above amounts can be reconciled to the Group’s EEV basis financial statements as follows: £m
Discounted expected generation from all in‑force business for years 2018 to 2057 37,564 Discounted expected generation from all in‑force business for years after 2057 1,576
Discounted expected generation from all in‑force business at 31 December 2017 39,140 Add: Free surplus of life operations held at 31 December 2017 6,242 Less: Time value of guarantees (836) Other non‑modelled items 1,371
(2) For operating profit and shareholders’ funds, UK sterling includes amounts in respect of M&G Prudential and other operations (including central operations, Africa operations and Prudential Capital). Operating profit for central operations includes amounts for corporate expenditure for Group Head Office as well as Asia Regional Head Office which is incurred in HK dollars.
www.prudential.co.uk Annual Report 2017 Prudential plc 385 01 G roup overview 02 Strategic report 03 G
II(i) Option schemes The Group presently grants share options through four schemes, and exercises of the options are satisfied by the issue of new shares. Executive Directors and eligible employees based in the UK may participate in the UK savings‑related share option scheme. Executives and eligible employees based in Asia as well as eligible employees based in Europe can participate in the international savings‑related share option scheme, while agents based in certain regions of Asia can participate in the international savings‑related share option scheme for non‑employees. Employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan, which currently has no outstanding options in issue. Further details of the schemes and accounting policies are detailed in note B2.2 of the IFRS basis consolidated financial statements.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £18.17.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £17.67.
The weighted average fair value of options granted under the plan in the period was £3.41.
www.prudential.co.uk Annual Report 2017 Prudential plc 387 01 G roup overview 02 Strategic report 03 G
Profit (loss) attaching to disposal of businesses 228 (238) (46) (13) (120)
Total charges, net of reinsurance and profit (loss) attaching to disposal of businesses (82,894) (68,812) (38,222) (57,275) (50,440)
Tax charges attributable to policyholders’ returns (674) (937) (173) (540) (447)
Dividend per share declared and paid in reporting period (in pence) 45.07p 49.40p 38.05p 35.03p 30.52p Interim ordinary dividend/final ordinary dividend 45.07p 39.40p 38.05p 35.03p 30.52p Special dividend – 10.00p – – –
Operating profit based on longer‑term investment returns note 2 4,699 4,256 3,969 3,154 2,937
Operating profit based on longer‑term investment returns note 2 6,598 5,497 4,840 4,108 4,224
Annual premium equivalent (APE) sales 6,958 6,320 5,466 4,514 4,310 EEV new business profit (NBP) (post‑tax) 3,610 3,088 2,609 2,104 2,057 * Excluding the £23 million APE and £11 million NBP for the sold PruHealth and PruProtect businesses.
As of and for the year ended 31 December 2017 2016 2015 2014 2013
3 Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations. 4 The 2017 surplus is estimated.
II(k) Reconciliation between IFRS and EEV shareholders’ funds The table below shows the reconciliation of EEV shareholders’ funds and IFRS shareholders’ funds at the end of the year: £m £m
II(l) Reconciliation of APE new business sales to earned premiums The Group reports APE new business sales as a measure of the new policies sold in the year. This differs from the IFRS measure of premiums earned as shown below: Annual premium equivalents as published 6,958 6,320 Adjustment to include 100% of single premiums on new business sold in the year note (a) 28,769 25,057 Premiums from in‑force business and other adjustments note (b) 8,278 7,604
Earned premiums, net of reinsurance as shown in the IFRS financial statements 41,943 36,961
II(m) Calculation of return on embedded value Return on embedded value is calculated as the EEV post‑tax operating profit based on longer‑term investment returns, as a percentage of opening EEV basis shareholders’ funds.
Operating profit based on longer‑term investment returns (£ million) 2 6,598 5,497 Opening EEV basis shareholders' funds (£ million) 9 38,968 31,886
Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Uncertainty, fluctuations or negative trends in international economic and investment climates could have a material adverse effect on Prudential’s business and profitability. Prudential operates in a macroeconomic and global financial market environment that presents significant uncertainties and potential challenges, For example, government interest rates remain low in the US, the UK and some Asian countries in which Prudential operates.
Global financial markets are subject to uncertainty and volatility created by a variety of factors. These factors include the reduction in accommodative monetary policies in the US, the UK and other jurisdictions together with its impact on the valuation of all asset classes, effects on interest rates and the risk of disorderly repricing of inflation expectations and global bond yields, concerns over sovereign debt, a general slowing in world growth, the increased level of geopolitical risk and policy‑related uncertainty and potentially negative socio‑political events.
In the US, Jackson writes a significant amount of variable annuities that offer capital or income protection guarantees. The value of these guarantees is affected by market factors (such as interest rates, equity values, bond spreads and realised volatility) and policyholder behaviour. Jackson uses a derivative hedging programme to reduce its exposure to market risks arising on these guarantees. There could be market circumstances where the derivatives that Jackson enters into to hedge its market risks may not cover its exposures under the guarantees. The cost of the guarantees that remain unhedged will also affect Prudential’s results.
On 29 March 2017 the UK submitted the formal notification of its intention to withdraw from the EU pursuant to Article 50 of the Treaty on the European Union, as amended. Following submission of this notification, the UK has a maximum period of two years to negotiate the terms of its withdrawal from the EU. If no formal withdrawal agreement is reached between the UK and the EU, then it is expected the UK’s membership of the EU will automatically terminate two years after the submission of the notification of the UK’s intention to withdraw from the EU. The UK’s decision to leave the EU will have political, legal and economic ramifications for both the UK and the EU, although these are expected to be more pronounced for the UK. The Group has several UK domiciled operations, including M&G Prudential, and these may be impacted by a UK withdrawal from the EU. The outcome of the negotiations on the UK’s withdrawal and any subsequent negotiations on trade and access to the country’s major trading markets, including the single EU market, is currently unknown. As a result, there is ongoing uncertainty over the terms under which the UK will leave the EU, whether any transitional arrangements will be agreed between the UK and the EU, the possibility of a lengthy period before negotiations are concluded, and the potential for a disorderly exit by the UK without a negotiated agreement. This uncertainty may increase volatility in the markets where the Group operates and create the potential for a general downturn in economic activity and for further or prolonged interest rate reductions in some jurisdictions due to monetary easing and investor sentiment.
A significant part of the profit from M&G Prudential’s insurance operations is related to bonuses for policyholders declared on with‑profits products, which are broadly based on historical and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns. This profit could be lower in a sustained low interest rate environment.
Prudential is subject to the risk of potential sovereign debt credit deterioration owing to the amounts of sovereign debt obligations held in its investment portfolio Investing in sovereign debt creates exposure to the direct or indirect consequences of political, social or economic changes (including changes in governments, heads of state or monarchs) in the countries in which the issuers are located and the creditworthiness of the sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject.
In addition, if a sovereign default or other such events described above were to occur, other financial institutions may also suffer losses or experience solvency or other concerns, and Prudential might face additional risks relating to any debt of such financial institutions held in its investment portfolio. There is also risk that public perceptions about the stability and creditworthiness of financial institutions and the financial sector generally might be adversely affected, as might counterparty relationships between financial institutions. If a sovereign were to default on its obligations, or adopted policies that devalued or otherwise altered the currencies in which its obligations were denominated this could have a material adverse effect on Prudential’s financial condition and results of operations.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due to the geographical diversity of Prudential’s businesses, Prudential is subject to the risk of exchange rate fluctuations. Prudential’s operations in the US and Asia, which represent a significant proportion of operating profit based on longer‑term investment returns and shareholders’ funds, generally write policies and invest in assets denominated in local currencies. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon the translation of results into pounds sterling. This exposure is not currently separately managed. The currency exposure relating to the translation of reported earnings could impact financial reporting ratios such as dividend cover, which is calculated as operating profit after tax on an IFRS basis, divided by the dividends relating to the reporting year. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within other comprehensive income. Consequently, this could impact Prudential’s gearing ratios (defined as debt over debt plus shareholders’ funds). The Group’s surplus capital position for regulatory reporting purposes may also be affected by fluctuations in exchange rates with possible consequences for the degree of flexibility that Prudential has in managing its business.
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates Changes in government policy and legislation (including in relation to tax), capital control measures on companies and individuals, regulation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, or decisions taken by regulators in connection with their supervision of members of the Group, which in some circumstances may be applied retrospectively, may adversely affect Prudential. The adverse impact from these changes may affect Prudential’s product range, distribution channels, competitiveness, profitability, capital requirements, risk management approaches, corporate or governance structure and, consequently, reported results and financing requirements. Also, regulators in jurisdictions in which Prudential operates may impose requirements affecting the allocation of capital and liquidity between different business units in the Group, whether on a geographic, legal entity, product line or other basis. Regulators may change the level of capital required to be held by individual businesses or could introduce possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of interventions by governments following recent financial and global economic conditions, there may continue to be changes in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transactions and enhanced supervisory powers.
Recent shifts in the focus of some national governments toward more protectionist or restrictive economic and trade policies could impact on the degree and nature of regulatory changes and Prudential’s competitive position in some geographic markets. This could take effect, for example, through increased friction in cross‑border trade or measures favouring local enterprises such as changes to the maximum level of non‑domestic ownership by foreign companies.
The European Union’s Solvency II Directive came into effect on 1 January 2016. This measure of regulatory capital is more volatile than under the previous Solvency I regime and regulatory policy may evolve under the new regime. The European Commission began a review in late 2016 of some aspects of the Solvency II legislation, which is expected to continue until 2021 and covers, among other things, a review of the Long Term Guarantee measures. Prudential applied for, and has been granted approval by the UK Prudential Regulation Authority to use the following measures when calculating its Solvency II capital requirements: the use of an internal model, the ‘matching adjustment’ for UK annuities, the ‘volatility adjustment’ for selected US Dollar‑denominated business, and UK transitional measures. Prudential also has permission to use ‘deduction and aggregation’ as the method by which the contribution of the Group’s US insurance entities to the Group’s solvency is calculated, which in effect recognises surplus in US insurance entities in excess of 250 per cent of local US Risk Based Capital requirements. There is a risk that in the future changes are required to be made to the approved internal model and these related applications which could have a material impact on the Group Solvency II capital position. Where internal model changes are subject to regulatory approval, there is a risk that the approval is delayed or not given. In such circumstances, changes in our risk profile would not be able to be appropriately reflected in our internal model, which could have a material impact on the Group’s Solvency II capital position.
The UK’s decision to leave the EU could result in significant changes to the legal and regulatory regime under which the Group operates, the nature and extent of which are uncertain while the outcome of negotiations regarding the UK’s withdrawal from the EU and the extent and terms of any future access to the single EU market remains unknown.
The Dodd‑Frank Act provides for a comprehensive overhaul of the financial services industry within the US including reforms to financial services entities, products and markets. The full impact of the Dodd‑Frank Act on Prudential’s businesses remains unclear, as many of its provisions are primarily focused on the banking industry, have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years. There is also potential uncertainty surrounding future changes to the Dodd‑Frank Act under the current US administration.
Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event of a failure of a market participant. As a major participant in the majority of its chosen markets, circumstances could arise in which Prudential, along with other companies, may be required to make such contributions.
The Group’s accounts are prepared in accordance with current International Financial Reporting Standards (IFRS) applicable to the insurance industry. The International Accounting Standards Board (IASB) introduced a framework that it described as Phase I which, under its standard IFRS 4 permitted insurers to continue to use the statutory basis of accounting for insurance assets and liabilities that existed in their jurisdictions prior to January 2005. In May 2017, the IASB published its replacement standard on insurance accounting (IFRS 17, ‘Insurance Contracts’), which will have the effect of introducing fundamental changes to the statutory reporting of insurance entities that prepare accounts according to IFRS from 2021. The European Union will apply its usual process for assessing whether the standard meets the necessary criteria for endorsement. The Group is reviewing the complex requirements of this standard and considering its potential impact. The effect of changes required to the Group’s accounting policies as a result of implementing the new standard is currently uncertain, but these changes can be expected to, amongst other things, alter the timing of IFRS profit recognition. The implementation of this standard is also likely to require significant enhancements to IT, actuarial and finance systems of the Group, and so will have an increase on the Group’s expenses.
The resolution of several issues affecting the financial services industry could have a negative impact on Prudential’s reported results or on its relations with current and potential customers Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the UK and internationally. Such actions may relate to the application of current regulations for example the Financial Conduct Authority’s (FCA) principles and conduct of business rules or the failure to implement new regulations. These actions could involve a review of types of business sold in the past under acceptable market practices at the time, such as the requirement in the UK to provide redress to certain past purchasers of pensions and mortgage endowment policies, changes to the tax regime affecting products, and regulatory reviews on products sold and industry practices, including, in the latter case, lines of business it has closed. Current regulatory actions include the UK business’s undertaking to the FCA to review annuities sold without advice after 1 July 2008 to its contract‑based defined contribution pension customers. This will result in the UK business being required to provide redress to certain such customers, the ultimate amount of which remains uncertain.
Prudential’s businesses are conducted in highly competitive environments with developing demographic trends and continued profitability depends upon management’s ability to respond to these pressures and trends The markets for financial services in the UK, US and Asia are highly competitive, with several factors affecting Prudential’s ability to sell its products and continued profitability, including price and yields offered, financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance, historical bonus levels, the ability to respond to developing demographic trends, customer appetite for certain savings products and technological advances. In some of its markets, Prudential faces competitors that are larger, have greater
alue (EEV ) basis results 07 A dditional inform ation financial resources or a greater market share, offer a broader range of products or have higher bonus rates. Further, heightened competition for talented and skilled employees and agents with local experience, particularly in Asia, may limit Prudential’s potential to grow its business as quickly as planned.
Prudential believes competition will intensify across all regions in response to consumer demand, digital and other technological advances, the need for economies of scale and the consequential impact of consolidation, regulatory actions and other factors. Prudential’s ability to generate an appropriate return depends significantly upon its capacity to anticipate and respond appropriately to these competitive pressures.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and damage its relationships with creditors or trading counterparties Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in Prudential’s products, and as a result, its competitiveness. Downgrades in Prudential’s ratings as a result of, for example, decreased profitability, increased costs, increased indebtedness or other concerns could have an adverse effect on its ability to market products, retain current policyholders, and on the Group’s financial flexibility. In addition, the interest rates Prudential pays on its borrowings are affected by its credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations.
Adverse experience in the operational risks inherent in Prudential’s business could disrupt its business functions and have a negative impact on its results of operations Operational risks are present in all of Prudential’s businesses, including the risk (from both Prudential and its outsourcing partners) of direct or indirect loss resulting from inadequate or failed internal and external processes, systems or human error, the effects of natural or man‑made catastrophic events (such as natural disasters, pandemics, cyber‑attacks, acts of terrorism, civil unrest and other catastrophes) or from other external events. Exposure to such events could disrupt Prudential’s systems and operations significantly, which may result in financial loss and reputational damage.
Prudential’s business is dependent on processing a large number of transactions across numerous and diverse products, and it employs a large number of models, and user developed applications, some of which are complex, in its processes. The long‑term nature of much of the Group’s business also means that accurate records have to be maintained for significant periods. Further, Prudential operates in an extensive and evolving legal and regulated environment which adds to the operational complexity of its business processes and controls.
These factors, among others, result in significant reliance on and require significant investment in information technology (IT), compliance and other operational systems, personnel and processes.
As part of the implementation of its business strategies, Prudential has commenced a number of change initiatives to be established across the Group, some of which are interconnected and/or of large scale, that may have material financial and reputational implications if such initiatives fail (either wholly or in part) to meet their objectives and could place strain on the operational capacity of the Group. These initiatives include the combination of M&G and Prudential UK & Europe, the proposed demerger of M&G Prudential and the intended sale of part of the UK annuity portfolio. In addition, Prudential outsources several operations, including a significant part of its back office and customer‑facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
Although Prudential’s IT, compliance and other operational systems, models and processes incorporate controls designed to manage and mitigate the operational and model risks associated with its activities, there can be no assurance that such controls will always be effective. Due to human error among other reasons, operational and model risk incidents do happen periodically and no system or process can entirely prevent them although there have not been any material events to date. Prudential’s legacy and other IT systems and processes, as with operational systems and processes generally, may be susceptible to failure or security breaches.
Attempts by third parties to access or disrupt Prudential’s IT systems could result in loss of trust from Prudential’s customers, reputational damage and financial loss Prudential and its business partners are increasingly exposed to the risk that third parties may attempt to disrupt the availability, confidentiality and integrity of its IT systems, which could result in disruption to key operations, make it difficult to recover critical services, damage assets and compromise the integrity and security of data (both corporate and customer). This could result in loss of trust from Prudential’s customers, reputational damage and direct or indirect financial loss. The cyber‑security threat continues to evolve globally in sophistication and potential significance. Prudential’s increasing market profile, growing customer interest in interacting with their insurance providers and asset managers through the internet and social media, improved brand awareness and the classification of Prudential as a G‑SII could also increase the likelihood of Prudential being considered a target by cyber criminals. Further, there have been recent changes to the threat landscape and the risk from untargeted but sophisticated and automated attacks has increased. Developments in data protection worldwide (such as the EU General Data Protection Regulation that comes into force in May 2018) may also increase the financial and reputational implications for Prudential following a significant breach of its (or its third‑party suppliers’) IT systems. To date, Prudential has not identified a failure or breach which has had a material impact in relation to its legacy and other IT systems and processes. However, it has been, and likely will continue to be, subject to potential damage from computer viruses, attempts at unauthorised access and cyber‑security attacks such as ‘denial of service’ attacks (which, for example, can cause temporary disruption to websites and IT networks), phishing and disruptive software campaigns.
Global commitments to limit climate change were recently agreed and governmental and corporate efforts to transition to a low‑carbon economy in the coming decades could have an adverse impact on global investment assets. In particular, there is a risk that this transition including the related changes to technology, policies and regulations and the speed of their implementation, could result in some sectors (such as but not limited to the fossil fuel industry) facing significantly higher costs and a disorderly adjustment to their asset values. This could lead to an adverse impact on the value and the future performance of the investment assets of the Group if climate considerations are not effectively integrated into investment decisions and fiduciary and stewardship duties. Where Prudential’s investment horizons are long term, the relevant assets are potentially more exposed to the long‑term impact of climate change.
Guaranteed Minimum Withdrawal Benefit (GMWB) of Jackson’s variable annuity business. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
In addition, Prudential’s business may be adversely affected by epidemics and other effects that give rise to a large number of deaths or additional sickness claims. Significant influenza epidemics have occurred a number of times historically but the likelihood, timing, or the severity of future epidemics cannot be predicted. The effectiveness of external parties, including governmental and non‑governmental organisations, in combating the spread and severity of any epidemics could have a material impact on the Group’s loss experience.
As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments The Group’s insurance and investment management operations are generally conducted through direct and indirect subsidiaries, which are subject to the risks discussed elsewhere in this ‘Risk Factors’ section.
As a holding company, Prudential’s principal sources of funds are remittances from subsidiaries, shareholder‑backed funds, the shareholder transfer from long‑term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper.
Available for sale (AFS) Securities that have been acquired neither for short‑term sale nor to be held to maturity. AFS securities are measured at fair value on the statement of financial position with unrealised gains and losses being booked in Other Comprehensive Income instead of the income statement.
Bonuses Bonuses refer to the non‑guaranteed benefit added to participating life insurance policies and are the way in which policyholders receive their share of the profits of the policies. There are normally two types of bonus; — Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and
Closed-book life insurance business A ‘closed book’ is essentially a group of insurance policies that are no longer sold, but are still featured on the books of a life insurer as a premium‑paying policy. The insurance company has ‘closed the books’ on new sales of these products which will remain in run‑off until the policies expire and all claims are settled.
Deferred annuities Annuities or pensions due to be paid from a future date or when the policyholder reaches a specified age.
Dividend cover Dividend cover is calculated as operating profit after tax on an IFRS basis, divided by the current year interim dividend plus the proposed final dividend.
European Embedded Value or EEV Financial results that are prepared on a supplementary basis to the Group’s consolidated IFRS results and which are prepared in accordance with a set of Principles issued by the Chief Financial Officers Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance of EEV Disclosures published in October 2005. The principles are designed to capture the value of the new business sold in the period and of the business in force.
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Funds under management These comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations.
Group free surplus Group free surplus at the end of the period comprises free surplus for the insurance businesses, representing the excess of the net worth over the required capital included in the EEV results, and IFRS net assets for the asset management businesses excluding goodwill. The free surplus generated during the period comprises the movement in this balance excluding foreign exchange, capital, and other reserve movements. Specifically, it includes amounts maturing from the in‑force operations during the period less the investment in new business, the effect of market movements and other one‑off items.
Guaranteed minimum income benefit (GMIB) (US) A guarantee that ensures, under certain conditions, that the owner may annuitise the variable annuity contract based on the greater of (a) the actual account value or (b) a pay‑out base equal to premiums credited with some interest rate, or the maximum anniversary value of the account prior to annuitisation.
Market value reduction (MVR) A reduction applied to the payment on with‑profits bonds when policyholders surrender in adverse market conditions.
Net premiums Life insurance premiums, net of reinsurance ceded to third‑party reinsurers.
Non-participating business A life insurance policy where the policyholder is not entitled to a share of the company’s profits and surplus, but receives certain guaranteed benefits. Also known as non‑profit in the UK. Examples include pure risk policies (eg fixed annuities, term insurance, critical illness) and unit‑linked insurance contracts.
Prudential Regulation Authority or PRA The PRA is a UK regulatory body responsible for prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms.
Separate account A separate account is a pool of investments held by an insurance company not in or ‘separate’ from its general account. The returns from the separate account generally accrue to the policyholder. A separate account allows an investor to choose an investment category according to his individual risk tolerance, and desire for performance.
Total shareholder return (TSR) TSR represents the growth in the value of a share plus the value of dividends paid, assuming that the dividends are reinvested in the Company’s shares on the ex‑ dividend date.
Unit-linked products or unit-linked contracts See ‘investment‑linked products or contracts’ above.
Whole of life A type of life insurance policy that provides lifetime protection; premiums must usually be paid for life. The sum assured is paid out whenever death occurs. Commonly used for estate planning purposes.
Communication with shareholders The Group maintains a corporate website containing a wide range of information relevant for private and institutional investors, including the Group’s financial calendar: www.prudential.co.uk
Prudential will continue its practice of calling a poll on all resolutions and the voting results, including all proxies lodged prior to the meeting, will be displayed at the meeting and subsequently published on the Company’s website.
In accordance with relevant legislation, shareholders holding 5 per cent or more of the fully paid up issued share capital are able to require the Directors to hold a general meeting. Written shareholder requests should be addressed to the Group Company Secretary at the registered office.
Share capital Issued share capital The issued share capital as at 31 December 2017 consisted of 2,587,175,445 (2016: 2,581,061,573) ordinary shares of 5 pence each, all fully paid up and listed on the London Stock Exchange and the Hong Kong Stock Exchange. As at 31 December 2017, there were 48,086 (2016: 48,534) accounts on the register. Further information can be found in note C10 on page 277.
Major shareholders The following notifications have been disclosed under the Financial Conduct Authority’s (FCA) Disclosure Guidance and Transparency Rules in respect of notifiable interests exceeding 3 per cent in the voting rights of the issued share capital.
As at 14 March 2018, no notifications have been received since the year end.
As at 14 March 2018, Trustees held 0.48 per cent of the issued share capital under the various plans in operation.
Authority to issue shares The Directors require authority from shareholders in relation to the issue of shares. Whenever shares are issued, these must be offered to existing shareholders pro rata to their holdings unless the Directors have been given authority by shareholders to issue shares without offering them first to existing shareholders. Prudential seeks authority from its shareholders on an annual basis to issue shares up to a maximum amount, of which a defined number may be issued without pre‑emption. Disapplication of statutory pre‑emption procedures is also sought for rights issues. The 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 AGM. Relevant resolutions to authorise share capital issuances will be put to shareholders at the AGM on 17 May 2018.
Shareholders registered on the UK register and Hong Kong and Irish branch registers
Principal UK register Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex, BN99 6DA, UK.
Irish branch register Link Asset Services, Link Registrars Limited, PO Box 7117, Dublin 2, Ireland.
Singapore register Shareholders who have shares standing to the credit of their securities accounts with The Central Depository (PTE) Limited (CDP) in Singapore may refer queries to the CDP at 9 North Buona Vista Drive, #01‑19/20, The Metropolis, Singapore 138588. Enquiries regarding shares held in Depository Agent Sub‑accounts should be directed to your Depository Agent or broker.
Cash dividend alternative The Company operates a Dividend Re‑investment Plan (DRIP). Shareholders who have elected for the DRIP will automatically receive shares for all future dividends in respect of which a DRIP alternative is offered. The election may be cancelled at any time by the shareholder. Further details of the DRIP and the timetable are available at www.shareview.co.uk/4/Info/Portfolio/ default/en/home/shareholders/Pages/ ReinvestDividends.aspx
ShareGift Shareholders who have only a small number of shares, the value of which makes them uneconomic to sell, may wish to consider donating them to ShareGift (Registered Charity 1052686). The relevant share transfer form may be downloaded from our website www.prudential.co.uk/investors/ shareholder‑information/forms or from Equiniti. Further information about ShareGift may be obtained on +44 (0)20 7930 3737 or from www.ShareGift.org
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Forward-looking statements This document may contain ‘forward‑ looking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations and including, without limitation, statements containing the words ‘may’, ‘will’, ‘should’, ‘continue’, ‘aims’, ‘estimates’, ‘projects’, ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward‑looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward‑looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future financial condition or performance or other indicated results to differ materially from those indicated in any forward‑looking statement. Such factors include, but are not limited to, the timing, costs and successful implementation of the demerger described herein; the future trading value of the shares of Prudential plc and the trading value and liquidity of the to‑be‑ listed M&G Prudential business following such demerger; future market conditions, including fluctuations in interest rates and exchange rates, the potential for a sustained low‑interest rate environment, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives; the political, legal and economic effects of the UK’s decision to leave the European Union; the impact of continuing designation as a Global Systemically Important Insurer or ‘G‑SII’; the impact of competition, economic uncertainty, inflation and deflation; the effect on Prudential’s business and results from, in particular, mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of internal projects and other strategic actions failing to meet their objectives; disruption to the availability, confidentiality or integrity of Prudential’s IT systems (or those of its suppliers); the impact of changes in capital, solvency standards, accounting standards or relevant regulatory frameworks, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate; and the impact of legal and regulatory actions, investigations and disputes. These and other important factors may, for example, result in changes to assumptions used for determining results of operations or re‑estimations of reserves for future policy benefits. Further discussion of these and other important factors that could cause Prudential’s actual future financial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward‑looking statements can be found under the ‘Risk factors’ heading in this document and the annual report and the ‘Risk factors’ heading of Prudential’s most recent annual report on Form 20‑F filed with the US Securities and Exchange Commission. Prudential’s most recent annual report and Form 20‑F are available on its website at www.prudential.co.uk
Any forward‑looking statements contained in this document speak only as of the date on which they are made. Prudential expressly disclaims any obligation to update any of the forward‑looking statements contained in this document or any other forward‑looking statements it may make, whether as a result of future events, new information or otherwise except as required pursuant to the UK Prospectus Rules, the UK Listing Rules, the UK Disclosure and Transparency Rules, the Hong Kong Listing Rules, the SGX‑ST listing rules or other applicable laws and regulations.
Prudential opens the Industrial Department to sell a new type of insurance, Industrial Insurance, to the working classes, for premiums of a penny and upwards.
The Company becomes one of the first in the City to employ women. Calculating machines are also introduced, bringing efficiencies to the processing of an increasing volume of business.
Prudential plc is listed on stock exchanges in Hong Kong and Singapore.
Providing financial security since 1848 Successive generations have looked to Prudential to safeguard their financial security – from industrial workers and their families in Victorian Britain to over 26 million customers worldwide today. Our financial strength, heritage, prudence and focus on our customers’ long-term needs ensure that people continue to turn to our trusted brands to help them plan for today and tomorrow.
Adding more to life: The founding of Prudential The Prudential Mutual Assurance, Investment and Loan Association was formed on 30 May 1848, in a room at 12 Hatton Garden, London (the premises of Hanslip and Manning solicitors).
The Company’s leather‑bound Deed of Settlement lists the first shareholders and directors, and outlines the Company’s purpose – to offer life assurance and loans to the middle classes. Shareholders including lawyers, doctors, a wine merchant and a number of ‘gentlemen’ accounted for the first 1,530 shares in the Company.