Note 1 Total shareholders’ return 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.
The fourth key factor in our success is that we benefit from a stable and highquality shareholder base. We respect our shareholders’ views and we take the time and effort to engage with them. Being accessible and transparent towards our shareholders is essential to our success, and we are ensuring that we do everything we can to understand their needs and meet their requirements.
Our Group IFRS operating profit based on longer-term investment returns increased by 14 per cent during the year to £3,186 million.
New business profit3 was up 10 per cent to £2,126 million, driven in 2014 by a combination of higher volumes and pricing and product actions aimed at enhancing profitability. All three of our life businesses made strong contributions, with new business profits from Asia growing by 13 per cent to £1,162 million, the US delivering £694 million, up 4 per cent, and the UK reporting £270 million, up 14 per cent.
Group Chief Executive’s report continued discipline and our focus on quality growth and value creation. Net cash remittances were £400 million, in line with 2013.
Our businesses and their performance – United States page 27 £1,482m net cash remittances from business units increase on 2013
Prudential’s continuing focus on the delivery of excellent customer service was recognised at the 2014 Financial Adviser Service Awards where we received an outstanding achievement award for retaining our two ‘Five Star’ ratings in the Life & Pensions and Investment categories for the fourth year running.
practical details of Solvency II, including the final implementing measures, are both workable and effective.
Balanced metrics and disclosures We aim to have clarity and consistency internally and externally in the performance indicators that drive our businesses. Alongside this we develop our financial disclosures to enable our stakeholders to fairly assess our long-term performance. We have three objectives: — To demonstrate how we generate profits under the different accounting regimes; for example, by analysing our IFRS profit by source as set out in the Chief Financial Officer’s report; — To show how we think about capital allocation via measures that highlight the returns we generate on capital invested in new business, including internal rates of return, payback periods and new business profitability; and
– Riding a wave of growth. 5 Asian Development Bank (ADB)
All—our—subsidiaries—continue—to—hold— strong—capital—positions—on—a—local— regulatory—basis.—Jackson’s—Risk-Based— Capital—ratio—at—the—end—of—2014—was— 456—per—cent,—having—remitted—£415—million— to—Group—earlier—in—the—year,—which— underlines—our—disciplined—approach—to— managing—the—balance—between—volume,— value,—risk—and—cash—in—this—business.—We— experienced—no—default—losses—and— reported—modest—levels—of—impairments— across—our—fixed-income—securities— portfolios.—Notwithstanding,—we—have— retained—our—cautious—stance—on—credit— risk—and—have—maintained—our—£2.2—billion— credit—default—reserves—in—our—UK—annuity— operations.—Further—information—on—our— capital—and—solvency—position—is—provided— in—the—Group—Chief—Risk—Officer’s—report.—
and—short-term—investments,—as—a— proportion—of—IFRS—shareholders’—funds— plus—net—debt)—was—19—per—cent,—compared— to—20—per—cent—at—31—December—2013.— Prudential—plc—has—strong—debt—ratings—from— Standard—&—Poor’s,—Moody’s—and—Fitch.— Prudential—plc’s—long-term—senior—debt—is— rated—A+,—A2—and—A—from—Standard—&—Poor’s,— Moody’s—and—Fitch,—while—short-term— ratings—are—A-1,—P-1—and—F1—respectively.—All— ratings—on—Prudential—and—its—subsidiaries— are—on—stable—outlook—except—PAC,—which— was—placed—on—negative—outlook—by— Moody’s—in—April—2014—following—the—UK— market—reforms—announced—in—the—March— 2014—UK—Budget.
in an cial O ffi cer’s rep o rt o n o u r 20 14 fi n an cial p erfo rm an ce 49 Prudential plc Annual Report 2014
Profit after tax for the year 2,216 1,346 4,343 4,358 Exchange—movements,—net—of—related—tax 220 (255) 737 (1,077) Unrealised—gains—and—losses—on—Jackson—fixed-income—securities—classified—
Net increase (decrease) in shareholders’ funds 2,161 (709) 4,316 2,413 Shareholders’—funds—at—beginning—of—the—year 9,650 10,359 24,856 22,443 Effect—of—domestication—of—Hong—Kong—branch— – – (11) –
— Entrance into Ghana and Kenya life insurance markets In—April—2014—we—completed—the—acquisition— of—Express—Life—of—Ghana,—and—in—September— 2014—we—entered—the—Kenyan—life—insurance— market—via—our—acquisition—of—Shield— Assurance—Company—Limited.—
10 Investment in new business as a percentage of underlying free surplus generated from in-force life business and asset management.
Furthermore,—on—a—statutory—(Pillar—1)— basis—the—total—credit—default—reserve—for— the—UK—shareholder—annuity—funds—also— contributes—to—protecting—our—capital— position—in—excess—of—the—IGD—surplus.— Notwithstanding—the—absence—of—defaults— in—the—year,—at—31—December—2014—we— maintained—sizeable—credit—default—reserves— at—£2.2—billion—(31—December—2013:— £1.9—billion),—representing—41—per—cent—of—the— portfolio—spread—over—swaps,—compared— with—47—per—cent—at—31—December—2013.—
2 The methodology and assumptions used in calculating the economic capital results are set out in note II (c) of Additional unaudited financial information. The economic capital ratio is based on outputs from the Group’s Solvency II internal model which will be subject to Prudential Regulation Authority review and approval before its formal adoption in 2016. We remain on track to submit our Solvency II internal model to the Prudential Regulation Authority for approval in 2015 but given the degree of uncertainty remaining these economic capital disclosures should not be interpreted as outputs from an approved internal model.
Relevant skills and experience Tidjane spent the first part of his professional career with McKinsey & Company in Paris and New York, serving insurance companies and banks. He then spent a number of years in Africa where he was Chief Executive and later Chairman of the National Bureau for Technical Studies and Development in Côte d’Ivoire and a cabinet member as Secretary of Planning and Development. Tidjane returned to France to become a partner with McKinsey & Company and one of the leaders of their Financial Institutions practice before joining Aviva in 2002. He worked at Aviva until 2008, holding successively the positions of Group Strategy and Development Director, Managing Director of Aviva International, Group Executive Director and Chief Executive Officer, Europe.
Current external appointments Jackie is the Senior Independent Director of National Express Group PLC and a non-executive director of TheCityUK. She is also a member of the FCA Practitioner Panel. Age 46.
Throughout the year, the non-executive directors were considered by the Board to be independent in character and judgement and met the criteria for independence as set out in the UK and HK Codes. The Company has received confirmation of independence from each of the independent non-executive directors as required by the HK Listing Rules.
Sets out the Group-wide approach to risk management and the key risk provisions which support compliance with the Group’s internal, statutory and regulatory requirements in this area
Internal control standards and guidance also support the Group Risk Framework does not apply to certain material joint ventures where the Group does not exercise full management control. In these cases, the Group satisfies itself that suitable governance and risk management arrangements are in place to protect the Group’s interests. However, the relevant Group company which is party to the joint venture must, in respect of any services it provides in support of the joint venture, comply with the requirements of the Group’s internal governance framework.
In—addition,—with—the—expansion—of—the— term—and—geographic—scope—of—our—strategic— pan-Asia—bancassurance—partnership—with— Standard—Chartered—Bank,—the—Committee— reviewed—the—IFRS—and—EEV—accounting— bases—applied—to—distribution—rights.— The—Committee—also—considered—the—impact— that—the—disposal—of—the—Group’s—remaining— stake—in—PruHealth—and—PruProtect—and—the— disposal—of—the—Japan—life—business—would— have—on—the—financial—statements.—
Fees paid to the auditor The—fees—paid—to—KPMG—for—the—year—— ended—31—December—2014—amounted—to— £16.6—million,—of—which—£5.1—million—was— payable—in—respect—of—non-audit—services.— Non-audit—services—accounted—for— 31—per—cent—of—total—fees—payable.
In—particular,—in—relation—to—s.302—of—the— Sarbanes-Oxley—Act—2002—which—covers— disclosure—controls—and—procedures,— a—Disclosure—Committee—has—been— established,—reporting—to—the—Group—Chief— Executive,—chaired—by—the—Chief—Financial— Officer—and—comprising—members—of—senior— management.—The—work—of—the—Disclosure— Committee—supports—the—Group—Chief— Executive—and—Chief—Financial—Officer—in— making—the—certifications—regarding—the— effectiveness—of—the—Group’s—disclosure— procedures.
To reward executives for delivering our business plans and generating sustainable growth and returns for shareholders Reward must be: — Determined by delivery of the Group’s annual and longer term business objectives; — Aligned with shareholder value creation; and — Consistent with the Group’s risk appetite so that the delivery of the business plan can be sustained.
The Company’s Directors’ Remuneration Policy was approved by shareholders at the 2014 AGM. This Policy came into effect following the AGM on 15 May 2014 and will apply for a period of three years unless shareholders approve a revised Policy within that time.
Executive directors are entitled to receive pension contributions or a cash supplement (or combination of the two) up to a total of 25 per cent of base salary.
The Committee has the authority to apply a malus adjustment to all, or a portion of, an outstanding award in specific circumstances.
In setting the Directors’ Remuneration Policy, the Committee considers a range of factors including: Conditions elsewhere in Group Across the Group, remuneration is reviewed regularly with the intention that all employees are paid appropriately in the context of their local market and given their individual skills, experience and performance. Each business unit’s salary increase budget is set with reference to local market conditions. The Remuneration Committee considers salary increase budgets in each business unit when determining the salaries of executive directors.
December 2014 Review the level of participation in the Company’s all-employee share plans; consider feedback received from shareholders about executive remuneration in 2015; approve executive directors’ 2015 salaries and incentive opportunities; consider the annual bonus and long-term incentive measures and targets to be used in 2015; review an initial draft of the 2014 directors’ remuneration report; consider the introduction of a clawback facility; and approve the Committee’s 2015 work plan.
4 In addition to the AIP, Mike Wells receives a 10 per cent share of the Jackson Senior Management Bonus Pool. This is determined by the financial performance of Jackson.
2014 AIP performance measures and achievement Financial performance The financial performance measures set for 2014 are shown below. Prior to the start of the year the Committee set stretching performance ranges for each of these measures in line with the Group’s performance targets. The Committee reviewed performance against these ranges at its meeting in February 2015; in all of our key performance metrics the Group’s 2014 results exceeded those achieved in 2013. The Committee also reviewed a report from the Group Chief Risk Officer which confirmed that these results were achieved within the Group’s risk appetite and framework.
Performance graph and table The chart below illustrates the TSR performance of Prudential, the FTSE 100 and International Insurers over the past six years. The information in the table below shows the total remuneration for the Group Chief Executive over the period: Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2014Dec 2013
Chairman Paul Manduca 15 October 2010 AGM 2011 12 months AGM 2018 Non-executive director Howard Davies 15 October 2010 AGM 2011 6 months AGM 2017 Ann Godbehere 2 August 2007 AGM 2008 6 months AGM 2015 Alistair Johnston 1 January 2012 AGM 2012 6 months AGM 2015 Kaikhushru Nargolwala 1 January 2012 AGM 2012 6 months AGM 2015 Anthony Nightingale 1 June 2013 AGM 2014 6 months AGM 2017 Philip Remnant 1 January 2013 AGM 2013 6 months AGM 2016 Alice Schroeder 10 June 2013 AGM 2014 6 months AGM 2017 Lord Turnbull 18 May 2006 AGM 2006 6 months AGM 2015
Payments to past directors Rob Devey Rob Devey’s employment in the Group ended on 31 October 2013. The 2013 directors’ remuneration report provided details of the remuneration arrangements that would apply to Rob Devey after his resignation. These arrangements were implemented as intended by the Committee. In line with his contractual entitlements, Mr Devey was entitled to receive a payment in lieu of salary and pension allowance for the period 1 November 2013 to 25 April 2014. This entitlement was subject to mitigation if Mr Devey commenced other employment during this period, which he did on 15 April 2014. As a result the total amount paid in 2014 was £236,809. Medical and life assurance cover was provided until 25 April 2014.
— Changes were made to the maximum opportunities under the annual incentive plan and long-term incentive awards for two executive directors – Chief Executive, PCA and Chief Executive, UK & Europe; there were no changes to the maximum opportunities for the other executive directors
Share Incentive Plan (SIP) UK-based executive directors are also eligible to participate in the Company’s Share Incentive Plan (SIP). From April 2014, all UK based employees were able to purchase Prudential plc shares up to a value of £150 per month from their gross salary (partnership shares) through the SIP. For every four partnership shares bought, an additional matching share is awarded which is purchased by Prudential on the open market. Dividend shares accumulate while the employee participates in the plan. If the employee withdraws from the plan, or leaves the Group, matching shares may be forfeited.
analysis by segment 170 C1.2 Group statement of financial position –
Section D: Other notes 256 D1 Corporate transactions 257 D2 Domestication of the Hong Kong branch business 257 D3 Contingencies and related obligations 259 D4 Post balance sheet events 259 D5 Subsidiary undertakings 259 D6 Investments in joint ventures and associates 260 D7 Related party transactions 260 D8 Commitments
Reserve movements in respect of share-based payments – – 98 – – 98 – 98 Change in non-controlling interests – – – – – – (4) (4)
Issue of subordinated debt, net of costs – 1,124 Redemption of subordinated debt (445) – Interest paid (330) (291) With-profits operations:note (v) C6.2
Jackson’s separate account assets Jackson offers variable contracts that invest contract holder’s premiums, at the contract holders’ direction, in investment vehicles (‘Separate Accounts’) that invest in equity, fixed income, bonds and money market mutual funds. The contract holder retains the underlying returns and the ownership risks related to the separate accounts and its underlying investments. The shareholder’s economic interest in separate accounts is limited to the administrative fees charged. The separate accounts are set up as separate regulated entities governed by a Board of Governors or trustees for which the majority of the members are independent of Jackson or any affiliated entity. The independent members represent contract holders’ interest and are responsible for any decision making that impacts contract holders’ interest and governs the operational activities of the entities’ advisers, including asset managers managing the investment vehicles. Accordingly, the Group does not control these vehicles. These investments are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position.
As at 31 December 2014, the Group does not have an agreement, contractual or otherwise, or intention to provide financial support to structured entities that could expose the Group to a loss.
c Classification of insurance and investment contracts IFRS 4 requires contracts written by insurers to be classified as either ‘insurance contracts’ or ‘investment contracts’ depending on the level of insurance risk transferred. Insurance risk is a pre-existing risk, other than financial risk, transferred from the contract holder to the contract issuer. If significant insurance risk is transferred to the Group then it is classified as an insurance contract. Contracts that transfer financial risk to the Group, but not significant insurance risk, are termed investment contracts. Furthermore, some contracts, both insurance and investment, contain discretionary participating features representing the contractual right to receive additional benefits as a supplement to guaranteed benefits: a That are likely to be a significant portion of the total contract benefits; b Whose amount or timing is contractually at the discretion of the insurer; and c That are contractually based on asset or fund performance, as discussed in IFRS 4.
For the operations in India, Japan and Taiwan the local GAAP is not appropriate as a starting point in the context of the modified statutory basis, and, instead, the accounting for insurance contracts is based on US GAAP. For these operations the business written is primarily non-participating linked and participating business. The future policyholder benefit provisions for non-participating linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claim expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business. Where appropriate, liabilities for participating business for these operations include provisions for the policyholders’ interest in investment gains and other surpluses that have yet to be declared as bonuses.
ii Use of fair value The Group uses current bid prices to value its investments with quoted prices. Actively traded investments without quoted prices are valued using prices provided by third parties as described further in note C3.2. If there is no active established market for an investment, the Group applies an appropriate valuation technique such as a discounted cash flow technique.
For UK with-profits funds the derivative programme derivatives are used for the purposes of efficient portfolio management or reduction in investment risk. For shareholder-backed UK annuity business the derivatives are held to contribute to the matching as far as practical, of asset returns and duration with those of liabilities to policyholders. The carrying value of these liabilities is sensitive to the return on the matching financial assets including derivatives held.
k Presentation of results before tax The total tax charge for the Group reflects tax that, in addition to relating to shareholders’ profits, is also attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. This is explained in more detail in note B5. Reported profit before the total tax charge is not representative of pre-tax profits attributable to shareholders. Accordingly, in order to provide a measure of pre-tax profits attributable to shareholders the Group has chosen to adopt an income statement presentation of the tax charge and pre-tax results that distinguishes between policyholder and shareholder components.
Gain on sale of PruHealth and PruProtectnote (iv) 86 – – n/a n/a Amortisation of acquisition accounting adjustmentsnote (vi) D1 (79) (72) (68) (10)% (16)% Loss attaching to held for sale Japan life business D1 – (102) (89) 100% 100% Costs of domestication of Hong Kong branch D2 (5) (35) (35) 86% 86%
– GMWB ‘not for life’ embedded derivative liabilities which are required to be fair valued. Fair value movements on these liabilities include the effects of changes to levels of equity markets, implied volatility and interest rates.
Risk margin reserve charge to operating profit for longer-term credit related losses (104) (63) (109) (69)
(v) Other shareholder-financed business The measurement of operating profit based on longer-term investment returns reflects the particular features of long-term insurance business where assets and liabilities are held for the long-term and for which the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying performance of life businesses exclusive of the effects of short-term fluctuations in market conditions. In determining the profit on this basis, the following key elements are applied to the results of the Group’s shareholder-financed operations.
Gain on sale of PruHealth and PruProtect – – 86 – – – 86 – 86 Amortisation of acquisition accounting
Underlying profit before performance-related fees 400 358 Share of associate results 13 12 Performance-related fees 33 25
Operating profit from asset management operations 446 395 Operating profit from Prudential Capital 42 46
(iii) Short-term fluctuations in investment returns for M&G are primarily in respect of unrealised fair value movements on Prudential Capital’s bond portfolio. (iv) The US asset management results include a charge of £38 million related primarily to the refund of certain fees by Curian.
Pension costs* 120 196 * The charge incorporates the effect of actuarial gains and losses.
For all options and awards, the expected volatility is based on the market implied volatilities as quoted on Bloomberg. The Prudential specific at-the-money implied volatilities are adjusted to allow for the different terms and discounted exercise price on SAYE options by using information on the volatility surface of the FTSE 100.
The principal reason for the increase in the tax charge attributable to policyholders’ returns is an increase in current tax in the with-profits life fund in the UK insurance operations. The main elements of the deferred tax credit shown in the table below are a credit of £309 million on short-term temporary differences reflecting future tax relief arising from increases in policy reserves in the US insurance operations and a charge of £127 million on unrealised gains and losses on investments reflecting an increase in unrealised gains on investments in the UK and Asia insurance operations.
Gain on sale of PruHealth and PruProtect D1 86 – 86 3.4p 3.4p Amortisation of acquisition accounting
Amortisation of acquisition accounting adjustments D1 (72) 24 (48) (1.9)p (1.9)p
Liabilities held for sale D1(b) 770 – – 770 – – – 770
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 1,038 26 4,214 5,278 – – – 5,278
Notes (i) The non-current assets of the Group comprise goodwill, intangible assets other than DAC and present value of acquired in-force business and property, plant and equipment included within ‘other non-investment and non-cash assets’. Items defined as financial instruments or related to insurance contracts are excluded. The Group’s total non-current assets at 31 December comprise: UK including insurance operations, M&G and central operations 2,138 2,090 * No individual country in Asia held non-current assets at the end of the year which exceeded 10 per cent of the Group total.
Assets Intangible assets attributable to shareholders: Deferred acquisition costs and other intangibles – 5,197 5,197 4,140
Profit for the year (as above) 249 452 Items recognised in other comprehensive income: Exchange movements 235 (32) Unrealised valuation movements on securities classified as available-for-sale: Unrealised holding gains (losses) arising during the year 1,039 (2,025) Deduct net gains included in the income statement (83) (64)
C2.3 UK insurance operations Of the total investments of £165 billion in UK insurance operations, £103 billion of investments are held by Scottish Amicable Insurance Fund and the PAC with-profits sub-fund. Shareholders are exposed only indirectly to value movements on these assets.
Other non-investment and non-cash assets 208 3,633 467 2,518 2,985 6,826 5,808 Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the equity method – 536 – – – 536 449 Financial investments: Equity securities and portfolio holdings in unit trusts 2,508 25,180 15,714 66 15,780 43,468 39,745
e Transfers into and transfers out of levels The Group’s policy is to recognise transfers into and transfers out of levels as of the end of each half year reporting period except for material transfers which are recognised as of the date of the event or change in circumstances that caused the transfer.
In addition, in 2014, the transfers into level 3 were £13 million and the transfers out of level 3 were £34 million. These transfers were between levels 3 and 2 and primarily for equity securities and debt securities.
Fair value (as included in statement of financial position) 27,178 20,229
Where no external ratings are available, internal ratings produced by the Group’s asset management operation, which are prepared on the Company’s assessment of a comparable basis to external ratings, are used where possible. The £10,087 million total debt securities held at 31 December 2014 (2013: £8,421 million) which are not externally rated are either internally rated or unrated. These are analysed as follows: Internal ratings or unrated: AAA to A- 4,917 3,691 BBB to B- 3,755 3,456 Below B- or unrated 1,415 1,274
ii Market and other financial risks The Group’s maximum exposure to credit risk of financial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk comprising cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note C3.5(b) below for derivative assets. The collateral in place in relation to derivatives is described in note C3.5(c) below. Note C3.4 describes the security for these loans held by the Group, as disclosed at the start of this note.
Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £13 million (2013: £59 million). In addition, during 2014 and 2013 the Group did not take possession of any other collateral held as security. Further details of collateral and pledges are provided in note C3.5(c) below.
Net flows: Investment-related items and other movements 1,859 3,712 4,840 10,411 Foreign exchange translation differences 683 7,360 – 8,043
At 31 December 2013/1 January 2014 218,185 6,018 12,061 Income and expense included in the income statement and other comprehensive income 23,532 (41) 54 Foreign exchange translation differences 8,321 338 335 iv Reinsurers’ share of insurance contract liabilities
The policy provides that at Jackson’s discretion it may reset the interest rate, subject to a guaranteed minimum. At 31 December 2014, Jackson had fixed interest rate annuities totalling £11.7 billion (2013: £11.2 billion) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 3.03 per cent average guaranteed rate (2013: 1.0 per cent to 5.5 per cent and a 3.05 per cent average guaranteed rate).
— A With-Profits Committee of independent individuals, which assesses the degree of compliance with the Principles and Practices of Financial Management and the manner in which conflicting rights have been addressed.
New mortality projection models are released annually by the Continuous Mortality Investigation (CMI). The CMI 2012 model was used to produce the 2014 and 2013 results, calibrated to reflect an appropriate view of future mortality improvements.
Distribution rights attributable to with-profits funds of the Asia insurance operations Distribution rights relate to facilitation fees paid in relation to the bancassurance partnership arrangements in Asia for the bank distribution of Prudential’s insurance products for a fixed period of time. The distribution rights amounts are amortised over the term of the distribution contracts.
Notes (i) These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the Prudential Regulation Authority handbook. Tier 1 subordinated debt is entirely US$ denominated. The Group has designated all US$2.80 billion (2013: US$3.55 billion) of its Tier 1 subordinated debt as a net investment hedge under IAS 39 to hedge the currency risks related to the net investment in Jackson.
Profit before tax attributable to shareholders (54) (137) 311 (215) Related deferred tax (where applicable) (5) 24 (34) 40
As with other shareholder-backed business the profit or loss for Jackson is presented by distinguishing the result for the year between an operating result based on longer-term investment returns and short-term fluctuations in investment returns. In this way the most significant direct effect of market changes that have taken place to the Jackson result are separately identified. The principal determinants of variations in operating profit based on longer-term returns are: — Growth in the size of assets under management covering the liabilities for the contracts in force; — Variations in fees and other income, offset by variations in market value adjustment payments and, where necessary, strengthening of liabilities; — Spread returns for the difference between investment returns and rates credited to policyholders; and — Amortisation of deferred acquisition costs.
Rate of increase in salaries Nil Rate of inflation: Retail Prices Index (RPI) 3.7 Consumer Prices Index (CPI) 3.0
Allowance for future improvements to post-retirement mortality For males (females) 100% (75%) of Medium Cohort subject to a minimum rate of improvement of 2.00% (1.25%) up to the age of 90, decreasing linearly to zero by age of 120 with a long-term rate of 1.75% pa (1.5% pa) but adjusted as follows: — Period improvements are blended between ages 60 to 80 to the long-term improvement rate over a 15 year period (compared with a 20 year period in the core CMI model); and
Adjustments to regulatory basis Unallocated surplus of with-profits funds – 10,348 10,348 – – 2,102 12,450 12,061 Shareholders' share of realistic liabilities note (i) – (2,503) (2,503) – – – (2,503) (3,112) Deferred acquisition costs, distribution rights and goodwill of non-participating business not recognised for regulatory reporting – (3) (3) (83) (5,177) (1,187) (6,450) (5,300)
Total available capital resources of life assurance businesses on local regulatory bases – 7,200 7,200 3,297 3,141 4,823 18,461 15,413
For participating business, mathematical reserves are based on the guaranteed benefits only and use a modified net premium approach with no allowance for future discontinuances. Similar to above, the underlying assumptions are based on a best estimate basis with prudent margins for adverse deviations with the valuation interest rate being a blend of the risk-adjusted portfolio yield and the reinvestment rate.
a Sale of PruHealth and PruProtect businesses On 10 November 2014, the Prudential Assurance Company Limited announced an agreement to sell its 25 per cent equity stake in the PruHealth and PruProtect businesses to Discovery Group Europe Limited (‘Discovery’) for £155 million in cash.
The assets and liabilities of the Japan life business classified as held for sale on the statement of financial position as at 31 December 2014 are as follows: Assets
P aren t co m p an y 263 Prudential plc Annual Report 2014
Using external actuarial advice provided by the professionally qualified actuaries, Towers Watson, for the valuation of the Scheme, the most recent full valuations have been updated to 31 December 2014 applying the principles prescribed by FRS 17. The long-term expected rates of return are set out below: Prospectively
Fair value of Scheme assets, at 31 December 6,997 6,042 * The contributions comprise ongoing service contributions and expenses.
Experience (losses) gains on Scheme liabilities (1% (2013: 0%) (2012: 0%) (2011: 6%) (2010: 0%) of liabilities) (34) (2) (19) 295 1
We subjected the Group’s operations to audits for Group reporting purposes as follows: — Audits for Group reporting purposes in relation to the financial information of the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, Korea, Vietnam and fund management operations in the UK (M&G). These audits covered 92 per cent of total Group revenue; 88 per cent of Group profit before tax; 91 per cent of total Group assets and 89 per cent of Group shareholders’ equity.
Other income and expenditurenote (i) (531) (482) Solvency II and restructuring costsnote (ii) (36) (34)
Share capital 128 128 Share premium 1,908 1,895 IFRS basis shareholders’ reserves 9,775 7,627
Total IFRS basis shareholders’ equity 12 11,811 9,650 Additional EEV basis retained profit 12 17,350 15,206
The 2013 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2013 CER comparative results are translated at 2014 average exchange rates.
Experience variances and other items: Mortality and morbiditynote (e) 23 33 Persistency and withdrawalsnote (f) 44 36
(c) Other items of £66 million for 2014 (2013: £60 million) principally reflect the positive effects of rebalancing the investment portfolio backing annuity business
New business contributionnotes (ii) and 3 (187) 216 29 665 694 Existing business – transfer to net worth 883 (210) 673 (673) – Expected return on existing businessnote 4 30 48 78 304 382 Changes in operating assumptions and experience variancesnote 4 278 4 282 170 452
Gain on sale of PruHealth and PruProtectnote 7 130 (32) 98 (54) 44
(iv) The increase in the cost of time value of guarantees for US operations from £(146) million at 2013 to £(462) million at 2014 primarily relates to variable annuity business. It mainly arises from the decrease in the expected long-term separate account rate of return following the 90 basis points decline in the US 10-year treasury bond rate and the impact from new business written in the year, partly offset by the level of equity performance.
Market risk allowance The allowance for market risk represents the beta multiplied by an equity risk premium. Except for UK shareholder-backed annuity business (as explained opposite) such an approach has been used for all of the Group’s businesses.
These allowances are initially reflected in determining best estimate returns and through the market risk allowance described above. However, for those businesses largely backed by holdings of debt securities, these allowances in the projected returns and market risk allowances may not be sufficient, and an additional allowance may be appropriate.
Total profit attributable to shareholders and basic earnings per share include these items, together with actual investment returns. The Company believes that operating profit, as adjusted for these items, better reflects underlying performance.
(iv) Asia operations — The stochastic cost of guarantees is primarily of significance for the Hong Kong, Korea, 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 UK insurance operations below; and — The volatility of equity returns ranges from 18 per cent to 35 per cent in both years, and the volatility of government bond yields ranges from 0.9 per cent to 2.3 per cent in both years.
Fee income represents profits driven by net investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses.
I: IFRS profit and loss information continued 2013 CER £m note (iii)
(vi) The DAC adjustment contains £11 million in respect of joint ventures in 2014 (2013: AER £1 million).
Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2014 of £4.8 billion (2013: £4.3 billion).
There are significant limitations with both (i) the notion that this market consistent approach to valuing assets and liabilities represents at all times the underlying economic reality, and (ii) the emphasis that Solvency II places on the fluctuation of these proxy market values over a one year timeframe. The business typically undertaken by life insurers is long term in nature, with liability profiles that are matched by maturity with similarly termed assets. This is why appropriately risk managed insurers can tolerate and withstand significant investment market volatility. What is critical in the assessment of the viability of insurers is their ability to meet claims when they fall due, over many years, rather than whether they can meet a one-year test based on theoretical proxy market values.
The economic capital results are based on outputs from our current Solvency II internal model with a number of working assumptions. Further explanation of the underlying methodology and assumptions are set out in the sections below. Certain aspects of this methodology and assumptions will differ from those which are applied in obtaining final internal model approval. Consequently, the position is expected to evolve to reflect policy clarifications and feedback from the Prudential Regulation Authority on Prudential’s approach to applying this new regime. Against this background of uncertainty, it is expected that the Solvency II ratio based on an approved model will be lower than the position shown above.
The risk-free curve at which best estimate liability cash flows are discounted is based on market swap rates (with the exception of Vietnam, India and Poland where no liquid swap market exists and government bond yields are therefore used), with a deduction of between 10 and 35 basis points (depending on country) to allow for a ‘credit risk adjustment’ to swap rates. This treatment reflects the likely outcome under Solvency II. In addition, an estimated matching adjustment is added to the liability discount rate for UK annuities, in both the base balance sheet and in the stressed conditions underlying the Economic Capital Requirement.
New business – 25 22 23 22 23 658 773 Sale of PruHealth and PruProtect – (2) (2) (5) (7) (7) (48) (71) Operating movements – 19 13 9 3 10 Non-operating and other movements – (7) 14 7 6 2 (469) (393)
This increase primarily reflects the new business written in 2014, which is expected to generate £1,379 million of free surplus over the next five years. Operating, non-operating and disposal of our share of PruHealth and PruProtect businesses and other items are expected to decrease free surplus generation by £70 million over the next five years, which is more than offset by the favourable foreign exchange movements of £345 million.
At 31 December 2014, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £47.1 billion, up from the £43.5 billion expected at end of 2013, reflecting the effect of new business written across all three business operations and a positive foreign exchange translation effect arising in the US and Asia operations of £1.2 billion. These positive effects have been offset by a £(1.7) billion adverse effect reflecting operating, market assumption changes and the disposal of our share of PruHealth and PruProtect businesses and other items. These principally reflect the impact of falling interest rates, particularly in Asia. The overall growth in the undiscounted value of free surplus reflects our ability to write both growing and profitable new business.
Notes 1 US$ linked – comprising the Hong Kong and Vietnam operations where the currencies are pegged to the US dollar, and the Malaysia and Singapore operations where the currencies are managed against a basket of currencies including the US dollar. 2 Includes long-term, asset management business and other businesses. 3 For operating profit and shareholders’ funds, UK sterling includes amounts in respect of central operations as well as UK insurance operations and M&G. 4 For shareholders’ funds, the US$ grouping includes US$-denominated core structural borrowings. Sterling operating profits include all interest payable as sterling denominated, reflecting interest rate currency swaps in place.
Profit before tax attributable to shareholders 2,614 1,635 2,747 1,866 1,283 Tax (charge) credit attributable to shareholders’ returns (398) (289) (584) (415) 43
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 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 on financial reporting ratios such as dividend cover, which is calculated as operating profit after tax on an IFRS basis, divided by the current year interim dividend plus the proposed final dividend. 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 on 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 the Prudential has in managing its business.
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, developing demographic trends and customer appetite for certain savings products. In some of its markets, Prudential faces competitors that are larger, have greater 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.
A d d itio n al in fo rm atio n 345 Prudential plc Annual Report 2014
Risk margin reserve (RMR) charge An RMR is included within operating profit based on longer-term investment returns and represents a charge for long-term expected defaults of debt securities, determined by reference to the credit quality of the portfolio.