AAAAAAAAAAAA Two ‘Five Star’ ratings for excellent service in the Investment and Life and Pensions categories at the Financial Adviser Service Awards 2012
As a Board, we must ensure that our results translate into real returns for our shareholders. The continued strength of our operations in Asia, the US and the UK gives us confi dence that we will continue generating sustainable growth over the long term. So for the second time in three years, we have been able to announce the rebasing of our full-year dividend upwards by 4 pence. The Board has therefore recommended a fi nal dividend of 20.79 pence per share, which brings the total dividend for the year to 29.19 pence per share, 4 pence or 15.9 per cent higher than the 2011 total dividend.
We have maintained our bias in favour of insurance income and fee income, which have grown as a proportion of our profi ts, ahead of spread income. True to that logic, in the US we acquired Reassure America Life Insurance Company (REALIC), which increased our insurance income. We also continue to drive our product mix to achieve the optimal balance between growth in sales, profi t growth, cash generation and capital strength. Therefore, we have continued to emphasise and to grow protection products in Asia, which also provide excellent value to our customers. In the US, we have seen growing demand for Elite Access, a variable annuity without guarantees, launched in March 2012. Elite Access allows us to meet the needs of a key customer segment and to grow profi tably while staying within our quantitative risk appetite in the year. We believe Elite Access has excellent prospects in the US market. More generally, we have continually and proactively re-priced our products and modifi ed their features to ensure they continued to generate adequate returns in the new interest rate environment.
3 Total Asia operating profi t from long-term business and Eastspring Investments aft er development costs. 2012 operating profi t includes a one-off gain of £51 million arising on sale of the Group’s holding in China Life Insurance Company of Taiwan.
Overall, our geographic footprint, combined with the exceptional quality of our distribution and of our products, has enabled us to deliver another year of very strong performance in Asia. Our 13 million insurance customers, whom we serve well and profi tably, represent only a small proportion of the long-term potential of this part of the world for our company.
We continue to assess the impact of the RDR, which was implemented on 31 December 2012, and the resulting changes to distributors’ business models. This is likely to lead to some short-term dislocation in the market as consumers and distributors adjust to the new sales environment. We expect this transition phase to dampen our sales of investment bonds in 2013, compared to the high sales in 2012. We are confi dent that the strength of our brand combined with our investment capabilities, fi nancial strength and experience will ensure that we remain well placed to provide customers with dependable retirement income. We believe that with-profi ts products will continue to be popular with customers seeking competitive long-term real investment returns.
There is broad agreement that ultimately it would be benefi cial to replace the IGD regime with a regime that is more risk-based. Solvency II may provide such a framework but we now know that it will not be implemented before 31 December 2015. In common with other insurers we have been working with regulators to ensure that the current capital regime remains robust while we wait for the implementation of Solvency II.
B al an ce d m et ri cs a nd d is clo sures
2 Remittances from Asia in 2012 include net remittance of £27 million, representing cash from sale of Group’s holding in China Life Insurance Company in Taiwan off set by repayment of funding contingent on future profi ts of the Hong Kong life insurance operations. 2010 remittances included a one-off remittance of £130 million, representing the accumulation of historic distributable reserves.
Market overview Asia’s rapidly-growing middle class remains a key growth driver for the retail fi nancial services sector, particularly life insurance with an emphasis on protection. Research has shown that as the middle class becomes more established the proportion of income they allocate to fi nancial planning increases from 5 per cent to around 12 per cent1.
We believe the Asian life insurance markets remain a highly compelling opportunity for delivering profi table growth over the long term with South-east Asia, including Hong Kong, currently offering the most attractive market dynamics for insurance providers, with increasing opportunities to provide fi nancial security to the new middle class whose expectations now go beyond basic subsistence to protecting and improving their personal fi nances over the long term.
Prudential’s joint venture with ICICI continues to be the leader in the private sector.
The latest statistics released by the Malaysian Life Insurance Association show that the industry grew by 2.2 per cent during 2012 in terms of weighted premiums relative to 2011 refl ecting general concerns about the economic outlook. Prudential remains the market leader in Malaysia with a highly productive agency force and growing bank distribution.
Fixed annuity APE sales of £58 million were 23 per cent higher than the level of sales in 2011. Jackson ranked seventh in sales of traditional deferred fi xed annuities through the third quarter of 2012, with a market share of 3.6 per cent, compared to thirteenth with a 2.1 per cent market share for the full year 20111.
Total APE sales for 2012 were £836 million (2011: £746 million) of which sales of individual annuities of APE £241 million were 35 per cent higher than in 2011.
Corporate pensions sales of APE £189 million were 19 per cent lower than the previous year. Sales in 2011 were particularly high due to new defi ned contribution members joining our schemes following closure of a number of defi ned benefi t schemes operated by existing clients. We continue to focus on securing new members and incremental business from our current portfolio of corporate pensions customers rather than acquiring new corporate pensions schemes where market pricing is currently unattractive. Prudential UK remains the largest provider of additional voluntary contribution plans within the public sector, where we now provide schemes for 68 of the 99 public sector authorities in the UK.
Markets have remained diffi cult and volatile in 2012, and as a result the business remains focused on liquidity across the Prudential Group, management of the existing asset portfolio and conservative levels of new investment. Prudential Capital has continued to invest in developing its capabilities, by seeking to maintain the dynamism and fl exibility necessary to ensure that the treasury and wholesale services remain robust in a period of increased regulatory change, and to identify and realise opportunities for profi t within acceptable risk parameters. Prudential Capital is committed to working closely with other business units across the Prudential Group to exploit opportunities and increase value creation for Prudential as a whole.
Operating profi t based on longer-term investment returns 2,580 2,038 2,034
(iv) DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in the basis of preparation and note A5 of the IFRS fi nancial statements.
RPI to CPI infl ation measure change on defi ned benefi t pension schemes(note) – 45 – 45 – Solvency II implementation costs (50) (56) 11 (56) 11 Restructuring costs (22) (19) (16) (18) (22)
EEV basis operating profi t based on longer-term investment returns 4,321 3,978 Short-term fl uctuations in investment returns: – Insurance operations 456 (787) – Other operations 82 (120)
Mark to market value movement on core borrowings The mark to market value movement on core borrowings of negative £380 million in 2012 refl ects the effect on the market value of Prudential’s borrowings from reductions in both interest rates and credit spreads.
Total profi t before tax 2,810 1,828 5,020 2,922 Tax and non-controlling interests (613) (413) (1,207) (780)
Shareholders’ funds at end of the year 10,359 8,564 22,443 19,637
Value created through investment in new business by life operations continued Overall, the Group wrote £4,195 million of sales on an APE basis in 2012 (2011: £3,681 million) generating a post-tax new business contribution to embedded value of £1,791 million (2011: £1,536 million). To support these sales, we invested £618 million of capital (2011: £553 million) equivalent to 23 per cent (2011: 22 per cent) of underlying free surplus generated by the life in-force and asset management businesses.
Outside of the normal recurring central cash fl ow items and in light of the heightened risks surrounding the Eurozone, we incurred a net cash fl ow of £32 million for short-dated hedges to provide downside protection against severe equity market falls. We also incurred £43 million of other net cash payments in 2012, representing payments of £68 million to the UK tax authorities following the settlement reached in 2010 on historic tax issues offset by a receipt of £25 million from an increased bank loan in the year. A fi nal instalment on the agreed settlement will be paid in 2013 to the UK tax authorities at a level similar to 2012.
The Group retains revenues locally to support the growth of the Group’s business and capital is held in the local currency of the business to meet local regulatory and market requirements, accepting the balance sheet translation risks this can produce. However, in cases where a surplus arising in an overseas operation supports Group capital or shareholders’ interest (ie remittances), this exposure is hedged if it is economically optimal to do so. The Group does not have appetite for signifi cant shareholder exposures to foreign exchange risks in currencies outside the local territory. Currency borrowings, swaps and other derivatives are used to manage exposures.
i Debt portfolio (Audited) The investments held by the shareholder-backed operations are predominantly debt securities, of which 95 per cent are rated, either externally or internally, as investment grade (31 December 2011: 95 per cent).
Of the £68.6 billion of debt securities backing shareholder business, excluding holdings attributable to external holders of consolidated unit trusts, 3 per cent or £2.2 billion was in Tier 1 and Tier 2 hybrid bank debt. A further £3.2 billion was in the form of senior debt.
B.2 Non-fi nancial risk (Unaudited) Prudential is exposed to operational, business environment and strategic risk in the course of running its businesses.
Note 1 The estimated position at 28 February 2013 allows for economic conditions and surplus generation since 31 December 2012 and is stated before the fi nal dividend and the eff ect of the Thanachart acquisition and aft er allowing for a reduction in Jackson’s contribution to IGD surplus of £1.3 billion.
We commissioned additional demographic research in partnership with CSIS, looking, in further detail, at retirement expectations in Asia. Based on a survey conducted by CSIS in six East Asia countries, it explores how rapid development and rapid ageing are transforming retirement behaviour and expectations in the emerging world. The fi ndings of the study were published in 2012 and it is available at
Across the region, we have a highly trained tied agency force, and we provide support to new and experienced agents so that they can deliver the best possible service for our customers. In Hong Kong, we have developed the ‘Certifi ed Agency Builder Programme’, through which fi nancial professionals follow a series of certifi ed training courses.
In the US, The Jackson University continues to provide business-specifi c development activities for employees. Jackson’s senior management team play a central role in shaping the curriculum, ensuring it aligns to major corporate initiatives for the business. In addition, the LEAP programme for senior leaders aims to accelerate their leadership potential and organisational impact.
In 2012, the Prudence Foundation was established in Asia as a unifi ed platform to coordinate charitable activity in the region. As part of the creation of the Prudence Foundation, Prudential Corporation Asia’s approach has turned to disaster preparedness. A designated fund has been established to help communities develop preventative programmes before disasters occur to improve the ability of communities to better prepare for, cope with and recover from any unfortunate natural disasters.
Tidjane was a non-executive director of Arkema in France until November 2009. He is a member of the Board of the Association of British Insurers (ABI) and he was appointed as Chairman in July 2012. He is a member of the Council of the Overseas Development Institute (ODI) in London, a member of the Africa Progress Panel chaired by Kofi Annan and a sponsor of Opportunity International. Tidjane is a member of the UK-ASEAN Business Council and of the Strategic Advisory Group on UK Trade and Investment. In January 2012, Tidjane was appointed to the Prime Minister’s Business Advisory Group and has been a member of the European Financial Round Table (EFR) since January 2013. Tidjane was awarded the Légion d’Honneur by the French President in July 2011. Age 50.
Appointments Board: October 2010 Chairman of the Board: July 2012 Chairman of the Nomination Committee: July 2012
Your Chairman’s view: Prudential’s governance framework makes a vital contribution to the long-term success of the Group. To ensure that our business is both successful and sustainable, the Board works closely with management in evaluating the opportunities and risks we face. We ensure that the Group’s strategy remains appropriate and that rigorous oversight is in place across our geographically diverse business.
Diversity The Group seeks, through its diversity policy, to encourage the recruitment and retention of talented women at all levels. Furthermore, the Board remains committed to inclusion in all its forms and believes that leading companies seek out, and not simply tolerate, diversity.
Throughout the year the non-executive directors were considered by the Board to be independent in character and judgement and met the provisions for independence as set out in the UK and HK Codes. The Company has received confi rmation of independence from each of the independent non-executive directors as required by the Hong Kong Listing Rules.
The Committee also received in-depth presentations on a range of topics and received the minutes of both the Disclosure Committee and the Assumptions Approval Committee. Further information on the Disclosure Committee appears under the heading ‘US corporate governance and regulations’ on page 109. The Assumptions Approval Committee reviews the economic assumptions to be used for EEV reporting, business planning, forecasting and the IAS 19 valuation of the three UK defi ned benefi t pension schemes. Further information on risk governance appears on pages 105 and 106 respectively.
In line with the Auditing Practices Board Ethical Statements and the Sarbanes-Oxley Act, the lead audit partner who was appointed by KPMG Audit Plc in 2007, was replaced by a new lead audit partner in respect of the 2012 fi nancial year.
Full biographical details of the members of the Committee are set out on pages 91 to 92.
The Group maintains a corporate website containing a wide range of relevant information for private and institutional investors, including the Group’s fi nancial calendar. The shareholder information section on pages 396 and 397 contains further details which may be of interest to shareholders.
Annual General Meeting The Annual General Meeting will be held in the Churchill Auditorium at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on 16 May 2013 at 11.00am.
Going concern After making enquiries the directors have a reasonable expectation that the Company and the Group have adequate resources to continue their operations for the foreseeable future. In support of this expectation, the Company’s business activities, together with the factors likely to affect its future development, successful performance and position in the current economic climate are set out in the Business review on pages 14 to 67. The risks facing the Group’s capital and liquidity positions and their sensitivities are referred to in the Chief Financial Offi cer’s overview. Specifi cally, the Group’s borrowings are detailed in Note H13 on pages 289 to 291, the market risk and liquidity analysis associated with the Group’s assets and liabilities can be found in note G2 on pages 269 to 272, policyholder liability maturity profi le by business units in notes D2, D3, D4 on pages 212, 230 and 237 respectively, cash fl ow details in the consolidated statement of cash fl ows and provisions and contingencies in Note H14. The directors therefore have continued to adopt the going concern basis of accounting in preparing the fi nancial statements.
Compensation for loss of offi ce None of the terms of employment of the Company’s directors includes provisions for payment of compensation for loss of offi ce or employment that occurs as a result of a change of control. Terms applying on a termination of their offi ce are set out in the Directors’ remuneration report. In the US, senior executives participate on a discretionary basis in a plan which entitles them to compensation, in the event that their employment is terminated or adversely affected as a result of a change of control.
AAAAAAAAAAAA To reward executives for delivering our business plans and generating sustainable growth and returns for shareholders.
Reward must be: AAAAAAAAAAAA Determined by delivery of the Group’s annual and longer-term business objectives; AAAAAAAAAAAA Aligned with shareholder value creation; and
The calculation of the Chief Executive of M&G's annual bonus opportunity is transparent and linked to the success of the M&G business.
Long-term incentives To incentivise and reward the achievement of: Longer-term commitments to shareholders; Sustainable long-term returns for shareholders; and
Benefi ts To provide executives with items and allowances that assist them in carrying out their duties effi ciently.
R em u n eratio n p o licy rep o rt 2012 opportunity 2012 performance metrics Changes to policy for 2013 2012 base salaries are set out on page 124.
The annual bonus opportunity for the Chief Executive of M&G will be capped at the lower of 0.75 per cent of M&G’s IFRS profi t or six times salary.
4 Nic Nicandrou’s interest in shares on 12 March 2013 includes his monthly purchases made under the SIP plan in January, February and March 2013. 5 Kathleen O’Donovan retired from the Board on 31 March 2012.
Section A: Background and accounting policies 154 A1: Nature of operations 154 A2: Basis of preparation 154 A3: Accounting policies 166 A4: Critical accounting estimates and judgements 170 A5: New accounting pronouncements
Profi t before tax (being tax attributable to shareholders’ and policyholders’ returns)† 3,188 1,811 (Less) add tax (charge) credit attributable to policyholders’ returns (378) 17
Unrealised valuation movements on securities of US insurance operations classifi ed as available-for-sale: D3(a) Unrealised holding gains arising during the year 930 912 Deduct net gains included in the income statement on disposal and impairment (68) (101)
At beginning of year: As previously reported 127 1,873 5,839 354 924 9,117 43 9,160 Effect of change in accounting policy
Properties held for sale H9 98 3 257 Cash and cash equivalents G1,H10 6,384 7,257 6,631 * The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 and 2010 comparative results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had always applied, as described in note A5.
† As a result of the adoption of the altered US GAAP requirements as noted above, the 2010 balance sheet has been presented in accordance with IAS 1. The 2010 comparatives for the relevant balance sheet notes which have been impacted by this change have been retrospectively adjusted accordingly.
Cash fl ows from investing activities Purchases of property, plant and equipment H6 (139) (124) Proceeds from disposal of property, plant and equipment 14 10 Acquisition of subsidiaries, net of cash balance note (iii) I1 (224) (53) Change to Group's holdings, net of cash balance I2 23 –
The usage of these bases of accounting has varying effects on the way in which product options and guarantees are measured. For UK regulated with-profi ts funds, options and guarantees are valued on a market consistent basis. The basis is described in section 2(a) below. For other operations a market consistent basis is not applied under the accounting basis described in section 2(a) below. Details of the guarantees, basis of setting assumptions and sensitivity to altered assumptions are described in notes D3 and D4.
The cost of guarantees, options and smoothing is very sensitive to the bonus, market value reduction (MVR) and investment policies the Group employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse scenarios. Substantial fl exibility has been included in the modelled management actions in order to refl ect the discretion that the Group retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with management’s policy for with-profi ts funds and the disclosures made in the publicly available Principles and Practices of Financial Management.
For these contracts ‘grandfathered’ UK GAAP has been applied, which refl ects the MSB. Under this basis the following approach applies: i Other UK insurance contracts Other UK insurance contracts that contain signifi cant insurance risk include unit-linked, annuity and other non-profi t business. For the purposes of local regulations, segregated accounts are established for linked business for which policyholder benefi ts are wholly or partly determined by reference to specifi c investments or to an investment-related index. The interest rates used in establishing policyholder benefi t provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefi ts are based on published mortality tables adjusted to refl ect actual experience.
For those investment contracts in the US with fi xed and guaranteed terms, the Group uses the amortised cost model to measure the liability.
AAAAAAAAAAAAAAAA Assets backing unit-linked and US variable annuity business separate account liabilities. For such business, the policyholder unit liabilities are directly refl ective of the asset value movements. Accordingly, the operating results based on longer-term investment returns refl ect the current period value movements in unit liabilities and the backing assets.
For debt securities backing non-linked shareholder-fi nanced business of the UK insurance operations (other than the annuity business) and of the Asia insurance operations, the realised gains and losses are principally interest related. Accordingly, all realised gains and losses to date for these operations are being amortised over the period to the date those securities would otherwise have matured, with no explicit RMR charge.
Asia operations The insurance products written in the Group’s Asia operations principally cover with-profi ts business, unit-linked business and other non-participating business. The results of with-profi ts business are relatively insensitive to changes in estimates and assumptions that affect the measurement of policyholder liabilities. As for the UK business, this feature arises because unallocated surplus is accounted for by the Group as a liability. The results of Asia unit-linked business are also relatively insensitive to changes in estimates or assumptions due to the matching of asset value and liability movements. For other Asia non-participating business the degree of sensitivity of results to changes in interest rates depends upon the degree to which the liabilities under the ‘grandfathered’ IFRS 4 measurement basis refl ects market interest rates from period to period for example, for those countries, such as those applying US GAAP, the results can be more sensitive as the effect of interest rate movements on the backing investments may not be offset by liability movements due to the US GAAP basis of measurement of insurance contracts.
Profi t for the year 2,296 (99) 2,197 1,494 (75) 1,419 Exchange movements on foreign operations and net investment hedges, net of related tax (236) 20 (216) (100) (5) (105) Unrealised valuation movements on securities of US insurance operations classifi ed as available-for-sale 862 – 862 811 – 811
Total comprehensive income for the year attributable to equity holders of the Company 2,418 (50) 2,368 1,702 (43) 1,659
This decision refl ects the inherent constraints of IAS 39 for hedge accounting investments and life assurance assets and liabilities under ‘grandfathered’ US GAAP under IFRS 4.
Dividends paid in cash, as set in the consolidated statement of cash fl ows for 2012 were £655 million (2011: £642 million).
Note Further segmental analysis: 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 defi ned as fi nancial 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 1,927 1,906 US 152 144 Asia* 640 681 * No individual country in Asia held non-current assets at the end of the year which exceeds 10 per cent of the Group total.
Equity and liabilities Equity Shareholders’ equity H11 3,033 4,343 2,529 9,905 1,937 (1,483) – 10,359 Non-controlling interests 1 – 4 5 – – – 5
Operational borrowings attributable to shareholder-fi nanced operations 103 127 141 371 13 2,956 – 3,340
: Su m m ary o f resu lts 2012 £m 2011* £m
Core structural borrowings of shareholder-fi nanced operations: Subordinated debt – – – – 2,577 – 2,577 2,652 Other – – 153 275 549 – 977 959
Operational borrowings attributable to shareholder-fi nanced operations – 1 159 1 2,084 – 2,245 3,340
Offi ce buildings 4,195 38.7 4,443 41.5 Shopping centres/commercial 4,389 40.4 4,315 40.3 Retail warehouses/industrial 1,624 15.0 1,406 13.1 Development 465 4.3 383 3.6 Other 179 1.6 165 1.5 47.6 per cent (2011: 42.9 per cent) of the UK held investment property is located in London and Southeast England with 35.4 per cent (2011: 41.1 per cent) located throughout the rest of the UK and the remaining 17.0 per cent (2011: 16.0 per cent) located overseas.
The provisions have been determined on a basis consistent with the detailed methodology included in regulations contained in the FSA’s rules for the determination of reserves on the FSA’s ‘realistic’ Peak 2 basis. In aggregate, the regime has the effect of placing a value on the liabilities of UK with-profi ts contracts, which refl ects the amounts expected to be paid based on the current value of investments held by the with-profi ts funds and current circumstances. These contracts are a combination of insurance and investment contracts with discretionary participation features, as defi ned by IFRS 4.
D2: UK insurance operations continued iii Annuity business Credit risk provisions
The prudent Pillar 1 regulatory basis refl ects the overriding objective of maintaining suffi cient provisions and capital to ensure payments to policyholders can be made. The approach for IFRS aims to establish liabilities that are closer to ‘best estimate’.
Shareholder UK results of UK with-profi ts business (including non-participating annuity business of the WPSF and of Prudential Annuities Limited (PAL), which is owned by the WPSF) are only sensitive to market risk through the indirect effect of investment performance on declared policyholder bonuses.
† Partnerships in investment pools and other comprise primarily investments in limited partnerships. These include interests in the PPM America Private Equity Fund and diversifi ed investments in 167 (2011: 167) other partnerships by independent money managers that generally invest in various equities and fi xed income loans and securities.
Corporate and government security and commercial loans: Government 4,126 2,163 Publicly traded and SEC Rule 144A* securities 19,699 16,281 Non-SEC Rule 144A* securities 3,542 3,198
The policy provides that at Jackson’s discretion it may reset the interest rate, subject to a guaranteed minimum. At 31 December 2012, Jackson had fi xed interest rate annuities totalling £11.7 billion (US$19.0 billion) (2011: £11.5 billion (US$17.8 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 3.09 per cent average guaranteed rate (2011: 1.0 per cent to 5.5 per cent and a 3.08 per cent average guaranteed rate).
GMIB benefi ts are essentially fully reinsured, subject to annual claim limits. As this reinsurance benefi t is net settled, it is considered to be a derivative under IAS 39, and is therefore recognised at fair value with the change in fair value included as a component of short-term derivative fl uctuations.
(b) The reduction in the previously assumed future rates of return for the upcoming fi ve years from 15 per cent, to a level nearer the middle of the corridor (of 0 per cent and 15 per cent), so that, in combination with the historical returns, the eight-year average in the mean reversion calculation was the 8.4 per cent assumption.
Statement of changes in equity – ‘shadow DAC adjustments’ Consequent upon the positive unrealised valuation movement in 2012 of £862 million (2011: positive £811 million), there is a debit of £270 million (2011: £275 million debit) for altered ‘shadow’ DAC amortisation booked within other comprehensive income. These adjustments refl ect movement from period to period, in the changes to the pattern of reported gross profi ts that would have happened if the assets refl ected in the statement of fi nancial position had been sold, crystallising the unrealised gains or losses, and the proceeds reinvested at the yields currently available in the market. At 31 December 2012, the cumulative ‘shadow DAC balance’ was negative £952 million (2011: negative £720 million).
AAAAAAAAAAAAAAAAAAA Credit default swaps represent agreements under which Jackson has purchased default protection on certain underlying corporate bonds held in its portfolio. These contracts allow Jackson to sell the protected bonds at par value to the counterparty if a default event occurs in exchange for periodic payments made by Jackson for the life of the agreement. Jackson does not write default protection using credit derivatives.
GMAB – Premium only 0% 53 – Highest specifi ed anniversary account value minus withdrawals post-anniversary
The directional movements in the sensitivities refl ect the hedging programme in place at 31 December 2012.
Pre-tax profi t, net of related changes in amortisation of DAC (143) (72) (129) (64)
Related effect on charge for deferred tax 65 – 19 65 (172) (80) 57 98
Policyholder liabilities 10,958 12,724 4,992 28,674 Unallocated surplus of with-profi ts funds 66 – – 66
In general terms, the Asia participating products provide savings and protection where the basic sum assured can be enhanced by a profi t share (or bonus) from the underlying fund, as determined at the discretion of the insurers. The Asia operations’ non-participating term, whole life and endowment products offer savings and/or protection where the benefi ts are guaranteed or determined by a set of defi ned market-related parameters. Unit-linked products combine savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. Health and Protection (H&P) policies provide mortality or morbidity benefi ts and include health, disability, critical illness and accident coverage. H&P products are commonly offered as supplements to main life policies but can be sold separately.
The method for determining liabilities of insurance contracts for UK GAAP, and IFRS, purposes for some Asia operations is based on US GAAP principles and this method applies to contracts with cash value and interest rate guarantees. Following standard US GAAP procedure, premium defi ciency reserve calculations are performed each year to establish whether the carrying values of the liabilities are suffi cient.
As for the UK insurance operations, for unit-linked business, the main factor affecting the profi t and shareholders’ equity of the Asia operations is investment performance through asset management fees. The sensitivity of profi ts and shareholders’ equity to changes in insurance risk, interest rate risk and credit risk are not material.
Interest rate risk Asia operations offer a range of insurance and investment products, predominantly with-profi ts and non-participating term, whole life endowment and unit-linked. Excluding with-profi t and unit-linked business, the results of the Asia business are sensitive to the vagaries of routine movements in interest rates.
In the equity risk sensitivity analysis shown above, the Group has considered the impact of an instantaneous 20 per cent fall in equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous fall but rather this would be expected to occur over a period of time during which the Group would be able to put in place mitigating management actions.
Investment contracts without discretionary participation features (principally unit-linked and similar contracts in the UK and GIC liabilities of Jackson)note (vi) – 17 17 14,927 1,911 112 16,967
Determination of the ECR involves the comparison of two separate measurements of the fi rm’s resources requirement, which the FSA refers to as the ‘twin peaks’ approach.
The two separate peaks are: i The requirement comprised by the mathematical reserves plus the ‘Long-Term Insurance Capital Requirement’ (LTICR), together known as the ‘regulatory peak’; and ii A calculation of the ‘realistic’ present value of the insurer’s expected future contractual liabilities together with projected ‘fair’ discretionary bonuses to policyholders, plus a risk capital margin, together known as the ‘realistic peak’.
Participating fund surplus is not allowed to be used to support defi cit (if any) and capital requirement of the non-participating business. The capital requirement is calculated based on a prescribed series of risk charges. The local regulator has set a Supervisory Target Capital Level of 130 per cent below which supervisory actions of increasing intensity will be taken. Each insurer is also required to set its own Individual Target Capital Level to refl ect its own risk profi le and this is expected to be higher than the Supervisory Target Capital Level; Vietnam
iv Group capital requirements In addition to the requirements at individual company level, FSA requirements under the IGD apply additional prudential requirements for the Group as a whole. Discussion of the Group’s estimated IGD position at 31 December 2012, together with market risk sensitivity disclosure provided to key management, is provided in the business review section of the Group’s 2012 Annual Report.
Charges of consolidated investment fundsnote (i) 11 – – 11 (9) NPH broker-dealer feesnote (i) – (435) – (435) (405)
E4: Sensitivity of profi t and shareholders’ equity to market and other fi nancial risk i Currency translation Consistent with the Group’s accounting policies, the profi ts of Eastspring Investments and US asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. The rates for the functional currencies of most signifi cant operations are shown in note B4.
Acquisition costs and other operating expenditureF3 (1,239) (815) (1,562) (704) (630) (212) (5,162) 42 (5,120)
(iii) The movement in unallocated surplus of with-profi ts funds for Asia above includes movement relating to the Hong Kong branch of PAC. For the purpose of the presentation of unallocated surplus of with-profi ts funds within the statement of fi nancial position, the Hong Kong branch balance is shown within the unallocated surplus of the PAC with-profi ts sub-fund.
Deferred tax arising from: Origination and reversal of temporary differences (178) 293 (Expense) credit in respect of a previously unrecognised tax loss, tax credit or temporary difference from a prior period (6) 57
The total tax expense arises as follows: 2012 £m 2011* £m
The fair value estimates are made at a specifi c point in time, based upon available market information and judgements about the fi nancial instruments, including estimates of the timing and amount of expected future cash fl ows and the credit standing of counterparties. Such estimates do not refl ect any premium or discount that could result from offering for sale at one time the Group’s entire holdings of a particular fi nancial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the fi nancial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the fi nancial instrument.
The estimated fair value of derivative fi nancial instruments refl ects the estimated amount the Group would receive or pay in an arm’s length transaction. This amount is determined using quoted prices if exchange listed, quotations from independent third parties or valued internally using standard market practices. In accordance with the Group’s risk management framework, all internally generated valuations are subject to assessment against external counterparties’ valuations.
Group total Loans – 279 – 279 Equity securities and portfolio holdings in unit trusts 84,838 2,136 375 87,349 Debt securities 29,211 94,378 909 124,498 Other investments (including derivative assets) 300 3,710 3,499 7,509 Derivative liabilities (294) (2,542) (218) (3,054)
Total fi nancial instruments at fair value 111,469 81,780 4,116 197,365 Percentage of total 57% 41% 2% 100%
In addition, during the year the Group took possession of £16 million (2011: £13 million) of other collateral held as security, which mainly consists of assets that could be readily convertible into cash.
Amortisation charge (9) (5) Exchange differences (4) 1 Reclassifi cation – (10)
Of the total shares held in trust no shares were held by a qualifying employee share ownership trust (2011: 0.1 million). The shares purchased each month are as follows: Number of shares 2012 share price
Reserves The translation reserve of £66 million (2011: £282 million) represents cumulative foreign exchange translation differences taken directly to equity in accordance with IFRS, net of related tax. In accordance with IFRS 1, cumulative translation differences are deemed to be zero at 1 January 2004, the date of transition to IFRS. The available-for-sale reserve represents gains or losses arising from changes in the fair value of available-for-sale securities of Jackson, net of the related change in amortisation of deferred income and acquisition costs and of the related tax.
(vii) In January 2013, the Company issued core structural borrowings of US$700 million Tier 1 perpetual subordinated capital securities. The proceeds, net of costs, were US$689 million.
Borrowings in respect of short-term fi xed income securities programmes Commercial paper 1,535 2,706 Medium-Term Notes 2013 note (vi) 250 250 Medium-Term Notes 2015 299 –
Other borrowings Bank loans and overdrafts 1 13 Obligations under fi nance leases 1 1 Other borrowings note (iii) 139 349
At 31 December 2012 the pension mis-selling provision was £306 million (31 December 2011: £362 million). The pension mis-selling provision is included within the liabilities in respect of investment contracts with discretionary participation features under IFRS 4. The pension mis-selling provision at 31 December 2012 of £306 million is stochastically determined on a discounted basis. The average discount rate implied in the movement in the year is 2.3 per cent (2011: 2.6 per cent).
The inherited estate, as working capital, enables PAC to support with-profi ts business by providing the benefi ts associated with smoothing and guarantees, by providing investment fl exibility for the fund’s assets, by meeting the regulatory capital requirements that demonstrate solvency and by absorbing the costs of certain signifi cant events or fundamental changes in its long-term business without affecting the bonus and investment policies. The size of the inherited estate fl uctuates from year to year depending on the investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events.
Jackson owns debt instruments issued by securitisation trusts managed by PPM America. At 31 December 2012, the support provided by certain forbearance agreements Jackson entered into with the counterparty to certain of these trusts could potentially expose Jackson to maximum losses of £31 million (2011: £71 million), if circumstances allowed the forbearance period to cease. Jackson believes that, so long as the forbearance period continues, the risk of loss under the agreements is remote.
Total goodwill arising on acquisition attributable to the with-profi ts fund 12
IAS 19 pension asset (liability) on the Group statement of fi nancial position* 164 (205) (41) (229)
Shareholders' share: Gross of tax (defi cit) surplus (23) (18) 50 41 50 Related tax 6 3 (12) (9) (12)
Note (i) The PSPS scheme has entered into a derivatives based strategy to match the duration and infl ation profi le of its liabilities. This involved a reallocation from other investments to other assets with an interest and infl ation swap overlay. In broad terms, the scheme is committed to making a series of payments related to LIBOR on a nominal amount and in return the scheme receives a series of fi xed and infl ation-linked payments which match a proportion of its liabilities. As at 31 December 2012, the nominal value of the interest and infl ation-linked swaps amounted to £0.9 billion (2011: £0.9 billion) and £2.0 billion (2011: £2.0 billion) respectively.
Benefi t payments (15) 15 5 5 Contributions 54 40 (1) 93 (21) 72 Actuarial and other gains and losses (4) 12 28 36 1 37 Transfer out of investment in Prudential
RPI to CPI infl ation measure change in 2011 – 282 Exceptional discretionary pension increase for PSPS in 2012 (106) – Finance (expense) income: Interest cost (263) (299) Expected return on assets – IAS 19 basis 227 283 Add: expected return on investments of scheme assets in Prudential insurance policies 8 25 Expected return on assets – economic basis 235 308
Actuarial gains and losses – IAS 19 basis (as recognised in the income statement and referred to in note I3a) 145 37
Notes (a) Past service cost – RPI/CPI infl ation measure change in 2011 During 2011 the Group altered its infl ation measure basis for future statutory increases to pension payments for certain tranches of its UK defi ned benefi t pension schemes. This refl ected the UK Government’s decision to replace the basis of indexation from RPI with CPI. The £282 million credit in 2011 shown above comprised £216 million for PSPS and £66 million for other schemes. As noted earlier, the PSPS scheme surplus was not recognised for accounting purposes due to the application of IFRIC 14. The £66 million for other schemes was allocated as £24 million to PAC with-profi ts fund and £42 million to shareholders as referred to in note C.
Discount rate 4.4% 4.7% Increase by 0.2% Decrease in scheme liabilities by: Other schemes 4.6% 4.5%
ii Other pension plans The Group operates various defi ned contribution pension schemes including schemes in Jackson and Asia. The cost of the Group’s contributions for continuing operations to these schemes in 2012 was £47 million (2011: £40 million).
Profi t aft er tax of the Group attributable to shareholders in accordance with IFRS 2,197 1,415
Based on profi t after tax and non-controlling interests of £3,813 million (2011: £2,142 million) 13 150.1p 84.6p
Where appropriate, a full stochastic valuation has been undertaken to determine the time value of the fi nancial options and guarantees.
Notes (a) The increase in unwind of discount and other expected returns of £63 million from £349 million for 2011 to £412 million for 2012 includes the £67 million eff ect of the increase in opening value of in-force business (aft er economic assumption changes), an impact of £19 million relating to the post-acquisition unwind of discount for REALIC, partly off set by the £(23) million eff ect of lower risk discount rates driven by the 0.1 per cent reduction in the 10-year US treasury rate together with the decrease in additional allowance for credit risk as explained in note 1(b) (iii).
(iv) UK insurance operations The short-term fl uctuations in investment returns for UK insurance operations arise from the following types of business: With-profi tsnote (a) 285 (201) Shareholder-backed annuitynote (b) (3) 56 Unit-linked and other 33 4
For fi xed annuity and other general account business the eff ect of changes to the risk-free rate, which is defi ned as the 10-year treasury rate, is refl ected in the risk discount rate. This discount rate is in turn applied to projected cash fl ows which principally refl ect projected spread, which is largely insensitive to changes in the risk-free rate. Secondary eff ects on the cash fl ows also result from changes to assumed future yield and resulting policyholder behaviour. For VA business, changes to the risk-free rate are also refl ected in determining the risk discount rate. However, the projected cash fl ows are also reassessed for altered investment returns on the underlying separate account assets on which fees are charged. In 2012, for fi xed annuity and other general account business the credit of £20 million principally arises from the eff ect of a lower discount rate on the opening value of the in-force book, driven by the 10 basis points reduction in the risk-free rate (as shown in note 17(ii)), partially off set by the eff ect for the acquired REALIC book, refl ecting the 20 basis point increase in the risk-free rate from the 4 September acquisition date.
For 2011, the credit of £282 million refl ected the 140 basis points reduction in the risk-free rate. For VA business, the charge of £(83) million (2011: £(333) million) refl ects the 10 basis points reduction (2011: a reduction of 140 basis points) in the risk-free rate (as shown in note 17(ii)).
Effect of changes in expected long-term rates of return (62) (1,113) Effect of changes in risk discount rates 24 627 Other changes (8) (84)
For 2011, the charge of £(1,113) million for the eff ect of changes in expected long-term rates of return arises from the reduction in fund earned rates, driven by the 1.5 per cent decrease in gilt rates and reduction in additional returns assumed on corporate bonds, refl ecting changes in asset mix. The credit of £627 million for the eff ect of changes in risk discount rates refl ects the 1.35 per cent reduction in the risk discount rate, driven by the 1.5 per cent decrease in gilt rates, partly off set by the impact of an increase in beta for with-profi ts business. Beta allowances are explained in note 1(b)(iii).
Notes (i) For the purposes of the table above, goodwill related to Asia long-term operations is included in Other operations. (ii) Intra-group dividends (including statutory transfers) represent dividends that have been declared in the year and amounts accrued in respect of statutory transfers. For long-term business operations, the diff erence between the net amount of £999 million for intra-group dividends (including statutory transfers) and investment in operations shown above and the net cash fl ows to parent company of £921 million (as shown in note 9) primarily relates to intra-group loans, timing diff erences arising on statutory transfers and other non-cash items.
Cost of time value of guarantees (33) (650) – (683) (22) (596) (67) (685)
(v) US operations (Jackson) AAAAAAAAAAAAAAAAAAA Interest rates are projected using a log-normal generator calibrated to historical US treasury yield curves; AAAAAAAAAAAAAAAAAAA Corporate bond returns are based on treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and AAAAAAAAAAAAAAAAAAA Variable annuity equity returns and bond interest rates have been stochastically generated using a log-normal model with parameters determined by reference to historical data. The volatility of equity fund returns ranges from 19 per cent to 32 per cent for all periods throughout these results, depending on the risk class and the class of equity, and the standard deviation of interest rates ranges from 2.2 per cent to 2.5 per cent (2011: 2.1 per cent to 2.4 per cent).
V b asis su p p lem en tary in fo rm atio n /D
(VIF) and required capital business to free surplus 382 c Option schemes
2011 comparatives have been amended to be on a comparable basis. Monthly funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations which are managed by third parties outside of the Prudential Group are excluded from these amounts.
Undiscounted expected free surplus generation for years 2013 to 2052 2,709 1,406 622 4,737 Less: discount effect (1,499) (406) (348) (2,253)
Declines in spread from these products or other spread businesses that Jackson conducts could have a material impact on its businesses or results of operations. Jackson also writes a signifi cant amount of variable annuities that offer capital or income protection guarantees. There could be market circumstances where the derivatives that it enters into to hedge its market risks may not fully offset its losses, and any cost of the guarantees that remain unhedged will also affect Prudential’s results.
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the eff ects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates Changes in government policy, legislation (including tax) or regulatory interpretation applying to companies in the fi nancial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, profi tability, capital requirements and, consequently, reported results and fi nancing requirements. Also, regulators in jurisdictions in which Prudential operates 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 the recent interventions by governments in response to global economic conditions, it is widely expected that there will be a substantial increase in government regulation and supervision of the fi nancial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure and enhanced supervisory powers.
The Dodd-Frank Act represents a comprehensive overhaul of the fi nancial services industry within the United States that, among other reforms to fi nancial services entities, products and markets, may subject fi nancial institutions designated as systematically important to heightened prudential and other requirements intended to prevent or mitigate the impact of future disruptions in the US fi nancial system. The full impact of the Dodd-Frank Act on Prudential’s businesses is not currently clear, as many of its provisions have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years.
Regulators are increasingly interested in the approach that product providers use to select third party distributors and to monitor the appropriateness of sales made by them. In some cases, product providers can be held responsible for the defi ciencies of third-party distributors.
The Prudential Assurance Company Limited’s fi nancial strength is rated Aa2 by Moody’s, AA by Standard & Poor’s and AA by Fitch. The Moody’s and Fitch ratings are on stable outlook and the Standard & Poor’s rating is on negative outlook.
Adverse experience in the operational risks inherent in Prudential’s business could have a negative impact on its results of operations Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. Further, because of the long-term nature of much of the Group’s business, accurate records have to be maintained for signifi cant periods. These factors, among others, result in signifi cant reliance on and require signifi cant investment in information technology, compliance and other systems, personnel and processes. In addition, Prudential outsources several operations, including a signifi cant part of its UK back offi ce and customer-facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
European Embedded Value or EEV Financial results prepared in accordance with a set of Principles issued by the Chief Financial Offi cers Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance of EEV Disclosures published in October 2005.
Internal rate of return (IRR) The IRR is equivalent to the discount rate at which the present EEV value of the post-tax cash fl ows expected to be earned over the lifetime of the business written in shareholder-backed life funds is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is equal to the amount required to pay acquisition costs and set up reserves less premiums received, plus encumbered capital. The impact of the time value of options and guarantees is included in the calculation.