• Two ‘Five Star’ ratings for excellent service in the Investment and Life and Pensions categories at the Financial Adviser Service Awards 2011
Financial statements and European Embedded Value (EEV) basis supplementary information 160 Summary of statutory and supplementary International Financial Reporting Standards (IFRS) basis and EEV basis results 162 Index to Group financial statements 163 Consolidated income statement 164 Consolidated statement of comprehensive income 165 Consolidated statement of changes in equity 167 Consolidated statement of financial position 169 Consolidated statement of cash flows 170 Notes on the Group financial statements 371 Balance sheet of the parent company 372 Notes on the parent company financial statements 383 Statement of directors’ responsibilities in respect of the Annual Report and the financial statements 384 Independent auditor’s report to the members of Prudential plc 385 EEV basis supplementary information 391 Notes on the EEV basis supplementary information 433 Statement of directors’ responsibilities in respect of the EEV basis supplementary information 434 Independent auditor’s report to Prudential plc on the EEV basis supplementary information 435 Additional unaudited financial information
As previously indicated, the market in India has been challenging since the fourth quarter of 2010 due to significant regulatory reforms across the industry in that year. We are now coming out of this difficult period, a year after the reform, and our joint venture with ICICI continues to be the leading private sector player. In the fourth quarter of 2011, our sales increased notably, demonstrating that our business in India is gathering some momentum. We remain confident about the long-term prospects of that market as we train our extensive agency force to sell a new product suite.
Our performance in 2011 shows we continue to be a market leader both in individual annuities and in with-profits products. In individual annuities, we registered a decrease in our sales as we continued to proactively control capital consumption. The strength and performance track record of Prudential UK’s With-Profits Fund is widely recognised. Despite the market volatility in 2011, with-profits customers’ policy values were augmented by a total of £2.1 billion. Our customers continue to benefit from solid returns and the security offered by the large inherited estate. Our results in 2010 benefited from a large bulk annuity contract. There were no similar opportunities of comparable size which met our strict value criteria so our level of activity in that segment was materially reduced.
Capital and risk management Proactive and disciplined management and allocation of capital are the foundations of a robust balance sheet and remain critical in the current economic and financial environment. Using the regulatory measure of the Insurance Groups Directive (IGD), before allowing for the final dividend, our Group capital surplus at 31 December 2011 was estimated at £4.0 billion (2010: £4.3 billion). The Group’s required capital is covered 2.75 times.
Outlook We continue to believe our long-term success rests on our substantial presence in fast-growing economies across Asia. Our chosen markets benefit from solid economic growth, increasing wealth, favourable demographics – particularly a rapidly expanding middle class – with significant and increasing health and protection demands.
Asia US UK Other movements £13,050m £48,311m £38,700m £43,944m £60,523m £1,839m £7,824m £(657)m £46,048m £69,189m £18,269m
4 Based on operating profit after tax and non-controlling interests. 2010 excludes an exceptional tax credit of £158 million which primarily related to the impact of a settlement agreed with the UK tax authorities.
5 Underlying free surplus generated comprises underlying free surplus generated from the Group’s long-term business (net of investment in new business) and asset management operations.
The remaining free surplus generated in the period was retained within our businesses and this has bolstered local capital ratios. The total free surplus balance deployed across our life and asset management operations increased from £3,338 million at the beginning of the period to £3,421 million at the end of the period.
‘ These results were delivered during a particularly challenging macroeconomic environment and are testament to the quality of our franchises across Asia, the US and the UK.’
Solvency II, which is currently anticipated to be effective from 1 January 2014, represents a major overhaul of the capital adequacy regime for European insurers. We are supportive in principle of the development of a more risk-based approach to capital, but we have concerns as to the potential consequences of some aspects of the Solvency II regime under consideration. With the continued delays to policy development, the final outcome of Solvency II remains uncertain. Despite this uncertainty, we continue to prepare for when the regime is eventually implemented.
Asia looks set to remain a world economic powerhouse as although lower external demand is impacting growth, regional and domestic demand remains robust. Prudential is well placed to participate in this growth as one of the region’s leading providers of long-term savings and protection products.
Economic Monitor December 2011. 2 Excluding Australia and New Zealand 3 IFRS operating profit for insurance operations.
In September 2011 Prudential launched a major new CSR initiative in collaboration with Turner Broadcasting in the form of a fictional band called Cha-Ching, who through episodes running on the Cartoon Network across Asia and a fully interactive website, teach children about the basics of financial planning. Currently Cha-Ching is seen daily in over four million homes in seven markets (Hong Kong, the Philippines, Singapore, Indonesia, Vietnam, Thailand, and Malaysia). Cha-Ching.com has had over 18 million pages viewed in its first four months with an average duration of over nine minutes. The programme is being actively supported by regulators and local schools.
Financial performance Total APE sales of £746 million were down 9 per cent on 2010, including bulk annuities of APE £33 million in 2011 and £93 million in 2010. EEV new business profit reduced by 29 per cent to £260 million and the total new business profit margin was 35 per cent for the period, 10 percentage points lower than in 2010. This reduction reflected the lower impact of bulk annuity transactions in 2011. The 2011 transactions generated EEV new business profit of £28 million (2010: £106 million) and IFRS operating profit of £23 million (2010: £63 million).
Business performance Total funds under management of £50.3 billion were down 3 per cent over the same period last year. The effect of positive net flows from the Asian Life Business and third party retail and institutional clients, was offset by the combined effect of outflows in the low margin money market funds (MMF) and the negative market movements particularly in the second half of the year.
Note (i) Operating earnings per share reflects operating profit based on longer-term investment returns after related tax and non-controlling interests but
these businesses have been shown as a single line in the insurance margin line consistent with associate accounting principles. 2010 has been amended in light of this change.
Negative fluctuations of £95 million arising in our US operation comprise negative £183 million from short-term fluctuations offset by positive £88 million relating to Jackson’s debt securities portfolio. These gains arise as a result of a high level of realised investment gains in 2011, following management’s credit risk reduction programme.
Other income and expenditure (536) (494) 9 (493) 9 RPI to CPI inflation measure change on defined benefit pension schemes(i) 45 – n/a – n/a Solvency II implementation costs (56) (46) 22 (46) 22 Restructuring costs (19) (28) (32) (28) (32)
Strong new business margins continue to be recorded across the Group. The margin for the Asian business increased from 60 per cent to 65 per cent driven by a shift in country mix and the ongoing high mix of health and protection business. The reduction in the US new business profit margin was curtailed to a one percentage point decrease to 64 per cent despite the significant falls in 10-year Treasury yields, as management took strong pricing and business actions. The UK new business margin was lower than last year at 35 per cent (2010: 45 per cent). Comparisons here are distorted by our selective approach to bulk annuity sales. The retail margin (which excludes credit life and bulk annuities) fell from 35 per cent in 2010 to 32 per cent in 2011 due to lower sales of the higher margin annuity business.
The Asia and UK effect principally reflects the effect on economic profits of the reduction in long-term yields and the associated decrease in the risk discount rates. This effect is positive in Asia given the predominance of health and protection while in the UK this effect is negative as the majority of future profits relate to with-profits business.
Asset management operations(i) 1,783 1,787 Holding company net borrowings (2,188) (2,212) Other, net 392 418
Free surplus and holding company cash flow continued Overview The Group manages its internal cash flow by focusing on the free surplus generated by the life and asset management businesses. Remittances are, however, made as and when required by the holding company, with excess surplus being left in the businesses where it can be redeployed most profitably. The tables below set out the Group’s free surplus generation, and the holding company cash flow statement for 2011.
Underlying free surplus generated from in-force business has been used by our life businesses to invest in new business. Despite the strong growth in APE sales, investment in new business1 has fallen by 14 per cent to £553 million in 2011 as a result of improved capital efficiency. This compares to a 6 per cent increase in sales1 and a 6 per cent increase in new business profits1. The strong improvement in capital efficiency is primarily the result of continuing the active management of the product and geographical mix of the new business sold, in line with the Group’s disciplined approach to capital conservation and value optimisation.
Value of in-force created by new business 1,011 – 1,011 500 172 1,683 1,683
Total holding company cash flow (31) (273) Cash and short-term investments at beginning of period 1,232 1,486 Foreign exchange movements (1) 19
Cash received from Jackson was £322 million in 2011 (2010: £80 million), above the 2013 sustainable remittance target of £200 million. Jackson’s remittance to the Group for 2011 was taken in the first half, with £200 million representing the remittances for the year and a further £122 million representing releases of excess surplus to Group. These exceptional releases reflect the success that Jackson has enjoyed in rebuilding its balance sheet strength post the 2008 financial crisis and in writing business at high internal rates of return (IRRs) and with fast payback.
After central costs, there was a net cash inflow before dividend of £809 million in 2011 compared to £709 million for 2010. The dividend paid was £642 million in 2011, compared to £449 million (net of scrip of £62 million) in 2010.
The actuarial valuation of SAPS as at 31 March 2008 demonstrated the scheme to be 91 per cent funded. Based on this valuation and subsequent agreement with the Trustees, £13.1 million per annum of deficit funding is currently being paid into the scheme. The actuarial valuation of SAPS as at 31 March 2011 is currently being finalised.
Despite the decline in financial markets during 2011, Prudential UK’s with-profits fund performed relatively strongly achieving a 2.1 per cent pre-tax investment return for policyholder asset shares during 2011.
• Exposure to forces in the external environment that could significantly change the fundamentals that drive the business’s overall strategy.
i) Debt portfolio 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 compared to 95 per cent at 31 December 2010.
Total 21,642 20,231 Residential mortgage-backed securities (RMBS) 2,591 2,784 Commercial mortgage-backed securities (CMBS) 2,169 2,375 Other debt securities 620 976
Prudential actively mitigates the level of Group wide credit risk (invested credit and counterparty) through a comprehensive system of hard limits, collateralisation agreements and centrally managed ‘watch lists’.
In addition to the exposures held by the shareholder-backed business, the Group held the following banks’ securities at 31 December 2011 within its with-profits funds: Bank debt securities – participating funds
B.3 Risk factors Our disclosures covering risk factors can be found at the end of this document.
The movements during 2011 mainly comprise: • Net capital generation mainly through operating earnings (in-force releases less investment in new business, net of tax) of £1.5 billion; Offset by: • Investment market related impacts of £0.6 billion; • Final 2010 dividend of £0.4 billion and interim 2011 dividend of £0.2 billion; • External financing costs and other central costs, net of tax, of £0.5 billion; and
Having assessed the requirements of Solvency II, an implementation programme was initiated with dedicated teams to manage the required work across the Group. The activity of the local Solvency II teams is being coordinated centrally to achieve consistency in the understanding and application of the requirements. We are continuing our preparations to adopt the regime when it eventually arrives and are undertaking in parallel an evaluation of the possible actions to mitigate its effects. Prudential regularly reviews its range of options to maximise the strategic flexibility of the Group. This includes consideration of optimising the Group’s domicile, including as a possible response to an adverse outcome on Solvency II.
Asia The life insurance products offered by Prudential Corporation Asia include with-profits (participating) and non-participating term, whole life and endowment and unit-linked policies often combined with protection riders and typically with regular premium payments.
It is thought that the EEV basis not only provides a good indication of the value being added by management in a given accounting period, but also helps demonstrate whether shareholder capital is being deployed to best effect. Indeed insurance companies in many countries use comparable bases of accounting for management purposes.
‘Best Investment Bond Provider’ in the Moneyfacts Investment Life & Pensions Awards
Jackson forges long-lasting strong relationships with its distribution partners and was ranked number one in the sector for advocacy and loyalty among advisers in the Cogent 2011 Advisor Brandscape Report.3
In 2011, we commissioned additional demographic research in partnership with CSIS, looking in further detail at retirement expectations in Asia. The findings of the study, which will be shared with policymakers, will be available in 2012.
In 2011 we also conducted a monitoring trial at our sites in Asia, enabling us to measure the environmental impact of those offices as a first step in improving our environmental performance in these growing markets.
Under the European Union Energy Performance of Buildings Directive, Energy Performance Certificates (EPCs) are required for any building that is constructed, sold or rented. EPCs rate energy use and efficiency, enabling property investors and prospective occupiers to consider ratings and levels of carbon emissions for our occupied and commercial properties in the UK. In 2011 we retained ISO 14001 environmental management certification for all our UK occupied properties.
Supporting local communities For us, part of being a long-term business means a commitment to supporting the long-term well-being of the communities in which we operate.
The social value of our business – helping customers manage uncertainty and build a more secure future, as well as our investments providing long-term capital that finances businesses, builds infrastructure and fosters economic growth – is further underpinned by our community programmes and activities.
Prudential UK has worked with Citizens Advice since 2002, and we are now a leading partner on its Financial Skills for Life programme. Our partnership with Personal Finance Education Group began in 2001, and our funding has allowed it to maintain and develop its Quality Mark accreditation system for financial capability teaching resources. Also in the UK, an online financial education training tool in partnership with The Schools Network attracted 8,700 visits in 2011. The resource, called ‘Adding Up to a Lifetime’, has been used in English schools since 2006.
Chairman’s Challenge Many of our volunteers are involved in our flagship volunteering programme, the Chairman’s Challenge, which was launched six years ago. Since then 133 projects have been supported by our employees in partnership with charities. In 2011, more than 3,000 employees signed up as Chairman’s Challenge volunteers, an increase of 14 per cent on 2010. Last year, our office in Mumbai joined the programme for the first time and 23 per cent of employees participated. All of the projects included in the Chairman’s Challenge receive a financial donation from the Group for each employee who signs up as a volunteer and five shortlisted projects receive additional funding.
The Prompt Payment Code and its signatories can be found at www.promptpaymentcode.org.uk
Before he retired from Unilever in 2005, Keki was Director, Home and Personal Care, responsible for the HPC business of Unilever worldwide, a Board member of Unilever PLC and Unilever N.V., and a member of Unilever’s Executive Committee. He joined Hindustan Lever Ltd in India in 1973 and in 1987, he joined the Board of Hindustan
The responsibilities of the Group Audit Committee (the ‘Committee’) and the activities it carried out during the year are set out below.
Role of the Committee The Committee’s principal responsibilities consist of oversight over financial reporting, the effectiveness of the internal control systems and monitoring auditor independence. Its duties include gaining assurance on the control over financial processes and the integrity of the Group’s financial reports, monitoring the performance, objectivity and independence of the external auditor, and reviewing the work of the internal auditor.
The Committee recognises the need to meet without the presence of executive management. Such sessions were held with the external auditor in February and July 2011, and with the internal auditor in February and October 2011. At all other times management and auditors had open access to the Chairman and the Committee.
Financial reporting As part of its review of financial statements prior to recommending their publication to the Board, the Committee focused on the critical accounting policies and practices, and any changes or decisions requiring a major element of judgement, unusual transactions, clarity of disclosures, significant audit adjustments (of which there were none in 2011), the going concern assumption, compliance with accounting standards, and compliance with obligations under applicable laws, regulations and governance codes.
Business unit audit committees Each business unit has its own audit committee to provide oversight to the respective business unit and to assist the Committee in its oversight responsibilities for the Group. The members and chairmen are comprised primarily of senior management who are independent of the respective business unit. The minutes of these committees are reported regularly to the Committee and their meetings are attended by senior management of the respective business unit, including the business units’ heads of finance, risk, compliance and Group-wide internal audit. Business unit audit committees have adopted standard terms of reference across the Group with minor variations to address local requirements or particular requirements of the business. The terms of reference of those committees were reviewed during the year and all include escalation of significant matters to the Committee, recommendations for approval of the business unit internal audit plans and overseeing the adequacy of internal audit resources. During the year the business unit audit committees reviewed their respective internal audit plans, resources and the results of internal audit work, and both external and internal auditors were able to discuss any relevant matters with the Chairman and members of the Committee as required.
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 17 May 2012 at 11.00am.
Authority to purchase own shares The directors also require authority from shareholders in relation to the purchase of own shares by the Company. The Company seeks authority by special resolution on an annual basis for the buyback of its own shares in accordance with the relevant provisions of the Companies Act 2006 and other related guidance. The Company has not made use of that authority since it was last granted at its Annual General Meeting in 2011. This existing authority is due to expire at the end of this year’s Annual General Meeting. A special resolution to approve the renewal of this authority will be put to shareholders at the Annual General Meeting on 17 May 2012.
Structure of share capital, including restrictions on the transfer of securities, voting rights and significant shareholders
Rules governing changes to the articles of association Corporate governance 126
Significant agreements impacted by a change of control Additional disclosures 130
This report is the first prepared since I became Chairman of the Remuneration Committee in June 2011. I would like to take this opportunity to thank my predecessor, Bridget Macaskill, for her contribution to the Committee over the last eight years. I would also like to welcome Kai Nargolwala, who joined the Committee on 1 January 2012.
In order to achieve the first of these aims, the Committee reviews remuneration packages regularly, taking account of individual performance and contributions, and information about the reward offered by the UK and overseas organisations with which we compete for executive talent.
This report has been drawn up in accordance with the UK Corporate Governance Code, Schedule 8 of the Large and Medium Sized Companies and Groups (Accounts and Reports) Regulations 2008, the UK Listing Authority Listing Rules and the Code on Corporate Governance Practices in Appendix 14 of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong. KPMG Audit Plc has audited the information provided on pages 148 to 156.
Business unit Chief Executives also participate in business unit plans that focus on financial measures which contribute to the long-term success of the business unit and, therefore, the Group. Given the cash-generative priorities of the UK business unit, the Chief Executive of UK & Europe participates in a plan using the same TSR measures as the GPSP.
Pension Provides opportunities for executive directors to save for an income in retirement in a cost efficient manner.
Long-term incentives All executive directors participate in the Group Performance Share Plan (GPSP). Those executive directors with responsibility for a business unit also participate in plans linked to the long-term success of the relevant unit. The Committee will continue to keep the performance measures used in the long-term incentive plans under review to ensure their relevance.
Jackson BUPP In 2011 Mike Wells was granted a Jackson BUPP award with vesting dependent on the increase in Jackson’s Shareholder Capital Value (SCV) over the performance period.
The levels of SCV growth required for vesting of Mike Wells’ award are set out in the table below. Vesting occurs between these performance levels on a straight line basis. On 31 December 2011, the performance period for the 2009 Jackson BUPP award came to an end. Although no current executive director had a 2009 award under this plan the vesting level for other participants was 93.75 per cent (for reference, the SCV performance measure attached to the 2008 Jackson BUPP award was not achieved and so no part of that award vested).
Investment performance The value of phantom shares vesting will be adjusted by an investment performance measure as follows: • Where the investment performance of M&G’s funds is in the top two quartiles during the three-year performance period, the value of phantom shares vesting will be enhanced. The value of phantom shares may be doubled if performance is in the top quartile; • Investment performance in the third quartile will not change the value of phantom shares vesting; • Investment performance in the bottom quartile will result in awards being forfeited, irrespective of any profit growth.
Executive directors should have a substantial shareholding to maximise the community of interest between them and other shareholders. This may be built up over a period of five years. Shares earned and deferred under the annual incentive plan are included in calculating the executive director’s shareholding.
Before becoming an executive director, John Foley participated in the Company’s defined benefit pension arrangement on the same basis as other employees who joined the Group before 2003. John Foley elected to become a deferred member of this arrangement on 31 December 2010 and to join the defined contribution scheme with effect from 1 April 2011.
† Pension benefits are described in the section on Pensions and long-term savings on page 143. ‡ Value of anticipated long-term incentive plan releases is the total of cash paid plus, for shares released, the value of the released shares based on the share price at 31 December 2011. All executive directors participate in long-term incentive plans and the details of share releases from awards with a performance period ending 31 December 2011 are provided in the footnotes to the tables on share awards on pages 151 to 152. This figure does not include releases from other share plans (detailed on pages 153 to 155) or all-employee share plans, (set out on pages 155 and 156). Dividend equivalents will be released on these vested shares.
Outstanding awards made under the GPSP and BUPP will vest (subject to the achievement of performance conditions) on the same schedule as awards made to other executive directors. These awards will be prorated to reflect the portion of the performance periods which had elapsed on 31 December 2011.
No amounts were paid to Mike Wells or John Foley in connection with their appointment as executive directors.
The sterling face value of Mike Wells’ JNL LTIP awards have been calculated using the average exchange rate for the year in which the grant was made. The face value of conditional share awards outstanding on 1 January 2011 and 31 December 2011 was $5,600,000 and $4,200,000 respectively.
Other share awards The table below sets out the share awards that have been made to executive directors under their appointment terms and those deferred from annual incentive plan payouts. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the awards from the 2010 annual incentives, made in 2011, the average share price was 735 pence. Please see the table on page 155 for details of shares acquired under the Share Incentive Plan.
Deferred Bonus Plan award(note 1 ) 2011 87,508 3,346 90,854 31 Dec 13 721.5
Five highest paid individuals (unaudited information) Of the five individuals with the highest emoluments in 2011, two were directors whose emoluments are disclosed in this report (2010: one; 2009: two). The aggregate of the emoluments of the other three individuals for 2011 (2010: four; 2009: three) were as follows: Base salaries, allowances and benefits in kind 1 1 1
The following tables and referenced disclosure notes show the results reported in the statutory IFRS financial statements on pages 163 to 382 and supplementary EEV basis results on pages 385 to 432. This page does not form part of the statutory financial statements.
Treasury shares Movement in own shares in respect of share-based payment plans – – (30) – – (30) – (30) Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS – – (5) – – (5) – (5)
Properties held for sale H9 3 257 Cash and cash equivalents G1,H10 7,257 6,631 * Included within financial investments are £7,843 million (2010: £8,708 million) of lent securities. See note G4.
The consolidated financial statements on pages 163 to 370 were approved by the Board of directors on 12 March 2012 and signed on its behalf.
Other interests in entities, where significant influence is not exercised, are carried as investments at fair value through profit and loss. The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2011 except where entities have non-coterminous year ends. In such cases, the information consolidated is based on the accounting period of these entities and is adjusted for material changes up to 31 December. Accordingly, the information consolidated is deemed to cover the same period for all entities throughout the Group. The results of subsidiaries are included in the financial statements from the date control commences to the date control ceases. All inter-company transactions are eliminated on consolidation. Results of asset management activities include those for managing internal funds.
ii US variable and fixed index annuity business The following value movements for Jackson’s variable and fixed index annuity business are excluded from operating profit based on longer-term investment returns: • Fair value movements for equity-based derivatives; • Fair value movements for embedded derivatives for Guaranteed Minimum Withdrawal Benefit (GMWB) ‘not for life’ and fixed index annuity business, and Guaranteed Minimum Income Benefit (GMIB) reinsurance (see note); • Movements in accounts carrying value of Guaranteed Minimum Death Benefit (GMDB) and GMWB ‘for life’ liabilities, for which, under the ‘grandfathered’ US GAAP applied under IFRS, for Jackson insurance assets and liabilities the measurement basis gives rise to a muted impact of current period market movements; • Fee assessments and claim payments, in respect of guarantee liabilities; and • Related changes to amortisation of deferred acquisition costs for each of the above items.
Other income and expenditure Investment return and other income 22 30 Interest payable on core structural borrowings (286) (257) Corporate expenditureF3 (219) (223)
Basic earnings per share is calculated by dividing the earnings attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the year, excluding those held in employee share trusts and consolidated unit-trusts and OEICs, which are treated as cancelled. For diluted earnings per share, the weighted average number of shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Group’s only class of potentially dilutive ordinary shares are those share options granted to employees where the exercise price is less than the average market price of the Company’s ordinary shares during the year. No adjustment is made if the impact is anti-dilutive overall. Earnings per share are calculated based on earnings attributable to ordinary shareholders, after related tax and non-controlling interests.
Hong Kong 12.07 12.48 12.17 12.01 Indonesia 14,091.80 14,049.41 14,106.51 14,033.41 Malaysia 4.93 4.90 4.83 4.97 Singapore 2.02 2.02 2.01 2.11 India 82.53 74.80 70.01 70.66 Vietnam 33,688.16 33,139.22 30,526.26 29,587.63 US 1.55 1.60 1.57 1.55
Group insurance operations Asia - excluding Indianote (iii) 1,321 1,019 1,426 1,211 1,559 1,313 India 135 85 88 180 101 188
The two measures used to monitor the volatility of earnings are European Embedded Value (EEV) operating profit and IFRS operating profit, although EEV and IFRS total profits are also considered.
v Non-financial risks – operational, business environment and strategic risk Operational risk is the risk of loss arising from inadequate or failed internal processes, or from personnel and systems, or from external events. Business environment risk is the exposure to forces in the external environment that could significantly change the fundamentals that drive the business’s overall strategy. Strategic risk is the risk of ineffective, inefficient or inadequate senior management processes for the development and implementation of business strategy in relation to the business environment and the Group’s capabilities.
The most significant items for which the IFRS basis shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business is sensitive to these variables are shown in the following tables. The distinction between direct and indirect exposure is not intended to indicate the relative size of the sensitivity.
Other shareholder-backed unit-linked business Due to the matching of policyholder liabilities to attaching asset value movements the UK unit-linked business is not directly affected by market or credit risk. The principal factor affecting the IFRS results is investment performance through asset management fees.
Deferred tax liabilities 41 691 135 826 – 482 482 1,349 1,738 Other non-insurance liabilities 397 4,200 569 4,769 992 3,306 4,298 9,464 8,341
At 1 January 2010 Total investments (including derivative assets) 9,848 67,832 13,794 81,626 18,421 22,795 132,690 Less: Investments held by consolidated investment funds – (1,050) (19) (1,069) (729) (37) (1,835)
Net cash (outflow) inflow from operating activities (762) (838) (21) (859) 1,000 1,950 1,329 Realised gains in the year 368 1,502 73 1,575 267 23 2,233 Unrealised gains and losses and exchange movements in the year 249 2,963 608 3,571 1,131 1,007 5,958 Reclassification of property under development – – – – – 56 56
Directly held investments, net of derivative liabilities 8,413 76,279 6,858 83,137 20,447 28,155 140,152
The assumptions used in the stochastic models are calibrated to produce risk-free returns on each asset class. Volatilities of, and correlations between, investment returns from different asset classes are as determined by the Group’s Portfolio Management Group and aim to be market-consistent. The cost of guarantees, options and smoothing is very sensitive to the bonus, market value reduction (MVR), and investment policy employed and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse investment scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that is retained in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with the Group’s management policy for with-profits funds and the Group’s disclosures in the publicly available PPFM. The contract liabilities for with-profits business also require assumptions for persistency. These are set based on the results of recent experience analysis.
The very prudent Pillar 1 regulatory basis reflects the overriding objective of maintaining sufficient 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’.
Total comprehensive income for the year 786 901 Dividends, interest payments to central companies and other movements (330) (97)
Included within the movement in gross unrealised losses for the debt securities of Jackson of £122 million (2010: £634 million) as shown above was a net decrease in value of £12 million (2010: £84 million increase) relating to the sub-prime and Alt-A securities as referred to in section B5.
Net cash inflow from operating activities 6,441 865 7,306 Realised gains in the year – 21 21 Unrealised gains and losses and exchange movements in the year 4,123 2,141 6,264
* These relate to assets with a fair market value and book value of £2,209 million (2010: £4,002 million) and £2,455 million (2010: £4,372 million) respectively.
Capitalised acquisition costs and deferred income for these contracts are amortised over the life of the book of contracts. The present value of the estimated gross profits is generally computed using the rate of interest that accrues to policyholder balances (sometimes referred to as the contract rate). Estimated gross profits include estimates of the following elements, each of which will be determined based on the best estimate of amounts of the following individual elements over the life of the book of contracts without provision for adverse deviation for: • amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances, • amounts expected to be assessed for contract administration less costs incurred for contract administration, • amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances, • amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender charges), and • other expected assessments and credits.
The assumptions used for calculating the direct GMIB liability at 31 December 2011 and 2010 are consistent with those used for calculating the GMDB and ‘for life’ GMWB liabilities. The change in these reserves, along with claim payments and associated fees included in reserves are included along with the hedge results in short-term fluctuations, resulting in removal of the market impact from the operating profit based on longer-term investment returns. Jackson regularly evaluates estimates used and adjusts the additional GMDB, GMIB and GMWB ‘for life’ liability balances, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
i Exposure to equity risk Variable annuity contract related Jackson issues variable contracts through its separate accounts for which investment income and investment gains and losses accrue to, and investment risk is borne by, the contract holder (traditional variable annuities). It also issues variable annuity and life contracts through separate accounts where it contractually guarantees to the contract holder (variable contracts with guarantees) either a) return of no less than deposits made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial withdrawals plus a minimum return, or c) the highest contract value on a specified anniversary date adjusted for any withdrawals following the contract anniversary. These guarantees include benefits that are payable in the event of death (GMDB), annuitisation (GMIB), at specified dates during the accumulation period (GMWB) or at the end of a specified period (GMAB). At 31 December 2011 and 2010, Jackson had variable annuity contracts with guarantees, for which the net amount at risk (‘NAR’) is generally the amount of guaranteed benefit in excess of current account value, as follows: Minimum return
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within profit and loss. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease and increase in interest rates at 31 December 2011 and 2010 is as follows: A 2% decrease
Profit before tax attributable to shareholders note (i) (54) (41) 66 50 Profit for the year (39) (31) 48 37 Shareholders’ equity attributable to US insurance operations (388) (347) 475 424
D3: US insurance operations continued iv Other sensitivities As noted in section D1, total profit is very sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts. 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.
(iii) Other UK life assurance subsidiaries and funds The effect from the changes in assumptions of valuation interest rates on insurance liabilities is broadly matched by the corresponding effect on assets leaving no significant impact on the available capital.
S b ro k er-d ealer) an d o th er o p eratio n s
Directly held investments, net of derivative liabilities 3,597 29 51 3,677
This is represented in the segmental analysis of profit from continuing operations before tax attributable to shareholders in note B1 as follows: Year ended 31 December 2011 £m
Profit (loss) from continuing operations before tax attributable to shareholders 860 455 646 326 22 72 2,381 (920) 1,461
The total tax expense arises as follows: Current tax expense: UK (475) (61)
Actual tax rate: Operating profit based on longer-term investment returns 17% 29% 26% 125% 22%
Asian operations Policyholder returns Assets backing unit-linked liabilities (812) 1,279 With-profits business 756 1,039
Note The unallocated surplus of with-profits funds represents the excess of assets of with-profits funds over policyholder and other liabilities of the funds. The surplus is therefore sensitive to the measurement basis of the assets and liabilities. The movements on unallocated surplus of with-profits funds also reflect the impact of market fluctuations of investment values backing the surplus. The Asia movement principally arises in the Hong Kong branch operation.
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)
Other financial liabilities held at fair value – (281) – (281)
Group Total Loans – 227 – 227 Equity securities and portfolio holdings in unit trusts 84,755 1,304 576 86,635 Debt securities 25,287 89,948 1,117 116,352 Other investments (including derivative assets) 232 2,441 3,106 5,779 Derivative liabilities (136) (1,675) (226) (2,037)
Obligations under funding, securities lending and sale and repurchase agreements 4,199 4,199 – – – – – – 4,199
Most investment contracts have options to surrender early, albeit these are often subject to surrender or other penalties. It is therefore the case that most contracts could be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts means these are unlikely to be exercised in practice and the more useful information is to present information on expected payment. The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of £11 billion (2010: £11 billion) which has no stated maturity but which is repayable on demand. This table has been prepared on an undiscounted basis and accordingly the amounts shown for life assurance investment contracts differ from those disclosed on the statement of financial position. Durations of long-term business contracts, covering insurance and investment contracts, on a discounted basis are included in section D.
Hedging The Group has formally assessed and documented the effectiveness of the following hedges under IAS 39.
Impairment testing Goodwill does not generate cash flows independently of other groups of assets and thus is assigned to CGUs for the purposes of impairment testing. These CGUs are based upon how management monitors the business and represent the lowest level to which goodwill can be allocated on a reasonable basis.
Total of deferred acquisition costs and other intangible assets 5,069 4,667*
The present values of these minimum lease payments are: Less than 1 year 6 7 1 to 5 years 23 24 Over 5 years 98 104
Investments in joint ventures Joint ventures represent activities over which the Group exercises joint control through contractual agreement with one or more parties. The Group’s significant joint ventures, which are accounted for using proportionate consolidation, comprise the following interests: Investment % held Principal activity Country
(iv) The £250 million PruCap bank loan was made in December 2010 in two tranches: £135 million maturing in June 2014, currently drawn at a cost of twelve month £LIBOR plus 1.2 per cent and £115 million maturing on 20 December 2012, currently drawn at a cost of twelve month £LIBOR plus 0.99 per cent.
Borrowings in respect of short-term fixed income securities programmes Commercial paper 2,706 2,311 Bank Notes 2013 250 249
Economic deficit (64) (220) Exclude: investments in Prudential insurance liabilities (offset on consolidation in the Group financial statements against insurance liabilities) (165) (227)
Estimated pension scheme deficit – economic basis Movements on the pension scheme deficit (determined on the economic basis) are as follows, with the effect of the application of IFRIC 14 being shown separately: Surplus
1,588 (45) 1,543 485 (173) 312 Effect of the application of IFRIC 14 for pension schemes: Derecognition of PSPS surplus (1,588) – (1,588) (485) – (485) Adjust for additional funding for PSPS (19) – (19)
Total goodwill arising on acquisition attributable to the with-profits fund 12
Less liabilities: amounts falling due within one year Commercial paper 7 (2,706) (2,311)
Pensions The Company assumes a portion of the pension surplus or deficit of the Group’s main pension scheme, the Prudential Staff Pension Scheme (PSPS) and applied the requirements of FRS 17, ‘Retirement Benefits’ (as amended in December 2006) to its interest in the PSPS surplus or deficit. Further details are disclosed in note 9.
For each category of deferred tax asset recognised, its recoverability against forecast taxable profits is not significantly impacted by expected changes to accounting standards. The UK government’s tax rate change to 25 per cent has had the effect of reducing the Company’s net deferred tax balance at 31 December 2011 by £29 million. The change to 25 per cent is effective from 1 April 2012 but is substantively enacted as at 31 December 2011. The subsequent proposed rate change to 23 per cent by 1 April 2014 is not expected to have a material effect on the deferred tax balance recognised at 31 December 2011.
Actual less expected return on Scheme assets (15% (2010: 5%) (2009: 2%) (2008: 5%) (2007: 0%) of assets) 973 275 85 (259) (12)
b Methodology (i) Embedded value Overview The embedded value is the present value of the shareholders’ interest in the earnings distributable from assets allocated to covered business after sufficient allowance has been made for the aggregate risks in that business. The shareholders’ interest in the Group’s long-term business comprises: • present value of future shareholder cash flows from in-force covered business (value of in-force business), less deductions for: – the cost of locked-in required capital, – the time value of cost of options and guarantees,
Cost of capital A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as required capital. The cost is the difference between the nominal value of the capital and the discounted value of the projected releases of this capital allowing for investment earnings (net of tax) on the capital. The annual result is affected by the movement in this cost from year-to-year which comprises a charge against new business profit and generally a release in respect of the reduction in capital requirements for business in force as this runs off. Where required capital is held within a with-profits long-term fund, the value placed on surplus assets in the fund is already discounted to reflect its release over time and no further adjustment is necessary in respect of required capital.
Financial statements | European Embedded Value (EEV) basis supplementary information 3 Operating profit from business in force
(1) The credit in Malaysia of £69 million relates to revised mortality and morbidity assumptions, reflecting recent experience. (2) The credit in Indonesia of £33 million represents the effect of revised morbidity assumptions of £48 million, the revision of reinsurance rates of £8 million, offset by modelling enhancements for the cost of reinsurance of £(23) million.
Notes on the EEV basis results continued 3 Operating profit from business in force continued
(c) The short-term fluctuations in investment returns for unit-linked business represents the increase in capitalised value of future fees arising from the positive movements in market values experienced during the year.
Asian operations 2,349 6,396 8,745 2,149 5,532 7,681 US operations 4,271 811 5,082 3,815 984 4,799 UK insurance operations 2,552 3,506 6,058 2,115 3,855 5,970
(iii) The EEV basis shareholders’ equity for Asian long-term business for 2010 of £7,445 million includes the £(39) million effect of moving from a passive to an active basis of economic assumption setting as described in note 17a(v).
b asis su p p lem en tary in fo rm atio n 8 Analysis of movement in free surplus
Holding company* cash and short-term investments (1,200) – (1,200) (1,232) – (1,232)
Profit after tax from long-term business 423 96 519 (199) 320 Intragroup dividends (including statutory transfers) and investment in operationsnote (ii) (393) – (393) 179 (214) Other transfers from net worth (18) – (18) – (18)
Pre-tax new business contributionnote 2 1,076 815 260 2,151 – 2,151 Tax (265) (285) (65) (615) – (615)
The effect of the change in 2010 to move to an ‘active’ basis for Asia operations was as follows: Effect on: 2010 £m
(iv) For US operations, the risk discount rates shown above include an additional allowance for a combination of credit risk premium and short-term downgrade and default allowance for general account business of 200 basis points (2010: 150 basis points) and for variable annuity business of 40 basis points (2010: 30 basis points) to reflect the fact that a proportion of the variable annuity business is allocated to the general account (as described in note 1b(iii)).
Mean returns have been derived as the annualised arithmetic average return across all simulations and durations. For each projection year, standard deviations have been calculated by taking the square root of the annualised variance of the returns over all the simulations. These have been averaged over all durations in the projection. For equity and property, the standard deviations relate to the total return on these assets. The standard deviations applied for all years are as follows: Equities:
Asian insurance operations Hong Kong 180 107 313 276 331 287 2,023 1,693 Indonesia 250 141 338 269 363 283 1,435 1,011 Malaysia 79 58 215 198 223 204 1,225 1,153 Philippines 95 64 20 17 30 23 153 108 Singapore 371 318 198 143 235 175 1,855 1,357 Thailand 11 15 26 25 27 26 102 100 Vietnam 1 1 42 41 42 41 143 148
UK and Europe insurance operations Direct and partnership annuities 328 593 – – 33 59 328 593 Intermediated annuities 241 221 – – 24 22 241 221 Internal vesting annuities 1,223 1,235 – – 122 124 1,223 1,235
In preparing the EEV supplementary information, the directors have: • prepared the supplementary information in accordance with the EEV Principles,
I. Selected historical financial information of Prudential 436 Selected historical financial information of Prudential
(4) Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations.
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued
• DAC adjustments decreased by £246 million to £271 million in 2011 compared to £517 million in 2010. This mainly reflects additional DAC amortisation of approximately £166 million related to the reversal of the benefit received in 2008 from the mean reversion formula, as well as accelerated DAC amortisation of £66 million as separate account returns, were lower than 2010.
Effect of policy improvement in 2012 on comparative results for 2011 and full-year 2010
Costs of terminated AIA transaction – – – – – – (377) – (377) Gain on dilution of Group holdings – – – – – – 30 – 30
Operating (diluted) – excluding, for 2010, exceptional tax credit (pence) 63.8p (1.1)p 62.7p 32.1p (0.8)p 31.3p 61.9p (3.0)p 58.9p
Other operations Holding company net borrowings (2,001) (2,035) Shareholders' share of provision for future deficit funding of the Prudential Staff Pension Scheme
Other income and expenditure (536) (493) RPI to CPI inflation measure change on defined benefit pension schemes 45 – Solvency II implementation costs (56) (46) Restructuring costs (19) (28)
The options schemes will terminate as follows, unless the directors resolve to terminate the plans at an earlier date: • UK Savings Related Share Option Scheme: 8 May 2013, • International Savings Related Share Option Scheme: 31 May 2021, • Prudential International Assurance Sharesave Plan: 3 August 2019, and • Non-employee Savings Related Share Option Scheme: 9 May 2012.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and hurt its relationships with creditors or trading counterparties Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in most of Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings, as a result of, for example, decreased profitability, increased costs, increased indebtedness or other concerns, could have an adverse effect on its ability to market products; retain current policyholders; and on the Group’s financial flexibility. In addition, the interest rates Prudential pays on its borrowings are affected by its debt credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations.
Bonuses Bonuses refer to the non-guaranteed benefit added to participating life insurance policies and are the way in which policyholders receive their share of the profits of the policies. There are normally two types of bonus: • Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and
Cash surrender value The amount of cash available to a policyholder on the surrender of or withdrawal from a life insurance policy or annuity contract.
Health and protection These comprise health and personal accident insurance products, which provide morbidity or sickness benefits and include health, disability, critical illness and accident coverage. Health and protection products are sold both as standalone policies and as riders that can be attached to life insurance products. Health and Protection riders are presented together with ordinary individual life insurance products for purposes of disclosure of financial information.