Our European Embedded Value (EEV) total operating profit was up 17 per cent to £2,961 million, and Group International Financial Reporting Standards (IFRS) statutory operating profit was up by 12 per cent to £1,347 million.
Our operating model enables each of our businesses to stay close to their customers within the framework of a consistent, Group-wide global approach to managing risk, capital, cash, reputation and leadership development and succession.
Prudential Corporation Asia is the leading European-based life insurer in Asia by market coverage and number of top five market positions. We have life and asset management operations in 13 markets covering China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand, Vietnam and the United Arab Emirates. Having entered Asia in the 1920s, we have built a unique position from which to realise the unrivalled opportunities in the most dynamic and populous economies in the region.
Our US business Jackson is one of the most respected life insurance companies in the US, the world’s biggest retirement savings market. Jackson’s success continues to be driven by its industry-leading distribution model, product innovation and speed to market providing retirement solutions to customers in the mass and mass-affluent segments.
Group performance Turning to our performance during 2008, our Group operating profit before tax from continuing operations, on the European Embedded Value (EEV) basis, rose to £2,961 million, an increase of 17 per cent. This means our EEV operating profit before tax has grown at a compound annual rate of 25 per cent since the end of 2004. The Group’s return on embedded value was 15.0 per cent (2007: 15.4 per cent).
Our strategy The Group’s overriding objective remains the generation of sustainable value for our shareholders, resulting from sound strategic positioning to capture long-term growth opportunities in the pre- and post-retirement market, combined with a focused approach to delivering the optimal level of capital-efficient profitable growth in the short and medium term.
Equally important, at Prudential effective capital and risk management are central to our approach to managing the Group. We took to heart the lessons from the last downturn in 2002 and 2003, and responded by improving our skills base, reducing concentration levels, and managing our exposures prudently, but proactively. These measures paid off in 2008.
• Increased average number of agents in the region to 425,000 with the largest increases in Indonesia up 43 per cent to 57,000 and India up 21 per cent to 287,000. Aside from Thailand, all operations grew their agency forces
• Net inflows of £3.4 billion compared with net outflows of €334 billion across the European asset management industry and £2.1 billion net outflows from UK asset managers across retail and institutional funds
Total IFRS operating profit from continuing operationsnotes 3,5 1,347 1,201 12 1,262 7
Given the movement in spreads observed in the US, unrealised losses for the year were £3.2 billion. It should be noted that we apply a policy of holding assets to maturity, which in economic terms limits the impact of current price levels.
In our calculation of EEV operating profit, we use longer-term investment return assumptions rather than the actual investment returns achieved. Short-term fluctuations in investment returns represent the difference between the actual investment return and the unwind of discount on the value of in-force and expected returns on net worth. Group short-term investment fluctuations were negative £5,127 million in 2008, compared to positive £174 million in 2007.
Total EEV basis operating profit from continuing operations after restructuring costs 2,961 2,530 17 2,676 11
Actuarial gains and losses on defined benefit pension schemes: (15) (5) Effect of change in economic assumptions: (550) 748
Movement in mark to market value of core borrowings: 656 223
Total IFRS basis operating profit based on longer-term investment returns before restructuring costs 1,375 1,220 13 1,281 7
We do not generally seek to hedge foreign currency revenues, as these are substantially retained locally to support the growth of the Group’s business and meet local regulatory and market requirements. However, in cases where a foreign surplus is deemed to be supporting Group capital or shareholders’ interests, this exposure is hedged if we deem it economically optimal to do so. Currency borrowings and derivatives are used to manage exposures within the set limits.
The final and most significant area of exposure to credit risk for the shareholder is Jackson in the US. At 31 December 2008 Jackson’s fixed income portfolio was estimated at £24 billion, comprised of £16 billion of Corporate Debt, £2 billion of Commercial Mortgage Backed Securities (CMBS), £4 billion of Residential Mortgage Backed Securities (RMBS) and £2 billion of other instruments. We entered the cycle in a defensive position and continue to manage the portfolio rigorously.
However, the scope is wider than Basel II and will cover valuations, the treatment of insurance groups, the definition of capital and the overall level of capital requirements.
During 2008, our risk management and mitigation initiatives resulted in the rebalancing of the Group’s USD hedge to reflect our exposure to IGD regulatory surplus held in USD. Since the year-end we have also implemented additional equity hedging in Jackson to reduce the exposure to further falls in the level of the S&P index. A wide range of capital management initiatives and risk mitigation options remain available to the Group to manage the IGD capital position. These include the use of reinsurance and similar structures to crystallise the value of future cash flows, the implementation of further hedging strategies, and taking steps to conserve and/or release capital.
Prudential’s operations in Asia are unified under the Prudence face icon, which retains a consistently high recognition rate, outperforming other financial service companies in the region.
embedded value metrics. As the scale of our business in Asia continues to increase, as evidenced by premium revenues of £5.5 billion in 2008, there is a greater focus on demonstrating the emergence of this value in terms of distributable IFRS profits and cash. Given the current economic climate, a thorough review has been undertaken of all the operations’ solvency positions from the local regulatory and the IGD perspectives. Optimising capital efficiency from the Group’s perspective has always been a priority, but with the worldwide collapse of market valuations and interest rates we paid particular attention to this during 2008.
Total new business from the bank channel grew by 27 per cent during 2008 and accounted for 20 per cent of total new business.
Initiatives in 2008 Distribution The success in the marketplace of Prudential’s US business, Jackson, continues to be driven by our industry-leading distribution organisation and product innovation, coupled with our sound evaluation of product economics. Our long-term goals for Jackson include the continued and profitable expansion of our share of the US annuities and retail asset management markets, which we plan to achieve by building on our advantaged position in the advice-based distribution channels. Ongoing profitable growth in Jackson’s share of the US annuities market largely depends on the continued enhancement and expansion of our existing product offering, increased penetration of existing distribution channels and entry into new distribution channels, as well as opportunistic inorganic growth.
Fixed annuity APE sales of £172 million were up 202 per cent over 2007, reflecting our ability to meet changing customer demands through the company’s diversified product portfolio. We ranked sixth in sales of traditional deferred fixed annuities during the first three quarters of 2008, with a market share of five per cent, up from 10th as at year-end 2007.
PruProtect, which was launched in the third quarter of 2007, follows the success of PruHealth by applying the Vitality points system. PruProtect’s product is focused around a core philosophy of helping people become healthier while protecting and improving the quality of their lives.
EEV basis total operating profit based on longer-term investment returns of £1,081 million, before restructuring costs of £14 million, were up 26 per cent on 2007. The 2008 in-force year operating result includes £569 million relating to the unwind of discount to the value of in-force business, the release of £80 million of provisions not now required, and a £118 million benefit from rebalancing assets, including lifetime mortgage assets, that support the shareholder backed annuity portfolio.
Among M&G’s institutional businesses, a difficult year for our Macro Investment Business (net outflows of £0.9 billion) was more than offset by strong net inflows of £0.3 billion to our infrastructure fund and £0.8 billion to segregated equity funds. Our high quality of client servicing and diverse product offering enabled us to maintain positive inflows of £1.3 billion during a period that saw net institutional outflows for asset managers of £6.3 billion according to the IMA4.
During 2008, M&G continued to focus on effective cost management to limit the impact of falling FUM on bottom-line results. Our overall overhead costs fell 16 per cent in 2008. However it is important to note that this partially reflects a one-off reduction in long-term incentive costs.
In order to capitalise on the exciting and sizeable opportunities in Asia’s retail financial services market, Prudential’s Asian asset management business maintained its focus in 2008 on building a strong third-party customer retail franchise. Prudential now has retail operations in 10 Asian markets and its growth strategy is targeted at meeting specific market needs.
Defined benefit pension schemes The Group operates four defined benefit schemes, three in the UK, of which by far the largest is the Prudential Staff Pension Scheme (PSPS), and a small scheme in Taiwan. The level of surplus or deficit of assets over liabilities for defined benefit schemes is currently measured in three ways: the actuarial valuation, FRS 17 (for parent company and subsidiary accounting in the UK), and IAS 19 for the Group financial statements.
In 2008 our total contributions for the year including expenses and augmentations were £79 million. Deficit funding for PSPS is apportioned in the ratio of 70/30 between the PAC life fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing of previous contributions. Employer contributions for the ongoing service of current employees are apportioned in the ratio relevant to current activity. The PSPS valuation as at 5 April 2008 is currently being finalised.
Products and drivers of insurance operations’ profits 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. To supplement our core life products we also offer health, disablement, critical illness and accident cover.
While we hedge our risk on an economic basis, the nature and duration of the hedging instruments, which are recorded at fair value through the income statement, will fluctuate and produce some accounting volatility. We continue to believe that, on a long-term economic basis, the equity exposure remains well managed.
Life insurance Jackson also sells several types of life insurance including term life, universal life and variable universal life. Term life provides protection for a defined period of time and a benefit that is payable to a designated beneficiary upon the insured’s death. Universal life provides permanent individual life insurance for the life of the insured and includes a savings element. Variable universal life is a life insurance policy that combines death benefit protection and the important tax advantages of life insurance with the long-term growth potential of professionally managed investments. Our life insurance book has also delivered consistent profitability, driven primarily by positive mortality and persistency experience.
Developing credible successors Identifying and developing Prudential’s future leaders is critical to our ability to sustain the success of our business over the long term. In 2008, as in previous years, we undertook a review of talent across the Group, identifying, developing and rewarding people with leadership potential. We also continue the series of Group-wide management development programmes we launched in 2007, assessing senior talent and identifying the development they need to be credible successors to future leadership roles.
Developing an effective organisation structure Having engaged and committed staff is key to the smooth operation and success of our business, and effective communication is invaluable in achieving this goal. Each of our Business Units runs its own intranet site to keep staff up to date, and provides staff with an opportunity to pose questions to the Chief Executive of their business. There are also a number of employee consultation forums, such as the M&G staff Consultative Committee and the UK Insurance Operations’ Employee Forum.
Responsible investment (RI) Prudential is committed to responsible investment (RI), which involves focusing on the way the entities we invest in manage their own CR issues. M&G’s approach to RI is described in the booklet ‘Issues Arising from Share Ownership’, available at www.mandg.co.uk. To date, RI has tended to focus principally on equity markets, but its scope is now expanding to other types of investment, including property. With around £15 billion of funds under management as at 31 December 2008, PRUPIM is one of the UK’s largest commercial property investment managers and accounts for over 75 per cent of Prudential’s direct environmental impact in the UK. Through its participation in the Institutional Investor’s Group on climate change and the property working group of the United Nations Environment Programme Finance Initiative (UNEP FI), PRUPIM is helping to boost awareness of the implications of climate change for property investment, while also providing us with valuable insights into how Prudential can constructively address this important issue.
Tidjane Thiam Chief Financial Officer (until 30 September 2009) Group Chief Executive (from 1 October 2009) Tidjane Thiam has been an executive director of Prudential and Chief Financial Officer since 25 March 2008, and will succeed Mark Tucker as Group Chief Executive with effect from 1 October 2009. He was previously Chief Executive Officer, Europe at Aviva, where he also held successively the positions of Group Strategy and Development Director and Managing Director, Aviva International. Prior to that, Tidjane was a partner with McKinsey & Company in France and one of the leaders of their Financial Institutions practice, focusing on insurance companies and banks. Earlier in his career, he spent a number of years in Africa where he was Chief Executive and then Chairman of the National Bureau for Technical Studies and Development in Cote d'Ivoire and a cabinet member as Minister of Planning and Development. He is a non-executive director of Arkema in France, a member of the Council of the Overseas Development Institute (ODI) in London and a sponsor of Opportunity International, a charity focusing on microfinance in developing countries.
Michael Garrett Independent non-executive director and member of the Remuneration Committee Michael Garrett has been an independent non-executive director of Prudential since September 2004. He worked for Nestlé from 1961, becoming Head of Japan (1990 – 1993), and then Zone Director and Member of the Executive Board, responsible for Asia and Oceania, and in 1996 his responsibilities were expanded to include Africa and the Middle East. Michael retired as Executive Vice President of Nestlé in 2005. He served the Government of Australia as Chairman of the Food Industry Council and as a Member of the Industry Council of Australia, and was also a member of the Advisory Committee for an APEC (Asia-Pacific Economic Cooperation) Food System, a Member of The Turkish Prime Minister's Advisory Group and the WTO (World Trade Organization) Business Advisory Council in Switzerland. Michael remains a director of Nestlé in India, and was appointed Chairman of the Evian Group in 2001, a think tank and forum for dialogue promoting free trade. He also serves as a non-executive director on the Boards of the Bobst Group in Switzerland, Hasbro Inc. in the USA, and Gottex Fund Management Holdings Limited in Guernsey. In addition, he is a member of the Finance and Performance Review Committee of The Prince of Wales International Business Leaders Forum (IBLF), as well as a Member of the Swaziland International Business Advisory Panel under the auspices of the Global Leadership Foundation (GLF) London.
As a UK company listed on the Main Market of the London Stock Exchange, Prudential is subject to the governance rules set out in the Combined Code. The Board has approved a governance framework which maps out the internal approvals processes and those matters which may be delegated. These principally relate to the operational management of the Group’s businesses and include pre-determined authority limits delegated by the Board to the Group Chief Executive for further delegation by him in respect of matters which are necessary for the effective day-to-day running and management of the business. The chief executive of each business unit has authority for the management of that business unit and has established a management board comprising its most senior executives.
In 2008, the evaluation of the Board as a whole was carried out by an independent consultant, following a briefing by the Chairman, the Chairman Designate and the Senior Independent Director. Each director and the members of the Group Executive Committee completed a questionnaire and were interviewed by the independent consultant. The questions asked were based on the Combined Code and on previously identified matters, and sought views on the effectiveness of the Board as a whole. The review was carried out at the end of 2008, during the last month of Sir David Clementi’s chairmanship of the Board. Ordinarily, the effectiveness of the Chairman would also be reviewed as part of this process, however, given that a new Chairman was appointed with effect from 1 January 2009, it was not considered necessary to carry out a review of the performance of the outgoing Chairman for 2008.
In performing its duties the Committee has access to employees and their financial or other relevant expertise across the Group, and to the services of the Group-wide Internal Audit Director and the Company Secretary. The Committee may also seek external professional advice at the Group’s expense.
Audit fees For the year ended 31 December 2008, the Committee approved fees of £9.0 million to its auditor, KPMG Audit Plc, for audit services and other services supplied pursuant to relevant legislation. In addition, the Committee approved fees of £1.8 million to KPMG for services not related to audit work, which accounted for 17 per cent of total fees paid to the external auditor in the year. Non-audit services primarily related to actuarial services and basic tax compliance work. In accordance with the Group’s Auditor Independence Policy, all services were approved prior to work commencing, and each of the non-audit services was confirmed to be permissible for the external auditor to undertake, as defined by the Sarbanes-Oxley Act. The Committee reviewed the non-audit services being provided to the Group by KPMG at regular intervals during 2008. A summary of audit fees is provided in Note I4 of the Group Financial Statements.
Changes to the Articles of Association will be proposed at this year’s Annual General Meeting. Details of the proposed changes are set out in the Notice of Annual General Meeting 2009 and Explanation of Business, which is sent to shareholders and is also available on the Company’s website at plc/investors/agminfo/2009/
Below Board level, the Responsibility Committee is a specialist Group-wide committee chaired by Stephen Whitehead, Group Communications Director. This committee is responsible for reviewing Prudential’s business conduct and social and environmental policy, and ensures consistency of approach across the Group’s international businesses.
Directors’ Remuneration Regulations The 2008 Directors’ Remuneration Report has been approved by the Board in accordance with Section 234C of the Companies Act 1985, and in accordance with Section 241A of the Companies Act a resolution will be put to shareholders at the Annual General Meeting inviting them to consider and vote on it. This report complies with the requirements of the Regulations and KPMG Audit Plc has audited the sections contained on pages 117 to 127.
Mark Tucker is leaving Prudential on 30 September 2009 and Tidjane Thiam will become Group Chief Executive from 1 October 2009. The remuneration arrangements which will apply to Mark following his resignation and Tidjane on his appointment are included on page 114 of this Report.
A portion of bonus in the form of an award of shares deferred for three years.
For the other executive directors, the deferral policy for 2009 bonus awards will be as follows: • Chief Financial Officer and the Chief Executives of UK and Asia: deferral of 30% of total bonus awarded. This results in an increased deferral at lower levels of bonus; • Chief Executive of Jackson: 15% of total bonus awarded.
3 As part of his appointment terms, Tidjane Thiam was provided with the following: • to compensate for the loss of 2007 bonus, a cash payment of £325,000 on joining and an award of shares deferred for three years with a value of £325,000; • a guarantee that his bonus for 2008 would not be less than 100% of his salary. Any amount of the 2008 bonus paid which is greater than 50% of his salary will be awarded in shares which are deferred for three years; • for 2008, a double award of 320% of his salary under the Group Performance Share Plan (Group PSP); and • In order to compensate for the loss of outstanding deferred share awards under annual incentive plans and long-term awards with his previous employer: – a cash sum on joining in lieu of the 2005 awards which were due to vest in March 2008; and – restricted share awards, in lieu of his 2006 and 2007 awards, without performance measures which will vest in March 2009 and 2010, respectively. All the awards described above were fully disclosed in the 2007 Directors’ Remuneration Report.
2009 Group Performance Share Plan (Group PSP) – all executive directors The Group PSP delivers shares to participants subject to performance over a three-year period. The performance measure which will be used in 2009 is Total Shareholder Return (TSR).
Group Total Shareholder Return Prudential’s Total Shareholder Return performance is measured over the performance period compared with the TSR performance of an index comprised of peer companies. TSR is measured on a local currency basis which is considered to have the benefits of simplicity and directness of comparison.
Executive directors’ non-executive director earnings Executive directors who are released to serve as non-executive directors of other external companies retain the earnings resulting from such duties. In 2008, Tidjane Thiam earned 27,000 euros and Michael McLintock earned £38,333 from external companies. Other directors served as non-executive directors on the boards of companies in the educational and cultural sectors without receiving a fee for those services.
2 2008 Group performance against the EEV profit and Cashflow in the executive directors’ annual incentive plans was very strong. Group IFRS profit was also at a level against the target set which resulted in a payment being triggered. 3 Under the UK annual plan, performance against all the measures was very strong.
Notes Performance levels under current awards at 31 December 2008: Note Plan Award year Performance levels 1 Restricted Share Plan 2005 The ranking of the Company’s TSR at the end of the three-year performance period ending on 31 December 2007 was 30th out of the remaining 85 companies in the FTSE 100 (35th percentile) and as a result options over 62.5 per cent of the maximum number of shares in each award was made.
Face value Face value of conditional of conditional awards Conditionally Payments awards Date of Year of outstanding awarded made outstanding end of initial at 1 Jan 2008 in 2008 in 2008 at 31 Dec 2008 performance
For the 2005 award the phantom share price at the end of the performance period was £2.34. This resulted in a payment from the phantom share award of £526,500 and a phantom option award of 367,800 units. Michael McLintock did not exercise any of these options. For the 2006 award, the phantom share price at the end of the performance period was £1.69. This will result in a payment of £380,250 from the share element of the award.
Dividends per share in respect of the reporting period (including interim dividend of 5.99p (2007: 5.70p) and final dividend of 12.91p (2007: 12.30p) declared after the end of the reporting period) IFRS note B3 162 18.90p 18.00p
Section A: Background and accounting policies 137 A1: Nature of operations 137 A2: Basis of preparation 137 A3: Critical accounting policies, estimates and judgements 144 A4: Significant accounting policies 154 A5: New accounting pronouncements
Section E: Asset management (including US broker dealer) and other operations 240 E1: Income statement for asset management operations 241 E2: Balance sheet for asset management operations 243 E3: Regulatory capital positions 243 E4: Sensitivity of profit and equity to market and other financial risk 243 E5: Other operations
Based on profit from discontinued operations attributable to the equity holders of the Company – 9.9p
Total items of income and expense recognised directly in equity 13 (105) (2) (94) (94)
For shareholder-backed business, with the exception of debt securities held by Jackson and assets classified as loans and receivables, all financial investments and investment property are designated as fair value through profit and loss. Short-term fluctuations in investment returns on such assets held by with-profits funds, do not affect directly reported shareholder results. This is because (i) the unallocated surplus of with-profits funds are accounted for as liabilities and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from unallocated surplus. However, for shareholder-backed businesses the short-term fluctuations affect the result for the year and the Group provides additional analysis of results to provide information on results before and after short-term fluctuations in investment returns.
For Jackson’s residential mortgage-backed securities, the model used to analyse cash flows, begins with the current delinquency experience of the underlying collateral pool for the structure, by applying assumptions about how much of the currently delinquent loans will eventually default, and multiplying this by an assumed loss severity. Additional factors are applied to anticipate ageing effect. After applying a cash flow simulation an indication is obtained as to whether or not the security has suffered a principal payment shortfall. If a shortfall applies an impairment charge is generally recorded.
Other insurance contracts (i.e. contracts which contain significant insurance risk as defined under IFRS 4) For these contracts UK GAAP has been applied, which reflects the MSB. Under this basis the following approach applies: Other UK insurance contracts Other UK insurance contracts that contain significant insurance risk include unit-linked, annuity and other non-profit business. For the purposes of local regulations, segregated accounts are established for linked business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefit provisions were based on published mortality tables adjusted to reflect actual experience.
Asian operations Except for the operations in Taiwan, Vietnam and Japan, the future policyholder benefit provisions for Asian businesses are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP. For the Hong Kong business, which is a branch of the PAC, and the Singapore and Malaysian operations the valuation principles and sensitivities to changes of assumptions of conventional with-profits and other protection-type policies are similar to those described above for equivalent products written by the UK operations.
Property, plant and equipment All property, plant and equipment such as owner occupied property, computer equipment and furniture and fixtures, are carried at depreciated cost. Costs including expenditure directly attributable to the acquisition of the assets are capitalised. Depreciation is calculated and charged on a straight-line basis over an asset’s estimated useful life. The residual values and useful lives are reviewed at each balance sheet date. If the carrying amount of an asset is greater than its recoverable amount then its carrying value is written down to that recoverable amount.
Examples where such bifurcation is necessary are: a Asia Vietnamese participating business For the participating business in Vietnam the liabilities include policyholders’ interest in investment appreciation and other surplus. Bonuses paid in a reporting period and accrued policyholder interest in investment appreciation and other surpluses primarily reflect the level of realised investment gains above contract specific hurdle levels. For this business operating profit
*The charges on debt securities incurred in 2008 of £624 million comprise the following: Losses on sale of impaired and
Before tax Tax Minority minority earnings earnings note B1 note F5 interests interests per share per share £m £m £m £m Pence Pence
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes 174 – – 174 – – – 174 Deferred acquisition costs and
Borrowings attributable to with-profits fundsG1,H13 1,308 – – 1,308 – – – 1,308 Other non-insurance liabilities:G1,H4,H9,H14,H15
At 1 January 2007 Total investments (including derivative assets) 138,537 36,129 13,725 188,391 2,963 240 191,594 Less: investments held by consolidated investment funds (1,179) – (547) (1,726) – – (1,726)
In the table above, Standard & Poor’s (S&P) ratings have been used where available. For securities where S&P ratings are not immediately available, those produced by Moody’s and then Fitch have been used as an alternative. Notes D2(d), D3(d), D4(d) and E2 provide further details on the credit risks of debt securities by segment.
Under Capital Asset Pricing Methodology (CAPM), the discount rate is determined as the aggregate of the risk-free rate and the risk margin for market risk. The latter is calculated as the ‘beta’ multiplied by the equity risk premium. Under CAPM, the beta of a portfolio or product measures its relative market risk. The risk discount rates reflect the market risk inherent in each product group and hence the volatility of product cash flows. They are determined by considering how the profits from each product are impacted by changes in expected returns on various asset classes, and by converting this into a relative rate of return, it is possible to derive a product specific beta.
Non-participating business (in particular Taiwan) Interest rate and price risk Long-term interest rates
Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ provisions for UK regulated with-profits funds) – 6,705 1,549 8,254 – – – 8,254 13,813
Directly held investments, net of derivative liabilities 13,553 78,010 14,468 92,478 18,047 18,110 142,188
ii WPSF and SAIF The policyholder liabilities reported for the WPSF are primarily for two broad types of business. These are accumulating and conventional with-profits contracts. The policyholder liabilities of the WPSF are accounted for under FRS 27.
D2: UK insurance operations continued k Duration of liabilities With the exception of most unitised with-profits bonds and other whole of life contracts the majority of the contracts of the UK insurance operations have a contract term. However, in effect, the maturity term of contracts reflects the earlier of death, maturity, or lapsation. In addition, with-profit contract liabilities as noted in note D2(g) above include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
In general, the debt securities of the Group’s US insurance operations are purchased with the intention and the ability to hold them for the longer term. In 2008, there was a movement in the balance sheet value for debt securities classified as available-forsale from a net unrealised loss of £136 million to a net unrealised loss of £2,897 million (2007: net unrealised gain of £110 million to a net unrealised loss of £136 million). During 2008, as a result of these factors, the gross unrealised gain in the balance sheet decreased from £303 million at 31 December 2007 to £281 million at 31 December 2008 while the gross unrealised loss increased from £439 million at 31 December 2007 to £3,178 million at 31 December 2008. Details of the securities in an unrealised loss position are shown in D3(d) below.
Net cash inflow from operating activities 1,363 1,499 2,862 Realised gains (losses) in the year – (385) (385) Unrealised gains (losses) in the year (5,924) (2,901) (8,825) Foreign exchange translation differences 4,072 8,947 13,019
Investment-related items and other movements 914 311 1,225 Foreign exchange translation differences (172) (337) (509)
The following table shows the quality of publicly traded and SEC Rule 144A traded debt securities held by the US operations as at 31 December 2008 and 2007 by NAIC classifications: Carrying value Carrying value £m % of total £m % of total
In 2008, US equity market indices fell by some 38.5 per cent. If there had been no mean reversion methodology in place there would have been an increased amortisation charge of approximately £250 million.
Movement in the year of directly held investments, net of derivative liabilities 961 387 1,769 3,117
The positive investment related items and other movements seen within Other during 2008 are principally driven from unwinding the discounted liabilities using the valuation interest rate. Variable annuity separate account liabilities are mainly impacted by market movements.
The method for determining liabilities of insurance contracts for UK GAAP, and hence IFRS, purposes for some Asian 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 deficiency reserve calculations are performed each year to establish whether the carrying values of the liabilities are sufficient.
D5: Capital position statement for life assurance businesses continued 2008 £m
Other adjustments to restate these amounts to a regulatory basis (with SAIF and the WPSF on a Peak 2 realistic basis)note v 4 355 359 (239) 1,364 149 1,633
Debt securities valued using valuation techniques held for UK insurance operations were £13,026 million (2007: £11,149 million) and of this amount £12,341 million (2007: £10,640 million) related to securities held by with-profits operations and £685 million (2007: £509 million) related to securities held by the UK shareholder-backed business.
arising from investment properties: That generated rental income during the year 109 117 That did not generate rental income during the year 1 –
On 29 September 2007, following expiry of the previous management agreement, a revised arrangement was put in place in respect of CITIC – Prudential Life Insurance Company Limited following which the Group’s investment has been accounted for as a joint venture. Prior to the change in management agreement CITIC – Prudential Life Insurance Company Limited was accounted for as a subsidiary undertaking. Whilst the management agreement has been revised there has been no change in the Group’s level of holding.
In January 2009, this swap was cancelled. iv The US$250 million 6.75 per cent borrowings and the US$300 million 6.5 per cent borrowings can be converted, in whole or in part, at the
Non-recourse borrowings of consolidated investment fundsnote i 1,161 789 £100m 8.5% Undated Subordinated Guaranteed Bonds of Scottish Amicable Finance plcnote ii 100 100 Other borrowings (predominantly obligations under finance leases) 47 98
The table below summarises the change in the pension mis-selling provision for the years ended 31 December 2008 and 2007. The change in the provision is included in benefits and claims in the income statement and the movement in unallocated surplus of with-profits funds has been determined accordingly.
The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling as well as the costs and expenses of the Group’s pension review unit established to identify and settle such cases. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased.
Deferred tax assets 10 26 Other debtors (625) (388) Policyholders’ liability – contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) (103) (140) Unallocated surplus of with-profits funds 495 392 Deferred tax liabilities 113 73
4 Summary financial position The Group liability in respect of defined benefit pension schemes is as follows: Economic position: Deficit, gross of deferred tax, based on scheme assets held, including investments in Prudential insurance policies: Attributable to the PAC with-profits fund (i.e. absorbed by the liability for unallocated surplus) (67) (98) Attributable to shareholder-financed operations (i.e. to shareholders’ equity) (82) (85)
On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the underlying balance sheets of the schemes at 31 December were: Other Other schemes schemes
At beginning returns) shareholders shareholder translation At end of year note i note ii operations difference of year 2007 £m
The fair value amounts relating to all options including conditional nil cost options above were determined using the BlackScholes and the Monte Carlo option-pricing models using the following assumptions: Other RSP and Other GPSP options GPSP options
I6: Subsidiary undertakings i Principal subsidiaries The principal subsidiary undertakings of the Company at 31 December 2008, all wholly owned except PCA Life Assurance Company Limited, were: Country of Main activity incorporation
Net interest income 113 Fee and commission income 41 Fee and commission expense (8)
Fair value of scheme assets, end of year 4,803 4,889 *The contributions include deficit funding and ongoing service contributions.
c Risk discount rates Overview Under the EEV Principles, discount rates used to determine the present value of future cash flows are set equal to risk-free rates plus a risk margin. The risk margin should reflect any non-diversifiable risk associated with the emergence of distributable earnings that is not allowed for elsewhere in the valuation. Prudential has selected a granular approach to better reflect differences in market risk inherent in each product group. The risk discount rate so derived does not reflect a market beta but instead reflects the expected volatility associated with the cash flows in the embedded value model.
c Pension costs Profit before tax Movements on the shareholders’ share of surplus (to the extent not restricted by IFRIC 14) and deficits of the Group’s defined benefit pension schemes adjusted for contributions paid in the year are recorded within the income statement. Consistent with the basis of distribution of bonuses and the treatment of the estate described in notes 2d and 2e, the shareholders’ share incorporates 10 per cent of the proportion of the surpluses or deficits attributable to the PAC with-profits fund. The surplus or deficit is determined by applying the requirements of IAS 19.
ii The table above include for 2007 the transfer of 62,000 with-profits annuity policies from Equitable Life on 31 December 2007 with assets of approximately £1.7 billion. The transfer represented an APE of £174 million.
6 The surplus note borrowings have been reflected as contributing to the capital in the net worth but with the obligation deducted from the value of in-force business, with an overall net nil effect on the embedded value.
Strengthening of mortality assumptions (312) Release of margins: Projected benefit related 144 Investment related 82 Expense related 29 Other 57 c Other items Other items for UK insurance operations in 2008 are in aggregate a credit of £195 million. Consistent with the methodology applied in previous years, this amount includes a credit of £118 million resulting from part of the effect of rebalancing the asset portfolio backing annuity business on the valuation interest rate for determining Pillar I liabilities. The rebalancing reflects changes to the portfolio to more closely align the credit quality with management benchmark. The £118 million effect of rebalancing included in operating profit reflects longer-term levels of credit spread evident as at 31 December 2006 i.e. prior to the exceptional credit spread widening in 2007 and 2008. The additional increase in the Pillar I valuation interest rate due to rebalancing at the credit spreads at which assets were traded in 2008 is reflected within non-operating profit together with, via the increase in discount rate, the additional allowance for credit risk for the portfolio as a whole as described in note 12. The £195 million credit also includes a cost of capital charge of £(34) million for the effect of holding the short-term credit risk reserve for statutory reporting, as described in note 3b, and releasing it over an assumed five year period. Also included in operating profit for business in-force is a credit of £56 million in respect of the release of certain annuity business reserves, a credit of £24 million in respect of the release of prior period provisions relating to Credit Life business, and a net credit of £31 million for other items.
Total tax (credit) charge on items not included in operating profit from continuing operations (1,536) 235
Net assets of operations – EEV basis shareholders’ funds 5,264 3,726 Acquired goodwillnote ii 111 111
Asian US insurance business Other GroupEEV basis shareholders’ equity operations operations operations operations operations total at 1 January 2008 £m £m £m £m £m £m
Total net worth (353) (236) Value of in-force business 1,290 1,094
18 Expected transfer of value of in-force business to free surplus
Expected period of conversion of future post tax distributable earnings and required capital flows to free surplus 2008 Total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 20+ years £m £m £m £m £m £m
21 Intended sale of legacy agency book and agency force in Taiwan to China Life Insurance of Taiwan continued
We have audited the EEV basis supplementary information (the supplementary information) of Prudential plc on pages 318 to 356 in respect of the year ended 31 December 2008. The supplementary information has been prepared in accordance with the European Embedded Value Principles issued in May 2004 by the CFO Forum of European Insurance Companies and expanded by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 (together the EEV Principles) using the methodology and assumptions set out on pages 322 to 330. The supplementary information should be read in conjunction with the Group financial statements which are on pages 131 to 315.
In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. There is a risk that new requirements are retrospectively applied to sales made prior to their introduction.
Institutional Analyst and Investor Enquiries Tel +44 (0) 20 7548 2007 E-mail investor.relations@prudential.co.uk