These results are possible because we provide customers with products and services of value to them. Across Asia, we deliver health and protection products to families at an affordable price in markets where there are limited social safety nets. In the US, our range of variable annuities is providing income to retirees in the world’s largest retirement market. In the UK, we have a history of more than 165 years of providing savings and protection to policyholders whatever the prevailing economic conditions.
B o ard o f d irecto rs 64 65Prudential plc Annual Report 2013 Governance Prudential plc Annual Report 2013
Our operating performance by business unit Asia Prudential’s businesses in Asia continued to perform well in 2013 against turbulent markets, particularly during the second half of the year. Significantly, we succeeded in more than doubling the 2009 new business profit (£713 million) by 2013, reaching £1,460 million. We have therefore completed all three Asia-specific financial objectives we set ourselves in 2010 – the IFRS profit and cash remittance objectives were achieved last year, one year ahead of our initial ambition. This performance reflects the appropriateness of our strategic choices and our discipline in building the distribution reach necessary to make our products and services available to Asia’s rapidly growing middle classes so that we can both meet their needs and generate value for shareholders.
IFRS life operating profit was in line with 2012 at £706 million (2012: £703 million), and EEV life operating profit of £1,033 million increased 19 per cent, reflecting our active management of the in-force book.
5 Excluding money market funds. 6 Before allowing for final dividend. 7 The objectives assume exchange rates at December 2013 and economic assumptions made by Prudential in calculating the EEV basis supplementary information for the half year ended 30 June 2013, and are based on regulatory and solvency regimes applicable across the Group at the time the objectives were set. The objectives assume that the existing EEV, IFRS and Free Surplus methodology at December 2013 will be applicable over the period.
A sset m anagement: Our strategy is designed to create sustainable economic value for our customers and our shareholders. It is focused on three long-term opportunities: The significant protection gap in Asia; The transition of US baby boomers into retirement; and The UK ‘savings gap’ and ageing population in need of returns and income.
O u r strategy Im p lem en tin g o u r strategy
2017 objectives8 1 Asia underlying free surplus generation9 of £0.9 billion to £1.1 billion in 2017 (2012: £484 million)
Since 2008 we have de-emphasised Korea and Taiwan, as the mass life insurance markets are currently driven by product and distribution options that are not attractive to us and consequently we have concentrated on developing successful niche positions. In 2013 we announced our intention to sell our Japan life business, subject to regulatory approvals. However, the mutual fund industries in these markets are highly attractive and, through Eastspring Investments, we are able to take advantage of exciting growth opportunities.
Products Our product portfolio is centred on providing a robust financial safety net to customers at a reasonable price. The product mix reflects this with around one third of premiums directed to health and protection products, one third to unit-linked products and one third to participating products. This profile shows that we are de-risking our customers’ lives while also de-risking the business from the shareholders’ perspective.
In April 2013, the Prudence Foundation announced a series of four multi-country programmes in partnership with Save the
u r bu sin esses an d th eir p erfo rm an ce 25 Prudential plc Annual Report 2013
B Awarded ‘World Class Certification’ by Service Quality Measurement Group and ‘Highest Customer Satisfaction by Industry’ award – the eighth consecutive year of recognition for customer service performance in these two categories
This focus on our operational platforms, and the efficiencies achieved as a result, has provided us with among the lowest general and administration expense to asset ratio relative to competitors.
Notes 1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs implemented in 2012.
IFRS operating pro�t £657m £656m £23m £700m £31m £705m £25m £710m £657m £719m £723m £736m £735m
Our success is evident in the fact that we have achieved positive external net flows for 11 years in a row, reflecting the attractiveness of our diverse fund offering and strong investment performance delivered for our customers. M&G recorded net flows of £9.5 billion during 2013 compared to net flows of £16.9 billion in 2012, a record level which included a single low-margin institutional mandate of £7.6 billion. Included in 2013 net flows are total net retail flows of £7.3 billion, into a diversified range of funds including 10 retail funds that attracted net flows of at least £100 million each during 2013.
— Country: M&G is an international asset manager with operations in 18 countries. Retail products are distributed in 20 jurisdictions, with over a third of retail funds under management sourced from outside the UK.
Corporate activities/other (including foreign exchange) 605 (76) Dividend paid (781) (655)
Risk control and oversight constitutes the second line of defence, and is achieved through the operation of the Group Executive Risk Committee and its sub-committees which monitor and keep risk exposures under regular review. These committees are supported by the Group Chief Risk Officer, with functional oversight provided by Group Risk, Group Compliance and Group Security.
We also define risk appetite statements and measures (ie limits, triggers, indicators) for the major constituents of each risk type as categorised and defined in the Group Risk Framework, where appropriate. These appetite statements and measures cover the most significant exposures to the Group, particularly those that could impact our aggregate risk limits. The Group Risk Framework risk categorisation is shown in the table below.
Liquidity risk The risk of the Group being unable to generate sufficient cash resources or to meet financial obligations as they fall due in business as usual and stress scenarios.
There is significant uncertainty regarding the final outcome of this process. In particular, certain detailed aspects of the Solvency II rules relating to the determination of the liability discount rate for UK annuity business remain to be clarified and our capital position is sensitive to these outcomes. Further, the effective application of a number of key measures incorporated in the Omnibus II Directive, including the provisions for third-country equivalence, are expected to be subject to supervisory judgement and approval. There is a risk that the effect of the measures finally adopted could be adverse for us, including potentially a significant increase in the capital required to support our business and that we may be placed at a competitive disadvantage to other European and non-European financial services groups. We are actively participating in shaping the outcome through our involvement in industry bodies and trade associations, including the Chief Risk Officer and Chief Financial Officer Forums, together with the Association of British Insurers and Insurance Europe.
Capital allocation (Unaudited) Our approach to capital allocation is to attain a balance between risk and return, investing in those businesses that create shareholder value. In order to efficiently allocate capital, we measure the use of, and the return on, capital.
We�are�committed�to�responding�to� customer�concerns�quickly�and�efficiently� and�we�aim�to�maintain�loyalty�by� continuing�to�improve�our�service� year-on-year�for�both�customers�and� intermediaries.�This�focus�on�continuing�to� deliver�excellent�customer�service�was� recognised�at�the�2013�Financial�Adviser� Service�Awards,�where�we�retained�our� two�five-star�ratings�in�the�Life�&�Pensions� and�Investment�categories.�In�the�most� recent�data�published�by�the�Financial� Ombudsman�Service,�Prudential�UK� continued�to�perform�well�and�was�placed� second�in�the�‘life�and�pension�and� decumulation’�peer�group.
Our�three-year�partnership�with� Greenhouse�has�allowed�over�1,000� disadvantaged�young�people�to�participate� weekly�through�their�basketball� programme.�Greenhouse�uses�sport�to� encourage�educational�performance� among�teenagers�from�some�of�London’s� most�deprived�areas.�Sport�coaches�work� full�time�in�schools�to�help�young�people� improve�their�health�and�fitness,�while� mentoring�them�to�increase�their� engagement�with�their�education�and� community.�Through�these�intensive�sport� programmes�participating�teenagers�have� improved�school�attendance�and�better� classroom�discipline,�as�well�as�showing� significant�progress�in�maths�and�English.�
Fuel combustion UK�Occupied 1,216 0.0155 UK�Investments 12,099 0.0054 Continental�Europe�Occupied 111 0.0097 Continental�Europe�Investments 41 0.0003 US�Occupied 1,448 0.0136 North�America�Investments 2,716 0.0110 Asia�Occupied 35 0.0001 Asia�Investments 266 0.0021
Business travel Booked�by�UK�employees�only 9,398 0.003 * Statutory carbon reporting disclosures required by the Companies Act 2006.
Nationality: British Appointment date: August 2007 Committee memberships: Chairman of the Audit Committee (from October 2009), Risk Committee (from November 2010), Nomination Committee (from July 2012)
Alistair is a member of the Strategy and Development Board and a Visiting Professor at Cass Business School. He is also a Trustee of the Design Museum in London and a Trustee of Create Arts. Age 61.
Governance framework Group governance framework: Documents the Group’s internal control policies and processes in an online manual, including the Group’s risk framework, Code of Business Conduct and detailed policies on key operational and financial risks. Business units are also required to follow any additional processes necessary to comply with local statutory and regulatory requirements.
During the year, the Board constituted a Group Disclosure Committee with the purpose of assisting the Company in fulfilling its obligations for the release of any inside information under the various listing requirements to which the Company is subject. A Standing Committee was also constituted with authority to deal with business requiring attention between scheduled Board meetings.
The Committee also considered judgemental matters regarding provisions for certain open tax items.
The assessment was conducted by the internal audit teams in each of the business units and considered whether each of the committees was fulfilling its responsibilities as documented in their terms of reference. Attendance rates by committee members and evidence of the committees’ coverage of key business unit issues, as well as the appropriate escalation of concerns to the Committee formed part of the criteria used for the evaluation. The assessment further factored in the suitability of the business unit audit committee structures and the appropriateness of the membership on each committee.
Internal control and risk management The Committee reviewed the Group’s statement on internal control systems prior to its endorsement by the Board.
Auditor independence The Committee’s responsibility to monitor the independence and objectivity of the external auditor is supported by the Auditor Independence Policy (the ‘Policy’), which is reviewed by the Committee annually. The Policy sets out the circumstances in which the external auditor may be permitted to undertake non-audit services.
The Committee regularly reviewed the external audit strategy and received reports from the auditor on its own policies and procedures regarding independence and quality control, and sought annual confirmation of KPMG’s independence in line with industry standards.
The Committee determined that the principal risks to the Group remained largely unchanged and continued to provide oversight to management’s actions in respect of these risks.
Reporting The Committee is provided with regular reports on the activities of the risk function and, where it affects the results of the assurances under the Turnbull compliance statement, the Audit Committee also receives appropriate reporting from the same function. Reports to the Committee include information on the activities of the Group Executive Risk Committee, the Group Operational Risk Committee, the Group Credit Risk Committee, the Solvency II Technical Oversight Committee, the Technical Actuarial Committee and the Group Compliance Committee, as well as reports from Group-wide Internal Audit.
The Group maintains a corporate website containing a wide range of relevant information for private and institutional investors, including the Group’s financial calendar. The shareholder information section on pages 371 to 372 contains further details which may be of interest to shareholders.
Prudential has continued its practice of calling a poll on all resolutions and the voting results, including all proxies lodged prior to the meeting, are displayed at the meeting and published on the Group’s website.
As at 11 March 2014, Trustees held 3 per cent of the issued share capital under the various plans in operation.
The provisions of Section 404 of the Act require the Company’s management to report on the effectiveness of internal controls over financial reporting in its Annual Report on Form 20-F, which is filed with the US Securities and Exchange Commission. To comply with this requirement and report on the effectiveness of internal control, the Group has documented and tested its internal controls over financial reporting in the format required by the Act. The annual assessment and related report from the external auditor will be included in the Group’s Annual Report on Form 20-F.
Significant contracts At no time during the year did any director hold a material interest in any contract of significance with the Company or any subsidiary undertaking.
Rules governing changes to the Articles of Association Corporate governance report 84
Firstly, I am delighted to welcome Philip Remnant and Anthony Nightingale, who joined the Committee in 2013. Keki Dadiseth and Michael Garrett stepped down from the Committee in 2013 following eight and nine years’ service respectively, and I would like to thank them for their contribution.
Rewarding 2013 performance During 2013, the Group delivered further increases in new business profitability, IFRS profitability and cash generation, due to strong performances across all of our business units. This was accomplished in an environment of continued global macroeconomic uncertainty, while operating within the Group’s risk appetite, risk framework and maintaining appropriate levels of capital.
The Remuneration Committee is extremely grateful for this feedback and support received from shareholders on Prudential’s remuneration architecture and directors’ remuneration policy, which builds on the significant vote in favour of the 2012 directors’ remuneration report.
At the AGM in May 2014: — Prudential’s directors’ remuneration policy for future years will be subject to a binding shareholder vote; and
Aligned with our long-term business strategy and delivery of shareholder value, vesting is currently subject to: B Relative TSR; and B Group IFRS Profit; or B Business unit IFRS profit.
Financial and personal objectives set with reference to business plans approved by the Board
Executive director Role increase 2014 salary Maximum bonus Bonus deferred LTI award (% salary)
Expatriate and relocation benefits allow Prudential to attract high calibre executives in the international talent market and deploy them appropriately within the Group.
Executive directors are entitled to receive pension contributions or a cash supplement (or combination of the two) up to a total of 25 per cent of base salary or, retain membership of a defined benefit scheme.
In the event of a corporate transaction (eg takeover, merger, winding up, rights issue etc), the Remuneration Committee will determine whether awards will: — Vest in part or in full; and/or
See page 104 for details of the Committee’s powers in respect of PLTIP participants joining or leaving the Group.
TSR is measured against a peer group of international insurers (currently 18) which are similar to Prudential in size, geographic footprint and products. The peer group for each award is disclosed in the relevant annual report on remuneration.
IFRS profit Three year cumulative IFRS operating profit is assessed at Group or business unit level.
Jackson BUPP Vesting of awards made under the Jackson BUPP are dependent on Shareholder Capital Value (SCV) growth over the performance period. At threshold performance of 8 per cent compound annual growth in SCV, 30 per cent of the award vests. This increases on a straight-line basis to 75 per cent vesting for 10 per cent growth, and full vesting for 12 per cent compound annual growth in SCV.
Barry Stowe Pension supplement in lieu of pension of 25 per cent of salary and a HK$30,000 payment to the Hong Kong Mandatory Provident Fund.
Note 1 Mark Tucker left the Company on 30 September 2009. Tidjane Thiam became Group Chief Executive on 1 October 2009. The figures shown for Tidjane Thiam’s remuneration in 2009 relate only to his service as Group Chief Executive.
Notes 1 Paul Manduca was appointed as Chairman on 2 July 2012. The figures for 2012 above include the fees he received as the Senior Independent Director prior to his appointment as Chairman.
Long-term incentives awarded in 2013 2013 share-based long-term incentive awards The table below shows the awards made to executive directors in 2013 under share-based long-term incentive plans and the performance conditions attached to these awards: Executive Role
Group Chief Executive 2,500 1 year Yes 350% 5 years Yes Other executive directors 2,500 1 year Yes 200% 5 years Yes Chairman 2,500 1 year Yes 100% 5 years On course Non-executive directors 2,500 1 year Yes 100% 3 years Yes
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 dollar face value of conditional share awards outstanding on 1 January 2013 and 31 December 2013 was US$2,800,000 and US$1,400,000 respectively.
Related change in amortisation of deferred acquisition costs C5.1(b) 498 (270) Related tax 557 (205)
Net increase (decrease) in equity 1 16 1,607 (216) 387 1,795 (38) 1,757 * The Group has adopted new accounting standards on consolidated financial statements and joint arrangements, and amendments to the employee benefits accounting standard, from 1 January 2013, as described in note A2. Accordingly, the 2012 comparative results and related notes have been adjusted retrospectively from those previously published.
P rim ary statem en ts 131 Prudential plc Annual Report 2013
Cash flows from operating activities Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)note (i) 2,082 3,117 Non-cash movements in operating assets and liabilities reflected in profit before tax: Other non-investment and non-cash assets (1,146) (774) Policyholder liabilities (including unallocated surplus) 21,951 26,362 Other liabilities (including operational borrowings) 1,907 (511)
In Asia, the Group has operations in Hong Kong, Malaysia, Singapore, Indonesia and other Asian countries. The life insurance products offered by the Group’s operations in Asia include with-profits (participating) and non-participating term, whole life and endowment and unit-linked policies. In Asia, unit-linked policies are usually sold with insurance riders such as for health cover.
ack gro u n d an d acco u n tin g p o licies 135 Prudential plc Annual Report 2013
The principal category of vehicles affected is the Group’s interest in investment funds.
These factors and other observable conditions may indicate that an investment is impaired.
vi Embedded derivatives Embedded derivatives are present in host contracts issued by various Group companies, in particular Jackson. They are embedded within other non-derivative host financial instruments and insurance contracts to create hybrid instruments. Embedded derivatives meeting the definition of an insurance contract are accounted for under IFRS 4. Where economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host instrument, and where the hybrid instrument is not measured at fair value with the changes in fair value recognised in the income statement, the embedded derivative is bifurcated and carried at fair value as a derivative in accordance with IAS 39. For Jackson’s ‘not for life’ Guaranteed Minimum Withdrawal Benefit and Fixed Index Annuity reserves the determination of fair value requires assumptions regarding future mix of Separate Account assets, equity volatility levels, and policyholder behaviour.
o Investment properties Investments in leasehold and freehold properties not for occupation by the Group, including properties under development for future use as investment properties, are carried at fair value, with changes in fair value included in the income statement. Properties are valued annually either by the Group’s qualified surveyors or by taking into consideration the advice of professional external valuers using the Royal Institution of Chartered Surveyors valuation standards. Each property is externally valued at least once every three years.
Deferred taxes are provided under the liability method for all relevant temporary differences. IAS 12, ‘Income Taxes’ does not require all temporary differences to be provided for, in particular, the Group does not provide for deferred tax on undistributed earnings of subsidiaries where the Group is able to control the timing of the distribution and the temporary difference created is not expected to reverse in the foreseeable future. Deferred tax assets are only recognised when it is more likely than not that future taxable profits will be available against which these losses can be utilised.
ack gro u n d an d acco u n tin g p o licies 147 Prudential plc Annual Report 2013 t Goodwill Goodwill arising on acquisitions of subsidiaries and businesses is capitalised and carried on the Group statement of financial position as an intangible asset at initial value less any accumulated impairment losses. Goodwill impairment testing is conducted annually and when there is an indication of impairment. For the purposes of impairment testing, goodwill is allocated to cash generating units.
The short-term fluctuations in investment returns shown in the table above are stated net of a credit for the related amortisation of deferred acquisition costs of £228 million (2012: credit of £76 million). See note C5.1(b).
The amounts principally reflect the fair value movement on these instruments, net of related amortisation of deferred acquisition costs. Under the Group’s IFRS reporting of Jackson’s derivatives (other than equity-related) programme significant accounting mismatches arise. This is because: – The derivatives are required to be fair valued with the value movements booked in the income statement; – As noted above, part of the derivative value movements arises in respect of interest rate exposures within Jackson’s guarantee liabilities for variable annuity and fixed index annuity business which are only partially fair valued under IFRS (see below); and – The GMIB liability is valued under the US GAAP insurance measurement basis applied for IFRS in a way that substantially does not recognise the effect of market movements. However, notwithstanding that the liability is reinsured, as the reinsurance asset is net settled it is deemed a derivative under IAS 39 which requires fair valuation.
Share of profit from joint ventures and associates, net of related tax 29 – 83 12 – 23 147 – 147
Total revenue, net of reinsurance 10,303 20,658 21,631 1,214 731 229 54,766 (328) 54,438
Total revenue 52,375 54,438 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Revenue from external customers of Asia, US and UK insurance operations shown above are net of outwards reinsurance premiums of £190 million, £278 million, and £190 million respectively (2012: £163 million, £193 million and £135 million respectively). In Asia, revenue from external customers from no individual country exceeds 10 per cent of the Group total. The largest country is Hong Kong, with a total revenue from external customers of £2,243 million (2012: Hong Kong £1,745 million).
(b) The charge for non-deferred acquisition costs and the amortisation of those costs that are deferred, was £(1,987) million (2012: (1,962) million). These amounts comprise £(1,953) million and £(34) million for insurance and investment contracts respectively (2012: £(1,742) million and £(220) million, respectively).
(g) There were no fee expenses relating to financial liabilities held at amortised cost included in acquisition costs in 2013 and 2012.
(ii) Long-term expected defaults are derived by applying Moody’s data from 1970 to 2009 and the definition of the credit rating used is the second highest credit rating published by Moody’s, Standard & Poor’s and Fitch. (iii) Additional provisions comprise credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a one-notch downgrade of the portfolio subject to credit risk and an additional allowance for short-term defaults. The 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’.
arn in gs p erfo rm an ce 167 Prudential plc Annual Report 2013 b Reconciliation of effective tax rate For the purposes of explaining the relationship between tax expense and accounting profit, it is appropriate to consider the sources of profit and tax by reference to those that are attributable to shareholders and policyholders. A reconciliation of tax charge on profit attributable to shareholders is provided below.
† For the column entitled ‘Attributable to policyholders’, the profit (loss) before tax represents income, before tax attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. This income has been determined after deduction of charges for policyholder benefits and movements on unallocated surplus which are determined net of tax. Hence, the pre-tax results attributable to policyholders is the inverse of the tax charge attributable to policyholders.
* The expected and actual tax rates as shown includes the impact of the held for sale Japan life business. The tax rates for Asia insurance and Group, excluding the impact of the held for sale Japan life business are as follows: Asia insurance Total Group
The geographical split of taxes remitted by Prudential is as follows: Corporation taxes*
Investments of long-term business and other operations: Investments in joint ventures and associates accounted for using the
Total accrued investment income and other debtors 4,355 4,096 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
Liabilities held for sale D1 – 328 540 – – – 868 –
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classified as investment contracts under IFRS 4) 13,138 11,918 6,854 31,910 31,501 Unallocated surplus of with-profits funds note (ii) 77 – – 77 63
C3.1 Group assets and liabilities – Classification The classification of the Group’s assets and liabilities, and its corresponding accounting carrying values reflect the requirements of IFRS. For financial investments the basis of valuation reflects the Group’s application of IAS 39 ’Financial Instruments: Recognition and Measurement’ as described further below. Where assets and liabilities have been valued at fair value or measured on a different basis but fair value is disclosed, the Group has followed the principles under IFRS 13 ‘Fair Value Measurement’. The basis applied is summarised below: 2013 £m
Other business Total Total * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
In addition to the debt securities shown above, the assets held for sale on the consolidated statement of financial position at 31 December 2013 in respect of Japan life business included a debt securities balance of £387 million. Of this amount, £356 million were rated as AA+ to AA- and £29 million were rated A+ to A-.
Corporate and government security and commercial loans: Publicly traded and SEC Rule 144A securities* 18,875 19,699 Non-SEC Rule 144A securities 3,395 3,542
Fair value (as included in statement of financial position) 30,205 32,825 * Book value represents cost/amortised cost of the debt securities. † Translated at the average rate of US$1.5646: £1.00.
(2012: 63 per cent) are investment graded. (ii) US insurance operations US insurance operations’ exposure to asset-backed securities at 31 December 2013 comprises: RMBS Sub-prime (2013: 10% AAA, 10% AA) 255 261
— Some products, especially in the US, have guarantee features linked to equity indexes. A mismatch between guaranteed product liabilities and the performance of the underlying assets, exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to better match asset performance with liabilities under equity-indexed products.
Gross amounts not offset in the consolidated statement of financial position
Notes (a) Including net flows of the Group’s insurance joint ventures. (b) The reclassification of Japan life business as held for sale reflects the value of policyholder liabilities held at 1 January 2013 following its reclassification during 2013 as held for sale. No other amounts are shown within the 2013 analysis above in respect of Japan.
Shareholders’ transfers post tax (31) – – (31) Investment-related items and other movements 639 1,451 88 2,178 Foreign exchange translation differencesnote (a) (239) (361) (216) (816)
Shareholders’ transfers post tax (38) – – (38) Investment-related items and other movementsnote (d) (160) 369 253 462 Acquisition of Thanachart life – – 487 487 Foreign exchange translation differencesnote (a) (517) (1,241) (473) (2,231)
The provisions have been determined on a basis consistent with the detailed methodology included in regulations contained in the PRA’s rules for the determination of reserves on the PRA’s ‘realistic’ Peak 2 basis. In aggregate, the regime has the effect of placing a value on the liabilities of UK with-profits contracts, which reflects the amounts expected to be paid based on the current value of investments held by the with-profits funds and current circumstances. These contracts are a combination of insurance and investment contracts with discretionary participation features, as defined by IFRS 4.
C4: Policyholder liabilities and unallocated surplus of with-profits funds continued iii Annuity business Credit risk provisions For IFRS reporting, the results for UK shareholder-backed annuity business are particularly sensitive to the allowances made for credit risk. Further details on credit risk allowance are provided in note B4(c).
In payment 93% – 99% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2012 mortality model, with a long-term improvement rate of 2.25%.
91% – 96% PCMA00 with future improvements in line with Prudential’s own calibration of the CMI 2012 mortality model, with a long-term improvement rate of 2.25%.
Other operating assumption changes The effect of other operating assumption changes for the shareholder-backed business is set out in note B4 (c).
alan ce sh eet n o tes 231 Prudential plc Annual Report 2013
Deferred acquisition costs related to insurance and investment contracts attributable to shareholders Additional movement analysis of deferred acquisition costs and other intangibles attributable to shareholders The movement in deferred acquisition costs relating to insurance and investment contracts attributable to shareholders are as follows: 2013 £m 2012* £m
Bank loans and overdrafts 3 1 Obligations under finance leases – 1 Other borrowings note (iii) 198 139
The financial and insurance assets and liabilities attaching to the Group’s life assurance business are, to varying degrees, subject to market and insurance risk and other changes of experience assumptions that may have a material effect on IFRS basis profit or loss and shareholders’ equity.
Three key points are to be noted, namely: — The Group’s with-profits and unit-linked funds absorb most market risk attaching to the funds’ investments. Except for second order effects, for example on asset management fees and shareholders’ share of cost of bonuses for with-profits business, shareholder results are not directly affected by market value movements on the assets of these funds; — The Group’s shareholder results are most sensitive to market risks for assets of the shareholder-backed business; and — The main exposures of the Group’s IFRS basis results to market risk for its life assurance operations on investments of the shareholder-backed business are for debt securities.
The estimated sensitivity to a 10 per cent and 20 per cent change in equity and property prices for shareholder-backed Asia other business, which would be reflected in the short-term fluctuation component of the Group’s segmental analysis of profit before tax, at 31 December 2013 and 2012 would be as follows: 2013 £m 2012* £m
Jackson’s main exposures are to market risk through its exposure to interest rate risk and equity risk. Approximately 94 per cent (2012: 94 per cent) of its general account investments support fixed interest rate and fixed index annuities, life business and surplus and 6 per cent (2012: 6 per cent) support institutional business. All of these types of business contain considerable interest rate guarantee features and, consequently, require that the assets that support them are primarily fixed income or fixed maturity.
Other comprehensive income: Direct effect on carrying value of debt securities (net of related changes in amortisation
Jackson is sensitive to lapse risk. However, Jackson uses derivatives to ameliorate the effect of a sharp rise in interest rates, which would be the most likely cause of a sudden change in policyholder behaviour.
A decrease in assumed mortality rates of 1 per cent would decrease gross profits by approximately £71 million (2012: £74 million). A decrease in credit default assumptions of five basis points would increase gross profits by £151 million (2012: £157 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase gross profits by £27 million (2012: £25 million). The effect on profits would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above.
US insurance operations 2,042 1,889 Asia insurance operations 55 76 Other operations 173 158 * The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note A2.
The reduction in the UK corporation tax rate to 21 per cent from 1 April 2014 and a further reduction to 20 per cent from 1 April 2015 was substantively enacted on 2 July 2013 which has had the effect of reducing the UK with-profits and shareholder-backed business element of the deferred tax balances as at 31 December 2013 by £51 million. As the 2013 Finance Act has been enacted at the balance sheet date, the effects of these changes are reflected in the financial statements for the year ended 31 December 2013.
The Group’s businesses operate a number of pension schemes. The specific features of these plans vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS). PSPS accounts for 84 per cent (2012: 86 per cent) of the underlying scheme liabilities of the Group’s defined benefit schemes.
Equities: Bonds*: * 97 per cent of the bonds are investment graded (2012: 98 per cent). † The 2012 comparatives have been reclassified to align to the current year’s asset categorisation.
alan ce sh eet n o tes 255 Prudential plc Annual Report 2013
Discount rate 4.4% 4.4% Increase by 0.2% Decrease in scheme liabilities by: Other schemes 4.7% 4.6%
Issued shares of 5p each fully paid: Shares issued under share-based schemes 3,139,384 – 6 9,203,022 1 16
alan ce sh eet n o tes 261 Prudential plc Annual Report 2013 d Basis of preparation, capital requirements and management Each of the Group’s long-term business operations is capitalised to a sufficiently strong level for its individual circumstances. Details by the Group’s major operations are shown below.
PAC with-profits sub-fund and Scottish Amicable Insurance Fund Under PRA rules, insurers with with-profits liabilities of more than £500 million must hold capital equal to the higher of the MCR and the Enhanced Capital Requirement (ECR). The ECR is intended to provide a more risk responsive and ‘realistic’ measure of a with-profit insurer’s capital requirements, whereas the MCR is broadly speaking equivalent to the previous required minimum margin under the Interim Prudential Sourcebook and satisfies the minimum EU Standards.
For Jackson, capital retention is maintained at a level consistent with an appropriate rating by Standard & Poor’s. Currently Jackson is rated AA. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, dividends which exceed the greater of statutory net gain from operations for the prior year or 10 per cent of Jackson’s prior year-end statutory surplus require prior regulatory approval.
Assets Acquired value of in-force business 21 Investments (principally debt securities) 642 Cash and cash equivalents 4 Other assets (including distribution rights) 293
Net assets 48 d PAC with-profits funds acquisitions In December 2013, the PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, acquired a 100 per cent interest of Falbygdens Energi AB, a Swedish utility company. The main business operations comprise the production and distribution of district heating and the distribution of electricity primarily within the municipality of Falköping. The company also operates a broadband business in the municipality.
Profit before tax attributable to shareholders 2,810 – (18) (45) 2,747 Total tax charge attributable to policyholders and shareholders (991) – 20 17 (954) Adjustment to remove tax charge (credit) attributable
Equity Shareholders’ equity 9,650 – – – 9,650 Non-controlling interests 1 – – – 1
Details of all Prudential subsidiaries, joint ventures and associates will be annexed to the next Annual Returns of Prudential plc filed with the UK Registrar of Companies.
The assets and liabilities of the Scheme were: 31 Dec 2013 31 Dec 2012 31 Dec 2011 31 Dec 2010 31 Dec 2009
Present value of Scheme liabilities, at 31 December 5,316 5,226 * The past service cost in 2012 of £106 million resulted from an exceptional discretionary increase to pensions in payment of the Scheme.
The pension charge attributable to the Company is net of the apportionment to the PAC with-profits fund and is related to the surplus recognised on the balance sheet of the Company. No adjustment was made to the pension charge in 2013 or 2012 relating to the unrecognised portion of the Scheme’s surplus.
Our response – We used own valuation specialists and pricing services to assist us in performing our audit procedures in this area, which included: — Assessing whether the valuation process is appropriately designed and captures relevant valuation inputs; — Testing associated controls in respect of the valuation process; — Performing our own independent price checks using external quotes where available for illiquid positions; — Assessing pricing model methodologies and assumptions against industry practice and valuation guidelines; and
Profit for the year attributable to equity holders of the Company* 4,358 3,769 * The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of IFRS 11 and revised ‘Employee benefits’ (IAS 19) and for the reclassification of the result attributable to the held for sale Japan life business – see note 18.
Based on post-tax profit of £4,358 million (2012*: £3,769 million) 11 171.0p 148.3p * The 2012 comparative results have been adjusted retrospectively from those previously published for the adoption of IFRS 11 and revised IAS 19 – see note 18.
Share capital 128 128 Share premium 1,895 1,889 IFRS basis shareholders’ reserves 7,627 8,342
(g) The result includes a full year contribution from the REALIC book of business of £61 million (2012: four months of £19 million).
(iii) US operations The effect of changes in economic assumptions for US operations reflects the following: Effect of changes in 10-year treasury rates and beta: Fixed annuity and other general account business note (a) (375) 20 Variable annuity business note (b) 587 (83)
(b) For variable annuity business, the credit of £587 million principally reflects an increase in projected fee income and a decrease in projected benefit costs, arising from the increase in the rate of assumed future return on the underlying separate account assets, driven by the 130 basis points increase in the risk-free rate. There is a partial offset arising from the increase in the discount rate applied to those cash flows. The charge of £(83) million in 2012 reflected a decrease in the risk-free rate of 10 basis points.
Net increase in shareholders’ equity 843 934 570 2,347 66 2,413 2,806 Shareholders’ equity at 1 January 2013 note (i) 9,462 6,032 6,772 22,266 177 22,443 19,637
Pre-tax new business contribution note 2 1,460 1,086 297 2,843 1,266 873 313 2,452
There are also various non-participating long-term products with guarantees. The principal guarantees are those for whole of life contracts with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions.
(v) Debt capital Core structural debt liabilities are carried at market value. As the liabilities are generally held to maturity or for the long-term, no deferred tax asset or liability has been established on the difference, compared to the IFRS carrying value. Accordingly, no deferred tax credit or charge is recorded in the results for the reporting period in respect of the mark to market value adjustment.
(iii) Effect of changes in operating assumptions Operating profit includes the effect of changes to operating assumptions on the value of in-force at the end of the period. For presentational purposes, the effect of change is delineated to show the effect on the opening value of in-force with the experience variance being determined by reference to the end of period assumptions.
Expected long-term rate of inflation 3.4 2.9 Equity risk premium 4.0 4.0 Assumed tax rate for value of in-force business note 3(iv)(b) 20.0 23.0
US insurance operations Variable annuities 10,795 11,596 – – 1,079 1,160 10,795 11,596 Elite Access (variable annuity) 2,585 849 – – 259 85 2,585 849 Fixed annuities 555 581 – – 55 58 555 581 Fixed index annuities 907 1,094 – – 91 109 907 1,094 Life 1 6 2 12 2 12 12 102 Wholesale 869 378 – – 87 38 869 378
Long-term business: Before reclassification of held for sale Japan life business 2,394 – – 2,394 Reclassification of Japan life business (7) – – (7)
Effect of changes in economic assumptions: Before reclassification of held for sale Japan life business 818 – – 818 Reclassification of Japan life business 3 – – 3
Loss attaching to held for sale Japan life business: Reclassification from pre-tax operating profit based on longer-term investment returns 7 – – 7 Reclassification from short-term fluctuations in investment returns 28 – – 28 Reclassification from effect of changes in economic assumptions (3) – – (3) Remeasurement of carrying value of Japan life business classified as held for sale (67) – – (67)
Total operating profit based on longer-term investment returns 1,091 (16) 1,075 1,302 1,176 (599) 2,954
US operations New businessnote (ii) 1,086 873 479 706 568 311 Business in force: Unwind of discount and other expected returns 608 412 287 395 268 187
Short-term fluctuations in investment returns: Effect of changes in economic assumptions: Asia operations 283 (135) 333 255 (99) 272 US operations 372 85 62 242 56 40 UK insurance operations 166 48 289 132 37 222 * The 2012 comparative results have been adjusted retrospectively from those previously published for the revised IAS 19 and for the reclassification of the result attributable to the held for sale Japan life business – see note 18 of the EEV basis results section.
Discounted expected free surplus generation for years 2014 to 2053 1,242 999 261 2,502 Discounted expected free surplus generation for years 2053+ 52 – 2 54 Less: free surplus investment in new business (310) (298) (29) (637)
Less: amounts expected to be realised in the current year (446) – – – – – – (446)
At 31 December 2013, the total free surplus expected to be generated on an undiscounted basis in the next forty years is £43.5 billion, up from the £35 billion expected at end of 2012, reflecting the effect of new business written and the positive market movements in Asia, following increases in bond yields principally in Hong Kong, Indonesia and Singapore, together with higher projected separate account fees following increase in US equities values. The foreign exchange translation effect arising across US and Asia operations is a reduction of £1.6 billion. The overall growth in the undiscounted value of free surplus, reflects both our ability to write new business on attractive economics and to manage the in-force book for value, as well as the positive gearing of our cash flows to rising long-term yields and equity markets.
— Holding companies are measured on a Solvency II basis, as if they were insurance companies, in line with draft Solvency II rules.
During 2013, the Group’s economic capital surplus increased from £8.8 billion to £11.3 billion. The total movement over the year was equivalent to a 42 percentage point increase in the Group economic solvency ratio, driven by: — Model changes: a positive impact to Group surplus arising from a number of modelling enhancements and refinements; — Operating experience: generated by in-force business, new business written in 2013, the beneficial impact of management actions taken during 2013 to de-risk the business, and small impacts from non-market assumption changes and non-market experience variances over the year; — Non-operating experience: mainly arising from positive market experience during 2013; and — Other capital movements: a reduction in surplus from the acquisition of Thanachart Life and the preparation for sale of the Japanese business, the negative impact of exchange rate movements, an increase in surplus from new subordinated debt issuances and a reduction in surplus due to dividend payments in 2013.
The total number of securities available for issue under the scheme is 4,323,598 which represents 0.169 per cent of the issued share capital at 31 December 2013.
In the future, the adverse effects of such factors would be felt principally through the following items: — Investment impairments or reduced investment returns, which could impair Prudential’s ability to write significant volumes of new business and would have a negative impact on its assets under management and profit; — Higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses; — Failure of counterparties to transactions with Prudential or, for derivative transactions adequate collateral not being in place; — Estimates of the value of financial instruments being difficult because in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain such values require substantial elements of judgement, assumptions and estimates (which may change over time); and
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates Changes in government policy, legislation (including tax) or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, profitability, capital requirements and, consequently, reported results and financing requirements. Also, regulators in jurisdictions in which Prudential operates may change the level of capital required to be held by individual businesses or could introduce possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of interventions by governments in response to recent financial and global economic conditions, it is widely expected that there will continue to be a substantial increase in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure and enhanced supervisory powers.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States that, among other reforms to financial services entities, products and markets, may subject financial institutions designated as systemically important to heightened prudential and other requirements intended to prevent or mitigate the impact of future disruptions in the US financial system. The full impact of the Dodd-Frank Act on Prudential’s businesses is not currently clear, as many of its provisions have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years.
Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential is, and may be in the future, subject to legal actions, disputes and regulatory investigations in various contexts, including in the ordinary course of its insurance, investment management and other business operations. These legal actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to
Within the UK, Prudential’s principal competitors include many of the major retail financial services companies and fund management companies including, in particular, Aviva, Legal & General, Lloyds Banking Group, Standard Life, Schroders, Invesco Perpetual and Fidelity.
Prudential’s legacy and other IT systems and processes, as with operational systems and processes generally, may be susceptible to failure or breaches. Such events could, among other things, harm Prudential’s ability to perform necessary business functions, result in the loss of confidential or proprietary data (exposing it to potential legal claims and regulatory sanctions) and damage its relationships with its business partners and customers. Similarly, any weakness in the administration systems or actuarial reserving processes could have an impact on its results of operations during the effective period.
Adverse experience relative to the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations Prudential needs to make assumptions about a number of factors in determining the pricing of its products, setting reserves, for reporting its capital levels and the results of its long-term business operations. For example, the assumption that Prudential makes about future expected levels of mortality is particularly relevant for its UK annuity business. In exchange for a premium equal to the capital value of their accumulated pension fund, pension annuity policyholders receive a guaranteed payment, usually monthly, for as long as they are alive. Prudential conducts rigorous research into longevity risk, using data from its substantial annuitant portfolio. As part of its pension annuity pricing and reserving policy, Prudential’s UK business assumes that current rates of mortality continuously improve over time at levels based on adjusted data and models from the Continuous Mortality Investigations (CMI) as published by the Institute and Faculty of Actuaries. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
In-force An insurance policy or contract reflected on records that has not expired, matured or otherwise been surrendered or terminated.