Our founding principles of integrity, security and prudence continue to drive our commitment to supporting our customers and the well-being of the communities in which we operate.
In Asia, a challenging economic climate in the first half of 2009 gave way to more positive conditions in the second half of the year. While we saw our single premium volumes decline as a result of economic uncertainty, our regular premium and higher-margin protection business remained resilient, ensuring we outperformed the competition, while remaining protected, especially in the second half.
In 2009, we delivered an outstanding performance generating significantly higher profits while consuming less capital. This performance demonstrates the success of our strategy to focus on the most profitable growth opportunities in our chosen markets around the world.
The global economic environment has gradually improved through 2009, led by emerging economies, especially Asia. The Asian region appears to be more resilient than the rest of the world and we expect it is likely to return sooner to strong growth while the western world seems to be set for a prolonged period of weaker growth. Against this backdrop, and in particular in those countries in Asia where we have leading positions, our long-term growth potential remains intact, and we believe we are well positioned to take advantage of opportunities in the pre and post retirement markets in our chosen geographical markets.
At 31 December 2009 holding company cash and short-term investments was £1.5 billion, an increase of £0.3 billion over 2008. This increase comprises proceeds of £0.6 billion from higher borrowings, (before allowing for exchange translation gains of £0.2 billion on foreign currency denominated borrowings), and positive operating holding company cash flow of £38 million, net of exceptional payments of £360 million.
Effect of changes in economic assumptions and time value of cost of options and guarantees (910) (398)
For our US business, short-term fluctuations in investment returns were negative £401 million versus negative £1,344 million in 2008, and primarily reflected the excess of impairment losses for fixed income securities incurred in the year over the long-term charge included within operating profit.
The shareholders’ funds at the end of 2009 relating to long-term business of £15.3 billion comprise £5.8 billion for our Asian long-term business operations, £4.1 billion for our US long-term business operations and £5.4 billion for our UK long-term business operations.
In the US, investment in new business was £326 million, five per cent lower than 2008 on a CER basis (£342 million). For each £1 million of free surplus invested we generated £1.3 million of post-tax new business contribution to embedded value (2008: £0.7 million). This higher return reflects the Group’s prioritisation of capital preservation which resulted in a change in business mix away from capital intensive wholesale products to sales of more profitable variable annuities, as well as an increase in spread
Operating holding company* cash flow before dividend 382 340 Dividend paid net of scrip and share options (344) (286)
Tax received in 2009 was £71 million, down £59 million from 2008, due to lower UK taxable profits available for offset. Payments for corporate activities at £163 million were £14 million lower, mainly due to the non-recurrence of 2008 costs relating to the investigation of the potential reattribution of the inherited estate.
Total investments held by the Group at 31 December 2009 were £208.7 billion, of which £101.0 billion were held by participating funds, £49.0 billion by unit-linked funds and £58.7 billion by shareholder-backed operations. Shareholders are not directly exposed to value movements on assets backing participating or unit-linked operations, with sensitivity mainly related to shareholder-backed operations.
In Asia, a high proportion of our in-force book is made up of unitlinked products with limited shareholder exposure to equities. We have minimal direct shareholder exposure to Asian equity markets outside our unit-linked holdings.
Jackson hedges the economics of its products rather than the accounting result. Accordingly, while its hedges are effective on an economics basis, due to different accounting treatment for the hedges and some of the underlying hedged items, the reported income effect is more volatile. For Jackson’s variable annuities guaranteed benefits and related hedges, while there has been some volatility of results in 2008 and 2009, there has been a small cumulative net operating loss of £7 million over the 24 month period, reflecting the overall effectiveness of the hedging programme.
Interest rates primarily impact our Asia, US and UK with-profits businesses. Following the sale of the agency-based business in Taiwan, the exposure to interest rate risk in Asia has significantly reduced. The remaining risk in the region relates mostly to guarantees on traditional shareholder-backed life products and asset-liability mismatches, driven by limited availability of longterm assets in some territories. This exposure is monitored and managed carefully on an ongoing basis, for example by setting clear limits on duration risk set in the investment guidelines. We have a range of risk mitigation options available that would help to reduce the exposure to interest rate movements.
c) Insurance risk The inherent uncertainty as to the occurrence, amount and timing of insurance cash flows. This includes the impact of adverse mortality, morbidity and persistency experience.
2 Non-financial Operational risk The risk of direct or indirect loss resulting from inadequate or failed internal risks processes, people or systems, or from external events. This includes legal and regulatory compliance risk.
Over the coming months we will be progressing our implementation plans further and remaining in regular contact with the FSA as we prepare for the initial stage of the approval process for the internal model.
Financial performance Although some challenges remain in the Asian economies, there are encouraging signs that the recovery is well underway. Importantly, consumer confidence is returning to the retail financial services sector. Prudential had its highest ever quarter in terms of new business volumes during the fourth quarter of 2009 at £415 million up 42 per cent and 45 per cent from the third quarter of 2009 and the equivalent quarter in 2008 respectively, driven by a continued improvement in sentiment. Full year new business results of £1,261 million represent a growth rate of 4 per cent over 2008.
EEV basis new business profits of £664 million were 127 per cent higher than in 2008, reflecting a 27 per cent increase in APE sales and a significant shift in the mix of business toward variable annuities. Total new business margin was 73 per cent, significantly higher than the 41 per cent achieved in 2008.
In 2009, Prudential UK performed strongly against a challenging background of difficult capital and equity markets and widespread economic uncertainty which led to consumers looking for greater certainty and security through trusted and financially strong brands. We believe that the business has a unique combination of competitive advantages including our longevity experience, multi-asset investment capabilities, strong brand and financial strength, which help put Prudential UK in a strong position to generate attractive returns across its businesses.
Sales of individual annuities of APE £219 million were 22 per cent lower than 2008. Sales of external annuities of £83 million were down 31 per cent year-on-year as Prudential UK continued to actively manage the flow of external business to reduce capital consumption. For internal vestings, although rates remained robust, sales were impacted by a reduction of eight per cent in average case sizes as a result of depressed asset values and by customers choosing to delay their retirement to allow asset values to recover. As a result, internal vestings sales fell by 15 per cent. However, the year-on-year decline is also explained by the fact that vestings were stronger than usual in the last quarter of 2008.
Strengthening our distribution capabilities The business increased its field sales-force with an additional 13 regional sales units and the focus is to continue developing deeper and better relationships with key accounts and through partnership arrangements. Prudential UK was successful in gaining over 50 new panel positions across our 24 key accounts in 2009, meaning that its products are now even more widely available to intermediaries than before.
Financial performance Market conditions remained challenging in 2009, with ABI statistics data showing a 23 per cent fall in the retail sales market in the twelve months to September. As explained above, Prudential UK continued to maintain a strict focus on the disciplined use of capital and pricing to achieve its return on capital targets. Against this background, Retail APE sales of £717 million were down 11 per cent on 2008. Total UK APE sales of £723 million were down 24 per cent on last year, although the 2008 figure included a large bulk annuity transaction which has not been repeated in 2009, due to the unavailability of transactions which met Prudential’s return criteria.
M&G’s Retail Business has had a particularly strong year, seeing net inflows jump by 259 per cent over the year to £7.5 billion. Gross fund sales were up 50 per cent at £13.6 billion. Sales of our top-performing fixed income funds accounted for the lion’s share of inflows for most of the year before investor appetite switched to our equity and property funds during the second half as sentiment turned more bullish.
Financial performance The collapse in investor confidence in the autumn of 2008 and the subsequent economic turmoil had a limited impact on that year’s results, coming as it did late in the year. Market levels are the single most important determinant of our profits. The average level of the FT All Share Index during 2008 was 2,743. Despite the recovery in markets from March 2009 onwards, the average level of the FT All Share Index in 2009 was materially lower at 2,327.
Fixed index annuities (formerly referred to as equity-indexed annuities) are similar to fixed annuities, in that the contract holder pays a premium that is credited to the contract holder’s account, and also in that interest is periodically credited to the contract holder’s account and administrative charges deducted, as appropriate. An annual minimum interest rate is guaranteed, although actual interest credited may be higher and is linked to an equity index over its indexed option period. Profit comes from the investment income earned and the fees charged on the contract, less the expenses incurred, which include the costs of the guarantees, and the interest credited to the contract. Fixed index annuities are subject to early surrender charges for the first five to twelve years of the contract. During the surrender charge period, the contract holder may cancel the contract for the surrender value. Fixed index annuities continue to be a profitable product, benefiting from favourable spread and the effective management of equity risk. The fixed index book provides natural offsetting equity exposure to the guarantees issued in connection with our variable annuity products, which allows for efficient hedging of the net equity exposure.
• Group Head Office (GHO) expenses consist of other operating income and expenditure and UK restructuring costs.
– underlying results 65 46 – exceptional credit for Malaysia operations 63 –
Serving our customers We do not underestimate the importance of the financial decisions our customers face and the trust they place in us to help them meet their changing requirements for savings, income and protection.
In the US, the Jackson Professional Development Unit (PDU) and its training programme was expanded. The PDU runs a comprehensive training curriculum for all Jackson’s wholesalers, who in turn provide ongoing training to advisers. In addition during 2009, Jackson launched a monthly training programme to help the company’s field wholesalers to enhance their product knowledge.
For the second year running, we also endorsed the ClimateWise principles on climate change in the UK. All of Prudential’s North America operations – including Jackson, and PPM America – signed up for the second successive year to the US Climate Leaders programme. This is an Environmental Protection Agency (EPA) and industry/government partnership that works with companies to develop comprehensive climate change strategies. In 2009, Jackson also launched its environmental ‘Work Smart’ programme for employees.
PRUPIM also launched the Sustainable Refurbishment Framework. This complements the Sustainable Development Framework, both of which are public resources to actively encourage sustainable practices, with the aim of sharing PRUPIM’s many years of experience in this area with the property industry as a whole.
Lord Turnbull has been an independent non-executive director of Prudential since May 2006, and a member of the Audit Committee since January 2007. He entered the House of Lords as a Life Peer in 2005. In 2002, he became Secretary of the Cabinet and Head of the Home Civil Service until he retired in 2005. Prior to that, he held a number of positions in the Civil Service, including Permanent Secretary at HM Treasury; Permanent Secretary at the Department of the Environment (later Environment, Transport and the Regions); Private Secretary (Economics) to the Prime Minister; and Principal Private Secretary to Margaret Thatcher and then John Major. He joined HM Treasury in 1970.
Executive directors may accept external directorships and retain any fees earned from those directorships, subject to prior discussion with the Group Chief Executive, and always provided this does not lead to any conflicts of interest. In line with the Combined Code, executive directors would be expected to hold no more than one non-executive directorship of a FTSE 100 company. Tidjane Thiam was a non-executive director of Arkema in France until November 2009. Some of our other executive directors hold directorships or trustee positions of unquoted companies or institutions. Details of any fees retained are included in the Directors’ Remuneration Report on page 104, and major commitments of our executive directors are detailed in their biographies on page 77.
Fees payable to the auditor For the year ended 31 December 2009, the Committee approved fees of £10 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 £2.4 million to KPMG for services not related to audit work, which accounted for 19 per cent of total fees paid to the external auditor in the year. Non-audit services primarily related to services for corporate transactions 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 2009. A summary of audit fees is provided in Note I5 of the Group Financial Statements.
As at 8 March 2010, trustees held 0.17 per cent of the issued share capital of the Company under the various plans in operation.
US corporate governance and regulations As a result of the listing of its securities on the New York Stock Exchange, the Company is required to comply with the relevant provisions of the Sarbanes-Oxley Act 2002 (the Act) as they apply to foreign private issuers, and has adopted procedures to ensure this is the case.
The Chief Financial Officer‘s Review includes, on pages 40 to 45, a description of the Group’s risk and capital management, which includes a description of the Group’s liquidity position. These risks are also discussed in Note C to the financial statements on pages 162 to 165. The Group has considerable internal and external financial resources and the directors believe that the Group is well placed to manage its business risks successfully.
• Reviewing the remuneration arrangements for individuals earning over £1 million per annum.
Provides appropriate compensation structures and reward payouts which attract high calibre executive directors.
The annual bonus for the Chief Executive of Jackson includes a 10% share of a senior management bonus pool determined by the performance of Jackson for the year.
The Chief Executive of M&G also participates in the M&G Executive Long-term Incentive Plan (LTIP).
2010 remuneration policy Proportions of fixed and variable remuneration On a policy basis, the distribution between fixed and variable and short and long-term remuneration for our executive directors is as follows: The assumptions used are: • Good performance leads to plan bonus and threshold vesting under long-term incentive plans.
Components of remuneration Base salary The Committee normally reviews base salaries on an annual basis, taking into account the relevant market for the role, total remuneration and the individual’s contribution and experience.
A proportion of the annual bonus for all executive directors is based on individual strategic goals. These include the executive director’s contribution to Group strategy as a member of the plc Board, and specific goals related to their functional and/or business unit roles. In addition, all employees have a requirement to comply with the regulatory, governance and risk management practices and policies as it applies to their role and business area. Specifically all business units must remain within the Group’s risk appetite.
For the UK & Europe BUPP, the 2010 award will be based on the same relative TSR measure as applies under the GPSP.
For any BUPP award to vest, the Committee must also be satisfied that the quality of underlying financial performance of each business unit justifies the level of award delivered at the end of the performance period and may adjust vesting levels accordingly at its discretion. To ensure close alignment with our shareholders’ long-term interests, participants receive the value of reinvested dividends over the performance period for those shares that vest.
Clark Manning is eligible to participate in Jackson's Defined Contribution Retirement Plan, a qualified 401(k) retirement plan, on the same basis as all other US based employees. The Company provides matching contributions of six per cent of base salary. He is also eligible to participate in the profit sharing element of the plan that provides eligible participants with an annual profit sharing contribution, depending on the financial results of Jackson for the plan year, with a maximum of six per cent of base salary.
Notes 1 Based on the share price as at 31 December 2009 (£6.40). 2 Shareholdings for Barry Stowe include American Depositary
The interests of directors in shares of the Company include changes between 31 December 2009 and 8 March 2010. All interests are beneficial.
Notes Michael McLintock’s 2005 and 2006 cash long-term incentive awards were under the M&G Chief Executive Long-Term Incentive Plan that provides a cash reward through phantom M&G share awards and options. For both these awards, the phantom share price at the beginning of the performance period was £1. The change in the phantom share price equals the change in M&G profit, modified up or down by the investment performance of M&G over the performance period. For each year the face value of the share award was £225,000 and the phantom option award had a face value of £367,800. Provided the phantom share options have value, they may be exercised in part or in full during annual exercise periods (three to seven years after the start of the performance period).
Michael McLintock participates in a contributory scheme that provides a target pension of 2/3rds of Final Pensionable Earnings on retirement at age 60 for an employee with 30 years or more potential service, for which his contribution is four per cent of basic salary. In both cases Final Pensionable Earnings are capped by a notional scheme earnings cap which replicates the HMRC earnings cap in force before A-Day (6 April 2006). Michael McLintock is entitled to supplements based on the portion of his basic salary not covered for pension benefits under a HMRC approved scheme. He is also provided with life assurance cover of four times salary.
Details of directors’ pension entitlements under HMRC approved defined benefit schemes and supplements that are in the form of contributions to pension arrangements paid by the Company are set out in the following table.
After adjusting for related tax and minority interests, the amounts excluded from operating profit based on longer-term investment returns are included in the calculation of basic earnings per share.
Primary statements 119 Consolidated income statement 120 Consolidated statement of comprehensive income 121 Consolidated statement of changes in equity 123 Consolidated statement of financial position 125 Consolidated statement of cash flows
Related change in amortisation of deferred income and acquisition costs H1 (1,069) 831
Share Share Retained lation securities holders’ Minority Total Year ended 31 December 2009 Note capital premium earnings reserve reserve equity interests equity
Other non-cash items (including £559 million in 2009 for the loss on disposal of Taiwan agency business) 650 (74)
Long-term business products written in the UK and Asia are principally with-profits deposit administration, other conventional and unitised with-profits policies and non-participating pension annuities in the course of payment. Long-term business also includes linked business written in the UK and Asia. The principal products written by Jackson are interest-sensitive deferred annuities and whole-life policies, variable annuities, guaranteed investment contracts, fixed index deferred annuities and term life insurance.
Valuation assumptions i Contracts of with-profits funds The Group’s insurance contracts and investment contracts with discretionary participating features are primarily with-profits and other protection type policies. For UK regulated with-profits funds, the contract liabilities are valued by reference to the UK Financial Services Authority’s (FSA) realistic basis. In aggregate, this basis 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.
Jackson Jackson offers individual fixed annuities, fixed index annuities, immediate annuities, variable annuities, individual and variable life insurance and institutional products. With the exception of institutional products and an incidental amount of business for annuity certain contracts, which are accounted for as investment contracts under IAS 39, all of Jackson’s contracts are accounted for under IFRS 4 as insurance contracts by applying US GAAP, the previous GAAP used before IFRS adoption. Under US GAAP the requirements of SFAS 60 ‘Accounting and Reporting for Insurance Enterprises’ and SFAS 97 ‘Accounting and Reporting by Insurance Enterprises for certain LongDuration Contracts and for Realised Gains and Losses from the Sale of Investments’ apply to these contracts. The accounting requirements under these standards and the effect of changes in valuation assumptions are considered below for fixed annuity, variable annuity and traditional life insurance contracts.
Variable annuity contracts written by Jackson may provide for guaranteed minimum death, income, or withdrawal benefit features. In general terms, liabilities for these benefits are accounted for under US GAAP by using estimates of future benefits and fees under best estimate assumptions. For variable annuity business the key assumption is the expected long-term level of equity market returns, which for 2009 and 2008 was 8.4 per cent per annum (gross of fund management fees) determined using a mean reversion methodology.
ii Financial investments on an available-for-sale basis – this comprises assets that are designated by management and/or do not fall into any of the other categories. These investments are carried at fair value. Interest income is recognised on an effective interest basis in the income statement. Except for foreign exchange gains and losses on debt securities, not in functional currency, which are included in the income statement, unrealised gains and losses are recognised in other comprehensive income (i.e. outside of the income statement). Upon disposal or impairment, accumulated unrealised gains and losses are transferred from other comprehensive income to the income statement as realised gains or losses.
Those investment contracts without fixed and guaranteed terms are designated at fair value through profit and loss because the resulting liabilities are managed and their performance is evaluated on a fair value basis. Fair value is based upon the fair value of the underlying assets of the fund. Where the contract includes a surrender option its carrying value is subject to a minimum carrying value equal to its surrender value.
Insurance operations principally comprise of products that contain both significant and insignificant elements of insurance risk. The products are managed together and there is no distinction between these two categories other than for accounting purposes. This segment also includes the commission earned on general insurance business and investment subsidiaries held for supporting the Group’s insurance operations.
iii Liabilities to policyholders and embedded derivatives for product guarantees Under IFRS, the degree to which the carrying values of liabilities to policyholders are sensitive to current market conditions varies between territories depending upon the nature of the ‘grandfathered’ measurement basis. In general, in those instances where the liabilities are particularly sensitive to routine changes in market conditions, the accounting basis is such that the impact of market movements on the assets and liabilities are broadly equivalent in the income statement, and operating profit based on longer-term investment returns is not distorted. In these circumstances there is no need for the movement in the liability to be bifurcated between the element that relates to longer-term market conditions and short-term effects.
The Group has also introduced a consolidated statement of comprehensive income in accordance with the revised IAS 1. Components of comprehensive income recognised outside of the income statement, for example exchange movements and the unrealised valuation movement of Jackson’s available-for-sale debt securities, are now presented separately from changes in equity and are disclosed in the statement of comprehensive income. Consequent to this presentational change, the Group has altered the exchange translation method of the unrealised valuation movement of Jackson’s available-for-sale debt securities from the previous application of closing exchange rate to the average exchange rate consistent with the translation method of foreign subsidiaries’ income statement items. Accordingly, the Group’s 2008 comparatives in the consolidated statement of comprehensive income and the consolidated statement of changes in equity have been altered with a reclassification of £240 million of exchange losses from the unrealised valuation movement of Jackson’s available-for-sale debt securities, net of related change in amortisation of deferred income and acquisition costs and tax to the exchange translation reserve. There is no impact on shareholders’ equity or the income statement from this change.
Less: risk margin charge included in operating profit based on longer-term investment returnsB1 (iv) 76 54
Other gains and losses Movement in the provision for deficit funding of PSPS (48) (13) Less: amount attributable to the PAC with-profits sub-fund 34 9
At 31 December 2008 there were seven million shares under option offset by six million shares that would have been issued at fair value on assumed option exercise. The net one million potentially dilutive ordinary shares have been excluded from the 2008 diluted earnings per share calculation as their inclusion would have decreased the loss per share.
In the table above, with the exception in 2009 of residential mortgage-backed securities within Jackson, 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. During 2009, the National Association of Insurance Commissioners in the US revised the regulatory ratings process for more than 20,000 residential mortgage-backed securities. The table above includes these securities, held by Jackson, using the regulatory ratings levels established by an external third party (PIMCO). Notes D2(c), D3(c), D4(c) and E2 provide further details on the credit risks of debt securities by segment.
Prudential optimises capital allocation across the Group by using a consistent set of capital performance metrics across all business units to ensure meaningful comparison. Capital utilisation, return on capital and new business value creation are measured at a product level. The use of these capital performance metrics is embedded into our decision-making processes for product launches, product design and product pricing.
Investment contracts Investment contracts are further delineated under IFRS 4 between those with and without discretionary participation features. For those contracts with discretionary participation features, IFRS 4 also permits the continued application of previously applied GAAP. The Group has adopted this approach, again subject to the FRS 27 improvement.
Variable annuity Net effect of market risk arising from incidence of business guarantee features and variability of asset management fees offset by derivative hedging programme
M&G profits are affected primarily by movements in the growth in funds under management and by the effect of any impairment on the loan book and fair value movements on debt securities held by Prudential Capital.
Accordingly, Prudential’s PPFM contains an explanation of how it determines regular and final bonus rates within the discretionary framework that applies to all with-profits policies, subject to the general legislative requirements applicable. The purpose of Prudential’s PPFM is therefore to: • explain the nature and extent of the discretion available; • show how competing or conflicting interests or expectations of: – different groups and generations of policyholders; and – policyholders and shareholders are managed so that all policyholders and shareholders are treated fairly; and
The contract liabilities for with-profits business also require assumptions for persistency. These are set based on the results of recent experience analysis.
With the exception of debt securities for US insurance operations classified as ‘available-for-sale’ under IAS 39, unrealised value movements on the Group’s investments are booked within the income statement. However, for debt securities classified as ‘availablefor -sale’, unless impaired, fair value movements are recognised in other comprehensive income. Realised gains and losses, including impairments, are recorded in the income statement. This classification is applied for most of the debt securities of the Group’s US operations. In 2009, Jackson recorded £630 million (2008: £497 million) of impairment losses arising from: Residential mortgage-backed securities 509 167
Notes i Assets and liabilities attaching to variable annuity business that are not held in the separate account are shown within other business. ii Loans
Notes on the Group financial statements > D: Life assurance businesses > continued b Deferred acquisition costs Income statement – amortisation for variable annuity business Under IFRS 4, the Group applies US GAAP to the insurance assets and liabilities of Jackson. Under US GAAP, acquisition costs for Jackson’s fixed and variable annuity business are deferred and then amortised in line with the expected emergence of margins. The amortisation profile is dependant on assumptions which, for variable annuity business, the key assumption is the expected level of equity market returns. For 2009 and recent previous years a rate of 8.4 per cent has been applied using, as is industry practice, a mean reversion methodology.
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within profit and loss. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a one per cent and two per cent decrease and increase in interest rates at 31 December 2009 and 2008 and is as follows: D3: US insurance operations continued
Other non-insurance liabilities: Operational borrowings attributable to shareholders-financed operations – – 210 210 130
c Information on credit risks of debt securities The following table summarises the credit quality of the debt securities of the Asian insurance operations as at 31 December 2009 by rating agency ratings: With- Unitprofits linked Other business business business Total Total
Net effect on profit and equity (50) (25) (171) (85) (43)
j Duration of liabilities The table below shows the carrying value of policyholder liabilities. Separately the Group uses cash flow projections of expected benefit payments as part of the determination of the value of in-force business when preparing EEV basis results. The table below also shows the maturity profile of the cash flows, taking account of expected future premiums and investment returns used for that purpose for 2009 and 2008: Policyholder liabilities 21,858 20,909
and GIC liabilities of Jackson)note vi – – – 13,794 1,965 46 15,805
Total policyholder liabilities shown in the consolidated statement of financial position 9,972 67,557 77,529 38,700 48,311 21,858 186,398
Notes i WPSF unallocated surplus includes amounts related to the Hong Kong branch. Policyholder liabilities of the Hong Kong branch are included in the amounts of Asian life assurance subsidiaries.
The decrease in 2008 reflected primarily the negative investment returns earned on the opening available capital and £149 million negative effect of changes in assumptions on a regulatory basis compares to the £83 million effect of change in assumptions on an IFRS basis as shown in note D2(i).
d Transferability of available capital For PAC and all other UK long-term insurers, long-term business assets and liabilities must, by law, be maintained in funds separate from those for the assets and liabilities attributable to non-life insurance business or to shareholders. Only the ‘established surplus’, the excess of assets over liabilities in the long-term fund determined through a formal valuation, may be transferred so as to be available for other purposes. Distributions from the with-profits sub-fund to shareholders reflect the shareholders’ one-ninth share of the cost of declared policyholders’ bonuses.
†No impairments were recorded in 2009. In 2008 operating profit based on longer-term investment returns includes a £28 million charge for an impairment loss on a holding in Lehman Brothers.
E4: Sensitivity of profit and equity to market and other financial risk
Short-term fluctuations in investment returns 25% 35% 28% 36% – Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes – – 28% 28% 28% Loss on sale and results for Taiwan agency business 25% – – – 25%
Investment contracts with discretionary participation featuresnote iv – – 23,446 23,446 –
Net asset value attributable to unit holders of consolidated unit trusts
Total financial investments, net of derivative liabilities 4,760 161 (675) 214 (813) (2) 242 (2,203) 1,684
Interest income and expense The interest income on financial assets not at fair value through profit and loss for the year ended 31 December 2009 from continuing operations was £1,998 million (2008: £2,532 million).
No further analysis has been provided of the element of loans and receivables that was neither past due nor impaired for the total portfolio. This is on the grounds of immateriality of the difference between the neither past due nor impaired elements and the total portfolio.
Year ended 31 December 2009 Opening net book amount 263 131 241 635
Future minimum lease payments are due as follows: Less than 1 year 9 5
The total minimum future rentals to be received on non-cancellable sub-leases for land and buildings at 31 December 2009 are £3,684 million (2008: £3,730 million).
Restructuring provisions Restructuring provisions of £17 million (2008: £21 million) relate to restructuring activities of UK insurance operations. In 2004 and 2005, UK insurance operations implemented restructurings relating to document management review, streamlining operations, and the relocation of activities to an offshore base in India. In December 2005, the Group announced an initiative for UK insurance operations to work more closely with M&G and in the process facilitate the realisation of substantial annualised pre-tax cost savings and opportunities for revenue synergies.
Support for long-term business funds by shareholders’ funds As a proprietary insurance company, PAC is liable to meet its obligations to policyholders even if the assets of the long-term funds are insufficient to do so. The assets, represented by the unallocated surplus of with-profits funds, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (‘the excess assets’) in the long-term funds could be materially depleted over time by, for example, a significant or sustained equity market downturn, costs of significant fundamental strategic change or a material increase in the pension mis-selling provision. In the unlikely circumstance that the depletion of the excess assets within the long-term fund was such that the Group’s ability to satisfy policyholders’ reasonable expectations was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders’ funds to the long-term funds to provide financial support.
Notes on the Group financial statements > I: Other notes F
The loss on sale and trading results of the Taiwan agency business for the period of ownership comprise: Loss on sale: As estimated and announced on 20 February 2009: Proceeds – –
Trading losses to completion, net of tax, as shown below 44 –
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (14) 1 (13)
†The rates of 2.5 per cent shown are those for PSPS. Assumed rates of increase of pensions in payment for inflation for all other schemes are 3.7 per cent in 2009 (2008: 3.0 per cent).
Deficit under IAS 19 included in provisions in the statement of financial position – as explained in note 7 below (437) (306)
Shareholders’ share: Gross of tax (deficit) surplus (85) (26) (13) (1) 47 (4) (82)
(Losses) gains on changes of assumptions for plan liabilities (521) 272
Fair value of scheme assets, end of year (IAS 19 basis) 5,224 5,057 5,150 4,988 4,622
Underlying scheme assets in surplus (deficit) of benefit obligation, before the effect of IFRIC 14 50 384 135 (222) (796)
The experience adjustments on scheme liabilities in 2008 of a gain of £145 million related mainly to the ‘true up’ reflecting improvements in data consequent upon the 2008 triennial valuation of PSPS.
Discount rate Decrease by 0.2% from 6.1% to 5.9% Increase in scheme liabilities by: PSPS 3.3%
UK-based executive directors are eligible to participate in the Prudential HM Revenue & Customs (HMRC) approved UK Savings Related Share Option Scheme (SAYE scheme) and the Asia-based executive directors can participate in the equivalent International SAYE scheme. The schemes allow employees to save towards the exercise of options over Prudential plc shares, at an option price set at the beginning of the savings period at a discount of up to 20 per cent to the market price. In 2009, the rules governing the SAYE scheme were amended so that savings contracts for seven years was discontinued and employees may save up to £250 per month for three or five years. On maturity at the end of the set term, participants may exercise their options within six months of the end of the savings period and purchase Prudential plc shares. If an option is not exercised within six months, participants are entitled to a refund of their cash contributions plus interest if applicable under the rules. Shares are issued to satisfy options that are exercised. No options may be granted under the schemes if the grant would cause the number of shares which have been issued, or which remain issuable pursuant to options granted in the preceding 10 years under the scheme and other share option schemes operated by the Company, or which have been issued under any other share incentive scheme of the Company, to exceed 10 per cent of the Company’s ordinary share capital at the proposed date of grant.
Apart from the transactions with directors referred to below, no director had interests in shares, transactions or arrangements that require disclosure, other than those given in the directors’ remuneration report. Key management remuneration is disclosed in note I4.
ii Japanese insurance subsidiary’s suspension of writing new business On 15 January 2010 the Group’s Japanese insurance subsidiary announced its intention to suspend writing new policyholder contracts in Japan after 15 February 2010. The company reinforced its commitment to servicing its existing policyholder base, which comprised over 170,000 contracts as at 30 September 2009. This decision will be reviewed on an on-going basis in light of changes to the business environment.
Capital Securitiesnotes vi, vii, viii 188 186 – – 188 186
Borrowings are repayable as follows: Within 1 year or on demand – 249 2,238 1,469 2,238 1,718
On 8 March 2010, the Company confirmed that the Prudential Group had entered into foreign exchange hedging arrangements in respect of its requirement to convert the pounds sterling proceeds of the rights issue into US dollars, which is the currency in which Prudential must pay the cash element of the consideration.
For UK shareholder-backed annuity business, a margin of 100 basis points is used to cover the non-diversifiable non-market risks associated with the business. For the Group’s other business a margin of 50 basis points is applied with, where necessary, an additional allowance for emerging market risk. The additional 50 basis points for UK annuities business reflects the longevity risk which is of particular relevance.
Asian US UK operations operations operations note iv note v note vi Total £m £m £m £m
US statutory basis over the amortisation of interest-related gains and longer-term default assumption included within operating profit. 2 The charge in 2009 of £(144) million for actual less long-term return on equity based investments and other items primarily relates to the shortfall of actual return against the expected return on investments in limited partnerships. 3 This gain (loss) arises due to the market returns being higher (lower) than the assumed longer-term rate of return. This gives rise to higher (lower)
than expected year end values of variable annuity assets under management with a resulting effect on the projected value of future account values and hence future profitability from altered fees. For 2009, the US equity market returns were approximately positive 24 per cent compared to the assumed longer-term rate of return of 7.4 per cent. For 2008, the US equity market returns were approximately negative 38.5 per cent compared to the assumed longer-term rate of return of 5.8 per cent.
(2008: negative 25.3 per cent) against the assumed long-term return for the investments covering policyholder liabilities and unallocated surplus. 2 Short-term fluctuations in investment returns on shareholder-backed annuity business for 2009 of £(40) million primarily represents mismatching losses arising from a fall in yields on assets of £(105) million, partially offset by better than expected default experience of £22 million. The remaining balance of £43 million consists of positive movements in other asset values partially offset by losses on surplus assets relative to the expected return. The charge for 2008 of £(213) million primarily represented an unrealised loss on surplus assets and default experience.
Notes 1 In 2008, the £(317) million charge comprises £(400) million for the effect of strengthening credit risk assumptions, offset by a credit of £231 million for the effect of rebalancing the asset portfolio calculated by reference to the exceptional changes in credit spreads from 31 December 2006 to 31 December 2008, and an underlying charge of £(148) million for regular changes in yields and discount rates. In 2009, the charge of £(19) million reflects the effects of regular economic assumption changes. However, the amounts for the component line items shown above reflect a change in the composition of the default allowance between best estimate levels (which are reflected in the long-term rates of return) and allowance for credit risk premium and additional short-term defaults reflected in the risk discount rate.
Asian operations Long-term business: Net assets of operations – EEV basis shareholders’ funds 5,781 5,264
IFRS basis deficit (relating to shareholder-backed operations) (16) (31) Additional EEV deficit (relating to shareholders’ 10 per cent share of the IFRS basis deficit attributable to the PAC with-profits fund) (5) (6)
ii The additional retained profit on an EEV basis for Other operations represents the mark to market value difference on holding company net borrowings of a charge of £(26) million (2008: credit of £802 million) and the effect of accounting for pension costs for the Prudential Staff Pension Scheme.
Tax credit on effect of changes in economic assumptions and time value of cost of options and guarantees (336) (79)
Expected period of conversion of future post tax distributable earnings and required capital flows to free surplus 2009 Total as shown above 1-5 years 6-10 years 11-15 years 16-20 years 20+ years 2008 £m
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 a Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2009 (31 December 2008) and the new business contribution after the effect of encumbered capital for 2009 and 2008 to: • one per cent increase in the discount rates; • one per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); • one per cent rise in equity and property yields; • 10 per cent fall in market value of equity and property assets (not applicable for new business contribution); • holding company statutory minimum capital (by contrast to economic capital); • five basis point increase in long-term expected defaults; and • 10 basis point increase in the liquidity premium for UK shareholder-backed annuities (2009 only).
15 Sensitivity of results to alternative assumptions 14 Expected transfer of value of in-force business to free surplus continued
The credit assumptions used and the residual liquidity premium element of the bond spread over swap rates is as follows: (bps) (bps)
b Japanese insurance subsidiary’s suspension of writing new business On 15 January 2010 the Group’s Japanese insurance subsidiary announced its intention to suspend writing new policyholder contracts in Japan after 15 February 2010. The Company reinforced its commitment to servicing its existing policyholder base, which comprised over 170,000 contracts as at 30 September 2009. This decision will be reviewed on an on-going basis in light of changes to the business environment.
c Agreement to acquire AIA Group Limited On 1 March 2010, Prudential plc announced that it had reached agreement with American International Group Inc. (‘AIG’), on terms for the combination of Prudential and AIA Group Limited (‘AIA’), a wholly-owned subsidiary of AIG (the ‘Transaction’). AIA is a leading life insurance organisation in Asia which provides individuals and businesses with products and services for their insurance, protection, savings, investment and retirement needs in 15 geographical markets in the region. The combined group will be the leading life insurer in Hong Kong, Singapore, Malaysia, Indonesia, Vietnam, Thailand and the Philippines with the leading foreign life insurance business in China and India, a significantly enhanced presence in the high growth South East Asian life markets and strong operations in the US and UK.
G Bainbridge for and on behalf of KPMG Audit Plc Chartered Accountants London
Litigation and disputes may adversely affect Prudential’s profitability and financial condition.
Prudential’s insurance and investment management operations are generally conducted through direct and indirect subsidiaries. As a holding company, Prudential’s principal sources of funds are remittances from subsidiaries, shareholder-backed funds, the shareholder transfer from Prudential’s long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper. Certain of the subsidiaries have regulatory restrictions that can limit the payment of dividends, which in some circumstances could limit the Group’s ability to pay dividends to shareholders.
American Depositary Receipts (ADRs) The Company's ordinary shares are listed on the New York Stock Exchange in the form of American Depositary Shares, evidenced by ADRs and traded under the symbol PUK. Each American Depositary Share represents two ordinary shares. All enquiries regarding ADR holder accounts should be directed to JP Morgan, the authorised depositary bank, at JPMorgan Chase & Co, P O Box 64504, St.Paul, MN 55164-0504, USA, telephone +1 651 453 2128 or log on to www.adr.com