SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
For the month of April, 2013
PRUDENTIAL PUBLIC LIMITED COMPANY
(Translation of registrant’s name into English)
LAURENCE POUNTNEY HILL,
LONDON, EC4R 0HH, ENGLAND
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F. Form 20-F x Form 40-F ¨
Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934. Yes ¨ No x
If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: April 10, 2013
| PRUDENTIAL PUBLIC LIMITED COMPANY | ||
| By: | /s/ Stefan Bort | |
| Stefan Bort | ||
| Assistant Group Secretary | ||
Prudential plc Annual Report 2012
Delivering long-term value
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Prudential at a glance
Providing fi nancial security for our customers
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Prudential plc is an international fi nancial services group with signifi cant operations in Asia, the US and the UK. We serve around 24 million insurance customers and have Ł405 billion of assets under management. We are listed on stock exchanges in London, Hong Kong, Singapore and New York.
The Group is structured around four main business units: Prudential Corporation Asia, Jackson National Life Insurance Company, Prudential UK and M&G.
Prudential uses long-term thinking to create long-term value. Through our strong fi nancial performance and international strategy, we create fi nancial benefi ts for our shareholders and investors and deliver economic and social benefi ts for the communities in which we operate.
Life assurance % of Group
APE new business premiums
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Notes
1 Including Cambodia where operations were launched in 2013.
2 Source: survey conducted by Asia Asset Management Magazine as at 30 June 2012 (based on assets sourced from Asia ex-Japan).
3 Operating profit from long-term operations excluding Eastspring Investments, development costs and Asia regional head office costs.
4 In terms of new business APE.
5 Based on operating profit before other income and expenditure.
6 EEV long-term business.
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Prudential Corporation Asia
Prudential is a leading international life insurer in Asia with operations in 13 markets1. We have built a high-performing platform with eff ective, multi-channel distribution, a product portfolio centred on regular savings and protection, award-winning customer services and a well respected brand. Prudential’s Asia-based asset management division, Eastspring Investments, is one of the region’s leading fund managers and the largest retail asset manager2.
Asia life insurance business operating profi t3 up 30 per cent to Ł920 million High-performing multi-channel distribution with increasing agent activity and productivity and strongly growing sales through an extensive range of bank partners Well balanced life insurance product portfolio emphasising regular premium savings and protection that off ers good returns for customers and shareholders More top three market positions4 than any other life insurer in the region and the region’s largest retail asset manager
More about our Asia business:
Asia page 20 www.prudentialcorporation-asia.com
32%
IFRS % of Group operating profi ts5
44%
EEV6 % of Group operating profi ts
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Jackson
Jackson is one of the largest life insurance companies in the US, providing retirement savings and income solutions to approximately 4 million customers. Jackson is also one of the top two providers of variable annuities in the US. Founded 50 years ago, Jackson has a long and successful record of providing advisers with the products, tools and support to design eff ective retirement solutions for their clients.
New business profi t of Ł873 million Top two provider of variable annuities in US
Rated as a ‘World Class’ service provider for seven successive years by Service Quality Measurement Group ‘Highest Customer Satisfaction by Industry’ award from Service Quality Measurement Group
More about our US business:
United States page 26 www.jackson.com
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Prudential UK
Prudential UK is a leading life and pensions provider to approximately 7 million customers in the United Kingdom.
Our expertise in areas such as longevity, risk management and multi-asset investment, together with our fi nancial strength and highly respected brand, means that the business is strongly positioned to continue pursuing a value-driven strategy built around our core strengths in with-profi ts and annuities.
Total IFRS operating profi t of Ł736 million Strength and investment performance of With-Profi ts Fund allowed Prudential to deliver strong annualised returns for policyholders Two ‘Five Star’ ratings for excellent service in the Investment and Life and Pensions categories at the Financial Adviser Service Awards 2012
More about our UK business:
United Kingdom page 32 www.pru.co.uk
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M&G
M&G is Prudential’s UK and European fund management business with total assets under management of Ł228 billion.
M&G has been investing money for individual and institutional clients for over 80 years. Today it is one of Europe’s largest active investment managers.
Record operating profi t up 6 per cent to Ł320 million Record net infl ows of Ł16.9 billion M&G’s retail business has been awarded the prestigious Outstanding Investment House of the Year 2012 Award for the third year running at the OBSR Awards M&G’s institutional business was recognised for its strength and expertise at the UK Pensions Awards, where it was named Fixed Income Manager of the Year 2012 Ł228 billion assets under management
More about M&G:
Asset management page 38 www.mandg.co.uk
32% 24% 12%
IFRS % of Group operating profits5 IFRS % of Group operating profits5 IFRS % of Group operating profits5
36% 20%
EEV6 % of Group operating profits EEV6 % of Group operating profits
Highlights
A strong performance in 2012
Key performance indicators
Prudential has produced a strong European Embedded Value
performance in 2012. Globally, we have new business pro_t
around 24 million insurance customers
and have continued to provide each of them Ł2,452m +14%
Ł2,151m
with products and services that they value
highly, delivering on our promise to offer
quality savings and protection products.
The quality of our products, the strength
of our multi-channel distribution platform 2011 2012
and our ability to innovate and develop International Financial Reporting
creative solutions to meet our customers’ Standards operating pro
t based
on longer-term investment returns*
needs translate over time into profitable
and sustainable growth. Our focus on Ł2,533m +25%
capital and risk management has allowed Ł2,027m
us to deliver both growth and cash to
shareholders, despite a challenging
macroeconomic environment.
We have increased our dividend by 2011 2012
15.9 per cent to 29.19 pence per share. Business unit net remittances
This is the second time in three years
we have rebased our dividend upwards.
Our approach to growing the dividend Ł1,200m +9%
Ł1,105m
demonstrates our confidence in our
ability to continue to deliver long-term
value for our shareholders.
2011 2012
European Embedded Value
operating pro_t from long-term business
Ł4,429m +10%
Ł4,043m
2011 2012
29.19p
full-year dividend
+15.9%
increase on 2011
Note
*2011 comparative adjusted for retrospective
The directors’ report of Prudential plc for the year ended 31 December 2012 application of the accounting policy change for
is set out on pages 1–110, 366–384 and 386–391 and includes the sections of the deferred acquisition costs as discussed in note A5
Annual Report referred to in these pages. of the IFRS financial statements.
Contents Prudential plc Annual Report 2012 01
Contents
Overview
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Section 1: Overview
2 Chairman’s statement
4 Group Chief Executive’s report
Section 2: Business review
12 Financial highlights
14 Chief Financial Officer’s overview
20 Business unit review:
Insurance operations: Asia, US, UK
Asset management: M&G, Eastspring Investments, US
46 Financial review
68 Risk and capital management
79 Corporate responsibility review
Section 3: Governance
88 Board of directors
93 Governance report
110 Additional disclosures
111 Index to principal directors’ report disclosures
Section 4: Directors’ remuneration report
114 Directors’ remuneration report
116 Remuneration policy report
122 2012 implementation of remuneration policy
136 Supplementary information
Section 5: Financial statements and European Embedded Value (EEV) basis supplementary information
146 Index to Group financial statements
147 Consolidated income statement
148 Consolidated statement of comprehensive income
149 Consolidated statement of changes in equity
151 Consolidated statement of financial position
153 Consolidated statement of cash flows
154 Notes on the Group financial statements
315 Balance sheet of the parent company
316 Notes on the parent company financial statements
324 Statement of directors’ responsibilities in respect of the Annual Report and the financial statements
325 Independent auditor’s report to the members of Prudential plc
326 EEV basis supplementary information
331 Notes on the EEV basis supplementary information
363 Statement of directors’ responsibilities in respect of the EEV basis supplementary information
364 Independent auditor’s report to Prudential plc on the EEV basis supplementary information
365 Additional unaudited financial information
Section 6: Additional information
386 Risk factors
392 Glossary
396 Shareholder information
398 How to contact us
02 Overview Prudential plc Annual Report 2012
Chairman’s statement
Value for customers and real returns for shareholders
‘Our ability to generate strong fi nancial
performance despite adverse market
conditions and the challenge of historically
low long-term interest rates is testament to
both the success of our strategy and the
eff orts of our management team.’
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Welcome to Prudential’s 2012 Annual Report, the fi rst since I became Chairman in July 2012. I am pleased to report that the Group has delivered another excellent performance in 2012, providing products and services of real value to our 24 million insurance customers around the world and strong returns to our shareholders. Our leading presence in the fast-growing economies of Asia drives our long-term profi table growth while our focused businesses in the US and the UK continue to make solid contributions to the Group’s overall performance.
The global economic outlook remains depressed and, although there were some signs of improvement in 2012, there is a debate about how sustainable the recovery may be. However, our ability to generate strong fi nancial performance despite adverse market conditions and the challenge of historically low long-term interest rates is testament to both the success of our strategy and the efforts of our management team led by Group Chief Executive Tidjane Thiam. The Group remains on track to deliver the 2013 ‘Growth and Cash’ objectives announced in December 2010. We have achieved two major ones regarding Asia – the IFRS operating pro? t and cash remittance targets – one year ahead of schedule.
As a Board, we must ensure that our results translate into real returns for our shareholders. The continued strength of our operations in Asia, the US and the UK gives us confi dence that we will continue generating sustainable growth over the long term. So for the second time in three years, we have been able to announce the rebasing of our full-year dividend upwards by 4 pence. The Board has therefore recommended a fi nal dividend of 20.79 pence per share, which brings the total dividend for the year to 29.19 pence per share, 4 pence or 15.9 per cent higher than the 2011 total dividend.
There have been some changes to the Board during the year. When I succeeded Harvey McGrath as Chairman in the middle of last year, I refl ected that his tenure encompassed some of the most diffi cult economic conditions a business like ours could face. On behalf of the Board and the entire Company, I would like to thank him for his stewardship of Prudential during those diffi cult times.
A key part of my role is to ensure appropriate governance around the execution of the Group’s strategy, and to engage with shareholders and other stakeholders on this matter. As Chairman, I need to make sure the Board is equipped with the right people to help me perform this role. We need directors with the appropriate skill sets to bring different perspectives to bear, as we face the complexities of a rapidly changing world.
In December 2012, we announced that Philip Remnant CBE would become Senior Independent Director from 1 January 2013, replacing myself in that position. He is currently a senior adviser at Credit Suisse, a Deputy Chairman of the Takeover Panel and a non-executive director of UK Financial Investments Limited. He has joined the Nomination, Audit and Remuneration Committees. Philip brings a wealth of experience of fi nancial services at the highest level, a deep understanding of the needs of shareholders and a strong record of public service.
Chairman’s statement Prudential plc Annual Report 2012 03
Overview
In March 2013, we announced that Anthony Nightingale, CMG, would be joining the Board on 1 June 2013 as a non-executive director and member of the Remuneration Committee. He has spent more than 40 years at Jardine Matheson Group, which is one of Asia’s leading and most diverse business groups, including six years as Managing Director until he retired from
executive offi ce in March 2012. Anthony is a Hong Kong representative to the APEC Business Advisory Council and is a member of the Commission on Strategic Development in Hong Kong.
Anthony replaces Keki Dadiseth who announced he would be retiring from the Board on 1 May 2013 after eight years of service. He joined the Board in April 2005 and is a member of the Remuneration Committee. Keki was also a member of the Audit Committee from 2005 to 2007. I would like to thank him for his hard work and trusted advice during his time at Prudential.
Wherever we operate in the world, we strive to make a strong contribution to the communities we serve, not just through our business activities, but by helping to address the needs of the disadvantaged in those societies. Each of our businesses has a community investment programme in place which provides support to charitable organisations, both through long-term funding and the experience and expertise of our employees.
The diversity of our markets means that our programmes vary from region to region, but the shared focus for our community investment is education and life skills. These activities include fi nancial education, support to improve social mobility and employee volunteering. Last year more than 7,350 employees across the Group gave up their time to help others in their communities, using their skills and knowledge to benefi t those who most need our help.
Many volunteer as part of the Chairman’s Challenge, our fl agship volunteering programme. The Chairman’s Challenge encourages employees from across the Group to volunteer on projects initiated by our global charity partners. I am extremely proud that so many colleagues from across our business are so dedicated and enthusiastic in helping others.
We continue to place great value on the UK, our home market, where we were born 165 years ago. In 2013, we have agreed to be the offi cial title sponsor of Prudential RideLondon, a two-day cycling festival that will take place on 3 and 4 August 2013, which we hope will help build on the legacy of the 2012 London Olympics.
I would like to thank all our employees for contributing to what has been another very strong year. It is their commitment to supporting our customers, along with executing our successful strategy, which allows us to be confi dent that we can continue to provide shareholders with growing returns in the years to come.
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Paul Manduca Chairman
04 Overview Prudential plc Annual Report 2012
Group Chief Executive’s report
A strong performance based on consistent strategy
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• In 2012, we have delivered a strong performance. Our Group has achieved significant and profitable growth and produced increased levels of cash, which allowed us to provide our shareholders with a growing dividend.’
Tidjane Thiam
Group Chief Executive
Full-year dividend
+15.9%
29.19p
23.85p 25.19p
18.90p 19.85p
2008 2009 2010 2011 2012
IFRS operating profit based on
longer-term investment returns1
+25%
Ł2,533m
Ł2,027m
Ł1,826m
Ł1,428m
Ł1,248m
2008 2009 2010 2011 2012
I am pleased to report a strong performance in 2012. Our focus on our customers in each of our geographies, combined with the strength of our distribution, franchise and brands, has allowed us to continue to provide distinctive value to our customers. Thanks to this, the Group has continued to deliver on the three key fi nancial metrics we have focused on since 2009: IFRS operating profi t, new business profi t and net cash remittances. In 2012 in Asia, we have achieved two of the 2013 ‘Growth and Cash’ objectives and have continued to make progress towards achieving the others, despite a global macroeconomic environment which remains challenging and historically low long-term interest rates.
Our strategy has remained consistent: to accelerate growth in Asia; to build on the strength of our US operations; to focus the UK business and to optimise asset management. We have remained focused on executing that strategy with discipline and on producing strong results across our geographies.
Asia has delivered excellent results in 2012. Our business, Prudential Corporation Asia, which is already one of the largest in the region, has nevertheless been able to more than double its IFRS operating profi t in three years to almost Ł1 billion, delivering Ł988 million in 2012. That growth in IFRS operating profi t was not achieved at the expense of cash generation or by slowing down sales growth. Asia reported record new business profi t in 2012. It also delivered a net cash remittance of Ł341 million, exceeding its 2013 objective of Ł300 million. For the fi rst time in our history, Asia was the largest contributor of cash to the Group, an exceptional performance when you consider that in 2009 Asia’s net cash remittance was Ł40 million. This performance was largely driven by the clear progress we have made in some of our ‘sweet-spot’ markets, particularly Indonesia, Singapore, Malaysia, the Philippines and Thailand.
There was strong growth in the US, with total IFRS operating profi t exceeding Ł1 billion for the fi rst time, demonstrating the strength of Jackson’s operations in a competitive marketplace. The UK remains focused on with-profi ts products and individual annuities, seeing strong sales of both in a diffi cult market. M&G has seen record net fl ows at Ł16.9 billion, IFRS operating profi t and funds under management, all driven by its investment performance and customer proposition.
In a turbulent environment, we have continued to take proactive and decisive management action to deliver on our strategy. In our industry, distribution is absolutely key. Therefore we have continued to strengthen our ability to reach our chosen customers in our chosen markets. For instance, we have strengthened our distribution in Thailand by establishing an exclusive partnership with Thanachart Bank, a leading bank in this market, and through the acquisition of its life business,
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Group Chief Executive’s report Prudential plc Annual Report 2012 05
Overview
Thanachart Life. In the US, we have continued to invest in our distribution as well, strengthening our relationship with our partners. We have, throughout the year, ensured that we put value ahead of volume, ensuring that we reached our return on capital and payback targets. To mention a few examples, in Malaysia we refocused the business on higher-value, lower-volume protection business. In Korea and in Taiwan, at times during the year, we refused to write poor-value business, sacrifi cing some sales growth in the process.
We have maintained our bias in favour of insurance income and fee income, which have grown as a proportion of our profi ts, ahead of spread income. True to that logic, in the US we acquired Reassure America Life Insurance Company (REALIC), which increased our insurance income. We also continue to drive our product mix to achieve the optimal balance between growth in sales, profi t growth, cash generation and capital strength. Therefore, we have continued to emphasise and to grow protection products in Asia, which also provide excellent value to our customers. In the US, we have seen growing demand for Elite Access, a variable annuity without guarantees, launched in March 2012. Elite Access allows us to meet the needs of a key customer segment and to grow profi tably while staying within our quantitative risk appetite in the year. We believe Elite Access has excellent prospects in the US market. More generally, we have continually and proactively re-priced our products and modifi ed their features to ensure they continued to generate adequate returns in the new interest rate environment.
Having looked at the strength and sustainability of the results we have generated, the Board has decided to rebase our dividend upwards for the second time in three years. This decision refl ects the Board’s confi dence in the Group’s ability to continue to deliver strong, sustainable fi nancial performance.
Group performance
The Group’s strategy is supported by three key Group-wide operating principles.
First, we take a balanced approach to performance management across the key measures of IFRS, EEV and cash, with a particular focus on IFRS and cash. The Group has reported a strong performance across all
business units on these measures. Our IFRS operating profi t based on longer-term investment returns increased by 25 per cent in 2012 to Ł2,533 million (2011: Ł2,027 million1) led by Asia and the US. IFRS shareholders’ funds increased by 21 per cent to
Ł10.4 billion, compared to Ł8.6 billion1 as at 31 December 2011.
EEV operating profi t grew by 9 per cent to Ł4,321 million (2011: Ł3,978 million). Net cash remittances to the Group from our businesses increased by 9 per cent to Ł1,200 million (2011: Ł1,105 million), with Asia now the largest contributor.
06 Overview Prudential plc Annual Report 2012
Group Chief Executive’s report continued
Second, we focus on allocating capital to the highest return and shortest payback opportunities across the Group, taking strong action where necessary, such as deliberately reducing sales in geographies, products or channels where our return and payback criteria are not met. Our insurance businesses in Asia, the US, and the UK have delivered a 14 per cent increase in new business profi t to Ł2,452 million (2011: Ł2,151 million) with a distinctive 18 per cent increase in Asia. APE sales for the Group have increased by 14 per cent to Ł4,195 million (2011: Ł3,681 million) in 2012 and included the Group’s best-ever fourth quarter. M&G has attracted strong net infl ows of Ł16.9 billion (2011: Ł4.4 billion), a record performance led by the return of investors’ risk appetite in Continental Europe, where M&G has built a strong position over the last few years, and market-leading sales in the UK retail market.
Third, we are proactive in managing risk across the cycle. Our balance sheet continues to be defensively positioned and at the end of the period our IGD surplus was Ł5.1 billion1 (31 December 2011: Ł4.0 billion). Our surplus increased due to strong net capital generation through operating earnings offset, as usual, by external dividend payments and other costs.
We continue to focus on promoting transparency by providing shareholders with relevant disclosures about our business and how we run it, to ensure that both our strategy and our operating principles are well understood. In addition to the disclosures that are provided with our quarterly fi nancial results, since 2010 we have organised an annual seminar to provide investors and analysts with a further opportunity to discuss the business in detail with the Group’s senior management.
We have organised three investor seminars in London (on
1 December 2010), Kuala Lumpur (on 15 November 2011) and New York (on 29 November 2012). These seminars consisted of presentations on different aspects of our business including: Group strategy; our operating principles; the 2013 ‘Growth and Cash’ objectives; our Asian business, including country-by-country presentations; and Jackson, with further insights into its hedging strategy, capital position and sensitivity to market shocks. We intend to hold a fourth annual seminar in the last quarter of 2013 in London.
Notes
1 From March 2013, the basis of calculating Jackson’s contribution to the Group’s IGD surplus will change. Further detail can be found in the ‘Capital position, financing and liquidity’ section of the Chief Financial Officer’s overview.
2 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
3 Total Asia operating profit from long-term business and Eastspring Investments after development costs. 2012 operating profit includes a one-off gain of Ł51 million arising on sale of the Group’s holding in China Life Insurance Company of Taiwan.
4 Remittances from Asia in 2012 include a non-recurring net remittance of Ł27 million, representing cash from sale of Group’s holding in China Life Insurance Company in Taiwan offset by repayment of funding contingent on future profits of the Hong Kong life insurance operations.
5 The net remittance objective for Jackson was increased from Ł200 million to Ł260 million to reflect the positive impact of the acquisition of REALIC.
2013 ‘Growth and Cash’ objectives
2012 has made a strong contribution to our progress towards delivering our challenging 2013 ‘Growth and Cash’ objectives that I set out at our 2010 investor conference. Asia has achieved two of its three 2013 objectives in 2012 and the Group remains on track to meet the remaining objectives.
Turning fi rst to our Asia objectives, I said in 2010 that we would aim to double our 2009 IFRS operating profi t to Ł930 million by 2013 or, in other words, that we would double our IFRS operating profi t in four years. In 2012, we have achieved IFRS operating profi t of Ł988 million (2011: Ł784 million2). We have, therefore, more than doubled profi ts in three years, rather than four. Asia has also exceeded its 2013 cash objective, remitting a total of Ł341 million to the Group against a 2013 objective of Ł300 million. Looking at the remaining Asia objective, by the end of 2013 we aim to double 2009 new business profi t to Ł1,426 million and we remain on target to reach this, with the business producing Ł1,266 million in 2012 (2011: Ł1,076 million). These results were achieved despite an unfavourable and volatile macroeconomic environment.
Beyond Asia, there has been continued progress towards our other cash objectives. The US remitted Ł249 million in 2012 (2011: Ł322 million including exceptional release of surplus), on track to meet its 2013 cash objective raised from Ł200 million to Ł260 million earlier this year. The UK made remittances to the Group of Ł313 million in 2012, on track to meet its 2013 objective of Ł350 million.
Looking at the cumulative cash target of Ł3.8 billion over the four-year period from 2010 to end-2013, we have so far achieved 85 per cent of the total objective with one year remaining.
Actual Objective
2012 2013
Łm Łm
Asia profitability
Value of new business 1,266 1,426
IFRS operating profitnote 3 988 930
Business unit net remittance objectives
Asianote 4 341 300
Jackson 249 260note 5
UK 313 350
Cumulative net cash remittances from
2010 onwards 3,240 3,800
Our operating performance by business unit
Prudential Corporation Asia
Our strategy in Asia is focused on meeting the needs of the emerging middle class in the region for savings and protection. The region’s positive demographics, strong economic growth, sound public finances and favourable public policy environment with a clear preference for private provision of protection, have all led to a rapidly expanding middle class, with a strong and growing demand for our savings and protection products.
Geographically, Asia is a vast and diverse region. Our primary area of focus is on what we call our ‘sweet-spot’ – Indonesia, Hong Kong, Singapore, Malaysia, the Philippines, Thailand and Vietnam. All these markets have attractive long-term characteristics. We are in a strong position to capture profi tably the growing demand for our products and services in these selected markets. We continuously invest in these markets to grow our distribution and to ensure we are well positioned in
terms of people, systems and capabilities. We will continue to innovate to meet the evolving needs of our customers and maintain our focus on regular premium savings and protection products.
Our primary growth metric is new business profit rather than sales. This focus on new business profit has ensured we have delivered healthy and sustainable quality growth. In 2012, new business profit was up 18 per cent in the region, led by Indonesia, Singapore and Malaysia, up 27 per cent collectively. While under-penetration of insurance in markets across the region offers significant long-term growth opportunities, we retain our focus on value not volume. New business profit grew more quickly than sales as we refocused our businesses in Taiwan, Korea and Malaysia, deliberately reducing sales of lower-margin products to ensure a consistent focus on higher-value lines. We are determined to continue taking management action across the region where and when required, to maintain our internal rates of return of more than 20 per cent across all businesses, with a payback period in Asia of three years, despite the low interest rate environment.
Our life business in Asia, with its focus on capital-efficient products and fast payback periods, continues to deliver profitable, cash-generative growth. IFRS long-term operating profit in Asia increased by 30 per cent in the period to Ł920 million (2011: Ł709 million1) and net cash remittances increased by 66 per cent to Ł341 million (2011: Ł206 million).
Our multi-channel distribution model is at the heart of our success and we have continued to grow and strengthen our distribution further in 2012. In both the agency and the bank channels – bancassurance – the returns comfortably cover the cost of capital, so we have a strong appetite for growth in both. These channels grew their respective contribution to new business profit at similar rates in 2012. Agency is the largest channel and we continue to increase both the scale and,
Notes
| 1 |
|
Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs, as discussed in note A5 of the IFRS financial statements. |
| 2 |
|
Source: US Census Bureau. |
Group Chief Executive’s report Prudential plc Annual Report 2012 07
Overview
importantly, the quality and productivity of our agency force. In the bank channel, where we are the regional leader, our partnerships with Standard Chartered Bank (SCB) and United Overseas Bank (UOB) have seen considerable sales growth, up 42 per cent and 65 per cent respectively. Regular premium products make up the bulk of our new business – in excess of 90 per cent of total APE sales – with higher-margin protection products making up almost one-third of new business APE.
Our four largest markets – Indonesia, Hong Kong, Singapore and Malaysia – have made the most material contribution to the region’s growth in recent years. In addition to our well known strength in these four markets, we are building our presence and distribution in other markets that have the potential to become material drivers of growth over the medium and long term. Two such markets are Thailand and the Philippines, which in aggregate grew new business profit by 93 per cent in 2012. In Thailand, a market with considerable and attractive growth potential, where we were historically underweight, our recently announced exclusive long-term bancassurance partnership with Thanachart, and the acquisition of Thanachart Life, fulfils our long-standing ambition to significantly
increase our footprint in that country. In the Philippines, where we are a market leader, our business is now making good progress, delivering strong and profitable growth. We believe this market has promising prospects due to its large population and the improved quality of its macroeconomic management, with its renewed emphasis on attracting foreign direct investment as well as the upgrading of the country’s infrastructure. In January 2013, we started life insurance operations in Cambodia, our 13th market, and entered into a partnership with ACLEDA Bank PLC, the largest retail and commercial bank in the country. This is the fi rst deal of its kind in Cambodia, where we believe there are significant opportunities for growth as the market develops.
Overall, our geographic footprint, combined with the exceptional quality of our distribution and of our products, has enabled us to deliver another year of very strong performance in Asia. Our 13 million insurance customers, whom we serve well and profitably, represent only a small proportion of the long-term potential of this part of the world for our company.
Jackson National Life Insurance Company (Jackson)
The US is the world’s largest retirement savings market, with large cohorts of the 78 million baby-boomers2 reaching retirement age each year, creating significant demand for retirement income products. Our strategy in the US is to take advantage of this profitable growth opportunity. We approach this with a long-term perspective, proactively managing sales through the economic cycle as our experience has shown us how important it is to put value ahead of volume in the variable annuity market. We take at all times a conservative approach to pricing, even when that means losing market share to other players, while hedging our financial risks and managing our balance sheet.
08 Overview Prudential plc Annual Report 2012
Group Chief Executive’s report continued
In 2012, Jackson delivered IFRS long-term operating profit of Ł964 million, up 48 per cent on the prior year (2011: Ł651 million1). This increase in profits is in part due to increased fee income from the significant net flows captured in the last few years, and in part due to the non-recurring in 2012 of an accelerated deferred acquisition cost amortisation charge of Ł190 million in 2011. In 2012, new business profi t grew 7 per cent, with APE sales up 15 per cent as historically low interest rates continued to weigh on profits. The pricing actions taken during the year allowed Jackson to mitigate the negative impact of these interest rates.
There is always a degree of tactical management in the variable annuity market as sales are impacted by a number of factors, including but not limited to equity market levels, interest rates and the actions of Jackson’s competitors. During the second half of 2012, as equity markets recovered, we saw stronger sales growth in variable annuities despite pricing actions taken earlier in the year to mitigate the impact of lower investment returns as bond yields remained low. Therefore, in November and December Jackson worked closely with distributors to proactively manage volumes and to ensure that the level of sales for 2012 would remain within the Group’s quantitative risk appetite. We will continue to proactively balance value, volume, capital and balance sheet strength in this market.
In March 2012 we launched Elite Access, a variable annuity without guarantees, which offers access to alternative investments. It taps into an unmet demand from customers and has been particularly well received by distributors. The launch of Elite Access helps Jackson to continue growing within the Group’s risk appetite for products with guarantees. The acquisition of REALIC, a traditional US life business, has helped to diversify Jackson’s earnings and make the business more resilient.
In the context of industry debates about the advantages and disadvantages of various accounting methods, we believe that cash generation is ultimately a very tangible metric of the quality and value of a strategy. Therefore we set Jackson a net cash remittance objective for 2013 which, following the acquisition of REALIC, was increased from Ł200 million to Ł260 million. In 2012, Jackson delivered net cash remittances of Ł249 million in the year (2011: Ł322 million including an exceptional release of surplus) and is on track to meet this objective.
Prudential UK and Europe
In the UK, Prudential has adopted a focused strategy and competes selectively to help Britain’s ageing population convert their accumulated wealth into retirement income. We have a clear focus on writing profitable new business while generating cash sustainably and preserving our capital. We concentrate on areas in which we have a clear competitive advantage, namely individual annuities and with-profits products, where we continue to be market leaders.
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs, as discussed in note A5 of the IFRS financial statements.
Over the last decade, Prudential has been widely recognised as the UK’s leading with-profi ts manager. Our long-term approach to the management of the with-profits fund has continued to benefit customers during 2012 as it helps to provide protection from the full impact of volatile market conditions. The fund has consistently outperformed the FTSE All-Share Index. Over the last 15 years, the fund has delivered a cumulative investment return of 184.3 per cent on investments covering policyholder liabilities. This compares favourably with the FTSE All-Share Index total return of 106.5 per cent over the same period. Total bonus payments are expected to top Ł2 billion in 2013 and our policyholders will typically see year-on-year increases of between 3.5 per cent and 6.5 per cent in accumulating with-profits policy values. Since 2003 an estimated Ł22 billion has been added to policy values. Our UK business is also one of the largest providers of annuities in the UK and in 2012 paid out
Ł2.9 billion in income to UK annuitants.
Our performance in 2012 has been strong in a difficult market, which has been impacted by significant UK and EU regulatory change. This includes the implementation of the Retail Distribution Review (RDR), auto-enrolment for company pension schemes and gender neutral pricing.
Our UK business has demonstrated resilience as it continues to benefit from its focus on its core products, with-profits and individual annuities, with sales of both increasing by more than 30 per cent. We achieve internal rates of return that are commensurate with other parts of the business. New business profit increased 20 per cent to Ł313 million (2011: Ł260 million) and IFRS long-term operating profit grew 3 per cent to Ł703 million (2011: Ł683 million). We completed two selective bulk annuity deals that contributed to this figure.
Where we see opportunities for future profitable growth we will seek to capitalise on them but only if they meet our payback criteria. In 2013 we have commenced sales operations in Poland, one of Europe’s fastest-growing economies, which has an expanding middle class and high savings rates.
We continue to assess the impact of the RDR, which was implemented on 31 December 2012, and the resulting changes to distributors’ business models. This is likely to lead to some short-term dislocation in the market
as consumers and distributors adjust to the new sales environment. We expect this transition phase to dampen our sales of investment bonds in 2013, compared to the high sales in 2012. We are confi dent that the strength of our brand combined with our investment capabilities, financial strength and experience will ensure that we remain well placed to provide customers with dependable retirement income. We believe that with-profits products will continue to be popular with customers seeking competitive long-term real investment returns.
Net cash remittances were Ł313 million, up 5 per cent (2011: Ł297 million). Our inherited estate, which is estimated at Ł7.0 billion (31 December 2011: Ł6.1 billion), is a key source of capital strength.
Asset management
Our asset management business, M&G, has continued to focus on delivering superior investment performance for our customers while maximising the strength of its distribution capabilities. It has pursued business diversifi cation across both geographies and asset classes. Its retail funds are now registered for sale in 20 jurisdictions, with offi ces in 15 countries. During 2012, the business has seen record net sales, funds under management and IFRS operating profi t. The growth in sales has been driven by M&G’s business in Continental Europe as investor risk appetite returned.
M&G continued to attract signifi cant new asset fl ows during the recent years of global market volatility, testament to the strength of its reputation and focus on investment performance. It has seen record total retail and institutional net infl ows of
Ł16.9 billion in 2012, signifi cantly higher than 2011 and the previous high of Ł13.5 billion in 2009.
Total net sales in the UK were lower than 2011, refl ecting the maturity of the UK business and management decisions to slow the infl ow of new money into two market-leading UK corporate bond funds to safeguard investment performance. We expect these trends to persist in 2013. Despite the deliberate slowing of sales in the UK, M&G was the UK’s top-selling investment management house in 2012 and has ranked number one for both net and gross fund sales for an unprecedented four consecutive calendar years. Net fund sales in Continental Europe have increased, generating a record Ł5.2 billion of net sales in 2012. Assets sourced from outside the UK account for 29 per cent of total retail funds under management, up from 25 per cent in 2011.
Underlying profi ts for the full year rose by 14 per cent to a new record level of Ł298 million. Following the addition of performance-related fees and profi t from our associate investment in South Africa, total operating profi t for 2012 was Ł320 million. M&G’s funds under management also grew to a record Ł228 billion (2011: Ł201 billion).
Looking ahead, the diversifi cation of our business by asset class and geography positions us well to manage the expected shifts in consumer asset allocation going forward.
Eastspring Investments, our rebranded Asia asset management business, increased funds under management to Ł58.1 billion, up 16 per cent (2011: Ł50.3 billion). IFRS operating profi t was marginally lower, refl ecting a change in product mix towards bond funds that attract lower fees. Also costs were higher as we continued to invest in people and infrastructure, as we build out our offshore capabilities following the launch of the new brand. This included opening a US distribution offi ce, starting an operation in Indonesia and launching new funds in Taiwan, China and India.
Note
1 The estimated position at 28 February 2013 allows for economic conditions and surplus generation since 31 December 2012. It is stated before the final dividend and the effect of the Thanachart acquisition and after allowing for a reduction in Jackson’s contribution to IGD surplus of Ł1.3 billion.
Group Chief Executive’s report Prudential plc Annual Report 2012 09
Overview
Capital and risk management
We take a disciplined approach to capital management and continue to take action to ensure our capital works effi ciently and effectively for the Group. Using the regulatory measure of the Insurance Groups Directive (IGD), our Group capital surplus position at 31 December 2012 was estimated at
Ł5.1 billion (31 December 2011: Ł4.0 billion), before allowing for the fi nal dividend. The Group’s required capital cover was three times. The structure of the Group, and the approach we have taken to managing our risks, with a sizeable credit reserve in the UK annuity book, a strong inherited estate in UK with-profi ts and the relatively low-risk nature of our asset management and Asia operations, together with a high level of IGD surplus, means we have positioned ourselves well for future regulatory developments and stresses to our business.
There is broad agreement that ultimately it would be benefi cial to replace the IGD regime with a regime that is more risk-based. Solvency II may provide such a framework but we now know that it will not be implemented before 31 December 2015. In common with other insurers we have been working with regulators to ensure that the current capital regime remains robust while we wait for the implementation of Solvency II.
In early March 2013, we agreed with the FSA to revise the calculation of the contribution Jackson makes to the Group’s IGD surplus. We consider the revised basis to be an improvement as it is more closely aligned to the one we use to assess and report free surplus. In the absence of an agreed Solvency II approach, we believe that this change makes the IGD surplus a more meaningful measure and one that is more closely aligned with economic reality. The revised IGD surplus calculation has no impact on the way that the US business is managed or regulated locally. On this revised basis, the IGD surplus at 28 February 2013 is estimated at Ł4.4 billion1, before allowing for the fi nal dividend, equivalent to a capital cover of 2.5 times.
Uncertainty about the fi nal Solvency II outcome remains. We will continue to evaluate our options, including consideration of the Group’s domicile, in the event that the fi nal outcome is negative and potentially impacts our ability to deliver value to our customers and shareholders. We welcome the decision by the UK Financial Services Authority to strengthen the existing Individual Capital Adequacy Standards (ICAS) regime in the absence of the implementation of Solvency II.
10 Overview Prudential plc Annual Report 2012
Group Chief Executive’s report continued
Dividend
The Board has decided to rebase the full-year dividend upwards by 4 pence, refl ecting the strong progress made in both the earnings and free surplus generation of the business and in the delivery of our fi nancial objectives. In line with this, the directors recommend a fi nal dividend of 20.79 pence per share (2011: 17.24 pence), which brings the total dividend for the year to 29.19 pence (2011: 25.19 pence), representing an increase of 15.9 per cent over 2011.
The Board will maintain its focus on delivering a growing dividend from
this new higher base, which will continue to be determined after taking into account the Group’s fi nancial fl exibility and our assessment of opportunities to generate attractive returns by investing in specifi c areas of the business. The Board believes that in the medium term a dividend cover of around two times is appropriate.
Outlook
In 2012, we have delivered a strong performance. In spite of tough macroeconomic conditions and the negative effect of persistently low long-term interest rates, our Group has achieved signifi cant and profi table growth and produced increased levels of cash, which allowed us to provide our shareholders with a growing dividend.
Our strategy and operating principles remain clear and unchanged. Asia is the key driver of sustainable and profi table growth, building on the signifi cant opportunity that the emergence of the growing and increasingly wealthy middle class in this region represents. Our best opportunities lie in South-east Asia, where the depth and breadth of Prudential’s franchise is a source of strength. Our business units in the US and in the UK will continue to focus on delivering strong earnings and cash. We will achieve this by continuing to execute with discipline, by maintaining a robust balance sheet and with proactive risk management.
Our Group is set to continue to provide a distinctive combination of profi table growth and cash by meeting the needs of our customers across the world. Our confi dence is refl ected in the decision to rebase the dividend upwards, the second time in three years, as we remain focused on creating long-term, sustainable value for our shareholders.
[Graphic Appears Here]
Strategy and operating principles
[Graphic Appears Here]
Prudential plc Annual Report 2012 11
Section 2
Business
review
Business review
12 Financial highlights
14 Chief Financial Officer’s overview
20 Business unit review:
Insurance operations:
Asia, US, UK
Asset management:
M&G, Eastspring Investments, US
46 Financial review
68 Risk and capital management
79 Corporate responsibility review
[Graphic Appears Here]
12 Business review Prudential plc Annual Report 2012
Financial highlights
Life APE new business sales, profits and investment in new business
Balancing capital consumption and value optimisation
Life APE new business sales New business profit Free surplus investment
in new business
Ł4,195m Ł2,452m 2011 2012
Ł3,681m Ł836m +14% Ł2,151m Ł313m +14%
Ł746m Ł260m Ł873m
Ł1,462m Ł815m
Ł1,275m Ł(297)m Ł(292)m
Ł1,266m
Ł1,660m Ł1,897m Ł1,076m
Ł(202)m
Ł(54)m Ł(281)m
Ł(553)m Ł(45)m –12%
2011 2012 2011 2012 Ł(618)m
Asia US UK
Asia US UK Group
2012 2011 2012 2011 2012 2011 2012 2011
New business profit margin 67% 65% 60% 64% 37% 35% 58% 58%
Payback period 3 years 3 years 2 years 1 year 3 years 4 years 2 years 2 years
Internal rate of return >20% >20% >20% >20% >20% >20% >20% >20%
Shareholder-backed policyholder liabilities
Ł19,023m Ł162,979m
Ł7,824m Ł2,317m Ł133,506m Ł1,982m Ł9,597m Ł49,505m
Ł122,183m Ł1,839m Ł(1,129)m
Ł(657)m Ł46,048m
Ł43,944m Ł92,261m
Ł69,189m
Ł60,523m
Net liability flows1 Net liability flows1
Ł17,716m Ł18,269m Ł21,213m
At 1 Jan At 1 Jan At 31 Dec
2011 2012 2012
Asia US UK Other movements
Asset management, profitability, external funds under management and net inflows
IFRS operating profit External funds under Total asset management M&G net inflows
management net inflows
Ł461m Ł485m Ł133.5bn Ł18,281m Ł16,881m
Ł104m Ł114m +5% Ł111.2bn Ł21.6bn +20% +306% +285%
Ł19.3bn Ł111.9bn
Ł357m Ł371m Ł91.9bn
Ł4,506m Ł4,385m
2011 2012 2011 2012 2011 2012 2011 2012
M&G2 Other asset management business Total asset management
Operating profit, dividends and earnings per share
IFRS operating profit 3, 4, 5 EEV operating profit Dividend per share relating Basic earnings per share – based Financial
to the reporting year on operating profit after tax and
non-controlling interest
Ł2,533m +25% Ł4,321m +9% 29.19p +15.9%
Ł3,978m 25.19p 115.7p +8% highlights
Ł2,027m 125.0p
62.8p +22%
76.8p Business
2011 2012 2011 2012 2011 2012 2011 2012 review
EEV IFRS3
Free surplus, capital and cash
Underlying free IGD capital before
surplus generated 6 final dividend 7, 8
Ł1,983m Ł2,082m +5% Ł5.1bn +28%
Ł4.0bn
2011
2012
2011
2012
Group shareholders’ funds
(including goodwill attributable to shareholders)
EEV shareholders’ funds IFRS shareholders’ funds 3
Ł22.4bn +14% Ł10.4bn +21%
Ł19.6bn
Ł8.6bn
2011 2012 2011 2012
16% 16% 21% 23%
Return on shareholders’ funds 10, 11
Notes
1 Defined as movements in shareholder-backed policyholder liabilities arising from premiums (net of charges), surrenders, maturities and deaths.
2 2012 includes M&G’s 49.99 per cent proportionate share in the metrics above of PPM South Africa after the divestment transaction. 100 per cent of these metrics were included in 2011.
3 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
4 2012 operating profit includes one-off gain of Ł51 million arising on sale of Group’s interest in China Life Insurance Company of Taiwan.
5 2011 included accelerated deferred acquisition costs (DAC) amortisation of Ł190 million which has not recurred.
6 Underlying free surplus generated comprises underlying free surplus generated from the Group’s long-term business (net of investment in new business) and that generated from asset management operations.
Business unit Holding company
net remittances 9 cash balances
Ł1,200m +9% Ł1,380m +15%
Ł1,105m Ł1,200m
2011 2012 2011 2012
EEV shareholders’ funds per share
[Graphic Appears Here]
7 Estimated.
8 From March 2013 the basis of calculating Jackson’s contribution to the Group’s IGD surplus will change, further detail can be found in the ‘Capital position, financing and liquidity’ section of the Chief Financial Officer’s Overview.
9 Remittances from Asia in 2012 include net remittance of Ł27 million, representing cash from the sale of the Group’s holding in China Life Insurance Company in Taiwan offset by repayment of funding contingent on future profits of the Hong Kong life insurance operations.
10 IFRS operating profit after tax and non-controlling interests as percentage of opening IFRS shareholders’ funds. Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of IFRS financial statements.
11 EEV operating profit after tax and non-controlling interests as percentage of opening EEV shareholders’ funds.
14 Business review Prudential plc Annual Report 2012
Chief Financial Offi cer’s overview
Delivering profi table growth and enhanced capital fl exibility
[Graphic Appears Here]
‘Over the last few years, our success has been founded on attracting new customers and on retaining those who have chosen Prudential for their savings and protection needs. We operate in markets where consumer demand for the products that we provide is strong and we have achieved success by providing both value and service to our customers while generating attractive returns for shareholders.’
Nic Nicandrou
Chief Financial Offi cer
EEV new business profit IFRS operating profit based on
longer-term investment returns1
Ł2,452m +14% Ł2,533m +25%
Ł2,151m
Ł2,027m
2011
2012
2011
2012
Our guiding operating principle is simple – drive remitting over Ł300 million for the fi rst time in its history and the creation of sustainable shareholder value while exceeding its 2013 cash objective. With IFRS operating profi t, operating within a conservative risk management after development expenses, of Ł988 million in 2012, Asia framework. Over the last four years, through a has also exceeded its 2013 IFRS operating profi t objective. combination of disciplined execution and prudent
EEV new business profi t (‘new business profi t’), our primary management of our balance sheet risks, Prudential has growth measure, increased by 14 per cent to Ł2,452 million delivered profi table growth and enhanced its capital
(2011: Ł2,151 million), IFRS operating profi t based on fl exibility, despite the challenging market environment. longer-term investment returns (‘IFRS operating profi t’)
2012 has seen Prudential continue to build on the positive increased by 25 per cent to Ł2,533 million (2011: Ł2,027 million)1 momentum of recent years, with a strong fi nancial performance and net cash remitted from the business units to the Group that included two of our 2013 ‘Growth and Cash’ fi nancial increased by 9 per cent to Ł1,200 million (2011: Ł1,105 million). objectives being exceeded and continued progress towards the As these results demonstrate, the quality of our businesses rest. This performance refl ects good contributions across our key across Asia, the US and the UK, combined with the strength of fi nancial measures from each of our business operations, despite our balance sheet and fi nancial discipline, underpins the Group’s the
challenge of low long-term interest rates and weak growth in ability to deliver both growth and cash in the face of continued the global economy. It is particularly pleasing to note that Asia macroeconomic headwinds. became the largest contributor of cash to the Group in 2012,
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Profi tability
Over the last few years, our success has been founded on attracting new customers and on retaining those who have chosen Prudential for their saving and protection needs. We operate in markets where consumer demand for the products that we provide is strong and we have achieved success by providing both value and service to our customers while generating attractive returns for shareholders. In 2012 this approach produced Ł10.5 billion of life business net infl ows on shareholder-backed business, which together with investment-related and other movements, drove an increase in the overall size of our life insurance book of business by 22 per cent to Ł163 billion (2011: Ł133.5 billion). At the same time, our combined asset management operations attracted
Ł18.3 billion of retail and institutional net fl ows, surpassing the previous highs in 2009 and 2010, driving an increase in the third party managed funds by 20 per cent to Ł133 billion (2011: Ł111 billion). By attracting, retaining and growing our customers’ savings and our obligations towards them, we are able to generate higher revenues, which in 2012 have once again increased at a faster rate than our expenses, culminating in greater overall profi ts.
Group IFRS operating profi t increased by 25 per cent in 2012 to Ł2,533 million (2011: Ł2,027 million)1, driven by strong growth in total contributions2 from Asia and the US, which were up 26 per cent and 49 per cent respectively. Group EEV operating profi t based on longer-term investment returns (‘EEV operating profi t’) increased by 9 per cent to Ł4,321 million (2011: Ł3,978 million), with growth in all regions. Non-UK operations now account for a larger proportion of both total IFRS and EEV operating profi t than ever before, while the contribution to these metrics from each business operation and each earnings source remains well balanced, preserving both the quality and the resilience of the Group’s earnings.
Our Asia long-term business has continued to build on the progress of recent years, with IFRS operating profi t of Ł920 million (2011: Ł709 million)1 up 30 per cent. This strong performance has been driven by the increase in the size of the in-force portfolio including the growth of our health and protection business. Our largest markets of Indonesia, Hong Kong, Singapore and Malaysia continue to generate good levels of growth, with IFRS operating profi t up 22 per cent collectively. Asia’s long-term EEV operating profi t grew by 11 per cent in 2012 to Ł1,960 million (2011: Ł1,764 million), with progress on this measure impacted by lower expected returns as a result of the fall in interest rates during the year.
Notes
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
2 Operating profit from long-term and asset management business.
Chief Financial Offi cer’s overview Prudential plc Annual Report 2012 15
Chief
Financial
Offi
In the US, long-term business IFRS operating profit was up cer’s
48 per cent in 2012 to Ł964 million (2011: Ł651 million)1, which
includes a contribution of Ł67 million from REALIC, following its
acquisition in September 2012. The remaining increase primarily overview
reflects higher fee income generated by growth in the separate
account assets, as well as the expected non-recurring impact
of accelerated deferred acquisition cost (DAC) amortisation
of Ł190 million in 2011. This has been partially offset by the
adverse effect on spread income of lower bond yields. Fee Business
income increased by 29 per cent to Ł875 million in 2012
(2011: Ł680 million), as a result of growth in separate account review
asset balances, which stood at Ł49 billion at 31 December
2012 (31 December 2011: Ł38 billion), together with higher
average fee levels. Spread income (including the expected
return on shareholders’ assets) was Ł757 million in 2012
(2011: Ł813 million), with lower yields reducing the average
spread margin that we earned on general account liabilities
from 258 basis points in 2011 to 239 basis points in 2012 as
expected. Jackson’s long-term EEV operating profit increased
by 13 per cent to Ł1,610 million (2011: Ł1,431 million) primarily
due to improved new business profits and higher opening value
of in-force business following recent growth in the portfolio.
We are pleased with the acquisition of REALIC as it presents
a financially attractive deal, generating seasoned insurance
income, immediate earnings accretion and a gain on EEV
shareholders’ funds of Ł453 million.
UK long-term business IFRS operating profit was 3 per cent
higher at Ł703 million (2011: Ł683 million) including Ł431 million
from the shareholder-backed business. The strength of the
with-profits fund, which currently has a surplus estate of
Ł7.0 billion, offers strong policyholder protection and assists
in generating positive returns for both policyholders and
shareholders. EEV long-term operating earnings increased
by 2 per cent in 2012 to Ł866 million (2011: Ł853 million),
representing higher new business profits offset by the impact
of lower interest rates on the recognition of in-force profits.
Our asset management businesses generated IFRS operating
profit of Ł485 million in 2012 (2011: Ł461 million), with M&G’s
contribution higher at Ł371 million (including Prudential Capital).
M&G continues to benefit from the delivery of strong inflows,
with underlying profits (excluding performance-related
payments and earnings from associates) up 14 per cent in 2012.
This progress reflects higher revenues, up 10 per cent in 2012,
as the scale and proportion of external funds continues to grow,
and improvements in the cost-income ratio, to 59 per cent in
2012 (2011: 61 per cent). IFRS operating profit from Eastspring
Investments of Ł75 million (2011: Ł80 million) was impacted by
lower average margins on funds under management following
a consumer-led shift in business mix away from equities to
fixed income funds, as well as increased costs as the business
continues to invest in growth opportunities. This included
the opening of its first US office, in Chicago, in June 2012 and
starting operations in Indonesia.
16 Business review Prudential plc Annual Report 2012
Chief Financial Offi cer’s overview continued
Capital generation
We continue to promote disciplined use of our capital resources across the Group, and focus on allocating capital to the growth opportunities that offer the most attractive returns with the shortest payback periods. We have taken several important steps over the last few years to improve the effi ciency and effectiveness of the capital allocation process, which has improved not only our returns on capital invested but also our overall fi nancial fl exibility. In 2012 we have continued to produce signifi cant amounts of free capital, which we measure as free surplus generated.
In 2012, we generated Ł2,700 million of underlying free surplus (before reinvestment in new business) from our life in-force and asset management businesses. This is 6 per cent higher than the Ł2,536 million generated in 2011, refl ecting increases from Asia and the US. We reinvested Ł618 million of the free surplus generated in the period into writing new business (2011: Ł553 million).
Asia continues to be our preferred destination for new capital and accounted for Ł292 million of this reinvestment (2011: Ł297 million), falling despite the growth in new business as we continue to focus on more capital-effi cient products. We have not sought to invest in spread-based products in the region that carry more onerous capital charges and produce insuffi cient returns. In the US, new business investment has increased to Ł281 million from Ł202 million in 2011, which primarily refl ects the higher level of new business written, changes in business mix, and the impact on regulatory reserving requirements for new business from the low interest rate environment. In the UK, our capital-effi cient product focus on annuities and with-profi ts bonds means we invested just Ł45 million, yet delivered more new business profi t. The IRRs on invested capital were more than 20 per cent in Asia, the US, and the UK; with payback periods of three years, two years and three years respectively.
Of the remaining free surplus generated after reinvestment in new business, Ł1,200 million was remitted from the business units to Group. This cash was used to meet central costs of Ł205 million, service net interest payments of Ł278 million and meet dividend payments of Ł655 million. The total free surplus balance deployed across our life and asset management operations at the end of the year was Ł3,689 million (2011: Ł3,421 million).
Notes
1 The objectives assume current exchange rates and a normalised economic environment consistent with the economic assumptions made by Prudential in calculating the EEV basis supplementary information for the half-year ended 30 June 2010. They have been prepared using current solvency rules and do not pre-judge the outcome of Solvency II, which remains uncertain.
2 The net remittance objective for Jackson was increased from Ł200 million to Ł260 million to reflect the positive impact of the acquisition of REALIC.
3 Representing the underlying remittances excluding the Ł150 million impact of proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis.
‘Growth and Cash’ fi nancial objectives
The following discussion contains forward-looking statements that involve inherent risks and uncertainties. Prudential’s actual future fi nancial condition or performance or other indicated results may differ materially from those indicated in any such forward-looking statement due to a number of important factors (including those discussed under the heading ‘Risk factors’ in this document). See the discussion under the heading ‘Forward-looking statements’ at the front of this document.
At our 2010 investor conference, entitled ‘Growth and Cash’, we announced new fi nancial objectives demonstrating our confi dence in continued rapid growth in Asia, and increasing levels of cash remittances from all of our businesses. These objectives have been defi ned as follows:
(i) Asia growth and profitability objectives1:
To double the 2009 value of IFRS life and asset management pre-tax operating profit in 2013 (2009: Ł465 million); and
To double the 2009 value of new business profits in 2013 (2009: Ł713 million).
(ii) Business unit cash remittance objectives1:
Asia to deliver Ł300 million of net cash remittance to the Group in 2013 (2009: Ł40 million);
Jackson to deliver Ł260 million2 of net cash remittance to the Group in 2013 (2009: Ł39 million); and
UK to deliver Ł350 million of net cash remittance to the Group in 2013 (2009: Ł284 million3).
(iii) Cumulative net cash remittances1:
All business units in aggregate to deliver cumulative net cash remittances of at least Ł3.8 billion over the period 2010 to end-2013. These net remittances are to be underpinned by a targeted level of cumulative underlying free surplus generation of Ł6.5 billion over the same period.
As mentioned in the Group Chief Executive’s report, we remain focused on these objectives and have continued to make progress towards them. In 2012 we have exceeded our 2013 IFRS operating profi t and net remittance objectives for Asia and we are on track to achieve the rest. We set out below in more detail our progress towards these objectives based on our results for 2012.
Chief Financial Officer’s overview Prudential plc Annual Report 2012 17
Chief
Financial
Offi
Asia profitability objectives Actual (as originally reported) Objective cer’s
Change Change
(over(since
2009 2010 2011 2012 2011) 2009) 2013
Łm Łm Łm Łm%% Łm overview
Value of new business 713 901 1,076 1,266 18 78 1,426
IFRS operating profit(note 1) 465 604 784 988 26 112 930
Business unit net cash remittance objectives Actual Objective Business
2009 2010 2011 2012 2013
Łm Łm Łm Łm Łm
Asia(note 2) 40 233 206 341 300 review
Jackson(note 3) 39 80 322 249 260note 6
UK(note 4) 434 420 297 313 350
M&G(note 5) 175 202 280 297
688 935 1,105 1,200
Objectives for cumulative period 1 January 2010 to 31 December 2013 Percent-
age
Actual Objective achieved
1 Jan 2010 1 Jan 2010
to 31 Dec to 31 Dec At 31 Dec
2012 2013 2012
Łm Łm%
Cumulative net cash remittances from 2010 onwards 3,240 3,800 85
Cumulative underlying group free surplus generation (which is net of investment in new business) 5,779 6,500 89
Notes
1 Total Asia operating profit from long-term business and Eastspring Investments after development costs. 2012 operating profit includes a one-off gain of Ł51 million arising on sale of Group’s interest in China Life Insurance Company of Taiwan. The comparatives represent results as reported in the respective periods and excludes adjustment for altered US GAAP requirements for deferred acquisition costs as described in note A5 to the IFRS financial statements.
2 Remittances from Asia in 2012 include net remittance of Ł27 million, representing cash from sale of Group’s holding in China Life Insurance Company in Taiwan offset by repayment of funding contingent on future profits of the Hong Kong life insurance operations. 2010 remittances included a one-off remittance of Ł130 million, representing the accumulation of historic distributable reserves.
3 Net remittances from Jackson in 2011 include releases of excess surplus to Group.
4 In 2009, the net remittances from the UK included the Ł150 million arising from the proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis. The 2010 net remittances included an amount of Ł120 million representing the releases of surplus and net financing payments.
5 Including Prudential Capital.
6 The net remittance objective for Jackson was increased from Ł200 million to Ł260 million to reflect the positive impact of the acquisition of REALIC.
18 Business review Prudential plc Annual Report 2012
Chief Financial Offi cer’s overview continued
In 2012, cash remitted to the Group increased by 9 per cent to Ł1,200 million (2011: Ł1,105 million), with considerable amounts of cash remitted
from all our business operations highlighting the improved balance of contributions from across the Group. Asia’s remittances increased 66 per cent to Ł341 million (2011: Ł206 million), demonstrating its transition into a highly cash-generative business as a result of signifi cant growth and its focus on health and protection products. Asia’s 2012 cash remittance is ahead of its 2013 fi nancial objective of Ł300 million. We remain confi dent of further positive progress underpinned by strong cash generation from the in-force portfolio and continued growth in capital-effi cient new business. The quality of Jackson’s post-fi nancial crisis expansion in variable annuities is evidenced by its cash remittance of Ł249 million while continuing to grow the business, and fi nancing the acquisition of REALIC through its internal resources. The positive impact of this fi nancially attractive acquisition will enable Jackson to increase its net remittance objective for Group from Ł200 million to Ł260 million in 2013 and beyond. The UK life operations have continued to make sizeable remittances at Ł313 million (2011: Ł297 million), supported by shareholder transfers from the with-profi ts fund and cash-positive new annuity business. M&G (including Prudential Capital) delivered net remittances of Ł297 million (2011: Ł280 million), refl ecting its relatively capital-light business model that facilitates a high dividend payout ratio from earnings.
Against the cumulative 2010 to 2013 net remittance objective of Ł3.8 billion, by 31 December 2012 over Ł3.2 billion has been remitted by business operations. We remain confi dent of achieving this target. Our confi dence is underpinned by the strong underlying free surplus generation of our businesses which, by 31 December 2012, had generated a total of
Ł5.8 billion against our 2010 to 2013 cumulative objective of Ł6.5 billion.
Note
1 The National Association of Insurance Commissioners designed the Risk-Based Capital (RBC) formula as an early warning tool for State regulators to identify potentially inadequately capitalised companies for purposes of initiating regulatory action. The RBC ratio, being the ratio of available capital to regulatory capital, is based on the highest level of capital requirement at which remedial action may be initiated, the Company Action Level.
Capital position, fi nancing and liquidity
Despite the challenging macroeconomic conditions, we continue to operate with a strong solvency position, while maintaining high levels of liquidity and capital generation. This is testament to our capital discipline, the effectiveness of our hedging activities, our low direct Eurozone exposure, the minimal level of credit impairments and our comparatively low interest rate sensitivity.
The Group has maintained a strong capital position.
At 31 December 2012, our IGD surplus before fi nal dividend is estimated at Ł5.1 billion (31 December 2011: Ł4.0 billion), generating very strong coverage of three times the requirement.
All of our subsidiaries continue to hold strong capital positions on a local regulatory basis. In particular, at 31 December 2012, the value of the estate of our UK with-profi ts funds is estimated at Ł7.0 billion (31 December 2011: Ł6.1 billion), while Jackson’s risk-based capital (RBC)1 ratio was 423 per cent at
31 December 2012, excluding the gains on interest rate swaps under permitted practice, which if included would increase the RBC ratio to 478 per cent.
Furthermore, on a statutory (Pillar 1) basis the total credit default reserve for the UK shareholder annuity funds also contributes to protecting our capital position in excess of the IGD surplus. Notwithstanding the absence of defaults in the period, at
31 December 2012 we have maintained our credit default reserves at Ł2.1 billion, representing 40 per cent of the portfolio spread over swaps,
compared with 33 per cent at 31 December 2011.
The delays in fi nalising the implementation measures for Solvency II prolong the uncertainty of the effective date of the capital adequacy regime, a major overhaul for European insurers. We are supportive in principle of the development of a more risk-based approach to capital, but we have concerns as to the potential consequences of some aspects of the Solvency II regime under consideration. With the continued delays to policy development, the fi nal outcome of Solvency II remains uncertain. Despite this uncertainty we remain focused on preparing for implementation of the new regime.
In March 2013, we have agreed with the FSA to revise the calculation of the contribution Jackson makes to the Group’s IGD surplus. Until now the contribution of Jackson to the reported IGD surplus was based on an intervention level set at 75 per cent of US Risk-Based Capital Company Action Level (CAL). Going forward the contribution of Jackson to IGD surplus will equal the surplus in excess of 250 per cent of CAL. This is more in line with the level at which we currently report free surplus, which we have set at 235 per cent of CAL. In the absence of an agreed Solvency II approach, we believe that this change makes the IGD surplus a more meaningful measure and one that is more closely aligned with economic reality. The change has no impact on the way that the US business is managed or regulated locally. For consistency we also intend to align our free surplus calibration to 250 per cent of CAL going forward.
On the new basis, the IGD surplus at 28 February 2013 is estimated at Ł4.4 billion1 (equivalent to a capital cover of 2.5 times), which includes the proceeds of Ł0.4 billion of subordinated debt, raised in January 2013, and is after deducting Ł1.3 billion in respect of the Jackson change from 75 per cent to 250 per cent of CAL. The intended change to free surplus will have a negligible effect on EEV and is estimated to reduce total free surplus by around Ł100 million.
Our fi nancing and liquidity position remained strong throughout the period. The issue of US$700 million (Ł0.4 billion) of subordinated debt (perpetual tier 1 notes) in January 2013 further supports the fi nancial fl exibility of the Group, while taking advantage of very favourable market conditions. Our central cash resources amounted to Ł1.4 billion at 31 December 2012, up from Ł1.2 billion at 31 December 2011, and we retain a further
Ł2.1 billion of untapped committed liquidity facilities.
Notes
| 1 |
|
The estimated position at 28 February 2013 allows for economic conditions and surplus generation since 31 December 2012 and is stated before the final dividend and the effect of the Thanachart acquisition, and after allowing for a reduction in Jackson’s contribution to IGD surplus of Ł1.3 billion. |
| 2 |
|
Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements. |
Chief Financial Offi cer’s overview Prudential plc Annual Report 2012 19
Chief
Financial
Offi
During Shareholders’ 2012, investment funds markets continued to experience cer’s
considerable volatility, with positive movements in global
equity market indices only towards the end of the year and overview
further falls in long-term interest rates in the US, the UK
and a number of Asian countries, most notably Hong Kong
and Singapore. Despite these effects, the Group’s EEV
shareholders’ funds increased by 14 per cent during 2012
to Ł22.4 billion (31 December 2011: Ł19.6 billion). On a Business
per share basis EEV at the end of 31 December 2012 stood
at 878 pence, up from 771 pence at 31 December 2011. IFRS review
shareholders’ funds were 21 per cent higher at Ł10.4 billion
(31 December 2011: Ł8.6 billion)2.
The increases in shareholders’ funds on both reporting bases
are the result of the Group’s strong operating performance,
while our balance sheet continues to benefit from both the
quality of the asset portfolio and the effectiveness of our
proactive approach to risk management.
Summary
The financial progress we have reported in 2012 demonstrates
the Group’s resilience to the challenges faced by the global
economy. By maintaining our bias in favour of less volatile types
of income, such as insurance and fee, and by diversifying our
products set and distribution platforms, we have continued
to improve both the quality and the balance of our earnings.
Our disciplined approach to value creation and focus on cash
generation, combined with a robust capital position and
a conservative risk management stance, provide us with
a strong foundation for the future.
[Graphic Appears Here]
[Graphic Appears Here]
Insurance operations: Asia Prudential plc Annual Report 2012 21
Our strategy in Asia is focused on
meeting the needs of the emerging
middle class for savings and
protection. The region’s positive
demographics, strong economic
growth, sound public finances
and favourable public policy
environment with a clear
preference for private provision of
protection, have all led to a rapidly Business
expanding middle class, with a
strong and growing demand for our unit
savings and protection products. review
insurance 13m+ customers Business
400,000+ review
agents
[Graphic Appears Here]
22 Business review Prudential plc Annual Report 2012
Insurance operations
Asia: accelerate
‘Prudential’s strategy in Asia is well established and
continues to be highly effective. We are focused on
building high-quality, multi-channel distribution that
provides customers with access to products that are
appropriate for their financial planning needs. Typically
this involves a high proportion of regular premium
policies that combine savings and protection.’
Barry Stowe
Chief Executive
Prudential Corporation Asia
New business profit Total IFRS operating 2013 financial objectives
profit Double 2009 value
Ł1,266m +18% Ł920m +30% of IFRS life and asset
management pre-tax
Ł1,076m Ł709m operating profit
Double 2009 value of
new business profits
Deliver Ł300 million
of net cash remittance
to the Group.
2011 2012 2011 2012
Financial performance AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 1,897 1,660 14 1,642 16
New business profit 1,266 1,076 18 1,065 19
Total IFRS operating profitnotes (i)(ii) 920 709 30 697 32
Total EEV operating profitnote (i) 1,960 1,764 11 1,747 12
Notes
(i) Operating profit from long-term operations excluding Eastspring Investments, development costs and Asia regional head office costs.
(ii) Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Market overview
Asia’s rapidly-growing middle class remains a key growth driver for the retail fi nancial services sector, particularly life insurance with an emphasis on protection. Research has shown that as the middle class becomes more established the proportion of income they allocate to fi nancial planning increases from 5 per cent to around 12 per cent1.
The manifestation of this demand varies signifi cantly across the region, refl ecting the various stages of development in each individual market, together with their distinct regulatory and competitive environments, cultural differences and customer preferences. However, across all markets there is increasing recognition among governments and regulators of the social utility of a vibrant private sector life insurance market that provides fi nancial security to families, effi ciently channels long-term savings into fi nancial markets and generates employment opportunities within the industry.
During 2012, Asia’s average economic growth rates, although they remained well above the global average, continued to moderate following the post-crisis high seen in 2010. This is to some degree a consequence of the weakness of the economies of North America and Europe. While domestic factors were a signifi cant infl uence in India and China as policymakers grapple with sensitive political situations and economic imbalances, the resilience of many other economies in the region, particularly in South-east Asia, was highlighted by upward revisions to IMF growth forecasts in the second half of the year. Hong Kong’s economic growth accelerated during the fourth quarter last year and looks set to have an improved year in 2013 and the Singaporean Government has said that the outlook for its economy is cautiously positive as it also had a better than expected fourth quarter. However, the strongest performing regional economies were led by Indonesia, Malaysia, the Philippines and Thailand where growth is increasingly driven by the expansion of domestic demand and is less reliant on exports. Face to face sales, typically through an agent, remains the dominant distribution channel throughout the Asia region and the expertise needed to build and manage agency represents a signifi cant barrier for new entrants. Bancassurance has been growing at a faster rate than agency in recent years from a lower base.
As the life insurance industry continues to grow, so the regulatory environment continues to evolve. Regulators are encouraging insurers to strengthen their risk and solvency management processes and to improve their sales processes to ensure that customers receive good quality advice and buy products suitable to their needs. Most international insurers operating in the region are supportive of these trends and generally aim to operate above current local regulatory standards. The recent recommendations of the Monetary Authority of Singapore’s FAIR Panel are indicative of the kind of regulatory efforts under way in the region to improve the overall standard of agency distribution in insurance.
Note
1 HSBC Global Research.
Insurance operations: Asia Prudential plc Annual Report 2012 23
We believe the Asian life insurance markets remain a highly Business
compelling opportunity for delivering profitable growth over the unit
long term with South-east Asia, including Hong Kong, currently
offering the most attractive market dynamics for insurance review
providers, with increasing opportunities to provide financial
security to the new middle class whose expectations now go
beyond basic subsistence to protecting and improving their
personal finances over the long term. Business
Business performance
Prudential’s strategy in Asia is well established and continues to review
be highly effective. The customer is at the heart of our strategy
and Asian customers find our offering of regular premium
savings and protection products distributed principally through
high-quality face to face distribution channels particularly
attractive. The quality of our brand, our products, and of our
distribution allows us to translate our sales into strong returns
to our shareholders.
Building and strengthening Prudential’s multichannel distribution
capabilities is a constant objective for us. Tied-agency remains
a highly effective and efficient distribution channel in Asia and
Prudential has one of the region’s largest agency forces. We
focus both on the size and the productivity of our agency force.
Agency activity is a key indicator of quality and performance;
during 2012 Prudential’s average active agency manpower rate
increased by 14 per cent (excluding India). In our sweet-spot
of South-east Asia, the increase in active agency manpower of
15 per cent contributed significantly to a 19 per cent increase in
new business profit in the agency channel.
Bancassurance has been growing rapidly in the region in recent
years and Prudential remains a regional leader in this channel
with APE growth of 29 per cent, led by highly productive
relationships including SCB, where APE sales were up 42 per cent
this year and UOB, where APE sales grew at an even faster rate of
65 per cent year-on-year. In November, Prudential announced a
new and strategically significant, exclusive long-term partnership
with Thailand’s Thanachart Bank as part of a deal that will see
Thanachart Life merged with our existing life operation in the
country immediately doubling our market share. The deal is
expected to complete during the first half of 2013.
It is part of our strategy to focus on regular premium products
which allow our customers to invest over the long term and
smooth the impact of timing on their investment returns. We aim
to make most of our sales as regular premiums and in 2012, the
proportion of regular premium in our APE sales was in excess of
90 per cent, which ensures the profitability and resilience of our
growing in-force book. Although single premium products can
provide appropriate opportunities for customers with lump
sums, we believe that regular premium policies with protection
riders best meet the majority of our customers’ needs. In 2012,
32 per cent of our new business APE was related to protection,
up 2 percentage points over prior year. Given the recent volatility
in the financial markets, we have seen a shift towards non-linked
products; the proportion of linked products in the new business
APE mix declined to 29 per cent compared to 32 per cent for 2011.
24 Business review Prudential plc Annual Report 2012
Insurance operations continued
Asia: accelerate
Managing the in-force book is always a high priority as this ensures that the shareholder value that we expect to capture over the life of the product does emerge over time as distributable shareholder profi ts. For 2012 we reported small net positive experience and assumptions change of Ł95 million up from Ł75 million in 2011.
On 2 July, we announced that Prudential has received in-principle approval from Cambodia’s Ministry of Economy and Finance to establish a wholly foreign-owned life insurance operation in the country. Although the Cambodian economy is relatively small at present, it has delivered strong GDP growth over the past 10 years and we believe this presents excellent opportunities to develop the life insurance industry in the coming years. The business sold its fi rst policies in January 2013.
In addition to providing value directly to our customers through our products and services, we aim to provide wider benefi ts to the community where we operate. Therefore, Prudential supports a range of corporate social responsibility activities across Asia, with a focus on providing disaster relief, promoting fi nancial literacy and benefi ting children. During 2012, Prudential extended its highly successful children’s fi nancial literacy programme, ‘Cha-Ching’; for example, this has now been adopted in the Philippines as part of the school curriculum.
Financial performance
Prudential Asia has delivered in 2012 IFRS operating profi t and cash remittance ahead of the 2013 objectives with strong operational performances enhanced by some non-recurring items. We remain on track to meet our third objective in the region of doubling the 2009 new business profi t by 2013.
New business APE was Ł1,897 million, an increase of 14 per cent over prior year. During the second half of 2012 the reported growth rates did moderate as the economic climate became generally more challenging and specifi cally in Malaysia, Korea and Taiwan we deliberately and proactively slowed sales of lower margin products.
New business profi t of Ł1,266 million grew at a faster rate than APE at 18 per cent. This refl ects the positive impacts of product participation
decisions as outlined above, proactive pricing actions to mitigate the adverse effects of low interest rates and a shift in country mix. Our agency and bank channels grew their respective contribution to new business profi t at similar rates in 2012.
EEV operating profi t from our in-force business of Ł694 million is in line with prior year as the impact of the signifi cant increase in the unwind that comes from a larger in-force book and the net positive movement in the contribution to profi ts from assumption changes and experience variances was offset by the drag from lower discount rates.
Operating profi t on an IFRS basis from Asia’s life businesses, continues to grow strongly at Ł920 million, 30 per cent higher than in 2011. This includes Ł51 million of one-off profi t from the sale of the Group’s interest in China Life Insurance Company of Taiwan. Excluding this amount, IFRS operating profi t was Ł869 million, 23 per cent higher than last year. This is principally driven by improved in-force profi ts, which grew by 18 per cent in the year, refl ecting the increasing scale of the business.
During 2012, shareholder-backed business policyholder liabilities have increased by 16 per cent to Ł21.2 billion (31 December 2011: Ł18.3 billion), due to strong business fl ows of Ł2.0 billion (up 8 per cent on last year’s equivalent amount of
Ł1.8 billion) and higher bond and equity values.
Underlying free surplus generated by the in-force life business was 9 per cent higher at Ł771 million (2011: Ł707 million) refl ecting the increasing scale of the business. Of this total, Ł292 million (2011: Ł297 million) was reinvested in new business at internal rates of return of over 20 per cent and average payback periods of three years. The overall cash generating capacity of the life business is clearly demonstrated by net remittances of Ł384 million to the Group during 2012.
Looking at individual countries:
China AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales
(Prudential’s
50 per cent share) 56 59(5) 61(8)
Market conditions in China during 2012 have been challenging as economic growth slowed and the country continued to adjust to a changing political environment.
CITIC-Prudential remains one of the leading foreign joint ventures in a market that remains dominated by domestic players. We do anticipate the market liberalising at some point in the future, however the timing of such an opening remains uncertain. In the meantime, we are focused on continuing to build a high-quality, multichannel distribution organisation.
Prudential’s 50 per cent share of sales for 2012 was Ł56 million, broadly in line with the prior year. During this year we continued to focus on agent recruitment and on promoting sales of regular premium business. Bancassurance, which accounts for nearly half of our total sales in China, has seen lower productivity from bank branches following the tightening of regulations that came into effect last year.
Hong Kong AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 396 331 20 336 18
The Hong Kong economy continues to benefi t from its close ties with mainland China and it remains a fi nancial and logistics hub for the region beyond China, which ensures a continued and strong demand for our products.
Prudential Hong Kong delivered strong new business APE growth with an increase of 20 per cent over the prior year to Ł396 million. Prudential remains the only leading player in Hong Kong to have a material presence in both agency and bank distribution, enabling it to reach the widest range of customers. Both channels performed well in 2012.
India AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales
(Prudential’s
26 per cent share) 102 101 1 90 13
The Indian life insurance market has been going through a signifi cant period of change, however there are signs it has begun to grow again following the regulator-driven refocus on savings and protection products, which came into effect in 2010. During the second half the economy faltered, impacted by domestic imbalances and a challenging political environment. Although we remain optimistic about the long-term potential of the market, we expect it will be some time before private sector sales volumes return to pre-2010 levels.
Prudential’s joint venture with ICICI continues to be the leader in the private sector.
Indonesia AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 446 363 23 343 30
The Indonesian economy continues to outperform and this is underpinned by the scale and resilience of its domestic demand. Indonesia has one of the region’s largest populations and lowest rates of insurance penetration.
Prudential has a strong market leading position with over 60 per cent of the industry’s registered tied-agents and has successfully been building its business outside of Jakarta; now around 45 per cent of APE is from outside the capital. New business APE growth of 23 per cent to Ł446 million has been primarily driven by the continued expansion of the agency force. Growth in the agency force is now being supplemented by the smaller but fast growing bancassurance channel which includes partnerships with UOB, BII, Citibank and Permata.
Korea AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 95 101(6) 101(6)
In Korea, the weak economic climate has resulted in a decline in demand for unit-linked products, with consumers opting instead for interest sensitive products. Against this backdrop, we have chosen to relinquish volume rather than compete for the low margin, capital-intensive guaranteed return segment of the market. Consequently, we have deliberately let our sales via banks and brokers decline. Our business has continued to focus on developing a high-quality proprietary distribution channel which saw active agents increase by 9 per cent in 2012.
Malaysia AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 218 223(2) 224(3)
Note
1 Source: Life Insurance Association of Singapore.
Insurance operations: Asia Prudential plc Annual Report 2012 25
The latest statistics released by the Malaysian Life Insurance Business
Association show that the industry grew by 2.2 per cent during
2012 in terms of weighted premiums relative to 2011 reflecting unit
general concerns about the economic outlook. Prudential
remains the market leader in Malaysia with a highly productive review
agency force and growing bank distribution.
Our focus in 2012 on health and protection rather than lower margin,
higher premium volume savings related top ups has boosted the
mix of these products to around 60 per cent and improved our Business
profitability, at the expense of top line growth. We have continued
to expand in the Takaful sector where we remain market leader. review
Singapore AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 301 235 28 239 26
The Singapore market continues to perform strongly with the Life
Insurance Association having announced that industry APE grew
by 8 per cent during 2012 with regular premiums growing even
more strongly at 18 per cent.
Prudential’s APE was Ł301 million up 28 per cent on prior year.
Bancassurance was an important driver of growth where we
now have a number of partners including UOB, SCB, Maybank
and Singpost, enabling us to access a broad range of customers.
Our agency channel continues to be one of Singapore’s most
productive, and according to the latest available market statistics,
we lead the market in terms of regular premium new business
generated per agent1.
Taiwan AER CER
2012 2011 Change 2011 Change
Łm Łm% Łm%
APE sales 156 148 5 149 5
Taiwan is mainly focused on bank distribution through our
partnership with E.Sun Commercial Bank and SCB, supplemented
by direct marketing and worksite marketing activities which are
growing fast. APE was depressed by our decision not to compete
in the market with products we consider to be uneconomic.
Others – Philippines, Thailand and Vietnam
AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 127 99 28 99 28
In Vietnam, we saw a very strong recovery during the fourth quarter with new business APE up 23 per cent over prior year, to deliver an overall 7 per cent increase for the year. In Thailand, we saw growth of 37 per cent driven by our bancassurance capabilities. The Philippines delivered growth of 50 per cent, refl ecting increased agency activity and the success of partnership distribution.
[Graphic Appears Here]
Barry Stowe
Chief Executive
Prudential Corporation Asia
26 Business review Prudential plc Annual Report 2012
[Graphic Appears Here]
Insurance operations: United States Prudential plc Annual Report 2012 27
The US is the world’s largest
retirement savings market, with
large cohorts of the 78 million
baby-boomers1 reaching retirement
age each year, creating significant
demand for retirement income
products. Our strategy in the
US is to take advantage of this
profitable growth opportunity. Business
4m unit
customers review
Note
1 Source: US Census Bureau. Business
review
[Graphic Appears Here]
28 Business review Prudential plc Annual Report 2012
Insurance operations continued
United States: build on strength
‘Jackson’s strategy remains focused on providing value
to its customers and driving shareholder value while
operating within a conservative risk management
framework. This approach has enabled us to successfully
navigate the significant macroeconomic and financial
market challenges of the last five years and ensured
a continuation of our strong performance in 2012.’
Mike Wells
President and
Chief Executive Officer
Jackson National
Life Insurance Company
New business profit Total IFRS operating 2013 financial objective
profit Deliver Ł260 million
Ł873m +7% Ł964m +48% of net cash remittance
Ł815m to the Group*
Ł651m
2011 2012 2011 2012
Financial performance AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 1,462 1,275 15 1,290 13
New business profit 873 815 7 825 6
Total IFRS operating profitnote 964 651 48 659 46
Total EEV operating profit 1,610 1,431 13 1,448 11
Note
Comparatives adjusted for retrospective application of the accounting
policy change for deferred acquisition costs as discussed in note A5 of
the IFRS fi nancial statements.
*The net remittance objective for Jackson was increased from Ł200 million
to Ł260 million to refl ect the positive impact of the acquisition of REALIC.
Market overview
The United States is the world’s largest retirement savings market. Each year, many of the 78 million ‘baby- boomers’ reach retirement age, which will trigger a shift from savings accumulation to retirement income generation for more than US$10 trillion of accumulated wealth over the next decade1.
This demographic transition constitutes a signifi cant opportunity for those companies that are able to provide the ‘baby-boomers’ with long-term retirement solutions. Jackson takes a selective approach to this opportunity by leveraging its distinctive distribution capabilities and asset liability management expertise to offer prudently priced annuity products.
Despite the challenges faced by the global economy, US equity markets delivered strong gains in 2012. The S&P 500 index increased by 13.4 per cent over the course of the year and market volatility declined notably from the levels experienced in 2011. Interest rates remained historically low with the 10-year treasury rate ending below 180 basis points at year end, while corporate spreads tightened considerably from 2011 year end levels.
The competitive environment continues to favour companies with good fi nancial strength ratings and a track record of fi nancial discipline. Companies that were hardest hit by the market disruptions over the last few years still have to work to regain market share as customers and distributors seek product providers that offer consistency, stability and fi nancial strength. Jackson continues to benefi t from this fl ight to quality and heightened risk aversion.
Notes
1 Source: US Census Bureau.
2 Sources: Morningstar Annuity Research Center (MARC) Third Quarter 2012 Sales Report© and Fourth Quarter 2011 Sales Report©. © Morningstar, Inc.
All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely.
Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Insurance operations: United States Prudential plc Annual Report 2012 29
Business performance Business
Jackson’s strategy remains focused on providing value to its unit
customers and driving shareholder value while operating within
a conservative risk management framework. This approach has review
enabled us to successfully navigate the significant macroeconomic
and financial market challenges of the last five years and ensured
a continuation of our strong performance in 2012.
In 2012, Jackson delivered APE retail sales of Ł1,424 million, Business
an increase of 14 per cent over 2011. With the addition of a
modest level of institutional sales, total APE sales increased by
15 per cent to Ł1,462 million. These strong sales levels helped review
to drive annuity net flows higher to Ł8.8 billion during 2012,
a 19 per cent increase over 2011. Although we do not target
volume or market share, our ranking climbed to second in
variable annuity sales in the US through the third quarter of 2012
(latest information available), while market share increased to
14.0 per cent from 11.4 per cent for the full year 20112.
In March 2012, we launched a new variable annuity product,
Elite Access, which has no guaranteed benefits and provides
tax efficient access to alternative investments. The rollout of this
new product has received a positive reaction from distributors,
with close to 100 per cent of them signing up to distribute this
product. Single premium sales in the period since launch were
Ł849 million. We are optimistic about the future of Elite Access
and will continue to drive product innovation as a way of both
meeting the needs of our customers and driving shareholder value.
30 Business review Prudential plc Annual Report 2012
Insurance operations continued
United States: build on strength
Jackson continues to be one of the most effi cient operators within the US life insurance market. The ratio of statutory general expenses to average assets improved slightly to 41 basis points in 2012 versus 42 basis points in 2011. This effi ciency has been delivered while maintaining world class standards of customer service for our customers. In 2012, Jackson was rated as a ‘World Class’ service provider by the Service Quality Measurement Group for the seventh consecutive year.
On 4 September 2012, Jackson completed the acquisition of SRLC America Holding Corp (SRLC) from Swiss Re for a consideration of Ł370 million which is subject to fi nalisation of completion procedures. SRLC was the US holding company of REALIC. The acquisition helps diversify Jackson’s sources of earnings by increasing the amount of income generated from underwriting activities. The transaction is expected to add an additional Ł100 million to Jackson’s IFRS pre-tax profi ts in the fi rst year, representing stand-alone earnings from REALIC of approximately Ł115 million, less Ł15 million of income foregone on the assets sold to fi nance the transaction. In the four month period since completion, REALIC contributed Ł67 million to Jackson’s IFRS operating profi t while having only a modest impact on statutory capital.
Financial performance
Jackson’s IFRS pre-tax operating profi t in 2012 was 48 per cent higher at Ł964 million (2011: Ł651 million)1. This result refl ects the strong underlying growth in fee income, and lower deferred acquisition cost (DAC) amortisation. The result also includes four months of REALIC operating profi t.
At 31 December 2012, Jackson held Ł49 billion in separate account
assets, compared to Ł38 billion in 2011. The increase in separate account assets primarily refl ects the impact of positive net fl ows. This resulted in variable annuity separate account fee income of Ł875 million in 2012, up 29 per cent over the Ł680 million achieved in 2011.
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
With corporate spreads tightening during 2012 and continued low levels of absolute interest rates, total spread income, including the expected return on shareholders’ assets, was lower at Ł757 million, compared to Ł813 million in the previous year.
Product acquisition costs during 2012 increased slightly compared to 2011, despite the growth in sales as a greater proportion of distributors are opting for asset-based commission. Following the introduction of new DAC guidance in 2012, which was applied retrospectively, acquisition costs are no longer fully deferrable, resulting in IFRS new business strain of Ł174 million in 2012, compared to Ł156 million in 2011.
DAC amortisation of Ł356 million decreased in 2012, compared to Ł506 million in 2011. This decrease is primarily a result of the negative prior year impact of the reversal of the benefi t received in 2008 from the mean reversion formula. Partially offsetting this decrease was higher amortisation due to the higher earnings base in 2012.
Administration expenses increased to Ł537 million in 2012 compared to Ł412 million in 2011, with the increase due primarily to higher asset-based commissions paid on the larger 2012 separate account balance, which is classifi ed as an administration expense. This increase was also attributable to larger home offi ce staff due to the growing in-force book, the acquisition of REALIC, and certain non-recurring expenditures.
Jackson continues to actively manage its investment portfolio to mitigate investment risk. Net realised gains on debt securities amounted to Ł47 million in 2012 compared to gains of Ł106 million in 2011. This includes a realised loss net of recoveries of Ł10 million (2011: gains of Ł10 million) on credit-related sales of impaired bonds. Write-downs on debt securities were Ł37 million (2011: Ł62 million).
Interest related gains during the period totalled Ł94 million (2011: Ł158 million), primarily due to sales of corporate debt.
The net unrealised gain position has improved from Ł2,057 million at 31 December 2011 to Ł2,807 million at 31 December 2012 due to the decline in the US Treasury rates and tighter spreads. Gross unrealised losses improved from Ł246 million at
31 December 2011 to Ł178 million at 31 December 2012.
Jackson delivered total APE sales of Ł1,462 million, a 15 per cent increase over 2011. Jackson has achieved these sales levels, while maintaining its pricing discipline, as it continued to write new business at aggregate internal rates of return in excess of 20 per cent.
Variable annuity APE sales of Ł1,245 million were 14 per cent higher than in 2011. Expressed in local currency most of the increase was accounted for by APE sales of Elite Access, which totalled US$135 million. Excluding the contribution of Elite Access variable annuity APE sales of US$1,837 million were 5 per cent higher than those achieved in 2011 of US$1,749 million. In the course of the year and particularly in the second half of 2012, Jackson implemented various product initiatives to continue to balance value, volume, capital and balance sheet strength.
Fixed annuity APE sales of Ł58 million were 23 per cent higher than the level of sales in 2011. Jackson ranked seventh in sales of traditional deferred
fi xed annuities through the third quarter of 2012, with a market share of 3.6 per cent, compared to thirteenth with a 2.1 per cent market share for the full year 20111.
Fixed index annuity APE sales of Ł109 million in 2012 increased 17 per cent from 2011. Jackson ranked eighth in sales of fi xed index annuities through the third quarter of 2012, with a market share of 4.9 per cent, up from a market share of 4.6 per cent in the full year 20112.
Total EEV basis operating profi t for the long-term business in 2012 was Ł1,610 million, compared to Ł1,431 million in 2011 refl ecting increases in both new and in-force business profi ts. Jackson’s new business profi t increased by 7 per cent to Ł873 million, refl ecting active management of sales volumes and mix, higher charges and lower levels of guarantees offered. These actions counteracted the adverse effect of lower long-term yields and tighter spreads. Higher in-force profi t was driven largely by higher unwind of discount, due to growth in the underlying book, and larger positive contributions from operating experience variances and assumption changes.
Notes
1 Sources: LIMRA U.S. Individual Annuities Sales Survey. Third Quarter 2012 and Fourth Quarter 2011.
2 Sources: AnnuitySpecs.com’s Indexed Sales & Market Report, Third Quarter 2012 and Fourth Quarter 2011: Copyright © 2012, AnnuitySpecs.com.
All rights reserved.
Insurance operations: United States Prudential plc Annual Report 2012 31
In 2012, Jackson’s life in-force book generated Ł755 million of Business
underlying free surplus (2011: Ł748 million) reflecting an increase unit
due to the growth in the business and higher operating variances
offset by the impact of low interest rates. Some Ł281 million review
was reinvested to write new business (2011: Ł202 million). The
increase in capital consumption was driven by the significant
decrease in interest rates which in turn caused a large drop in
the valuation rate used to set reserves, resulting in higher strain
compared to 2011. Notwithstanding this effect, the fast payback Business
nature of the products, which in 2012 averaged two years across
the portfolio (2011: one year) means that returns remain review
extremely attractive.
Jackson’s RBC level at the end of 2012 was 423 per cent which
compares to 429 per cent at the end of 2011. In 2012, capital
formation was strong reflecting both the good operating
performance, the modest level of impairments and other
market value related net gains. This strong capital formation
enabled Jackson to remit Ł249 million to Group and complete
the acquisition of REALIC, while supporting its balance sheet
growth and growing total adjusted capital from year end
2011 levels.
[Graphic Appears Here]
Mike Wells
President and Chief Executive Offi cer Jackson National Life Insurance Company
[Graphic Appears Here]
32 Business review Prudential plc Annual Report 2012
United Kingdom:
focus
London Eye conceived and designed by Marks Barfi eld Architects
Insurance operations: United Kingdom Prudential plc Annual Report 2012 33
In the UK, Prudential has adopted
a focused strategy and competes
selectively to help Britain’s
ageing population convert their
accumulated wealth into retirement
income. We have a clear focus on
writing profitable new business
while generating cash sustainably
and preserving our capital. We
concentrate on areas in which we Business
have a clear competitive advantage,
namely individual annuities and unit
with-profits products, where we review
continue to be market leaders.
7m Business
customers review
[Graphic Appears Here]
34 Business review Prudential plc Annual Report 2012
Insurance operations continued
United Kingdom: focus
‘Our ability to deliver value to our customers and the
resulting market franchise allowed us to achieve higher
new business profitability in 2012, as well as increasing
cash generation and preserving our strong capital position,
despite the challenging economic environment and
competitive conditions that prevailed in the
UK marketplace.’
Rob Devey
Chief Executive
Prudential UK and Europe
Total IFRS operating 2013 financial objective
profit Deliver Ł350 million
Ł723m Ł736m +2% of net cash remittance
to the Group
2011 2012
Financial performance AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
APE sales 836 746 12 746 12
New business profit 313 260 20 260 20
Total IFRS operating profit 736 723 2 723 2
Total EEV operating profit 899 893 1 893 1
Market overview
The life and pensions market in the UK is mature and highly regulated. Signifi cant regulatory change occurred in 2012 with the implementation of the conclusions of the Retail Distribution Review (RDR), auto-enrolment for company pension schemes and gender neutral pricing.
These new regulations represent major changes to the way business is conducted in a number of areas of the markets in which we operate in the UK, and impact not only insurance and investments providers, but also distributors and consumers. It is inevitable that regulatory change of this scale and scope creates a period of uncertainty before the shape of the new long-term competitive landscape becomes evident.
The UK market is also characterised by an ageing population and a
concentration of wealth in the 50+ age group, many of whom have built up substantial pension funds in employer-sponsored schemes. These customers require help to convert their wealth into sustainable lifetime income. For the next generation of savers, the responsibility for retirement provision has shifted substantially away from government and employers towards the individual. These customers are typically under-funded for retirement and helping them accumulate saving constitutes a signifi cant opportunity for long-term savings and retirement income providers, at a time when the ability of the state to intervene is signifi cantly diminished.
Prudential UK’s longevity experience, multi-asset investment capabilities, long-standing trusted brand and fi nancial strength mean that we are favourably positioned to help consumers translate their accumulated wealth into dependable retirement income through our range of market leading with-profi ts and annuity products.
Insurance operations: United Kingdom Prudential plc Annual Report 2012 35
We do so by focusing on those areas of the market where we are Business
able to bring superior value to our customers and where we enjoy unit
a competitive advantage. The performance of our with-profits
fund in 2012 has allowed us to declare bonuses which mean that review
our policyholders should see year-on-year increases of between
3.5 per cent and 6.5 per cent in accumulating with-profits policy
values and our total bonus payments are expected to top
Ł2.0 billion in 2013. Business
Our ability to deliver value to our customers and the resulting
market franchise allowed us to achieve higher new business
profitability in 2012, as well as increasing cash generation and review
preserving our strong capital position, despite the challenging
economic environment and competitive conditions that prevailed
in the UK marketplace.
Business performance
Prudential UK has a well-established individual annuity business, built on a robust pipeline of internal vestings from maturing pension policy customers. The internal vestings pipeline is supplemented by sales through intermediaries and strategic partnerships with third parties where Prudential is the offered annuity provider for customers vesting their pensions at retirement.
Total APE sales for 2012 were Ł836 million (2011: Ł746 million) of which sales of individual annuities of APE Ł241 million were 35 per cent higher than in 2011.
Annuity sales from internal vestings of Ł146 million were 20 per cent higher than 2011, due to a combination of several factors – a higher number of customers retiring, higher average fund values and increased client contact activity. Sales of external annuities of APE Ł95 million were 67 per cent higher in 2012 refl ecting an increase in demand for our with-profi ts Income Choice Annuity which offers customers income security with the potential for income growth.
36 Business review Prudential plc Annual Report 2012
Insurance operations continued
United Kingdom: focus
Onshore bonds sales of APE Ł228 million were up 28 per cent on 2011, including with-profi ts bond sales of APE Ł214 million, which increased by 34 per cent. Our PruFund range made up 75 per cent of with-profi ts bond sales, with 35 per cent higher sales than in 2011. PruFund continues to be popular with consumers, providing smoothed returns and a range of optional guarantees, which offer a degree of security against potential market falls in a post-crisis environment where investors have become much more risk-averse. Although the demand for guarantees remains high, the increase in PruFund sales is based entirely on the non-guaranteed version of the product, which is attractive to those customers who are prepared to accept some risk to their capital but still want to benefi t from the smoothing offered by a with-profi t product.
The RDR, one of a number of current reforms to the UK regulatory framework, was implemented on 31 December 2012. It means that fi nancial advisers can no longer be paid commissions for recommending investment products. This is likely to lead to some short-term disruption in the market as consumers adjust to paying fees for advice and adviser fi rms adapt their business models for the new rules. We have seen an increase in sales of with-profi t bonds in 2012 and, while we have prepared our business for the post-RDR regulatory environment, we expect this transition phase to have a negative impact on our sales of investment bonds in 2013.
Corporate pensions sales of APE Ł189 million were 19 per cent lower than the previous year. Sales in 2011 were particularly high due to new defi ned contribution members joining our schemes following closure of a number of defi ned benefi t schemes operated by existing clients. We continue to focus on securing new members and incremental business from our current portfolio of corporate pensions customers rather than acquiring new corporate pensions schemes where market pricing is currently unattractive. Prudential UK remains the largest provider of additional voluntary contribution plans within the public sector, where we now provide schemes for 68 of the 99 public sector authorities in the UK.
Sales of other products, principally individual pensions,
PruProtect, PruHealth and offshore bonds of Ł137 million were 12 per cent higher than in 2011. Individual pensions APE sales (including income drawdown) of Ł80 million were 11 per cent higher, refl ecting increased demand for our Flexible Retirement Plan among advisers and their clients.
In the wholesale market, we aim to continue our selective participation approach to bulk and back-book buyouts using our fi nancial strength, superior investment track record, annuitant mortality risk assessment and servicing capabilities. In line with this opportunistic approach, two bulk annuity buy-in insurance agreements were signed in 2012 totalling APE Ł41 million (2011: single deal APE Ł33 million). We will continue to maintain our focus on value and only participate in transactions that meet our return on capital and payback requirements.
Our direct advice service, Prudential Financial Planning (PFP), was launched in December 2011 and grew to 129 advisers in 2012, generating APE sales of Ł21 million. PFP offers a complete fi nancial planning service, focused primarily on our existing direct customer base. The response from our customers has been very encouraging and we intend to continue to grow this channel to 200 advisers by the end of 2013.
The combined fi nancial strength and investment performance track record of Prudential’s UK With-Profi ts Fund continues to provide a key
source of non-price differentiation in a competitive market. Our with-profi ts customers benefi t from the security of Prudential’s large inherited estate, which was valued at Ł7 billion at the year end, and provides a high degree of protection against adverse market movements. The Fund continues to provide customers with solid returns and to outperform the FTSE
All-Share Index over medium to long-term horizons. Over the last 15 years, the Fund has delivered a cumulative investment return of 184.3 per cent on investments covering policyholder liabilities. This compares favourably with other with-profi ts funds and the FTSE All-Share Index total return of 106.5 per cent over the same period, and, by offering customers a smoothed return, helps provide protection from the full impact of volatile market conditions. This performance shows that investing in a strong with-profi ts fund can produce good returns for cautious investors, in spite of the combined pressures of volatile market conditions and UK interest rates remaining at historically low levels.
Retention and management of our customer base of approximately seven million remains a key focus for the business. We aim to maintain loyalty by continuing to improve our service year-on-year for both customers and intermediaries. Prudential UK’s focus on continuing to deliver excellent customer service was recognised at the 2012 Financial Adviser Service Awards, where we retained our two 5-Star ratings in the Life & Pensions and Investment categories.
Financial performance
Total APE sales of Ł836 million were 12 per cent higher than 2011, principally due to increased sales of individual annuities and with-profi ts bonds, partly offset by lower sales of corporate pensions. Retail APE sales of Ł795 million were up 12 per cent on the previous year (2011: Ł712 million). Although the lower level of interest rates in 2012 had a negative impact on retail new business profi tability, this was more than offset by the positive mix effect from growth in higher margin products such as individual annuities and with-profi ts bonds.
New business profi t increased by 20 per cent to Ł313 million (2011: Ł260 million), including bulk annuity transactions. Retail new business profi t at Ł274 million was 19 per cent above 2011 (2011: Ł231 million), primarily driven by increased volumes in higher margin product areas.
IFRS life operating profi t was higher than in 2011 at Ł736 million (2011: Ł723 million), with Ł272 million (2011: Ł293 million) from with-profi ts and the balance from shareholder-backed business. Commission received on Prudential-branded General Insurance products contributed Ł33 million to IFRS operating profi t in 2012, Ł7 million lower than in 2011 as the book of business originally transferred to Churchill in 2002 is, as expected, decreasing in size.
At half year 2010 we announced that the business had achieved its cost savings target of Ł195 million per annum. At the end of 2010, an additional series of initiatives to reduce costs by a further Ł75 million per annum by the end of 2013 was announced. By 31 December 2012 these additional annual cost savings of Ł75 million per annum had also been achieved, one year earlier than planned.
EEV total operating profi t of Ł899 million was 1 per cent higher than in 2011, refl ecting higher new business profi ts, partly offset by lower in-force profi ts which were impacted by the lower level of interest rates in the period. EEV profi t also included a contribution of Ł87 million from a change in the long-term tax rate assumption (including future tax rate changes which take effect in April 2013) from 25 per cent to 23 per cent, compared with Ł79 million from the 2 per cent tax rate reduction in 2011.
Insurance operations: United Kingdom Prudential plc Annual Report 2012 37
Prudential UK writes with-profits annuity, with-profits bond and Business
with-profits corporate and individual pensions business in its unit
Life Fund, with other products backed by shareholder capital.
For shareholder-backed business written in 2012, the weighted review
average post-tax internal rate of return (IRR) on the shareholder
capital allocated to new business was in excess of 20 per cent
and the undiscounted payback period on that new business
was three years. Business
Operating free surplus generated from the long-term in-force
business in the UK amounted to Ł507 million (2011: Ł503 million).
Of this total, Ł45 million (2011: Ł54 million) was reinvested in review
writing shareholder-backed business at attractive average IRRs.
During 2012 Prudential UK remitted cash of Ł313 million
to the Group (2011: Ł297 million), comprising Ł216 million
(2011: Ł223 million) from the annual with-profits transfer
to shareholders and Ł97 million (2011: Ł74 million) from the
shareholder-backed business. The business expects to generate
Ł350 million per annum of sustainable cash remittances by 2013,
supported by the strength of the with-profits business and
surpluses arising from the large book of shareholder-backed
annuities, maintained into the future by the pipeline of maturing
individual and corporate pensions.
[Graphic Appears Here]
Rob Devey
Chief Executive
Prudential UK and Europe
38 Business review Prudential plc Annual Report 2012
Asset management: optimise
M&G has continued to focus on
delivering superior investment
performance for our customers
while maximising the strength
of its distribution capabilities.
It has pursued business
diversifi cation both across
geographies and asset classes.
Ł228bn
assets under management
[Graphic Appears Here]
Asset management Prudential plc Annual Report 2012 39
Eastspring Investments recently
became the largest retail asset
manager in Asia1, and continues to
build a cohesive regional presence,
penetrating the offshore segment
more effectively.
Ł58.1bn Busi
assets under management ness
Note unit
1 Source: survey conducted by Asia Asset
Management Magazine as at 30 June 2012
(based on assets sourced from Asia ex-Japan). review
Business
review
40 Business review Prudential plc Annual Report 2012
Asset management
Asset management: optimise M&G
‘ M&G has had a record-breaking year in terms of net sales, funds under management and profi ts. It continues to execute against its strategy and deliver strong performance for both clients and its shareholder, the Prudential Group.’
Michael McLintock
Chief Executive
M&G
Total IFRS operating External funds under
profit management
Ł357m Ł371m +4% Ł111.9bn +22%
Ł91.9bn
2011 2012 2011 2012
M&G AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
Gross investment inflows 36,464 25,981 40 25,981 40
Net investment inflows:
Retail business 7,842 3,895 101 3,895 101
Institutional business 9,039 490 1,745 490 1,745
Total 16,881 4,385 285 4,385 285
Revenue 728 662 10 662 10
Other income 6 4 50 4 50
Staff costs(289)(270)(7)(270)(7)
Other costs(147)(134)(10)(134)(10)
Underlying profit before performance-related fees 298 262 14 262 14
Share of associate’s resultsnote (i) 13 26(50) 26(50)
Performance-related fees 9 13(31) 13(31)
Operating profit from asset management operations 320 301 6 301 6
Operating profit from Prudential Capital 51 56(9) 56(9)
Total IFRS operating profit 371 357 4 357 4
Funds under managementnote (ii) Ł228bn Ł201bn 13 Ł201bn 13
Notes
(i) The 2012 figure represents M&G’s 49.99 per cent proportionate share in the operating profit (including performance-related fees) of PPM South Africa following the divestment transaction in 2012. 100 per cent of operating profits were included in 2011.
(ii) Funds under management includes M&G’s share of the assets managed by PPM South Africa at 49.99 per cent and 100 per cent for 2012 (Ł4.4 billion) and 2011 (Ł7.9 billion) respectively.
Market overview
M&G is the UK and European fund manager of the Prudential Group with responsibility for investments on behalf of both internal and
external clients. It is an investment-led business with a clear focus on generating superior long-term returns for investors, whether they are third-party clients or the funds of Prudential’s insurance operations. This is achieved by creating an environment that is attractive to talented investment professionals.
Against a backdrop of continued political and macroeconomic uncertainty, M&G continues to deliver strong investment performance. Over the three years to 31 December 2012, 20 funds representing approximately 61 per cent of retail funds under management (FUM) produced fi rst or second quartile investment returns. The performance of funds managed on behalf of institutional fi xed income clients also remains extremely strong with all actively-managed mandates meeting or outperforming their benchmarks over this period.
Business performance
M&G has had a record-breaking year in terms of net sales, funds under management and profi ts.
Total net sales for the 12 months to the end of December 2012 were Ł16.9 billion, 25 per cent higher than the previous full year peak of Ł13.5 billion in 2009 and 285 per cent higher than net sales of Ł4.4 billion in 2011.
The strength of net fl ows, together with increases in equities and bond values in the year, have led to an increase of 13 per cent in total funds under management, to an all-time high of Ł228 billion. The FTSE All Share Index has increased by 8 per cent over the year and the sterling corporate bond index has increased by 15 per cent. Building on the strength of the net fl ows generated by the business over recent years, M&G was the largest retail fund manager in the UK1, measured by funds under management. M&G’s total UK retail FUM is Ł41.2 billion, as noted by the Investment Management Association at the end of December 2012.
Underlying operating profi t for the year was Ł298 million, 14 per cent higher than the previous best of Ł262 million in 2011. Total operating profi t for 2012 was Ł320 million.
This caps a decade of extremely strong growth for M&G. Since 2003 net fund sales have increased at an annual compound rate of 32 per cent and external client assets have grown at an annual compound rate of 19 per cent. Over this period underlying profi t has grown at an annual rate of 22 per cent.
Retail
In the retail market, M&G operates a single fund range from the UK, which it distributes both locally and internationally through increasingly diverse channels. Assets sourced from investors outside the UK now account for 29 per cent of M&G’s total retail FUM.
Notes
1 Source: Investment Management Association, data as at end of December 2012.
2 Source: SimFund Global. Data as at end of December 2012 in EUR. Based on estimated net sales of funds classed as fund market ‘International’ (registered for sale in more than five countries). Excludes Money Market and Alternative funds.
Asset management: M&G Prudential plc Annual Report 2012 41
Its reputation for delivering superior long-term investment Business
returns and a high standard of client service enabled M&G to unit
attract a record level of net fund sales in the retail market in 2012.
Excluding the results of our South African associate company, review
where our shareholding reduced from 75 per cent to 49.99 per cent
during 2012, total net sales were Ł8.2 billion. This is 15 per cent
higher than their previous high of Ł7.2 billion in 2010.
In the UK, M&G’s core market, net sales totalled Ł3.0 billion, Business
30 per cent lower than the previous year, but still sufficiently
high to rank M&G as the top selling house for the year. M&G has
ranked first for both net and gross fund sales in the UK for four review
consecutive calendar years, an unprecedented achievement.
Fund sales slowed in the second half as a direct consequence
of a decision in July to limit flows of new money into two of our
best-selling sterling corporate bond funds to ensure continued
flexibility in the management of the funds. We expect UK net
sales to continue to slow in 2013.
By contrast, net fund sales in mainland Europe increased sharply.
Following a minor net outflow in 2011, the business generated
a record Ł5.2 billion of net sales representing 67 per cent of total
retail net sales in 2012. Over the year M&G saw retail assets
sourced from European clients grow by 75 per cent to Ł14.4 billion
(2011: Ł8.2 billion). Today M&G has offices in 15 different countries
and its retail funds are registered for sale in 20 jurisdictions.
A core pillar of M&G’s retail business is to offer a diversified range
of investment funds and so be well-placed for changes in investor
trends. The demand for conservatively managed portfolios for
most of 2012 saw strong inflows into the M&G Optimal Income
Fund, a highly flexible international fixed income fund, and into
the M&G Global Dividend Fund. In Europe, Optimal Income was
the fourth best-selling fund, while Global Dividend ranked ninth
over the year to end of December 2012 and was the top selling
cross border Equity fund in 20122.
No fewer than 10 of M&G’s retail funds, across the major asset
classes of fixed income, equities and real estate, each attracted
net sales of at least Ł100 million during the 12 month period.
The Ł8.2 billion of net retail inflows in the UK and Europe were
partially off-set by a Ł0.4 billion net outflow from funds managed
by M&G’s associate entity in South Africa. These redemptions
were entirely from the PPM South Africa Dividend Income Fund,
which was closed on 31 March 2012 ahead of the implementation
of new tax legislation on 1 April 2012, which would have had a
materially adverse impact on the treatment of the distribution
made by the fund to its investors. Fund flows into other retail
funds of the South African business have been positive.
Institutional
In the institutional marketplace, M&G’s approach is to leverage
investment strategies developed primarily for Prudential’s
internal funds to create higher margin external business
opportunities. M&G offers third-party clients, such as pension
funds and sovereign wealth funds, an innovative range of
specialist fixed income and real estate strategies, including
private debt opportunities and infrastructure investment.
42 Business review Prudential plc Annual Report 2012
Asset management continued
Asset management: optimise M&G
The institutional business attracted a record level of net funds in 2012, predominantly into fi xed income strategies on the strength of its outstanding record of outperformance. At Ł9.0 billion, net infl ows were 50 per cent higher than the previous best of
Ł6.0 billion in 2009. The 2012 infl ows include a single Ł7.6 billion mandate which is expected to be partially or wholly redeemed within the next 24 months.
M&G continues to grow its business with external institutional clients, including the provision of alternatives to bank lending. The M&G UK Companies Financing Fund, a loan facility for medium-sized companies launched in the wake of the 2008 credit crisis, has increased its total commitments to Ł930 million across 11 individual loans. During the year, loans were made to three new clients, while a fourth advance went to an existing borrower.
Other innovations for third-party clients include a series of investment strategies to manage long-term infl ation-linked liabilities. The business successfully launched the M&G Infl ation Opportunities Fund and the M&G Debt Opportunities Fund, which complement the existing M&G Secured Property Income Fund, a portfolio of long-lease properties with inbuilt infl ation-linked increases. This last fund, which has total investor commitments of Ł1.3 billion, has delivered an annualised return of 7 per cent above the retail prices index (RPI) over the past three years.
In infrastructure, Infracapital, M&G’s unlisted infrastructure equity division, led a consortium (comprising Infracapital and other parties independent of Prudential) in the acquisition of a 90 per cent interest in Veolia Environnement S.A.’s (Veolia) UK regulated water business (now renamed Affi nity Water). Affi nity Water is the largest regulated water-only company in the UK by turnover. The acquisition is the fi rst investment for Infracapital Partners II LP, which has current commitments of Ł358 million.
Financial performance
M&G continues to execute against its strategy and deliver strong performance for both clients and its shareholder, the Prudential Group. M&G’s 2012 fi nancial performance continues the momentum from the strong full year results recorded in both 2011 and 2010, with further growth in profi ts and improvement in operating margins.
Total revenues, including other income, were Ł734 million, an increase of 10 per cent on the 2011 position. The increased scale of the business following the strong growth in FUM over recent periods has generated operational effi ciencies. Combined with a focus on cost discipline across the business, this has resulted in the cost/income ratio1 improving from 61 per cent in 2011 to 59 per cent for 2012. Underlying profi t for the full year rose by 14 per cent to a new record level of Ł298 million. Following the addition of performance-related fees and profi t from our associate investment in South Africa, total operating profi t for 2012 was at a record level of Ł320 million. Although affected by the reduction in our holding in
our South African business, this is an increase of 6 per cent on the 2011 position of Ł301 million, which had been the previous record year.
Note
1 Excluding performance-related fees, carried interest on private equity investment and profit from the PPM South Africa entity.
The profi t from the South Africa entity represents our proportionate share of its operating profi t which, following the divestment transaction in the fi rst quarter of 2012, reduced our ownership to 49.99 per cent. For 2011 and prior periods, the results of the South Africa entity were fully consolidated within our operating profi t.
Given the ongoing strength of its fi nancial performance, M&G continues to provide capital-effi cient profi ts and cash generation for the Prudential Group. This is in addition to the strong investment returns generated on the internally managed funds. M&G remits a substantial proportion of its post-tax profi ts to the shareholder. During 2012 cash totalling Ł206 million (2011: Ł213 million) was remitted to Group.
Prudential Capital
Prudential Capital manages the Group’s balance sheet for profi t by leveraging Prudential’s market position. This business has three strategic objectives: (i) to provide professional treasury services to the Prudential Group; (ii) to operate a fi rst-class wholesale and capital markets interface; and (iii) to realise profi table opportunities within a tightly controlled risk framework. Prudential Capital generates revenue by providing bridging fi nance, managing investments and operating a securities lending and cash management business for the Prudential Group and its clients.
Markets have remained diffi cult and volatile in 2012, and as a result the business remains focused on liquidity across the Prudential Group, management of the existing asset portfolio and conservative levels of new investment. Prudential Capital has continued to invest in developing its capabilities, by seeking to maintain the dynamism and fl exibility necessary to ensure that the treasury and wholesale services remain robust in a period of increased regulatory change, and to identify and realise opportunities for profi t within acceptable risk parameters. Prudential Capital is committed to working closely with other business units across the Prudential Group to exploit opportunities and increase value creation for Prudential as a whole.
Prudential Capital has a diversifi ed earnings base derived from its portfolio of secured loans, debt investments and the provision of wholesale markets services. IFRS operating profi t was
• 51 million in 2012 (2011: Ł56 million). In 2012 a total of
• 91 million (2011: Ł67 million) cash was remitted to Group.
[Graphic Appears Here]
Asset management: M&G/ Eastspring Investments Prudential plc Annual Report 2012 43
Asset management continued
Asset management: optimise
Eastspring Investments
Eastspring Investments AER CER Business
2012 Łm 2011 Łm Change % 2011 Łm Change % unit
Gross investment inflowsnote 9,036 7,824 15 7,707 17
Net investment flowsnote 1,626 633 157 599 171 review
Total IFRS operating profit 75 80(6) 79(5)
Funds under management Ł58.1bn Ł50.3bn 16 Ł49.8bn 17
Market overview During 2012 Eastspring Investments delivered excellent Business
Prudential’s asset management business in Asia investment performance with 65 per cent of funds exceeding
manages investments for Asia’s third-party retail their benchmarks or were peer-ranked within the top two review
and institutional clients in addition to investments quartiles over a three year period.
of Prudential’s Asia, UK and US life companies. It has
operations in 11 markets, including Indonesia which Business performance
was successfully opened during 2012, increasing our Net third-party inflows (excluding Money Market Funds) of
asset management footprint in the region. Ł1,626 million were driven by net inflows in India, Taiwan and
China. Specifically, strong fund-raising was seen in India for our
Markets remained challenging in 2012. Equity funds struggled to
fixed maturity plan range and open-ended bond funds, while the
gain traction, due to poor investor sentiment in the face of weak
Taiwan business saw a successful launch of the Emerging Asian
macroeconomic signals. Fixed income and regular yield products
Local Fixed Income Fund in the first half of the year and the
remained in favour.
Global Aggregate Strategy High Yield Bond Fund in the second
In November 2011, Prudential announced that its Asia Asset half. In addition, Taiwan’s existing range of onshore and offshore
Management operations would be rebranded Eastspring bond funds also generated significant net inflows in 2012. In
Investments. The new brand, which was officially launched in China, both the CSI 500 Index Fund and the Tianjin Split Bond
February 2012, is enabling the business to establish a cohesive Fund launched in the second half of the year attracted positive
regional presence, thereby penetrating the offshore segment flows. The positive net flows were partially offset by redemptions
more effectively. It also supports distribution to new markets from an institutional client in Singapore and another in Korea.
outside Asia and we have recently opened a distribution office
Total funds under management (FUM) reached a record
in the US.
Ł58.1 billion and represent a 16 per cent increase from a year ago
Eastspring Investment’s leading presence in Asia was on the back of strong net inflows and positive market movements.
acknowledged when it was ranked the largest retail asset
manager in Asia (based on assets sourced from Asia ex-Japan), Financial performance
as at 30 June 2012, in a survey conducted by Asia Asset Fee income rose by a more modest 3 per cent, reflecting a change
Management magazine. Eastspring Investments also received in FUM mix, with a higher proportion of internal, institutional and
multiple accolades for its investment capabilities, including four retail bond funds, all of which attract lower average annual
fund managers from Singapore, Malaysia and Indonesia being charges. At the same time costs have increased as we continue to
named ‘2012 Most Astute Investors in Asian currency bonds’ by invest in the development of the Eastspring Investments platform
The Asset Benchmark Research and the joint venture business in and expand into new markets. IFRS operating profit was,
India being recognised as the ‘Best Debt Fund House of the year’ therefore, 6 per cent lower than the prior year at Ł75 million.
in the Morningstar Awards 2012.
Note
Gross and net investment fl ows exclude Eastspring Money Market Funds, that had net outfl ows of Ł226 million in 2012 (2011: net outfl ows Ł512 million).
44 Business review Prudential plc Annual Report 2012
Asset management continued
Asset management: optimise United States
PPM America AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
Total IFRS operating profit 6 4 50 4 50
Market overview Financial performance
PPM America (PPMA) manages assets for Prudential’s US, IFRS operating profit in 2012 was Ł6 million, compared
UK and Asia affiliates. PPMA also provides other affiliated to Ł4 million in 2011, principally reflecting the increase in
and unaffiliated institutional clients with investment services funds under management over the period.
including collateralised debt obligations (CDOs), private equity
At 31 December 2012, funds under management of Ł64 billion
funds, institutional accounts, and mutual funds. PPMA’s strategy
were as follows:
is focused on managing existing assets effectively, maximising
the benefits derived from synergies with our international asset
management affiliates, and leveraging investment management
capabilities across the Prudential Group. PPMA also pursues
third-party mandates on an opportunistic basis.
AER
2012 Łbn 2011 Łbn
US UK Asia Total US UK Asia Total
Insurance 38 15 1 54 32 15 – 47
Unitised 2 1 6 9 1 1 5 7
CDOs 1 – – 1 1 – – 1
Total funds under management 41 16 7 64 34 16 5 55
Curian AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
Gross investment inflows 1,550 1,684(8) 1,704(9)
Revenue 69 51 35 52 33
Costs(54)(45)(20)(46)(17)
Total IFRS operating profit 15 6 150 6 150
Total funds under management Ł7.1bn Ł4.7bn 51 Ł4.5bn 58
Market overview
Curian Capital, Jackson’s registered investment adviser, provides innovative fee-based managed accounts and investment products to advisers through a sophisticated technology platform. Curian expands Jackson’s access to advisers while also complementing Jackson’s core annuity product lines with Curian’s retail asset management products.
Business performance
At 31 December 2012, Curian had total assets under management of Ł7.1 billion, compared to Ł4.7 billion at the end of 2011. Curian generated deposits of Ł1,550 million in 2012, down 8 per cent from 2011. Curian’s asset growth continues to benefi t from its prior investment platform expansions and its significant expansion in 2012 of the firm’s wholesaling team and new distribution territories.
Financial performance
Curian reported an IFRS basis operating profit of Ł15 million in
2012 compared to Ł6 million in 2011. This increase was primarily due to higher net revenue from a larger book of assets under management.
Asset management: United States Prudential plc Annual Report 2012 45
US Broker-dealer AER CER Business
National Planning Holdings, Inc. 2012 Łm 2011 Łm Change % 2011 Łm Change %
Revenue 528 491 8 497 6 unit
Costs(510)(477)(7)(483)(6)
Total IFRS operating profit 18 14 29 14 29 review
Market overview Financial performance
National Planning Holdings, Inc. (NPH) is Jackson’s affiliated NPH generated revenues of Ł528 million in 2012, up from Business
independent broker-dealer network. The business is comprised Ł491 million in 2011, on gross product sales of Ł10.5 billion
of four broker-dealer firms, including INVEST Financial(2011: Ł8.6 billion). The network continues to achieve
Corporation, Investment Centers of America, National Planning profitable results, with 2012 IFRS operating profit of Ł18 million, review
Corporation, and SII Investments. a 29 per cent increase from Ł14 million in 2011. At 31 December
2012, the NPH network had 3,540 registered advisers
NPH continues to grow the average business and revenue
(2011: 3,636 registered advisers).
per representative. By utilising high-quality, state-of-the-art
technology, Jackson provides NPH’s advisers with the tools they
need to operate their practices more efficiently. At the same time,
through its relationship with NPH, Jackson continues to benefit
from an important retail distribution outlet, as well as receive
valuable insights into the needs of financial advisers and
their clients.
46 Business review Prudential plc Annual Report 2012
Financial review
Results summary
International Financial Reporting Standards (IFRS) basis results*
Statutory IFRS basis results
2012 2011
note (i)
Profit after tax attributable to equity holders of the Company Ł2,197m Ł1,415m
Basic earnings per share 86.5p 55.8p
Shareholders’ equity, excluding non-controlling interests Ł10.4bn Ł8.6bn
Supplementary IFRS basis information
2012 Łm 2011 Łm
note (i)
Operating profit based on longer-term investment returns* 2,533 2,027
Short-term fiuctuations in investment returns on shareholder-backed business 204(220)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 50 21
Gain on dilution of Group holdings 42 –
Amortisation of acquisition accounting adjustments arising on the purchase of REALIC(19) –
Profit before tax attributable to shareholders 2,810 1,828
Operating earnings per share*(refiecting operating profit based on longer-term investment returns after
related tax and non-controlling interests) 76.8p 62.8p
European Embedded Value (EEV) basis results*
2012 Łm 2011 Łm
Operating profit based on longer-term investment returns* 4,321 3,978
Short-term fiuctuations in investment returns 538(907)
Mark to market value movements on core borrowings(380)(14)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 62 23
Effect of changes in economic assumptions(16)(158)
Gain on dilution of Group holdings 42 –
Gain on acquisition of REALIC 453 –
Profit before tax (including actual investment returns) 5,020 2,922
Operating earnings per share* (refiecting operating profit based on longer-term investment returns after
related tax and non-controlling interests) 125.0p 115.7p
Shareholders’ equity, excluding non-controlling interests Ł22.4bn Ł19.6bn
2012 2011
Dividends per share declared and paid in reporting period 25.64p 25.19p
Dividends per share relating to reporting period 29.19p 25.19p
Funds under management Ł405bn Ł351bn
Insurance Groups Directive capital surplus (as adjusted)notes (ii) and (iii) Ł5.1bn Ł4.0bn
Notes
(i) Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
(ii) The surpluses shown for 2012, which is estimated, and 2011 are before allowing for the final dividends for 2012 and 2011 respectively.
(iii) From March 2013, the basis of calculating Jackson’s contribution to the Group’s IGD surplus will change, further detail can be found in the ‘Capital position, financing and liquidity’ section of the Chief Financial Officer’s overview.
Financial review Prudential plc Annual Report 2012 47
* Basis of preparation
Results bases
The IFRS basis results have been prepared in accordance
with the accounting policies discussed in notes A2 to A4
of the IFRS financial statements.
Life insurance products are, by their nature, long-term and the
profit on this business is generated over a significant number
of years. Accounting under IFRS alone does not, in Prudential’s Financial
opinion, fully reflect the value of future profit streams. Prudential
considers that embedded value reporting provides investors review
with a measure of the future profit streams of the Group’s in-force
long-term businesses and is a valuable supplement to statutory
accounts. The EEV basis results have been prepared in
accordance with the EEV principles discussed in note 1
of EEV basis supplementary information. Business
Operating profit based on longer-term investment returns
The Group provides supplementary analysis of profit before tax review
attributable to shareholders so as to distinguish operating profit
based on longer-term investment returns from the other elements
of total profit shown. Operating profit per share is calculated using
operating profits based on longer-term investment returns, after
related tax and non-controlling interests.
Exchange translation – Actual Exchange Rate (AER) and
Constant Exchange Rate (CER)
The comparative results have been prepared using previously
reported exchange rates (AER basis) except where otherwise
stated. Results on a CER basis are also shown for the analysis
of IFRS and EEV operating profit based on longer-term
investment returns.
48 Business review Prudential plc Annual Report 2012
Financial review continued
IFRS results
IFRS basis operating profit based on longer-term investment returns
AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
note (i) note (i)
Insurance business
Long-term business:
Asia 920 709 30 697 32
US 964 651 48 659 46
UK 703 683 3 683 3
Development expenses(7)(5)(40)(5)(40)
Long-term business profit 2,580 2,038 27 2,034 27
UK general insurance commission 33 40(18) 40(18)
Asset management business:
M&G (including Prudential Capital) 371 357 4 357 4
Eastspring Investments 75 80(6) 79(5)
Curian 15 6 150 6 150
US broker-dealer and asset management 24 18 33 18 33
3,098 2,539 22 2,534 22
Other income and expenditure(498)(483) 3(483) 3
RPI to CPI infiation measure change on defined benefit
pension schemesnote (ii) – 42(100) 42(100)
Solvency II implementation costs(48)(55) 13(55) 13
Restructuring costs(19)(16)(19)(16)(19)
Total IFRS basis operating profit based on longer-term
investment returns 2,533 2,027 25 2,022 25
Notes
(i) Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
(ii) During 2011 the Group altered its assumptions for future statutory increases to pension payments for its UK defined benefit pension schemes. This reflects the UK Government’s decision to change the basis of indexation from RPI to CPI.
In 2012, the Group’s IFRS operating profi t based on longer-term investment returns was Ł2,533 million, an increase of 25 per cent from 2011.
In Asia, IFRS operating profit based on longer-term investment returns for long-term business increased by Ł211 million from Ł709 million1 in 2011 to Ł920 million in 2012. Included with this result is a Ł51 million one-off profi t on sale of the Group’s interest in China Life Insurance Company of Taiwan, which was originally acquired in 2008 when Prudential sold its Taiwanese agency business to the company. Excluding this amount, Asia’s long-term business operating profit increased by 23 per cent to Ł869 million, primarily refl ecting strong growth in the size of our business in the region, particularly health and protection.
Notes
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
2 Before non-recurring items.
The contribution to profits from Indonesia, Hong Kong, Singapore and Malaysia, Prudential’s largest markets in Asia, continues to rise, with operating profi ts from these businesses2 up 22 per cent from Ł552 million in 2011 to Ł674 million in 2012. High consumer demand for savings and protection in Indonesia continues to drive growth in premiums and earnings, with operating profit2 up 23 per cent from Ł212 million to Ł260 million. Hong Kong’s operating profi t2 increased by 28 per cent to Ł88 million (2011: Ł69 million), as business mix has shifted towards higher return products. Singapore increased by 23 per cent to Ł206 million (2011: Ł167 million)2 and Malaysia’s operating profit2 at Ł120 million (2011: Ł104 million) increased by 15 per cent. Operating profits from our other long-term insurance operations in the region also increased by 24 per cent to Ł147 million (2011: Ł119 million), as these businesses increase in size.
The US long-term business operating profit increased by 48 per cent from Ł651 million1 in 2011 to Ł964 million in 2012. The 2011 result included an accelerated deferred acquisition cost (DAC) amortisation of Ł190 million that did not recur. Excluding this item the underlying increase refl ects the continued growth in fee income on the separate account business offset by lower earnings from fixed annuities in line with the compression in corporate spreads experienced in the course of the year. The result also includes a Ł67 million contribution from REALIC which was acquired in September 2012 and is performing in line with our expectations.
Prudential’s UK business has sustained its performance at similar levels to the previous year, with total IFRS operating profi t of
• 736 million (2011: Ł723 million). Long-term business generated
• 703 million (2011: Ł683 million) driven by an increase in profits
from individual annuities and bulk annuity transactions, the latter contributing Ł31 million (2011: Ł23 million) to the total. Shareholders with-profi ts business transfers amounted to Ł272 million, compared with Ł293 million in 2011, in line with reductions in policy bonus rates. Profi t from UK general insurance commission continued to decline as expected to Ł33 million (2011: Ł40 million) as the business matures and in-force policy numbers fall.
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Financial review Prudential plc Annual Report 2012 49
Total operating profit for 2012 from M&G and Prudential Capital
increased by 4 per cent from Ł357 million in 2011 to Ł371 million
in 2012, primarily refiecting positive net inflows into M&G during
2011 and 2012.
Eastspring Investments reported operating profit of Ł75 million,
down by Ł5 million from the Ł80 million recognised in 2011. This
refiects a broadly unchanged level of fee income with the effect
of higher fund values offset by a shift in business mix towards Financial
bond mandates, together with increased costs as the business
develops the Eastspring Investments platform and expands into review
new markets.
Business
review
50 Business review Prudential plc Annual Report 2012
Financial review continued
IFRS basis results – Analysis of long-term insurance business pre-tax IFRS operating profi t based on longer-term investment returns by driver
AER AER CER
2012 2011 2011
Operating Average Operating Average Operating Average
profit liability Margin profit liability Margin profit liability Margin
note (ii) note (i) note (ii) note (i) note (ii) note (i)
Łm Łm bps Łm Łm bps Łm Łm bps
Spread income 1,074 62,174 173 1,065 57,417 185 1,072 57,572 186
Fee income 1,077 78,807 137 870 68,298 127 875 68,331 128
With-profits 311 95,681 33 331 93,056 36 331 92,946 36
Insurance margin 1,032 736 729
Margin on revenues 1,669 1,425 1,404
Expenses:
Acquisition costsnote (iii)(1,997) 4,195(48)%(1,783) 3,681(48)%(1,782) 3,678(48)%
Administration expenses(1,248) 143,321(87)(1,043) 125,715(83)(1,039) 125,903(82)
DAC adjustmentsnote (iv) 406 237 243
Expected return on shareholder assets 205 200 201
Gain on China Life (Taiwan) shares 51 – –
Operating profit based on longer-term
investment returns 2,580 2,038 2,034
Notes
(i) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus.
(ii) For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as this is seen as a good proxy for average balances throughout the year. The calculation of average liabilities for Jackson is derived from month-end balances throughout the year as opposed to opening and closing balances only. Liabilities held in the general account for variable annuity living and death guaranteed benefits together with other amounts on which no spread income is earned (eg REALIC liabilities), are excluded from the calculation of the average. In addition for REALIC, which are included in the average liability to calculate the administration expense margin, the calculation excludes the liabilities reinsured to (and in essence retained by) Swiss Re immediately prior to the acquisition by Jackson.
(iii) Acquisition cost ratio represents shareholder acquisition costs as a percentage of total APE including with-profits sales. Acquisition costs include only those relating to shareholders.
(iv) DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in the basis of preparation and note A5 of the IFRS financial statements.
Spread income earned in 2012 was Ł1,074 million, Ł9 million higher than the amount received in the prior year of Ł1,065 million. As expected the margin secured has fallen from 185 basis points in 2011 to 173 basis points in 2012 principally due to spread compression in the US general account business, down from 258 basis points in 2011 to 239 basis points in 2012. Further reductions in this source of income are anticipated in the next few years if the current low interest rate environment persists.
Fee income has increased by 24 per cent to Ł1,077 million driven by the 15 per cent increase in the Group’s average unit-linked liabilities, which principally refl ects the Ł8 billion net infl ows into Jackson’s separate accounts as well as positive net fl ows in Asia’s linked business in 2012. The fee income margin has increased from 127 basis points in 2011 to 137 basis points in 2012 as Jackson, where the fee margin is higher, contributes a greater proportion to the Group total fee income.
With-profits income has fallen from Ł331 million in 2011 to Ł311 million in 2012 in line with reductions in annual bonus rates on UK with-profits policies.
Insurance margin has increased by 40 per cent from Ł736 million in 2011 to Ł1,032 million in 2012 mainly due to the continued success of the health and protection strategy in Asia and an increase in guarantee fees in the US. 2012 also includes four months of revenue from REALIC amounting to Ł87 million following its acquisition by Jackson in September 2012.
Margin on revenues principally comprises amounts deducted from premiums to cover acquisition costs and administration expenses. The margin has increased by 17 per cent from Ł1,425 million in 2011 to Ł1,669 million in 2012. This increase is driven by Asia and primarily refiects higher premium income levels in the year.
Acquisition costs have increased in absolute terms to Ł1,997 million, in line with the increased new business sales. Expressed as a percentage of new business APE, 2012 has remained constant with 2011 at 48 per cent.
Administration expenses have increased to Ł1,248 million, principally refiecting the growth of the business in the year. Expressed as a ratio to
average liabilities, acquisition costs have increased from 83 basis points in 2011 to 87 basis points in 2012. This refiects changes in business mix and the increased proportion of commission on new sales being taken by US distributors on an annual as opposed to an initial basis.
DAC adjustments are a net benefit to the result as the deferral of current year’s acquisition costs exceeds the amortisation of previously deferred costs. This net benefit increased from Ł237 million in 2011 to Ł406 million in 2012. This increase arises in the US (where DAC adjustments were Ł442 million in 2012 compared with Ł228 million in 2011), refl ecting a return to more normal levels of DAC amortisation in 2012. 2011 included a Ł190 million charge for accelerated DAC amortisation, representing the reversal of the benefi t received in 2008 from the use of the mean reversion formula.
Financial review Prudential plc Annual Report 2012 51
IFRS basis results – Margin analysis of asset management pre-tax IFRS operating profi t based on longer-term investment returns by driver
2012 Łm
Eastspring
M&G Investments PruCap US Total
note (i)
Operating incomenote (i) 734 201 120 296 1,351
Operating profit based on longer-term investment returns 320 75 51 39 485 Financial
Average funds under management (FUM), including 49.99% review
proportional share of PPM South Africa Ł209.0bn
Average FUM, excluding PPM South Africa Ł205.1bn Ł55.0bn
Margin based on operating incomenote (ii) 36 bps 37 bps
Cost/income rationote (iii) 59% 64% Business
2011 Łm review
Eastspring
M&G Investments PruCap US Total
note (i)
Operating incomenote (i) 666 196 122 249 1,233
Operating profit based on longer-term investment returns 301 80 56 24 461
Average funds under management (FUM), including
49.99% proportional share of PPM South Africa Ł195.1bn
Average FUM, excluding PPM South Africa Ł190.9bn Ł51.4bn
Margin based on operating incomenote (ii) 35 bps 38 bps
Cost/income rationote (iii) 61% 62%
Notes
(i) Operating income is presented net of commissions and excludes performance related fees, and for M&G carried interest on private equity investments. Following the divestment in 2012 of M&G’s holding in PPM South Africa from 75 per cent to 49.99 per cent and its treatment from 2012 as an associate, M&G’s operating income and expense shown in the table above, no longer includes any element from PPM South Africa, with the share of associate’s results being presented in a separate line. In order to avoid year-on-year distortion, in the table above the 2011 operating income, margin and cost/income ratio reflect the retrospective application of the basis of presentation for 2011 results.
(ii) Margin represents operating income as defined in note (i) above as a proportion of average FUM, being the average of monthly FUM, excluding PPM South Africa. The comparatives have been altered to present 2011 on the same basis.
(iii) Cost/income ratio represents cost as a percentage of operating income as defined in note (i) above. M&G’s operating income and expense excludes any contribution from M&G’s associate, PPM South Africa.
M&G’s recent growth has seen average funds under management, excluding PPM South Africa, increase from Ł190.9 billion during 2011 to Ł205.1 billion in 2012. This has led to a 10 per cent increase in operating income to Ł734 million, equivalent to a margin of 36 basis points, an increase from 35 basis points in 2011. M&G continues to focus on cost control and the efficiencies created as the scale of the business grows. The benefit of this operational leverage is evident in an improvement in the cost to income ratio from 61 per cent in 2011 to 59 per cent in 2012.
At Eastspring Investments strong net inflows and positive market movements have led to an increase in average funds under management from Ł51.4 billion to Ł55.0 billion, with operating income rising from Ł196 million to Ł201 million. As the growth in funds stemmed principally from internal clients and fixed income mandates, the average fee margin declined from 38 basis points in 2011 to 37 basis points in 2012. Continued investment in developing the Eastspring Investment platform contributed to a higher cost to income ratio of 64 per cent in 2012 (2011: 62 per cent).
52 Business review Prudential plc Annual Report 2012
Financial review continued
IFRS basis profit after tax
AER
2012 Łm 2011 Łm
note
Operating profit based on longer-term investment returns 2,533 2,027
Short-term fiuctuations in investment returns:
– Insurance operations 122(100)
– Other operations 82(120)
204(220)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 50 21
Gain on dilution of Group holdings 42 –
Amortisation of acquisition accounting adjustments arising on the purchase of REALIC(19) –
Profit before tax attributable to shareholders 2,810 1,828
Tax charge attributable to shareholders’ profit(613)(409)
Non-controlling interests –(4)
Profit for the year attributable to shareholders 2,197 1,415
Note
Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the
IFRS financial statements.
IFRS basis profi t aft er tax
The 2012 total profit before tax attributable to shareholders was 54 per cent higher at Ł2,810 million in 2012 (2011: Ł1,828 million)1. The improvement predominantly refiects the increase in operating profit based on longer-term investment returns, and the positive investment market returns earned in the year.
IFRS operating profit is based on longer-term investment return assumptions rather than actual investment returns arising in the year. The difference between actual investment returns recorded in the income statement and longer-term returns is shown in the analysis of profits as short-term fiuctuations in investment returns.
IFRS short-term fl uctuations in investment returns
Short-term fiuctuations in investment returns for our insurance operations of positive Ł122 million comprised of positive
• 76 million for Asia, negative Ł90 million in the US and positive
• 136 million in the UK.
The positive short-term fiuctuations of Ł76 million for our Asia operations in 2012 relates to unrealised gains on bond assets held across the region following the fall in long-term yields in the period.
The combination of higher equity markets and lower market volatility in the US has reduced the technical reserves held for the variable annuity guarantees. This favourable effect was more than offset by the net unrealised value movement on derivative instruments held to manage the Group’s exposure to these guarantees, producing a net Ł90 million negative fl uctuation in our US operation.
The positive short-term fiuctuations of Ł136 million for our UK operations primarily refiect net valuation gains on fixed income assets supporting the capital of the shareholder-backed annuity business.
Short-term fiuctuations for other operations were positive Ł82 million. This primarily represents appreciation on Prudential Capital’s bond portfolio partially offset by net realised and unrealised losses in the year on derivatives held centrally to manage market risks.
Note
1 Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
Shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes
The shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes of positive Ł50 million (2011: positive Ł21 million) mainly refl ects the partial recognition of actuarial surplus in the Prudential Staff Pension Scheme following the results of the triennial valuation, further details of which are given in note I3 of the IFRS basis results.
Gain on dilution of Group holdings
On 22 February 2012, M&G completed transactions to reduce its majority holding in PPM South Africa from 75 per cent to
49.99 per cent. Under IFRS the transactions give rise to a gain on dilution of Ł42 million, which has been excluded from the Group’s IFRS operating profi t.
Amortisation of acquisition accounting adjustments arising on the purchase of REALIC
On 4 September 2012, Jackson completed the acquisition of 100 per cent of
the issued share capital of SRLC America Holding Corp. (SRLC), and its primary operating subsidiary, REALIC for a total cash consideration of Ł370 million. The amortisation primarily comprises the difference between the yield on the acquired investments based on market values at acquisition and historic investment income on book yields recognised in IFRS operating profit. Movement in the fair value acquisition adjustments on the value of business acquired and policyholder liabilities is also included. Further details are given in note I1 of IFRS basis results.
Eff ective tax rates
The effective rate of tax on operating profit based on longer-term investment returns was 23 per cent (2011: 21 per cent). The 2011 effective rate had benefited from utilising carried forward tax losses for which no deferred tax asset had been recognised.
The effective rate of tax on the total IFRS profit was 22 per cent (2011: 22 per cent). In both 2012 and 2011 we have benefited from reductions in the main UK corporation tax rate – 28 per cent to 26 per cent in 2011 and 26 per cent to 24 per cent in 2012.
Financial review Prudential plc Annual Report 2012 53
EEV results
EEV basis operating profit based on longer-term investment returns
AER CER
2012 Łm 2011 Łm Change % 2011 Łm Change %
(note)(note)
Insurance business: Financial
Asia 1,960 1,764 11 1,747 12
US 1,610 1,431 13 1,448 11 review
UK 866 853 2 853 2
Development expenses(7)(5)(40)(5)(40)
Long-term business profit 4,429 4,043 10 4,043 10 Business
UK general insurance commission 33 40(18) 40(18)
Asset management business: review
M&G (including Prudential Capital) 371 357 4 357 4
Eastspring Investments 75 80(6) 79(5)
Curian 15 6 150 6 150
US broker-dealer and asset management 24 18 33 18 33
4,947 4,544 9 4,543 9
Other income and expenditure(554)(536)(3)(536)(3)
RPI to CPI infiation measure change on defined benefit
pension schemes(note) – 45 – 45 –
Solvency II implementation costs(50)(56) 11(56) 11
Restructuring costs(22)(19)(16)(18)(22)
Total EEV basis operating profit 4,321 3,978 9 3,978 9
Note
During 2011 the Group altered its assumptions for future statutory increases to pension payments for its UK defi ned benefi t pension schemes. This refl ects the UK government’s decision to change the basis of indexation from RPI to CPI.
Prudential Group’s total EEV basis operating profi t based on longer-term investment returns was Ł4,321 million in 2012, 9 per cent higher than the Ł3,978 million earned in 2011.
Long-term business operating profit generated by the Group was Ł4,429 million (2011: Ł4,043 million). This profi t comprises:
New business profit of Ł2,452 million (2011: Ł2,151 million);
In-force profit of Ł1,984 million (2011: Ł1,897 million); and
Negative Ł7 million for development expenses (2011: negative Ł5 million).
New business profit at Ł2,452 million was 14 per cent higher than last year, refiecting a 14 per cent increase in new business APE. The higher sales volumes and pricing actions coupled with favourable business mix mitigated the pressure on margins from the low level of long-term interest rates.
The new business profit for the Asia business increased by 18 per cent to Ł1,266 million compared to Ł1,076 million in 2011. The growth in new business profit was driven by Indonesia, Singapore and Malaysia refiecting strong volume growth in Indonesia and Singapore and favourable product mix changes in Malaysia. Jackson in the US delivered new business profit of Ł873 million, an increase of 7 per cent compared to Ł815 million. Throughout 2012, Jackson proactively adjusted pricing and product features to respond to both market conditions and the competitive environment, actions which counteracted the adverse effect of lower long-term yields and tighter spreads. UK new business profit increased by 20 per cent to Ł313 million in 2012 compared to Ł260 million in 2011 and includes the benefit of two bulk annuity buy-ins in 2012. This increase refiected higher sales volumes, and a favourable change in product mix towards higher margin individual annuities and with-profits bonds.
54 Business review Prudential plc Annual Report 2012
Financial review continued
EEV basis operating profi t based on longer-term investment returns continued
The contribution to operating profi t from life in-force business was Ł1,984 million (2011: Ł1,897 million) and comprises Ł1,493 million (2011: Ł1,447 million) from the unwind of the discount on the opening embedded value and other expected returns, and Ł491 million (2011: Ł450 million) from the effect of operating assumption changes, experience variances and other items. The unwind of discount and other expected returns is Ł46 million higher than 2011 with the growth in the business more than offsetting the effect on this profi t measure of lower interest rates. The economic effects have adversely affected the unwind and other expected returns by an estimated Ł83 million.
Asia continues to be the highest contributor to the Group’s life profi t, contributing Ł1,960 million in 2012 (2011: Ł1,764 million). Included in Asia’s result is Ł694 million of profi t from in-force business (2011: Ł688 million) which includes an overall positive contribution from operating experience and assumption changes of Ł95 million (2011: Ł75 million).
US life in-force profi t was higher at Ł737 million in 2012 compared to Ł616 million in 2011, with 2012 including Ł19 million of post-acquisition profi t from REALIC. Overall experience and operating assumption changes contributed positive Ł325 million towards in-force profi ts
compared to Ł267 million in 2011. Within these amounts, swap transactions undertaken from 2010 to more closely match the overall asset and liability duration contributed enhanced profi ts with an overall spread gain of Ł205 million (2011: Ł152 million).
UK life in-force profi t was lower at Ł553 million (2011: Ł593 million) and included Ł482 million (2011: Ł485 million) from the unwind of the discount rate on the opening embedded value. Other in-force profi ts totalled Ł71 million (2011: Ł108 million) which includes a charge of Ł52 million for the annuity business refi ecting the net impact of strengthening longevity assumptions, gains on portfolio rebalancing, and releases of margins previously held in the balance sheet. Included in both years are the benefi cial effects on future profi ts arising from the reduction in UK corporation taxes enacted in both periods; in 2012 this amounted to Ł87 million, while in 2011 it amounted to Ł79 million.
Financial review Prudential plc Annual Report 2012 55
EEV basis profit after tax
AER
2012 Łm 2011 Łm
EEV basis operating profit based on longer-term investment returns 4,321 3,978
Short-term fiuctuations in investment returns:
– Insurance operations 456(787)
– Other operations 82(120) Financial
538(907)
Mark to market value movements on core borrowings(380)(14) review
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes 62 23
Effect of changes in economic assumptions(16)(158)
Gain on dilution of Group holdings 42 –
Gain on acquisition of REALIC 453 – Business
Profit before tax attributable to shareholders 5,020 2,922
Tax charge attributable to shareholders’ profit(1,207)(776) review
Non-controlling interests –(4)
Profit for the year attributable to shareholders 3,813 2,142
EEV basis profit after tax For our UK business, the short-term fiuctuations in investment
The 2012 total profits before tax attributable to shareholders was returns were positive Ł315 million (2011: negative Ł141 million).
72 per cent higher at Ł5,020 million (2011: Ł2,922 million). The This arises principally because the actual 2012 investment return
improvement predominantly reflects the increase in operating of the with-profits fund (covering policyholder liabilities and
profit based on longer-term investment returns, improved unallocated surplus) of 9.8 per cent was higher than the
markets and the gain posted on this reporting basis on the longer-term assumed rate of 5.0 per cent.
acquisition of REALIC.
Mark to market value movement on core borrowings
EEV operating profit is based on longer-term investment return The mark to market value movement on core borrowings of
assumptions rather than actual investment returns achieved. negative Ł380 million in 2012 reflects the effect on the market
Short-term fiuctuations in investment returns represent the value of Prudential’s borrowings from reductions in both interest
difference between the actual investment return and those rates and credit spreads.
assumed in arriving at the reported operating profit.
Shareholders’ share of actuarial and other gains
EEV Short-term fluctuations in investment returns and losses on defined benefit pension schemes
Short-term fiuctuations in investment returns for insurance The shareholders’ share of actuarial and other gains and
operations of positive Ł456 million comprised of positive losses on defined benefit pension schemes on the EEV basis
Ł395 million for Asia, negative Ł254 million for our US comprises the IFRS charge attributable to shareholders, and
operations and positive Ł315 million in the UK. the shareholders’ share of movements in the scheme assets and
In Asia, positive short-term fiuctuations in investment returns liabilities attributable to the PAC with-profits fund. On the EEV
of Ł395 million (2011: negative Ł155 million) principally reflect basis there was a gain of Ł62 million (2011: gain of Ł23 million)
unrealised bond and equity gains following market movements mainly reflecting the partial recognition of actuarial surplus in
in the year, principally in Hong Kong, Singapore and Taiwan. the Prudential Staff Pension Scheme following the results of the
triennial valuation, further details of which are given in note 7
In the US, short-term fiuctuations in investment returns were of EEV basis results.
negative Ł254 million (2011: negative Ł491 million). This includes
the net value movements on derivatives held to manage the
Group’s equity and interest rate exposures offset by the positive
impact of equity market increases on the expected level of future
fee income from the variable annuity separate accounts.
56 Business review Prudential plc Annual Report 2012
Financial review continued
EEV basis profi t aft er tax continued
Eff ect of changes in economic assumptions
The effect of changes in economic assumptions of negative
• 16 million, comprises negative Ł149 million for Asia, positive
• 85 million for the US and positive Ł48 million for the UK.
These refi ect the aggregate effects of the reduction in long-term yields and the associated decrease in risk discount rates across these businesses.
The adverse changes in economic assumptions for Asia of negative Ł149 million primarily refl ects the impact of lower interest rates and projected fund earned rates in Hong Kong, partially offset by the impact of a lower discount rate for Indonesia and Malaysia.
In our US business, economic effects totalled positive Ł85 million, principally refl ecting the 50 basis point reduction in the allowance for short-term credit risk for our fi xed annuity business, as the market stabilises and credit spreads reduce.
In the UK, the positive Ł48 million represents the net impact on future profi ts of reduced bond yields, where the negative impact on with-profi ts has been more than offset by the positive shareholder annuity impact.
Gain on dilution of Group holdings
On 22 February 2012, M&G completed transactions to reduce its majority holding in PPM South Africa from 75 per cent to
49.99 per cent, giving rise to gain on dilution of Ł42 million.
Gain on acquisition of REALIC
On 4 September 2012, Jackson completed acquisition of
100 per cent issued share capital of SRLC America Holding Corp., and its primary operating subsidiary, REALIC. The embedded value of the acquired business at that date of Ł823 million was higher than the consideration of Ł370 million resulting in a gain on acquisition of Ł453 million. In line with fi nancial reporting guidelines this gain has been recognised in full as a profi t in the year.
Eff ective tax rates
The 2012 effective rate on operating profi t based on longer-term investment returns of 26 per cent was consistent with the equivalent rate in 2011. The 2012 effective rate of tax on total EEV profi t of 24 per cent was lower than the equivalent rate in the previous year (2011: 27 per cent), refi ecting changes in the composition of non-operating items.
Financial review Prudential plc Annual Report 2012 57
Earnings and dividends per share
Earnings per share (EPS)
2012 pence 2011 pence
Basic EPS based on operating profit after tax and non-controlling interests
IFRSnote 76.8 62.8
EEV 125.0 115.7 Financial
Basic EPS based on total profit after tax and non-controlling interests review
IFRSnote 86.5 55.8
EEV 150.1 84.6
Note
Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the Business
IFRS financial statements.
Dividend per share Holders of US American Depositary Receipts (US Shareholders) review
Interim dividends are recorded in the period in which they are will be paid their dividends in US dollars on or about 3 June 2013.
paid. Final dividends are recorded in the period in which they are The final dividend will be paid on or about 30 May 2013 in
approved by shareholders. The final dividend for the year ended Singapore dollars to shareholders with shares standing to
31 December 2011 of 17.24 pence per ordinary share was paid the credit of their securities accounts with The Central
to eligible shareholders on 24 May 2012 and the 2012 interim Depository (Pte.) Limited (CDP) at 5.00pm Singapore time
dividend of 8.4 pence per ordinary share was paid to eligible on the Record Date (SG Shareholders). The dividend payable
shareholders on 27 September 2012. to the HK Shareholders will be translated using the exchange
rate quoted by the WM Company at the close of business on
The Board has decided to rebase the full year dividend 12 March 2013. The exchange rate at which the dividend
upwards by 4 pence, reflecting the strong progress made in payable to the SG Shareholders will be translated into SG$,
both the earnings and free surplus generation of the business will be determined by CDP. The dividend will distribute an
and in the delivery of our financial objectives. In line with this, estimated Ł532 million of shareholders’ funds.
the directors recommend a final dividend of 20.79 pence
per share (2011: 17.24 pence), which brings the total dividend Shareholders on the principal register and Irish branch register
for the year to 29.19 pence (2011: 25.19 pence), representing will be able to participate in a Dividend Reinvestment Plan.
an increase of 15.9 per cent over 2011. The Board will maintain its focus on delivering a growing
The 2012 final dividend of 20.79 pence per ordinary share will dividend from this new higher base, which will continue to
be paid on 23 May 2013 in sterling to shareholders on the be determined after taking into account the Group’s financial
principal register and the Irish branch register at 6.00pm BST on fiexibility and our assessment of opportunities to generate
Tuesday, 2 April 2013 (Record Date), and in Hong Kong dollars attractive returns by investing in specific areas of the business.
to shareholders on the Hong Kong branch register at 4.30pm The Board believes that in the medium term a dividend cover
Hong Kong time on the Record Date (HK Shareholders). of around two times is appropriate.
58 Business review Prudential plc Annual Report 2012
Financial review continued
Movement on shareholders’ funds
IFRS Łm EEV Łm
2012 2011 2012 2011
AER AER
note (a)
Operating profit based on longer-term investment returns 2,533 2,027 4,321 3,978
Items excluded from operating profit 277(199) 699(1,056)
Total profit before tax 2,810 1,828 5,020 2,922
Tax and non-controlling interests(613)(413)(1,207)(780)
Profit for the year 2,197 1,415 3,813 2,142
Exchange movements, net of related tax(216)(105)(469)(158)
Unrealised gains and losses on Jackson securities classified
as available for salenote (b) 387 349 – –
Dividends(655)(642)(655)(642)
New share capital subscribed 17 17 17 17
Other 65 9 100 71
Net increase in shareholders’ funds 1,795 1,043 2,806 1,430
Shareholders’ funds at beginning of the year 8,564 7,521 19,637 18,207
Shareholders’ funds at end of the year 10,359 8,564 22,443 19,637
Comprising
Long-term business:
Free surplusnote (c) 2,957 2,839
Required capital 3,898 3,447
Net worth 6,855 6,286
Value of in-force 15,411 13,364
Total 22,266 19,650
Other businessnote (d) 177(13)
Total(note e) 22,443 19,637
Notes
(a) Comparatives adjusted for retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 of the IFRS financial statements.
(b) Net of related changes to deferred acquisition costs and tax.
(c) The Ł1,364 million free surplus generated by the long-term business (net of new business investment and market related movements and investment in REALIC) in the year, has been used to pay Ł921 million to the holding company.
(d) Shareholders’ funds for other than long-term business comprises:
2012 Łm 2011 Łm
Asset management operationsnote 1,937 1,783
Holding company net borrowings(2,282)(2,188)
Other, net 522 392
Total shareholders’ funds for other business 177(13)
Note
Including goodwill of Ł1,230 million for 31 December 2012 and 31 December 2011.
(e) EEV shareholders’ funds excluding goodwill attributable to shareholders at 31 December 2012 is Ł20,974 million (31 December 2011: Ł18,172 million).
EEV shareholders’ funds
The shareholders’ funds at 31 December 2012 relating to long-term business of Ł22.3 billion comprise Ł9.5 billion (up 11 per cent from 31 December 2011) for our Asia long-term business operations, Ł6.0 billion
(up 19 per cent from
31 December 2011) for our US long-term business operations and Ł6.8 billion (up 12 per cent from 31 December 2011) for our UK long-term business operations.
At 31 December 2012, the embedded value for our Asian long-term business operations was Ł9.5 billion, with Ł8.0 billion (up Ł0.9 billion from 2011) being in the South-east Asia countries of Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam together with Hong Kong. For Prudential’s other Asian markets, the embedded value was Ł1.5 billion in aggregate, broadly unchanged from 2011.
Financial review Prudential plc Annual Report 2012 59
Free surplus and holding company cash flow
Overview The free surplus generation for the insurance business represents
The Group manages its internal cash flow by focusing on the free amounts maturing from the in-force operations during the year
surplus generated by the life and asset management businesses. less the investment in new business. For asset management
Remittances are, however, made as and when required by the operations we have defined free surplus generation to be the
holding company with excess surplus being left in the businesses total post-tax IFRS profit for the year.
where it can be redeployed most profitably. Financial
The Group’s free surplus generated also includes the general
Free surplus generation insurance commission earned during the year and excludes
Sources and uses of free surplus generation from the foreign exchange, capital movements, shareholders’ other review
Group’s insurance and asset management operations income and expenditure and centrally arising restructuring
The Group’s free surplus at the end of the year comprises free and Solvency II implementation costs.
surplus for the insurance businesses, representing the excess
of the net worth over the required capital included in the EEV Business
results, and IFRS net assets for the asset management businesses
excluding goodwill. review
The total movement in free surplus net of tax in the year can be analysed as follows:
2012 Łm 2011 Łm
Free surplus generation
Expected in-force cash flows (including expected return on net assets) 2,405 2,335
– Life operations 2,019 1,972
– Asset management and other operations 386 363
Changes in operating assumptions and experience variances 295 168
RPI to CPI infiation measure change on defined benefit pension schemes – 33
Underlying free surplus generated in the year from in-force business 2,700 2,536
Investment in new business(618)(553)
Underlying free surplus generated in the year 2,082 1,983
Market-related items(79)(531)
Gain on dilution of Group holdings 42 –
Acquisition of REALIC(169) –
Free surplus generated in the year 1,876 1,452
Net cash remitted by the business units(1,200)(1,105)
Other movements (including foreign exchange effects) and timing differences(408)(264)
Total movement during the year 268 83
Free surplus at 1 January 3,421 3,338
Free surplus at end of year 3,689 3,421
Comprised of:
Free surplus relating to long-term insurance business 2,957 2,839
Free surplus of other insurance business 25 29
IFRS net assets of asset management businesses excluding goodwill 707 553
Total free surplus 3,689 3,421
60 Business review Prudential plc Annual Report 2012
Financial review continued
Free surplus and holding company cash fl ow continued
During 2012 Prudential generated underlying free surplus from the in-force book of Ł2,700 million (2011: Ł2,536 million) despite lower investment return conditions, refl ecting the progress we have made in growing the portfolio of business and our focus on managing the in-force book for value. Changes in operating assumptions and experience variances were Ł295 million in 2012 compared with Ł168 million in 2011. These variances included positive Ł80 million from Asia (2011: positive Ł52 million), which in 2012 included Ł51 million from the sale of the Group’s share-holding in China Life Insurance Company of Taiwan. The US continued to record strong positive variances of Ł219 million (2011: positive Ł154 million), which included a signifi cant level of favourable spread experience. These variances also included a reduced negative Ł4 million from the UK (2011: negative Ł38 million). 2011 also benefi ted from a one-off credit of Ł33 million arising from a reduction in the liabilities of the Group’s defi ned benefi t pension schemes following the UK Government’s decision to change the basis of indexation from RPI to CPI, which did not reoccur in 2012.
Underlying free surplus generated from in-force business has been used by our life businesses to invest in new business. Investment in new business has increased by 12 per cent to Ł618 million in 2012. This compares to a 14 per cent increase in sales and a 14 per cent increase in new business profi t.
Market-related movements of negative Ł79 million in 2012 includes negative Ł330 million from the US, principally refl ecting the valuation movements of derivatives, net of movements in reserves held for variable annuity guarantees refi ecting market movements in the year. Offsetting these amounts are positive
• 114 million in Asia, positive Ł53 million from the UK and positive
• 84 million from our asset management business primarily
refi ecting in part the impact of lower bond yields on bond values in the year.
The acquisition of REALIC consumed Ł169 million of free surplus.
In contrast free surplus benefi ted by Ł42 million as a result of the divestment of M&G’s holding in PPM South Africa from 75 per cent to 49.99 per cent.
Financial review Prudential plc Annual Report 2012 61
Value created through investment in new business by life operations
2012 Łm
Asia US UK
insurance insurance insurance Group
operations operations operations total
Free surplus invested in new business(292)(281)(45)(618)
Increase in required capital 97 271 86 454 Financial
Net worth invested in new business(195)(10) 41(164)
Value of in-force created by new business 1,177 578 200 1,955 review
Post-tax new business profit for the year 982 568 241 1,791
Tax 284 305 72 661
Pre-tax new business profit for the year 1,266 873 313 2,452 Business
New business sales (APE) 1,897 1,462 836
Internal rate of returnnote >20% >20% >20% review
AER
2011 Łm
Asia US UK
insurance insurance insurance Group
operations operations operations total
Free surplus invested in new business(297)(202)(54)(553)
Increase in required capital 97 232 77 406
Net worth invested in new business(200) 30 23(147)
Value of in-force created by new business 1,011 500 172 1,683
Post-tax new business profit for the year 811 530 195 1,536
Tax 265 285 65 615
Pre-tax new business profit for the year 1,076 815 260 2,151
New business sales (APE) 1,660 1,275 746
Internal rate of returnnote >20% >20% >20%
CER
2011 Łm
Asia US UK
insurance insurance insurance Group
operations operations operations total
Free surplus invested in new business(295)(205)(54)(554)
Increase in required capital 96 235 77 408
Net worth invested in new business(199) 30 23(146)
Value of in-force created by new business 1,003 506 172 1,681
Post-tax new business profit for the year 804 536 195 1,535
Tax 261 289 65 615
Pre-tax new business profit for the year 1,065 825 260 2,150
New business sales (APE) 1,642 1,290 746
Internal rate of returnnote >20% >20% >20%
Note
The internal rate of return (IRR) is equivalent to the discount rate at which the present value of the post-tax cash fl ows expected to be earned over the lifetime of the business written in shareholder-backed life funds is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is equal to the amount required to pay acquisition costs and set up statutory reserves less premiums received, plus encumbered capital. The impact of the time value of options and guarantees is included in the calculation.
62 Business review Prudential plc Annual Report 2012
Financial review continued
Value created through investment in new business by life operations continued
Overall, the Group wrote Ł4,195 million of sales on an APE basis in 2012 (2011: Ł3,681 million) generating a post-tax new business contribution to embedded value of Ł1,791 million (2011: Ł1,536 million). To support these sales, we invested Ł618 million of capital (2011: Ł553 million) equivalent to 23 per cent (2011: 22 per cent) of underlying free surplus generated by the life in-force and asset management businesses.
In Asia, we generated an 18 per cent increase in new business profi t despite investing 2 per cent less capital at Ł292 million (2011: Ł297 million). In other words, for each Ł1 million of free surplus invested we generated Ł3.4 million of post-tax new business profi t (2011: Ł2.7 million). This improved capital effi ciency refi ects the benefi t of pricing actions and a shift in mix towards those products and geographies with lower strain and higher return characteristics. The average free surplus undiscounted payback period for business written in 2012 was three years (2011: three years).
In the US, investment in new business was Ł281 million (2011: Ł202 million), an increase of 39 per cent, and compares to a 7 per cent increase in new business profi t in the year. Consequently, for each Ł1 million of free surplus invested we generated Ł2.0 million of post-tax new business contribution to embedded value (2011: Ł2.6 million). The higher capital consumption per unit of profi t refi ects a more punitive valuation interest rate being used to establish liabilities upon policy inception following recent falls in interest rates. Notwithstanding this effect, the internal rates of return achieved in the US remain attractive at above 20 per cent, and the fast payback nature of the business written means that the initial capital outlay is recouped quickly. The average free surplus undiscounted payback period
for business written in 2012 was two years (2011: one year).
In the UK, we continue to manage capital with discipline and have achieved a 20 per cent increase in new business profi t, while investing 17 per cent less capital at Ł45 million (2011: Ł54 million). For each Ł1 million of free surplus invested, therefore, we generated Ł5.4 million of post-tax new business contribution to embedded value (2011: Ł3.6 million) benefi ting from favourable changes in business mix. These sustained levels of high capital effi ciency in the UK refi ect our strategy of participating selectively in the UK’s retirement savings and income market, focusing on those products and distribution mechanisms which meet our strict high return and short payback characteristics. The average free surplus undiscounted payback period for shareholder-backed business written in 2012 was three years (2011: four years).
Financial review Prudential plc Annual Report 2012 63
Holding company cash flow
2012 Łm 2011 Łm
Net cash remitted by business units:
UK net remittances to the Group
UK Life fund paid to the Group 216 223
Shareholder-backed business:
Other UK paid to the Group 101 116 Financial
Group invested in UK(4)(42)
Total shareholder-backed business 97 74 review
Total UK net remittances to the Group 313 297
US remittances to the Group 249 322 Business
Asia net remittances to the Group
Asia paid to the Group: review
Long-term business 491 289
Other operations 60 55
551 344
Group invested in Asia:
Long-term business(107)(50)
Other operations(103)(88)
(210)(138)
Total Asia net remittances to the Group 341 206
M&G remittances to the Group 206 213
PruCap remittances to the Group 91 67
Net remittances to the Group from business units 1,200 1,105
Net interest paid(278)(282)
Tax received 194 181
Corporate activities(158)(139)
Solvency II costs(47)(56)
Total central outflows(289)(296)
Operating holding company cash flow before dividendnote 911 809
Dividend paid(655)(642)
Operating holding company cash flow after dividendnote 256 167
Issue of hybrid debt, net of costs – 340
Repayment of subordinated debt –(333)
Hedge purchase cost (equity tail risks)(32) –
Other net cash payments(43)(205)
Total holding company cash flow 181(31)
Cash and short-term investments at beginning of year 1,200 1,232
Foreign exchange movements(1)(1)
Cash and short-term investments at end of year 1,380 1,200
Note
Including central finance subsidiaries.
64 Business review Prudential plc Annual Report 2012
Financial review continued
Holding company cash fl ow continued
We continue to manage cash fi ows across the Group with a view to achieving a balance between ensuring suffi cient net remittances from the businesses to cover the dividend (after corporate costs) and maximising value for shareholders through the retention of the free surplus generated at business unit level, so that it can be reinvested in the profi table opportunities available to the Group. On this basis, the holding company cash fi ow statement at an operating level should ordinarily balance close to zero before exceptional cash fi ows, but from time to time additional remittances from business operations will be made to provide the Group with greater fi nancial fi exibility at the corporate centre.
Operating holding company cash fi ow for 2012 before the shareholder dividend was Ł911 million, Ł102 million higher than 2011. After deducting the shareholder dividend the operating holding company cash fi ow was Ł256 million (2011: Ł167 million).
Cash remittances to the Group from business units
The holding company received Ł1,200 million of net cash remittances from the business units in 2012, an increase of 9 per cent over the Ł1,105 million received in 2011.
Asia became the largest contributor of cash, with net cash remittances to the Group in 2012 of Ł341 million (2011: Ł206 million) exceeding its 2013 cash objective. This includes non-recurring items of Ł27 million representing cash received from the sale of the Group’s holdings in China Life Insurance Company of Taiwan of Ł97 million offset by repayments of funding contingent on future profi ts of the Hong Kong Life insurance operations of Ł70 million. This fi nancing was taken out in 2009 and 2010
in order to increase the fi nancial fi exibility of the Group during the investment market crisis and has now been repaid.
Cash received from Jackson of Ł249 million for 2012 is lower than the Ł322 million remitted in 2011 as annual remittances return to a more sustainable level. This follows the exceptional release of excess surplus made in the prior year.
The UK insurance operations remitted Ł313 million in 2012 (2011: Ł297 million). Cash from the annual with-profi ts transfer to shareholders contributed Ł216 million (2011: Ł223 million). During 2012, surpluses in the UK’s shareholder-backed business were utilised to repay Ł60 million of funding contingent on future profi ts that was taken out in 2009 and 2010 and to remit a net Ł97 million (2011: Ł74 million) to Group. The UK’s objective remains Ł350 million of net cash remittances in 2013.
M&G and PruCap collectively remitted Ł297 million in 2012, as the asset management businesses continue to remit signifi cant portions of their annual post-tax earnings to the Group.
Net central outfl ows and other movements
Net central outfi ows improved to Ł289 million in 2012 (2011: Ł296 million) with higher corporate costs offset by lower net interest payments, lower Solvency II costs, and higher tax receipts.
After central costs, there was a net cash infi ow before dividend of Ł911 million in 2012 compared to Ł809 million in 2011. The dividend paid was Ł655 million in 2012 compared to Ł642 million in the same period in 2011.
Outside of the normal recurring central cash fi ow items and in light of the heightened risks surrounding the Eurozone, we incurred a net cash fi ow of Ł32 million for short-dated hedges to provide downside protection against severe equity market falls. We also incurred Ł43 million of other net cash payments in 2012, representing payments of Ł68 million to the UK tax authorities following the settlement reached in 2010 on historic tax issues offset by a receipt of Ł25 million from an increased bank loan in the year. A fi nal instalment on the agreed settlement will be paid in 2013 to the UK tax authorities at a level similar to 2012.
The overall holding company cash and short-term investment balances at 31 December 2012 was Ł180 million higher than the balance held at the end of 2011 at Ł1.4 billion. The company seeks to maintain a central cash balance in excess of Ł1 billion.
Financial review Prudential plc Annual Report 2012 65
EEV balance sheet
Summary
AER
2012 Łm 2011 Łm
(note)
Goodwill attributable to shareholders 1,469 1,465 Financial
Investments 283,428 250,605
Holding company cash and short-term investments 1,380 1,200 review
Other 23,976 19,475
Total assets 310,253 272,745
Less: Liabilities
Policyholder liabilities 260,774 227,075 Business
Unallocated surplus of with-profits funds 10,589 9,215 review
271,363 236,290
Less: Shareholders’ accrued interest in the long-term business(12,084)(11,073)
259,279 225,217
Core structural borrowings of shareholders’ financed operations (IFRS book value basis) 3,554 3,611
Other liabilities including non-controlling interest 24,977 24,280
Total liabilities and non-controlling interest 287,810 253,108
EEV basis net assets 22,443 19,637
Share capital and premium 2,017 2,000
IFRS basis shareholders’ reserves 8,342 6,564
IFRS basis shareholders’ equity 10,359 8,564
Additional EEV basis retained profit 12,084 11,073
EEV basis shareholders’ equity (excluding non-controlling interest) 22,443 19,637
Note
The 2011 comparative component of EEV shareholders’ funds for the IFRS basis shareholders’ equity and the additional EEV basis retained profi t have been adjusted for the retrospective application of the accounting policy change for deferred acquisition costs as discussed in note A5 to the IFRS fi nancial statements. Total EEV shareholders’ funds for 2011 are not altered by the change of IFRS policy.
Net asset value per share Investments
2012 2011 The Group is exposed to financial risk through its financial assets,
financial liabilities and policyholder liabilities. The key financial
EEV 878p 771p risk factors that affect the Group include market risk, credit risk
IFRS 405p 336p and liquidity risk. Information on the Group’s exposure to
financial risk factors, and our financial risk management
objectives and policies, is provided in the Risk and capital
management section. Further information on the sensitivity of
the Group’s financial instruments to market risk and its use of
derivatives is also provided in the IFRS financial statements.
The Group’s investments are discussed in further detail in the
Risk and capital management section B.1.b ‘Credit risk’.
66 Business review Prudential plc Annual Report 2012
Financial review continued
Policyholder liabilities and unallocated surplus of with-profits funds
2012 Łm 2011 Łm
Shareholder-backed business Asia US UK Total Total
At 1 January 18,269 69,189 46,048 133,506 122,183
Premiums 4,141 14,907 3,801 22,849 20,296
Surrenders(1,933)(4,356)(2,585)(8,874)(7,975)
Maturities/Deaths(226)(954)(2,345)(3,525)(3,315)
Net cash flows 1,982 9,597(1,129) 10,450 9,006
Investment related items and other movements 1,539 4,241 4,586 10,366 1,988
Acquisition of REALIC – 12,912 – 12,912 –
Foreign exchange translation differences(577)(3,678) –(4,255) 329
At 31 December 21,213 92,261 49,505 162,979 133,506
With-profits funds
– Policyholder liabilities 97,795 93,569
– Unallocated surplus 10,589 9,215
Total at 31 December 108,384 102,784
Total policyholder liabilities including unallocated surplus
at 31 December 271,363 236,290
Policyholder liabilities and unallocated surplus of with-profi ts funds
Policyholder liabilities relating to shareholder-backed business grew by Ł29.5 billion from Ł133.5 billion at 31 December 2011 to Ł163.0 billion at 31 December 2012.
The increase refi ects positive net fi ows (premiums net of upfront charges less surrenders, maturities and deaths) of Ł10.5 billion in 2012 (2011: Ł9.0 billion), driven by strong infl ows in the US
• 9.6 billion and Asia Ł2.0 billion. The negative net flows in UK
• 1.1 billion are distorted by the fiuctuating nature of unit-linked
corporate pension scheme transfers. Net fi ows in Asia have increased by 8 per cent to Ł2.0 billion in 2012 (2011: Ł1.8 billion) while the overall rate of surrenders in the region (expressed as a percentage of opening liabilities) was 10.6 per cent in 2012 (2011: 9.8 per cent). Excluding India, where the market has been going through a signifi cant period of change following regulatory changes in 2010, the surrender rate in 2012 was 9.7 per cent (2011: 9.6 per cent).
Other movements include negative foreign exchange effects of
Ł4.3 billion (2011: positive Ł0.3 billion) together with investment related and other items of Ł10.4 billion. Investment related and other items increased from Ł2.0 billion in 2011 to Ł10.4 billion in 2012 principally following improvements in the bond and equity markets. The acquisition of REALIC refi ects the liabilities acquired at the date of acquisition.
During 2012, the unallocated surplus, which represents the excess of assets over policyholder liabilities for the Group’s with-profi ts funds on an IFRS basis, increased by 15 per cent from Ł9.2 billion at 31 December 2011 to Ł10.6 billion at
31 December 2012.
Financial review Prudential plc Annual Report 2012 67
Shareholders’ net borrowings and ratings
Shareholders’ net borrowings at 31 December 2012:
2012 Łm 2011 Łm
Mark to Mark to
IFRS market EEV IFRS market EEV
basis value basis basis value basis
Perpetual subordinated Capital securities Financial
(Innovative Tier 1) 1,746 120 1,866 1,823(10) 1,813
Subordinated notes (Lower Tier 2) 831 258 1,089 829 120 949 review
2,577 378 2,955 2,652 110 2,762
Senior debt:
2023 300 94 394 300 56 356
2029 249 64 313 249 21 270 Business
Holding company total 3,126 536 3,662 3,201 187 3,388 review
Prudential Capital 275 – 275 250 – 250
Jackson surplus notes (Lower Tier 2) 153 43 196 160 17 177
Total 3,554 579 4,133 3,611 204 3,815
Less: Holding company cash and short-term
investments(1,380) –(1,380)(1,200) –(1,200)
Net core structural borrowings of shareholder-
financed operations 2,174 579 2,753 2,411 204 2,615
Shareholders’ net borrowings and ratings
On an IFRS basis, the Group’s core structural borrowings at
31 December 2012 were broadly unchanged at Ł3.6 billion.
After adjusting for holding company cash and short-term investments of Ł1,380 million, net core structural borrowings at 31 December 2012 were Ł2,174 million compared with
• 2,411 million at 31 December 2011. The decrease of
• 237 million represents the net fall in borrowings of Ł57 million,
mainly refi ecting the foreign exchange movements in the year, together with a Ł180 million rise in holding company cash and short-term investments.
In addition to its core structural borrowings set out above, Prudential also has in place an unlimited global commercial paper programme. As at 31 December 2012, commercial paper issued under this programme totalled Ł183 million, US$1,512 million, ¤493 million, CHF20 million and AU$12 million. The central treasury function also manages our Ł5 billion medium-term note (MTN) programme, covering both core and non-core borrowings. In November 2012 Prudential issued a Ł300 million three-year senior note to pre-fi nance a Ł250 million senior note maturing in January 2013 for operational funding. Also in January 2013 Prudential issued a new US$700 million 5.25 per cent perpetual Innovative Tier 1 hybrid under this programme, primarily to Asian retail investors. Under the MTN programme at 31 December 2012 the outstanding subordinated debt was Ł835 million, US$1,300 million and ¤20 million and the senior debt outstanding was
Ł550 million. In addition, Prudential’s holding company has access to Ł2.1 billion of syndicated and bilateral committed revolving credit facilities, provided by 17 major international banks, expiring between 2013 and 2017. Apart from small draw downs to test the process, these facilities have never been drawn, and there were no amounts outstanding at 31 December 2012. The commercial paper
programme, the MTN programme and the committed revolving credit facilities are all available for general corporate purposes and to support the liquidity needs of Prudential’s holding company and are intended to maintain a strong and fl exible funding capacity.
Prudential manages the Group’s core debt within a target level consistent with its current debt ratings. At 31 December 2012, the gearing ratio (debt, net of cash and short-term investments, as a proportion of EEV shareholders’ funds plus net debt) was 8.8 per cent, compared with 10.9 per cent at 31 December 2011. Prudential plc has strong debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential’s long-term senior debt is rated A+, A2 and A from Standard & Poor’s, Moody’s and Fitch, while short-term ratings are A-1, P-1 and F1 respectively. All ratings from Fitch and Moody’s are on stable outlook, and all ratings from Standard & Poor’s are on negative outlook.
The fi nancial strength of PAC is rated AA by Standard & Poor’s, Aa2 by Moody’s and AA by Fitch.
Jackson National Life Insurance Company’s fi nancial strength is rated AA by Standard & Poor’s, A1 by Moody’s and AA by Fitch.
Financial strength of the UK Long-term Fund
On a realistic valuation basis, with liabilities recorded on a market consistent basis, the free assets were valued at approximately Ł7.0 billion at 31 December 2012 (31 December 2011: Ł6.1 billion), before a deduction for the risk capital margin. The value of the shareholders’ interest in future transfers from the UK with-profi ts fund is estimated at Ł2.1 billion (31 December 2011: Ł2.0 billion).
Despite the continued volatility in fi nancial markets, Prudential UK’s With-Profi ts fund performed relatively strongly achieving a 9.8 per cent pre-tax investment return for policyholder asset shares during 2012.
68 Business review Prudential plc Annual Report 2012
Risk and capital management
As a provider of fi nancial services, including insurance, the management of risk lies at the heart of Prudential’s business. As a result, eff ective risk management capabilities represent a key source of competitive advantage for the Group.
The Group’s risk framework includes the Group’s appetite for risk exposures as well as its approach to risk management. Under this approach, Prudential continuously assesses the Group’s top risks and monitors its risk profi le against approved limits. Prudential’s main strategies for managing and mitigating risk include asset liability management, using derivatives to hedge relevant market risks, and implementing reinsurance and corporate
insurance programmes.
A. Group risk appetite
(Audited)
Prudential defi nes and monitors aggregate risk limits based on fi nancial and non-fi nancial stresses for its earnings volatility,
liquidity and capital requirements.
Earnings volatility: the objectives of the limits are to ensure that:
a the volatility of earnings is consistent with the expectations of stakeholders;
b the Group has adequate earnings (and cash flows) to service debt, expected dividends and to withstand unexpected shocks; and
c earnings (and cash flows) are managed properly across geographies and are consistent with funding strategies.
B. Risk exposures
The two measures used to monitor the volatility of earnings are European Embedded Value (EEV) operating profi t and International Financial Reporting Standards (IFRS) operating profi t, although EEV and IFRS total profi ts are also considered.
Liquidity: the objective is to ensure that the Group is able to generate suffi cient cash resources to meet fi nancial obligations as they fall due in business as usual and stressed scenarios.
Capital requirements: the limits aim to ensure that:
a the Group meets its internal economic capital requirements;
b the Group achieves its desired target rating to meet its business objectives; and
c supervisory intervention is avoided.
The two measures used are the EU Insurance Groups Directive (IGD) capital requirements and internal economic capital requirements. In addition, capital requirements are monitored on both local statutory and future Solvency II regulatory bases.
Prudential’s risk appetite framework forms an integral part of its annual business planning cycle. The Group Risk Committee is responsible for reviewing the risks inherent in the Group’s business plan and for providing the Board with input on the risk/reward trade offs implicit therein. This review is supported by the Group Risk function, which uses submissions by business units to calculate the Group’s aggregated position (allowing for diversifi cation effects between business units) relative to the limits contained within the risk appetite statements.
(Audited)
The Group Risk Framework deploys a common risk language, allowing meaningful comparisons to be made between different business units. Risks are broadly categorised as shown below:
Category Risk type Definition
Financial risks Market risk The risk of loss for the Group’s business, or of adverse change in the
financial situation, resulting, directly or indirectly, from fluctuations
in the level or volatility of market prices of assets and liabilities.
Credit risk The risk of loss for the Group’s business or of adverse change in the
financial position, resulting from fluctuations in the credit standing
of issuers of securities, counterparties and any debtors in the form of
default or other significant credit event (eg downgrade or spread widening).
Insurance risk The risk of loss for the Group’s business or of adverse change in the value
of insurance liabilities, resulting from changes in the level, trend, or
volatility of a number of insurance risk drivers. This includes adverse
mortality, longevity, morbidity, persistency and expense experience.
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.
Non-financial risks Operational risk The risk of loss arising from inadequate or failed internal processes, or
from personnel and systems, or from external events other than those
covered by business environment risk.
Business Exposure to forces in the external environment that could significantly
environment risk change the fundamentals that drive the business’s overall strategy.
Strategic risk Ineffective, inefficient or inadequate senior management processes for
the development and implementation of business strategy in relation to
the business environment and the Group’s capabilities.
The key fi nancial and non-fi nancial risks and uncertainties faced by the Group, that have been considered by the Group Risk Committee, and Prudential’s approaches to managing them, are described below:
B.1 Financial risks a Market risk i Equity risk
(Audited)
In the UK business, most of Prudential’s equity exposure is incurred in the with-profi ts fund, which includes a large inherited estate estimated at Ł7.0 billion as at
31 December 2012 (31 December 2011: Ł6.1 billion). This can absorb market fl uctuations and protect the fund’s solvency. The inherited estate itself is partially protected against falls in equity markets through an active hedging policy.
In Asia, Prudential’s shareholder exposure to equities relates to revenue from unit-linked products and, from a capital perspective, to the effect of falling equity markets on the with-profi ts businesses.
In the US, where we are a leading provider of variable annuities, there are risks associated with the guarantees embedded in our products. We provide guaranteed minimum death benefi ts (GMDB) on substantially all policies in this class, guaranteed minimum withdrawal benefi ts (GMWB) on a signifi cant proportion of the book, and guaranteed minimum income benefi ts (GMIB) on only 3 per cent. To protect the shareholders against the volatility introduced by these embedded options, we use both a comprehensive hedging programme and reinsurance. The GMIB is no longer offered, with existing coverage being reinsured.
The Jackson IFRS shareholders’ equity and US statutory capital are sensitive to the effects of policyholder behaviour on the valuation of GMWB guarantees, but to manageable levels.
In our variable annuity sales activities, we focus on meeting the needs of conservative and risk averse customers who are seeking reliable income in retirement, and who display little tendency to arbitrage their guarantees. These customers generally select conservative investment options. We are able to meet the needs of these customers because of the strength of our operational platform.
It is our philosophy not to compete on price; rather, we seek to sell at a price suffi cient to fund the cost we incur to hedge or reinsure our risks and to achieve an acceptable return for our shareholders.
We use a macro approach to hedging that covers the risks inherent across the US business. Within this macro approach we make use of the natural offsets that exist between the variable annuity guarantees and the fi xed index annuity book, and then use a combination of over-the-counter (OTC) options and exchange traded derivatives to hedge the remaining risk, considering signifi cant market shocks and limiting the amount of capital we are putting at risk. Internal positions are generally netted before any external hedge positions are considered. The hedging programme also covers the fees on variable annuity guarantees.
Risk and capital management Prudential plc Annual Report 2012 69
Jackson hedges the economics of its products rather than the
accounting result. This focus means that we accept a degree of
variability in our accounting results in order to ensure we achieve Risk
the appropriate economic result. Accordingly, while Jackson’s and
hedges are effective on an economic basis, due to different
accounting treatment for the hedges and some of the underlying capital
hedged items on an IFRS basis, the reported income effect is
more variable.
ii Interest rate risk
(Audited) management
Interest rate risk arises from Prudential’s investments in long-term
debt and fixed income securities, and also exists in policies that
carry investment guarantees on early surrender or at maturity,
where claim values can become higher than the value of backing Business
assets as a result of rises or falls in interest rates.
In Asia, the exposure to interest rate risk arises from the review
guarantees of some non-unit-linked investment products. This
exposure arises because it may not be possible to hold assets
which will provide cash flows to match exactly those relating to
policyholder liabilities. This results in a mismatch due to the
duration and uncertainty of the liability cash flows and the lack of
sufficient assets of a suitable duration. While this residual asset/
liability mismatch risk can be managed, it cannot be eliminated.
In the US, there is interest rate risk across the portfolio. The
majority of Jackson’s fixed annuity and life liabilities allow for
an annual reset of the crediting rate, which provides for a greater
level of discretion in determining the amount of interest rate risk
to assume. The primary concerns with these liabilities relate to
potential surrenders when rates increase and, in a low interest
environment, the minimum guarantees required by state law. For
variable annuities, interest rate changes will infiuence the level of
reserves held for certain guaranteed benefits. With its large fixed
annuity and fixed index annuity books, Jackson has natural
offsets for its variable annuity interest-rate related risks. Jackson
manages interest rate exposure through a combination of interest
rate swaps and interest rate options.
In the UK, the investment policy for the shareholder-backed
annuity business is to match the annuity payments with the cash
flows from investments. As a result, assets and liabilities are
closely matched by duration. The impact on profit of any residual
cash flow mismatching can be adversely affected by changes in
interest rates; therefore the mismatching position is regularly
monitored. The guarantees of the with-profit business give rise
to some interest rate discounting risk as falling rates may result
in an increase in the cost of guarantees. Except for severe stress
scenarios where shareholders’ support may be required, this
risk is borne by the with-profits fund.
iii Foreign exchange risk
(Audited)
Prudential principally operates in the UK, the US and in
Asia. The geographical diversity of its businesses means that
Prudential is inevitably subject to the risk of exchange rate
fluctuations. Prudential’s international operations in the US and
Asia, which represent a significant proportion of its operating
profit and shareholders’ funds, generally write policies and invest
in assets denominated in local currency. Although this practice
limits the effect of exchange rate fiuctuations on local operating
results, it can lead to significant fluctuations in Prudential’s
consolidated financial statements when results are expressed
in pounds sterling.
70 Business review Prudential plc Annual Report 2012
Risk and capital management continued
The Group retains revenues locally to support the growth of the Group’s business and capital is held in the local currency of the business to meet local regulatory and market requirements, accepting the balance sheet translation risks this can produce. However, in cases where a surplus arising in an overseas operation supports Group capital or shareholders’ interest (ie remittances), this exposure is hedged if it is economically optimal to do so. The Group does not have appetite for signifi cant shareholder exposures to foreign exchange risks in currencies outside the local territory. Currency borrowings, swaps and other derivatives are used to manage exposures.
b Credit risk
(Audited)
In addition to business unit and Group-wide operational limits on credit risk, Prudential monitors closely its counterparty exposures at Group level, highlighting those that are large or of concern. Where appropriate, Prudential will reduce its exposure, purchase credit protection or make use of collateral arrangements to control its levels of credit risk.
The Group’s balance sheet held the following total investments at 31 December 2012:
2012 Łbn 2011 Łbn
Unit-linked
Participating and variable Shareholder- Total Total
funds annuities backed Group Group
Debt securities 62.0 9.5 68.6 140.1 124.5
Equity 25.1 73.9 1.0 100.0 87.3
Property investments 8.7 0.6 1.6 10.9 10.8
Mortgage loans 1.3 – 4.8 6.1 5.7
Other loans 1.4 – 4.3 5.7 4.0
Deposits 9.5 1.4 1.8 12.7 10.7
Other investments 4.7 – 3.2 7.9 7.6
Total 112.7 85.4 85.3 283.4 250.6
The table below presents the balances of investments related to shareholder-backed operations at 31 December 2012.
2012 Łbn 2011 Łbn
Shareholder-backed investments:
Asia life 8.7 7.1
UK life 31.3 28.5
US life 42.0 34.0
Other 3.3 3.8
Total 85.3 73.4
Shareholders are not directly exposed to value movements on assets backing participating or unit-linked operations, with sensitivity mainly related to shareholder-backed operations.
i Debt portfolio
(Audited)
The investments held by the shareholder-backed operations are predominantly debt securities, of which 95 per cent are rated, either externally or internally, as investment grade (31 December 2011: 95 per cent).
The Group’s total debt securities portfolio on an IFRS basis comprised the following at 31 December 2012:
2012 Łbn 2011 Łbn
Unit-linked
Participating and variable Shareholder- Total Total
funds annuities* backed Group Group
Insurance operations:
UK 50.5 6.3 27.1 83.9 78.0
Jackson National Life – – 33.0 33.0 27.0
Asia long-term business 11.5 3.2 6.7 21.4 17.7
Other operations – – 1.8 1.8 1.8
Total 62.0 9.5 68.6 140.1 124.5
* Jackson’s variable annuity separate account assets comprise equity securities and portfolio holdings in unit trusts (including mutual funds), the majority of which are equity based.
Risk and capital management Prudential plc Annual Report 2012 71
UK unit-linked funds where the shareholders’ risk is limited, with
The UK’s debt portfolio on an IFRS basis is Ł83.9 billion as the remaining Ł27.1 billion backing the shareholders’ annuity
at 31 December 2012, including Ł50.5 billion within the UK business and other non-linked business (of which 75 per cent is Risk
with-profits fund. Shareholders’ risk exposure to the with-profits rated AAA to A-, 23 per cent BBB and 2 per cent non-investment and
fund is limited as the solvency is protected by the large inherited grade). The UK shareholder-backed portfolio did not experience
estate. Outside the with-profits fund there is Ł6.3 billion in any default losses in 2012. capital
US
At 31 December 2012, Jackson’s fixed income debt securities portfolio consisted of: management
Summary 2012 Łm 2011 Łm
Corporate and government security and commercial loans:
Government 4,126 2,163 Business
Publicly traded and SEC Rule 144A securitiesnote 19,699 16,281
Non-SEC Rule 144A securities 3,542 3,198 review
Total 27,367 21,642
Residential mortgage-backed securities (RMBS) 2,400 2,591
Commercial mortgage-backed securities (CMBS) 2,639 2,169
Other debt securities 587 620
Total US debt securities 32,993 27,022
Note
A 1990 SEC rule that facilitates the resale of privately placed securities that are without SEC registration to qualifi ed institutional investors. The rule was designed to develop a more liquid and effi cient institutional resale market for unregistered securities.
Of the Ł23.2 billion of corporate debt, 95 per cent is investment grade. Concentration risk within the corporate debt portfolio is low, with the top ten holdings accounting for approximately 8 per cent of the portfolio. Our largest sector exposures in the investment grade corporate debt portfolio are Energy and Utilities at 15 per cent and 13 per cent, respectively. We actively manage the portfolio and will sell exposures as events dictate.
Within the RMBS portfolio of Ł2.4 billion, the portion guaranteed by the US government sponsored agencies is 57 per cent.
The CMBS portfolio of Ł2.6 billion is performing strongly, with 40 per cent of the portfolio rated AAA and less than 2 per cent rated below investment grade. The entire portfolio has an average credit enhancement level of 31 per cent. This level provides signifi cant protection, since it means the underlying collateral has to incur a 31 per cent loss, net of recoveries, before our holding is at risk.
Jackson’s debt securities experienced total credit-related losses in 2012 of Ł47 million (2011: Ł52 million). This includes a loss net of recoveries of Ł10 million (2011: gains of Ł10 million) on credit-related sales of impaired bonds. IFRS write-downs on debt securities were Ł37 million (2011: Ł62 million). Of this amount of write-downs, Ł8 million (2011: Ł21 million) was in respect to RMBS securities. In addition to the amounts for debt securities, there were Ł5 million (2011: Ł28 million) of write-downs on Jackson’s commercial mortgage loan portfolio. In 2012 and 2011, Jackson did not experience any defaults on its debt securities.
The impairment process refi ects a review of every bond and security in
our portfolio. Our accounting policy requires us to book full mark to market losses on impaired securities through our balance sheet. However, we would expect only a proportion of these losses eventually to turn into defaults, and some of the impaired securities to recover in price over time.
Unrealised gains and losses on debt securities in the US
Jackson’s net unrealised gains from debt securities were Ł2,807 million at 31 December 2012, compared to Ł2,057 million at 31 December 2011. The gross unrealised loss position was Ł178 million at 31 December 2012 (31 December 2011: Ł246 million). Gross unrealised losses on securities priced at less than 80 per cent of face value totalled Ł53 million at 31 December 2012 compared to Ł158 million at
31 December 2011.
Asia
Asia’s debt portfolio totalled Ł21.4 billion at 31 December 2012. Of this, approximately 69 per cent was in unit-linked and with-profi ts funds with minimal shareholders’ risk. The remaining 31 per cent is shareholder exposure and is invested predominantly (65 per cent) in investment grade bonds. The Asian portfolio has performed very well, and did not experience any default losses in 2012.
Asset management
The debt portfolio of the Group’s asset management operations of Ł1.8 billion as at 31 December 2012 is principally related to Prudential Capital operations. Of this amount Ł1.5 billion were rated AAA to A- by S&P or Aaa by Moody’s.
ii Group sovereign debt exposure
(Audited)
Sovereign debt represented 15 per cent or Ł10.4 billion of the debt portfolio backing shareholder business (excluding unit-linked business) at 31 December 2012 (2011: 16 per cent and
Ł9.2 billion respectively). 38 per cent of this was rated AAA and 92 per cent investment grade (2011: 43 per cent and 94 per cent respectively). Of the Group’s holdings in Continental Europe of Ł564 million, 79 per cent was AAA rated (2011: Ł690 million and 87 per cent respectively). Shareholder exposure to the Eurozone sovereigns of Portugal, Italy, Ireland, Greece and Spain (PIIGS) is Ł52 million (2011: Ł44 million). The Group does not have any sovereign debt exposure to Greece, Portugal or Ireland.
72 Business review Prudential plc Annual Report 2012
Risk and capital management continued
The exposure of the Group’s shareholder and with-profi ts funds to sovereign debt (including credit default swaps that are referenced to sovereign debt) at 31 December 2012 is as follows.
31 December 2012 Łm 31 December 2011 Łm
Shareholder With-profits Shareholder With-profits
sovereign sovereign sovereign sovereign
debt debt debt debt
Continental Europe:
Italy 51 59 43 52
Spain 1 31 1 33
52 90 44 85
Germany 444 469 598 602
Other Europe (principally Belgium and Isle of Man) 68 41 48 62
564 600 690 749
United Kingdom 3,432 2,306 3,254 2,801
United States 3,585 1,169 2,448 2,615
Other, predominantly Asia 2,867 271 2,850 332
Total 10,448 4,346 9,242 6,497
Holdings of UK government debt accounted for Ł3.4 billion of the Prudential actively mitigates the level of Group-wide credit risk
shareholder sovereign debt portfolio at 31 December 2012. Post(invested credit and counterparty) through a comprehensive
year end, the United Kingdom no longer has a unanimous AAA system of hard limits, collateralisation agreements and centrally
rating, as Moody’s on 22 February 2013 lowered its rating to Aa1. managed ‘watch lists’.
However, given that the vast majority of the debt backs sterling
Of the Ł68.6 billion of debt securities backing shareholder
liabilities, the downgrade has not resulted in large price
business, excluding holdings attributable to external holders of
fiuctuations in the gilt market and that the rating remains very
consolidated unit trusts, 3 per cent or Ł2.2 billion was in Tier 1
strong, the downgrade is not expected to significantly impact
and Tier 2 hybrid bank debt. A further Ł3.2 billion was in the
the Group’s balance sheet and earnings.
form of senior debt.
iii Exposure to bank debt securities In terms of shareholder exposures to the bank debt of PIIGS,
(Audited) Prudential held Ł260 million at 31 December 2012
Prudential expects that any second order sovereign credit(31 December 2011: Ł328 million). This comprised Ł130 million
exposures would most likely be concentrated in the banking of covered bonds, Ł93 million senior debt, Ł3 million Tier 1 debt
sector. The Group’s bank exposure is a function of its core and Ł34 million Tier 2 debt. There was no direct exposure to
investment business, as well as of the hedging and other activities Greek banks.
undertaken to manage its various financial risks. Prudential relies
on public information and credit research sources to identify
banks with large concentrations of indirect exposure.
Prudential has a range of controls and processes to manage
credit exposure. In addition to the control frameworks that cover
shareholder and policyholder credit risk within each business
unit, the Group Credit Risk Committee oversees shareholder
credit risk across the Group. The Committee receives
comprehensive management information, including details of
counterparty and invested credit exposure (including structured
credit and loans), secured and unsecured cash balances, top
30 credit exposures, and an analysis of shareholder exposure by
industry/country and rating. The business units and the Group
Risk function also continually monitor the portfolio for emerging
credit risks through various tools and processes.
Risk and capital management Prudential plc Annual Report 2012 73
The Group held the following direct exposures to banks’ debt securities of shareholder-backed business at 31 December 2012.
Bank debt securities – shareholder-backed business Łm Risk
Senior debt Subordinated debt and
Total
Total senior subordinated 31 Dec 2012 31 Dec 2011 capital
Covered Senior debt Tier 2 Tier 1 debt Total Total
Portugal – 37 37 – – – 37 24
Ireland – 16 16 – – – 16 13
Italy – 29 29 10 – 10 39 81 management
Greece – – – – – – – –
Spain 130 11 141 24 3 27 168 210
130 93 223 34 3 37 260 328
Austria – – – 11 – 11 11 9 Business
France 18 62 80 72 43 115 195 149
Germany – 33 33 18 – 18 51 29 review
Luxembourg – – – – – – – –
Netherlands – 16 16 86 80 166 182 152
United Kingdom 486 181 667 700 99 799 1,466 1,083
Total Europe 634 385 1,019 921 225 1,146 2,165 1,750
United States – 1,770 1,770 467 6 473 2,243 1,716
Other, predominantly
Asia 30 334 364 352 220 572 936 841
Total 664 2,489 3,153 1,740 451 2,191 5,344 4,307
In addition to the exposures held by the shareholder-backed business, the Group held the following banks’ securities at 31 December 2012 within its with-profi ts funds.
Bank debt securities – participating funds Łm
Senior debt Subordinated debt
Total
Total senior subordinated 31 Dec 2012 31 Dec 2011
Covered Senior debt Tier 2 Tier 1 debt Total Total
Portugal – 6 6 – – – 6 7
Ireland 6 – 6 – – – 6 –
Italy – 71 71 4 – 4 75 96
Greece – – – – – – – 5
Spain 173 12 185 – 1 1 186 138
179 89 268 4 1 5 273 246
Austria – – – – – – – –
France 16 78 94 56 7 63 157 144
Germany – – – – – – – 7
Luxembourg – – – – – – – 7
Netherlands – 136 136 2 – 2 138 122
United Kingdom 725 423 1,148 749 7 756 1,904 1,550
Total Europe 920 726 1,646 811 15 826 2,472 2,076
United States – 1,837 1,837 240 6 246 2,083 2,052
Other, predominantly
Asia 48 340 388 206 61 267 655 746
Total 968 2,903 3,871 1,257 82 1,339 5,210 4,874
74 Business review Prudential plc Annual Report 2012
Risk and capital management continued
iv Other possible impacts of a Eurozone crisis
(Audited)
Other knock on impacts of a Eurozone crisis may represent some risk to the Group, both in terms of fi nancial market impact and potential operational issues. These third order exposures are intrinsically more diffi cult to quantify. However, as well as the monitoring routines noted above, Prudential has also developed tools to identify the Group’s exposure to counterparties at risk (including contingent credit exposures), and has in place Group-wide processes to facilitate the management of such risks should they materialise.
In respect of operational risks, we believe we have strong investment operations, counterparty risk and change management capabilities that enable us to manage the transition to a new Eurozone regime if events require it to do so.
v Loans
(Audited)
Of the total Group loans of Ł11.8 billion at 31 December 2012, the following are held by shareholder-backed operations.
2012 Łbn 2011 Łbn
Mortgage Other Mortgage Other
loans loans Total loans loans Total
Asia insurance operationsnote (i) – 0.4 0.4 – 0.4 0.4
US insurance operationsnote (ii) 3.5 2.7 6.2 3.6 0.6 4.2
UK insurance operationsnote (iii) 1.3 – 1.3 1.1 – 1.1
Asset management operationsnote (iv) – 1.2 1.2 – 1.3 1.3
Total loans held by shareholder-backed
operations 4.8 4.3 9.1 4.7 2.3 7.0
Notes
(i) The majority of Asia insurance operations loans are commercial loans held by the Malaysian operation that are rated investment grade by two local rating agencies.
(ii) The US insurance operations held Ł6.2 billion of loans, comprising Ł3.5 billion of commercial mortgage loans and Ł2.7 billion of policy loans.
Approximately Ł1.8 billion of the policy loans are held as collateral related to the three reinsurance treaties with Swiss Re, which are offset by a funds withheld liability. These loans are carried at fair value. All other loans are accounted for at amortised cost, less any impairment. All commercial mortgage loans held by US insurance operations are collateralised by properties. The US commercial mortgage loan portfolio does not include any single-family residential mortgage loans and therefore is not exposed to the risk of defaults associated with residential sub-prime mortgage loans. Jackson incurred write downs of Ł5 million on its commercial mortgage book (2011: write-downs of Ł28 million).
(iii) The majority of mortgage loans held by UK insurance operations are mortgage loans collateralised by properties.
(iv) Relates to bridging loan finance managed by Prudential Capital.
vi Counterparty credit risk
(Audited)
The Group enters into a variety of exchange traded and over-the-counter derivative fi nancial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.
All over-the-counter derivative transactions, with the exception of some Asian transactions, are conducted under standardised ISDA (International Swaps and Derivatives Association Inc) master agreements and the Group has collateral agreements between the individual Group entities and relevant counterparties in place under each of these market master agreements.
The Group’s exposure to derivative counterparty and reinsurance counterparty credit risk is subject to the same framework of Group-wide operational limits and monitoring as its invested credit risk. Where appropriate, Prudential will reduce its exposure, purchase credit protection or make use of additional collateral arrangements to control its levels of counterparty credit risk.
c Insurance risk
(Audited)
The processes of determining the price of Prudential’s products and reporting the results of its long-term business operations require Prudential to make a number of assumptions. In common with other industry players, the profi tability of Prudential’s businesses depends on a mix of factors including mortality and morbidity levels and trends, persistency, investment performance, unit cost of administration and new business acquisition expenses.
Prudential continues to conduct research into longevity risk using data from its substantial annuity portfolio. The assumptions that Prudential makes about future expected levels of mortality are particularly relevant in its UK annuity business. The attractiveness of transferring longevity risk (via reinsurance and other external solutions) is regularly evaluated. These are used as risk management tools where it is appropriate and attractive to do so.
Prudential’s morbidity risk is mitigated by appropriate underwriting and use of reinsurance and the morbidity assumptions refi ect recent experience and expectation of future trends for each relevant line of business.
Prudential’s persistency assumptions refl ect recent experience for each relevant line of business, and any expectations of future persistency. Persistency risk is mitigated by appropriate training and sales processes and managed proactively post sale. Where appropriate, allowance is also made for the relationship – either assumed or historically observed – between persistency and investment returns, and for the resulting additional risk.
d Liquidity risk
(Audited)
The parent company has signifi cant internal sources of liquidity which are
suffi cient to meet all of its expected requirements for the foreseeable future without having to make use of external funding. In aggregate the Group has Ł2.1 billion of undrawn committed facilities, expiring between 2013 and 2017. In addition, the Group has access to liquidity via the debt capital markets. Prudential also has in place an unlimited commercial paper programme and has maintained a consistent presence as an issuer in this market for the last decade. Liquidity uses and sources have been assessed at the Group and at a business unit level under base case and stressed assumptions. The liquidity resources available and the subsequent Liquidity Coverage Ratio are regularly monitored and have been assessed to be suffi cient under both sets of assumptions.
B.2 Non-fi nancial risk
(Unaudited)
Prudential is exposed to operational, business environment and strategic risk in the course of running its businesses.
Prudential is exposed to operational risk through the course of running its business. It is dependent on the successful processing of a large and complex number of transactions, utilising various IT applications and platforms, across numerous and diverse products. It also operates under the ever evolving requirements set out by different regulatory and legal regimes (including tax), as well as utilising a signifi cant number of third parties to distribute products and to support business operations.
Prudential’s systems and processes incorporate controls that are designed to manage and mitigate the operational risks associated with its activities. The Prudential Group Governance Manual was developed to make a key contribution to the sound system of internal control that the Group is expected to maintain under the UK Corporate Governance Code and the Hong Kong Code on Corporate Governance Practices. Group Head Offi ce and business units confi rm that they have implemented the necessary controls to evidence compliance with the Manual.
Prudential has an operational risk management framework in place that facilitates both the qualitative and quantitative analysis of operational risk exposures. The output of this framework, in particular management information on key operational risk and control assessments, scenario analysis, internal incidents and external incidents, is reported by the business units and presented to the Group Operational Risk Committee. This information also supports business decision-making and lessons-learned activities; the ongoing improvement of the control environment; and determination of the adequacy of Prudential’s corporate insurance programme.
Risk and capital management Prudential plc Annual Report 2012 75
With regard to business environment risk, including the impacts
of regulatory developments, the Group has a wide-ranging
programme of active and constructive engagement with Risk
governments, policymakers and regulators in its key markets and
and with relevant international institutions. Such engagement
is undertaken both directly and indirectly via trade associations. capital
The Group has procedures in place to monitor and track political
and regulatory developments and assess their potential impact
on the Group. Where appropriate, the Group provides
submissions and technical input to officials and others, either
via submissions to formal consultations or through interactions management
with officials.
With regard to strategic risk, both business units and the Group
Head Office are required to adopt a forward-looking approach Business
to risk management by performing risk assessments as part
of the annual strategic planning process. This supports the
identification of potential threats and the initiatives needed to review
address them, as well as competitive opportunities. The impact
on the underlying businesses and/or Group-wide risk profile is
also considered to ensure that strategic initiatives are within
risk appetite.
Solvency II represents a regulatory risk due to the uncertainty
of what the rules will be when finalised, their potential impacts,
and the timing of their introduction. The risks are that the Group
may not be able to respond sufficiently quickly to the strategic
implication of the change given levels of uncertainty around the
content and timing; operational risk in terms of the scale and
complexity of the delivery and uncertainty over timelines; and
the additional capital that the Group may be required to hold.
Solvency II is covered in more detail in the Capital Management
section below.
B.3 Risk factors
Our disclosures covering risk factors can be found at the end
of this document.
C. Capital management
C. 1 Regulatory capital (IGD)
(Audited)
Prudential is subject to the capital adequacy requirements of the European Union Insurance Groups Directive (IGD) as implemented by the Financial Services Authority (FSA) in the UK. The IGD capital adequacy requirements involve aggregating surplus capital calculated on a FSA consistent basis for regulated subsidiaries, from which Group borrowings, except those subordinated debt issues that qualify as capital, are deducted. No credit for the benefi t of diversifi cation is permitted under this approach.
Prudential’s capital position remains strong. Prudential has continued to place emphasis on maintaining the Group’s fi nancial strength through optimising the balance between writing profi table new business, conserving capital and generating cash. Prudential estimates that its IGD capital surplus is Ł5.1 billion at
31 December 2012 (before taking into account the 2012 fi nal dividend), with available capital covering its capital requirements
3.0 times. This compares to a capital surplus of Ł4.0 billion at the end of 2011 (before taking into account the 2011 fi nal dividend).
76 Business review Prudential plc Annual Report 2012
Risk and capital management continued
The movements in 2012 mainly comprise:
Net capital generation mainly through operating earnings (in-force releases less investment in new business, net of tax) of Ł2.5 billion.
Offset by:
Negative impact arising from market movements estimated at Ł0.2 billion;
Final 2011 dividend of Ł0.5 billion and interim 2012 dividend of Ł0.2 billion;
External fi nancing costs and other central costs, net of tax, of Ł0.4 billion; and
Negative impact arising from foreign exchange movements of Ł0.1 billion.
IGD surplus represents the accumulation of surpluses across all of our operations based on local regulatory minimum capital requirements with some adjustments, pursuant to the requirements of Solvency I. The calculation does not fully adjust capital requirements for risk nor does it capture the true economic value of assets. Global regulatory developments, such as Solvency II and ComFrame, aim to ensure that the calculation of regulatory surplus continues to evolve over time into a more meaningful economic measure.
There is broad agreement that ultimately it would be benefi cial to replace the IGD regime with a regime that would be more risk based. Solvency II was supposed to provide such a framework but we now know that it will not be implemented before
31 December 2015. The structure of the Group and the approach we have taken to managing our risks, with a sizeable credit reserve in the UK annuity book, a strong inherited estate in UK with profi ts and the relatively low risk nature of our asset management and Asian operations, together with a high level of IGD surplus, means we have positioned ourselves well for future regulatory developments and stresses to our business.
(Unaudited)
In March 2013, we have agreed with the FSA to amend the calculation of the contribution Jackson makes to the Group’s IGD surplus. Until now, the contribution of Jackson to the reported IGD was based on an intervention level set at 75 per cent of US Risk-Based Capital Company Action Level (CAL). Going forward, the contribution of Jackson to IGD surplus will equal the surplus in excess of 250 per cent of CAL. This is more in line with the level at which we currently report free surplus, which we have set at 235 per cent of CAL. In the absence of an agreed Solvency II approach, we believe that this change makes the IGD surplus a more meaningful measure and one that is more closely aligned with economic reality. The revised IGD surplus calculation has no impact on the way that the US business is managed or regulated locally.
Note
1 The estimated position at 28 February 2013 allows for economic conditions and surplus generation since 31 December 2012 and is stated before the final dividend and the effect of the Thanachart acquisition and after allowing for a reduction in Jackson’s contribution to IGD surplus of Ł1.3 billion.
* The impact of the 100 basis points reduction in interest rates is exacerbated by the current regulatory permitted practice used by Jackson, which values all interest rate swaps at book value rather than fair value for regulatory purposes. At 31 December 2012, removing the permitted practice would have increased reported IGD surplus by Ł0.3 billion. As at 31 December 2012, it is estimated that a 100 basis point reduction in interest rates (subject to a floor of zero) would have resulted in an IGD surplus of Ł4.9 billion, excluding the permitted practice. The effect of the revised calculation of Jackson’s contribution to IGD surplus as at 31 December 2012 would have been to increase the sensitivity to equity market falls by approximately Ł50 million.
(Unaudited)
On this revised basis, the IGD surplus at 28 February 2013 is
estimated at Ł4.4 billion1 (equivalent to a capital cover of
2.5 times) which includes the Ł0.4 billion of subordinated debt raised in January 2013 and is after deducting Ł1.3 billion in respect of the Jackson change from 75 per cent to 250 per cent of CAL.
Prudential continues to have further options available to manage available and required capital. These could take the form of increasing available capital (for example, through fi nancial reinsurance) or reducing required capital (for example, through the mix and level of new business) and the use of other risk mitigation measures such as hedging and reinsurance. A number of such options were utilised through the last fi nancial crisis in 2008 and 2009 to enhance the Group’s IGD surplus. One such arrangement allowed the Group to recognise a proportion of the shareholder’s interest in future transfers from the UK’s with-profi ts business and this remained in place, contributing
Ł0.36 billion to the IGD at 31 December 2012. We will phase this out in two equal steps, reducing the credit taken to Ł0.18 billion from January 2013 and we expect to take zero credit from January 2014.
In addition to its strong capital position, on a statutory (Pillar 1) basis, the total credit reserve for the UK shareholder annuity funds also protects its capital position in excess of the IGD surplus. This credit reserve as at 31 December 2012 was
Ł2.1 billion. This credit risk allowance represents 40 per cent of the bond portfolio spread over swap rates, compared to 33 per cent as at 31 December 2011.
Stress testing
(Unaudited)
As at 31 December 2012, stress testing of our IGD capital position to various events has the following results:
An instantaneous 20 per cent fall in equity markets from
31 December 2012 levels would reduce the IGD surplus by Ł450 million;
A 40 per cent fall in equity markets (comprising an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four-week period) would reduce the IGD surplus by Ł950 million;
A 100 basis points reduction (subject to a fi oor of zero) in interest rates would reduce the IGD surplus by Ł850 million*; and
Credit defaults of ten times the expected level would reduce IGD surplus by Ł700 million.
Prudential believes that the results of these stress tests, together with the Group’s strong underlying earnings capacity, its established hedging programmes and its additional areas of fi nancial fi exibility, demonstrate that it is in a position to withstand signifi cant deterioration in market conditions.
Prudential also uses an economic capital assessment to monitor its capital requirements across the Group, allowing for realistic diversifi cation benefi ts and continues to maintain a strong position. This assessment provides valuable insights into its risk profi le.
C.2 Solvency II and other global regulatory developments
(Unaudited)
The European Union (EU) is developing a new solvency framework for insurance companies, referred to as ‘Solvency II’. The Solvency II Directive, which sets out the new framework, was formally approved by the Economic and Financial Affairs Council in November 2009. The new approach is based on the concept of three pillars – minimum capital requirements, supervisory review of fi rms’ assessments of risk, and enhanced disclosure requirements.
Specifi cally, Pillar 1 covers the quantitative requirements around own
funds, valuation rules for assets and liabilities and capital requirements. Pillar 2 provides the qualitative requirements for risk management, governance and controls, including the requirement for insurers to submit an Own Risk and Solvency Assessment which will be used by the regulator as part of the supervisory review process. Pillar 3 deals with the enhanced requirements for supervisory reporting and public disclosure.
A key aspect of Solvency II is that the assessment of risks and capital requirements are intended to be aligned more closely with economic capital methodologies and may allow Prudential to make use of internal economic capital models if approved by the relevant supervisory authority.
Representatives from the European Parliament, the European Commission and the Council of the European Union are currently discussing the Omnibus II Directive which, once approved, will amend certain aspects of the original Solvency II Directive. In addition the European Commission is continuing to develop, in consultation with stakeholders including industry, the detailed rules that will complement the high-level principles of the Directive, referred to as ‘implementing measures’. The Omnibus II Directive is not currently scheduled to be fi nalised until late 2013, while the implementing measures cannot be fi nalised until after Omnibus II.
There is a signifi cant uncertainty regarding the fi nal outcome from this process. In particular, the Solvency II rules relating to the determination of the liability discount rate and to the treatment of US business remain unclear and Prudential’s capital position is sensitive to these outcomes. With reference to the liability discount rate, solutions to remove artifi cial volatility from the balance sheet have been suggested by policymakers as the regulations continue to evolve. These solutions, along with transitional arrangements for the treatment of the US business, are continuing to be considered by policymakers as part of the process to reach agreement on the Omnibus II Directive. There is a risk that the effect of the measures fi nally adopted could be
Risk and capital management Prudential plc Annual Report 2012 77
adverse for Prudential, including potentially that a significant
increase in capital may be required to support its business and
that Prudential may be placed at a competitive disadvantage to Risk
other European and non-European financial services groups. and
Prudential is actively participating in shaping the outcome
through our involvement in industry bodies and trade capital
associations, including the Chief Risk Officer and Chief Financial
Officer Forums, together with the Association of British Insurers
and Insurance Europe (formerly known as the Comité Européen
des Assurances). management
The delays in finalising the Omnibus II Directive and
implementing measures are expected to result in a deferral of the
Solvency II implementation date for firms beyond the previously
anticipated date of 1 January 2014. At this stage, it remains Business
unclear exactly when Solvency II will come into force, although
a deferral until 1 January 2016 or beyond appears likely. review
Having assessed the requirements of Solvency II, an
implementation programme was initiated with dedicated teams
to manage the required work across the Group. The activity of
the local Solvency II teams is being coordinated centrally to
achieve consistency in the understanding and application of
the requirements. Prudential is continuing its preparations to
adopt the regime when it eventually comes into force and is
undertaking in parallel an evaluation of the possible actions to
mitigate its effects. Prudential regularly reviews its range of
options to maximise the strategic fiexibility of the Group. This
includes consideration of optimising the Group’s domicile as a
possible response to an adverse outcome on Solvency II.
Over the coming months Prudential will remain in regular contact
with the FSA as it continues to engage in the ‘pre-application’
stage of the approval process for the internal model. In addition,
Prudential also expects to engage in the initial stage of the FSA’s
proposed ‘Individual Capital Adequacy Standards Plus (ICAS+)’
regime, which will ultimately enable its UK insurance entities to
leverage the developments made in relation to the Solvency II
internal model for the purpose of meeting existing ICAS regime.
Currently there are also a number of other prospective global
regulatory developments which could impact the way in which
Prudential is supervised in its many jurisdictions. These include
the Dodd-Frank Act in the US, the work of the Financial Stability
Board (FSB) on Globally Systemically Important Financial
Institutions (G-SIFIs) and the Common Framework for the
Supervision of Internationally Active Insurance Groups
(ComFrame) being developed by the International Association
of Insurance Supervisors (IAIS).
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, however, as many
of its provisions have a delayed effectiveness and/or require
rulemaking or other actions by various US regulators over the
coming years.
78 Business review Prudential plc Annual Report 2012
Risk and capital management continued
As part of a global initiative to identify G-SIFIs, in May 2012, the IAIS published proposed assessment methodology for designating Globally Systemically Important Insurers (G-SIIs). For those groups that are designated by the FSB as G-SII then additional policy measures including enhanced supervision, introduction of recovery and resolution
plans and higher loss absorbency requirements could be proposed. Further detail of the proposals is expected during 2013 and implementation is likely to be over a period of years. Furthermore, the FSA is considering the designation of Domestically Systemically Important Insurer (DSII) for those UK insurers that are signifi cant in UK terms. It is not yet clear what the impact of this designation may be.
ComFrame is also being developed by the IAIS to provide common global requirements for supervision of insurance groups. The framework is designed to develop common principles for supervision and so may increase the focus of regulators in some jurisdictions. It is also possible that some prescriptive requirements, including group capital, could be proposed. Further clarity on ComFrame is expected during the second half of 2013.
C.3 Capital allocation
(Unaudited)
Prudential’s approach to capital allocation is to attain a balance between risk and return, investing in those businesses that create shareholder value. In order to effi ciently allocate capital, Prudential measures the use of, and the return on, capital.
Prudential uses a variety of metrics for measuring capital performance and profi tability, including traditional accounting metrics and economic returns. Capital allocation decisions are supported by this quantitative analysis, as well as strategic considerations.
The economic framework measures risk adjusted returns on economic capital, a methodology that ensures meaningful comparison across the Group. Capital utilisation, return on capital and new business value creation are measured at the product level as part of the business planning process.
C.4 Risk mitigation and hedging
(Unaudited)
Prudential manages its actual risk profi le against its tolerance of risk. To do this, Prudential maintains risk registers that include details of the risks Prudential has identifi ed and of the controls and mitigating actions it employs in managing them. Any mitigation strategies involving large transactions such as a material derivative transaction involving shareholder business are subject to review at Group level before implementation.
Prudential uses a range of risk management and mitigation strategies. The most important of these include: adjusting asset portfolios to reduce investment risks (such as duration mismatches or overweight counterparty exposures); using derivatives to hedge market risks; implementing reinsurance programmes to manage insurance risk; implementing corporate insurance programmes to limit the impact of operational risks; and revising business plans where appropriate.
Corporate responsibility review
Creating social and economic value
Corporate responsibility (CR) is integral to the way we do business at Prudential. This review gives an overview of our activities. Prudential also publishes an annual CR report which is available online at www.prudential.co.uk
Creating social and economic value
As a business that provides savings, income, investment and protection products and services, we create social value through our day-to-day operations. We provide customers with ways to help manage uncertainty and build a more secure future. By playing a key role in fi nancial markets, we provide long-term capital that fi nances businesses, builds infrastructure and fosters growth in both developed and developing countries.
At Prudential, we aim to be sustainable in the broadest sense – fi nancially, socially and environmentally. Sustainability is integral to the way we do business. Our commitments to our customers and our employees, as well as our support for communities and our responsibility towards the environment, are rooted in our aim of continuing to deliver strong fi nancial performance sustainably.
As a Group with a long-term view, we believe it is important to participate in global debates and policy considerations that affect our customers. Across our business, we share our knowledge and expertise to help inform public policy in all our markets.
The complexities and challenges surrounding ageing populations have signifi cant policy implications in many countries around the world. For example, through our partnership with the Washington DC-based think tank, the Center for Strategic and International Studies (CSIS), we have continued to contribute to the debate, through events and seminars with policymakers promoting the Global Aging Preparedness Index.
We commissioned additional demographic research in partnership with CSIS, looking, in further detail, at retirement expectations in Asia. Based on a survey conducted by CSIS in six East Asia countries, it explores how rapid development and rapid ageing are transforming retirement behaviour and expectations in the emerging world. The fi ndings of the study were published in 2012 and it is available at http://gapindex.csis.org
Corporate responsibility review Prudential plc Annual Report 2012 79
Corporate
Serving our customers
Today we serve around 24 million insurance customers in diverse responsibility
markets where people’s specific savings, investment and
protection needs are different. However, what is common among review
all our customers is that the financial decisions they make are
among the most important of their lives.
The insurance industry plays a unique role in society by helping
people manage uncertainty and gain security. Prudential has Business
been meeting customers’ needs for 165 years and we are
always looking for new ways to ensure that we understand our
customers’ long-term financial goals and provide them with review
the right products to help them plan for the future. We do not
underestimate how important these decisions are for our
customers, nor do we take for granted the trust they place in
us to deliver for them over the long term. Our customers have
made a choice to purchase from us, and we value highly their
decision and their loyalty.
We want our customers to stay with us for the long term. We
know this means we must constantly listen to them to understand
their changing needs, and that we must provide them with fair
and transparent products – and customer service – that
maintains their trust and faith in our business.
Asia
In the emerging markets of Asia, where we now have 13 million insurance customers, the demand for savings and protection products continues to grow as people seek greater fi nancial security and peace of mind. We continue to broaden our offering to help meet our customers’ goals.
Prudential Corporation Asia launched a number of tailored products in 2012. PRUmyhealth medical plan was launched in Hong Kong, offering comprehensive health protection with lifetime global coverage, and in Malaysia PRUFlexi Med was launched, which provides customers with the fi exibility to choose a number of medical benefi ts based on their needs.
Across the region, we have a highly trained tied agency force, and we provide support to new and experienced agents so that they can deliver the best possible service for our customers. In Hong Kong, we have developed the ‘Certifi ed Agency Builder Programme’, through which fi nancial professionals follow a series of certifi ed training courses.
Our four guiding CR principles
In line with our federal operating model, we believe that corporate responsibility is best managed by those closest to our customers and stakeholders. Underpinning this approach are our four guiding principles. These provide clarity to our businesses on where they should focus their eff orts and resources.
Serving our customers: we aim to provide fair and transparent products which meet our customers’ needs; Valuing our people: we aspire to retain and develop highly engaged employees; Supporting local communities: we seek to make a positive contribution to our communities through long-term partnerships with charitable organisations that make a real diff erence; and Protecting the environment: we take responsibility for the environment in which we operate.
80 Business review Prudential plc Annual Report 2012
Corporate responsibility review continued
US
Founded over 50 years ago, Jackson National Life is one of the largest life insurance companies in the United States, providing retirement savings and income solutions, with approximately 4 million customers.
The US is the world’s largest retirement savings market, with considerable cohorts of the 78 million baby-boomers1 reaching retirement age each year, creating signifi cant demand for retirement income products.
Jackson has established a signifi cant presence in the alternative investments market, in a period where customers seek greater security in times of economic uncertainty, and is a leader in alternative investments in the retail adviser market.
Elite Access was created in 2012 to make Jackson’s products available to a
much greater range of customers. Elite Access is a variable annuity designed to combat the volatility of the market by providing investors with the opportunity for greater portfolio diversifi cation through the use of alternative asset classes.
UK
In the UK, challenging economic conditions continued to persist in 2012 and have led customers, more than ever, to seek fi nancial products that offer them the highest level of security from companies they feel they can trust.
Annuities are a key product for Prudential UK and market rates were at near historic lows during 2012. This means that it is more important than ever for customers looking to take income from their pensions to make informed choices. Our UK business paid out Ł2.9 billion in income to UK annuitants in 2012.
Over the last decade, Prudential has been widely recognised as the UK’s leading with-profi ts manager. Our long-term approach to the management of the with-profi ts fund has continued to benefi t customers during 2012, as it helps to provide protection from the full impact of volatile market conditions. The fund has consistently outperformed the FTSE All-Share Index. Over the last 15 years, the fund has delivered a cumulative investment return of 184.3 per cent on investments covering policyholder liabilities. This compares favourably with the FTSE All-Share Index total return of 106.5 per cent over the same period. Total bonus payments are expected to top Ł2 billion in 2013, and our policyholders will typically see year-on-year increases of between 3.5 per cent and 6.5 per cent in accumulating with-profi ts policy values. Since 2003, an estimated Ł22 billion has been added to policy values.
We are committed to responding to customer concerns quickly and effi ciently. The details of our approach to customers are published on the Prudential UK website in line with FSA guidance at www.pru.co.uk/about_us/complaints_data/
Prudential UK was in the best performing 8 per cent, up from 15 per cent in 2011, of fi nancial companies included in data published by the Financial Ombudsman Service.
Asset management
M&G, Prudential’s UK and European asset management business, has served retail and institutional investors for over 80 years, investing customers’ money in equities, fi xed income and real estate.
M&G is a long-term investor that takes its responsibilities as a shareholder seriously, often working closely with the management of the companies in which it invests. Active voting is an integral part of M&G’s investment approach. We believe that exercising our votes both adds value and protects our interests as shareholders. The M&G website provides an overview of voting history: www.mandg.co.uk/Corporate/CorporateResponsibility /CorporateGovernance/Votinghistory.jsp
M&G’s retail business launched the Bond Vigilantes blog providing market insight straight from the trading fi oor. In addition to the constant stream of market views posted by M&G, comments are posted by users, establishing the blog as a genuine discussion forum.
Valuing our people
We aim to create an environment that enables our people to fi nd value and meaning in their work, and to deliver outstanding performance for our customers, shareholders and communities. This is essential to our continued success, and is performed through our focus on four key areas – diversity and inclusion, talent development, employee engagement, and performance and reward.
Diversity and inclusion
We provide opportunities for our people regardless of their gender, ethnicity, disability status, age, religion, caring responsibilities or sexual orientation.
Our diversity and inclusion policies are guided by the principles of the UN’s Universal Declaration of Human Rights and the International Labour Organisation’s core labour standards. These are also incorporated in our Group Code of Business Conduct, which sets expected standards of employee behaviour.
We maintain an inclusive culture that is sensitive to the needs of employees with a disability. We continue employing people who become disabled, and provide training and career development opportunities for all. We also give full and fair consideration and encouragement to all applicants with suitable aptitude and abilities, regardless of disability.
Note
1 Source: US Census Bureau
We have several initiatives in place to maintain our commitment to diversity and inclusion. These include:
Apprenticeship schemes and support for underprivileged students to provide entry-level positions for young people;
Training in unconscious bias to improve inclusion throughout the organisation;
Pay reviews to prevent systematic concerns around equal pay and opportunity by gender, ethnic group and working patterns; and
Collaborative partnerships with organisations that strengthen and further the diversity and inclusion agenda, such as the Diversity and Inclusion in Asia Network (DIAN), and Peckham, an American non-profi t community rehabilitation organisation. In the UK, we are also sponsors of the 2012 Working Mums Top Employer Awards, and co-sponsors of the inaugural Women in Investment Management event targeting female students.
Talent development
All employees are encouraged to take responsibility for driving their own development and agreeing plans with their managers. To support them, the organisation provides on-going development activities. The majority of these activities sit within our business units, while Group HR focuses on programmes for senior leaders across the organisation.
At Group level, the emphasis is on succession planning for senior roles and development of our overall leadership talent pipeline. In support of this, there are a number of new Group-wide programmes. In addition to The Top 100 initiative, which focuses on individually tailored development for our most senior executives, we provide programmes that are specifi cally designed to enhance colleagues’ cross-business unit/functional leadership skills and experience.
Within our businesses, there are several programmes that demonstrate our commitment to furthering talent. Prudential Corporation Asia developed a holistic Talent Development Framework with clear segmentation, to enable the identifi cation of talent in each market, as well as the design and accurate targeting of ‘top of the class’ leadership development programmes.
In the US, The Jackson University continues to provide business-specifi c development activities for employees.
Jackson’s senior management team play a central role in shaping the curriculum, ensuring it aligns to major corporate initiatives for the business. In addition, the LEAP programme for senior leaders aims to accelerate their leadership potential and organisational impact.
In our UK-based businesses, we have various programmes designed to
create focused learning networks and active talent communities. These include: M&G’s Cornerstone, focused on senior management; Catalyst, aimed at junior talent; Investor Development Programmes; and Sales Business Leadership Programmes. Prudential UK provides Career Development Centres for middle managers, and at Group Head Offi ce, Enhance offers employees the opportunity to hone their skills for working effectively and to develop in areas such as cross-cultural awareness and building effectiveness partnerships.
Corporate responsibility review Prudential plc Annual Report 2012 81
Employee engagement
We strive to create a work environment and conditions that are
conducive to a culture of engagement. Engaging our employees
is critical to sustaining a high-performing business and retaining Corporate
talent. In 2012, we utilised a range of mechanisms to drive
engagement at all levels.
At Group Head Office, the Connect programme of lunchtime
events brings together colleagues on subjects ranging from responsibility
learning about developments in the business and Prudential’s
heritage, to themes like parenting. review
The wellbeing of our employees is paramount. We have a series
of initiatives, including assessments, activity programmes and
access to confidential telephone and face-to-face coaching and
counselling with professionals. Business
Across Prudential, we encourage continuous dialogue to engage
with our employees. Through events and ‘open forums’ – such as review
the M&G Staff Consultative Committee and the Employee Forum
within Prudential UK – employees can engage directly with their
executive teams and raise questions. In addition, our businesses
in the UK have a long-standing relationship with the union Unite.
The success of our engagement efforts have been recognised
internally and externally. Engagement surveys in various
business units have shown excellent results and several of our
businesses have won prestigious awards. For example, M&G was
named one of the best places to work in the City by the website
Here is the City News, and was also the highest-rated asset
management firm in a survey voted for by employees, and a
number of our businesses in Asia, including our Life business in
Singapore, were awarded The People Developer Standard.
Performance and reward
We offer reward packages that support a high-performing organisation, in order to attract, retain and motivate talented people. Each individual contributes to the success of the Group and should be rewarded accordingly.
Rewards are linked to the delivery of business goals and expected behaviours. We place emphasis on goals being met in an appropriate manner. To ensure this, employees are not only regularly assessed on
‘what’ they have achieved, but also on ‘how’ they did so.
We believe it is important for our employees to have the opportunity to benefi t from the Group’s success through share ownership. In the UK, we operate two all-employee share plans: a Share Incentive Plan (SIP) and a Save As You Earn (SAYE) scheme. In 2012, a majority of eligible employees participated in one or both of these plans.
In Asia, we operate two SAYE schemes, similar to those in the UK. Participation in these schemes continues to grow strongly among our employees and agents.
82 Business review Prudential plc Annual Report 2012
Corporate responsibility review continued
Supporting local communities
As a long-term business, we are committed to supporting the long-term well-being of the communities in which we operate.
The social value of our business – helping customers manage uncertainty and build a more secure future, as well as our investments providing long-term capital that fi nances businesses, builds infrastructure and fosters economic growth – is further underpinned by our community programmes and activities.
Each of Prudential’s businesses has community investment programmes in place which provide support to charitable organisations, both through funding and the experience and expertise of our employees.
Last year more than 7,350 employees across the Group gave up their time to help in their communities, using their skills and knowledge to benefi t others.
We establish long-term relationships with our charity partners to ensure that the projects we support are sustainable, and we work closely with them to ensure that our programmes continuously improve.
The diversity of our markets means that our programmes vary from region to region, but a shared focus for our community investment is education and life skills. These activities include fi nancial education, support to improve social mobility and employee volunteering.
Financial education
Financial education forms an important part of our educational activity. We believe that encouraging people to manage their money prudently helps to underpin overall economic development and success for communities.
Cha-Ching, PCA’s fl agship regional fi nancial education programme, gathered greater momentum in 2012.
Cha-Ching was launched in seven countries in 2011, to help parents in Asia develop money-smart values among children from the ages of seven to 12. The programme has produced a series of three-minute music videos with sing-a-long subtitles that teach children about four key money management concepts
– Earn, Save, Spend and Donate – through a band of six characters. These videos have been shown daily on the Cartoon Network, Asia’s most watched children’s channel. Cha-Ching is supported by an interactive website (www.cha-ching.com) and mobile applications offering digital resources for parents, children and teachers.
In 2012, Cha-Ching was developed with the launch of ‘Season Two’, featuring three new music videos on budgeting, credit and investing. A new online game, Cha-Ching Saver World Tour, and a fi rst mobile game app, Cha-Ching Band Manager, were also launched.
Over the last year, Cha-Ching has received signifi cant support across the region, with more than 20,000 children and teachers benefi ting from the programme to date. In April 2012, the Philippines Department of Education signed a Memorandum of Agreement to incorporate Cha-Ching into the curriculum of public primary schools, and NGOs including Junior Achievement have organised Cha-Ching workshops for children in Hong Kong and Thailand. Singapore Airlines and Garuda Indonesia have incorporated the music videos into their in-fi ight entertainment content for travelling families.
In the US, Jackson, alongside employees from across the Group, provided more than 5,000 volunteer hours in support of fi nancial literacy as part of its work with Junior Achievement, a charity which teaches young people about money management and how business works. Jackson is one of only 10 companies across the US to have been awarded a Bronze US President’s Volunteer Service Award for the 2011-2012 programme.
Improving education and skills
In Asia, with the support of the Ministry of Education, PCA partnered with the China Insurance Regulatory Commission and the Chinese Academy of Social Sciences to develop an insurance educational course that could be taught across schools in China. Since its launch in 2007, more than 57,000 children have benefi ted from the course to date, strengthening their knowledge of insurance and how it relates to their everyday lives.
In the UK, the Business Class programme, run by Business in the Community, gives Prudential UK colleagues the opportunity to use their knowledge, experience and skills to help with some of the most pressing issues in local schools. Businesses partner with schools in the most deprived areas, and work strategically for three years on an action plan driven by the school’s needs, covering areas such as leadership, curriculum and achievement. In 2012, the programme helped 15 schools, 7,500 students and 90 teachers.
Through the partnership, 86 volunteers are working with schools in Reading, Stirling and Westminster. As well as supporting performance management training and people management skills for senior teachers and school leaders, a ‘menu of activities’ has been created to help young people understand the opportunities available to them when they leave school, as well as working with young people to improve their confi dence and motivation.
At Group Head Offi ce, a new charitable partnership was established in 2012 with Greenhouse, a London-based charity which assists young people in some of the most deprived areas of the city. It uses sport, including basketball, to turn young lives around. Sports coaches work full-time in schools to help young people improve their health and fi tness, while mentoring them to increase their engagement with their education and community. Prudential’s support enables over 1,000 disadvantaged young people to participate weekly through Greenhouse’s basketball programme.
Employee volunteering
We believe in sharing the skills of our global workforce with their local communities. Many of our employees play an active role through volunteering, charitable donations and fundraising. Financial support is always important, but it is the combination of all these resources that means we can make a far more positive contribution to all our communities across the globe. We recognise that employee volunteering brings benefi t not only to the charities, but also to the development of our people, and we actively encourage colleagues to participate in our programmes.
Since its launch in Asia eight years ago, the ‘Investing in Your Future’ volunteer-led fi nancial literacy programme has reached more than 38,000 women. These seminars teach basic fi nancial planning skills for different
stages in their lives. Female volunteers from Prudential donate their time and expertise to deliver the seminars in China, India, Indonesia and Vietnam. The project works closely with the All-China Women’s Federation, the Women’s Association and Labour Union in Vietnam, and the Ministry of Women’s Empowerment and Child Protection in Indonesia.
In the US, Jackson staff gave over 6,500 volunteer hours in 2012, providing support to local charities benefi ting children and the elderly.
In the UK, 43 per cent of Prudential UK employees took part in volunteering during 2012, mentoring schoolchildren, supporting the elderly and skills-sharing with local charities.
At M&G, 118 employees have been actively involved in initiatives with community organisations, charities and schools in and around Chelmsford and London.
Chairman’s Challenge
In 2012, 4,500 employees volunteered through Prudential’s fi agship international programme, the Chairman’s Challenge. The programme encourages employees from across the Group to volunteer on projects initiated by our global charity partners, including Plan International, Help Age International and Junior Achievement. It allows us to support many different charities with volunteers, as well as fi nancial support. Prudential donates Ł150 to our charity partners for every employee who registers for the programme. Charity partners use this money to seed-fund charitable projects for Prudential volunteers.
Each year, employees across the Group vote for the shortlisted project they believe has made the greatest impact. In 2012, the winning project was ‘Learning About Earning’. This programme – in partnership with Junior Achievement – benefi ted 234 impoverished children from a small village outside Jakarta, through the commitment of 430 employees from Prudential Corporation Asia’s Indonesian business, who helped the children develop basic communication and fi nancial skills.
Shortlisted projects 2012:
The Taiwan Fund For Children and Families (TFCF) –
Children’s Financial Camp Annual Child Protection Campaign and Wishing Doll Fundraising Campaign. 766 employees volunteered in 2012, 30 of whom used their business skills to design and deliver four fi nancial camps to 120 disadvantaged children, while the remainder supported the TFCF’s protection and fundraising campaign;
Snehasadan, Mumbai – Holistic Development of Children. The programme rehabilitates homeless children and gives them education, life skills and professional training to make them independent. 50 volunteers supported the project for the fi rst time in 2012, benefi ting 240 children;
Junior Achievement, US – Economic Gardening: Growing Success One Student At A Time. 528 Jackson employees were involved in volunteering activities either in the classroom delivering fi nancial literacy sessions or through fundraising; and
Junior Achievement Thailand – Cha-Ching in Ourselves. 140 Prudential Corporation Asia employees dedicated volunteering time to educate young people in fi nancial literacy skills.
Corporate responsibility review Prudential plc Annual Report 2012 83
Prudential RideLondon
Prudential is sponsoring RideLondon, an annual two-day festival
of cycling which was formally launched in February 2013 with the
Mayor of London, Boris Johnson, who predicted the event will Corporate
become a living legacy of the London Olympic and Paralympic
Games of 2012. Prudential RideLondon will be a world-class
festival of cycling, starting in August 2013, that combines a free
family ride in central London, a world-class professional cyclists’ responsibility
race and an amateur cyclists’ race to raise money for charity.
Disaster relief and preparedness review
Many of our customers in Asia are located in areas prone to
natural disasters. For a number of years we have supported local
initiatives to support relief efforts following disasters in countries
where we operate, and we also maintain a disaster relief fund Business
which can be activated in emergencies. Our commitment to
disaster relief also often goes beyond financial aid, with our review
people helping on the ground.
In October 2011, many areas of northern and central Thailand
were hit by severe fiooding caused by tropical storm Nalgae.
More than 13 million people were affected by the catastrophe
which caused the loss of 750 lives.
In the aftermath of the disaster, Prudential partnered with Help
Age International and FOPDEV (Foundation for Older Persons
Development) to provide help where it was needed most. In June
2012, a team of 65 PRUvolunteers from 10 countries across Asia,
supported by our Thai colleagues, travelled to Fang District in
northern Thailand for six days to help build and renovate
fiood-resistant homes for old people in Mai Ai, as part of the
‘New House for New Life’ project. The team also helped
renovate a school, built a dam for improved water management,
and participated in an evacuation simulation exercise with the
residents to better prepare them for future fioods.
In 2012, the Prudence Foundation was established in Asia as a
unified platform to coordinate charitable activity in the region.
As part of the creation of the Prudence Foundation, Prudential
Corporation Asia’s approach has turned to disaster
preparedness. A designated fund has been established to help
communities develop preventative programmes before disasters
occur to improve the ability of communities to better prepare for,
cope with and recover from any unfortunate natural disasters.
84 Business review Prudential plc Annual Report 2012
Corporate responsibility review continued
Charitable donations
We calculate our community investment spend using the internationally recognised London Benchmarking Group standard. This includes cash donations to registered charitable organisations,
as well as a cash equivalent for in-kind contributions.
In 2012, the Group spent Ł12.6 million supporting community activities, an increase of 39.5 per cent on 2011.
The direct cash donations to charitable organisations amounted to Ł9.6 million, of which approximately Ł4.0 million came from our EU operations, which are principally our UK insurance operation and M&G, with the remaining Ł5.6 million being contributed to charitable organisations by Jackson National Life Insurance Company and Prudential Corporation Asia.
The cash contribution to charitable organisations from our EU operations is broken down as follows: education Ł1.3 million; social, welfare and environment Ł2.4 million; cultural Ł0.2 million and staff volunteering Ł0.1 million.
Political donations
It is the Group’s policy not to make donations to political parties, nor to incur political expenditure, within the meaning of those expressions as defi ned in the Political Parties, Elections and Referendums Act 2000. The Group did not make any such donations or incur any such expenditure in 2012.
Protecting the environment
We recognise that managing our buildings effi ciently and minimising our greenhouse gas emissions is not only benefi cial to the environment but also makes good business sense.
We aim to ensure that we minimise the impact of our activities on the environment. Our strategy focuses on reducing the direct impact of the properties we occupy, as well as the properties we manage through PRUPIM (Prudential Property Investment Managers Limited), which is a top-25 global real estate fund manager, with Ł16 billion of assets under management (at 31 December 2012).
Reducing our direct impact: occupied properties
We monitor energy consumption, carbon dioxide emissions, water consumption, waste, paper use and recycling at all our UK sites, and at Jackson’s main premises in North America in Lansing, Michigan, Denver, Colorado, and Nashville, Tennessee. We also monitor energy consumption and carbon dioxide emissions from 46 occupied properties in Asia, where Prudential Corporation Asia occupies approximately 20,000 square feet or more, for a combined total of 2.45 million square feet.
The Carbon Reduction Commitment (CRC) Energy Effi ciency Scheme is a mandatory UK scheme aimed at improving energy effi ciency and cutting carbon dioxide emissions in large public and private sector organisations, which are responsible for around 12 per cent of the UK’s emissions. The scheme features a range of reputational and fi nancial drivers, which aim to encourage organisations to develop energy management strategies that promote a better understanding of energy usage. All CRC participants must measure and report carbon emissions annually. The fi rst CRC performance league table, which is due to be updated later this year, placed Prudential ahead of its insurance peer group. In 2012, for the fi rst time, participants had to purchase allowances from the Government before the end of July. Prudential’s annual carbon emission for the 2011/12 compliance year was 75,742 tonnes of CO2, 5,438 tonnes less than in 2010/11, which translated into a fi nancial liability of Ł908,904.
Corporate Property continues to maintain certifi cation to ISO 14001 (an internationally recognised standard for environmental management) for services it provides to UK Business Units. Compliance with ISO 14001 drives improved environmental performance.
The Environmental Forum, a sub-group of Prudential plc’s Environment
Health and Safety Council, is supporting Corporate Property’s UK Environmental Employee Engagement programme. This initiative focuses on encouraging employees to make their own contribution to help their Business Unit improve its environmental performance. Each UK Business Unit has signed up to the programme to meet the challenge by a mix of intranet campaigns, competitions, employee forums and attitude surveys.
There will be a new mandatory greenhouse gas emissions reporting requirement for all listed companies on the London Stock Exchange. Prudential plc will include a carbon footprint report in its Annual Report 2013.
Reducing our impact: property investment portfolio
The fundamental principle behind PRUPIM’s approach to Responsible Property Investment is that by having a leading position we are better able to protect and enhance performance for its clients. This strategy focuses on four areas: ensuring portfolio resilience; driving environmental improvements; building strong relationships; and responsibility in its own operations.
PRUPIM’s focus on delivering energy reductions across its managed portfolio has achieved some signifi cant results. For example, in the UK, PRUPIM has reduced carbon emissions intensity by 17 per cent at 23 of its largest multi-let offi ces and 16 per cent at its shopping centres, generating savings of over
Ł3.6 million for its occupiers. Its UK shopping centres now divert 80 per cent of waste from landfi ll and 49 per cent of waste is diverted from landfi ll at our ISO 14001 offi ces.
We have also achieved the environmental standard ISO 14001 at nine shopping centres and 27 multi-let offi ces, which together account for 64 per cent of the carbon emission under management control.
PRUPIM’s approach and progress can be found in its annual Responsible Property Investment report at www.prupim.com/rpi
Accountability and governance
The Board
The Board regularly reviews the Group’s CR performance and scrutinises and approves the Group CR report and strategy on an annual basis.
Code of Business Conduct
Consideration of environmental, social and community matters is integrated in our Code of Business Conduct. Our code is reviewed by the Board on an annual basis. Refer to page 98 for more information.
Local governance
In M&G, Jackson and Prudential UK there are governance committees in place – with senior management representation –which agree strategy and spend. In Asia, the Prudence Foundation has been established as a unifi ed charitable platform to align and maximise the impact of community efforts across the region.
Corporate responsibility review Prudential plc Annual Report 2012 85
Payment policy
It is our Group policy to agree terms of payment when orders for
goods and services are placed, and to pay in accordance with
those terms. Corporate
In the UK, we have signed up to the Prompt Payment Code,
launched in December 2008 by the UK Department for Business,
Enterprise and Regulatory Reform. In 2012, our trade creditor
days, based on the ratio of amounts that were owed to trade responsibility
creditors at the year end to the aggregate of the amounts
invoiced by trade creditors during the year, were 22 days review
(2011: 22 days).
The Prompt Payment Code and its signatories can be found at
www.promptpaymentcode.org.uk Business
Supply chain management
Prudential recognises that its own social, environmental and review
economic impacts go beyond the products and services it
supplies, to include the performance of its suppliers and
contractors.
It is our policy to work in partnership with suppliers whose values
and standards are aligned with our Group Code of Business
Conduct.
Procurement practices in Prudential UK have been successfully
accredited with the Chartered Institute of Purchasing and
Supply certification, an industry benchmark of recognised
good practice.
86 Prudential plc Annual Report 2012
Prudential plc Annual Report 2012 87
Section 3
Governance
88 Board of directors
93 Corporate Governance report:
93 Role of the Board and Governance Framework
100 Audit Committee report
103 Nomination Committee report
104 Risk Committee report
105 Risk governance
107 Relations with shareholders
110 Additional disclosures
111 Index to principal directors’ report disclosures
Governance
88 Governance Prudential plc Annual Report 2012
Board of directors
[Graphic Appears Here]
Chairman Group Chief Executive
Paul Manduca Paul was the Senior Independent Tidjane Thiam Tidjane was a non-executive
Chairman Director and Chairman of the Group Chief Executive director of Arkema in France until
Appointments Audit Committee of Development Appointments November 2009. He is a member
Securities plc until March 2010, of the Board of the Association
Board: October 2010 Board: March 2008
Chairman of Bridgewell Group plc of British Insurers (ABI) and he
Chairman of the Board: July 2012 Group Chief Executive:
until 2007 and a director of was appointed as Chairman in
Chairman of the Nomination October 2009
Henderson Smaller Companies July 2012. He is a member of
Committee: July 2012
Investment Trust plc until 2006. Tidjane was the Chief Financial the Council of the Overseas
Paul Manduca was the Senior Prior to that, he was European Officer from March 2008 until Development Institute (ODI)
Independent Director prior to his CEO of Deutsche Asset his appointment as Group Chief in London, a member of the
appointment as Chairman. He was Management from 2002 to Executive in 2009. Africa Progress Panel chaired
also a member of the Audit and 2005, global CEO of Rothschild by Kofi Annan and a sponsor of
Tidjane spent the first part of his
Remuneration Committees from Asset Management from 1999 Opportunity International. Tidjane
professional career with McKinsey
October 2010 to June 2012 and to 2002 and founding CEO of is a member of the UK-ASEAN
& Company in Paris and New York,
a member of the Nomination Threadneedle Asset Management Business Council and of the
serving insurance companies and
Committee from January 2011. Limited from 1994 to 1999 when Strategic Advisory Group on UK
banks. He then spent a number of
he was also a director of Eagle Trade and Investment. In January
Paul was a non-executive director years in Africa where he was Chief
Star and Allied Dunbar. Paul is 2012, Tidjane was appointed to
of Wm Morrison Supermarkets Plc Executive and later Chairman of
a member of the Securities the Prime Minister’s Business
(Morrisons) from September the National Bureau for Technical
Institute, a former Chairman of Advisory Group and has been a
2005 until March 2011. During Studies and Development in Côte
the Association of Investment member of the European Financial
that time, he was the Senior d’Ivoire and a cabinet member
Companies from 1991 to 1993, Round Table (EFR) since January
Independent Director, a member as Secretary of Planning and
and former member of the 2013. Tidjane was awarded the
of the Nomination Committee and Development. Tidjane returned
Takeover Panel. He is also the Légion d’Honneur by the French
Chairman of the Remuneration to France to become a partner with
Chairman of Henderson President in July 2011. Age 50.
Committee of Morrisons, and McKinsey & Company and one
Diversified Income Limited.
prior to that he chaired the Audit of the leaders of their Financial
Age 61.
Committee of Morrisons. Paul Institutions practice before joining
retired as Chairman of JPM Aviva in 2002. He worked at Aviva
European Smaller Companies until 2008, holding successively
Investment Trust Plc in December the positions of Group Strategy
2012 and was the Chairman of and Development Director,
Aon UK Limited until September Managing Director of Aviva
2012. He was also a non-executive International, Group Executive
director and Chairman of the Director and Chief Executive
Audit Committee of KazMunaiGas Officer, Europe.
Exploration & Production until the
end of September 2012.
Board of directors Prudential plc Annual Report 2012 89
[Graphic Appears Here]
Executive Directors
Nicolaos Nicandrou ACA John Foley Robert Devey Michael McLintock Board
Chief Financial Officer Group Chief Risk Officer Executive Director Executive Director of
Appointments Appointments Appointments Appointments
Board: October 2009 Board: January 2011 Board: November 2009 Board: September 2000 directors
Before joining Prudential, Nic John Foley has been Group Chief Rob Devey has been the Chief Michael McLintock is the Chief
Nicandrou worked at Aviva, where Risk Officer since January 2011. Executive of Prudential UK and Executive of M&G, a position
he held a number of senior finance He joined Prudential as Deputy Europe since 2009. Before joining he held at the time of M&G’s
roles, including Norwich Union Group Treasurer in 2000 before Prudential, Rob worked at Lloyds acquisition by Prudential in
Life Finance Director and Board being appointed Managing Banking Group from 2002, where 1999, having joined M&G in Governance
Member, Aviva Group Financial Director, Prudential Capital he held a number of senior 1992. Michael has been a Trustee
Control Director, Aviva Group(formerly Prudential Finance (UK)) leadership roles across insurance of the Grosvenor Estate since
Financial Management and and Group Treasurer in 2001. He and retail banking. Prior to joining October 2008 and was appointed
Reporting Director and CGNU was appointed Chief Executive Lloyds Banking Group, Rob was as a non-executive director of
Group Financial Reporting of Prudential Capital and to the a consultant with the Boston Grosvenor Group Limited in
Director. Nic started his career Group Executive Committee in Consulting Group (BCG) in the March 2012. He previously served
at PriceWaterhouseCoopers 2007. Prior to joining Prudential, UK, US and Europe. on the board of Close Brothers
where he worked in both London John spent three years with Group plc as a non-executive
Rob chairs the London
and Paris. Age 47. National Australia Bank as director from 2001 to 2008 and
Leadership Team of Business
General Manager, Global Capital has been a member of the Finance
in The Community and is also
Markets. John began his career at Committee of the MCC since
a trustee of the LloydsTSB
Hill Samuel & Co Limited where, October 2005. Age 51.
Foundation for England and
over a 20 year period, he worked Wales. Age 44.
in every division of the bank,
culminating in senior roles in risk,
capital markets and treasury of the
combined TSB and Hill Samuel
Bank. Age 56.
90 Governance Prudential plc Annual Report 2012
Board of directors continued
[Graphic Appears Here]
Barry Stowe Executive Director Appointments
Board: November 2006
Barry Stowe is the Chief Executive of Prudential Corporation Asia, a position he has held since October 2006. Before joining Prudential, he was President, Accident & Health Worldwide for AIG Life Companies. He joined AIG in 1995, and prior to that was President and CEO of Nisus, a subsidiary of Pan-American Life, from 1992 to 1995. Before joining Nisus, Barry spent 12 years at Willis Corroon in the US.
Barry is a member of the Board of Directors of the International Insurance Society and was a director of the Life Insurance Marketing Research Association (LIMRA) and the Life Offi ce Management Association (LOMA) from October 2008 to October 2011. He is also a member of the Board of Visitors of Lipscomb University, a member of the Board of Managers of the Hong Kong International School and Chairman of Save the Children (HK) Ltd. Age 55.
Michael Wells Executive Director Appointments
Board: January 2011
Mike Wells is President and CEO of Jackson National Life Insurance Company (Jackson). Mike has served in a variety of senior and
strategic positions at Jackson over the last 15 years, including President of Jackson National Life Distributors. Mike has been Vice Chairman and Chief Operating Offi cer of Jackson for the last nine years. During this period he has led the development of Jackson’s variable annuity business and been responsible for IT, strategy, operations, communications, distributions, Curian and the retail broker dealers. Age 52.
Non-Executive Directors
Keki Dadiseth FCA Independent non-executive director Appointments
Board: April 2005
Remuneration Committee:
April 2005
Keki was a member of the Audit Committee from 2005 to 2007 and was appointed as a member of the Prudential Corporation Asia Audit Committee in July 2012. During 2006, he was appointed as a non-executive director of ICICI Prudential Life Assurance Company Limited and ICICI Prudential Trust Limited.
Keki is also a director of Britannia Industries Limited, JM Financial Limited, JM Financial Services Limited, Piramal Enterprises Limited, Siemens Limited, The Indian Hotels Company Limited and Godrej Properties Limited, all of which are quoted on the Bombay Stock Exchange. In addition, he acts as adviser to Fleishman-Hillard Inc and is Chairman of Marsh & McLennan Companies Group, India.
He is Chairman of the Breach Candy Hospital Trust and a trustee for a number of Indian charities. Keki is the non-executive Chairman of Omnicom India Marketing Advisory Services Private Limited, an unquoted Indian company, and is also a board member of various other unquoted Indian companies. He serves as Chairman of Sony India Pvt Ltd and Senior Advisor to Sony Group in India.
Before he retired from Unilever in 2005, Keki was Director, Home and Personal Care, responsible for the HPC business of Unilever worldwide, a Board member of Unilever PLC and Unilever N.V., and a member of Unilever’s Executive Committee. He joined Hindustan Lever Ltd in India in 1973 and in 1987, he joined the Board of Hindustan Lever and became Chairman in 1996. Age 67.
Board of directors Prudential plc Annual Report 2012 91
[Graphic Appears Here]
Non-Executive Directors
Sir Howard Davies Michael Garrett Ann Godbehere FCGA Alexander Johnston Board
Independent Independent Independent(Alistair) CMG FCA of
non-executive director non-executive director non-executive director Independent
Appointments Appointments Appointments non-executive director directors
Board: October 2010 Board: September 2004 Board: August 2007 Appointments
Chairman of the Risk Committee: Remuneration Committee: Chairman of the Audit Committee: Board: January 2012
October 2010 September 2004 October 2009 Audit Committee: January 2012
Audit Committee: Risk Committee: November 2010
Michael Garrett worked for Nestlé Alistair was a partner of KPMG
November 2010 Nomination Committee: July 2012
from 1961, becoming Head of Japan from 1986 to 2010. He joined
Nomination Committee: July 2012 Governance
from 1990 to 1993, and then Zone Ann was a member of the Audit KPMG (then Peat Marwick
Sir Howard is chairman of the Director and Member of the Committee from 2007. Mitchell) in 1973 and held a
Phoenix Group, and a Professor Executive Board, responsible for number of senior leadership
Ann began her career in 1976
at Institut d’Études Politiques Asia and Oceania. In 1996 his positions. These included Vice
with Sun Life of Canada, joining
(Sciences Po). He is also Chairman responsibilities were expanded to Chairman of UK Financial Services
Mercantile & General Reinsurance
of the UK Government’s Airports include Africa and the Middle East. and Head of UK Insurance
Group in 1981, where she held a
Commission. He chairs the Michael retired as Executive Vice Practice, International Managing
number of management roles
International Advisory Board of President of Nestlé in 2005. He Partner – Global Markets and UK
rising to Senior Vice President and
the China Securities Regulatory served the Government of Australia Vice Chairman. Latterly he served
Controller for life and health and
Commission and is a member of as Chairman of the Food Industry as a Global Vice Chairman of
property/casualty businesses in
the International Advisory Board Council and as a Member of the KPMG from 2007 to 2010.
North America in 1995. In 1996
of the China Banking Regulatory Industry Council of Australia, and Swiss Re acquired Mercantile & Alistair acted as a non-executive
Commission. He is also an was also a member of the Advisory General Reinsurance Group and director of the Foreign &
independent director of Morgan Committee for an APEC (Asia- Ann became Chief Financial Commonwealth Office from 2005
Stanley Inc and a Director of the Pacific Economic Cooperation) Food Officer of Swiss Re Life & Health, to 2010 and chaired the audit
National Theatre. Age 62. System, a Member of The Turkish North America. In 1997 she was committee until 2009. He was an
Prime Minister’s Advisory Group made Chief Executive Officer of Association Member of BUPA
and the WTO (World Trade Swiss Re Life & Health, Canada. until January 2012. Alistair is a
Organization) Business Advisory She moved to London as Chief member of the Strategy and
Council in Switzerland. Financial Officer of Swiss Re Life Development Board and a Visiting
Michael remains a director of & Health Division in 1998 and Professor at Cass Business School.
Nestlé in India, and was appointed joined the Property & Casualty In February 2012 Alistair was
Chairman of the Evian Group, a Business Group, based out of appointed as a Trustee of the
think tank and forum for dialogue Zurich, as Chief Financial Officer Design Museum in London.
promoting free trade, from 2001 on its establishment in 2001. From Age 60.
to 2011. He also serves as a 2003 until February 2007, Ann
non-executive director on the was Chief Financial Officer of the
Boards of the Bobst Group in Swiss Re Group.
Switzerland, Hasbro Inc. in the USA, Ann is also a non-executive
and Gottex Fund Management director of British American
Holdings Limited in Guernsey. Tobacco plc, Rio Tinto plc, Rio
In addition, he is a Member of the Tinto Limited, UBS AG, Arden
Swaziland International Business Holdings Limited, Atrium
Advisory Panel under the auspices Underwriting Group Limited and
of the Global Leadership Foundation Atrium Underwriters Limited.
(GLF) London, as well as being From its nationalisation in 2008
a member of the Development until January 2009, Ann was
Committee of the International Interim Chief Financial Officer and
Business Leaders Forum (IBLF) until Executive Director of Northern
stepping down in 2011. Age 70. Rock. Age 57.
92 Governance Prudential plc Annual Report 2012
Board of directors continued
[Graphic Appears Here]
Non-Executive Directors continued
Kaikhushru Nargolwala FCA Independent non-executive director Appointments
Board: January 2012
Remuneration and Risk
Committees: January 2012
Kai Nargolwala was the non-executive Chairman of Credit Suisse Asia Pacifi c until December 2011, having joined Credit Suisse in 2008 as a member of the Executive Board and CEO of the Asia Pacifi c region.
From 1998 to 2007, Kai worked for Standard Chartered PLC where he was a Group Executive Director responsible for Asia Governance and Risk. His responsibilities included developing strategy and business performance across Asia, as well as strategic
merger and acquisition activity. Prior to that, he spent 19 years at Bank of America and from 1990 was based in Asia as Group Executive Vice President and Head of the Asia Wholesale Banking Group. From 2004 to 2007, he was a non-executive director at Tate & Lyle plc and at Visa International, where he served on the Asia Pacifi c Board.
Kai is currently a non-executive director and lead independent director of Singapore Telecommunications Limited, a member of the Board of the Casino Regulatory Authority of Singapore, a non-executive director of PSA International Pte. Limited, Chairman of the Governing Board of the Duke-NUS Graduate Medical School and a director and Chairman of Clifford Capital Pte. Limited. Age 62.
Philip Remnant CBE ACA Senior Independent Director Appointments
Board: January 2013
Remuneration, Audit, Nomination Committees: January 2013
Philip Remnant is a senior adviser at Credit Suisse, a Deputy Chairman of the Takeover Panel, a non-executive director of UK Financial Investments Limited (since 2009) and Chairman of City of London Investment Trust plc (since 2011). He was previously a Vice Chairman of Credit Suisse First Boston (CSFB) Europe and Head of the UK Investment Banking Department. Philip was seconded to the role of Director General of the Takeover Panel, which administers the UK’s code on takeovers and mergers, from 2001 to 2003 and again in 2010. He served on the Board of Northern Rock plc from 2008 to 2010 and from 2007 to 2012 was Chairman of the Shareholder Executive, which manages the relationships between the UK Government and the businesses in which it is a shareholder. Age 58.
Lord Turnbull KCB CVO Independent non-executive director Appointments
Board: May 2006
Chairman of the Remuneration Committee: June 2011 Risk Committee: November 2010 Nomination Committee:
June 2011
Lord Turnbull was a member of the Remuneration Committee from November 2010, and a member of the Audit Committee from January 2007 to November 2010.
Lord Turnbull 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.
Lord Turnbull is a non-executive director of Frontier Economics Limited and The British Land Company PLC. He was formerly Chairman of BH Global Limited until January 2013 and a non-executive director of the Arup Group from 2006 to 2007. He also worked part-time as a Senior Adviser to the London partners of Booz and Co (UK) until February 2011. Age 68.
Corporate governance Prudential plc Annual Report 2012 93
Corporate governance
Good governance through leadership and accountability
Paul Manduca Compliance with Corporate Governance Codes
Chairman UK Corporate Governance Code and the Corporate
Governance Code for Hong Kong
In line with its premium and main listings on the London and
Hong Kong stock exchanges, Prudential applies the principles
of the UK Corporate Governance Code (the ‘UK Code’) and the
Corporate Governance Code issued by the Hong Kong Stock
Exchange (‘the HK Code’) to its governance framework.
The Board confirms Prudential is currently in compliance with
the UK Code provisions although, during the year, there was a
period when the Company was without a Senior Independent
Director (in accordance with Code Provision A.4.1) due to the
Your Chairman’s view: appointment of Paul Manduca as Chairman in July 2012.
Prudential’s governance framework makes a vital Following this appointment, the search for a new Senior
contribution to the long-term success of the Group. To ensure
that our business is both successful and sustainable, the Independent Director commenced and was successfully Governance
Board works closely with management in evaluating the concluded with the appointment of Philip Remnant, who joined
opportunities and risks we face. We ensure that the Group’s the Board in January 2013. Throughout the search process, the report
strategy remains appropriate and that rigorous oversight is Company ensured that the non-executive directors were
in place across our geographically diverse business. available for shareholders to contact should they have had any
The Board, which I lead, is responsible for ensuring that our concerns and the Company believes that the governance of the
governance is strong, clear and appropriate, and plays the Board and the Company as a whole was not adversely affected
best possible part in supporting our business and its growth. during the period while a successor was sought. Governance
Like all aspects of business, governance is constantly The Board confirms that it has also complied with the HK Code
evolving, and we ensure that we are well prepared for new throughout the period other than in respect of the responsibilities
developments. As well as complying with the relevant codes, of the Remuneration Committee as regards making
we keep a close eye on upcoming changes to those codes, and recommendations to the Board in respect of the remuneration
carry out intensive work to prepare our policies, structures
and procedures well in advance. of non-executive directors. It would be inconsistent with the
principles of the UK Code for the Remuneration Committee,
We are committed to reporting on our governance in a clear which is comprised solely of non-executive directors, to be
and transparent way, and will continue to ensure that our involved in the setting of their own fees.
governance is the best in its class and a central part of how
we do business. The principles of the UK and HK Codes have been applied as set
out below and in the Directors’ remuneration report, which can
be found on pages 113 to 143.
The UK Code can be viewed on the Financial Reporting Council’s
website, with a copy of the HK Code available on the website of
the Hong Kong Stock Exchange.
Leadership
Role of the Board
The Board is accountable for the long-term success of the Group
and for providing leadership within a framework of effective
controls. The control environment enables the Board to identify
significant risks and apply appropriate measures to manage and
mitigate them. The Board is responsible for setting strategic
targets and for ensuring that the Group is suitably resourced to
achieve those targets. In doing so, the Board takes account of
its responsibilities to the Group’s stakeholders, including the
Group’s employees, shareholders, suppliers and the communities
in which Prudential operates.
94 Governance Prudential plc Annual Report 2012
Corporate governance continued
The Board has terms of reference which specifi cally set out matters reserved for its decision. These are kept under regular review and include matters such as setting the Group’s strategy and monitoring its
implementation, the approval of annual budgets and business plans, as well as the risk appetite of the Group and its capital and liquidity positions. The Board has approved a governance framework and under these procedures, all business units are required to seek approval from the Board for matters exceeding pre-determined authority limits. The terms of reference are regularly reviewed and enable the Board to exercise effective control over the Group’s affairs.
The Board has delegated authority to a number of Board committees which assist the Board in delivering its responsibilities and ensuring that there is appropriate independent oversight of internal control and risk management. Each of these committees has established terms of reference and is comprised of independent non-executive directors, with the exception of the Nomination Committee which, in keeping with the provisions of UK Code, is chaired by the Chairman.
The Board has also delegated authority for the operational management of the Group’s businesses to the Group Chief Executive for execution or further delegation by him in respect of matters which are necessary for the effective day-to-day running
and management of the business. The chief executive of each business unit has authority for the management of that respective business unit and each has established a management board comprising its most senior executives.
In performing its duties, the Board has access to the services of the Group Company Secretary who advises on corporate governance matters, Board procedures and compliance with the applicable rules and regulations. Directors have the right to seek independent professional advice at the Group’s expense and copies of such advice are circulated to other directors where applicable and appropriate.
In the ordinary course of business, Board and Committee papers are provided to the directors approximately one week in advance of each meeting.
Powers of the Board
The Board may exercise all powers conferred on it by the
Company’s Articles of Association and the Companies Act 2006. This includes the powers of the Company to borrow money and to mortgage or charge any of its assets (subject to the limitations set out in the Companies Act 2006 and the Company’s Articles of Association) and to give a guarantee, security or indemnity in respect of a debt or other obligation of the Company.
Table 1
Board Board Audit Remuneration Nomination Risk
(scheduled)(additional) Committee Committee Committee Committee
Number of meetings held 10 7 12 5 9 5
Chairman
Harvey McGrath (retired 2 July 2012)1 5 5 – – 2 –
Paul Manduca (appointed 2 July 2012)2,3 9 6 5 3 8 –
Executive directors
Tidjane Thiam 10 7 – – – –
Nic Nicandrou 10 6 – – – –
Rob Devey 10 7 – – – –
John Foley 10 7 – – – –
Michael McLintock 9 6 – – – –
Barry Stowe 10 4 – – – –
Mike Wells 10 4 – – – –
Non-executive directors
Keki Dadiseth 9 3 – 4 – –
Howard Davies4 10 5 12 – 2 5
Michael Garrett 10 6 – 5 – –
Ann Godbehere4 10 7 12 – 2 5
Alistair Johnston 10 7 12 – – –
Kai Nargolwala6 10 6 – 5 – 4
Kathleen O’Donovan (retired 31 March 2012) 1 1 3 – 4 –
Lord Turnbull7 10 7 – 5 9 5
Notes
1 Harvey McGrath did not attend Nomination Committee meetings when it dealt with the appointment of the successor to his Chairmanship, in accordance with the UK Code.
2 Paul Manduca was the Senior Independent Director and attended all scheduled Audit and Remuneration Committee meetings prior to his appointment as Chairman on 2 July 2012.
3 Paul Manduca missed one Nomination Committee meeting and one additional Board meeting due to a conflict of interest.
4 Appointed as members of the Nomination Committee on 2 July 2012.
5 There was one additional Remuneration Committee meeting and two additional Risk Committee meetings during the year.
6 Kai Nargolwala was unable to attend one additional Risk Committee meeting and one additional Remuneration Committee meeting.
7 Lord Turnbull was unable to attend one additional Risk Committee meeting.
Chairman
The roles of Chairman and Group Chief Executive are separate and clearly defi ned. The scope of these roles is approved and kept under regular review by the Board so that no individual has unfettered decision-making powers.
The Chairman is responsible for the leadership and governance of the Board, and ensuring that suffi cient time is available for discussion of all agenda items. The Chairman also facilitates the contribution of the non-executive directors and constructive relationships between the non-executive and executive directors by promoting a culture of openness and debate.
Harvey McGrath retired as Chairman of the Board in July 2012 and was succeeded by Paul Manduca.
The Board was satisfi ed that during 2012 the Chairman’s external commitments did not hinder the day-to-day performance of his duties for Prudential and that he had the commitment and capability to make himself available under unforeseen circumstances. The major commitments of the Chairman, including changes during the year where applicable, are detailed in his biography on page 88.
Chief Executive
The Group Chief Executive is responsible for the management of the Group and the implementation of the strategy and policy approved by the Board. In discharging his responsibilities, the Group Chief Executive is advised and assisted by the Group Executive Committee which comprises business unit heads and a Group Head Offi ce team of functional specialists.
Senior Independent Director
Paul Manduca was the Senior Independent Director until July 2012 when he succeeded Harvey McGrath as Chairman of the Board. The Nomination Committee concluded its search for a suitable replacement in December 2012, with the appointment of Philip Remnant. Philip’s appointment became effective on
1 January 2013.
The Senior Independent Director is responsible for maintaining contact with shareholders with a view to understanding their concerns and issues,
as well as providing ongoing support to the Chairman and acting as an intermediary for the other non-executive directors if required. The Senior Independent Director is accessible to all stakeholders, including debt investors, particularly if they have concerns and where contact through the normal channels may have failed or would be inappropriate.
The Senior Independent Director is also responsible for leading the performance evaluation of the Chairman.
Corporate governance Prudential plc Annual Report 2012 95
Meetings
During 2012, the Board met on 10 scheduled occasions and held
seven additional meetings. A separate off-site strategy event was
also held. A detailed forward agenda has been in operation for
a number of years and this is kept updated to reflect not only
regular items of business but also any topical matters arising
during the year.
Given the geographical spread of the Group’s business, at least
one board meeting a year is held overseas at one of the Group’s
business operations. These meetings facilitate a fuller
understanding of operations in that jurisdiction and provide an
opportunity for the directors to meet with senior members of the
management teams in those countries. The overseas meeting for
2012 was held in Singapore.
Where a director was unable to attend board meetings, their
views were canvassed by the Chairman prior to the meeting.
During the year, the Chairman met with the non-executive
directors without the executive directors being present on four
occasions.
Table 1 on page 94 details the number of board and committee Governance
meetings attended by each director during the year.
Effectiveness report
Composition
At the date of this report, the Board comprised the Chairman,
seven executive directors and eight independent non-executive
directors. Governance
On 1 January 2012, Kai Nargolwala and Alistair Johnston joined
the Board as non-executive directors. Kathleen O’Donovan
retired as a non-executive director on 31 March 2012. Harvey
McGrath retired as a director on 2 July 2012 and was succeeded
as Chairman by Paul Manduca. Philip Remnant was appointed as
the Senior Independent Director with effect from 1 January 2013.
The biographies of all current directors are set out on pages 88
to 92.
The Board, or the members in a general meeting, may appoint
directors up to a maximum total number of 20 as set out in the
Company’s Articles of Association. The removal and resignation
of the Company’s directors is governed by the relevant provisions
of the Companies Act 2006, the UK and HK Codes and the
Company’s Articles of Association.
96 Governance Prudential plc Annual Report 2012
Corporate governance continued
Terms of appointment for non-executive directors
Non-executive directors are usually appointed for an initial three-year term commencing with their election by shareholders at the first Annual General Meeting following their appointment by the Board and are subject to annual re-election by shareholders. Each appointment is reviewed towards the end of the three-year term against performance and the requirements of the Group’s businesses. The terms and conditions of all directors’ appointments are available for inspection at the Company’s registered office during normal business hours and at the Annual General Meeting.
Non-executive directors are typically expected to serve for two terms of three years from their initial election by shareholders although the Board may invite them to serve for an additional period. Non-executive directors serving a third term are subject to rigorous annual review.
Re-election
Directors appointed to the Board since the 2012 Annual General Meeting will stand for election for the first time and, in accordance with the provisions of the UK Code, all other serving directors will offer themselves for re-election at the Annual General Meeting to be held on 16 May 2013. The Board believes that the non-executive directors bring a wide range of business, financial and international experience to the Board and its committees.
Succession planning
The Board is actively engaged in succession planning for both executive and non-executive roles to ensure that Board composition is regularly refreshed and that the Board retains its effectiveness at all times. This is delivered through an established review process that is applied across all businesses and covers both director and senior management succession and development and also through the work of the Nomination Committee as described more fully on page 103. The Board considers annually the outcome of the review and actions arising from the review are implemented as part of the management development agenda.
Diversity
The Group seeks, through its diversity policy, to encourage the recruitment and retention of talented women at all levels. Furthermore, the Board remains committed to inclusion in all its forms and believes that leading companies seek out, and not simply tolerate, diversity.
The inclusion of women extends to the Board and is an important consideration during searches for new Board members.
Prudential embraces the proposition that more women on boards would be advantageous to companies as well as to society at large. The Group remains duty-bound to recruit the best available talent, and although the Board does not endorse quotas, it does commit to having an increasing representation of women in senior positions in the Group and on the Board.
Independence
The independence of the non-executive directors is determined with reference to the UK and HK Codes. Prudential is required to affirm annually the independence of all non-executive directors under the Hong Kong Listing Rules and also the independence of its Audit Committee members under the Sarbanes-Oxley legislation. The Board has appropriate processes in place to manage any potential conflicts of interest.
Throughout the year the non-executive directors were considered by the Board to be independent in character and judgement and met the provisions for independence as set out in the UK and HK Codes. The Company has received confirmation of independence from each of the independent non-executive directors as required by the Hong Kong Listing Rules.
Paul Manduca succeeded Harvey McGrath as Chairman in July 2012 and is considered to have met the independence requirements of the UK Code on appointment. As the ongoing test of independence is not appropriate in relation to the Chairman under the UK Code, and to ensure a consistent approach in how the Chairman is described in all corporate communications, the Chairman has not been asked to provide confirmation of his independence for the purposes of the Hong Kong Listing Rules for the financial year 2012 and will not be asked to do so in future.
Keki Dadiseth and Barry Stowe serve as non-executive directors of ICICI Prudential Life Insurance Company Limited, an Indian company which is owned 26 per cent by Prudential. In addition, Keki serves, at Prudential’s request, as a non-executive director of ICICI Prudential Trust Limited, an Indian company which is owned 49 per cent by Prudential. The Board does not consider that these appointments in any way affect Keki’s status as an independent director of Prudential.
Alistair Johnston was a partner in the Company’s auditor, KPMG, from 1986 to 2010. However, he did not audit the Prudential Group and he no longer has any financial or other interest in KPMG. The Board does not consider that this former relationship with KPMG affects Alistair’s status as an independent director of Prudential.
Prudential is one of the UK’s largest institutional investors and the Board does not believe that this situation compromises the independence of those non-executive directors who are on the boards of companies in which the Group has a shareholding. The Board also believes that such shareholdings should not preclude the Company from having the most appropriate and highest calibre non-executive directors.
Induction and development
The Group Company Secretary supports the Chairman in providing tailored induction programmes for new directors and ongoing development for all directors. On appointment all directors embark upon a wide-ranging induction programme covering, amongst other things, the principal bases of accounting for the Group’s results, the role of the Board and its key committees and the ambit of the internal audit and risk management functions. In addition, they receive detailed briefings on the Group’s principal businesses, its product range, the markets in which it operates and the overall competitive environment. These sessions are facilitated through meetings with executive management and other senior members of the management team. Other areas addressed include the directors’ obligations under the different listing regimes, legal issues affecting directors of financial services companies, the Group’s governance arrangements and its investor relations programme, as well as its remuneration policies.
Throughout their period in office, directors are regularly updated on the Group’s businesses and the regulatory and industry-specific environments in which it operates as well as on their legal and other duties and obligations as directors where appropriate. The scope of these updates is reviewed in line with the requirements of the business and can be in the form of written reports to the Board, or presentations by senior executives or by external advisers where appropriate. In order to enhance their knowledge and effectiveness throughout their term in office, non-executive directors serving on key committees are updated regularly on matters specific to the relevant committee and receive presentations from senior executives on topics of interest to them.
Ongoing professional development was undertaken by all directors during 2012. This included a number of sector-specific and business issues as well as legal, accounting and regulatory changes and developments, and covered an update on key changes applicable to companies listed on the Hong Kong Stock Exchange. A number of business unit chief executive officers together with relevant senior executives gave presentations to the Board during the course of the year on the challenges and opportunities currently faced by their business unit. In addition, senior managers within certain head office functions presented to the Board on the key issues currently facing their function and directors received briefings on Solvency II. Members of the Audit Committee have the option to attend meetings of the business unit audit committees to aid their understanding of topical matters of interest to them and how they are handled by the Group.
Non-executive directors have also received updates and briefings relevant to their duties as directors of a company listed on the Hong Kong Stock Exchange.
Corporate governance Prudential plc Annual Report 2012 97
Performance evaluation
In respect of 2011, there was a formal and rigorous review of
the Board, its Committees and their effectiveness which was
undertaken by an external consultancy. Areas of improvement
were identified and good progress was made against these
during the course of 2012.
In respect of 2012, the review was carried out internally and
was facilitated by the Group Company Secretary. The review
was conducted using a combination of face-to-face meetings and
questionnaires, and the findings will be presented to the Board
in March 2013. Opportunities to improve Board performance
will be documented and an action plan for 2013 agreed.
The performance of the non-executive directors and the Group
Chief Executive is evaluated by the Chairman in individual
meetings. The Senior Independent Director leads the
non-executive directors in a performance evaluation
of the Chairman.
Executive directors are subject to regular review and the Group
Chief Executive individually appraises the performance of each
of the executive directors as part of the annual Group-wide
performance evaluation of all staff.
Governance
Conflicts of interest
report
Directors have a statutory duty to avoid conflicts of interest with
the Company. The Company’s Articles of Association allow the
directors to authorise conflicts of interest and the Board has
adopted a policy and effective procedures to manage and, where
appropriate, approve conflicts or potential conflicts of interest.
Governance
Under these procedures directors are required to declare all
directorships or other appointments to companies which are not
part of the Group as well as other situations which could result in
conflicts or could give rise to a potential conflict. The Nomination
Committee, or the Board where appropriate, evaluates and
approves each such situation individually where applicable.
Directors’ interests
Individual directors’ interests are set out on page 133 of the
Directors’ remuneration report.
98 Governance Prudential plc Annual Report 2012
Corporate governance continued
External appointments
Directors may hold directorships or other significant interests in companies outside the Group which may have business relationships with the Group.
Non-executive directors may serve on a number of other boards provided that they are able to demonstrate satisfactory time commitment to their role at Prudential and that they discuss any new appointment with the Chairman prior to accepting. This ensures that they do not compromise their independence and that any potential conflicts of interest and any possible issues arising out of the time commitments required by the new role can be identified and addressed appropriately. The major commitments of our non-executive directors are detailed in their biographies set out on pages 90 to 92.
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 UK Code, executive directors would be expected to hold no more than one non-executive directorship, nor the chairmanship, of a FTSE 100 company. Some of our 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 131 and major commitments of our executive directors are detailed in their biographies on pages 88 to 90.
Directors’ indemnities and protections
Suitable insurance cover is in place in respect of legal action against directors and senior managers of companies within the Prudential Group. Protection for directors, and certain senior managers, of companies within the Group, against personal financial exposure which may be incurred in their capacity as such, is also provided. These include qualifying third party indemnity provisions (as defined by the Companies Act 2006) for the benefit of directors of Prudential plc and other such persons including, where applicable, in their capacity as directors of other companies within the Group. These indemnities were in force during 2012 and remain in force.
In addition, the Articles of Association of the Company permit the directors and officers of the Company to be indemnified in respect of liabilities incurred as a result of their office.
Accountability
Internal control and risk management
The Board has overall responsibility for the system of internal control and risk management and for reviewing its effectiveness. The framework setting out the Group’s approach to internal control, risk management and corporate responsibility comprises the following:
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.
Group risk framework: Provides an overview of the Group-wide philosophy and approach to risk management and sets out the key risk management processes which support the Group’s compliance with internal, statutory and regulatory requirements.
Corporate responsibility framework: Provides an overview of the Group-wide philosophy and approach to corporate responsibility; supports the Group’s commercial focus and the increasing challenges faced including changes in stakeholder expectations. A key element is the Group Code of Business Conduct which sets out the ethical standards the Board requires of itself, employees, agents and others working on behalf of the Group, in their dealings with employees, customers, shareholders, suppliers, and competitors, in the wider community and in respect of the environment.
The governance framework principally relates to the operational management of the Group’s businesses and includes pre-determined authority limits delegated by the Board in respect of matters which are necessary for the effective day-to-day running and management of the business.
The system is regularly reviewed and complies with the UK and HK Codes, as well as the relevant provisions of Sarbanes-Oxley. In complying with the UK Code, the Group follows the 2005 Turnbull Guidance relating to the sections of the Code dealing with risk management and internal control. The Board reviewed the effectiveness of the system of internal control in February 2013, covering all material controls, including financial, operational and compliance controls, risk management systems and the adequacy of the resources, qualifications and experience of staff of the Group’s accounting and financial reporting function. The system is designed to manage rather than eliminate the risk of failure to achieve business objectives and gives reasonable, but not absolute, assurance. The Board confirms that there is an ongoing process for identifying, evaluating and managing the significant risks faced by the Group, which has been in place throughout the period and up to the date of this report.
Corporate governance Prudential plc Annual Report 2012 99
The chief executive and chief financial officer of each business
unit, as well as the senior management in Group Head Office,
annually certify compliance with the Group’s governance,
internal control and risk management requirements. The risk
management function reviewed any matters identified by the
certification process, and also assessed the risk and control
issues that arose and were reported during the year. This
included routine and exception-based risk reporting, matters
identified and reported by other Group Head Office oversight
functions and the findings from the work of the internal audit
function, which executes risk-based audit plans throughout
the Group. The results were reported to and reviewed by the
Audit Committee.
In line with the Turnbull Guidance, the certification provided
above does not apply to certain material joint ventures where
the Group does not exercise full management control. In these
cases, the Group satisfies itself that suitable governance and risk
management arrangements are in place to protect the Group’s
interests. However, the relevant Group company which is party
to the joint venture must, in respect of any services it provides in support of the joint venture, comply with the requirements of the Group’s internal governance framework.
The Business Review provides further detail on Prudential’s
risk appetite and exposures on pages 68 to 78 and corporate
responsibility activities on pages 79 to 85.
Further details on the procedures for the management of risk and
the systems of internal control operated by the Group are given
in the section on Risk Governance on pages 105 and 106.
The internal control and risk management systems described
above and also under the sections on Risk Governance on page 105
and the Audit Committee on page 101, cover the Company’s
financial reporting process and the Group’s process for the
preparation of consolidated financial statements.
Committees
The Board has established Audit, Remuneration, Nomination and
Risk Committees as principal standing committees of the Board.
Each committee has written terms of reference which are kept
under regular review. These committees are key elements of the
Group’s corporate governance framework and reports on each committee are included below.
Governance
report
Prudential plc
Board of directors Governance
Audit Committee Remuneration Committee Risk Committee Nomination Committee
Group Chief Executive
Group Executive Committee
Management Committees
Our committee structure
[Graphic Appears Here]
The Committee’s responsibilities consist of oversight over financial reporting, the effectiveness of the internal control systems and monitoring auditor independence. Its duties include gaining assurance on the control over financial processes and the integrity of the Group’s financial reports, monitoring the performance, objectivity and independence of the external auditor, reviewing the work of the internal auditor and providing oversight to the Group Compliance function.
During 2012, the Audit Committee continued to focus on ensuring the Group’s financial reporting remained clear, robust and informative, and continued to work closely with the Risk Committee to ensure an integrated approach to risk assurance and risk management was achieved. The Committee met regularly with the Group-wide Internal Audit Director and the Audit Partner from the external auditor.
The principal responsibilities of the Committee are to: monitor the integrity of the financial statements, including the review of half and full-year results, the annual report and accounts and other significant financial announcements and review the critical accounting policies and key judgmental areas contained therein; monitor the framework and effectiveness of the Group’s systems of internal control, including the Turnbull compliance statement and Sarbanes-Oxley procedures; monitor auditor independence and the external auditor’s plans and audit strategy, the effectiveness of the external audit process, the external auditor’s qualifications, expertise and resources, and make recommendations for the re-appointment of the external auditor; review the internal audit plan and resources, and monitor the audit framework and effectiveness of the internal audit function; monitor the effectiveness of compliance processes and controls, and performance against the Group Compliance Plan; review the anti-money laundering procedures in place, as well as the review of procedures operated for handling allegations from whistleblowers; and review the effectiveness of the business unit audit committees.
The Audit Committee has received balanced and timely information over the course of the year which has enabled it to provide effective oversight of the Group’s key financial reporting risks and internal controls.
Membership
The Audit Committee (the Committee) is comprised of the independent non-executive directors as set out below:
Ann Godbehere (Chairman)
Sir Howard Davies
Alistair Johnston
Paul Manduca (to 2 July 2012)
Kathleen O’Donovan (to 31 March 2012)
Philip Remnant (from 1 January 2013)
The membership is selected to provide a broad range of financial, commercial and other experience relevant to meet the Committee’s objectives.
In performing its duties, the Committee has access to employees and their financial or other relevant expertise across the Group and to the services of the Group-wide Internal Audit Director and the Group Company Secretary. The Committee may also seek external professional advice at the Company’s expense.
The Board has determined that Ann Godbehere, the Committee Chairman, has recent and relevant financial experience in respect of the financial reporting period under review and for the purposes of the UK Code and the Hong Kong Listing Rules. In March 2012, the Board designated Ann Godbehere as its audit committee financial expert for Sarbanes-Oxley Act purposes. This will be reviewed during 2013 in conjunction with the publication of Form 20-F.
Full biographical details of the members of the Committee are set out on pages 88 to 92.
Meetings
The Committee meets at least five times a year and gives consideration to the financial statements of the Group and the Group’s system of internal control, as well as its internal and external audit providers. The Chairman of the Committee is a member of the Risk Committee and works closely with that committee in fulfilling the Audit Committee’s responsibilities.
By invitation, the Chairman of the Board, the Group Chief Executive, the Chief Financial Officer, the Group Chief Risk Officer and the Group General Counsel, as well as other senior staff from the Group finance, internal audit, risk, compliance and security functions attended the meetings to contribute to the discussions relating to their respective areas of expertise. The lead and other partners of the external auditor also attended the meetings.
During 2012, the Committee held 12 scheduled meetings and details of Committee members’ attendance is set out on page 94.
A detailed forward agenda has been in operation for a number of years and is reviewed and updated regularly to ensure all matters for which the Committee is responsible are addressed at the appropriate time of year.
The Committee also received in-depth presentations on a range of topics and received the minutes of both the Disclosure Committee and the Assumptions Approval Committee. Further information on the Disclosure Committee appears under the heading ‘US corporate governance and regulations’ on page 109. The Assumptions Approval Committee reviews the economic assumptions to be used for EEV reporting, business planning, forecasting and the IAS 19 valuation of the three UK defi ned benefi t pension schemes. Further information on risk governance appears on pages 105 and 106 respectively.
The Committee Chairman reported to the Board on matters of particular signifi cance after each meeting and the minutes were circulated to all Board members. The terms of reference for the Committee are kept under regular review and are updated where required. A copy of these can be found on the Company’s website.
The Committee recognises the need to meet without the presence of executive management. Such sessions were held with the external auditor in July and October 2012, and with the internal auditor in July 2012. At all other times management and auditors had open access to the Chairman and the Committee.
Financial reporting
The Committee is regularly briefed by management on developments in International Financial Reporting Standards and focussed on the critical accounting policies and practices as part of its review of fi nancial statements prior to recommending their publication to the Board. The Committee also reviewed any changes or decisions requiring a major element of judgement, unusual transactions, clarity of disclosures, signifi cant audit adjustments (of which there were none in 2012), the going concern assumption, compliance with accounting standards, and compliance with obligations under applicable laws, regulations and governance codes.
Confi dential reporting
A standing agenda item of the Committee is to review a report on the use of the confi dential reporting procedures, which are available to employees to enable them to communicate confi dentially, and anonymously if they so wish, on matters of concern and actions taken in response to these communications.
No material control implications were raised through these procedures during the year.
Business unit audit committees
Every business unit has its own audit committee which provides oversight to the respective business unit and reports any relevant matters to the Committee. The members and chairmen are comprised primarily of senior management who are independent of the respective business unit. The minutes of these committees are reported regularly to the Committee and their meetings are attended by senior management of the respective business unit, including the business units’ heads of fi nance, risk, compliance and Group-wide internal audit.
Business unit audit committees have adopted standard terms of reference across the Group with minor variations to address local requirements or particular requirements of the business. The terms of reference of those committees were reviewed during the year and all include escalation of signifi cant matters to the Committee, recommendations for approval of the business unit internal audit plans and overseeing the adequacy of internal audit
Corporate governance Prudential plc Annual Report 2012 101
resources. During the year the business unit audit committees
reviewed their respective internal audit plans, resources and
the results of internal audit work, and both external and internal
auditors were able to discuss any relevant matters with the
Chairman and members of the Committee as required.
Effectiveness of business unit audit committees
Group-wide Internal Audit has reviewed the effectiveness
of each business unit audit committee using an established
evaluation tool. The evaluation comprises an annual review
questionnaire which is divided into specific areas for appraisal
and a walk through of each committee’s terms of reference,
assessing whether these are appropriate for the business unit
and if the committee has fulfilled its responsibilities under the
terms. A memorandum summarising the findings of the review,
as well as any action points, is compiled for each business unit
audit committee.
The findings were reviewed by the Group-wide Internal Audit
business unit audit director in conjunction with the Chairman and
discussed by the respective business unit audit committees. In
addition, the Chairman of each business unit audit committee has
confirmed that, in their opinion, the current members have the
Governance
appropriate balance of skills, knowledge and expertise to oversee
the relevant business unit.
report
On completion of the review, Group-wide Internal Audit
concluded that the overall arrangements for the business unit
audit committees remained appropriate for the nature and
purpose of each business unit and that each business unit audit
Governance
committee continued to meet the responsibilities as set out in
their respective terms of reference.
Internal control and risk management
The Committee reviewed the Group’s statement on internal control systems prior to its endorsement by the Board.
Pursuant to the requirements of Section 404 of the Sarbanes-Oxley Act, the Group undertakes an annual assessment of the effectiveness of internal control over fi nancial reporting. Further details are provided below.
Group-wide Internal Audit
The Committee regards its relationship with the internal audit function as pivotal to the effectiveness of its own activities. Group-wide Internal Audit plays an important role in supporting the Committee to fulfi l its responsibilities under the UK and HK Codes, as well as the Sarbanes-Oxley Act, and provides independent assurance on the Group’s processes of identifi cation and control of risk. Each of the Group’s business units has an internal audit team, the heads of which report to the Group-wide Internal Audit Director. Internal audit resources, plans and work are overseen by the Committee and by the business unit audit committees. Total approved internal audit headcount across the Group was 148 at 31 December 2012. The Group-wide Internal Audit Director reports functionally to the Committee and for management purposes to the Chief Financial Offi cer.
102 Governance Prudential plc Annual Report 2012
Corporate governance continued
The Committee assesses the effectiveness of the internal audit function by means of regular reviews, some of which are carried out by external advisers, and through ongoing dialogue with the Group-wide Internal Audit Director. A further external effectiveness review of Group-wide Internal Audit was undertaken in quarter four 2012, the fi ndings of which were reported to the Committee in detail in February 2013. The purpose of the review was to ensure that the activities and resources of internal audit continue to be effectively organised to support the oversight responsibilities of the Committee. The review, performed by PriceWaterhouseCoopers, confi rmed that Group-wide Internal Audit continued to remain in general conformance with the Institute of Internal Auditors (IIA) International Standards with no material exceptions and demonstrated a noted enhancement of GwIA processes and practices, since the last review in 2011.
The Committee approved the Group-wide Internal Audit annual audit plan of assurance work to be undertaken during 2013.
Group Compliance
The Committee receives regular reports from Group Compliance, who are responsible for assessing the risks posed to the Group as a result of non-compliance with relevant regulations, including those in respect of anti-money laundering and sanctions. Each business unit has its own compliance function, and the role of Group Compliance is to assess the effectiveness of these functions, as well as to provide oversight and support in the identifi cation, mitigation and reporting of regulatory risks arising from both current business activities and from changes in the regulatory environment.
During 2012, the Committee reviewed and approved the target operating model, as well as the plan of work to be undertaken by Group Compliance during 2013.
External audit
The Committee has a key oversight role in relation to the external auditor, KPMG Audit Plc, whose primary relationship is with the Committee. The Group has established an Auditor Independence Policy which ensures that the independence and objectivity of the external auditor is not impaired. The four key principles of the policy underpin the provision of non-audit services by the external auditor, namely that the auditor should not audit its own fi rm’s work, make management decisions for the Group, have a mutuality of fi nancial interest with the Group, or be put in the role of advocate for the Group.
All services provided by the auditor under this policy are provided in accordance with a pre-approved budget and are reviewed by the Committee and approved where necessary. The Committee regularly reviews and updates the policy to ensure alignment with the latest standards and best practice in establishing, maintaining and monitoring auditor independence and objectivity.
Fees payable to the auditor
For the year ended 31 December 2012 the Committee approved fees payable of Ł14.3 million to its auditor, KPMG Audit Plc. Within this total, the Committee approved fees payable of
Ł2.6 million to KPMG for services not related to audit work which accounted for 18 per cent of total fees payable to the external auditor in the year. 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 confi rmed to be permissible for the external auditor to undertake as defi ned by the Sarbanes-Oxley Act. The Committee reviewed the non-audit services provided to the Group by KPMG at regular intervals during 2012. These included tax services, due diligence services, attestation reports on internal controls not required by legislation, agreed-upon procedures, other reports, certifi cations and examinations required by regulators, risk and compliance work, advising on accounting standards and regulatory rules and provision of comfort letters. A summary of fees payable to the auditor for the year ended 31 December 2012 is provided in note I6 to the Group fi nancial statements.
Auditor performance and independence
The Committee assessed the performance, as well as the independence and objectivity, of the external auditor and the effectiveness of the audit process. The review of the effectiveness of the external audit process was conducted through a questionnaire-based exercise administered by Group Finance.
The Committee also reviewed the external audit strategy and received reports from the auditor on its own policies and procedures regarding independence and quality control, including an annual confi rmation of its independence in line with industry standards.
Re-appointment of auditor
The Group operates a policy under which at least once every fi ve years a formal review is undertaken by the Committee to assess whether the external audit should be re-tendered. The external audit was last put out to competitive tender in 1999 when the present auditor was appointed. Since 2005 the Committee has annually considered the need to re-tender the external audit service and it again considered this in February 2012, concluding that there was nothing in the performance of the auditor which required a change.
In line with the Auditing Practices Board Ethical Statements and the Sarbanes-Oxley Act, the lead audit partner who was appointed by KPMG Audit Plc in 2007, was replaced by a new lead audit partner in respect of the 2012 fi nancial year.
Following its review of the external auditor’s effectiveness and independence, the Committee has recommended to the Board that KPMG Audit Plc be re-appointed as auditor of the Company and a resolution for the re-appointment of KPMG Audit Plc as auditor of the Company will be put to a shareholder vote at the Annual General Meeting on 16 May 2013.
Review of Committee eff ectiveness
The effectiveness of the Committee was reviewed as part of the internally facilitated review of the Board and its committees. The fi ndings will be discussed by the Board in March 2013.
The Committee is satisfi ed, taking into account the fi ndings of the internal review, that it had been operating as an effective audit committee throughout the year. Further reviews of the effectiveness of the Committee will be undertaken regularly and will, from time to time, be conducted by external consultants.
[Graphic Appears Here]
The Nomination Committee plays a leading role in assessing the balance of skills and experience on the Board and the Group’s principal committees. The Committee identifi es the roles and capabilities required to meet the demands of the business and, with due regard to diversity, ensures that suitable succession planning is in place. Candidates continue to be considered on merit against specifi c criteria determined by the Committee.
The Committee also reviews confl icts of interest or potential confl icts of interest raised by directors between Board meetings and for prospective Board members. In cases where there might be an actual or potential confl ict of interest the Committee has powers to authorise any such actual or potential confl ict situation on behalf of the Board, imposing any terms and conditions it deems appropriate, or to make recommendations to the Board as to whether the confl ict or potential confl ict should be authorised and if any specifi c terms should be included in the authorisation.
During 2012, the Committee, under the leadership of
Lord Turnbull, led the search for a new Chairman and, once the Chairman had been appointed, embarked on the search for a Senior Independent Director led by the Chairman.
The principal responsibilities of the Committee are to: review the size, structure and composition of the Board, including the skills, knowledge, experience and diversity of Board members, and make recommendations to the Board with regard to changes; identify and nominate candidates for appointment to the Board, based on merit and against objective criteria; make recommendations to the membership of the audit, risk, remuneration and nomination committees in consultation with the Chairmen of those committees; and consider and, where necessary, authorise any actual or potential situational confl icts, upon such terms and conditions as the Committee considered appropriate, arising out of a proposed new appointment, the changed circumstances of an existing appointment or that of a director’s connected person.
The Committee will continue to review the time commitment required from each of our non-executive directors and, going into 2013, the Committee will continue to review and refresh the skills required to pursue our strategic objectives successfully.
Corporate governance Prudential plc Annual Report 2012 103
Membership
The Nomination Committee (the Committee) is comprised of the Chairman and the independent non-executive directors as set out below:
Harvey McGrath (Chairman to 2 July 2012) Paul Manduca (Chairman from 2 July 2012)
Sir Howard Davies (from 2 July 2012)
Ann Godbehere (from 2 July 2012)
Kathleen O’Donovan (to 31 March 2012) Philip Remnant (from 1 January 2013)
Lord Turnbull
In performing its duties, the Committee has access to the services
of the Group Company Secretary. The Committee may also seek
external professional advice at the Company’s expense.
Full biographical details of the members of the Committee are set
out on pages 88 to 92.
Meetings
The Committee meets at least twice a year to consider the Board
Governance
composition and membership of the principal Committees and
to consider the suitability of all directors standing for re-election
report
at the AGM. In addition, the Committee meets to consider
candidates for appointment to the Board. The Group Chief
Executive is closely involved in the work of the Committee and is
invited to attend and contribute to meetings. By invitation, the
Group HR Director also attends the meetings.
Governance
The Committee met on nine occasions during 2012 and details
of Committee members’ attendance is set out on page 94.
As part of the process for appointing any new director,
the Committee gives consideration to the balance of skills,
experience and knowledge on the Board and, in light of this
evaluation, prepares a description of the role and capabilities
required for a particular appointment, as well as the expected
time commitment. Appointments are made based on merit,
against objective criteria set by the Committee.
The focus of the Committee during the year was the search for
a new Chairman and a replacement for the role of the Senior
Independent Director. Harvey McGrath, the retiring Chairman,
was not involved in the selection or appointment of the new
Chairman, a process which was led by Lord Turnbull. Once this
appointment had been made, the Committee, led by Paul
Manduca, initiated the process for finding a Senior Independent
Director. The Committee used the services of Spencer Stuart,
Korn Ferry International and Ridgeway Partners, executive
search agencies to facilitate both of these searches. None of
these firms undertook any other significant projects for the Group.
The effectiveness of the Committee was reviewed as part of
the internally facilitated review of the Board and its committees.
The findings will be discussed by the Board in March 2013.
The Chairman reported to the Board on matters of particular
significance after each meeting. The terms of reference for the
Committee are kept under regular review and are updated where
required. A copy of these can be found on the Group’s website.
[Graphic Appears Here]
The Risk Committee continued its work during 2012 with the specifi c objectives of furthering the in depth understanding of the risks facing the business and enhancing the risk reporting framework with a view to ensuring that the various stakeholders received both timely and suitable information around risk exposures.
The Committee provides leadership, direction and oversight in relation to the Group’s overall risk appetite and tolerance and the risk management framework. Oversight of the framework includes reviewing the Group’s risk policies and standards, supporting risk limits, methodologies adopted and the processes and controls in place for assessing the Group’s risks. During the year the Committee carried out an in depth review of a number of policies and other components forming part of the overall Group Risk Framework and recommended improvements to the Board, providing eff ective oversight with regard to the Group’s risk appetite, tolerance and risk management framework. The Committee also provides oversight in respect of the Group Chief Risk Offi cer’s responsibilities.
The principal responsibilities of the Committee are to: review the Group risk, capital and liquidity management framework, as well as the Group’s risk appetite, its risk policies and standards, including the parameters used and methodologies and processes adopted for identifying and assessing risks; review the material and emerging risk exposures of the Group, including market, credit, insurance, operational, liquidity and economic and regulatory capital risks as well as regulatory and compliance matters; oversee the Group’s processes and policies for determining risk tolerance and reviewing management’s measurement and eff ectiveness of the Group’s risk tolerance levels; receive and review Group-wide Internal Audit reports on the risk management function; assist the Board in reviewing the risks inherent in the business plans; and provide qualitative and quantitative advice to the Remuneration Committee on risk weightings applied to performance objectives incorporated in executive remuneration and evaluate whether the remuneration approach for senior executives was positioned within the Group’s overall risk appetite framework.
The Committee also continued to build synergies with the Audit Committee, to ensure that areas of overlap were managed appropriately.
Membership
The Risk Committee (the Committee) is comprised of the independent non-executive directors as set out below:
Sir Howard Davies (Chairman)
Ann Godbehere
Kai Nargolwala
Lord Turnbull
In performing its duties, the Committee has access to the Group Chief Risk Offi cer and the services of the Group Company Secretary. The Committee may seek external professional advice at the Company’s expense.
Full biographical details of the members of the Committee are set out on pages 91 to 92.
Meetings
The Committee meets at least four times a year to consider the Group’s risk appetite and provide oversight to the management of risk within the Group. The Chairman of the Committee is a member of the Audit Committee and works closely with that committee in fulfi lling the Risk Committee’s responsibilities.
The Chairman of the Board, the Group Chief Executive, the Chief Financial Offi cer, the Group Chief Risk Offi cer, Group-wide Internal Audit Director, the Group General Counsel and the Group Risk Directors are invited to attend the meetings.
During 2012, the Committee held fi ve scheduled meetings and details of Committee members’ attendance is set out on page 94.
The Committee undertook the identifi cation and comprehensive analysis of the Group’s key risks and approved the enhancements to the management information provided to the Group Risk Committees and the Board. The Committee further received presentations from certain of the business units on the particular risks inherent in those businesses, as well as the systems and controls in place to monitor and manage those risks. The Committee approved and subsequently reviewed the process for approving large credit risk exposures; it also approved a framework which provides separate limits for global counterparties in respect of counterparty risk exposures. The Committee also reviewed the Group-wide risk appetite framework, including risk appetite statements and limits by risk type. The Committee worked closely with the Audit Committee to ensure any risk assurance relevant to fi nancial reporting was referred to the Audit Committee and with the Remuneration Committee on providing input in respect of risk adjustment measures for the executive remuneration policy. In addition, the role of the Committee includes responding to the needs of the business and carrying out reviews of specifi c areas of risk as they arise. The Committee worked closely with management and the Group-wide Internal Audit Director during the year and assisted the Board by providing oversight over requests for specifi c risk assessments.
The Chairman reviewed the work of the Committee and the Group’s risk framework as part of the ongoing dialogue with the regulator.
The effectiveness of the Committee was reviewed as part of the internally facilitated review of the Board and its committees. The fi ndings will be discussed by the Board in March 2013.
The Committee Chairman reported to the Board on matters of signifi cance after each meeting. The terms of reference for the Committee are kept under regular review and are updated where required. A copy of these can be found on the Group’s website.
Risk governance Prudential plc Annual Report 2012 105
Risk governance
Principles and objectives
Risk is defined as the uncertainty that Prudential faces in
successfully implementing its strategies and objectives.
This includes all internal or external events, acts or omissions
that have the potential to threaten the success and survival
of Prudential.
The control procedures and systems established within the
Group are designed to manage rather than eliminate the risk
of failure to meet business objectives. They can only provide
reasonable and not absolute assurance against material
misstatement or loss and focus on aligning the levels of
risk-taking with the achievement of business objectives.
Material risks will only be retained where this is consistent with
Prudential’s risk appetite framework and its philosophy towards
risk-taking. The Group’s current approach is to retain such risks
where doing so contributes to value creation and the Group is
able to withstand the impact of an adverse outcome, and has
the necessary capabilities, expertise, processes and controls
to appropriately manage the risk.
In keeping with this philosophy, the Group has five objectives
for risk and capital management which are as follows:
Framework: to design, implement and maintain a capital
management and risk oversight framework, which is consistent
with the Group’s risk appetite and philosophy towards risk taking;
Monitoring: to establish a ‘no surprises’ risk management culture
by identifying the risk landscape, assessing and monitoring risk
exposures and understanding change drivers;
Control: to implement suitable risk mitigation strategies and
remedial actions where exposures are deemed inappropriate,
and to manage the response to potentially extreme events;
Communication: to effectively communicate the Group risk,
capital and profitability position to both internal and external
stakeholders; and
Culture: to foster a risk management culture, providing quality
assurance and facilitating the sharing of best practice.
Governance
Diagram 1: Group level framework report
Board
Board Governance
Nomination Committee Remuneration Committee Risk Committee Audit Committee
1st line of defence 2nd line of defence 3rd line of defence
Executives
Group CEO
GEC GERC
[Graphic Appears Here]
Board-level Committees Direct Reporting Line GEC Group Executive Committee
Executive personnel Regular Communication BSCMC Balance Sheet & Capital Management Committee
Exec / Management Committees and Escalation GERC Group Executive Risk Committee
GHO Functions TAC Technical Actuarial Committee
GCRC Group Credit Risk Committee
GORC Group Operational Risk Committee
GCC Group Compliance Committee
STOC Solvency II Technical Oversight Committee
106 Governance Prudential plc Annual Report 2012
Risk governance continued
Prudential’s risk governance framework requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group. The framework is based on the concept of ‘three lines of defence’ comprising risk taking and management, risk control and oversight and independent assurance.
Diagram 1 on page 105 outlines the Group-level framework.
Primary responsibility for strategy, performance management and risk control lies with the Board, which has established the Risk Committee to assist in providing leadership, direction and oversight in respect of the Group’s signifi cant risks, and with the Group Chief Executive and the chief executives of each of the Group’s business units.
Risk management
Risk taking and the management thereof forms the fi rst line of defence and is facilitated through both the Group Executive Committee (GEC) and the Balance Sheet and Capital Management Committee (BSCMC).
The GEC is comprised of the chief executives of each of the Group’s major business units, as well as a number of functional specialists, and supports the Group Chief Executive in the executive management of the Group.
The BSCMC is comprised of functional specialists and supports the Chief Financial Offi cer in the management of the Group’s balance sheet, as well as providing oversight to the activities of Prudential Capital, which undertakes the treasury function for the Group.
Risk oversight
Risk control and oversight constitutes the second line of defence, and is achieved through the operation of a number of Group-level risk committees, chaired by either the Chief Financial Offi cer or the Group Chief Risk Offi cer, which monitor and keep risk exposures under regular review. These committees are as follows:
Group Executive Risk Committee: the committee meets monthly to oversee the Group’s risk exposures, including market, credit, liquidity, insurance and operational risks, and also monitors the Group’s capital position;
Group Credit Risk Committee: the committee reports directly to the Group Executive Risk Committee and meets monthly to review the Group’s investment and counterparty credit risk positions;
Group Operational Risk Committee: the committee meets quarterly to oversee the Group’s operational risk exposures. The committee reports directly to the Group Executive Risk Committee;
Solvency II Technical Oversight Committee: the committee normally meets ten times per year to provide ongoing technical oversight and advice to the Board and executive in respect of their duties with regard to the Group’s Internal Model. The committee reports to the Group Executive Risk Committee;
Technical Actuarial Committee: the committee reports to the Group Executive Risk Committee and usually meets monthly to set the methodology for valuing Prudential’s assets, liabilities and capital requirements under Solvency II and the Group’s internal economic capital basis; and
Group Compliance Committee: the committee reports to the Group Executive Risk Committee and meets every two months to oversee the effectiveness of risk and capital management for all
fi nancial and non-fi nancial risks faced by the Group and has responsibility to consider Group-wide regulatory compliance risks and controls.
The Group-level risk committees are supported by the Group Chief Risk Offi cer, with functional oversight provided by Group Security, Group Compliance and Group Risk. Group Security is responsible for developing and delivering appropriate security measures with a view to protecting the Group’s staff, physical assets and intellectual property. Group Compliance provides verifi cation of compliance with regulatory standards and informs the Board, as well as the Group’s management, on key regulatory issues affecting the Group. Group Risk has responsibility for establishing and embedding a capital management and risk oversight framework and culture consistent with Prudential’s risk appetite that protects and enhances the Group’s embedded and franchise value.
Independent assurance
The third line of defence comprises the Group-wide Internal Audit function, which provides independent and objective assurance to the Board, GEC, Audit and Risk Committees on the overall effectiveness of risk management, control and governance processes across the Group.
Reporting
The Risk 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 Risk 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’s capital position and overall position against risk limits are reviewed regularly by the Group Executive Risk Committee, the Group Risk Committee and the Board. Key economic capital metrics, as well as risk-adjusted profi tability information, are included in the business plans which are reviewed by the Group Executive Risk Committee, the Group Risk Committee and the Board.
Routine internal reporting by the business units vary according to the nature of the business, with each business unit responsible for ensuring that its risk reporting framework meets both the needs of the respective business unit and the standards set by the Group Risk function. Clear escalation criteria and processes are in place for the timely reporting of risks and incidents by business units to the various Group-level risk committees and, where appropriate, the Board.
Each business unit reviews the risks inherent in their business operations as part of the annual preparation of their business plan, and subsequently, these opportunities and risks are regularly reviewed against business objectives with Group Risk. The impact of large transactions or divergences from the agreed business plan are also reviewed and reported by Group Risk.
Remuneration
The report on the responsibilities and activities of the Remuneration Committee can be found in the Directors’ remuneration report, which is set out on pages 113 to 143.
Risk governance/ Re elations with sharehol olders Prudential plc Annual Report 2012 107
Relations with shareholders
Communication with shareholders
Being a major institutional investor, the Company is very aware of the importance of maintaining good relations with its shareholders, as well as with its debt investors. Discussions are held regularly with major shareholders and a programme of meetings took place throughout the year. In addition, Prudential regularly holds a conference for investors to provide further insight on selected areas of the business. In 2012, the conference was held in New York during November.
The latest analysts’ and brokers’ reports on the Company and the sector are circulated regularly to Board members to develop further their knowledge and understanding of external views about the Company. The Chairman and the non-executive directors also provided feedback to the Board on topics raised with them by major shareholders. Major shareholders and debt investors are welcome to meet with newly appointed directors, or any of the directors generally.
The Group maintains a corporate website containing a wide range of relevant information for private and institutional investors, including the Group’s fi nancial calendar. The shareholder information section on pages 396 and 397 contains further details which may be of interest to shareholders.
Annual General Meeting
The Annual General Meeting will be held in the Churchill Auditorium at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on
16 May 2013 at 11.00am.
The Annual General Meeting is an important forum for both institutional and private shareholders and the Company encourages all its shareholders to vote. Shareholders are given the opportunity during annual general meetings to put questions to the Board on matters relating to the Group’s operations and performance.
The Company 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 Company’s website. This practice provides shareholders present with suffi cient information regarding the level of support and opposition to each resolution and ensures all votes cast either at the meeting or through proxies are included in the result.
Details of the 2012 AGM, including the major items discussed at the meeting and the results of the voting, can be found on the Company’s website. All directors in offi ce at the time of the Annual General Meeting held on 17 May 2012 attended the AGM, with the exception of Michael Garrett, who was unable to do so due to a prior commitment.
In accordance with the relevant legislation, shareholders holding
5 per cent or more of the fully paid up issued share capital of the
Company, are able to require the directors to hold a general
meeting. If the shareholders’ request identifies a resolution to
be moved at the meeting, the resolution must be included in the
notice of meeting. Where such a request has been duly lodged
with the Company, the directors are obliged to call a general
meeting within 21 days of becoming subject to the request and
must set a date for the meeting not more than 28 days from the
date of the issue of the notice. Shareholders can also require the
Company to circulate a statement of not more than 1,000 words
on the subject matter of the resolution. Shareholders need not
cover the costs of circulating such statements where the requests
relate to the annual general meeting of a public company and
provided sufficient requests to require the circulation are
received prior to the financial year end preceding the meeting.
Written shareholder requests should be addressed to the Group
Company Secretary at the registered office.
Company constitution
The Company is governed by the Companies Act 2006, other
applicable legislation and regulation as well as by provisions of
Governance
its Articles of Association. The Memorandum and Articles of
Association are available on the Group’s website.
report
Any change to the Articles must be approved by special
resolution of the shareholders in accordance with the provisions
of the Companies Act 2006. There were no changes to the
Company’s constitutional documents during 2012.
Governance
Share capital
The Company’s issued share capital as at 31 December 2012,
which is set out in note H11 on page 287, consisted of
2,557,242,352 (2011: 2,548,039,330) ordinary shares of 5 pence
each, all fully paid up and listed on the London Stock Exchange
and the Hong Kong Stock Exchange. Subject to applicable local
securities law, the Company’s shares may be registered on the
main register in the UK or the Company’s branch registers in
Ireland or Hong Kong. The number of accounts on the share
register at 31 December 2012 was 60,522 (2011: 63,338).
The Company also maintains secondary listings on the New York
Stock Exchange in the form of American Depositary Receipts
which are referenced to ordinary shares on the main UK register,
under a depositary agreement with J.P. Morgan, and on the
Singapore Stock Exchange in the form of interests in shares,
which are referenced to the shares on the Hong Kong register
under a depository agreement with the Central Depository (Pte)
Limited (the ‘CDP’).
The Company has maintained a sufficiency of public float
throughout the reporting period as required by the Hong Kong
Listing Rules.
A number of dividend waivers are in place and these relate to
shares issued but not allocated under the Group’s employee
share plans. These shares are held by the Trustees and will, in
due course, be used to satisfy requirements under the Group’s
employee share plans.
108 Governance Prudential plc Annual Report 2012
Relations with shareholders continued
Rights and obligations
The rights and obligations attaching to the Company’s shares are set out in full in the Company’s Articles of Association. There are currently no voting restrictions on the ordinary shares, all of which are fully paid, and each share carries one vote on a poll. If votes are cast on a show of hands, each shareholder present in person or by proxy, or in the case of a corporation, each of its duly authorised corporate representatives, has one vote except that if a proxy is appointed by more than one member, the proxy has one vote for and one vote against if instructed by one or more members to vote for the resolution and by one or more members to vote against the resolution.
Where, under an employee share plan operated by the Company, participants are the benefi cial owners of the shares but not the registered owners, the voting rights are normally exercisable by the registered owner in accordance with the relevant plan rules. Trustees may vote at their discretion, but do not vote on any unawarded shares held as surplus assets.
As at 12 March 2013, Trustees held 0.34 per cent of the issued share capital of the Company under the various plans in operation.
Rights to dividends under the various schemes are set out in note I4 on page 308.
Restrictions on transfer
In accordance with English company law, shares may be transferred by an instrument of transfer or through an electronic system (currently CREST) and transfer is not restricted except that the directors may in certain circumstances refuse to register transfers of shares, but only if such refusal does not prevent dealings in the shares from taking place on an open and proper basis. If the directors make use of that power, they must send the transferee notice of the refusal within two months.
Certain restrictions may be imposed from time to time by applicable laws and regulations (for example, insider trading laws) and pursuant to the Listing Rules of both the Financial Services Authority, and any successor organisation, and the Hong Kong Stock Exchange, as well as Prudential’s own share dealing rules, whereby directors and certain employees of the Company require the approval of the Company to deal in the Company’s ordinary shares.
Some of the Company’s employee share plans include restrictions on transfer of shares while the shares are subject to the plan. All directors are required to obtain a number of qualifi cation shares within one year of appointment, which they would also be expected to retain under guidelines approved by the Board and as described on page 129 of the Directors’ remuneration report.
Signifi cant shareholdings
The Company had received notifi cation of interests in the shares of Prudential plc as at 31 December 2012 and in accordance with Rule 5.1.2 R of the Disclosure and Transparency Rules of the Financial Services Authority, from Legal & General Group plc of
3.99 per cent, from Norges Bank of an interest in 4.03 per cent, from BlackRock, Inc. of an interest in 5.08 per cent and from Capital Group International Inc., of an interest in 10.39 per cent. No further notifi cations have been received between the end of 2012 and the date of this report.
Authority to issue shares
The directors require authority from shareholders in relation to the issue of shares by the Company. Whenever shares are issued the Company has to offer the shares to existing shareholders pro rata to their holdings unless it has been given authority by shareholders to issue shares without offering them fi rst to existing shareholders. The Company seeks authority from its shareholders on an annual basis to issue shares up to a maximum amount and to issue up to 5 per cent of its issued share capital without observing pre-emption rights, in line with relevant regulations and best practice. Dis-application of statutory pre-emption procedures is also sought for rights issues. The Company’s existing authorities to issue shares and to do so without observing pre-emption rights are due to expire at the end of this year’s Annual General Meeting. An ordinary resolution and a special resolution to approve the renewal of these authorities respectively will be put to shareholders at the Annual General Meeting on 16 May 2013.
Details of shares issued during 2012 and 2011 are given in note H11 on page 287.
In accordance with the terms of a waiver granted by the Hong Kong Stock Exchange, the Company confi rms that it complies with the applicable law and regulation in the UK in relation to the holding of shares in treasury and with the conditions of the waiver in connection with the purchase of own shares and any treasury shares it may hold.
Authority to purchase own shares
The directors also require authority from shareholders in relation to the purchase of own shares by the Company. The Company seeks authority by special resolution on an annual basis for the buyback of its own shares in accordance with the relevant provisions of the Companies Act 2006 and other related guidance. The Company has not made use of that authority since it was last granted at its Annual General Meeting in 2012. This existing authority is due to expire at the end of this year’s Annual General Meeting. A special resolution to approve the renewal of this authority will be put to shareholders at the Annual General Meeting on 16 May 2013.
Model code for securities transactions by directors
The Company confi rms that it has adopted a code of conduct regarding securities transactions by directors on terms no less exacting than required by Appendix 10 to the Hong Kong Listing Rules, and that the directors of the Company have complied with this code of conduct throughout the period.
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.
In particular, in relation to the provisions of Section 302 of that Act, which covers disclosure controls and procedures, a Disclosure Committee has been established reporting to the Group Chief Executive, chaired by the Chief Financial Offi cer and comprising members of senior management. The objectives of this Committee are to:
Assist the Group Chief Executive and the Chief Financial Offi cer in designing, implementing and periodically evaluating the Company’s disclosure controls and procedures;
Monitor compliance with the Company’s disclosure controls and procedures;
Review and provide advice to the Group Chief Executive and the Chief Financial Offi cer with regard to the scope and content of all public disclosures made by the Company which are of material signifi cance to the market or investors; and
Review and consider, and where applicable follow up on, matters raised by other components of the disclosure process.
These may include, to the extent they are relevant to the disclosure process, any matters to be raised with the Audit Committee, the internal auditors or the external auditor on the Company’s internal controls.
Relations with shareholders Prudential plc Annual Report 2012 109
In discharging these objectives, the Committee helps to support the certifi cations by the Group Chief Executive and the Chief Financial Offi cer of the effectiveness of disclosure procedures and controls required by Section 302 of the Act.
The provisions of Section 404 of the Act require the Company’s management to report on the effectiveness of internal controls over fi nancial reporting in its annual report on Form 20-F, which is fi led with the US Securities and Exchange Commission. To comply with this requirement to report on the effectiveness of internal control, the Group has documented and tested its internal controls over fi nancial 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.
In addition, the Disclosure Committee evaluates whether or not a particular matter requires disclosure to the market, taking into account relevant regulations and reviews all forward looking statements.
Governance report Governance
110 Governance Prudential plc Annual Report 2012
Additional disclosures
The following additional disclosures are made in compliance with the Companies Act 2006, the Disclosure and Transparency Rules and the UK and HK Codes.
Financial reporting
The directors have a duty to report to shareholders on the performance and fi nancial position of the Group and are responsible for preparing the fi nancial statements on pages 147 to 323 and the supplementary information on pages 326 to 362. It is the responsibility of the auditor to form independent opinions, based on its audit of the fi nancial statements and its audit of the EEV basis supplementary information; and to report its opinions to the Company’s shareholders and to the Company. Its opinions are given on pages 325 and 364.
Company law requires the directors to prepare fi nancial statements for each fi nancial year which give a true and fair view of the state of affairs of the Company and of the Group. The criteria applied in the preparation of the fi nancial statements are set out in the statement of directors’ responsibilities on page 324 and page 363.
The directors are further required to confi rm that the directors’ report includes a fair review of the development and performance of the business, with a description of the principal risks and uncertainties. Such confi rmation is included in the statement of directors’ responsibilities on page 324 and page 363.
The Chief Financial Offi cer’s overview provides, on pages 68 to 78, a description of the Group’s risk and capital management, which includes a description of the Group’s liquidity position. The Group has considerable internal and external fi nancial resources and the directors believe that the Group is well placed to manage its business risks successfully.
The directors who held offi ce at the date of approval of this directors’ report confi rm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditor is unaware; each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confi rmation is given and should be interpreted in accordance with the provisions of Section 418 of the Companies Act 2006.
Going concern
After making enquiries the directors have a reasonable expectation that the Company and the Group have adequate resources to continue their operations for the foreseeable future. In support of this expectation, the Company’s business activities, together with the factors likely to affect its future development, successful performance and position in the current economic climate are set out in the Business review on pages 14 to 67. The risks facing the Group’s capital and liquidity positions and their sensitivities are referred to in the Chief Financial Offi cer’s overview. Specifi cally, the Group’s borrowings are detailed in Note H13 on pages 289 to 291, the market risk and liquidity analysis associated with the Group’s assets and liabilities can be found in note G2 on pages 269 to 272, policyholder liability maturity profi le by business units in notes D2, D3, D4 on pages 212, 230 and 237 respectively, cash fl ow details in the consolidated statement of cash fl ows and provisions and contingencies in Note H14. The directors therefore have continued to adopt the going concern basis of accounting in preparing the fi nancial statements.
Post-balance sheet events
Important events affecting the Company after the end of the fi nancial year are detailed in note I11 on page 314.
Change of control
Under the agreements governing Prudential Corporation Holdings Limited’s life insurance and fund management joint ventures with China International Trust & Investment Corporation (‘CITIC’), if there is a change of control of the Company, CITIC may terminate the agreements and either (i) purchase the Company’s entire interest in the joint venture or require the Company to sell its interest to a third party designated by CITIC, or (ii) require the Company to purchase all of CITIC’s interest in the joint venture. The price of such purchase or sale is to be the fair value of the shares to be transferred, as determined by the auditor of the joint venture.
Essential contracts or arrangements
There are a number of signifi cant relationships with third parties, which have value to the business. No single relationship, however, is considered to be essential to the Group as a whole.
At no time during the year did any director hold a material interest in any contract of signifi cance with the Company or any subsidiary undertaking.
Compensation for loss of offi ce
None of the terms of employment of the Company’s directors includes provisions for payment of compensation for loss of offi ce or employment that occurs as a result of a change of control. Terms applying on a termination of their offi ce are set out in the Directors’ remuneration report. In the US, senior executives participate on a discretionary basis in a plan which entitles them to compensation, in the event that their employment is terminated or adversely affected as a result of a change of control.
Customers
The fi ve largest customers of the Group constituted in aggregate less than 30 per cent of its total sales for each of 2011 and 2012.
For the year ended 31 December 2012, none of the directors of the Company, their associates or any shareholders of the Company (which have, to the knowledge of the directors of the Company, owned more than 5 per cent of the Company’s issued share capital) had any interest in the Group’s major customers.
Additional disclosures/Index to principal directors’ report disclosures Prudential plc Annual Report 2012 111
Index to principal directors’ report disclosures
Information required to be disclosed in the directors’ report may
be found in the following sections:
Information Section in Annual Report Page number(s) Additional
Business review Business review 11-85
Essential contracts or arrangements Additional disclosures 110
Disclosure of information to auditor Additional disclosures 110
Directors in office during the year Board of directors 88-92; 95
Principal activities Business review Cover; 20-45 disclosures/Index
Dividend recommended for the year Business review 57 to
Details of qualifying third-party indemnity provisions Corporate governance report 98
Corporate responsibility governance Corporate responsibility review 79-85 principal
Political and charitable donations and expenditure Corporate responsibility review 84
Financial instruments – risk management objectives Business review 65 directors’
and policies
Post balance sheet events Note I11 of the Notes on the Group financial 314 report
statements and Additional disclosures
Future developments of the business of the Company Group Chief Executive’s report 10
Employment policies and employee involvement Corporate responsibility review 80-81 disclosures
Creditors – policy on payment and practice Corporate responsibility review 85
Structure of share capital, including restrictions on the transfer Corporate governance report 107-108
of securities, voting rights and significant shareholders
Rules governing appointments of directors Corporate governance report 95-96 Governance
Rules governing changes to the articles of association Corporate governance report 107
Powers of directors Corporate governance report 94
Significant agreements impacted by a change of control Additional disclosures 110
Agreements for compensation for loss of office or employment Additional disclosures 110
on takeover
In addition, the risk factors set out on pages 386 to 391 and the
additional unaudited financial information set out on pages 366
to 384, are incorporated by reference into this directors’ report.
Signed on behalf of the Board of directors
[GRAPHIC APPEARS HERE]
Alan F Porter
Group Company Secretary
12 March 2013
112 Prudential plc Annual Report 2012
Prudential plc Annual Report 2012 113
Section 4
Directors’
remuneration
report
114 Directors’ remuneration report
116 Remuneration policy report
122 2012 implementation of remuneration policy
136 Supplementary information
[Graphic Appears Here]
114 Directors’ remuneration report Prudential plc Annual Report 2012
Directors’ remuneration report
[Graphic Appears Here]
Dear Shareholder
I am pleased to present the Remuneration Committee’s report on directors’ remuneration for the year to 31 December 2012.
As I indicated in my letter last year, during 2012 the Committee reviewed Prudential’s executive director remuneration architecture for 2013 and beyond. These are the fi rst major changes to the architecture since current arrangements were implemented in 2006.
The Group has developed substantially over recent years and we believe that it is essential that our executive reward arrangements remain closely aligned with the Group’s business strategy and ambitions.
Our aims
Our aim in undertaking the review was to develop and implement reward structures which provide lasting competitive advantage for the Group in order to:
Attract and retain the high calibre executives required to lead and develop the Group; and Reward executives for delivering our business plans and generating sustainable growth and returns for shareholders.
The proposed changes
Where aspects of the previous reward architecture remain appropriate and eff ective, we have retained them. For example, we have not proposed changes to executives’ maximum incentive opportunities as a percentage of salary. We have made revisions where there was scope for better alignment with our aims. Some of the key changes are:
A more consistent approach will apply to the deferral of annual bonuses across the senior executive team; Enhanced clawback provisions will apply to future deferred bonus awards; Shareholding guidelines for executive directors will be increased; and A new long-term incentive plan is proposed for shareholder approval. We have designed this plan to reward the achievement of IFRS profi t targets and the delivery of superior shareholder returns.
These changes are described in detail in the fi rst pages of this report.
Directors’ remuneration report Prudential plc Annual Report 2012 115
We have consulted widely on the proposals
We have undertaken extensive consultation with our
key institutional investors on the changes to the reward
architecture. I have personally met with shareholders and
their representatives who together comprise more than half
of our shareholder base.
I would like to take this opportunity to thank shareholders
for their feedback, which we have taken into account when
developing these proposals.
Rewarding 2012 performance
During 2012, the Group delivered further increases in new
business profitability, IFRS profitability and cash generation.
This was accomplished in the context of continuing
macroeconomic uncertainty. The Group exceeded the
targets that the Committee set at the start of the year as
well as the results delivered in 2011.
This outstanding growth was achieved while operating within
the Group’s risk appetite, risk framework, and maintaining
appropriate levels of capital. The 2012 bonuses that we
awarded to executive directors reflect these achievements.
The excellent results delivered in 2012 built on strong
financial performance over recent years. This has generated
significant returns for shareholders over the period 2010 to
2012 through share price growth and dividends paid. These
returns have significantly outstripped those produced by
our peers in the international insurance sector over the
same period. Directors’
The 2010 Group Performance Share Plan awards, which have
a performance condition of relative total shareholder return,
will therefore be released in full. remuneration
Clear information provided in this report
The UK Government continues to develop its proposals aimed
at increasing the information available to shareholders in report
remuneration reports. This report reflects some aspects of the
draft requirements. Once the final requirements are clear, we
will incorporate them into our report for 2013.
I look forward to receiving your support for the directors’
remuneration report at our AGM.
[GRAPHIC APPEARS HERE]
Lord Turnbull
Chairman of the Remuneration Committee
12 March 2013
116 Directors’ remuneration report Prudential plc Annual Report 2012
Remuneration policy report
Directors’ remuneration report
The directors’ remuneration report has been prepared by the Remuneration Committee (the ‘Committee’) and has been approved by the Board. Shareholders will be given the opportunity to approve the report at the Annual General Meeting on 16 May 2013.
This report has been drawn up in accordance with the UK Corporate Governance Code, Schedule 8 of the Large and Medium Sized Companies and Groups (Accounts and Reports) Regulations 2008, the UK Listing Authority Listing Rules and the Corporate Governance Code in Appendix 14 to the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong. KPMG Audit Plc has audited the information provided on pages 134 to 142.
During the year, the Company has complied with the provisions of Section D and Schedule A of the UK Corporate Governance Code which are in force regarding directors’ remuneration.
The Remuneration Committee
The Committee is responsible for:
Determining the remuneration of the Chairman and approving the remuneration of the executive directors of the Company; and
The oversight of the remuneration of a defi ned leadership population and for individuals with the opportunity to earn over Ł1 million per annum.
The Committee’s terms of reference are available on the Company’s website and a copy may be obtained from the Company Secretary. These terms of reference are reviewed annually.
Each business unit also has its own remuneration committee, with similar terms of reference, to ensure effective remuneration governance in all our businesses.
Remuneration strategy and principles
The aims of Prudential’s remuneration structure are:
To attract and retain the high calibre executives required to lead and develop the Group; and
To reward executives for delivering our business plans and generating sustainable growth and returns for shareholders.
As part of the review of remuneration architecture which took place during 2012, the Committee revisited the aims and operation of Prudential’s remuneration strategy. The table below summarises how the Remuneration Committee achieves these aims:
To attract and retain the high calibre executives required to lead and develop the Group
Reward must be:
Valued by executives; and
Competitive, to engage executives who are in demand in the global talent market and, if required, support hiring the best external talent.
To reward executives for delivering our business plans and generating sustainable growth and returns for shareholders
Reward must be:
Determined by delivery of the Group’s annual and longer-term business objectives; Aligned with shareholder value creation; and Consistent with the Group’s risk appetite so that the delivery of the business plan can be sustained.
The remuneration strategy is underpinned by a number of remuneration principles:
A substantial portion of total remuneration is delivered through performance-related reward, with the highest levels of reward only being paid for the highest levels of achievement;
A signifi cant element of performance-related reward is deferred and provided in the form of shares;
The total remuneration package for each executive director is set with reference to the relevant employment market(s);
The performance of executive directors responsible for business units is measured at both a business unit and Group level;
Performance measures include absolute fi nancial measures and a relative measure of Total Shareholder Return, as appropriate;
Reward structures are designed to deliver fair and equitable remuneration for all employees; and
Reward arrangements are designed to be consistent with the Group’s risk framework and appetite, and minimise regulatory and operational risk.
This strategy and these principles shape remuneration policies and practices which are aligned with our business model. They are designed to ensure that a strong governance approach is adopted and applied across all business units. The Committee continues to review this strategy and these principles regularly.
The remuneration strategy and principles outlined in this section are cascaded to other employees within the Company. Employees receive remuneration which is appropriate given their skills and experience, is competitive within the relevant market(s) and which rewards strong performance.
Remuneration architecture review
In 2012, the Committee undertook a review of all aspects of the Group’s executive remuneration architecture. The aim of the review was to ensure that the Group’s remuneration structures continue to be aligned with the Group’s business strategy and ambitions, and with the remuneration strategy set out above, giving the Company a competitive advantage in the international talent market. This was a review of remuneration structures and did not result in any changes to incentive opportunities as a percentage of salary.
Remuneration policy report Prudential plc Annual Report 2012 117
Key features of the proposed architecture
Salary and benefits No changes were made to the
policy on salary and benefits.
Cash bonus Bonus opportunities, as a
percentage of salary, are
unchanged.
Bonuses reward annual
performance using a range
of measures linked to the
annual business plan.
Deferred bonus 60 per cent of bonus is
payable immediately in cash.
All executive directors defer
40 per cent of bonus into
shares for three years.
Deferred awards are subject
to strengthened clawback
provisions.
Prudential Long Term Long-term incentive
Incentive Plan opportunities, as a
percentage of salary,
are unchanged. Remuneration
Prudential Long Term
Incentive Plan awards are policy
made in shares and vesting
will be dependent on two report
performance measures:
IFRS operating profit
(50 per cent of award); and
Relative TSR Directors’
(50 per cent of award).
Prudential’s performance
against these metrics is
measured over the three
financial years starting remuneration
from the year of award.
report
Share ownership guidelines Share ownership guidelines
have increased to:
350 per cent of salary for
the Group Chief Executive;
and
200 per cent of salary for
other executive directors.
Guidelines have been
introduced below the Board.
Note Key
The President and Chief Executive
Officer of Jackson also shares in the Fixed pay
JNL bonus pool while the Chief Short-term variable pay
Executive of M&G retains separate Long-term variable pay
arrangements. Share ownership guidelines
118 Directors’ remuneration report Prudential plc Annual Report 2012
Remuneration policy report continued
Summary of key changes
Element of What is unchanged?
compensation
Annual bonus Executives will continue to
receive awards under the
Annual Incentive Plan (AIP).
The percentage of salary
used to calculate maximum
bonus opportunity is
unchanged.
No changes are proposed to
the performance measures.
The three-year deferral
period remains.
The President and Chief
Executive Officer of Jackson
continues to share in the
JNL bonus pool in addition
to receiving awards under
the AIP.
Long-term Long-term incentive awards
incentives(as a percentage of salary)
are unchanged.
The use of a combination
of Group and business unit
metrics for business unit
Chief Executives continues.
Outstanding awards made
under the GPSP and BUPP
will not be affected by the
introduction of the
Prudential Long Term
Incentive Plan.
The Chief Executive of M&G
will continue to participate
in the M&G Executive LTIP.
Share ownership The guidelines continue to
guidelines be expressed as a percentage
of salary.
The five-year period to build
holding is maintained.
What is changing?
The proportion of bonus deferred will be 40 per cent for all executive directors.
Clawback provisions have been enhanced for the deferred portion of 2013 and subsequent bonuses. A cap will be introduced to the Chief Executive of M&G’s maximum annual bonus opportunity of the lower of 0.75 per cent of M&G’s IFRS profi t or six times salary.
A new long-term incentive plan (the
Prudential Long Term Incentive Plan) will be proposed for shareholder approval at the 2013 AGM.
The Prudential Long Term Incentive Plan provides reward for achievement of IFRS operating profi t as well as superior relative TSR.
TSR will be measured against a revised peer group and assessed against peers on a ranked (rather than an index) basis. Subject to shareholder approval, 2013 awards will be made under this plan. The awards made to the Chief Executive of M&G will be calculated as a percentage of salary. He will receive awards with a face value of 150 per cent of salary under the Prudential Long Term Incentive Plan and 300 per cent of salary under the M&G Executive LTIP.
The requirement for the Group Chief Executive has increased from 200 per cent to 350 per cent of salary. The requirement for all other executive directors will be increased to 200 per cent of salary. Most executive directors were previously required to hold Prudential plc shares with a value of 100 per cent of salary.
Executives will have fi ve years from the implementation of this policy (or the date of their appointment, if later) to build the additional level of required ownership.
Why?
Creates alignment among the executive directors.
Allows the deferred element of the bonus to be forfeited in specifi c circumstances, including a material, adverse restatement of the fi nancial results or regulatory breach. The calculation of the Chief Executive of M&G’s annual bonus opportunity is transparent and linked to the success of the M&G business.
The expanded TSR peer group ensures the continued relevance of comparators. Assessing performance against peers’ ranked performance (rather than an index) is more straightforward.
IFRS operating profi t is central to the management of the business and a key driver of shareholder value.
The calculation of the Chief Executive of M&G’s LTIP award is transparent and aligned with the other executive directors.
This change increases alignment with shareholder interests.
Remuneration policy report Prudential plc Annual Report 2012 119
Performance measures
Annual bonus
Executive directors receive bonus awards under the Annual Incentive Plan (the AIP). The 2012 AIP: Strongly aligns annual reward with the KPIs that underpin the Group’s business strategy; Incentivises the executive team to outperform stretching annual targets; and
Remains consistent with the Group’s risk framework and appetite.
No changes were proposed to the structure or the performance conditions, of the annual bonus for 2013.
Long-term incentives
The Prudential Long Term Incentive Plan has been designed to reward the creation of IFRS profi t as well as the sustained delivery of superior returns to shareholders. Performance will be assessed over a three-year period on the following basis:
Performance Measurement approach Assessment
condition
IFRS operating Participants will be incentivised to deliver and Cumulative performance will be measured over
profit outperform the long-term business plan. The three years.
(50 per cent of awards will vest based on achievement of IFRS Threshold, plan and maximum achievement levels
award) operating profit compared to performance ranges. will be set at the beginning of the performance
IFRS targets will be set at a Group or business unit periods in line with the three-year business plan.
level, dependent on role. 25 per cent of the award will vest for threshold
performance, increasing to 100 per cent for stretch
performance.
The target for Group IFRS operating profit will be Remuneration
disclosed when the performance period ends.
Total Shareholder The long-term incentive plan will continue to Relative three-year TSR will be measured on a policy
Return reward executives for superior shareholder ranked basis.
(50 per cent of returns. report
25 per cent of the award will vest for median
award) TSR will continue to be measured on a local performance increasing on a straight-line basis to
currency basis. full vesting for TSR at or above the upper quartile.
TSR will be measured relative to a revised peer
group to ensure the continued relevance of this Directors’
measure. In order to reflect the international
scope of the Group’s business operations, the peer
group has been extended to encompass the global
insurance peers with which we compete for
customers and capital. Our revised peer group remuneration
is outlined below.
report
Revised TSR peer group for awards made from 2013 onwards:
Aegon, Afl ac*, AIA*, AIG*, Allianz, Aviva, AXA, Generali, Legal & General, Manulife, MetLife*, Munich Re*, Old Mutual, Prudential Financial*, Standard Life, Sun Life Financial*, Swiss Re*, Zurich Insurance Group* Those peers marked with an asterisk have been added to the peer group for 2013 onwards.
The Remuneration Committee believes that adequate controls exist to ensure that these performance measures will not create an implicit incentive to take undue operational or fi nancial risks or to adopt an unduly risky capital structure.
For any Prudential Long Term Incentive Plan award to vest, the Committee must be satisfi ed that the quality of the Company’s underlying fi nancial performance justifi es the level of reward delivered at the end of the performance period. To ensure close alignment with our shareholders’ long-term interests, participants receive the value of reinvested dividends over the performance period for those shares which ultimately vest. If performance measures are not achieved in full, the unvested portion of any award lapses and performance cannot be retested.
As with the Group Performance Share Plan (GPSP), the performance achieved against target, and the resulting vesting of the award, will be assessed by an independent third party.
The Committee believes that the proposed performance measures are more relevant to the Group and at least as stretching as those used in the Group Performance Share Plan and the Business Unit Performance Plan.
We have undertaken an extensive process of consultation about these proposals with shareholders and their representatives who together comprise more than half of our shareholder base. The Committee took account of shareholder feedback when developing these proposals.
120 Directors’ remuneration report Prudential plc Annual Report 2012
Remuneration policy report continued
Summary of main elements of remuneration
Element Purpose
Base salary To provide executives with a
guaranteed level of remuneration.
Paying salaries at an appropriate
level ensures that Prudential
continues to be competitive
when recruiting and retaining
key executives.
Salary is intended to reward
executives for the performance
of their role.
Annual bonus To incentivise and reward the
achievement of stretching annual
business plans which are:
Determined in line with the
Group’s long-term commitments
to shareholders; and
Consistent with the Group’s risk
appetite.
Long-term incentives To incentivise and reward the
achievement of:
Longer-term commitments to
shareholders;
Sustainable long-term returns
for shareholders; and
Adherence to the Group’s risk
appetite.
Share ownership To create a community of interest
guidelines between the executives and
shareholders.
Benefits To provide executives with items
and allowances that assist them in
carrying out their duties efficiently.
Pension To provide executives with an
opportunity to save for an income in
retirement.
Policy in 2012
The Committee reviews salaries annually. Changes in base salaries are generally eff ective from 1 January.
In determining base salaries for each executive the Committee considers: The performance and experience of the executive;
Internal relativities;
Company fi nancial performance;
Salary increases for all employees; and
Benchmark information from appropriate markets.
Executive directors participate in annual bonus plans based on the achievement of Group and business unit fi nancial performance measures including profi tability, cash fl ow and capital adequacy, and personal objectives. Targets are determined in line with the business plan.
Executive directors are required to defer between 30 per cent and 50 per cent of annual bonus (for the Chief Executive of M&G, 50 per cent of bonus over Ł500,000 is deferred) into Prudential shares for three years.
Bonuses are not pensionable.
All executive directors participate in the Group Performance Share Plan (GPSP). GPSP awards vest based on relative TSR.
Business unit Chief Executives also participate in business unit performance plans (BUPPs or the M&G Executive LTIP) which focus on those fi nancial measures which contribute to the long-term success of the business unit and, therefore, the Group.
The Group Chief Executive and Chief Executive of M&G are required to build up and hold shares equal to 200 per cent of base salary.
Other executive directors are required to build up and hold shares equal to 100 per cent of base salary.
Executives have fi ve years to build up their shareholding. Full details of the current shareholdings of the directors are provided on page 133.
All executive directors received core health and security benefi ts (for example medical insurance and life assurance).
Other benefi ts may be off ered to executives, dependent on:
Local market practice;
The benefi ts off ered to other employees within the business unit; and Applicable expatriate and relocation benefi ts and allowances.
No benefi ts are pensionable. Details of the costs of providing the benefi ts to each executive director are outlined in the remuneration table on page 134.
The pension provision for executive directors depends on the arrangements in place for other employees in their business unit when they joined the Group.
Executives who joined aft er June 2003 have the option to: Receive payments into a defi ned contribution scheme; or Take a cash supplement in lieu of contributions.
Executives who joined the Group before June 2003 were entitled to join the defi ned benefi t plans available at that time. At the end of 2012, no executive director was an active member of a Group defi ned benefi t scheme.
Remuneration policy report Prudential plc Annual Report 2012 121
2012 opportunity
2012 base salaries are set out on page 124.
The maximum annual bonus opportunity available to the majority of executive directors is between 160 per cent and 200 per cent of salary. Based on relevant market practice, the Chief Executive of M&G and the President & CEO, Jackson have bonus opportunities which are not capped as a percentage of their salaries. The Chief Executive of M&G has an overriding cap on total remuneration of 3 per cent of M&G’s IFRS profi t.
Details of executive directors’ 2012 bonus opportunities are provided on page 125.
The maximum combined award under the GPSP and BUPP is 550 per cent of salary, although the actual awards made in 2012 were below this level. The Chief Executive of M&G’s long-term incentive opportunity was not capped as a percentage of salary in 2012. There is an overriding cap on total remuneration for this role of 3 per cent of M&G’s IFRS profi t.
A breakdown of the long-term incentive opportunities available to executive directors is set out on page 123.
Executive directors based in the UK and Asia are entitled to receive pension contributions or a cash supplement (or combination of the two) of 25 per cent of base salary.
The President & CEO, Jackson, participates in Jackson’s Defi ned Contribution Retirement Plan on the same basis as other JNL employees. Full details of the amounts paid by the Company with regards to pension provision are outlined in the remuneration table on page 134 and the pensions table on page 130.
2012 performance metrics
Awards for the majority of executive directors are subject to the achievement of: Net free surplus generated;
IFRS operating profi t;
EEV operating profi t;
Holding company cash fl ow; Insurance Groups Directive (IGD) Capital Surplus; and
Personal objectives.
GPSP awards vest based on relative TSR (Total Shareholder Return, a combination of share price growth and dividends paid) performance relative to an index of international insurers.
The performance measures for the BUPPs and the M&G Executive LTIP vary according to the business plan and strategy of the business unit. These are outlined on pages 127 to 128.
Jackson’s Defi ned Contribution Retirement Plan has a guaranteed element and additional contributions based on the profi tability of JNL. No other Group pension schemes have performance conditions.
Changes to policy for 2013
As part of the review of remuneration
architecture which took place during 2012, the
clawback provisions applied to the deferred
portion of bonuses for 2013 onwards have
been strengthened.
The percentage of annual bonus awards which
executives are required to defer has been made
consistent across our senior executive team at
40 per cent.
The annual bonus opportunity for the
Chief Executive of M&G will be capped at the
lower of 0.75 per cent of M&G’s IFRS profit or
six times salary.
Please see page 118 for further details. Remuneration
As part of the review of remuneration
architecture, the Remuneration Committee
has proposed a new long-term incentive (the policy
Prudential Long Term Incentive Plan) for approval
at the 2013 AGM.
Subject to shareholder approval, the first awards report
will be made under this plan in May 2013.
Full details of the proposal are outlined on
pages 118 to 119. Directors’
As part of the review of remuneration
architecture, the executive director shareholding
guidelines have been enhanced.
The revised guidelines are: remuneration
350 per cent of salary for the Group Chief
Executive; and report
200 per cent of salary for all other executive
directors.
Full details of the revised guidelines are outlined
on page 118.
122 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy
The operation of the Remuneration Committee in 2012
The members of the Committee during 2012 are listed below.
All are independent non-executive directors:
Lord Turnbull KCB CVO (Chairman)
Keki Dadiseth
Michael Garrett
Paul Manduca (until 2 July 2012)
Kai Nargolwala
Philip Remnant joined the Committee on 1 January 2013.
In 2012, the Committee met fi ve times. Key activities at each meeting are shown in the table below:
Meeting Key activities
February 2012 Approve the 2011 directors’ remuneration report;
Consider 2011 bonus awards for executive directors (and total compensation figure for Michael McLintock);
Consider vesting of the long-term incentive awards with a performance period ending on 31 December
2011; and
Approve the annual bonus measures and targets to be used in 2012.
March 2012 Approve 2012 long-term incentive awards and performance measures; and
Confirm 2011 annual bonuses and the vesting of long-term incentive awards with a performance
period ending on 31 December 2011 in light of audited financial results.
June 2012 Review the remuneration of the Group Leadership Team, senior risk staff and of employees
with a remuneration opportunity over Ł1 million per annum;
Note the dilution levels resulting from the Company’s share plans; and
Consider proposed changes to the remuneration architecture.
September 2012 Monitor performance against long-term incentive targets, based on the half year results;
Review the Committee’s terms of reference;
Approve proposed changes to the remuneration architecture for shareholder consultation; and
Review total remuneration of executive directors.
December 2012 Note the level of participation in the Company’s all-employee share plans;
Approve executive directors’ 2013 salaries and incentive opportunities;
Consider the annual bonus measures and targets to be used in 2013;
Review an initial draft of the 2012 directors’ remuneration report;
Confirm changes to the remuneration architecture in light of shareholder feedback; and
Approve the Committee’s 2013 work plan.
2012 implementation of remuneration policy Prudential plc Annual Report 2012 123
In January 2012, the Remuneration Committee met to conclude During 2012, Deloitte LLP were the independent
issues arising from the December 2011 Committee meeting. advisor to the Committee. Advice was also provided by
In addition, the Committee met for a working session in PricewaterhouseCoopers LLP. Market data was sourced from
September 2012 to discuss changes to the remuneration Deloitte LLP, Towers Watson, McLagan Partners and LOMA.
architecture to be implemented in 2013. Norton Rose, Slaughter & May, Linklaters and Allen & Overy
provided legal counsel, including advice on employment law and
The Chairman and the Group Chief Executive attend meetings by
the operation of the Company’s share plans. Some of these firms
invitation. The Committee also had the benefit of advice from the
also provided other services to the Company: Deloitte LLP and
Chief Financial Officer, Group Human Resources Director and
PricewaterhouseCoopers LLP provided advice on Solvency II,
Director of Group Reward and Employee Relations. The Group
taxation and other financial matters, Towers Watson provided
Chief Risk Officer advised the Committee on adherence to the
actuarial advice and Slaughter & May and Norton Rose provided
Group’s risk appetite and framework. Individuals are never
commercial, corporate and general legal advice.
present when their own remuneration is discussed.
The operation of the reward policy in 2012
In 2012, executive directors were rewarded on the basis set out below:
Long-term incentives (2012 award 2012
as a percentage of salary)
Annual bonus – Group
maximum Performance Business Unit
Base salary at percentage Share Plan Performance
Director Role 1 January 2012 of salary(GPSP) Plan (BUPP) Total
Rob Devey Chief Executive, UK & Europe Ł600,000 160% 112.5% 112.5% 225.0% implementation
John Foley Group Chief Risk Officer Ł610,000 160% 250.0% – 250.0% of
Michael McLintock Chief Executive, M&G Ł360,000 note 1 100.0% 344.1% 444.1%
Nic Nicandrou Chief Financial Officer Ł630,000 175% 225.0% – 225.0%
Barry Stowe Chief Executive, PCA HK$8,000,000 160% 112.5% 112.5% 225.0%
Tidjane Thiam Group Chief Executive Ł1,000,000 200% 400.0% – 400.0% remuneration
Mike Wells President & CEO, JNL US$1,050,000 note 2 230.0% 230.0% 460.0% policy
Notes
1 Michael McLintock’s annual bonus and long-term incentive opportunity under the M&G Executive LTIP (rather than the BUPP) are based on M&G’s
performance both in absolute terms and relative to its peers. In line with practice in the asset management sector, there is no specified maximum incentive
award. Michael’s total remuneration is subject to an overriding cap such that his total remuneration should not be greater than 3 per cent of M&G’s annual IFRS
profits. The figure shown for his 2012 M&G Executive LTIP award is the expected value of this grant.
2 Mike Wells’ maximum annual bonus figure is comprised of 160 per cent of salary and a 10 per cent share of the Jackson senior management bonus pool based Directors’
on the target performance of Jackson.
3 All long-term incentives have a three-year performance period. For the awards detailed above the performance period will end on 31 December 2014.
4 Where awards are made in shares, the final number of shares awarded is calculated in line with the respective plan rules. Details on the shares granted under
these plans are outlined in the Directors’ outstanding long-term incentive awards tables in the Supplementary information section. remuneration
The package for 2012 offered the following proportions of fixed and variable short- and long-term reward to executive directors
(average of executive directors): report
Good performance Superior performance
26% Base salary 15% Base salary
30% Cash bonus for 2012, paid in 2013 21% Cash bonus for 2012, paid in 2013
18% Deferred bonus for 2012, vesting in 2016 14% Deferred bonus for 2012, vesting in 2016
26% 2012 LTIP Award, vesting in 2015 50% 2012 LTIP Award, vesting in 2015
[Graphic Appears Here]
[Graphic Appears Here]
As illustrated above, ‘Good’ performance results in the payment of 2012 annual bonus at the target level and 2012 long-term incentive awards vesting at the threshold level. ‘Superior’ performance generates maximum payment of 2012 annual bonuses and 2012 long-term incentive awards vest in full.
124 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
The single fi gure
Although the UK Government’s proposed reporting requirements have not been fi nalised, we have anticipated the requirement to present a single fi gure for executives’ total remuneration. This is included in the main remuneration table for 2012 on page 134. The single fi gure has been calculated including the following elements:
The salary and the cost of providing benefi ts in 2012;
The bonus awarded for performance in 2012 (including the value at award of the deferred element which will be released in 2016);
The value of long-term incentive awards with a performance period ending in 2012 which will be released in 2013, using the average share price over the period 1 October 2012 to 31 December 2012; and
The value of any salary supplement for pension, employer contributions to a defi ned contribution pension plan or the increase in transfer value of fi nal salary pension benefi ts in 2012 (less contributions made by the director during 2012).
Base salary
Executive directors’ salaries were reviewed in 2012 with changes effective from 1 January 2013. In determining 2013 salaries, the Committee considered the performance, experience and internal relativities of each director, as well as the performance of the Group and the salary increases awarded to other employees. To provide context for this review, information was drawn from the following market reference points:
Director Role Benchmark(s) used to assess remuneration
Rob Devey Chief Executive, UK & Europe FTSE 40
International Insurance Companies
John Foley Group Chief Risk Officer FTSE 40
Michael McLintock Chief Executive, M&G McLagan UK Investment Management Survey
Nic Nicandrou Chief Financial Officer FTSE 40
International Insurance Companies
Barry Stowe Chief Executive, PCA Towers Watson Asian Insurance Survey
Tidjane Thiam Group Chief Executive FTSE 40
International Insurance Companies
Mike Wells President & CEO, JNL Towers Watson US Financial Services Survey
LOMA US Insurance Survey
After careful consideration the Committee decided to increase Executive 2012 salary 2013 salary (+3%)
salaries by 3 per cent as set out in the table on the right. Salary
increases for the wider workforce vary across our business units, Rob Devey Ł600,000 Ł618,000
based on local market conditions. It is anticipated that 2013 salary John Foley Ł610,000 Ł628,300
budgets will increase between 3 per cent and 5 per cent, for the Michael McLintock Ł360,000 Ł370,800
wider workforce. Nic Nicandrou Ł630,000 Ł648,900
Barry Stowe HK$8,000,000 HK$8,240,000
Tidjane Thiam Ł1,000,000 Ł1,030,000
Mike Wells US$1,050,000 US$1,081,500
2012 implementation of remuneration policy Prudential plc Annual Report 2012 125
Annual bonus requirements). In addition, all employees are required to comply
Performance measures with the regulatory, governance and risk management practices
The financial measures used to assess performance for the and policies as these relate to their role and business area.
2012 AIP are set out below. These remain unchanged for 2013. Specifically, all business units must act within the Group’s risk
Executive directors who have business unit responsibilities are appetite and framework, and all individuals must act within the
assessed on both Group and business unit performance. Group’s Code of Business Conduct.
A portion of the annual bonus for each executive director A proportion of each executive director’s annual bonus is not
is based on the achievement of personal objectives. These paid in cash and must be deferred. This portion is deferred for
objectives include the executive’s contribution to Group three years in the form of the Company’s shares. This deferral
strategy as a member of the Board and specific goals related aligns the interests of our executive directors with our
to their functional and/or business unit role (for instance, shareholders and helps to ensure a focus on the sustainable
project measures relating to the implementation of Solvency II success of the Company.
Annual bonus opportunities
Executive directors’ bonus opportunities, the weighting of performance measures for 2012 and the proportion of annual bonuses
deferred are set out below.
2012
Weighting of measures
Maximum bonus
opportunity Personal
(Percentage of salary) Deferral requirement Group Business unit objectives
Rob Devey 160% 40% of total bonus 20% 60% 20%
John Foley 160% 40% of total bonus 50% – 50% implementation
Michael McLintock Note 1 50% of bonus above Ł500,000 10% 60% 30% of
Nic Nicandrou 175% 40% of total bonus 80% – 20%
Barry Stowe 160% 40% of total bonus 20% 60% 20%
Tidjane Thiam 200% 50% of total bonus 80% – 20%
Mike Wells note 2 c.400% 30% of total bonus 30% 60% 10% remuneration
Notes policy
1 Michael McLintock’s annual bonus and long-term incentive opportunities in 2012 were based on M&G’s performance both in absolute terms and relative to its
peers. In line with practice in the asset management sector, there is no specified maximum incentive award. Michael’s total remuneration (including long-term
incentives) is subject to an overriding cap which requires that his total remuneration must not be greater than 3 per cent of M&G’s annual IFRS profit.
2 Mike Wells’ annual bonus figure comprises an AIP opportunity of 160 per cent of salary and a 10 per cent share of the Jackson senior management bonus pool.
The figure above is based on the target performance of Jackson. Directors’
Rewarding performance in 2012
As set out in the Remuneration Committee Chairman’s letter, during 2012 the Group delivered further increases in its key financial
measures, specifically new business profitability, IFRS profitability and cash generation. The outstanding performance delivered in
2012 against these measures exceeded both the Group’s 2011 performance and the stretching targets set by the Committee at the remuneration
start of the year. The Group Chief Risk Officer was invited to attend the Remuneration Committee meeting held in March 2013
and advised the Committee on the Group’s adherence to its risk appetite and framework during 2012. report
2012 financial performance, relative to the targets set by the Committee, is summarised below:
Measure Group PCA UK M&G
Cash flow Above stretch target Above stretch target At Plan level –
Net free surplus generated Above stretch target Between Plan and stretch target – –
IFRS profit Above stretch target Above stretch target Above stretch target Between Plan and
stretch target
IGD surplus Above stretch target Between Plan and stretch target Above stretch target –
NBP EEV profit Above stretch target Above stretch target Above stretch target –
In-force EEV profit Above stretch target Between Plan and stretch target Between Plan and –
stretch target
126 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
On the basis of this outstanding performance, the Committee approved the following 2012 AIP payments:
Maximum Total 2012
2012 salary 2012 AIP 2012 outcome 2011 outcome AIP payment
(as a percentage(as a percentage
Executive of max) of max)
Rob Devey Ł600,000 160% 73.9% 90.7% Ł709,200
John Foley Ł610,000 160% 100.0% 98.1% Ł976,000
Michael McLintock Ł360,000 n/a n/a n/a Ł1,307,275
Nic Nicandrou Ł630,000 175% 99.0% 95.9% Ł1,091,475
Barry Stowe HK$8,000,000 160% 98.1% 94.1% HK$12,560,000
Tidjane Thiam Ł1,000,000 200% 100.0% 96.9% Ł2,000,000
Mike Wells note 1 US$1,050,000 160% 99.0% 95.4% US$1,663,200
Note
1 In addition to the AIP, Mike Wells also received 10 per cent of the JNL senior management bonus pool. His total 2012 bonus, including his AIP and JNL senior management award, is US$4,599,500.
Long-term incentives
Details of the awards made under these plans in 2012 can be found on pages 137 to 139.
Group Performance Share Plan (GPSP)
All executive directors receive GPSP awards. GPSP awards vest on the basis of the Group’s Total Shareholder Return (TSR) performance over a three-year period. TSR is the combination of the share price growth and the dividends paid. Prudential’s TSR achievement over the performance period is compared with the TSR of an index composed of 10 international insurers (see box below). This performance measure was selected because it focuses on the value delivered to shareholders. TSR is measured on a local currency basis since this has the benefi t of simplicity and directness of comparison.
The vesting schedule for outstanding GPSP awards is set out below:
[Graphic Appears Here]
80% 90% 100% 110% 120%
x index x index x index x index x index
Performance to be achieved by Prudential
Peer companies used within the Index for all outstanding GPSP awards Aegon, Allianz, Aviva, Axa, Generali, ING, Legal & General, Manulife, Old Mutual and Standard Life
For any GPSP award to vest, the Committee must be satisfi ed that the quality of the Company’s underlying fi nancial performance justifi es the level of reward delivered at the end of the performance period. To ensure close alignment with our shareholders’ long-term interests, participants receive the value of reinvested dividends over the performance period for those shares which ultimately vest. If performance measures are not achieved in full, the unvested portion of any award lapses and performance cannot be retested.
On 31 December 2012, the performance period for 2010 GPSP awards (which began on 1 January 2010) came to an end. Over the performance period the Group has delivered superior returns for shareholders through share price growth and dividends paid. This resulted in Prudential achieving excellent TSR performance of 156.4 per cent.
The peer group’s TSR index was 100 at the start of the 2010 to 2012 performance period and was 111.8 at the end of the period (as illustrated opposite). In order for the 2010 GPSP awards to vest in full, Prudential’s TSR index over the period had to outperform the peer index by 20 per cent, ie increase from 100 to at least 134.2 (111.8 x 120 per cent). The TSR performance achieved by Prudential of 156.4 per cent equals an outperformance of the peer index of 139.9 per cent.
The Committee, having satisfi ed itself about the quality of the Company’s underlying fi nancial performance, confi rmed vesting of 100 per cent of the 2010 to 2012 GPSP award (for reference, 100 per cent of the 2009 to 2011 GPSP award vested).
The Committee believes that the GPSP performance condition is a stretching requirement that requires exceptional performance, relative to other international insurance companies, for awards to be released in full.
2012 implementation of remuneration policy Prudential plc Annual Report 2012 127
The line chart below compares Prudential’s TSR during the three years from 1 January 2010 to 31 December 2012 with that of the peer group against which TSR is measured for the purposes of the GPSP.
[Graphic Appears Here]
Dec 2009 Dec 2010 Dec 2011 Dec 2012
Prudential Peer group index
2012
Business Unit Performance Plans (BUPP) On 31 December 2012, the performance period for the 2010
Asia BUPP Jackson BUPP came to an end. Although no current executive
The Chief Executive, PCA receives awards under the Asia BUPP. director had a 2010 award under this plan the vesting level for
These awards are dependent on the achievement of PCA’s new other participants was 100 per cent (for reference 93.75 per cent implementation
business profit, IFRS profit and cash remittance targets over the of the 2009 to 2011 awards vested).
three-year performance period. Each of these measures will of
determine vesting of one third of each award. Threshold UK BUPP
performance results in 30 per cent of the award vesting, The Chief Executive, UK & Europe receives awards under
increasing to 100 per cent for stretch performance. the UK BUPP. Given the cash-generative priorities of the
UK Business Unit, UK BUPP awards are assessed using the remuneration
On 31 December 2012, the performance period for the 2010 Asia
same relative TSR measure applied to GPSP awards.
BUPP award (which began on 1 January 2010) came to an end. policy
Over the period, the new business profit, IFRS profit and cash On 31 December 2012, the performance period for the
remittance achieved by the PCA business unit meant that the 2010 UK BUPP (which began on 1 January 2010) came to an end.
Committee, having satisfied itself as to the quality of the business As detailed above, Prudential’s TSR over this period was equal to
units’ underlying financial performance, confirmed vesting of 139.9 per cent of the peer index. The Committee, having satisfied
95.2 per cent of Barry Stowe’s 2010 to 2012 Asia BUPP award itself as to the quality of the business unit’s underlying financial Directors’
(for reference, 86.5 per cent of Barry Stowe’s 2009 to 2011 Asia performance, confirmed vesting of 100 per cent of Rob Devey’s
BUPP award vested). 2010 to 2012 UK BUPP award (for reference 100 per cent of
Rob Devey’s 2009 to 2011 UK BUPP award vested).
Jackson BUPP
For any BUPP award to vest, the Committee must be satisfied that remuneration
The President and CEO, JNL receives an award under the Jackson
the quality of underlying financial performance of the relevant
BUPP. Vesting of awards made under this plan is dependent on
business unit justifies the level of reward delivered at the end of
Shareholder Capital Value (SCV) growth over the performance report
the performance period. To ensure close alignment with our
period. The SCV growth required is outlined in the table below.
shareholders’ long-term interests, participants receive the value
Vesting occurs between these performance levels on a
of reinvested dividends over the performance period for those
straight-line basis.
shares which ultimately vest. If the performance conditions are
Compound annual not achieved in full, the unvested portion of any award lapses
growth in SCV and cannot be retested.
Percentage of BUPP award which vests over three years
0% <8%
30% 8%
75% 10%
100% 12%
128 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
Limits on award sizes
The rules of the GPSP and BUPP set a limit on the value of shares which may be awarded to an executive in a fi nancial year. The combined value of shares awarded under the two plans may not exceed a maximum of 550 per cent of salary although the awards made in a particular year are often signifi cantly below this limit. On a change in control of Prudential, vesting of awards made under these arrangements would be prorated for performance and to refl ect the elapsed portion of the performance period.
M&G Executive Long-Term Incentive Plan
The Chief Executive, M&G receives awards under the M&G Executive Long-Term Incentive Plan. Under this plan an annual award of phantom shares is made with a notional starting share price of Ł1. The phantom share price at vesting is determined by the increase or decrease in M&G’s profi tability over the three-year performance period with profi t and investment performance adjustments also applied:
Profi t growth
The value of phantom shares vesting will be adjusted by a profi t measure as follows:
No adjustment will be made if profi ts in the third year of the performance period are at least equal to the average annual profi t generated over the performance period;
A loss or zero profi t will result in the value of the award being reduced to zero, irrespective of investment performance; and
Between these points, the value of phantom shares will be reduced on a straight-line basis from no reduction to the complete elimination of the value of the award.
Investment performance
The value of phantom shares vesting will be adjusted by an investment performance measure as follows:
Where the investment performance of M&G’s funds is in the top two quartiles during the three-year performance period, the value of phantom shares vesting will be enhanced. The value of phantom shares may be doubled if performance is in the top quartile;
Investment performance in the third quartile will not change the value of phantom shares vesting; and
Investment performance in the bottom quartile will result in awards being forfeited, irrespective of any profi t growth.
The value of the vested phantom shares will be paid in cash after the end of the three-year performance period.
On 31 December 2012, the performance period for the 2010 award under the M&G Executive Long-Term Incentive Plan (which began on 1 January 2010) came to an end. M&G’s profi t at the end of the performance period was 204 per cent of that at the start and M&G’s investment performance was in the second quartile. The Committee, having satisfi ed itself about the quality of M&G’s underlying fi nancial performance, confi rmed vesting of Michael McLintock’s 2010 award with a value of Ł2.65 per share. This will result in a payment of Ł2,616,024 to Michael McLintock in 2013 (for reference, the 2009 to 2011 award vested with a value of Ł2.96 per share which resulted in a payment of Ł5,417,359 to Michael McLintock during 2012). Based on 2011 performance, an award of 952,960 phantom shares with an expected value of Ł1,238,849 was made to Michael McLintock in 2012.
As described in the remuneration architecture review section of this report, the method used to determine the number of phantom shares awarded to Michael McLintock under the M&G Executive Long-Term Incentive Plan has been revised. With effect from 2013, Michael McLintock will receive an annual award with a face value of three times his salary. The ultimate value of the 2013 award will be determined with reference to the profi tability and investment performance of M&G over the three years from 1 January 2013 to 31 December 2015 using the measures set out above.
Jackson Long-Term Incentive Plans
Prior to his appointment as an executive director, Mike Wells participated in the two long-term incentive plans offered to senior staff within Jackson. Mike Wells was awarded ADRs under the JNL US Performance Share Plan and cash-based awards under the JNL Long-Term Incentive Plan. Awards made under both plans have a performance period of four years and vesting is dependent on the achievement of shareholder value targets. Up to 150 per cent of the original
number of ADRs awarded under the JNL Performance Share Plan may be released if stretch performance targets are achieved.
Outstanding awards made to Mike Wells before his appointment as an executive director remain subject to the original performance conditions and vesting schedule. No further awards will be made to Mike Wells under these plans.
On 31 December 2012, the performance periods for the 2009 awards under the JNL long-term incentive plans (which began on
1 January 2009) came to an end. Over the period the shareholder value of the US business grew by 22.68 per cent per annum (on a compound basis) and by 126.51 per cent over the performance period. This resulted in vesting of 150 per cent of Mike Wells’ 2009 JNL US Performance Share Plan award and of 126.51 per cent of his 2009 cash-settled JNL Long-Term Incentive Plan award (for reference 150 per cent of Mike Wells’ 2008 to 2011 JNL US Performance Share Plan award and 95 per cent of his 2008 to 2011 cash-settled JNL Long-Term Incentive Plan award vested).
2012 implementation of remuneration policy Prudential plc Annual Report 2012 129
Share ownership guidelines
As a condition of serving, all directors are required to have
beneficial ownership of a minimum of 2,500 ordinary shares in
the Company. This interest in shares must be acquired within
12 months of appointment to the Board if the director does not
have such an interest upon appointment.
Executive directors should have a substantial shareholding to
maximise the community of interest between them and other
shareholders. This may be built up over a period of five years
following their appointment.
The level of the requirements which applied to executive
directors in 2012 and the current holdings of directors are shown
below. The shareholding guidelines have been increased as part
of the review of remuneration architecture and full details of the
revised guidelines are outlined on page 118. Shares earned and
deferred under the Annual Incentive Plan are included in
calculating the executive director’s shareholding for these
purposes.
2012 Shareholding 2013
Shareholding at 31 December Shareholding
guideline as a 2012 as a guideline as a
percentage of percentage percentage of
base salary of base salary base salary
note
Rob Devey 100% 397% 200%
John Foley 100% 459% 200%
Michael McLintock 200% 1,641% 200%
Nic Nicandrou 100% 482% 200%
Barry Stowe 100% 680% 200%
Tidjane Thiam 200% 800% 350%
Mike Wells 100% 773% 200%
Note
Beneficial interest, based on the share price as at 31 December 2012 (Ł8.655).
Calculated using base salaries on 31 December 2012.
Benefits
All executive directors receive core health and security benefits,
for example medical insurance and life assurance.
Other benefits may be offered to executives, dependent on:
Local market practice;
The benefits offered to other employees within the business
unit; and
Applicable expatriate and relocation benefits and allowances.
The 2012 remuneration table on page 134 sets out the cost of
providing benefits in 2012.
All-employee share plans
It is important that all employees are offered the opportunity to
own shares in Prudential, connecting them both to the success
of the Company and to the interests of other shareholders.
Executive directors are invited to participate in these plans on
the same basis as other staff in their location.
Save As You Earn (SAYE) schemes
UK-based executive directors are eligible to participate in
the HM Revenue and Customs (HMRC) approved Prudential
Savings-Related Share Option Scheme and Barry Stowe is invited
to participate in the similar International Share Ownership
Scheme. These schemes allow all eligible employees to save
towards the exercise of options over Prudential plc shares with
the option price set at the beginning of the savings period at a
discount of up to 20 per cent of the market price.
Participants elect to enter into savings contracts of up to
Ł250 per month for a period of three or five years. At the end
of this term, participants may exercise their options within six
months and purchase shares. If an option is not exercised within
six months, participants are entitled to a refund of their cash
savings plus interest if applicable under the rules. Shares are
issued to satisfy those options which are exercised. No options
may be granted under the schemes if the grant would cause the
2012
number of shares which have been issued, or which remain
issuable pursuant to options granted in the preceding 10 years
under the scheme and any other 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. implementation
of
Share Incentive Plan (SIP)
UK-based executive directors are also eligible to participate in
the Company’s HMRC approved Share Incentive Plan (SIP).
This allows all UK-based employees to purchase Prudential plc remuneration
shares up to a value of Ł125 per month from their gross salary
(partnership shares). For every four partnership shares bought, policy
an additional matching share is awarded which is purchased by
Prudential on the open market. Dividend shares accumulate
while the employee participates in the plan. Partnership shares
may be withdrawn from the scheme at any time. If the employee Directors’
withdraws from the plan within five years, matching shares
are forfeited.
No directors or other employees are provided with loans to
enable them to buy shares.
remuneration
Pension benefits
Michael McLintock elected to become a deferred member report
of a contributory defined benefit scheme (described overleaf)
on 5 April 2012. Michael McLintock now receives a salary
supplement of 25 per cent of salary. John Foley elects to receive
a combination of contributions into the money purchase scheme
and a cash supplement with a total value of 25 per cent of salary.
All other executive directors based in the UK have chosen to
receive their pension benefits in the form of a cash supplement
of 25 per cent of salary throughout 2012. These executives are
provided with life assurance cover of up to four times salary
plus a dependants’ pension.
130 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
Barry Stowe receives a cash supplement of 25 per cent of salary and a payment to the Hong Kong Mandatory Provident Fund. He is provided with life assurance cover of up to four times salary. Mike Wells participates 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 6 per cent of base salary (Mike Wells’ salary for pension purposes is limited to US$250,000). He also participates in the profit sharing element of the plan which provides eligible participants with an annual profit sharing contribution, depending on the financial results of Jackson for
the plan year, to a maximum of an additional 6 per cent of pensionable salary. An annual profit sharing contribution equivalent to 6 per cent of pensionable salary was made in 2012 (in 2011, the profit share contribution was 5 per cent of pensionable salary). Mike Wells is provided with life assurance cover of two times salary.
Those executives who joined the Group before June 2003 were entitled to maintain their membership of the defined benefit plans available at that time. However, at the end of 2012, no executive director was an active member of a Group defined benefit scheme. Until 5 April 2012, Michael McLintock participated in a contributory defined benefit scheme that provides a target pension of two thirds of final pensionable earnings on retirement at age 60 for an employee with 30 years or more potential service, his contribution was 4 per cent of base salary. Michael McLintock participated on the same basis as other employees who joined M&G at the same date. Benefits under the plan are subject to a notional scheme earnings cap (set at Ł129,600 for the 2011/2012 tax year) which replicates the HMRC earnings cap in force before A-Day (6 April 2006). Michael McLintock was also entitled to supplements based on his salary above the notional earnings cap.
Details of directors’ pension entitlements under HMRC approved defined benefit schemes and supplements in the form of contributions to pension arrangements paid by the Company are set out in the following table:
Transfer value of
accrued benefit
Additional pension earned during at 31 December
year ended 31 December 2012 note (3)
Increase
Ignoring Allowing in transfer
Years of Accrued inflation for inflation value less Contributions
pensionable benefit at on pension on pension contributions to defined
Age at service at 31 December earned to earned to made by contribution
31 December 31 December 2012 31 December 31 December directors pension
2012 2012(Ł per annum) 2011 2011 2012 2011 during 2012 schemes
note (1) note (2) note (4)
Ł000 Ł000 Ł000 Ł000 Ł000 Ł0000 Ł0000
Rob Devey 44 –
John Foley 56 50
Michael McLintock (note 5) 51 20 56 1(1) 1,323 1,102 218 –
Nic Nicandrou 47 –
Barry Stowe 55 2
Tidjane Thiam 50 –
Mike Wells 52 19
Notes
1 As required by the Companies Act remuneration regulations.
2 As required by Stock Exchange Listing rules.
3 The transfer value equivalent has been calculated in accordance with the M&G Group Pension Scheme’s transfer basis.
4 This table includes employer contributions to defined contribution plans totalling Ł71,124 (2011: Ł56,224). Supplements in the form of cash are included in the table on page 134.
5 Michael McLintock became a deferred member of the M&G defined benefit scheme on 5 April 2012. The amounts shown above as at 31 December 2012 are calculated as at this date.
No enhancements to retirement benefits were paid to or receivable by directors or former directors other than the discretionary pension increases awarded to all pensioners which have been made during the year.
2012 implementation of remuneration policy Prudential plc Annual Report 2012 131
Executive directors’ service contracts Remuneration Committee will have regard to the specific
The normal notice of termination that the Company is required circumstances of each case, including the director’s obligation
to give executive directors is 12 months. Accordingly, in normal to mitigate his loss. Payments are phased over the notice period.
circumstances, a director whose contract is terminated would
Executive directors’ service contracts provide details of the broad
be entitled to one year’s salary and benefits in respect of their
types of remuneration to which they are entitled, and about the
notice period. Additionally, outstanding awards under annual
kinds of plans in which they may be invited to participate. The
and long-term incentive plans may vest depending on the
service contracts offer no certainty as to the value of
circumstances and according to the rules of the plans. When
performance-related reward and confirms that any variable
considering the termination of any service contract, the
payment will be at the discretion of the Company.
Details of the service contracts of the executive directors are outlined below:
Notice period Notice period
Executive director Date of contract to the Company from the Company
Rob Devey 1 July 2009 12 months 12 months
John Foley 8 December 2010 12 months 12 months
Michael McLintock 21 November 2001 6 months 12 months 2012
Nic Nicandrou 26 April 2009 12 months 12 months
Barry Stowe 18 October 2006 12 months 12 months
Tidjane Thiam 20 September 2007 12 months 12 months
Mike Wells note 15 October 2010 12 months 12 months implementation
Note
The contract for Mike Wells is a renewable one-year fixed term contract. The contract is renewable automatically upon the same terms and conditions unless the of
Company or the director gives at least 90 days’ notice prior to the end of the relevant term.
Policy on external appointments Chairman and non-executive directors’ letters remuneration
Subject to the Group Chief Executive’s or the Chairman’s of appointment and fees
approval, executive directors are able to accept external Non-executive directors’ letters of appointment
appointments as non-executive directors of other organisations. Non-executive directors do not have service contracts but are policy
Any fees paid may be retained by the executive director. During appointed pursuant to letters of appointment with notice periods
2012, Michael McLintock received Ł47,500 as a trustee of of six months without liability for compensation.
another organisation (for reference, Michael McLintock received
Under the terms of their letters of appointment, continuation
Ł45,000 for this role in 2011). Other directors served on the Directors’
of the non-executive directors’ appointment is contingent on
boards of educational, development, charitable and cultural
satisfactory performance and re-election by shareholders.
organisations without receiving a fee for such services.
Non-executive directors are typically expected to serve two
three-year terms from the date of their election by shareholders.
Thereafter, the Board may invite the Director to serve for an remuneration
additional period.
report
132 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
Details of the letters of appointment for the non-executive directors are outlined below:
Initial election by Expiration of current
Non-executive director Appointment by the Board shareholders at AGM Notice period term of appointment
Keki Dadiseth (note 1) 1 April 2005 AGM 2005 6 months AGM 2013
Howard Davies 15 October 2010 AGM 2011 6 months AGM 2014
Michael Garrett (note 1) 1 September 2004 AGM 2005 6 months AGM 2013
Ann Godbehere 2 August 2007 AGM 2008 6 months AGM 2014
Alistair Johnston 1 January 2012 AGM 2012 6 months AGM 2015
Paul Manduca (note 2) 15 October 2010 AGM 2011 6 months AGM 2014
Kaikhushru Nargolwala 1 January 2012 AGM 2012 6 months AGM 2015
Kathleen O’Donovan (note 3) 8 May 2003 AGM 2004 6 months n/a
Philip Remnant (note 4) 1 January 2013 AGM 2013 6 months AGM 2016
Lord Turnbull 18 May 2006 AGM 2006 6 months AGM 2015
Notes
1 Keki Dadiseth and Michael Garrett were reappointed in 2012 for one year. The Board will consider a further renewal term in May 2013.
2 Paul Manduca was appointed as Chairman of the Board on 2 July 2012.
3 Kathleen O’Donovan retired from the Board on 31 March 2012.
4 For Philip Remnant the table assumes initial election by shareholders at the 2013 AGM.
Chairman’s letter of appointment, fees and benefi ts
Paul Manduca was appointed as a non-executive director on
15 October 2010 and became Senior Independent Director on 1 January 2011. On 2 July 2012, he was appointed Chairman. He is paid an annual fee of Ł600,000. A contractual notice period of 12 months by either party applies. Paul Manduca is provided with life assurance cover of four times his annual fees plus an additional sum to buy a dependants’ annuity, private medical insurance and the use of a car and driver. No pension allowance is paid and he is not a member of any Group pension scheme.
Non-executive directors’ fees
Non-executive directors are not eligible to participate in annual bonus plans, long-term incentive plans or pension arrangements. Their fees are determined by the Board and refl ect their individual responsibilities, including chairmanship and membership of committees where appropriate. The Board reviews fees annually.
An increase of just under 3 per cent was made to the basic non-executive fee with effect from 1 July 2012. No increases were made to the additional fees paid to committee chairmen or members. The revised fees are:
From
1 July 2012
Annual fees Ł
Basic fee 87,500
Audit Committee Chairman – additional fee 70,000
Audit Committee member – additional fee 25,000
Remuneration Committee Chairman – additional fee 50,000
Remuneration Committee member – additional fee 25,000
Risk Committee Chairman – additional fee 60,000
Risk Committee member – additional fee 25,000
Senior Independent Director – additional fee 50,000
Notes
1 No fee is payable for chairmanship or membership of the Nomination Committee.
2 The Company may determine that additional fees should be paid if, in a particular year, the number of meetings is materially greater than usual.
Please see the table on page 134 for details of the fees received by individual non-executive directors during 2012.
2012 implementation of remuneration policy Prudential plc Annual Report 2012 133
Non-executive directors’ share ownership requirements
In July 2011, a share ownership requirement for non-executive directors was introduced. Non-executive directors are required to hold shares with a value equivalent to one times the annual basic fee (excluding additional fees for chairmanship and membership of any committees). Non-executive directors will be expected to attain this level of share ownership within three years of the implementation of this requirement (or within three years of their date of appointment, if later). The Chairman is required to hold shares with a value equivalent to one times his annual fee and is expected to attain this level of share ownership within fi ve years of the date of his appointment.
Directors’ shareholdings
The interests of directors in ordinary shares of the Company are set out below. ‘Shares subject to deferral’ includes shares acquired under the Share Incentive Plan (detailed in the table on page 142), deferred annual incentive awards and interests in shares awarded on appointment (detailed in the ‘Other Share Awards’ table on pages 140 and 141).
1 January 2012 31 December 2012 12 March 2013
Total
Beneficial beneficial Number of Beneficial
interest Number of Number of interest shares subject interest 2012
(Number shares owned shares subject(Number to performance(Number
of shares) outright to deferral of shares) conditions of shares)
Keki Dadiseth 32,196 32,196 – 32,196 – 32,196
Howard Davies 3,083 3,192 – 3,192 – 3,192
Rob Devey 126,006 154,746 120,697 275,443 537,208 275,443 implementation
John Foley 364,378 277,178 46,057 323,235 351,917 323,235 of
Michael Garrett 39,233 39,233 – 39,233 – 39,233
Ann Godbehere 15,914 15,914 – 15,914 – 15,914
Alistair Johnston note (1) – 5,000 – 5,000 – 5,000
Paul Manduca 2,500 2,500 – 2,500 – 2,500 remuneration
Harvey McGrath note (2) 300,636 – – – – –
Michael McLintock 595,363 487,203 195,530 682,733 161,834 682,733 policy
Kaikhushru Nargolwala note (3) – 16,000 – 16,000 – 16,000
Nic Nicandrou note (4) 167,655 227,791 123,067 350,858 546,037 350,907
Kathleen O’Donovan note (5) 24,425 – – – – –
Philip Remnant note 6) – – – – – – Directors’
Barry Stowe note (7) 274,575 359,997 151,234 511,231 625,976 511,231
Tidjane Thiam 650,116 524,123 399,716 923,839 1,408,368 923,839
Lord Turnbull 16,624 16,624 – 16,624 – 16,624
Mike Wells note (8) 438,718 369,142 222,666 591,808 1,152,908 591,808 remuneration
Notes
1 Alistair Johnston was appointed to the Board on 1 January 2012.
2 Harvey McGrath retired from the Board on 2 July 2012. report
3 Kaikhushru Nargolwala was appointed to the Board on 1 January 2012.
4 Nic Nicandrou’s interest in shares on 12 March 2013 includes his monthly purchases made under the SIP plan in January, February and March 2013.
5 Kathleen O’Donovan retired from the Board on 31 March 2012.
6 Philip Remnant was appointed to the Board on 1 January 2013.
7 Part of Barry Stowe’s beneficial interest in shares is made up of 207,963 ADRs (representing 415,926 ordinary shares) and 95,305 ordinary shares. 8,513.73 of these ADRs are held within an investment account which secures premium financing for a life assurance policy).
8 Mike Wells’ beneficial interest in shares is made up of 295,904 ADRs (representing 591,808 ordinary shares). In the table above, the figure for shares subject to performance conditions reflects the maximum number of shares (150 per cent of the original number awarded) which may be released to Mike Wells under the JNL Performance Share Plan. This maximum number of shares may be released if stretch performance targets are achieved.
134 Directors’ remuneration report Prudential plc Annual Report 2012
2012 implementation of remuneration policy continued
Directors’ remuneration for 2012 (audited information)
Value of
anticipated
releases
from LTIPs
in respect of
Cash 2012 performance Total 2012
supple- Total employers’ periods remuner-
2012 2012 Total ments for emolu- pension ending ation –
Salary/ cash deferred 2012 pension ments contribu- 31 December ‘The Single
Ł000 fees bonus bonus bonus Benefits* purposes 2012† tions‡ 2012§ Figure’¶
Chairman
Paul Manduca note (1) 393 – – – 71 – 464 – – 464
Harvey McGrath note ( 2) 252 – – – 50 – 302 – – 302
Executive directors
Rob Devey 600 426 284 710 114 150 1,574 – 1,804 3,378
John Foley 610 586 390 976 156 103 1,845 50 – 1,895
Michael McLintock note (3) 360 904 404 1,308 124 93 1,885 218 3,190 5,293
Nic Nicandrou 630 655 437 1,092 99 158 1,979 – 1,804 3,783
Barry Stowe note (4) 651 613 409 1,022 608 163 2,444 2 2,183 4,629
Tidjane Thiam 1,000 1,000 1,000 2,000 123 250 3,373 – 4,428 7,801
Mike Wells note (5) 663 2,031 871 2,902 55 – 3,620 19 3,008 6,647
Total executive directors 4,514 6,215 3,795 10,010 1,279 917 16,720 289 16,417 33,426
Non-executive directors
Keki Dadiseth note (6) 120 120 120
Howard Davies 171 171 171
Michael Garrett 111 111 111
Ann Godbehere 181 181 181
Alistair Johnston 111 111 111
Kaikhushru Nargolwala 136 136 136
Kathleen O’Donovan note (7) 28 28 28
Lord Turnbull 161 161 161
Total non-executive directors 1,019 1,019 1,019
Overall total 6,178 6,215 3,795 10,010 1,400 917 18,505 289 16,417 35,211
* The value of benefi ts is the cost to the Company of providing core and additional benefi ts.
† Each remuneration element is rounded to the nearest Ł1,000 and totals are the sum of these rounded fi gures.
‡ Pension benefi ts are described in the section on ‘Pensions benefi ts’ on page 129.
• Value of anticipated long-term incentive plan releases is the total of cash paid plus, for shares released, the value of the released shares based on the average closing share price over the period 1 October 2012 to 31 December 2012. All executive directors participate in long-term incentive plans and the details of share releases from awards with a performance period ending 31 December 2012 are provided in the footnote to the tables on share awards on pages 137 to 139. This figure does not include releases from other share plans (detailed on pages 140 to 141) or all-employee share plans, (set out on page 142). Dividend equivalents will be released on these vested shares.
• ‘The Single Figure’ is based on the methodology outlined on page 124.
Notes
1 Paul Manduca was appointed as Chairman on 2 July 2012. The figures above include the fees he received as senior independent non-executive director prior to his appointment as Chairman.
2 Harvey McGrath retired from the Board on 2 July 2012.
3 ‘The Single Figure’ for Michael McLintock includes the increase in transfer value of his defined benefit pension. This is outlined on page 130.
4 Barry Stowe’s benefits relate primarily to his expatriate status, including costs of Ł217,567 for housing, Ł32,104 for children’s education, Ł69,289 for home leave and a Ł248,894 Executive Director Location Allowance.
5 Mike Wells’ bonus figure excludes a contribution of US$15,000 from a profit sharing plan which has been made into a 401(k) retirement plan. This is included under employers’ pension contribution.
6 Keki Dadiseth was paid allowances totalling Ł8,997 in respect of his accommodation expenses in London whilst on the Company’s business.
7 Kathleen O’Donovan retired from the Board on 31 March 2012.
2012 implementation of remuneration policy Prudential plc Annual Report 2012 135
Directors’ remuneration for 2011 (audited information)
Value of
anticipated
releases
from LTIPs
in respect of
performance
Cash periods
2011 2011 Total supplements Total ending
Salary/ cash deferred 2011 for pension emoluments 31 December
Ł000 fees bonus bonus bonus Benefits* purposes† 2011 2011‡
Chairman
Harvey McGrath 500 – – – 82 – 582 –
Executive directors
Rob Devey 550 479 319 798 111 138 1,597 1,544
John Foley (note 1) 550 518 345 863 139 100 1,652 –
Michael McLintock 350 779 279 1,058 93 96 1,597 6,005
Nic Nicandrou 550 507 338 845 84 138 1,617 2,020
Barry Stowe (note 2) 641 579 386 965 544 160 2,310 2,341 2012
Tidjane Thiam 900 785 785 1,570 116 225 2,811 1,910
Mike Wells (notes 1 and 3) 624 1,660 711 2,371 64 – 3,059 1,369
Total executive directors 4,165 5,307 3,163 8,470 1,151 857 14,643 15,189 implementation
Non-executive directors
Keki Dadiseth (note 4) 102 102 of
Howard Davies 153 153
Michael Garrett 93 93
Ann Godbehere 158 158 remuneration
Bridget Macaskill (note 5) 65 65
Paul Manduca 156 156 policy
Kathleen O’Donovan 98 98
James Ross (note 6) 33 33
Lord Turnbull 129 129
Total non-executive directors 987 987 Directors’
Overall total 5,652 5,307 3,163 8,470 1,233 857 16,212 15,189
* Benefits include (where provided) the cost of providing the use of a car and driver, medical insurance, security arrangements and expatriate benefits.
† Pension benefits are described in the section on ‘Pensions and long-term savings’ in the 2011 Directors’ remuneration report.
‡ Value of anticipated long-term incentive plan releases is the total of cash paid plus, for shares released, the value of the released shares based on the share price remuneration
at 31 December 2011. This figure does not include releases from other share plans or all-employee share plans. Dividend equivalents will be released on these
vested shares. report
Notes
1 John Foley and Mike Wells were appointed to the Board on 1 January 2011.
2 Barry Stowe’s benefits relate primarily to his expatriate status, including costs of Ł184,489 for housing, Ł32,077 for children’s education, Ł35,093 for home leave and a Ł245,114 Executive Director Location Allowance.
3 Mike Wells’ bonus figure excludes a contribution of US$12,250 from a profit sharing plan which has been made into a 401(k) retirement plan. This is included in the table on pension contributions.
4 Keki Dadiseth was paid allowances totalling Ł8,997 in respect of his accommodation expenses in London whilst on the Company’s business as is the usual practice for directors who are not resident in the UK.
5 Bridget Macaskill retired from the Board on 30 September 2011.
6 James Ross retired from the Board on 19 May 2011.
136 Directors’ remuneration report Prudential plc Annual Report 2012
Supplementary information
Payments and share releases in 2012 to
past executive directors
Nick Prettejohn
The 2009 Directors’ remuneration report provided details of the remuneration arrangements that would apply to Nick Prettejohn after he resigned from the position of Chief Executive UK & Europe. These arrangements were implemented as intended by the Committee.
The performance periods of Nick Prettejohn’s GPSP and UK BUPP awards for 2009 ended on 31 December 2011. Vesting was prorated based on service (ie 9/36ths). Vesting remained dependent on performance achieved over the performance period and shares were released at the same time as for other participants in these plans.
The performance condition attached to the 2009 GPSP award was met in full and 100 per cent of the proportion of the award which was outstanding was released during 2012. Achievement against the shareholder capital value performance measure attached to the 2009 UK BUPP award was 12.5 per cent per annum (on a compound basis), so 87.5 per cent of the outstanding portion of this award was released during 2012. This award was the last that Nick Prettejohn had outstanding under a Prudential long-term incentive plan.
Clark Manning
Clark Manning stepped down from his role as President and Chief Executive of Jackson and as an executive director on
31 December 2010. Clark Manning remained Chairman of Jackson until 30 April 2011 and acted in an advisory role until
31 December 2011. The 2010 Directors’ remuneration report provided details of the remuneration arrangements that would apply to Clark Manning after his resignation. These arrangements were implemented as intended by the Committee.
During 2012, Clark Manning received the following payments:
Clark Manning had a prorated 2011 annual bonus opportunity (4/12ths) based on his length of service as Chairman of Jackson during 2011. On this basis, a cash payment of Ł725,389 was made to him in 2012;
The deferred portion of the bonuses awarded to Clark Manning in respect of performance in 2009 and 2010 were released to Clark Manning in July 2012;
The performance condition attached to the 2009 GPSP award was met in full and 100 per cent of the award was released in 2012; and
Achievement against the shareholder capital value performance measure attached to the 2009 JNL BUPP award was 11.5 per cent per annum (on a compound basis) so 93.75 per cent of the outstanding portion of this award was released in 2012.
The performance condition attached to the 2010 GPSP award was met in full and 100 per cent of the award will be released during 2013. Achievement of the SCV performance measure attached to the 2010 Jackson BUPP award was 22.68 per cent per annum (on a compound basis), so 100 per cent of the outstanding portion of this award will be released during 2013.
Outstanding 2010 awards made to Clark Manning under the GPSP and BUPP will vest (subject to the achievement of performance conditions) on the same schedule as awards made to other executive directors. These awards will be prorated to refl
ect the portion of the performance periods which had elapsed on 31 December 2011 (ie 24/36ths).
No awards were made to Clark Manning under any long-term incentive plan during 2011 or 2012 and none will be made in any subsequent year.
Payments and share releases in 2012 to newly appointed executive directors
Share awards made to Nic Nicandrou and Rob Devey in connection with their appointment were released, as scheduled, during 2012. Details of these awards were originally set out in the Directors’ remuneration report for 2009. Please see the Other share awards table for details.
No other amounts were paid during the fi nancial year or were receivable by directors (or past directors) in connection with leaving the organisation.
Supplementary information Prudential plc Annual Report 2012 137
Directors’ outstanding long-term incentive awards
Share-based long-term incentive awards
The section below sets out the outstanding share awards under the Group Performance Share Plan and the awards made under additional long-term plans (Business Unit Performance Plan and JNL Performance Share Plan) for the executive directors with regional responsibilities.
Dividend
Conditional equivalents Conditional
share awards on vested share awards
outstanding Conditional shares outstanding
at 1 January awards Market price(Number of at 31 December Date of
2012 in 2012 at date of shares Rights Rights 2012 end of
Year of(Number of(Number of award released) exercised lapsed(Number performance
Plan name award shares) shares)(pence) note (2) in 2012 in 2012 of shares) period
Rob Devey
GPSP 2009 120,898 639 15,361 136,259 – 31 Dec 11
BUPP 2009 120,897 639 15,361 136,258 – 31 Dec 11
GPSP 2010 104,089 568.5 104,089 31 Dec 12
BUPP 2010 104,089 568.5 104,089 31 Dec 12
GPSP 2011 76,242 733.5 76,242 31 Dec 13
BUPP 2011 76,242 733.5 76,242 31 Dec 13
GPSP 2012 88,273 678 88,273 31 Dec 14
BUPP 2012 88,273 678 88,273 31 Dec 14
602,457 176,546 30,722 272,517 537,208
John Foley
GPSP 2011 152,484 733.5 152,484 31 Dec 13
GPSP 2012 199,433 678 199,433 31 Dec 14 Supplementary
152,484 199,433 351,917
Michael McLintock
GPSP 2009 92,022 455.5 11,691 103,713 – 31 Dec 11 information
GPSP 2010 66,238 568.5 66,238 31 Dec 12
GPSP 2011 48,517 733.5 48,517 31 Dec 13
GPSP 2012 47,079 678 47,079 31 Dec 14
206,777 47,079 11,691 103,713 161,834 Directors’
Nic Nicandrou
GPSP 2009 316,328 639 40,197 356,525 – 31 Dec 11
GPSP 2010 208,179 568.5 208,179 31 Dec 12
GPSP 2011 152,484 733.5 152,484 31 Dec 13 remuneration
GPSP 2012 185,374 678 185,374 31 Dec 14
676,991 185,374 40,197 356,525 546,037 report
Barry Stowenote (1)
GPSP 2009 196,596 455.5 22,868 219,464 – 31 Dec 11
BUPP 2009 196,596 455.5 19,780 189,834 26,542 – 31 Dec 11
GPSP 2010 129,076 568.5 129,076 31 Dec 12
BUPP 2010 129,076 568.5 129,076 31 Dec 12
GPSP 2011 88,270 733.5 88,270 31 Dec 13
BUPP 2011 88,270 733.5 88,270 31 Dec 13
GPSP 2012 95,642 678 95,642 31 Dec 14
BUPP 2012 95,642 678 95,642 31 Dec 14
827,884 191,284 42,648 409,298 26,542 625,976
138 Directors’ remuneration report Prudential plc Annual Report 2012
Supplementary information continued
Dividend
Conditional equivalents Conditional
share awards on vested share awards
outstanding Conditional shares outstanding
at 1 January awards Market price(Number of at 31 December Date of
2012 in 2012 at date of shares Rights Rights 2012 end of
Year of(Number of(Number of award released) exercised lapsed(Number performance
Plan name award shares) shares)(pence) note (2) in 2012 in 2012 of shares) period
Tidjane Thiam
GPSP 2009 299,074 455.5 38,004 337,078 – 31 Dec 11
GPSP 2010 510,986 568.5 510,986 31 Dec 12
GPSP 2011 374,279 733.5 374,279 31 Dec 13
GPSP 2012 523,103 678 523,103 31 Dec 14
1,184,339 523,103 38,004 337,078 1,408,368
Mike Wellsnotes (1 & 5)
JNL PSP 2008 84,900 546 84,900 – 31 Dec 11
JNL PSP 2009 218,100 455.5 218,100 31 Dec 12
JNL PSP 2010 141,000 568.5 141,000 31 Dec 13
GPSP 2011 197,648 733.5 197,648 31 Dec 13
BUPP 2011 197,648 733.5 197,648 31 Dec 13
GPSP 2012 199,256 678 199,256 31 Dec 14
BUPP 2012 199,256 678 199,256 31 Dec 14
839,296 398,512 84,900 1,152,908
Notes
1 The awards for Barry Stowe and Mike Wells were made in ADRs (1 ADR = 2 Prudential plc shares). The figures in the table are represented in terms of Prudential shares.
2 In 2009 and 2010, a scrip dividend equivalent and in 2011 and 2012 a DRIP dividend equivalent were accumulated on these awards.
3 On 31 December 2012, the performance period of the 2010 GPSP awards came to an end. Prudential’s TSR performance was 139.9 per cent of the TSR performance of the peer index. On this basis, it is anticipated that awards granted under this plan in 2010 will vest in full. This will result in 104,089 shares vesting for Rob Devey, 66,238 shares for Michael McLintock, 208,179 shares for Nic Nicandrou, 129,076 shares for Barry Stowe and 510,986 shares for Tidjane Thiam under this plan. Dividend equivalents will be released on these vested shares.
4 At 31 December 2012, the performance period of the 2010 BUPP awards came to an end. Over the performance period the new business profit, IFRS profit and cash remittance achieved by the Asia business meant that it is anticipated that 95.2 per cent of the award will vest. This will result in 122,880 shares being released to Barry Stowe under this plan. Since the UK BUPP uses the same TSR performance measure as the GPSP, it is anticipated that 104,089 shares will be released to Rob Devey under this plan. No current executive director participated in the 2010 JNL BUPP. Dividend equivalents will be released on these vested shares.
5 The table above reflects the maximum number of shares (150 per cent of the original number awarded) which may be released to Mike Wells under the JNL Performance Share Plan. This maximum number of shares may be released if stretch performance targets are achieved. On 31 December 2012, the performance period of the 2009 JNL Performance Share Plan award came to an end. On the basis of the shareholder value being achieved by the Jackson business over the performance period, it is anticipated that 150 per cent of awards will vest, resulting in 218,100 shares being released to Mike Wells under this plan in 2013.
Supplementary information Prudential plc Annual Report 2012 139
Business-specifi c cash-based long-term incentive plans
Details of all outstanding awards under cash-based long-term incentive plans are set out in the table below. The performance period for all M&G Executive LTIP awards is three years while the performance period for all JNL LTIP awards is four years:
Face value of
Face value of conditional
conditional share awards
share awards Conditionally Payments outstanding at Date of end of
Year of initial outstanding at awarded made 31 December performance
award 1 January 2012 in 2012 in 2012 2012 period
Ł000 Ł000 Ł000 Ł000
Michael McLintock
M&G Executive LTIP 2009 1,830 5,417 – 31 Dec 11
M&G Executive LTIP 2010 987 987 31 Dec 12
M&G Executive LTIP 2011 1,318 1,318 31 Dec 13
M&G Executive LTIP 2012 953 953 31 Dec 14
Total cash payments made in 2012 5,417
Mike Wells
JNL LTIP 2008 756 827 – 31 Dec 11
JNL LTIP 2009 894 894 31 Dec 12
JNL LTIP 2010 906 906 31 Dec 13
Total cash payments made in 2012 827
Note
Under the M&G Executive LTIP, the value of each unit at award is Ł1. The value of units changes based on M&G’s profit growth and investment performance over
the performance period. For the 2009 award of 1,830,189 units, the unit price at the end of the performance period was Ł2.96 which resulted in a payment of
Ł5,417,359 to Michael McLintock during 2012. For the 2010 award of 987,179 units, the unit price at the end of the performance period was Ł2.65. This will result in
payment of Ł2,616,024 to Michael McLintock in 2013. Supplementary
See page 128 for a description of the JNL LTIP. Performance over the period from 2008 to 2011 resulted in a payment of Ł826,975 to Mike Wells during 2012.
Performance over the period from 2009 to 2012 will result in a payment of Ł1,117,509 being paid to Mike Wells in 2013. The awards above were made before
Mike Wells became an executive director and it is anticipated that no further awards will be made to him under this Plan.
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 2012 and 31 December 2012 was US$4,200,000 and US$2,800,000 respectively. information
Directors’
remuneration
report
140 Directors’ remuneration report Prudential plc Annual Report 2012
Supplementary information continued
Other share awards
The table below sets out the share awards that have been made to executive directors under their appointment terms and those deferred from annual incentive plan payments. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual fi nancial results for the relevant year. For the awards from the 2011 annual incentives, made in 2012, the average share price was 776 pence. Please see the table on page 142 for details of shares acquired under the Share Incentive Plan.
Con-
Con- ditional
ditional share
share Dividends awards out-
awards out- Con- accumu- standing Market
standing at ditionally lated Shares at 31 Market price at
1 January awarded in 2012 released December Date of price at date of
2012 in 2012(Number in 2012 2012 end of date of vesting
Year of(Number(Number of shares)(Number(Number restricted Date of award or release
grant of shares) of shares) note (2) of shares) of shares) period release(pence)(pence)
Rob Devey
Awards under
appointment terms 2009 50,575 50,575 – 31 Mar 12 29 Mar 12 639 750
Deferred 2009 annual
incentive award 2010 28,737 1,018 29,755 31 Dec 12 552.5
Deferred 2010 annual
incentive award 2011 46,694 1,655 48,349 31 Dec 13 721.5
Deferred 2011 annual
incentive award 2012 41,136 1,457 42,593 31 Dec 14 750
126,006 41,136 4,130 50,575 120,697
John Foley
Deferred 2009 deferred
PruCap award 2010 172,993 6,133 179,126 – 14 Dec 12 14 Dec 12 612 881
Deferred 2011 annual
incentive award 2012 44,481 1,576 46,057 31 Dec 14 750
172,993 44,481 7,709 179,126 46,057
Michael McLintock
Deferred 2008 annual
incentive award 2010 137,700 137,700 – 31 Dec 11 15 Mar 12 519.5 780
Deferred 2009 annual
incentive award 2010 74,840 2,653 77,493 31 Dec 12 552.5
Deferred 2010 annual
incentive award 2011 77,988 2,765 80,753 31 Dec 13 721.5
Deferred 2011 annual
incentive award 2012 36,008 1,276 37,284 31 Dec 14 750
290,528 36,008 6,694 137,700 195,530
Nic Nicandrou
Awards under
appointment terms 2009 68,191 68,191 – 31 Mar 12 29 Mar 12 639 750
Deferred 2009 annual
incentive award 2010 26,342 934 27,276 31 Dec 12 552.5
Deferred 2010 annual
incentive award 2011 48,155 1,707 49,862 31 Dec 13 721.5
Deferred 2011 annual
incentive award 2012 43,518 1,542 45,060 31 Dec 14 750
142,688 43,518 4,183 68,191 122,198
Supplementary information Prudential plc Annual Report 2012 141
Con-
Con- ditional
ditional share
share Dividends awards out-
awards out- Con- accumu- standing Market
standing at ditionally lated Shares at 31 Market price at
1 January awarded in 2012 released December Date of price at date of
2012 in 2012(Number in 2012 2012 end of date of vesting
Year of(Number(Number of shares)(Number(Number restricted Date of award or release
grant of shares) of shares) note (2) of shares) of shares) period release(pence)(pence)
Barry Stowenote (1)
Deferred 2008 annual
incentive award 2009 22,643 22,643 – 31 Dec 11 15 Mar 12 349.5 780
Deferred 2009 annual
incentive award 2010 39,088 1,386 40,474 31 Dec 12 552.5
Deferred 2010 annual
incentive award 2011 56,316 1,998 58,314 31 Dec 13 721.5
Deferred 2011 annual
incentive award 2012 50,648 1,798 52,446 31 Dec 14 750
118,047 50,648 5,182 22,643 151,234
Tidjane Thiam
Deferred 2008 annual
incentive award 2010 69,924 69,924 – 31 Dec 11 15 Mar 12 552.5 780
Deferred 2009 annual
incentive award 2010 63,240 2,242 65,482 31 Dec 12 552.5
Deferred 2010 annual
incentive award 2011 221,657 7,858 229,515 31 Dec 13 721.5 Supplementary
Deferred 2011 annual
incentive award 2012 101,134 3,585 104,719 31 Dec 14 750
354,821 101,134 13,685 69,924 399,716 information
Mike Wells note (1)
2009 After Tax Deferral
Program awardnote (3) 2010 32,250 32,250 15 Mar 13 520
Deferred 2010 Group Directors’
Deferred Bonus Plan
award 2011 90,854 3,226 94,080 31 Dec 13 721.5
Deferred 2011 annual
incentive award 2012 93,034 3,302 96,336 31 Dec 14 750 remuneration
123,104 93,034 6,528 222,666
Notes Notes
1 The Deferred Share Awards in 2010, 2011 and 2012 for Barry Stowe and Mike Wells were made in ADRs (1 ADR = 2 Prudential plc shares). The fi gures in the table are represented in terms of Prudential shares.
2 In 2009 and 2010 a scrip dividend equivalent and in 2011 and 2012 a DRIP dividend equivalent were accumulated on these awards.
3 This award attracts dividends in the form of cash rather than shares.
report
142 Directors’ remuneration report Prudential plc Annual Report 2012
Supplementary information continued
Shares acquired under the Share Incentive Plan
Share Share
incentive Incentive Plan
plan awards Partnership Matching Dividend awards held in
held in Trust shares shares shares Trust at
Year of at 1 January accumulated accumulated accumulated 31 December
initial grant 2012 in 2012 in 2012 in 2012 2012
(Number(Number(Number(Number(Number
of shares) of shares) of shares) of shares) of shares)
Nic Nicandrou
Shares held in Trust 2010 596 199 50 24 869
Note
The table above provides information about shares purchased under the SIP together with Matching shares (awarded on a 1:4 basis) and Dividend shares. The total number of shares will only be released if Nic Nicandrou remains in employment for fi ve years.
Outstanding share options
The following table sets out the share options held by the directors in the UK Savings-Related Share Option Scheme (SAYE) as at the end of the period. No other directors held shares in any other option scheme.
Exercise period Number of options
Market
price
at 31
Date of Exercise December Beginning End of
grant price 2012 Beginning End of period Granted Exercised Cancelled Forfeited Lapsed period
John Foley 25 Apr 08 551 865.5 01 Jun 13 29 Nov 13 2,953 – – – – – 2,953
Tidjane
Thiam 16 Sep 11 465.8666 865.5 01 Dec 14 29 May 15 965 – – – – – 965
Nic
Nicandrou 16 Sep 11 465.8666 865.5 01 Dec 16 31 May 17 3,268 – – – – – 3,268
Rob Devey 16 Sep 11 465.8666 865.5 01 Dec 16 31 May 17 3,268 – – – – – 3,268
Notes
1 No gains were made by directors in 2012 on the exercise of SAYE options (2011: Ł665).
2 No price was paid for the award of any option.
3 The highest and lowest closing share prices during 2012 were 911.5 pence and 633.5 pence respectively.
Dilution
Releases from Prudential’s GPSP and BUPP are satisfi ed using new issue shares rather than by purchasing shares in the open market. Shares relating to options granted under all-employee share plans are also satisfied by new issue shares. The combined dilution from all outstanding shares and options at 31 December 2012 was 0.1 per cent of the total share capital at the time. Deferred shares will continue to be satisfied by the purchase of shares in the open market.
Supplementary information Prudential plc Annual Report 2012 143
Company TSR performance (unaudited information)
As required by the Companies Act, the line chart below compares Prudential’s Total Shareholder Return (TSR) during the fi ve years from 1 January 2008 to 31 December 2012, with that of the peer group against which TSR is measured for the purposes of the Group Performance Share Plan. Our performance is also shown relative to the FTSE 100 since Prudential is a major company within this index. This chart is prepared using the methodology stipulated in the current remuneration regulations:
[Graphic Appears Here]
Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012
Prudential FTSE 100 Peer group index
Five highest paid individuals (unaudited information) Their emoluments were within the following bands:
Of the five individuals with the highest emoluments in 2012, Supplementary
three were directors whose emoluments are disclosed in this 2010 2011 2012
report (2011: two; 2010: one). The aggregate of the emoluments Ł5,000,001 – Ł5,100,000 1
of the other two individuals for 2012 (2011: three; 2010: four) Ł5,300,001 – Ł5,400,000 1
were as follows: Ł5,700,001 – Ł5,800,000 1 information
Ł000,000 2010 2011 2012 Ł6,000,001 – Ł6,100,000 1
Ł8,200,001 – Ł8,300,000 1
Base salaries, allowances and Ł8,300,001 – Ł8,400,000 1
benefits in kind (note 1) 1 1 – Ł8,400,001 – Ł8,500,000 2 Directors’
Pension contributions (note 2) – – – Ł10,000,001 – Ł10,100,000 1
Bonuses paid or receivable 18 23 15
Share-based payments and other
cash payments 6 2 1 remuneration
Total 25 26 16
Notes report
1 Base salaries, allowances and benefits in kind in 2012 were less than Ł400,000.
2 Pension contributions payable were less than Ł150,000 in each period.
Signed on behalf of the Board of directors
[Graphic Appears Here]
Lord Turnbull Paul Manduca
Chairman of the Remuneration Committee Chairman
12 March 2013 12 March 2013
144 Prudential plc Annual Report 2012
Prudential plc Annual Report 2012 145
Section 5
Financial
statements
Financial statements and European Embedded Value (EEV)
basis supplementary information
146 Index to Group financial statements
147 Consolidated income statement
148 Consolidated statement of comprehensive income
149 Consolidated statement of changes in equity
151 Consolidated statement of financial position
153 Consolidated statement of cash flows
154 Notes on the Group financial statements
315 Balance sheet of the parent company
316 Notes on the parent company financial statements
324 Statement of directors’ responsibilities in respect of the annual report and the financial statements
325 Independent auditor’s report to the members of Prudential plc
326 EEV basis results
331 Notes on the EEV basis results
363 Statement of directors’ responsibilities in respect of the EEV basis supplementary information
364 Independent auditor’s report to Prudential plc on the EEV basis supplementary information
366 Additional unaudited financial information
Financial statements
146 Financial statements Prudential plc Annual Report 2012
Index to Group fi nancial statements
Primary statements
147 Consolidated income statement
148 Consolidated statement of comprehensive income
149 Consolidated statement of changes in equity
151 Consolidated statement of financial position
153 Consolidated statement of cash flows
Notes on the Group financial statements
Section A: Background and accounting policies
154 A1: Nature of operations
154 A2: Basis of preparation
154 A3: Accounting policies
166 A4: Critical accounting estimates and judgements
170 A5: New accounting pronouncements
Section B: Summary of results
176 B1: Segment disclosure – profit before tax
179 B2: Earnings per share
180 B3: Dividends
181 B4: Exchange translation
182 B5: Group statement of financial position
Section C: Group risk management
191 C: Group risk management
Section D: Life assurance business
192 D1: Group overview
197 D2: UK insurance operations
213 D3: US insurance operations
231 D4: Asia insurance operations
238 D5: Capital position statement for life assurance businesses
Section E: Asset management (including US broker-dealer) and other operations
247 E1: Income statement for asset management operations
249 E2: Statement of financial position for asset management
operations
250 E3: Regulatory and other surplus for asset
management operations
251 E4: Sensitivity of profit and shareholders’ equity to
market and other financial risk
251 E5: Other operations
Section F: Income statement notes
252 F1: Segmental information
254 F2: Revenue
256 F3: Acquisition costs and other expenditure
257 F4: Finance costs – Interest on core structural borrowings
of shareholder-financed operations
257 F5: Tax
Section G: Financial assets and liabilities
262 G1: Financial instruments – Designation and fair values
269 G2: Market risk
273 G3: Derivatives and Hedging
274 G4: Derecognition and collateral
274 G5: Impairment of financial assets
Section H: Other information on statement of fi nancial position items
275 H1: Intangible assets attributable to shareholders
279 H2: Intangible assets attributable to with-profits funds
280 H3: Reinsurers’ share of insurance contract liabilities
281 H4: Tax assets and liabilities
283 H5: Accrued investment income and other debtors
283 H6: Property, plant and equipment
284 H7: Investment properties
285 H8: Investments in associates and joint ventures
287 H9: Properties held for sale
287 H10: Cash and cash equivalents
287 H11: Shareholders’ equity: share capital, share premium
and reserves
289 H12: Insurance contract liabilities and unallocated surplus
of with-profits funds
289 H13: Borrowings
291 H14: Provisions and contingencies
294 H15: Other liabilities
Section I: Other notes
295 I1: Acquisition of subsidiaries
297 I2: Changes to Group’s holdings
298 I3: Staff and pension plans
308 I4: Share-based payments
311 I5: Key management remuneration
312 I6: Fees payable to auditor
312 I7: Related party transactions
313 I8: Subsidiary undertakings
313 I9: Commitments
314 I10: Cash flows
314 I11: Post balance sheet events
Parent company fi nancial statements
315 Balance sheet of the parent company
316 Notes on the parent company financial statements
Statement of directors’ responsibilities and independent auditor’s report
324 Statement of directors’ responsibilities in respect of the annual report and the financial statements
325 Independent auditor’s report to the members of Prudential plc
European Embedded Value (EEV) basis results
326 Operating profit based on longer-term investment returns
328 Summarised consolidated income statement – EEV basis
328 Earnings per share – EEV basis
328 Dividends per share
329 Movement in shareholders’ equity (excluding non-controlling interests) – EEV basis
330 Net asset value per share – EEV basis
330 Summary statement of financial position – EEV basis
331 Notes on the EEV basis results
363 Statement of directors’ responsibilities in respect of the European Embedded Value (EEV) basis supplementary information
364 Independent auditor’s report to Prudential plc on the European Embedded Value (EEV) basis supplementary information
Additional unaudited fi nancial information
366 Additional unaudited fi nancial information
Primary statements Prudential plc Annual Report 2012 147
Consolidated income statement
Year ended 31 December Note 2012 Łm 2011* Łm
Gross premiums earned 29,910 25,706
Outward reinsurance premiums(506)(429)
Earned premiums, net of reinsurance F2 29,404 25,277
Investment return F2 24,051 9,360
Other income F2 2,021 1,869
Total revenue, net of reinsurance F1,F2 55,476 36,506
Benefits and claims(44,831)(31,060)
Outward reinsurers’ share of benefit and claims F1 259 746
Movement in unallocated surplus of with-profits funds H12(1,381) 1,025
Benefits and claims and movement in unallocated surplus of with-profits funds,
net of reinsurance(45,953)(29,289)
Acquisition costs and other expenditure F3(6,055)(5,120)
Finance costs: interest on core structural borrowings of shareholder-financed operations F4(280)(286)
Total charges, net of reinsurance F1(52,288)(34,695)
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)† 3,188 1,811
(Less) add tax (charge) credit attributable to policyholders’ returns(378) 17
Profit before tax attributable to shareholders B1 2,810 1,828
Total tax (charge) attributable to policyholders and shareholders F5(991)(392)
Adjustment to remove tax credit (charge) attributable to policyholders’ returns 378(17)
Tax charge attributable to shareholders’ returns F5(613)(409)
Profit for the year 2,197 1,419
Attributable to:
Equity holders of the Company 2,197 1,415
Non-controlling interests – 4
Profit for the year 2,197 1,419
Earnings per share (in pence)
Based on profit attributable to the equity holders of the Company:
Basic B2 86.5p 55.8p
Diluted B2 86.4p 55.7p
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those
operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative
results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had Primary
always applied, as described in note A5.
† This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders. This is principally because the corporate taxes
of the Group include those on the income of consolidated with-profits and unit-linked funds that, through adjustments to benefits, are borne by policyholders.
These amounts are required to be included in the tax charge of the Company under IAS 12. Consequently, the profit before all taxes measure (which is determined
after deducting the cost of policyholder benefits and movements in the liability for unallocated surplus of the PAC with-profits fund after adjusting for taxes borne statements
by policyholders) is not representative of pre-tax profits attributable to shareholders.
Financial
statements
148 Financial statements Prudential plc Annual Report 2012
Consolidated statement of comprehensive income
Year ended 31 December Note 2012 Łm 2011* Łm
Profit for the year 2,197 1,419
Other comprehensive income:
Exchange movements on foreign operations and net investment hedges:
Exchange movements arising during the year B4(214)(37)
Related tax(2)(68)
(216)(105)
Unrealised valuation movements on securities of US insurance operations classifled
as available-for-sale: D3(a)
Unrealised holding gains arising during the year 930 912
Deduct net gains included in the income statement on disposal and impairment(68)(101)
Total 862 811
Related change in amortisation of deferred acquisition costs H1(b)(270)(275)
Related tax(205)(187)
387 349
Other comprehensive income for the year, net of related tax 171 244
Total comprehensive income for the year 2,368 1,663
Attributable to:
Equity holders of the Company 2,368 1,659
Non-controlling interests – 4
Total comprehensive income for the year 2,368 1,663
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had always applied, as described in note A5.
Primary statements Prudential plc Annual Report 2012 149
Consolidated statement of changes in equity
2012 Łm
Available-
Trans- for-sale Share- Non-
Share Share Retained lation securities holders’ controlling Total
Year ended 31 December 2012 Note capital premium earnings reserve reserve equity interests equity
Reserves
Profit for the year – – 2,197 – – 2,197 – 2,197
Other comprehensive income:
Exchange movements on foreign
operations and net investment
hedges, net of related tax – – –(216) –(216) –(216)
Unrealised valuation movements, net
of related change in amortisation
of deferred acquisition costs and
related tax – – – – 387 387 – 387
Total other comprehensive income – – –(216) 387 171 – 171
Total comprehensive income for the year – – 2,197(216) 387 2,368 – 2,368
Dividends B3 – –(655) – –(655) –(655)
Reserve movements in respect of
share-based payments – – 42 – – 42 – 42
Change in non-controlling interests arising
principally from purchase and sale of
property partnerships of the PAC
with-profits fund and other consolidated
investment funds – – – – – –(38)(38)
Share capital and share premium
New share capital subscribed H11 1 16 – – – 17 – 17
Treasury shares
Movement in own shares in respect of
share-based payment plans – –(13) – –(13) –(13)
Movement in Prudential plc shares
purchased by unit trusts consolidated
under IFRS – – 36 – – 36 – 36
Net increase (decrease) in equity 1 16 1,607(216) 387 1,795(38) 1,757
At beginning of year:
As previously reported 127 1,873 5,839 354 924 9,117 43 9,160
Effect of change in accounting policy
for deferred acquisition costs A5 – –(595)(72) 114(553) –(553)
After effect of change 127 1,873 5,244 282 1,038 8,564 43 8,607
At end of year H11 128 1,889 6,851 66 1,425 10,359 5 10,364
150 Financial statements Prudential plc Annual Report 2012
Consolidated statement of changes in equity continued
2011* Łm
Available-
Trans- for-sale Share- Non-
Share Share Retained lation securities holders’ controlling Total
Year ended 31 December 2011 Note capital premium earnings reserve reserve equity interests equity
Reserves
Profit for the year – – 1,415 – – 1,415 4 1,419
Other comprehensive income:
Exchange movements on foreign
operations and net investment
hedges, net of related tax – – –(105) –(105) –(105)
Unrealised valuation movements, net
of related change in amortisation
of deferred acquisition costs and
related tax – – – – 349 349 – 349
Total other comprehensive income – – –(105) 349 244 – 244
Total comprehensive income for the year – – 1,415(105) 349 1,659 4 1,663
Dividends B3 – –(642) – –(642) –(642)
Reserve movements in respect
of share-based payments – – 44 – – 44 – 44
Change in non-controlling interests arising
principally from purchase and sale of
property partnerships of the PAC
with-profits fund and other consolidated
investment funds – – – – – –(5)(5)
Share capital and share premium
New share capital subscribed H11 – 17 – – – 17 – 17
Treasury shares
Movement in own shares in respect of
share-based payment plans – –(30) – –(30) –(30)
Movement in Prudential plc shares
purchased by unit trusts consolidated
under IFRS – –(5) – –(5) –(5)
Net increase (decrease) in equity – 17 782(105) 349 1,043(1) 1,042
At beginning of year:
As previously reported 127 1,856 4,982 454 612 8,031 44 8,075
Effect of change in accounting policy
for deferred acquisition costs – –(520)(67) 77(510) –(510)
After effect of change 127 1,856 4,462 387 689 7,521 44 7,565
At end of year H11 127 1,873 5,244 282 1,038 8,564 43 8,607
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had always applied, as described in note A5.
Primary statements Prudential plc Annual Report 2012 151
Consolidated statement of fi nancial position
Assets
31 December Note 2012 Łm 2011* Łm 2010*† Łm
Intangible assets attributable to shareholders:
Goodwill H1(a) 1,469 1,465 1,466
Deferred acquisition costs and other intangible assets H1(b) 4,267 4,234 3,901
Total 5,736 5,699 5,367
Intangible assets attributable to with-profits funds:
In respect of acquired subsidiaries for venture fund and other
investment purposes H2(a) 178 178 166
Deferred acquisition costs and other intangible assets H2(b) 78 89 110
Total 256 267 276
Total intangible assets 5,992 5,966 5,643
Other non-investment and non-cash assets:
Property, plant and equipment H6 765 748 554
Reinsurers’ share of insurance contract liabilities‡ H3 6,859 1,647 1,344
Deferred tax assets H4 2,314 2,276 2,188
Current tax recoverable H4 254 546 555
Accrued investment income G1,H5 2,798 2,710 2,668
Other debtors G1,H5 1,361 987 903
Total 14,351 8,914 8,212
Investments of long-term business and other operations:
Investment properties H7 10,880 10,757 11,247
Associate investments accounted for using the equity method H8 113 70 71
Financial investments§: G1
Loans 11,821 9,714 9,261
Equity securities and portfolio holdings in unit trusts 99,958 87,349 86,635
Debt securities 140,103 124,498 116,352
Other investments 7,900 7,509 5,779
Deposits 12,653 10,708 9,952
Total 283,428 250,605 239,297
Properties held for sale H9 98 3 257
Cash and cash equivalents G1,H10 6,384 7,257 6,631 Primary
Total assets B5 310,253 272,745 260,040
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those statements
operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 and 2010
comparative results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new
accounting policy had always applied, as described in note A5.
† As a result of the adoption of the altered US GAAP requirements as noted above, the 2010 balance sheet has been presented in accordance with IAS 1.
The 2010 comparatives for the relevant balance sheet notes which have been affected by this change have been retrospectively adjusted accordingly.
‡ The increase in reinsurers’ share of insurance contract liabilities and other liabilities from 2011 to 2012 is attributed to amounts due to the reinsurance Financial
arrangements attaching to the purchase by Jackson of REALIC in September 2012, as discussed in note I1.
§ Included within financial investments are Ł3,015 million (2011: Ł7,843 million) of lent securities and Ł2,012 million of loans and debt securities covering liabilities
for funds withheld under reinsurance arrangement of the Group’s US operations from the purchase of REALIC, as discussed in note I1. statements
152 Financial statements Prudential plc Annual Report 2012
Consolidated statement of fi nancial position
Equity and liabilities
31 December Note 2012 Łm 2011* Łm 2010† Łm
Equity
Shareholders’ equity H11 10,359 8,564 7,521
Non-controlling interests 5 43 44
Total equity 10,364 8,607 7,565
Liabilities
Policyholder liabilities and unallocated surplus of with-profits funds:
Insurance contract liabilities H12 208,584 180,363 171,291
Investment contract liabilities with discretionary participation features G1 33,812 29,745 25,732
Investment contract liabilities without discretionary participation features G1 18,378 16,967 17,704
Unallocated surplus of with-profits funds H12 10,589 9,215 10,253
Total 271,363 236,290 224,980
Core structural borrowings of shareholder-financed operations:
Subordinated debt H13 2,577 2,652 2,718
Other H13 977 959 958
Total G1,H13 3,554 3,611 3,676
Other borrowings:
Operational borrowings attributable to shareholder-financed operations G1,H13 2,245 3,340 3,004
Borrowings attributable to with-profits operations G1,H13 1,033 972 1,522
Other non-insurance liabilities:
Obligations under funding, securities lending and sale and repurchase
agreements G1 2,436 3,114 4,199
Net asset value attributable to unit holders of consolidated unit trusts
and similar funds G1 4,345 3,840 3,372
Deferred tax liabilities H4 3,970 3,929 3,968
Current tax liabilities H4 445 930 831
Accruals and deferred income 833 736 707
Other creditors G1 2,781 2,544 2,321
Provisions H14 601 529 729
Derivative liabilities G1,G3 2,829 3,054 2,037
Other liabilities‡ G1,H15 3,454 1,249 1,129
Total 21,694 19,925 19,293
Total liabilities B5 299,889 264,138 252,475
Total equity and liabilities 310,253 272,745 260,040
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had always applied, as described in note A5.
• As a result of the adoption of the altered US GAAP requirements as noted above, the 2010 balance sheet has been presented in accordance with IAS 1. The 2010 comparatives for the relevant balance sheet notes which have been impacted by this change have been retrospectively adjusted accordingly.
• The increase in reinsurers’ share of insurance contract liabilities and other liabilities from 2011 to 2012 is attributed to amounts due to the reinsurance arrangements attaching to the purchase by Jackson of REALIC in September 2012, as discussed in note I1.
The consolidated financial statements on pages 147 to 314 were approved by the Board of directors on 12 March 2013 and signed on its behalf.
[Graphic Appears Here]
Paul Manduca Tidjane Thiam Nic Nicandrou
Chairman Group Chief Executive Chief Financial Officer
Primary statements Prudential plc Annual Report 2012 153
Consolidated statement of cash fl ows
Year ended 31 December Note 2012 Łm 2011* Łm
Cash flows from operating activities
Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)note (i) 3,188 1,811
Non-cash movements in operating assets and liabilities reflected in profit before tax:
Investments(27,126)(8,854)
Other non-investment and non-cash assets(801)(999)
Policyholder liabilities (including unallocated surplus) 26,710 10,874
Other liabilities (including operational borrowings)(969)(859)
Interest income and expense and dividend income included in result before tax(7,772)(7,449)
Other non-cash items note (ii) 128 108
Operating cash items:
Interest receipts 6,483 6,365
Dividend receipts 1,530 1,302
Tax paid(925)(561)
Net cash flows from operating activities 446 1,738
Cash flows from investing activities
Purchases of property, plant and equipment H6(139)(124)
Proceeds from disposal of property, plant and equipment 14 10
Acquisition of subsidiaries, net of cash balance note (iii) I1(224)(53)
Change to Group’s holdings, net of cash balance I2 23 –
Net cash flows from investing activities(326)(167)
Cash flows from financing activities
Structural borrowings of the Group: I10
Shareholder-financed operations:note (iv)
Issue of subordinated debt, net of costs – 340
Redemption of senior debt –(333)
Bank loan 25 –
Interest paid(270)(286)
With-profits operations:note (v)
Interest paid(9)(9)
Equity capital:
Issues of ordinary share capital H11 17 17
Dividends paid B3(655)(642)
Net cash flows from financing activities(892)(913)
Net (decrease) increase in cash and cash equivalents(772) 658
Cash and cash equivalents at beginning of year 7,257 6,631
Effect of exchange rate changes on cash and cash equivalents(101)(32) Primary
Cash and cash equivalents at end of year H10 6,384 7,257
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS4, for those statements
operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2011 comparative
results and related notes have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy
had always applied, as described in note A5.
Notes Financial
(i) This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders.
(ii) Other non-cash items consist of the adjustment of non-cash items to profit before tax together with other net items, net purchases of treasury shares and
other net movements in equity.
(iii) The acquisition of REALIC in 2012, as explained further in note I1, resulted in a net cash outflow of Ł224 million. The acquisition of subsidiaries in 2011 related
to the PAC with-profits fund’s purchase of Earth & Wind and Alticom venture investments with an outflow of Ł53 million. statements
(iv) Structural borrowings of shareholder-financed operations comprise the core debt of the parent company, a PruCap bank loan and Jackson surplus notes.
Core debt excludes borrowings to support short-term fixed income securities programmes, non-recourse borrowings of investment subsidiaries of
shareholder-financed operations and other borrowings of shareholder-financed operations. Cash flows in respect of these borrowings are included within
cash flows from operating activities.
(v) Interest paid on structural borrowings of with-profits operations relate solely to the Ł100 million 8.5 per cent undated subordinated guaranteed bonds,
which contribute to the solvency base of the Scottish Amicable Insurance Fund (SAIF), a ring-fenced sub-fund of the PAC with-profits fund. Cash flows in
respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash flows from operating
activities.
154 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies
A1: Nature of operations
Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international financial services group with its principal operations in Asia, the US and the UK. Prudential offers a wide range of retail financial products and services and asset management services throughout these territories. The retail financial products and services principally include life insurance, pensions and annuities as well as collective investment schemes.
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-profi ts (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 health covers.
In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company (Jackson). The principal products written by Jackson are fi xed annuities (interest-sensitive, fixed indexed and immediate annuities), variable annuities (VA), life insurance and institutional products.
The Group operates in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited (PAC), Prudential Annuities Limited (PAL), Prudential Retirement Income Limited (PRIL) and M&G Investment Management Limited. Long-term business products written in the UK 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 written in the UK also includes unit-linked products.
Prudential plc is a public limited company incorporated and registered in England and Wales. The registered office is:
Laurence Pountney Hill
London
EC4R 0HH
UK Companies House registered number: 1397169
A2: Basis of preparation
The consolidated financial statements consolidate the Group and the Group’s interest in associates and jointly-controlled entities. The parent company financial statements present information about the Company as a separate
entity and not about the Group.
The consolidated financial statements have been prepared and approved by the directors in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and as endorsed by the European Union (EU) as required by EU law (IAS regulation EC 1606/2032). The Company has elected to prepare its parent company financial statements in accordance with UK Generally Accepted Accounting Practice (GAAP). These are presented on pages 315 to 323. A reconciliation to IFRS has also been provided for shareholders’ equity and profi t for the year of the parent company.
The Group has applied all IFRS standards and interpretations adopted by the EU that are effective for financial years commencing on or before 1 January 2012. The Group has applied the same accounting policies in preparing the 2012 results as for 2011 except for the adoption of altered US GAAP reporting requirements for Group IFRS reporting, which is described in note A5.
A3: Accounting policies
1 Critical accounting policies
Prudential’s discussion and analysis of its fi nancial condition and results of operations are based upon Prudential’s consolidated fi nancial statements, which have been prepared in accordance with IFRS as issued by the IASB and as endorsed by the EU. EU-endorsed IFRS may differ from IFRS as issued by the IASB if, at any point in time, new or amended IFRSs have not been endorsed by the EU. As at 31 December 2012, there were no unendorsed standards effective for the two years ended 31 December 2012 affecting the consolidated financial information of Prudential and there were no differences between IFRSs endorsed by the EU and IFRSs issued by the IASB in terms of their application to Prudential. Accordingly, Prudential’s fi nancial information for the two years ended
31 December 2012 is prepared in accordance with IFRS as issued by the IASB. Prudential adopts mandatory requirements of new or altered EU-adopted IFRS standards when required, and may consider earlier adoption where permitted and appropriate in the circumstances.
The preparation of these financial statements requires Prudential to make estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, Prudential evaluates its estimates, including those related to long-term business provisioning and the fair value of assets.
Critical accounting policies are defined as those that are reflective of significant judgements and uncertainties, and potentially give rise to different results under different assumptions and conditions. Prudential believes that its critical accounting policies are limited to those described below.
The critical accounting policies in respect of the items discussed below are critical for those that relate to the Group’s shareholder-fi nanced business. In particular this applies for Jackson which is the largest shareholder-backed business in the Group. The policies are not critical in respect of the Group’s with-profi ts business. This distinction reflects the basis of recognition of profit and accounting treatment of unallocated surplus of with-profits funds as a liability, as described elsewhere in these financial statements.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 155
Insurance contract accounting
With the exception of certain contracts described in note D1, the contracts issued by the Group’s life assurance business are classifi ed as insurance contracts and investment contracts with discretionary participating features. As permitted by IFRS 4, ‘Insurance Contracts’, assets and liabilities of these contracts are accounted for under previously applied GAAP. Accordingly, except as described below, the modifled statutory basis (MSB) of reporting as set out in the revised Statement of Recommended Practice (SORP) issued by the Association of British Insurers (ABI) in 2003 has been applied.
With-profits funds
With-profits funds are those in which the policyholder has a contractual right to receive at the discretion of the insurer, additional benefits based on factors such as the performance of a pool of assets held within the fund as a supplement to any guaranteed benefits.
UK regulated with-profits funds
For Group IFRS reporting, UK regulated with-profits funds are accounted for by the voluntary application of the UK accounting standard FRS 27, ‘Life Assurance’. Under this standard, for such funds, policyholder liabilities are measured on a ‘realistic basis’ as discussed in section 2(a) of this note.
Unallocated surplus of with-profits funds
Unallocated surplus represents the excess of assets over policyholder liabilities for the Group’s with-profi ts funds that have yet to be appropriated between policyholders and shareholders. The Group has elected to account for unallocated surplus wholly as a liability with no allocation to equity. This treatment reflects the fact that shareholders’ participation in the cost of bonuses arises only on distribution. The unallocated surplus is shown separately in the statement of financial position.
Overseas operations:
For Jackson, applying the MSB as applicable to overseas operations, which permits the application of local GAAP in some
circumstances, the assets and liabilities of insurance contracts are accounted for under insurance accounting prescribed by US GAAP.
For the assets and liabilities of insurance contracts of Asian operations, the local GAAP is applied with adjustments, where necessary,
to comply with UK GAAP. For the operations in India, Japan, Taiwan and, until 2012, Vietnam (as discussed in note A5), the local
GAAP is not appropriate in the context of the previously applied MSB. For these countries the insurance assets and liabilities are
measured principally by reference to US GAAP. For participating business the liabilities include provisions for the policyholders’
interest in investment gains and other surpluses that have yet to be declared as bonuses.
The usage of these bases of accounting has varying effects on the way in which product options and guarantees are measured.
For UK regulated with-profits funds, options and guarantees are valued on a market consistent basis. The basis is described in
section 2(a) below. For other operations a market consistent basis is not applied under the accounting basis described in section 2(a)
below. Details of the guarantees, basis of setting assumptions and sensitivity to altered assumptions are described in notes D3 and D4. A:
Additional details on the Group’s accounting policies for insurance assets and liabilities are shown in section 2 below.
Valuation and accounting presentation of fair value movements of derivatives and debt securities of Jackson
These policies are critical because of their significance to the volatility of the income statement result and shareholders’ equity. Under Background
investment IAS 39, ‘Financial Instruments: Recognition and Measurement’, derivatives are required to be carried at fair value. Unless net and
hedge accounting is applied, value movements on derivatives are recognised in the income statement.
For derivative instruments of Jackson, the Group has considered whether it is appropriate to undertake the necessary operational
changes to qualify for hedge accounting so as to achieve matching of value movements in hedging instruments and hedged items in
the performance statements. In reaching the decision a number of factors were particularly relevant. These were: accounting
IAS 39 hedging criteria have been designed primarily in the context of hedging and hedging instruments that are assessable as
financial instruments that are either stand-alone or separable from host contracts, rather than, for example, duration characteristics policies
of insurance contracts;
The high hurdle levels under IAS 39 of ensuring hedge effectiveness at the level of individual hedge transactions;
The difficulties in applying the macro hedge provisions under IAS 39 (which are more suited to banking arrangements) to Jackson’s
derivative book; Financial
The complexity of asset and liability matching of US life insurers such as those with Jackson’s product range; and finally
Whether it is possible or desirable, without an unacceptable level of costs and constraint on commercial activity, to achieve the
accounting hedge effectiveness required under IAS 39.
Taking account of these considerations the Group has decided that, except for occasional circumstances, it is not appropriate to seek statements
to achieve hedge accounting under IAS 39. As a result of this decision the total income statement results are more volatile as the
movements in the value of Jackson’s derivatives are reflected within it. This volatility is reflected in the level of short-term fluctuations
in investment returns, as shown in note B1.
Under IAS 39, unless carried at amortised cost (subject to impairment provisions where appropriate) under the held-to-maturity
category, debt securities are also carried at fair value. The Group has chosen not to classify any financial assets as held-to-maturity.
Debt securities of Jackson are designated as available-for-sale with value movements, unless impaired, being recorded as movements
within other comprehensive income. Impairments are recorded in the income statement.
156 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A3: Accounting policies continued
Presentation of results before tax
The total tax charge for the Group reflects tax that in addition to relating to shareholders’ profi ts is also attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. This is explained in more detail in note F5. Reported profit before the total tax charge is not representative of pre-tax profits attributable to shareholders. Accordingly, in order to provide a measure of pre-tax profits attributable to shareholders the Group has chosen to adopt an income statement presentation of the tax charge and pre-tax results that distinguishes between policyholder and shareholder components.
Segmental analysis of results and earnings attributable to shareholders
The Group uses operating profit based on longer-term investment returns as the segmental measure of its results. The basis of calculation is disclosed in section 2(d) below.
For shareholder-backed business, with the exception of debt securities held by Jackson and assets classifled as loans and receivables at amortised cost, all financial investments and investment property are designated as assets at fair value through profit and loss. The short-term fluctuations affect the result for the year and the Group provides additional analysis of results before and after short-term fluctuations in investment returns, together with other items that are of a short-term volatile or one-off nature. Short-term fluctuations in investment returns on such assets held by with-profits funds, do not affect directly reported shareholder results. This is because (i) the unallocated surplus of with-profits funds is accounted for as a liability and (ii) excess or deficits of income and expenditure of the funds over the required surplus for distribution are transferred to or from unallocated surplus.
2 Other signifi cant accounting policies
a Long-term business contracts
Income statement treatment
Insurance contracts and investment contracts with discretionary participation features (DPF)
Premium and annuity considerations for conventional with-profits policies and other protection type insurance policies are recognised as revenue when due. Premiums and annuity considerations for linked policies, unitised with-profits and other investment type policies are recognised as revenue when received or, in the case of unitised or unit-linked policies, when units are issued. These amounts exclude UK premium taxes and similar duties where Prudential collects and settles taxes borne by the customer.
Policy fees charged on linked and unitised with-profits policies for mortality, asset management and policy administration are recognised as revenue when related services are provided.
Claims paid include maturities, annuities, surrenders and deaths. Maturity claims are recorded as charges on the policy maturity date. Annuity claims are recorded when each annuity instalment becomes due for payment. Surrenders are charged to the income statement when paid and death claims are recorded when notifled.
Acquisition costs are deferred and amortised as described in note A4.
Investment contracts other than those with DPF
For investment contracts which do not contain discretionary participating features, the accounting is carried out in accordance with IAS 39 to reflect the deposit nature of the arrangement, with premiums and claims reflected as
deposits and withdrawals and taken directly to the statement of financial position as movements in the financial liability balance.
Under IFRS, investment contracts (excluding those with discretionary participation features) accounted for as financial liabilities in accordance with IAS 39 which also offer investment management services, require the application of IAS 18, ‘Revenue’, for the revenue attached to these services. Incremental, directly attributable acquisition costs relating to the investment management element of these contracts are capitalised and amortised in line with the related revenue. If the contracts involve up-front charges, this income is also deferred and amortised through the income statement in line with contractual service provision.
UK regulated with-profi ts funds
Prudential’s long-term business written in the UK comprises predominantly life insurance policies with discretionary participating features under which the policyholders are entitled to participate in the returns of the funds supporting these policies. Business similar to this type is also written in certain of the Group’s Asian operations subject to local market and regulatory conditions. Such policies are called with-profits policies. Prudential maintains with-profits funds within the Group’s long-term business funds, which segregate the assets and liabilities and accumulate the returns related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and final, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profi ts with respect to bonuses declared on with-profits business correspond to the shareholders’ share of the cost of bonuses as declared by the Board of directors. The shareholders’ share currently represents one-ninth of the cost to the with-profits fund of bonuses declared for with-profits policies.
Annual bonuses are declared and credited each year to with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account in the year declared. Final bonuses are declared each year and accrued for all policies scheduled to mature and for death benefits expected to be paid during the next financial year. Final bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or final bonus declarations.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 157
The policyholders’ liabilities of the regulated with-profi ts funds are accounted for under FRS 27, under which realistic basis liabilities are underpinned by the FSA’s Peak 2 basis of reporting. This Peak 2 basis requires the value of liabilities to be calculated as:
A with-profits benefits reserve (WPBR); plus
Future policy-related liabilities (FPRL); plus
The realistic current liabilities of the fund.
The WPBR is primarily based on the retrospective calculation of accumulated asset shares but is adjusted to reflect future policyholder benefits and other outgoings. Asset shares broadly reflect the policyholders’ share of the with-profi ts fund assets attributable to their policies.
The FPRL must include a market consistent valuation of costs of guarantees, options and smoothing, less any related charges, and this amount is determined using either a stochastic approach, hedging costs or a series of deterministic projections with attributed probabilities.
The assumptions used in the stochastic models are calibrated to produce risk-free returns on each asset class. Volatilities of, and correlations between, investment returns from different asset classes are as determined by the Group’s Portfolio Management Group on a market consistent basis.
The cost of guarantees, options and smoothing is very sensitive to the bonus, market value reduction (MVR) and investment policies the Group employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that the Group retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with management’s policy for with-profi ts funds and the disclosures made in the publicly available Principles and Practices of Financial Management.
The realistic basis liabilities representing the Peak 2 basis realistic liabilities for with-profits business included in the FSA regulatory returns include the element for the shareholders’ share of the future bonuses. For accounting purposes under FRS 27, this latter item is reversed because, consistent with the current basis of fi nancial reporting, shareholder transfers are recognised only on declaration.
Unallocated surplus
The unallocated surplus represents the excess of assets over policyholder liabilities for the Group’s with-profits funds. As allowed
under IFRS 4, the Group has opted to continue to record unallocated surplus of with-profits funds wholly as a liability. The annual
excess (shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to
policyholders and shareholders, is transferred to (from) the unallocated surplus each year through a charge (credit) to the income
statement. The balance retained in the unallocated surplus represents cumulative income arising on the with-profits business that
has not been allocated to policyholders or shareholders. The balance of the unallocated surplus is determined after full provision
for deferred tax on unrealised appreciation on investments.
Other insurance contracts (ie contracts which contain significant insurance risk as defined under IFRS 4) A:
For these contracts ‘grandfathered’ UK GAAP has been applied, which reflects the MSB. Under this basis the following
approach applies: Background
i Other UK insurance contracts
Other UK insurance contracts that contain significant insurance risk include unit-linked, annuity and other non-profit business. For and
the purposes of local regulations, segregated accounts are established for linked business for which policyholder benefits are wholly
or partly determined by reference to specific investments or to an investment-related index. The interest rates used in establishing
policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in accounting
establishing policyholder benefits are based on published mortality tables adjusted to reflect actual experience.
ii Overseas subsidiaries policies
The assets and liabilities of insurance contracts of overseas subsidiaries are determined initially using local GAAP bases of accounting
with subsequent adjustments where necessary to comply with the Group’s accounting policies.
Jackson Financial
The future policyholder benefit provisions for Jackson’s conventional protection-type policies are determined under US GAAP
principles with the locked in assumptions as to mortality, interest, policy lapses and expenses plus provisions for adverse deviations.
For non-conventional protection-type policies, the policyholder benefit provision included within policyholder liabilities in the
consolidated statement of financial position is the policyholder account balance. Acquisition costs are accounted for as explained statements
in note A4.
Jackson accounts for the majority of its investment portfolio on an available-for-sale basis (see investment policies above) whereby
unrealised gains and losses are recognised in other comprehensive income. As permitted by IFRS 4, Jackson has used shadow
accounting. Under shadow accounting, to the extent that recognition of unrealised gains or losses on available-for-sale securities
causes adjustments to the carrying value and amortisation patterns of deferred acquisition costs (DAC) and deferred income, these
adjustments are recognised in other comprehensive income to be consistent with the treatment of the gains or losses on the securities.
More precisely, shadow DAC adjustments reflect the change in DAC that would have arisen if the assets held in the statement of
financial position had been sold, crystallising unrealised gains or losses, and the proceeds reinvested at the yields currently available
in the market.
158 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A3: Accounting policies continued
Asia operations
Except for the operations in India, Japan, Taiwan and, until 2012, Vietnam, the future policyholder benefit provisions for Asian businesses are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP. Refinements to the local reserving methodology are generally treated as change in estimates, dependent on the nature of the change.
For the Asia operations referred to above where local GAAP is not appropriate in the context of the previously applied MSB, accounting for insurance contracts is based on US GAAP. For these operations the business written is primarily non-participating linked and participating business. The future policyholder benefit provisions for non-linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claim expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business. Where appropriate, liabilities for participating business for these three operations include provisions for the policyholders’ interest in investment gains and other surpluses that have yet to be declared as bonuses.
Although the basis of valuation of Prudential’s overseas operations is in accordance with the requirements of the Companies Act 2006 and ABI SORP, the valuation of policyholder benefi t provisions for these businesses may differ from that determined on a UK MSB for UK operations with the same features. These differences are permitted under IFRS 4.
Liability adequacy
The Group performs liability adequacy testing on its insurance provisions to ensure that the carrying amounts of provisions (less related DAC) and, where relevant, present value of acquired in-force business is sufficient to cover current estimates of future cash flows. Any deficiency is immediately charged to the income statement.
Reinsurance
The measurement of reinsurance assets is consistent with the measurement of the underlying direct insurance contracts.
The treatment of any gains or losses arising on the purchase of reinsurance contracts is dependent on the underlying accounting basis of the entity concerned amongst other things.
Investment contracts (contracts which do not contain signifi cant insurance risk as defi ned under IFRS 4)
For investment contracts with discretionary participation features, the accounting basis is consistent with the accounting for similar with-profits insurance contracts. Other investment contracts are accounted for on a basis that reflects the hybrid nature of the arrangements whereby part is accounted for as a financial instrument under IAS 39 and the investment management service component is accounted for under IAS 18, ‘Revenue’.
For those investment contracts in the US with fixed and guaranteed terms, the Group uses the amortised cost model to measure the liability.
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. Where the contract includes a surrender option its carrying value is subject to a minimum carrying value equal to its surrender value.
b Financial instruments other than fi nancial instruments classifi ed as long-term business contracts
Investment classifi cation
Under IAS 39, subject to specific criteria, financial instruments are required to be accounted for under one of the following categories: financial investments at fair value through profit and loss, financial investments held on an available-for-sale basis, financial investments held-to-maturity or loans and receivables. These IAS 39 classifications have been changed by IFRS 9 ‘Financial Investments: Classifi cation and Measurement’ which is not required to be adopted until 2015 and is still subject to EU endorsement. In addition, the International Accounting Standards Board
(IASB) continues to consult on future possible changes to IFRS 9. This standard has not been adopted by the Group in 2012. The Group holds financial investments on the following bases:
i Financial assets and liabilities at fair value through profit and loss – this comprises assets and liabilities designated by management as fair value through profit and loss on inception and derivatives that are held for trading. These investments are measured at fair value with all changes thereon being recognised in investment return in the income statement;
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. Available-for-sale financial assets are initially recognised at fair value plus attributable transaction costs. For available-for-sale debt securities, the difference between their cost and par value is amortised to the income statement using the effective interest rate. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset.
Available-for-sale financial assets are subsequently measured 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. Upon disposal or impairment, accumulated unrealised gains and losses are transferred from other comprehensive income to the income statement as realised gains or losses; and
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 159
iii Loans and receivables – except for those designated as at fair value through profit and loss or available-for-sale, these instruments comprise non-quoted investments that have fixed or determinable payments. These investments include loans collateralised by mortgages, deposits, loans to policyholders and other unsecured loans and receivables. These investments are initially recognised at fair value plus transaction costs. Subsequently, these investments are carried at amortised cost using the effective interest method.
As permitted under IAS 39 the Group has designated certain financial assets as fair value through profit and loss as these assets are managed and their performance is evaluated on a fair value basis. These assets represent all of the Group’s fi nancial assets other than those loans and receivables, carried at amortised cost, and debt securities accounted for on an available-for-sale basis by Jackson. The use of the fair value option is consistent with the Group’s risk management and investment strategies.
The Group uses the trade date method to account for regular purchases and sales of financial assets.
Use of fair values
The Group uses current bid prices to value its investments with quoted prices. Actively traded investments without quoted prices
are valued using prices provided by third parties. If there is no active established market for an investment, the Group applies an
appropriate valuation technique such as a discounted cash flow technique. Additional details are provided in note G1.
Impairments
If, in subsequent periods, an impaired debt security held on an available-for-sale basis or an impaired loan or receivable recovers in
value (in part or in full), and this recovery can be objectively related to an event occurring after the impairment, then the previously
recognised impairment loss is reversed through the income statement (in part or in full).
Derivatives and hedge accounting
Derivative financial instruments are used to reduce or manage investment, interest rate and currency exposures, to facilitate efficient
portfolio management and for investment purposes.
The Group may designate certain derivatives as hedges.
For hedges of net investments in foreign operations, the effective portion of any change in fair value of derivatives or other financial
instruments designated as net investment hedges is recognised in other comprehensive income. The ineffective portion of changes in
the fair value of the hedging instrument is recorded in the income statement. The gain or loss on the hedging instrument is recognised
directly in other comprehensive income while the foreign operation is held.
For fair value hedges, movements in the fair value of the hedged item attributable to the hedged risk are recognised in the income
statement.
The Group does not regularly seek to apply fair value or cash flow hedging treatment under IAS 39. The exceptions, where hedge
accounting has been applied in 2012 and 2011, are summarised in note G3.
All derivatives that are not designated as hedging instruments are carried at fair value with movements in fair value being recorded A:
in the income statement.
The primary areas of the Group’s continuing operations where derivative instruments are held are the UK with-profits funds and
annuity business, and Jackson.
For UK with-profits funds the derivative programme derivatives are used for the purposes of efficient portfolio management Background
or reduction in investment risk. and
For shareholder-backed UK annuity business the derivatives are held to contribute to the matching as far as practical, of asset
returns and duration with those of liabilities to policyholders. The carrying value of these liabilities is sensitive to the return on the
matching financial assets including derivatives held.
For Jackson an extensive derivative programme is maintained. Value movements on the derivatives held can be very significant in accounting
their effect on shareholder results. Further details on this aspect of the Group’s financial reporting are described in notes B1 and D3.
Embedded derivatives policies
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 Financial
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.
In addition, the Group applies the option of IFRS 4 to not separate and fair value surrender options embedded in host contracts
and with-profits investment contracts whose strike price is either a fixed amount or a fixed amount plus interest. Further details on the statements
valuation basis for embedded derivatives attaching to Jackson’s life assurance contracts are provided in note D3(e).
160 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A3: Accounting policies continued
Securities lending including repurchase agreements
The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not derecognised; rather, they continue to be recognised within the appropriate investment classification. The Group’s policy is that collateral in excess of 100 per cent of the fair value of securities loaned is required from all securities’ borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
In cases where the Group takes possession of the collateral under its securities lending programme, the collateral, and corresponding obligation to return such collateral, are recognised in the consolidated statement of financial position.
Derecognition of fi nancial assets and liabilities
The Group’s policy is to derecognise fi nancial assets when it is deemed that substantially all the risks and rewards of ownership have been transferred.
The Group derecognises financial liabilities only when the obligation specifled in the contract is discharged, cancelled or has expired.
Borrowings
Although initially recognised at fair value, net of transaction costs, borrowings, excluding liabilities of consolidated collateralised debt obligations, are subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds (net of related issue costs) is amortised through the income statement to the date of maturity or for hybrid debt, over the expected life of the instrument.
Financial liabilities designated at fair value through profi t and loss
Consistent with the Group’s risk management and investment strategy and the nature of the products concerned, the Group has designated under IAS 39 classifi cation certain financial liabilities at fair value through profit and loss as these instruments are managed and their performance evaluated on a fair value basis. These instruments include liabilities related to consolidated collateralised debt obligations and net assets attributable to unit holders of consolidated unit trusts and similar funds.
c Other assets, liabilities, income and expenditure
Basis of consolidation
The Group consolidates those entities it is deemed to control. The degree of control is determined by the ability of the Group to govern the financial and operating policies of an entity in order to obtain benefits. The results of subsidiaries are included in the financial statements from the date control commences to the date control ceases. All inter-company transactions are eliminated on consolidation. Results of asset management activities include those for managing internal funds.
The Group holds investments in internally and externally managed open-ended investment companies (OEICs) and unit trusts. These are consolidated where the Group’s percentage ownership level is (i) 50 per cent or greater, and (ii) where the Group’s ownership of internally managed funds declines marginally below 50 per cent and the decline in ownership is expected to be temporary.
Where the Group exercises significant influence or has the power to exercise significant influence over an entity, generally through ownership of 20 per cent or more of the entity’s voting rights, but does not control the entity, then this is considered to be an investment in an associate. With the exception of those referred to below, the Group’s investments in associates are recorded at the Group’s share of the associates’ net assets including any goodwill and intangibles arising upon initial acquisition. The carrying value of investments in associates is adjusted each year for the Group’s share of the entities’ profi t or loss. This does not apply to investments in associates held by the Group’s insurance or investment funds including the venture capital business or mutual funds and unit trusts, which as permitted by IAS 28, ‘Investments in Associates’, are carried at fair value through profi t and loss.
The Group’s investments in joint ventures are recognised using proportional consolidation whereby the Group’s share of an entity’s individual balances are combined line-by-line with similar items into the Group fi nancial statements. Other interests in entities, where significant influence is not exercised, are carried as investments at fair value through profit and loss.
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 qualifi ed surveyors or by taking into consideration the advice of professional external valuers using the Royal Institution of Chartered Surveyors guidelines. Each property is externally valued at least once every three years. Fair value is based on active market prices. If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or
recent prices in less active markets.
Leases of investment property where the Group has substantially all the risks and rewards of ownership are classifled as finance leases (leasehold property). Finance leases are capitalised at the lease’s inception at the lower of the fair value of the leased property and the present value of the minimum lease payments.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 161
Pension schemes
For the Group’s defined benefit schemes, if the present value of the defined benefit obligation exceeds the fair value of the scheme
assets, then a liability is recorded in the Group’s statement of financial position. By contrast, if the fair value of the assets exceeds the
present value of the defined benefit obligation then the surplus will only be recognised if the nature of the arrangements under the
trust deed, and funding arrangements between the Trustee and the Company support the availability of refunds or recoverability
through agreed reductions in future contributions. In addition, if there is a constructive obligation for the Company to pay deficit
funding, this is also recognised such that the financial position recorded for the scheme reflects the higher of any underlying IAS 19,
‘Employee Benefits’, deficit and the obligation for deficit funding.
The Group utilises the projected unit credit method to calculate the defined benefit obligation. This method sees each period of
service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation.
Estimated future cash flows are then discounted at a high-quality corporate bond rate, adjusted to allow for the difference in duration
between the bond index and the pension liabilities where appropriate, to determine its present value. These calculations are
performed by independent actuaries.
The plan assets of the Group’s pension schemes exclude several insurance contracts that have been issued by the Group. These
assets are excluded from plan assets in determining the pension obligation recognised in the consolidated statement of financial
position.
The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of discount on
liabilities at the start of the period, less the expected investment return on scheme assets at the start of the period, is charged to the
income statement. Actuarial gains and losses as a result of changes in assumptions or experience variances are also charged or
credited to the income statement.
Contributions to the Group’s defined contribution schemes are expensed when due.
Share-based payments
The Group offers share award and option plans for certain key employees and a Save As You Earn plan for all UK and certain overseas
employees. Shares held in trust relating to these plans are conditionally gifted to employees.
The compensation expense charged to the income statement is primarily based upon the fair value of the options granted, the
vesting period and the vesting conditions. The Company has established trusts to facilitate the delivery of Prudential plc shares under
employee incentive plans and savings-related share option schemes. The cost to the Company of acquiring these treasury shares held
in trusts is shown as a deduction from shareholders’ equity.
Tax
Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result
of taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year, they
can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
Deferred taxes are provided under the liability method for all relevant temporary differences. IAS 12, ‘Income Taxes’ does not A:
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 Background
taxable profits will be available against which these losses can be utilised.
The tax charge for long-term business includes tax expense attributable to both the policyholders and the shareholders. Different and
tax rules apply under UK law depending upon whether the business is life insurance or pension business.
Deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled,
based on tax rates (and laws) that have been enacted or are substantively enacted at the end of the reporting period. accounting
Business acquisitions and disposals
Business acquisitions are accounted for by applying the purchase method of accounting, which adjusts the net assets of the acquired policies
company to fair value at the date of purchase. The excess of the acquisition consideration over the fair value of the assets and liabilities
of the acquired entity is recorded as goodwill. Expenses related to acquiring new subsidiaries are expensed in the period in which they
are incurred. Income and expenses of acquired entities are included in the income statement from the date of acquisition. Financial
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. statements
Intangible assets
Intangible assets acquired on the purchase of a subsidiary or portfolio of contracts are fair valued at acquisition. Other intangible
assets, such as software, are valued at the price paid to acquire them. Intangible assets are carried at cost less amortisation and any
accumulated impairment losses. Amortisation calculated is charged on a straight-line basis over the estimated useful life of the assets.
162 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A3: Accounting policies continued
Cash and cash equivalents
Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, treasury bills and other short-term highly liquid investments with less than 90 days maturity from the date of acquisition.
Segments
Under IFRS 8, ‘Operating Segments’, the Group determines and presents operating segments based on the information that is internally provided to the Group Executive Committee which is the Group’s chief operating decision maker.
The operating segments identifled by the Group reflect the Group’s organisational structure, which is by both geography (Asia, US and UK) and by product line (insurance operations and asset management).
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 to support the Group’s insurance operations.
Asset management comprises both internal and third-party asset management services, inclusive of portfolio and mutual fund management, where the Group acts as an advisor, and broker-dealer activities. The nature of the products and the managing of the business differ from the risks inherent in the insurance operations segments, and the regulatory environment of the asset management industry differs from that of the insurance operations segments.
The Group’s operating segments determined in accordance with IFRS 8, ‘Operating Segments’, are as follows:
Insurance operations
Asia
US (Jackson)
UK
Asset management operations
M&G (including Prudential Capital)
Eastspring Investments
US broker-dealer and asset management (including Curian)
The Group’s operating segments are also its reportable segments with the exception of Prudential Capital (PruCap) which has been incorporated into the M&G operating segment for the purposes of segment reporting.
The performance measure of operating segments utilised by the Company is IFRS operating profit attributable to shareholders based on longer-term investment returns, as described below. This measure excludes the recurrent items of short-term fluctuations in investment returns and the shareholders’ share of actuarial and other gains and losses on defi ned benefit pension schemes. In addition for 2012 this measure excluded a gain arising upon the dilution of the Group’s holding in PPM South Africa and the amortisation of the acquisition accounting adjustments arising on the purchase of REALIC as described further in note I1. Operating earnings per share is based on operating profit based on longer-term investment returns, after tax and non-controlling interests. Further details on the determination of the performance measure of operating profit based on longer-term investment returns is provided below.
Segment results that are reported to the Group Executive Committee include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items are mainly in relation to the Group Head Office and the Asia Regional Head Office.
d Operating profi t based on longer-term investment returns
The Group provides supplementary analysis of profit before tax attributable to shareholders that distinguishes operating profit based on longer-term investment returns from other constituent elements of the total profit.
Except in the case of the assets backing the UK annuity business, unit-linked and US variable annuity separate account liabilities, operating profit based on longer-term investment returns for shareholder-financed business is determined on the basis of expected longer-term investment returns. In the case of assets backing the UK annuity business, unit-linked and US variable annuity separate account liabilities, the basis of determining operating profit based on longer-term investment returns is as follows:
Assets backing UK annuity business liabilities. For UK annuity business, policyholder liabilities are determined by reference to current interest rates. The value movements of the assets covering liabilities are closely correlated with the related change in liabilities. Accordingly, asset value movements are recorded within the ‘operating results based on longer-term investment returns’.
Policyholder liabilities include a margin for credit risk. Variations between actual and best estimate expected impairments are recorded as a component of short-term fluctuations in investment returns; and Assets backing unit-linked and US variable annuity business separate account liabilities. For such business, the policyholder unit liabilities are directly reflective of the asset value movements. Accordingly, the operating results based on longer-term investment returns reflect the current period value movements in unit liabilities and the backing assets.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 163
In the case of other shareholder-financed business, the measurement of operating profit based on longer-term investment returns
reflects the particular features of long-term insurance business where assets and liabilities are held for the long term and for which
the accounting basis for insurance liabilities under current IFRS is not generally conducive to demonstrating trends in underlying
performance of life businesses exclusive of the effects of short-term fluctuations in market conditions. In determining the profit on this
basis, the following key elements are applied to the results of the Group’s shareholder-financed operations as reflected in the segment
results shown in note B1.
i Debt, equity-type securities and loans
Longer-term investment returns for both debt, equity-type securities and loans comprise longer-term actual income receivable for the
period (interest/dividend income) and longer-term capital returns.
In principle, for debt securities and loans, the longer-term capital returns comprise two elements. The first element is a risk margin
reserve (RMR) based charge for the expected level of defaults for the period, which is determined by reference to the credit quality
of the portfolio. The difference between impairment losses in the reporting period and the RMR charge to the operating result is
reflected in short-term fluctuations in investment returns. The second element is for the amortisation of interest-related realised gains
and losses to operating results based on longer-term investment returns to the date when sold bonds would have otherwise matured.
Jackson is the shareholder-backed operation for which the distinction between impairment losses and interest-related realised
gains and losses is in practice relevant to a significant extent. Jackson has used the ratings by Nationally Recognised Statistical Ratings
Organisations (NRSRO) or ratings resulting from the regulatory ratings detail issued by the National Association of Insurance
Commissioners (NAIC) developed by external third parties such as PIMCO or BlackRock Solutions to determine the average annual
RMR to apply to debt securities held to back general account business. Debt securities held to back separate account and reinsurance
funds withheld are not subject to RMR charge. Further details of the RMR charge, as well as the amortisation of interest-related
realised gains and losses, for Jackson are shown in note B1(iv) to the consolidated financial statements.
For debt securities backing non-linked shareholder-financed business of the UK insurance operations (other than the annuity
business) and of the Asia insurance operations, the realised gains and losses are principally interest related. Accordingly, all realised
gains and losses to date for these operations are being amortised over the period to the date those securities would otherwise have
matured, with no explicit RMR charge.
At 31 December 2012, the level of unamortised interest-related realised gains and losses related to previously sold bonds for the
Group was a net gain of Ł498 million (31 December 2011: Ł462 million).
For equity-type securities, the longer-term rates of return are estimates of the long-term trend investment return for
income and capital having regard to past performance, current trends and future expectations. Equity-type securities held for
shareholder-financed operations other than the UK annuity business, unit-linked and US variable annuity are of significance
for the US and Asia insurance operations. Different rates apply to different categories of equity-type securities.
As at 31 December 2012, the equity-type securities for US insurance non-separate account operations amounted to Ł1,004 million
(31 December 2011: Ł902 million). For these operations, the longer-term rates of return for income and capital applied in 2012 reflects
the combination of risk free rates and appropriate risk premium are as follows: A:
2012 2011
Equity-type securities such as common and preferred stock and portfolio holdings in mutual funds 5.5% to 6.2% 5.9% to 7.5% Background
Other equity-type securities such as investments in limited partnerships and private equity funds 7.5% to 8.2% 7.9% to 9.5%
and
For Asia insurance operations, investments in equity securities held for non-linked shareholder-financed operations amounted to
Ł659 million as at 31 December 2012 (31 December 2011: Ł590 million). The rates of return applied in the years 2012 and 2011 ranged accounting
from 1.0 per cent to 13.8 per cent, with the rates applied varying by territory. The investment amounts for 2011 of Ł590 million
included the Group’s investment in China Life Insurance Company of Taiwan (China Life (Taiwan)) of Ł88 million which was sold
in 2012, as described in note B1. policies
The longer-term rates of return discussed above for equity-type securities are determined after consideration by the Group’s
in-house economists of long-term expected real government bond returns, equity risk premium and long-term infiation. These rates
are broadly stable from period to period but may be different between countries reflecting, for example, differing expectations of
infiation in each territory. The assumptions are for returns expected to apply in equilibrium conditions. The assumed rates of return Financial
do not reflect any cyclical variability in economic performance and are not set by reference to prevailing asset valuations.
statements
164 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A3: Accounting policies continued
ii US variable and fixed index annuity business
The following value movements for Jackson’s variable and fi xed index annuity business are excluded from operating profit based on longer-term investment returns:
Fair value movements for equity-based derivatives;
Fair value movements for embedded derivatives for Guaranteed Minimum Withdrawal Benefit (GMWB) ‘not for life’ and fi xed index annuity business, and Guaranteed Minimum Income Benefit (GMIB) reinsurance (see note); Movements in accounts carrying value of Guaranteed Minimum Death Benefit (GMDB) and GMWB ‘for life’ liabilities, for which, under the ‘grandfathered’ US GAAP applied under IFRS for Jackson’s insurance assets and liabilities, the measurement basis gives rise to a muted impact of current period market movements; Fee assessments and claim payments, in respect of guarantee liabilities; and Related changes to amortisation of deferred acquisition costs for each of the above items.
Note: US operations – embedded derivatives for variable annuity guarantee features
The GMIB liability, which is fully reinsured, subject to a deductible and annual claim limits, is accounted for in accordance with
FASB ASC Subtopic 944-80 Financial Services – Insurance – Separate Accounts (formerly SOP 03-1) under IFRS using ‘grandfathered’ US GAAP. As the corresponding reinsurance asset is net settled, it is considered to be a
derivative under IAS 39, and the asset is therefore recognised at fair value. As the GMIB benefit is economically reinsured the mark to market element of the reinsurance asset is included as a component of short-term fluctuations in investment returns.
iii Other derivative value movements
Generally, derivative value movements are excluded from operating results based on longer-term investment returns (unless those derivative value movements broadly offset changes in the accounting value of other assets and liabilities included in operating profit). The principal example of non-equity based derivatives (for example interest rate swaps and swaptions) whose value movements are excluded from operating profit arises in Jackson. Non-equity based derivatives are primarily held by Jackson as part of a broadly based hedging programme for features of Jackson’s bond portfolio (for which value movements are booked in the statement of comprehensive income rather than the income statement), product liabilities (for which US GAAP accounting as ‘grandfathered’ under IFRS 4 does not fully reflect the economic features being hedged), and the interest rate exposure attaching to equity-based embedded derivatives.
iv Other 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 is broadly equivalent in the income statement, and operating profit based on longer-term investments returns is not distorted. In these circumstances, there is no need for the movement in the liability to be bifurcated between the elements that relate to longer-term market conditions and short-term effects.
However, some types of business movements in liabilities do require bifurcation to ensure that at the net level (ie after allocated investment return and change for policyholder benefits) the operating result reflects longer-term market returns.
Examples where such bifurcation is necessary are:
Asia i Hong Kong
For certain non-participating business, the economic features are more akin to asset management products with policyholder liabilities reflecting asset shares over the contract term. For these products, the charge for policyholder benefits in the operating results should reflect the asset share feature rather than volatile movements that would otherwise be reflected if the local regulatory basis (which is applied for IFRS balance sheet purposes) was used.
For other Hong Kong non-participating business, longer-term interest rates are used to determine the movement in policyholder liabilities for determining operating results. Similar principles apply for other Asia operations;
ii Japan Guaranteed Minimum Death Benefit (GMDB) product features
For unhedged GMDB liabilities accounted for under IFRS using ‘grandfathered’ US GAAP, such as in the Japanese business, the change in carrying value is determined under FASB ASC subtopic 944-80, Financial Services – Insurance – Separate Accounts (formerly SOP 03-1), which partially reflects changes in market conditions. Under the Company’s segmental basis of reporting the operating profi t reflects the change in liability based on longer-term market conditions with the difference between the charge to the operating result and the movement reflected in the total result included in short-term fluctuations in investment returns;
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 165
UK shareholder-backed annuity business
The operating result based on longer-term investment returns reflects the impact of value movements on policyholder liabilities for annuity business in PRIL and the PAC non-profit sub-fund after adjustments to allocate the following elements of the movement to the category of ‘short-term fl uctuations in investment returns’ in the Group’s supplementary analysis of profi t:
The impact on credit risk provisioning of actual upgrades and downgrades during the period; Credit experience compared to assumptions; and Short-term value movements on assets backing the capital of the business.
Credit experience reflects the impact of defaults and other similar experience, such as asset exchanges arising from debt restructuring by issuers that include effectively an element of permanent impairment of the security held. Negative experience compared to assumptions is included within short-term fluctuations in investment returns without further adjustment. This is to be contrasted with positive experience where surpluses are retained in short-term allowances for credit risk for IFRS reporting purposes. The effects of other changes to credit risk provisioning are included in the operating result, as is the net effect of changes to the valuation rate of interest due to portfolio rebalancing to align more closely with management benchmark.
v Fund management and other non-insurance businesses
For these businesses, the particular features applicable for life assurance noted above do not apply. For these businesses it is
inappropriate to include returns in the operating result on the basis described above. Instead, it is appropriate to generally include
realised gains and losses (including impairments) in the operating result with unrealised gains and losses being included in short-term
fluctuations in investment returns. For this purpose impairments are calculated as the credit loss determined by comparing the
projected cash flows discounted at the original effective interest rate to the carrying value. In some instances it may also be
appropriate to amortise realised gains and losses on derivatives and other financial instruments to operating results over a time
period that reflects the underlying economic substance of the arrangements.
Shareholders’ dividends
Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are
approved by shareholders.
Share capital
Where there is no obligation to transfer assets, shares are classified as equity. The difference between the proceeds received on issue
of the shares, net of share issue costs, and the nominal value of the shares issued, is credited to share premium. Where the Company
purchases shares for the purposes of employee incentive plans, the consideration paid, net of issue costs, is deducted from retained
earnings. Upon issue or sale any consideration received is credited to retained earnings net of related costs.
Foreign exchange A:
The Group’s consolidated financial statements are presented in pounds sterling, the Group’s presentation currency. Accordingly,
the results and financial position of foreign subsidiaries must be translated into the presentation currency of the Group from their
functional currencies, ie the currency of the primary economic environment in which the entity operates. All assets and liabilities Background
of foreign subsidiaries are converted at year end exchange rates whilst all income and expenses are converted at average exchange
rates where this is a reasonable approximation of the rates prevailing on transaction dates. The impact of these currency translations and
is recorded as a separate component in the statement of comprehensive income.
Foreign currency borrowings that are used to provide a hedge against Group equity investments in overseas subsidiaries are
translated at year end exchange rates and movements recognised in other comprehensive income. Other foreign currency monetary accounting
items are translated at year end exchange rates with changes recognised in the income statement.
Foreign currency transactions are translated at the spot rate prevailing at the time. policies
Financial
statements
166 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A4: Critical accounting estimates and judgements
In determining the measurement of the Group’s assets and liabilities estimates and judgements are required. The critical aspects are described below.
Investments
Determining the fair value of fi nancial investments when the markets are not active
The Group holds certain financial investments for which the markets are not active. These can include financial investments which are not quoted on active markets and financial investments for which markets are no longer active as a result of market conditions eg market illiquidity. When the markets are not active, there is generally no or limited observable market data to account for financial investments at fair value. The determination of whether an active market exists for a financial investment requires management’s judgement.
If the market for a financial investment of the Group is not active, the fair value is determined by using valuation techniques. The Group establishes fair value for these financial investments by using quotations from independent third parties, such as brokers or pricing services or by using internally developed pricing models. Priority is given to publicly available prices from independent sources when available, but overall the source of pricing and/or the valuation technique is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The valuation techniques include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation and may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these financial investments.
The financial investments measured at fair value are classified into the following three level hierarchy on the basis of the lowest level of inputs that is significant to the fair value measurement of the financial investment concerned:
Level 1: Quoted prices (unadjusted) in active markets for identical assets and liabilities;
Level 2: Inputs other than quoted prices included within level 1 that are observable either directly or indirectly (ie derived from prices); and Level 3: Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs).
At 31 December 2012, Ł6,660 million (2011: Ł4,565 million) of the fi nancial investments (net of derivative liabilities) valued at fair value were classified as level 3. Of these Ł861 million (2011: Ł800 million) are held to back shareholder non-linked business and so changes to these valuations will directly impact shareholders’ equity. Further details of the level 3 investments and the classifi cation of financial instruments are given in note G1.
Determining impairments relating to fi nancial assets i Available-for-sale securities
The majority of Jackson’s debt securities portfolio are accounted for on available-for-sale basis. The consideration of evidence of impairment requires management’s judgement. In making this determination the factors considered include, for example:
Whether the decline of the financial investment’s fair value is substantial; a substantial decline in fair value might be indicative of a credit loss event that would lead to a measurable decrease in the estimated future cash flows; The impact of the duration of the security on the calculation of the revised estimated cash flows; the duration of a security to maturity helps to inform whether assessments of estimated future cash flows that are higher than market value are reasonable; The duration and extent to which the amortised cost exceeds fair value; this factor provides an indication of how the contractual cash flows and effective interest rate of a financial asset compares with the implicit market estimate of cash flows and the risk attaching to a ‘fair value’ measurement. The length of time for which that level of difference has been in place may also provide further evidence as to whether the market assessment implies an impairment loss has arisen; and The financial condition and prospects of the issuer or other observable conditions that indicate the investment may be impaired.
If a loss event that will have a detrimental effect on cash flows is identified an impairment loss in the income statement is recognised. The loss recognised is determined as the difference between the book cost and the fair value of the relevant impaired securities. This loss comprises the effect of the expected loss of contractual cash flows and any additional market-price-driven temporary reductions in values.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 167
For Jackson’s residential mortgage-backed and other asset-backed securities, all of which are classified as available-for-sale, the
model used to analyse cash flows begins with the current delinquency experience of the underlying collateral pool for the structure,
by applying assumptions about how much of the currently delinquent loans will eventually default, and multiplying this by an assumed
loss severity. Additional factors are applied to anticipate ageing effects. After applying a cash flow simulation an indication is obtained
as to whether or not the security has suffered, or is anticipated to suffer, contractual principal or interest payment shortfalls. If a
shortfall applies an impairment charge is recorded. The difference between the fair value and book cost for unimpaired securities
designated as available-for-sale, is accounted for as unrealised gains or losses, with the movements in the accounting period being
included in other comprehensive income.
The Group’s review of fair value involves several criteria, including economic conditions, credit loss experience, other
issuer-specific developments and future cash flows. These assessments are based on the best available information at the time.
Factors such as market liquidity, the widening of bid/ask spreads and a change in cash flow assumptions can contribute to future
price volatility. If actual experience differs negatively from the assumptions and other considerations used in the consolidated
financial statements, unrealised losses currently in equity may be recognised in the income statement in future periods.
Additional details on the impairments of the available-for-sale securities of Jackson are described in notes D3 and G5.
ii Assets held at amortised cost
Except for certain loans of the UK insurance operations and Jackson National Life, which are accounted for on a fair value through
profit and loss basis, and as described below, financial assets classified as loans and receivables under IAS 39 are carried at amortised
cost using the effective interest rate method. The loans and receivables include loans collateralised by mortgages, deposits and loans
to policyholders. In estimating future cash flows, the Group looks at the expected cash flows of the assets and applies historical loss
experience of assets with similar credit risks that has been adjusted for conditions in the historical loss experience which no longer
exist or for conditions that are expected to arise. The estimated future cash flows are discounted using the financial asset’s original
or variable effective interest rate and exclude credit losses that have not yet been incurred.
The risks inherent in reviewing the impairment of any investment include: the risk that market results may differ from expectations,
facts and circumstances may change in the future and differ from estimates and assumptions, or the Group may later decide to sell the
asset as a result of changed circumstances.
Certain mortgage loans of the UK insurance operations and, consequent upon the purchase of REALIC in 2012, policy loans held
to back funds withheld under reinsurance arrangements have been designated at fair value through profit and loss as these loan
portfolios are managed and evaluated on a fair value basis.
Insurance contracts
Product classification
IFRS 4 requires contracts written by insurers to be classified as either ‘insurance contracts’ or ‘investment contracts’ depending on the
level of insurance risk transferred. Insurance risk is a pre-existing risk, other than financial risk, transferred from the contract holder to
the contract issuer. If significant insurance risk is transferred by the contract then it is classified as an insurance contract. Contracts that A:
transfer financial risk but not significant insurance risk are termed investment contracts. Furthermore, some contracts, both insurance
and investment, contain discretionary participating features representing the contractual right to receive additional benefits as a
supplement to guaranteed benefits: Background
a That are likely to be a significant portion of the total contract benefits; and
b Whose amount or timing is contractually at the discretion of the insurer; and
c That are contractually based on asset or fund performance, as discussed in IFRS 4.
IFRS 4 permits the continued usage of previously applied GAAP for insurance contracts and investment contracts with discretionary accounting
participating features. Except for UK regulated with-profits funds, as described subsequently in section A3(2)(a), this basis has been
applied by the Group.
For investment contracts that do not contain discretionary participating features, IAS 39 and, where the contract includes an policies
investment management element, IAS 18,’Revenue’, apply measurement principles to assets and liabilities attaching to the contract.
Valuation assumptions
i Contracts of with-profits funds Financial
For UK regulated with-profits funds, the contract liabilities are valued by reference to the UK Financial Services Authority’s (FSA)
realistic basis as described in section A3(2)(a). 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. An explanation of the basis of liability measurement is contained in section A3(2)(a). statements
The Group’s other with-profits contracts are written in with-profits funds that operate in some of the Group’s Asian subsidiaries.
The liabilities for these contracts and those of Prudential Annuities Limited, which is a subsidiary company of the PAC with-profits
fund, are determined differently. For these contracts the liabilities are estimated using actuarial methods based on assumptions
relating to premiums, interest rates, investment returns, expenses, mortality and surrenders. The assumptions to which the estimation
of these reserves is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality
experience of policyholders.
168 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A4: Critical accounting estimates and judgements continued
ii Other contracts
Contracts, other than those of with-profits funds, are written by shareholder-backed operations of the Group. The
significant shareholder-backed product groupings and the factors that may significantly affect IFRS results due to experience against assumptions or changes of assumptions vary significantly between business units. For some types of business the effect of changes in assumptions may be significant, whilst for others, due to the nature of the product, assumption setting may be of less significance. The nature of the products and the significance of assumptions are discussed in notes D2, D3 and D4.
UK insurance operations
From the perspective of shareholder results the key sensitivity for UK insurance operations are the assumptions for allowance for credit risk and mortality for UK annuity business.
Jackson
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. 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.
Fixed annuity contracts, which are investment contracts under US GAAP terminology, are accounted for by applying in the first instance a retrospective deposit method to determine the liability for policyholder benefits. This is then augmented by potentially three additional amounts, namely deferred income, any amounts previously assessed against policyholders that are refundable on termination of the contract, and any premium deficiency, ie any probable future loss on the contract. These types of contracts contain considerable interest rate guarantee features. Notwithstanding the accompanying market risk exposure, except in the circumstances of interest rate scenarios where the guarantee rates included in contract terms are higher than crediting rates that can be supported from assets held to cover liabilities, the accounting measurement of Jackson’s fi xed annuity products is not generally sensitive to interest rate risk. This position derives from the nature of the products and the US GAAP basis of measurement.
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 traditional life insurance contracts, provisions for future policy benefits are determined using assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviation.
Except to the extent of mortality experience, which primarily affects profits through variations in claim payments and the guaranteed minimum death benefit reserves, the profits of Jackson are relatively insensitive to changes in insurance risk. This reflects the principally spread and fee-based nature of Jackson’s business.
Asia operations
The insurance products written in the Group’s Asia operations principally cover with-profi ts business, unit-linked business and other non-participating business. The results of with-profits business are relatively insensitive to changes in estimates and assumptions that affect the measurement of policyholder liabilities. As for the UK business, this feature arises because unallocated surplus is accounted for by the Group as a liability. The results of Asia unit-linked business are also relatively insensitive to changes in estimates or assumptions due to the matching of asset value and liability movements. For other Asia non-participating business the degree of sensitivity of results to changes in interest rates depends upon the degree to which the liabilities under the ‘grandfathered’ IFRS 4 measurement basis reflects market interest rates from period to period for example, for those countries, such as those applying US GAAP, the results can be more sensitive as the effect of interest rate movements on the backing investments may not be offset by liability movements due to the US GAAP basis of measurement of insurance contracts.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 169
Deferred acquisition costs for insurance contracts
Except for acquisition costs of with-profits contracts of the UK regulated with-profits funds, which are accounted for under the
realistic FSA regime, costs of acquiring new insurance business are accounted for in a way that is consistent with the principles of the
ABI SORP with deferral and amortisation against margins in future revenues on the related insurance policies. Costs of acquiring new
insurance business, principally commissions, marketing and advertising and certain other costs associated with policy insurance and
underwriting that are not reimbursed by policy charges, are specifically identified and capitalised as part of deferred acquisition costs
(DAC). In general, this deferral is presentationally shown by an explicit carrying value for DAC in the balance sheet. However, in some
Asia operations the deferral is implicit through the reserving methodology. The recoverability of the explicitly and implicitly deferred
acquisition costs is measured and are deemed impaired if the projected margins are less than the carrying value. To the extent that the
future margins differ from those anticipated, then an adjustment to the carrying value will be necessary.
For UK regulated with-profits funds where the realistic FSA regime is applied, the basis of setting liabilities is such that it would
be inappropriate for acquisition costs to be deferred, therefore these costs are expensed as incurred. The majority of the UK
shareholder-backed business is individual and group annuity business where the incidence of acquisition costs is negligible.
The deferral and amortisation of acquisition costs is of most relevance to the Group’s results for Jackson and Asia operations.
The DAC for Jackson and some Asia operations is determined with reference to US GAAP principles.
Jackson
Under IFRS 4, the Group applies ‘grandfathered’ US GAAP for measuring the insurance assets and liabilities of Jackson. In the case
of Jackson term business, acquisition costs are deferred and amortised in line with expected profits. For interest-sensitive business,
the key assumption is the long-term spread between the earned rate on investments and the rate credited to policyholders, which
is based on an annual spread analysis. In addition, expected gross profits depend on mortality assumptions, assumed unit costs and
terminations other than deaths (including the related charges), all of which are based on a combination of Jackson’s actual industry
experience and future expectations. A detailed analysis of actual mortality, lapse and expenses experience is performed using
internally developed experience studies.
For US variable annuity business the key assumption is the investment return from the separate accounts, which for 2012 and 2011
was 8.4 per cent per annum (after deduction of external fund management fees) determined using a mean reversion methodology.
Under the mean reversion methodology, projected returns over the next five years are flexed (subject to capping) so that, combined
with the actual rates of return for the current and the previous two years the 8.4 per cent rate is maintained. The projected rates of
return are capped at no more than 15 per cent for each of the next five years. Further details are explained in note D3(e). These returns
affect the level of future expected profits through their effects on the fee income with consequential impact on the amortisation
of DAC.
The level of acquisition costs carried in the statement of financial position is also sensitive to unrealised valuation movements
on debt securities held to back the liabilities and solvency capital. Further details are explained in notes D3(e) and H1.
As explained in note A5, the Group has adopted the US Financial Accounting Standards Board measurement and recognition
requirements in Accounting Standards update No 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing A:
Insurance Contracts’ (the ‘Update’) from 1 January 2012 into its IFRS reporting for the results of Jackson and those Asia operations
whose IFRS insurance assets and liabilities are measured principally by reference to US GAAP principles. Under the Update insurers
are required to capitalise only those incremental costs directly relating to acquiring a contract from 1 January 2012. For Group IFRS Background
reporting Prudential has chosen to apply this new basis retrospectively for the results of these operations.
On adoption of the new DAC policy for Jackson the deferred costs balance for business in force at 31 December 2011 was and
retrospectively reduced from Ł3,880 million to Ł3,095 million (31 December 2010: DAC balance reduced from Ł3,543 million
to Ł2,829 million). accounting
Asia operations
For those territories applying US GAAP to insurance assets and liabilities, as permitted by the ABI SORP, principles similar to those set
out in the Jackson paragraph above are applied to the deferral and amortisation of acquisition costs. For other territories in Asia, the policies
general principles of the ABI SORP are applied with, as described above, deferral of acquisition costs being either explicit or implicit
through the reserving basis.
Financial
statements
170 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A5: New accounting pronouncements
The following standards, interpretations and amendments have either been adopted for the first time in 2012 or have been issued but are not yet effective in 2012, including those which have not yet been adopted in the EU. This is not intended to be a complete list as only those standards, interpretations and amendments that could have an impact upon the Group’s fi nancial statements have been discussed.
a Accounting pronouncements adopted in 2012
Amendments to IFRS 7, ‘Financial instruments: Disclosures – Transfers of fi nancial assets’
The amendments introduce new disclosure requirements about transfers of financial assets which include disclosures for financial assets that are not derecognised in their entirety and financial assets that are derecognised in their entirety but for which the entity retains continuing involvement. The adoption of these amendments did not have a significant impact on the Group’s disclosures.
Amendments to IAS 12, ‘Income taxes’
These amendments require the measurement of deferred tax assets and liabilities arising from investment properties and plant, property and equipment valued at fair value on the presumption that the carrying amount of the asset will be, normally, recovered through sale. The adoption of these amendments did not have a material effect on the Group’s fi nancial statements.
b Adoption of updated US GAAP reporting requirements for Group IFRS reporting in 2012
Background
In October 2010, the Emerging Issues Task Force of the US Financial Accounting Standards Board issued update No 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ (the ‘Update’). The Update was issued to address perceived diversity in practices by companies preparing financial statements in accordance with US GAAP as regards the types of acquisition costs being deferred. Under US GAAP, costs that can be deferred and amortised are those that ‘vary with and are primarily related to the acquisition of insurance contracts’. The Update requires insurers to capitalise only those incremental costs directly relating to acquiring a contract for financial statements for reporting periods beginning after 15 December 2011. All other indirect acquisition expenses are required to be charged to the income statements as incurred expenses. Accordingly, the main impact of the Update is to disallow insurers from deferring costs that are not directly related to successful sales.
The Group’s IFRS accounting policies include that under IFRS 4, ‘Insurance Contracts’, insurance assets and liabilities other than those for UK regulated with-profits funds, are measured using the GAAP basis applied prior to IFRS adoption in 2005. On this basis insurance assets and liabilities are measured under the UK Modified Statutory Basis (MSB) which was codified by the Statement of Recommended Practice (SORP) on accounting for insurance
business issued by the Association of British Insurers (ABI) in 2003. The SORP also permits the use of local GAAP subject to the requirement for adjustments to be made to ensure sufficient consistency of measurement under the UK GAAP framework under which the SORP was developed.
In applying this overarching basis, the Group has chosen to apply US GAAP for measuring the insurance assets and liabilities of Jackson. In addition, for the Group’s operations in India, Japan, Taiwan and, until 2012, Vietnam*, where the local GAAP basis would not be appropriate as the start point for deriving MSB insurance asset and liabilities, the measurement has been determined substantially by reference to US GAAP requirements.
For 2012, the Group had the option to either continue with its current basis of measurement or improve its accounting policy under IFRS 4 to acknowledge the issuance of the Update. Prudential has chosen to improve its accounting policy in 2012 to apply the US GAAP update, on a retrospective basis, to the results of Jackson and the affected Asia operations.
The 2011 comparatives in these consolidated financial statements have been adjusted accordingly for the retrospective application of this Update.
* Separately from the DAC change noted above, in Vietnam, the Company has improved its estimation basis for liabilities in 2012 from one determined substantially by reference to US GAAP requirements. After making this change, the estimation basis for Vietnam is aligned substantially with that used in Singapore, Malaysia and some other Asia operations.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 171
Eff ect of the change in accounting policy
(a) The effect of the change in accounting policy for deferred acquisition costs (DAC) on the income statement, earnings per share, comprehensive income, changes in equity and statement of financial position is shown in the tables below:
Consolidated income statement
2012 Łm 2011 Łm
As reported
Under Under under Under
previous Effect of new previous Effect of new
Year ended 31 December policy change policy policy change policy
Total revenue, net of reinsurance 55,476 – 55,476 36,506 – 36,506
Acquisition costs and other expenditure(5,908)(147)(6,055)(5,005)(115)(5,120)
Total other charges, net of reinsurance(46,233) –(46,233)(29,575) –(29,575)
Profit before tax (being tax attributable to
shareholders’ and policyholders’ returns) 3,335(147) 3,188 1,926(115) 1,811
(Less) Add tax (charge) credit attributable to
policyholders’ returns(378) –(378) 17 – 17
Profit before tax attributable to shareholders 2,957(147) 2,810 1,943(115) 1,828
Total tax charge attributable to policyholders
and shareholders(1,039) 48(991)(432) 40(392)
Adjustment to remove tax charge (credit)
attributable to policyholders’ returns 378 – 378(17) –(17)
Tax charge attributable to shareholders’ returns(661) 48(613)(449) 40(409)
Profit for the year 2,296(99) 2,197 1,494(75) 1,419
Profit for the year attributable to
equity holders of the Company 2,296(99) 2,197 1,490(75) 1,415
Earnings per share (in pence)
Based on profit attributable to the equity
holders of the Company:
A:
Basic 90.4p(3.9)p 86.5p 58.8p(3.0)p 55.8p
Diluted 90.3p(3.9)p 86.4p 58.7p(3.0)p 55.7p Background
and
accounting
policies
Financial
statements
172 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A5: New accounting pronouncements continued
Consolidated statement of comprehensive income and statement of changes in equity
2012 Łm 2011 Łm
As reported
Under Under under Under
previous Effect of new previous Effect of new
Year ended 31 December policy change policy policy change policy
Profit for the year 2,296(99) 2,197 1,494(75) 1,419
Exchange movements on foreign operations and
net investment hedges, net of related tax(236) 20(216)(100)(5)(105)
Unrealised valuation movements on securities
of US insurance operations classified as
available-for-sale 862 – 862 811 – 811
Related change in amortisation of deferred
income and acquisition costs(314) 44(270)(331) 56(275)
Related tax(190)(15)(205)(168)(19)(187)
Net unrealised gains 358 29 387 312 37 349
Total comprehensive income for the year 2,418(50) 2,368 1,706(43) 1,663
Total comprehensive income for the year
attributable to equity holders of the
Company 2,418(50) 2,368 1,702(43) 1,659
Shareholders’ equity:
Net increase in shareholders’ equity 1,845(50) 1,795 1,086(43) 1,043
At beginning of year 9,117(553) 8,564 8,031(510) 7,521
At end of year 10,962(603) 10,359 9,117(553) 8,564
Consolidated statement of financial position
2012 Łm 2011 Łm
As reported
Under Under under Under
previous Effect of new previous Effect of new
Year ended 31 December policy change policy policy change policy
Assets
Deferred acquisition costs and other intangible
assets attributable to shareholders 5,173(906) 4,267 5,069(835) 4,234
Total other assets 305,986 – 305,986 268,511 – 268,511
Total assets 311,159(906) 310,253 273,580(835) 272,745
Liabilities
Deferred tax liabilities 4,273(303) 3,970 4,211(282) 3,929
Total other liabilities 295,919 – 295,919 260,209 – 260,209
Total liabilities 300,192(303) 299,889 264,420(282) 264,138
Equity
Shareholders’ equity 10,962(603) 10,359 9,117(553) 8,564
Non-controlling interests 5 – 5 43 – 43
Total equity 10,967(603) 10,364 9,160(553) 8,607
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 173
(b) The effect of the change in accounting policy for deferred acquisition costs on the Group’s supplementary analysis of profit is shown in the table below:
(b) The effect of the change in accounting policy for deferred acquisition costs on the Group’s supplementary analysis of profi t is shown in the table below:
Segment disclosure – profi t before tax
2012 Łm 2011 Łm As reported
Under Under under Under previous Eff ect of new previous Eff ect of new Year ended 31 December policy change policy policy change policy
Operating profi t based on longer-term investment returns
Asia insurance operationsnote (i) 922 (9) 913 704 – 704 US insurance operationsnote (ii) 1,081 (117) 964 694 (43) 651 Other operations 656 – 656 672 – 672
Total 2,659 (126) 2,533 2,070 (43) 2,027 Short-term fluctuations in investment returns on shareholder-backed business 225 (21) 204 (148) (72) (220) Shareholders’ share of actuarial and other gains and losses on defi ned benefit pension schemes 50 – 50 21 – 21 Gain on dilution of Group’s holdings 42 – 42 – – – Amortisation of acquisition accounting adjustments arising on the purchase of REALIC (19) – (19) – – –
Profi t before tax attributable to shareholders 2,957 (147) 2,810 1,943 (115) 1,828
Basic EPS from operating profit based on longer-term investment returns after tax and non-controlling interests 80.2p (3.4)p 76.8p 63.9p (1.1)p 62.8p
Basic EPS based on total profit after tax and non-controlling interests 90.4p (3.9)p 86.5p 58.8p (3.0)p 55.8p
Notes on the eff ect of the change in the accounting policy on operating profi t based on longer-term investment returns A:
(i) Asia insurance operations
Eff ect of change 2012 Łm 2011 Łm
New business Background Acquisition costs on new contracts not deferred under the new policy (14) (16) Business in force at beginning of periodand Reduction in amortisation on reduced DAC balance under the new policy 5 16 Total (9) – accounting
(ii) US insurance operations
Eff ect of change
2012 Łm 2011 Łm policies
New business
Acquisition costs on new contracts not deferred under the new policy (174) (156) Business in force at beginning of period
Reduction in amortisation on reduced DAC balance under the new policy 57 113 Financial
Total (117) (43) statements
174 Financial statements Prudential plc Annual Report 2012
A: Background and accounting policies continued
A5: New accounting pronouncements continued
c Accounting pronouncements endorsed by the EU but not yet eff ective
The following accounting pronouncements potentially relevant to the Group have been issued and endorsed for use in the EU but are not mandatory for adoption for the 31 December 2012 year end.
Amendments to IAS 19, ‘Employee benefi ts’
In June 2011, the IASB published amendments to IAS 19 on accounting for pensions and other post-employment benefits effective from annual periods beginning on or after 1 January 2013. The key revisions to the standard are:
The removal of the corridor option for actuarial gains and losses
The Group does not apply the corridor option, therefore, its removal has no impact to the Group; Presentation of actuarial gains and losses
The Group currently presents actuarial gains and losses in the income statement. Under the revised standard actuarial gains and losses will be presented in ‘other comprehensive income’. Details of the 2012 and 2011 actuarial gains and losses on the current basis are shown in note I3; The replacement of the expected return on plan assets with an amount based on the liability discount rate in the determination of pension costs This revision alters the pension costs included in the Group’s income statement with a corresponding equal and opposite effect on the actuarial gains and losses included in other comprehensive income. The effect of this change for Prudential is not expected to be significant; and Enhanced disclosures, specifically on risks arising from defined benefit plans.
Adoption of the revised IAS 19 standard will have no impact on shareholders’ equity.
Standards on joint arrangements and disclosures: IFRS 11, ‘Joint arrangements’, IFRS 12, ‘Disclosures of interest in other entities’ and IAS 28, ‘Investments in associates and joint ventures’
In May 2011, the IASB issued IFRS 11, ‘Joint arrangements’ to replace IAS 31, ‘Interests in Joint Ventures’. The standard also incorporates the guidance contained in related interpretation in SIC 13, Jointly Controlled Entities – Non-Monetary Contributions by Venturers. The standard requires a joint venture to be recognised as an investment and be accounted for using the equity method in accordance with IAS 28. The attaching changes to disclosure requirements for parties to joint arrangements are specified in IFRS 12, ‘Disclosures of interest in other entities’, which replaces the disclosure requirements of IAS 28, ‘Investments in associates and joint ventures’ and IAS 31, ‘Interests in Joint Ventures’.
The standards are effective from annual periods beginning on or after 1 January 2013 for IFRS as issued by the IASB and
1 January 2014 for IFRS as endorsed by the EU but with early adoption permitted. The Group’s investments in joint ventures are currently accounted for using proportionate consolidation. At 31 December 2012, this approach gave rise to consolidated gross assets and liabilities for the joint ventures of Ł3,946 million and Ł 3,595 million respectively. With the application of IFRS 11, the Group’s investments in joint ventures will be accounted for on a single line equity method thus giving rise at 31 December 2012 to a net interest of Ł351 million included within gross assets.
Similarly, the 2012 gross revenue and charges of Ł1,040 million and Ł942 million respectively, which are currently included on a line-by-line basis within the income statement will, after adoption of the standard, be presented as a single net contribution of Ł98 million. As a consequence, the standard will also have a small impact on profi t before tax as the tax on the profits of the joint ventures will no longer be presented in the tax line, instead the tax charges will be required to be netted against the Group’s share of joint ventures’ income included in profi t before tax. The tax charges for 2012 for the Group’s share of joint ventures’ income was Ł19 million. Adoption of the standard will have no impact on net of tax profi ts or shareholders’ equity.
Standards on consolidation and disclosures: IFRS 10, ‘Consolidated fi nancial statements’, IFRS 12, ‘Disclosures of interest in other entities’ and IAS 27, ‘Separate fi nancial statements’
In May 2011, the IASB issued these three standards to replace IAS 27, ‘Consolidated and separate fi nancial statements’ and SIC 12, ‘Consolidation – Special Purpose Entities’.
The standards are effective from annual periods beginning on or after 1 January 2013. The standards are expected to have a minor impact on the Group’s assessment of its interests in investment funds (including OEICs and unit trusts) and is likely to increase the number of funds consolidated. The Group is currently determining those additional funds that will require consolidation under the requirements of IFRS 10 and the effect of retrospective adjustment to comparative results. The principal effect will be to ‘gross up’ the consolidated balance sheet for:
(i) The difference between the net value of the newly consolidated assets and liabilities and the previous carrying value for the Group’s interest; and
(ii) The equal and opposite liability or minority interest for the external parties’ interests in the funds.
The grossing up effect on the 2012 statement of financial position is not expected to exceed Ł1 billion. Adoption of the standard is expected to have an insignifi cant effect on the retrospectively adjusted comparative 2012 profit and shareholders’ equity in the 2013 results.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 175
IFRS 13, ‘Fair value measurement’
In May 2011, the IASB issued IFRS 13, ‘Fair value measurement’ standard which creates a uniform framework to explain how to measure fair value and aims to enhance fair value disclosures, but it does not change when to measure fair value or require additional fair value measurements. The standard requires additional disclosure on the fair value of non-financial assets and liabilities and enhanced disclosures of recurring level 3 fair value measurements.
The standard is effective from annual periods beginning on or after 1 January 2013, with no adjustment to
comparative results. The Group is currently assessing the impact of the standard but it is not expected to have a material impact on the fair value measurement of the Group’s assets and liabilities. Disclosures will be enhanced in providing detail of the methodology and underlying assumptions used to determine fair value of the Group’s assets and liabilities, in line with the new requirements.
Amendments to IAS 1, ‘Presentation of fi nancial statements’
These amendments, effective on or after 1 January 2013, change the requirement for the disclosure of items presented in other comprehensive income, requiring items to be presented separately based on whether or not they may be recycled to profit or loss in the future. The Group is expecting the amendments to be purely presentational with no significant impact on the Group’s results and financial position.
Off setting Financial Assets and Financial Liabilities (Amendments to IAS 32, ‘Financial instruments: Presentation’ and IFRS 7, ‘Financial instruments: Disclosures’)
The two amendments, effective on or after 1 January 2013 and 2014, respectively clarifies the offsetting criteria for financial assets and financial liabilities in the statement of financial position. The Group is currently assessing the impact of these amendments.
d Accounting pronouncements not yet endorsed by the EU
The following accounting pronouncement potentially relevant to the Group has been issued but not yet endorsed for use in the EU.
IFRS 9, ‘Financial instruments: Classification and measurement’
The new standard, effective on or after 1 January 2015, will automatically replace IAS 39, ‘Financial Instruments – Recognition and
measurement’. Under the new requirements the classification and hence measurement of financial assets would be on two bases,
either amortised cost or fair value through profit or loss, rather than the existing four bases of classification. These requirements
maintain the existing amortised cost measurement for most liabilities but will require changes in fair value due to changes in the
entity’s own credit risk to be recognised in the other comprehensive income (OCI) section of the comprehensive income statement,
rather than within profit or loss for liabilities measured at fair value. On 28 November 2012, the IASB released an Exposure Draft
proposing amendments to IAS 9. The proposed changes would introduce a fair value through other comprehensive income (FVOCI)
category which would include certain financial assets that contain contractual cash flows that are solely payments of principal and
interest and are held in a business model in which assets are managed both in order to collect contractual cash flows and for sale.
The Group is still assessing the full impact of this standard. A:
Background
and
accounting
policies
Financial
statements
176 Financial statements Prudential plc Annual Report 2012
B: Summary of results
B1: Segment disclosure – profi t before tax
The determination of the operating segments and performance measure of the operating segments of the Group are as detailed in note A3(2)(d). Further segmentation of the income statement is provided in note F1 of these financial statements.
Note 2012 Łm 2011* Łm
Asia operations
Insurance operations notes (i), (ii)
Operating result before gain on sale of stake in China Life of Taiwan 869 709
Gain on sale of stake in China Life of Taiwan 51 –
Total Asia insurance operations 920 709
Development expenses(7)(5)
Total Asia insurance operations after development expenses 913 704
Eastspring Investments 75 80
Total Asia operations 988 784
US operations
Jackson (US insurance operations) notes (i),(ii),(iii) 964 651
Broker-dealer and asset management 39 24
Total US operations 1,003 675
UK operations
UK insurance operations: notes (i),(ii)
Long-term business 703 683
General insurance commission note (v) 33 40
Total UK insurance operations 736 723
M&G 371 357
Total UK operations 1,107 1,080
Total segment profit 3,098 2,539
Other income and expenditure
Investment return and other income 13 22
Interest payable on core structural borrowings(280)(286)
Corporate expenditure(231)(219)
Total(498)(483)
RPI to CPI inflation measure change on defined benefit pension schemes note (vi) – 42
Solvency II implementation costs(48)(55)
Restructuring costs note (vii)(19)(16)
Operating profit based on longer-term investment returns 2,533 2,027
Short-term fluctuations in investment returns on shareholder-backed business note (viii) 204(220)
Shareholders’ share of actuarial and other gains and losses on defined benefit pension
schemes note (ix) 50 21
Gain on dilution of Group’s holdings I2 42 –
Amortisation of acquisition accounting adjustments arising on the purchase of REALIC I1(19) –
Profit before tax attributable to shareholders 2,810 1,828
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes
(i) Operating profit based on longer-term investment returns
The Group provides supplementary analysis of IFRS profit before tax attributable to shareholders so as to distinguish operating profit based on longer-term investment returns from other elements of total profit. Operating profit based on longer-term investment returns is the basis on which management regularly reviews the performance of Prudential’s segments as defined by IFRS 8. Further discussion on the determination of operating profit based on longer-term investment returns is provided in note A3(2)(d).
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 177
(ii) Effect of changes to assumptions, estimates and bases of determining life assurance liabilities
The results of the Group’s long-term business operations are affected by changes to assumptions, estimates and bases of preparation.
These are described in notes D2(g), D3(g) and D4(g).
(iii) Jackson operating results based on longer-term investment returns
IFRS basis operating profits for US operations include the following amounts (net of related change in amortisation of deferred acquisition costs, where applicable) so as to derive longer-term investment returns.
2012 Łm 2011 Łm
Debt securities:
Amortisation of interest-related realised gains and losses 72 67
Risk margin reserve charge for longer-term credit-related losses (see note (iv) below)(66)(56)
Equity type investments:
Longer-term returns 54 51
(iv) The risk margin reserve (RMR) charge for longer-term credit-related losses included in operating profit based on longer-term investment returns of Jackson for 2012 is based on an average annual RMR of 26 basis points (2011: 25 basis points) on average book values of US$47.6 billion (2011: US$44.4 billion) as shown below:
2012 2011
Average Average
book Annual expected loss book Annual expected loss
Moody’s rating category value RMR value RMR
(or equivalent under NAIC ratings of MBS) US$m% US$m Łm US$m% US$m Łm
A3 or higher 23,129 0.11(26)(16) 21,255 0.08(17)(11)
Baa1, 2 or 3 21,892 0.26(56)(36) 20,688 0.26(54)(34)
Ba1, 2 or 3 1,604 1.12(18)(11) 1,788 1.04(19)(11)
B1, 2 or 3 597 2.82(17)(11) 474 3.01(14)(9)
Below B3 342 2.44(8)(5) 211 3.88(8)(5)
Total 47,564 0.26(125)(79) 44,416 0.25(112)(70)
Related change to amortisation of deferred acquisition
costs (see below) 21 13 22 14
Risk margin reserve charge to operating profit for
longer-term credit-related losses(104)(66)(90)(56)
Consistent with the basis of measurement of insurance assets and liabilities for Jackson’s IFRS results, the charges and credits to operating profits based on longer-term investment returns are partially offset by related changes to amortisation of deferred acquisition costs.
(v) General insurance commission
UK operations transferred its general insurance business to Churchill in 2002, with general insurance commission representing the commission received net of expenses for Prudential-branded general insurance products as part of this arrangement.
(v) RPI to CPI inflation measure change
During 2011, the Group altered its inflation measure basis for future statutory increases to pension payments for certain tranches of its UK defined benefit pension schemes. This reflected the UK Government’s decision to replace the basis of indexation from Retail Prices Index with Consumer Prices Index.
This resulted in a credit to the operating profit before tax in 2011 of Ł42 million.
(vii) Restructuring costs are incurred in the UK and represent one-off expenses incurred in securing expense savings.
(viii) Short-term fluctuations in investment returns on shareholder-backed business.
2012 Łm 2011* Łm B:
Insurance operations:
Asia 76(92)
US(90)(167) Summary
UK 136 159
Other operations: of
Economic hedge value movement(32) –
Other 114(120) results
Total 204(220)
General overview of defaults
The Group did not experience any defaults on its shareholder-backed debt securities portfolio in 2012 or 2011.
Asia insurance operations
The positive short-term fluctuations of Ł76 million in 2012 reflects unrealised gains on bond assets following a fall in yields in the period. These gains more
than offset the impact of falling interest rates in Hong Kong and the transfer to operating profit of previously booked unrealised gains on the sale of the
Group’s stake in China Life of Taiwan. The realised gain on the sale of the Group’s stake in China Life of Taiwan of Ł51 million is included in the Group’s statements
operating profit based on longer-term investment returns as disclosed above.
The fluctuations of Ł(92) million in 2011 in part reflected equity market falls in Taiwan and negative unrealised value movement on the Group’s stake
in China Life of Taiwan.
178 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B1: Segment disclosure – profit before tax continued
US insurance operations
The short-term fluctuations in investment returns for US insurance operations comprise the following items:
2012 Łm 2011* Łm
Short-term fluctuations relating to debt securities:
Charges in the year:
Defaults – –
Losses on sales of impaired and deteriorating bonds(23)(32)
Bond write downs(37)(62)
Recoveries/reversals 13 42
Total charges in the year note (a)(47)(52)
Less: Risk margin charge included in operating profit based on longer-term investment returns note (iii) 79 70
32 18
Interest-related realised gains:
Arising in the year 94 158
Less: amortisation of gains and losses arising in current and prior years to operating profit based on longer-term
investment returns(91)(84)
3 74
Related change to amortisation of deferred acquisition costs(3)(3)
Total short-term fluctuations related to debt securities 32 89
Derivatives (other than equity-related): market value movements (net of related change to amortisation of deferred
acquisition costs) note (b) 135 554
Net equity hedge results (principally guarantees and derivatives, net of related change to amortisation of deferred
acquisition costs) note (c)(302)(788)
Equity-type investments: actual less longer-term return (net of related change to amortisation of deferred acquisition
costs) A3(d)(i) 23 –
Other items (net of related change to amortisation of deferred acquisition costs) 22(22)
Total(90)(167)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes
(a) The charges on the debt securities of Jackson comprise the following:
2012 Łm 2011 Łm
Residential mortgage-backed securities:
Prime (including agency)(4)(25)
Alt-A(1)(1)
Sub-prime(3) –
Total residential mortgage-backed securities(8)(26)
Corporate debt securities(14)(14)
Other(25)(12)
Total(47)(52)
(b) The gain of Ł135 million (2011: gain of Ł554 million) is principally for the value movement of non-equity free-standing derivatives held to manage interest rate exposures, and for the GMIB reinsurance asset that is considered to be a derivative under IAS 39.
Under IAS 39, unless hedge accounting is applied value movements on derivatives are recognised in the income statement. For the derivatives programme attaching to the general account business, the Group has continued its approach of not seeking to apply hedge accounting under IAS 39. This decision refl ects the inherent constraints of IAS 39 for hedge accounting investments and life assurance assets and liabilities under ‘grandfathered’ US GAAP under IFRS 4.
(c) The amount of Ł(302) million (2011: Ł(788) million) relates to the net equity hedge accounting effect of the equity-based derivatives and associated guarantee liabilities of Jackson’s variable and fixed index annuity business. The details of the value movements excluded from operating profit based on longer-term investment returns are as described in note C. The principal movements are for (i) value for free-standing and GMWB ‘not for life’ embedded derivatives, (ii) accounting values for GMDB and GMWB ‘for life’ guarantees, (iii) fee assessments and claim payments in respect of guarantee liabilities and (iv) related changes to DAC amortisation. In 2012, the charge of (Ł302) million principally reflects fair value movements on free-standing futures contracts and short-dated options. The movements included within the net equity hedge result include the effect of lower interest rates for which the movement was particularly significant in 2011. The value movements on derivatives held to manage this and any other interest rate exposure are included in the Ł135 million (2011: Ł554 million) described above in note (b).
In addition to the items discussed above, for US insurance operations, included within the statement of comprehensive income is an increase in net unrealised gains on debt securities classified as available-for-sale of Ł862 million (2011: increase in net unrealised gains of Ł811 million). Temporary market value movements do not reflect defaults or impairments. Additional details on the movement in the value of the Jackson portfolio are included in note D3.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 179
UK Insurance operations
The gain on short-term fl uctuations in investment returns for UK insurance operations of Ł136 million (2011: Ł159 million) principally refl ect net investment gains arising in the year on fi xed income assets backing the capital of the shareholder-backed annuity business.
Economic hedge value movement
This item represents the costs on short-dated hedge contracts taken out in the fi rst half of 2012 to provide downside protection against severe equity market falls through a period of particular uncertainty with respect to the Eurozone. The hedge contracts were terminated in the second half of 2012.
Other operations
Short-term fl uctuations in investment returns for Other operations in 2012 of Ł114 million primarily represent unrealised fair value movements on Prudential Capital’s bond portfolio. Short-term fl uctuations in investment returns for Other operations in 2011 of Ł(120) million represent unrealised value movements on investments, including centrally held swaps to manage foreign exchange and certain macroeconomic exposures of the Group.
(ix) Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes
2012 Łm 2011 Łm
Actuarial gains and losses
Actual less expected return on scheme assets 11 9
Experience gains on scheme liabilities 15 19
(Losses) gains on changes of assumptions for scheme liabilities(40) 12
(14) 40
Less: amount attributable to the PAC with-profits sub-fund 15(18)
1 22
Other gains and losses
One-off uplift to recognise a portion of PSPS surplus 164 –
Movement in the provision for deficit funding of PSPS –(4)
Less: amount attributable to the PAC with-profits sub-fund(115) 3
49(1)
Total 50 21
The actuarial gains and losses shown in the table above relate to the Prudential Staff Pension Scheme (PSPS), and the Scottish Amicable and M&G schemes. The amounts did not include actuarial gains and losses for the Prudential Staff Pension Scheme, for which the Group has not recognised a substantial portion of its interest in the scheme’s underlying surplus.
For the 2011 comparatives, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes comprises the aggregate eff ect of actual less expected returns on scheme assets, experience gains and losses, the eff ect of changes in assumptions and altered provisions for defi cit funding, where relevant. For 2012, these items also apply. However, the shareholders’ share of actuarial and other gains and losses on defi ned benefi t pension schemes also includes Ł49 million for the eff ect of partial recognition of surplus of the main Prudential Staff Pension Scheme. This credit arose from an altered funding arrangement following the 5 April 2011 triennial valuation. Further details on the Group’s defi ned benefi t pension schemes are shown in note I3.
B2: Earnings per share
Basic earnings per share is calculated by dividing the earnings attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the year, excluding those held in employee share trusts and consolidated unit trusts and open
B:
ended investment companies (OEICs), which are treated as cancelled.
For diluted earnings per share, the weighted average number of shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Group’s only class of potentially dilutive ordinary shares are those share options granted to employees Summary where the exercise price is less than the average market price of the Company’s ordinary shares during the year. No adjustment is
of
made if the impact is anti-dilutive overall. Earnings per share are calculated based on earnings attributable to ordinary shareholders, after related tax and non-controlling results interests.
2012
Net of tax
Non- and non- Basic Diluted Financial Before controlling controlling earnings earnings Note tax Tax interests interests per share per share note B1 note F5 Łm Łm Łm Łm pence pence
Based on operating profit based on longer-term investment statements returns 2,533 (582) – 1,951 76.8p 76.7p
Short-term fluctuations in investment returns on shareholder-backed business B1 204 (26) – 178 7.0p 7.0p Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes B1 50 (12) – 38 1.5p 1.5p Gain on dilution of Group’s holdings I2 42 – – 42 1.7p 1.7p Amortisation of acquisition accounting adjustments arising on the purchase of REALIC I1 (19) 7 – (12) (0.5)p (0.5)p
Based on profit for the year 2,810 (613) – 2,197 86.5p 86.4p
180 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B2: Earnings per share continued
2011* Łm
Net of tax
Non- and non- Basic Diluted
Before controlling controlling earnings earnings
Note tax Tax interests interests per share per share
note B1 note F5
Łm Łm Łm Łm pence pence
Based on operating profit based on longer-term investment
returns 2,027(433)(4) 1,590 62.8p 62.7p
Short-term fluctuations in investment returns on
shareholder-backed business B1(220) 29 –(191)(7.6)p(7.6)p
Shareholders’ share of actuarial and other gains and losses
on defined benefit pension schemes B1 21(5) – 16 0.6p 0.6p
Based on profit for the year 1,828(409)(4) 1,415 55.8p 55.7p
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Number of shares
A reconciliation of the weighted average number of ordinary shares used for calculating basic and diluted earnings per share is set out as below:
2012 2011
millions millions
Weighted average shares for calculation of basic earnings per share 2,541 2,533
Shares under option at end of year 9 13
Number of shares that would have been issued at fair value on assumed option exercise(6)(8)
Weighted average shares for calculation of diluted earnings per share 2,544 2,538
B3: Dividends
2012 Łm 2011 Łm
Dividends declared and paid in reporting year
Parent company:
Interim dividend (2012: 8.40p; 2011: 7.95p) 215 203
Final dividend for prior period (2012: 17.24p; 2011: 17.24p) 440 439
Total 655 642
Dividends paid in cash, as set in the consolidated statement of cash flows for 2012 were Ł655 million (2011: Ł642 million).
2012 Łm 2011 Łm
Parent company dividends relating to reporting year:
Interim dividend (2012: 8.40p; 2011: 7.95p) 215 203
Final dividend (2012: 20.79p; 2011: 17.24p) 532 439
Total 747 642
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 181
Dividend per share
Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders. The final dividend for the year ended 31 December 2011 of 17.24 pence per ordinary share was paid to eligible shareholders on 24 May 2012 and the 2012 interim dividend of 8.4 pence per ordinary share was paid to eligible shareholders on 27 September 2012.
The Board has decided to rebase the full year dividend upwards by 4 pence, reflecting the strong progress made in both the earnings and free surplus generation of the business and in the delivery of our financial objectives. In line with this, the directors recommend a final dividend of 20.79 pence per share (2011: 17.24 pence), which brings the total dividend for the year to 29.19 pence (2011: 25.19 pence), representing an increase of 15.9 per cent over 2011.
The 2012 final dividend of 20.79 pence per ordinary share will be paid on 23 May 2013 in sterling to shareholders on the principal register and the Irish branch register at 6.00pm BST on Tuesday, 2 April 2013 (Record Date), and in Hong Kong dollars to shareholders on the Hong Kong branch register at 4.30pm Hong Kong time on the Record Date (HK Shareholders). Holders of US American Depositary Receipts (US Shareholders) will be paid their dividends in US dollars on or about 3 June 2013. The final dividend will be paid on or about 30 May 2013 in Singapore dollars to shareholders with shares standing to the credit of their securities accounts with The Central Depository (Pte.) Limited (CDP) at 5.00pm Singapore time on the Record Date (SG Shareholders). The dividend payable to the HK Shareholders will be translated using the exchange rate quoted by the WM Company at the close of business on 12 March 2013. The exchange rate at which the dividend payable to the SG Shareholders will be translated into SG$, will be determined by CDP. The dividend will distribute an estimated Ł532 million of shareholders’ funds.
Shareholders on the principal register and Irish branch register will be able to participate in a Dividend Reinvestment Plan.
B4: Exchange translation
Exchange movement recognised in other comprehensive income
2012 Łm 2011* Łm
Asia operations(87)(28)
US operations(187) 35
Unallocated to a segment (central funds) 60(44)
(214)(37)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
The movements for Asia and US operations reflect the application of year end exchange rates to the assets and liabilities, and average
exchange rates to the income statement on translation of these operations into the presentation currency of the Group. The movement
unallocated to a segment mainly reflects the translation of currency borrowings and forward contracts which have been designated as
a net investment hedge against the currency risk of the net investment in Jackson.
The exchange rates applied were: B:
Closing Closing
rate at Average rate at Average
Local currency: Ł 31 Dec 2012 for 2012 31 Dec 2011 for 2011 Summary
Hong Kong 12.60 12.29 12.07 12.48 of
Indonesia 15,665.76 14,842.01 14,091.80 14,049.41 results
Malaysia 4.97 4.89 4.93 4.90
Singapore 1.99 1.98 2.02 2.02
India 89.06 84.70 82.53 74.80
Vietnam 33,875.42 33,083.59 33,688.16 33,139.22 Financial
US 1.63 1.58 1.55 1.60
statements
182 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B5: Group statement of fi nancial position
To explain more comprehensively the assets, liabilities and capital of the Group’s businesses, it is appropriate to provide analyses of the Group’s statement of fi nancial position by operating segment and type of business.
The tables below aggregate the three asset management segments for ease of presentation and hence should be read in conjunction with the associated tables on asset management in note E2.
a Group statement of financial position by operating segment i Position at 31 December 2012
2012 Łm
Unallo-
Asset cated to a Intra-
Insurance operations Total manage- segment group 31 Dec insurance ment (central elimina- Group UK US Asia operations operations operations) tions total
By operating segment D2 D3 D4 E2 Assets
Intangible assets attributable to shareholders:
Goodwill – – 239 239 1,230 – – 1,469
Deferred acquisition costs and other intangible assets 105 3,222 908 4,235 14 18 – 4,267
Total 105 3,222 1,147 4,474 1,244 18 – 5,736
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes 178 – – 178 – – – 178
Deferred acquisition costs and other intangible assets 6 – 72 78 – – – 78
Total H1 184 – 72 256 – – – 256
Total intangible assets 289 3,222 1,219 4,730 1,244 18 – 5,992
Deferred tax assets H4 183 1,889 83 2,155 107 52 – 2,314 Other non-investment and non-cash assets H3,H6 5,424 6,792 1,117 13,333 1,051 3,766 (6,113) 12,037
Investments of long-term business and other operations:
Investment properties 10,852 24 4 10,880 – – – 10,880
Investments accounted for using the equity method 72 – – 72 41 – – 113
Financial investments:
Loans 3,373 6,235 1,014 10,622 1,199 – – 11,821
Equity securities and portfolio holdings in unit trusts 36,027 49,551 14,310 99,888 70 – – 99,958 Debt securities B5(c) 83,862 32,993 21,402 138,257 1,846 – – 140,103 Other investments 4,576 2,296 957 7,829 44 27 – 7,900 Deposits 11,131 211 1,227 12,569 84 – – 12,653
Total investments G1,H7,H8 149,893 91,310 38,914 280,117 3,284 27 – 283,428
Properties held for sale H9 98 – – 98 – – – 98
Cash and cash equivalents H10 2,638 513 1,668 4,819 1,083 482 – 6,384
Total assets 158,525 103,726 43,001 305,252 6,769 4,345 (6,113) 310,253
Note
Further segmental analysis:
The non-current assets of the Group comprise goodwill, intangible assets other than DAC and present value of acquired in-force business and property, plant and equipment included within ‘Other non-investment and non-cash assets’. Items defi ned as fi nancial instruments or related to insurance contracts are excluded. The Group’s total non-current assets at 31 December comprise:
2012 Łm 2011 Łm
UK including insurance operations, M&G and central operations 1,927 1,906
US 152 144
Asia* 640 681
Total 2,719 2,731
* No individual country in Asia held non-current assets at the end of the year which exceeds 10 per cent of the Group total.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 183
2012 Łm
Unallo-
Asset cated to a Intra-
Insurance operations Total manage- segment group 31 Dec insurance ment (central elimina- Group UK US Asia operations operations operations) tions total
By operating segment D2 D3 D4 E2 Equity and liabilities
Equity
Shareholders’ equity H11 3,033 4,343 2,529 9,905 1,937 (1,483) – 10,359
Non-controlling interests 1 – 4 5 – – – 5
Total equity 3,034 4,343 2,533 9,910 1,937 (1,483) – 10,364
Liabilities
Policyholder liabilities and unallocated surplus of with-profits funds:
Insurance contract liabilities H12 84,266 90,192 34,126 208,584 – – – 208,584
Investment contract liabilities with discretionary participation features G1 33,464 – 348 33,812 – – – 33,812 Investment contract liabilities without discretionary participation features G1 16,182 2,069 127 18,378 – – – 18,378
Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds) D2, H12 10,526 – 63 10,589 – – – 10,589
Total policyholder liabilities and unallocated surplus of with-profits funds 144,438 92,261 34,664 271,363 – – – 271,363
Core structural borrowings of shareholder-financed operations: H13
Subordinated debt – – – – – 2,577 – 2,577 Other – 153 – 153 275 549 – 977
Total – 153 – 153 275 3,126 – 3,554
Operational borrowings attributable to shareholder-financed operations 127 26 7 160 1 2,084 – 2,245 Borrowings attributable to with-profits operations 1,033 – – 1,033 – – – 1,033
Other non-insurance liabilities:
B:
Obligations under funding, securities lending and sale and repurchase agreements 1,461 920 55 2,436 – – – 2,436
Net asset value attributable to unit holders of Summary consolidated unit trusts and similar funds 2,307 25 1,851 4,183 162 – – 4,345 of
Deferred tax liabilities 1,185 2,168 588 3,941 13 16 – 3,970 Current tax liabilities 237 – 49 286 8 151 – 445 results
Accruals and deferred income 429 – 110 539 266 28 – 833
Other creditors 2,766 611 1,601 4,978 3,771 145 (6,113) 2,781 Provisions 291 20 66 377 149 75 – 601
Derivative liabilities 1,007 645 837 2,489 150 190 – 2,829 Financial Other liabilities 210 2,554 640 3,404 37 13 – 3,454
Total 9,893 6,943 5,797 22,633 4,556 618 (6,113) 21,694
Total liabilities 155,491 99,383 40,468 295,342 4,832 5,828 (6,113) 299,889 statements Total equity and liabilities 158,525 103,726 43,001 305,252 6,769 4,345 (6,113) 310,253
184 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B5: Group statement of financial position continued
i Position at 31 December 2011
2011* Łm
Unallo-
Asset cated to a Intra-
Insurance operations Total manage- segment group 31 Dec
insurance ment(central elimina- Group
UK US Asia operations operations operations) tions total
By operating segment D2 D3 D4 E2
Assets
Intangible assets attributable to shareholders:
Goodwill – – 235 235 1,230 – – 1,465
Deferred acquisition costs and other
intangible assets 113 3,115 977 4,205 16 13 – 4,234
Total H1 113 3,115 1,212 4,440 1,246 13 – 5,699
Intangible assets attributable to with-profits funds:
In respect of acquired subsidiaries for
venture fund and other investment
purposes 178 – – 178 – – – 178
Deferred acquisition costs and other
intangible assets 6 – 83 89 – – – 89
Total H2 184 – 83 267 – – – 267
Total intangible assets 297 3,115 1,295 4,707 1,246 13 – 5,966
Deferred tax assets 231 1,392 115 1,738 129 409 – 2,276
Other non-investment and non-cash assets H3,H6 4,771 1,542 1,024 7,337 1,000 4,532(6,231) 6,638
Investments of long-term business and other
operations:
Investment properties 10,712 35 10 10,757 – – – 10,757
Investments accounted for using the equity
method 70 – – 70 – – – 70
Financial investments:
Loans 3,115 4,110 1,233 8,458 1,256 – – 9,714
Equity securities and portfolio holdings
in unit trusts 36,722 38,036 11,997 86,755 594 – – 87,349
Debt securities B5(c) 77,953 27,022 17,681 122,656 1,842 – – 124,498
Other investments 4,568 2,376 470 7,414 78 17 – 7,509
Deposits 9,287 167 1,165 10,619 89 – – 10,708
Total investments G1,H7,H8 142,427 71,746 32,556 246,729 3,859 17 – 250,605
Properties held for sale H9 – 3 – 3 – – – 3
Cash and cash equivalents H10 2,965 271 1,977 5,213 1,735 309 – 7,257
Total assets 150,691 78,069 36,967 265,727 7,969 5,280(6,231) 272,745
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 185
2011* Łm
Unallo-
Asset cated to a Intra-
Insurance operations Total manage- segment group 31 Dec
insurance ment(central elimina- Group
UK US Asia operations operations operations) tions total
By operating segment D2 D3 D4 E2
Equity and liabilities
Equity
Shareholders’ equity H11 2,581 3,761 2,306 8,648 1,783(1,867) – 8,564
Non-controlling interests 33 – 5 38 5 – – 43
Total equity 2,614 3,761 2,311 8,686 1,788(1,867) – 8,607
Liabilities
Policyholder liabilities and unallocated surplus
of with-profits funds:
Insurance contract liabilities H12 82,732 67,278 30,353 180,363 – – – 180,363
Investment contract liabilities with
discretionary participation features G1 29,348 – 397 29,745 – – – 29,745
Investment contract liabilities without
discretionary participation features G1 14,944 1,911 112 16,967 – – – 16,967
Unallocated surplus of with-profits funds
(reflecting application of ‘realistic’ basis
provisions for UK regulated with-profits
funds) D2, H12 9,165 – 50 9,215 – – – 9,215
Total policyholder liabilities and unallocated
surplus of with-profits funds 136,189 69,189 30,912 236,290 – – – 236,290
Core structural borrowings of
shareholder-financed operations: G1, H13
Subordinated debt – – – – – 2,652 – 2,652
Other – 160 – 160 250 549 – 959
Total – 160 – 160 250 3,201 – 3,611
Operational borrowings attributable to
shareholder-financed operations 103 127 141 371 13 2,956 – 3,340
Borrowings attributable to with-profits
operations 972 – – 972 – – – 972
Other non-insurance liabilities:
Obligations under funding, securities lending B:
and sale and repurchase agreements H4, H14, H15 1,945 1,169 – 3,114 – – – 3,114
Net asset value attributable to unit holders of Summary
consolidated unit trusts and similar funds 2,043 18 1,101 3,162 678 – – 3,840
Deferred tax liabilities 1,349 1,818 506 3,673 5 251 – 3,929 of
Current tax liabilities 553 – 116 669 106 155 – 930 results
Accruals and deferred income 321 – 103 424 290 22 – 736
Other creditors 2,829 548 660 4,037 4,493 245(6,231) 2,544
Provisions 266 13 47 326 133 70 – 529
Derivative liabilities 1,298 887 480 2,665 182 207 – 3,054 Financial
Other liabilities 209 379 590 1,178 31 40 – 1,249
Total 10,813 4,832 3,603 19,248 5,918 990(6,231) 19,925
Total liabilities 148,077 74,308 34,656 257,041 6,181 7,147(6,231) 264,138 statements
Total equity and liabilities 150,691 78,069 36,967 265,727 7,969 5,280(6,231) 272,745
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
186 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
ii Group statement of fi nancial position – additional analysis by business type
2012 Łm 2011* Łm Shareholder-backed business Unit- Unallo-linked Asset cated to a Intra-Partici- and Non- manage- segment group 31 Dec 31 Dec pating variable linked ment (central elimina- Group Group funds annuity business operations operations) tions total total
E2
Assets
Intangible assets attributable to shareholders:
Goodwill – – 239 1,230 – – 1,469 1,465 Deferred acquisition costs and other intangible assets – – 4,235 14 18 – 4,267 4,234
Total – – 4,474 1,244 18 – 5,736 5,699
Intangible assets attributable to with-profits funds: In respect of acquired subsidiaries for venture fund and other investment purposes 178 – – – – – 178 178 Deferred acquisition costs and other intangible assets 78 – – – – – 78 89
Total 256 – – – – – 256 267
Total intangible assets 256 – 4,474 1,244 18 – 5,992 5,966
Deferred tax assets 114 – 2,041 107 52 – 2,314 2,276 Other non-investment and non-cash assets 3,133 508 9,692 1,051 3,766 (6,113) 12,037 6,638 Investments of long-term business and other operations: Investment properties 8,659 622 1,599 – – – 10,880 10,757 Investments accounted for using the equity method – – 72 41 – – 113 70 Financial investments: Loans 2,709 – 7,913 1,199 – – 11,821 9,714
Equity securities and portfolio holdings in unit trusts 25,105 73,860 923 70 – – 99,958 87,349 Debt securities 62,002 9,504 66,751 1,846 – – 140,103 124,498 Other investments 4,745 57 3,027 44 27 – 7,900 7,509 Deposits 9,470 1,396 1,703 84 – – 12,653 10,708
Total investments 112,690 85,439 81,988 3,284 27 – 283,428 250,605
Properties held for sale 98 – – – – – 98 3 Cash and cash equivalents 1,721 1,310 1,788 1,083 482 – 6,384 7,257
Total assets 118,012 87,257 99,983 6,769 4,345 (6,113) 310,253 272,745
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy
described in note A5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 187
2012 Łm 2011* Łm Shareholder-backed business Unit- Unallo-linked Asset cated to a Intra-Partici- and Non- manage- segment group 31 Dec 31 Dec pating variable linked ment (central elimina- Group Group funds annuity business operations operations) tions total total
E2
Equity and liabilities
Equity
Shareholders’ equity – – 9,905 1,937 (1,483) – 10,359 8,564 Non-controlling interests 1 – 4 – – – 5 43
Total equity 1 – 9,909 1,937 (1,483) – 10,364 8,607
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) 97,795 85,523 77,456 – – – 260,774 227,075 Unallocated surplus of with-profits funds 10,589 – – – – – 10,589 9,215
Total policyholder liabilities and unallocated surplus of with-profits funds 108,384 85,523 77,456 – – – 271,363 236,290
Core structural borrowings of shareholder-financed operations:
Subordinated debt – – – – 2,577 – 2,577 2,652 Other – – 153 275 549 – 977 959
Total – – 153 275 3,126 – 3,554 3,611
Operational borrowings attributable to shareholder-financed operations – 1 159 1 2,084 – 2,245 3,340 Borrowings attributable to with-profits operations 1,033 – – – – – 1,033 972 Deferred tax liabilities 1,086 46 2,809 13 16 – 3,970 3,929 Other non-insurance liabilities 7,508 1,687 9,497 4,543 602 (6,113) 17,724 15,996
Total liabilities 118,011 87,257 90,074 4,832 5,828 (6,113) 299,889 264,138
Total equity and liabilities 118,012 87,257 99,983 6,769 4,345 (6,113) 310,253 272,745
B:
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5. Summary of results
Financial statements
188 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B5: Group statement of fi nancial position continued
b Reconciliation of movement in policyholder liabilities and unallocated surplus of with-profi ts funds
A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of the Group from the beginning of the year to the end of the year is as follows:
Insurance operations Łm
Note UK US Asia Total
At 1 January 2011 135,717 60,523 28,740 224,980
Comprising:
Policyholder liabilities 125,530 60,523 28,674 214,727
Unallocated surplus of with-profits funds 10,187 – 66 10,253
Premiums 6,988 12,914 5,079 24,981
Surrenders(4,255)(4,270)(2,237)(10,762)
Maturities/deaths(7,813)(820)(664)(9,297)
Net flows(5,080) 7,824 2,178 4,922
Shareholders’ transfers post-tax(216) –(30)(246)
Investment-related items and other movements 5,862 136 365 6,363
Foreign exchange translation differences(94) 706(341) 271
As at 31 December 2011 136,189 69,189 30,912 236,290
Comprising:
Policyholder liabilities 127,024 69,189 30,862 227,075
Unallocated surplus of with-profits funds 9,165 – 50 9,215
At 1 January 2012 136,189 69,189 30,912 236,290
Premiums 8,340 14,907 5,620 28,867
Surrenders(4,785)(4,356)(2,541)(11,682)
Maturities/deaths(8,009)(954)(658)(9,621)
Net flows(4,454) 9,597 2,421 7,564
Shareholders’ transfers post-tax(205) –(31)(236)
Investment-related items and other movements 13,006 4,241 2,178 19,425
Foreign exchange translation differences(98)(3,678)(816)(4,592)
Acquisition of REALIC I1 – 12,912 – 12,912
At 31 December 2012 144,438 92,261 34,664 271,363
Comprising:
Policyholder liabilities 133,912 92,261 34,601 260,774
Unallocated surplus of with-profits funds 10,526 – 63 10,589
Average policyholder liability balances*
2012 130,468 77,497 32,732 240,697
2011 126,277 64,856 29,768 220,901
* Averages have been based on opening and closing balances and adjusted for acquisitions and disposals in the period and exclude unallocated surplus of with-profits funds.
The items above represent the amount attributable to changes in policyholder liabilities and unallocated surplus of with-profits funds as a result of each of the components listed. The policyholder liabilities shown include investment contracts without discretionary participation features (as defined in IFRS 4) and their full movement in the year. The items above are shown gross of reinsurance.
The analysis includes the impact of premiums, claims and investment movements on policyholders’ liabilities. The impact does not represent premiums, claims and investment movements as reported in the income statement. For example, the premiums shown above will exclude any deductions for fees/charges and claims represent the policyholder liabilities provision released rather than the claim amount paid to the policyholder.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 189
c Debt securities and loans i Information on the credit risks of debt securities
2012 Łm 2011 Łm
Insurance operations Total Asset
insurance manage- Group Group
UK US Asia operations ment total total
S&P – AAA 9,200 187 785 10,172 1,046 11,218 12,593
S&P – AA+ to AA- 9,623 6,343 5,523 21,489 106 21,595 17,038
S&P – A+ to A- 23,000 7,728 3,282 34,010 206 34,216 31,161
S&P – BBB+ to BBB- 17,720 10,230 1,906 29,856 235 30,091 25,860
S&P – Other 3,043 1,173 3,132 7,348 37 7,385 6,346
62,586 25,661 14,628 102,875 1,630 104,505 92,998
Moody’s – Aaa 8,446 55 1,389 9,890 135 10,025 9,615
Moody’s – Aa1 to Aa3 1,420 18 271 1,709 36 1,745 806
Moody’s – A1 to A3 927 21 169 1,117 – 1,117 1,352
Moody’s – Baa1 to Baa3 1,385 56 375 1,816 12 1,828 1,228
Moody’s – Other 307 13 112 432 – 432 318
12,485 163 2,316 14,964 183 15,147 13,319
Implicit ratings of MBS based on NAIC valuations
(see below)
NAIC 1 – 2,934 – 2,934 – 2,934 2,577
NAIC 2 – 207 – 207 – 207 147
NAIC 3-6 – 321 – 321 – 321 368
– 3,462 – 3,462 – 3,462 3,092
Fitch 527 184 533 1,244 21 1,265 1,039
Other 8,264 3,523 3,925 15,712 12 15,724 14,050
Total debt securities 83,862 32,993 21,402 138,257 1,846 140,103 124,498
In the table above, with the exception of some 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. For some mortgage-backed securities within Jackson, the table above includes these
securities using the regulatory ratings detail issued by the National Association of Insurance Commissioners (NAIC). These
regulatory ratings levels were established by external third parties (PIMCO for residential mortgage-backed securities and
BlackRock Solutions for commercial mortgage-backed securities). Notes D2(c), D3(c), D4(c) and E2 provide further details on B:
the credit risks of debt securities by segment. Summary
of
results
Financial
statements
190 Financial statements Prudential plc Annual Report 2012
B: Summary of results continued
B5: Group statement of fi nancial position continued
ii Group’s exposure to holdings in asset-backed securities
The Group’s exposure to holdings in asset-backed securities (ABS), which comprise residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralised debt obligations (CDO) funds and other asset-backed securities, at 31 December 2012 is as follows:
2012 Łm 2011 Łm
Shareholder-backed operations:
UK insurance operations (2012: 34% AAA, 17% AA) note (i) 1,408 1,358
US insurance operations D3 5,626 5,380
Asia insurance operations note (ii) 144 176
Asset management operations note (iii) 566 594
7,744 7,508
With-profits operations:
UK insurance operations (2012: 60% AAA, 9% AA) note (i) 5,850 5,351
Asia insurance operations note (ii) 241 454
6,091 5,805
Total 13,835 13,313
Notes
(i) UK insurance operations
All of the exposure of the shareholder-backed business relates to the UK market and primarily relates to investments held by PRIL. Of the Ł5,850 million (2011: Ł5,351 million) relating to with-profits business, Ł1,697 million (2011: Ł1,314 million) relates to exposure to the US and with the remaining exposure being primarily to the UK market.
(ii) Asia insurance operations
The Asia insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations. Of the Ł241 million, 63 per cent
(2011: Ł454 million, 75 per cent) are investment grade.
(iii) Asset management operations
Asset management operations’ exposure to asset-backed securities is held by Prudential Capital with no sub-prime exposure. Of the Ł566 million, 77 per cent (2011: Ł595 million, 77 per cent) are graded AAA.
iii Group sovereign debt exposure
The exposures held by the shareholder-backed business and with-profits funds in sovereign debts and bank debt securities at 31 December 2012 are given within the Risk and capital management section of the Business review under Credit risk.
iv Loans
Information on the credit quality of the portfolio of loans, which almost wholly is for amounts which are neither past due or impaired is shown in notes D2, D3, D4 and E2. Details of allowances for loans, losses and amounts past due are shown in notes G1 and G2. No additional analysis is provided of the element of loans and receivables that were neither past due nor impaired from those of the total portfolio on the grounds of the immateriality of the difference between the neither past due nor impaired element and the total portfolio.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 191
C: Group risk management
C: Group risk management
Disclosures concerning the Group’s risk framework and the management of the risk attached to the Group’s fi nancial instruments and insurance liabilities, together with the inter-relationship with the management of capital have been included in the audited sections of the Risk and capital management disclosure in the Business review. Additional disclosures are shown in section D1.
C: Group risk management Financial statements
192 Financial statements Prudential plc Annual Report 2012
D: Life assurance business
D1: Group overview
a Products and classifi cation for IFRS reporting
The measurement basis of assets and liabilities of long-term business contracts is dependent upon the classification of the contracts under IFRS. Under IFRS 4, contracts are initially classified as being either ‘insurance’ contracts, if the level of insurance risk in the contracts is signifi cant, or ‘investment’ contracts, if the risk is insignifi cant.
Insurance contracts
Insurance contracts are permitted to be accounted for under previously applied GAAP. The Group has chosen to adopt this approach. However, as an improvement to accounting policy, permitted by IFRS 4, the Group has applied the measurement principles for with-profits contracts of UK regulated entities and disclosures of the UK Standard FRS 27 from 1 January 2005. An explanation of the provisions under FRS 27 is provided in note D2.
Under the previously applied GAAP, UK GAAP, the assets and liabilities of contracts are reported in accordance with the Modified Statutory Basis (MSB) of reporting as set out in the ABI SORP.
The insurance contracts of the Group’s shareholder-backed business fall broadly into the following categories:
UK insurance operations
– bulk and individual annuity business, and other categories of non participating UK business; Jackson
– fi xed and variable annuity business and life insurance; and Prudential Corporation Asia
– non-participating term, whole life, and unit-linked policies, together with accident and health policies.
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.
For investment contracts that do not contain discretionary participation features, IAS 39 and, where the contract includes an investment management element, IAS 18, apply measurement principles to assets and liabilities attaching to the contract that may diverge from those previously applied.
Contracts of the Group, which are classified as investment contracts that do not contain discretionary participation features, can be summarised as:
UK
– certain unit-linked savings and similar contracts;
Jackson
• Guaranteed Investment Contracts (GICs) and funding agreements
• minor amounts of ‘annuity certain’ contracts; and
Prudential Corporation Asia
– minor amounts for a number of small categories of business.
b Concentration of risk i Business accepted
The Group’s exposure to life assurance risks is well diversified. This is achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types.
As part of the risk management framework, the Group regularly monitors concentration of risk using a variety of risk monitoring tools, including scenario testing and sensitivity analysis of the Group’s capital and profi tability metrics involving IGD, Group economic capital, EEV and IFRS, to help identify concentrations of risks by risk types, products and business units, as well as the benefits of diversification of risks.
An example of the diversification benefits for Prudential is that adverse scenarios do not affect all business units in the same way, providing natural hedges within the Group. For example, the Group’s US business is sensitive to increasing interest rates, whereas, in contrast, several business units in Asia benefit from increasing rates. Conversely, these Asian business units are sensitive towards low interest rates, whereas certain products in the US benefit from falling interest rates. The economic capital framework also takes into account situations where factors are correlated, for example, the extent of correlation between UK and US economies.
Business units are also required to disclose to the Group risk function all material risks, along with information on their severity and likelihood, and mitigating actions taken or planned.
Credit risk remains one of the largest risk exposures. This reflects the relative size of exposure in Jackson and the UK shareholder annuities business. The Group manages concentration of credit risks by setting limits on the maximum exposure to each counterparty based on their credit ratings.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 193
ii Ceded business
The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group of liability to its policyholders, the Group participates in such agreements for the purpose of managing its loss exposure. The Group evaluates the financial condition of its reinsurers and monitors concentration of credit risk from similar geographic regions, activities or economic characteristics of the reinsurers to minimise its exposure from reinsurer insolvencies. At 31 December 2012 the reinsurers’ share of insurance contract liabilities was Ł6,859 million (2011: Ł1,344 million). The increase arises from the acquisition of REALIC. Further details are shown in note D3(f) and I1. At 31 December 2012, 97 per cent (2011: 91 per cent) of the reinsurance recoverable insurance assets were ceded by the Group’s UK and US operations, of which 92 per cent (2011: 94 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above.
c Guarantees
Notes D2(d), D3(d) and D4(d) provide details of guarantee features of the Group’s life assurance products. In the UK, guarantees of the with-profi ts products are valued for accounting purposes on a market consistent basis for 2012 as described in section D2(e)(ii). The UK business also has products with guaranteed annuity option features, mostly within Scottish Amicable Insurance Fund (SAIF), as described in section D2(d). There is little exposure to financial options and guarantees in the shareholder-backed business of the UK operations. The US business annuity products have a variety of option and guarantee features as described in section D3(d). Jackson’s derivative programme seeks to
manage the exposures as described in section D3(h).
d Sensitivity of EEV shareholders’ basis profi t and equity to market and other risks
The Group prepares supplementary EEV basis financial statements for half-yearly and annual publication. These statements include sensitivity disclosures which are part of the market risk information provided to key management.
e Sensitivity of IFRS basis profit or loss and shareholders’ equity to market and other risks i Overview of risks by business unit
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.
Market risk is the risk that the fair value or future cash flows of a financial instrument or, in the case of liabilities of insurance contracts, their carrying value, will fluctuate because of changes in market prices. Market risk comprises three types of risk, namely:
Currency risk: due to changes in foreign exchange rates; Interest rate risk: due to changes in market interest rates; and
Other price risk: due to fluctuations in market prices (other than those arising from interest rate risk or currency risk).
Policyholder liabilities relating to the Group’s life assurance businesses are also sensitive to the effects of other changes in experience, or expected future experience, such as for mortality, other insurance risk and lapse risk.
Three key points are to be noted, namely:
D:
The Group’s with-profits and unit-linked funds absorb most market risk attaching to the funds’ investments. Except for second Life
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 assurance
shareholder-backed business are for debt securities.
The most significant items for which the IFRS shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business
business is sensitive to these variables are shown in the following tables. The distinction between direct and indirect exposure is
not intended to indicate the relative size of the sensitivity.
Financial
statements
194 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D1: Group overview continued
Type of business Market and credit risk Insurance and lapse risk
Investments/derivatives Liabilities/unallocated surplus Other exposure
UK insurance operations (see also section D2(h))
With-profits business Net neutral direct exposure (Indirect exposure only) Investment Persistency risk to
(including Prudential performance subject to future shareholder
Annuities Limited) smoothing through transfers
declared bonuses
SAIF sub-fund Net neutral direct exposure (Indirect exposure only) Asset management fees
earned by M&G
Unit-linked business Net neutral direct exposure (Indirect exposure only) Investment Persistency risk
performance through
asset management fees
Asset/liability mismatch risk
Shareholder-backed Credit risk for assets Mortality experience
annuity business covering liabilities and and assumptions for
shareholder capital longevity
Interest rate risk for assets
in excess of liabilities
ie assets representing
shareholder capital
US insurance operations (see also section D3(h))
All business Currency risk Persistency risk
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
Fixed indexed annuity Derivative hedge Incidence of equity
business programme to the extent participation features
not fully hedged against
liability and fund
performance
Fixed indexed annuities, Credit risk Spread difference Lapse risk, but the
Fixed annuities and Interest rate risk between earned effects of extreme
GIC business rate and events are mitigated
rate credited by the application of
to policyholders market value
adjustments and by
the use of swaption
contracts
Profit and loss and
shareholders’ equity are
volatile for these risks as
they affect the values of
derivatives and embedded
derivatives and
impairment losses.
In addition, shareholders’
equity is volatile for the
incidence of these risks on
unrealised appreciation of
fixed income securities
classified as available-for-sale
under IAS 39
Notes on the Group financial statements Prudential plc Annual Report 2012 195
Type of business Market and credit risk Insurance and lapse risk
Investments/derivatives Liabilities/unallocated surplus Other exposure
Asia insurance operations (see also section D4(h))
All business Currency risk Mortality and
morbidity risk
Persistency risk
With-profits business Net neutral direct exposure (Indirect exposure only) Investment performance
subject to smoothing
through declared
bonuses
Unit-linked business Net neutral direct exposure (Indirect exposure only) Investment performance
through asset
management fees
Asset/liability mismatch risk
Non-participating Credit risk Interest rates for those
business Interest rate and operations where the
price risk basis of insurance
liabilities is sensitive to
current market
movements .
ii IFRS shareholder results – Exposures for market and other risk
Key Group exposures
Detailed analyses of sensitivity of IFRS basis profit or loss and shareholders’ equity to key market and other risks are provided in
notes D2(h), D3(h), D4(h) and E4. The sensitivity analyses provided show the effect on profit or loss and shareholders’ equity to
changes in the relevant risk variables, all of which are reasonably possible at the relevant balance sheet date. Other features to note
are as follows.
UK
The IFRS operating profit based on longer-term investment returns for UK insurance operations has high potential sensitivity for
changes to longevity assumptions affecting the carrying value of liabilities to policyholders for UK shareholder-backed annuity
business. At the total IFRS profit level, the result is particularly sensitive to temporary value movements on assets backing US and
Asia policyholder liabilities (which in general are measured on a basis that is insensitive to current market movements) and
shareholder equity.
D:
US Life
For Jackson, at the level of operating profit based on longer-term investment returns, the results are sensitive to market conditions
to the extent of income earned on spread-based products and second order equity-based exposure in respect of variable annuity
asset management fees. Further information is given below in note D3h(iv). assurance
Jackson’s derivative programme is used to manage interest rate risk associated with a broad range of products and equity
market risk attaching to its equity-based products. Movements in equity markets, interest rates and credit spreads materially
affect the carrying value of derivatives which are used to manage the liabilities to policyholders and backing investment assets. business
Combined with the use of US GAAP measurement (as ‘grandfathered’ under IFRS 4) for the insurance contracts assets and
liabilities which is largely insensitive to current period market movements, the Jackson total profit (ie including short-term
fluctuations in investment returns) is very sensitive to market movements. In addition to these effects the Jackson shareholders’
equity is sensitive to the impact of interest rate and credit spread movements on the value of fixed income securities. Movements Financial
in unrealised appreciation on these securities are included as movement in shareholders’ equity (ie outside the income statement).
See D3(h) for details of the hedging.
statements
196 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D1: Group overview continued
Asia
For Asia operations, the operating profit based on longer-term investment returns is mainly affected by the impact of market levels on unit-linked business persistency, and other insurance risks.
At the total IFRS profit level the Asia result is affected by short-term value movements on the asset portfolio for non-linked shareholder-backed business.
Impact of diversification on risk exposure
The Group enjoys significant diversification benefits. This arises because not all risk scenarios will happen at the same time and across all geographic regions. Relevant correlation factors include:
Correlation across geographic regions
Financial risk factors
Non-financial risk factors
Correlation across risk factors
Longevity risk
Expenses
Persistency
Other risks
The effect of Group diversification across the Group’s life businesses is to signifi cantly reduce the aggregate standalone volatility risk to IFRS operating profit based on longer-term investment returns. The effect is almost wholly explained by the correlations across risk types, in particular longevity risk.
f Duration of liabilities
Under the terms of the Group’s contracts, as for life assurance contracts generally, the contractual maturity date is the earlier of the end of the contract term, death, other insurable events or surrender. The Group has therefore chosen to provide details of liability duration that reflect the actuarially determined best estimate of the likely incidence of these factors on contract duration. Details are shown in sections D2(i), D3(i) and D4(i).
In the years 2008 to 2012, claims paid on the Group’s life assurance contracts, including those classifi ed as investment contracts under IFRS 4, ranged from Ł17 billion to Ł21 billion. Indicatively, it is to be expected that, of the Group’s policyholder liabilities (excluding unallocated surplus) at 31 December 2012 of Ł260.8 billion, the amounts likely to be paid in
2013 will be of a similar magnitude.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 197
D2: UK insurance operations
a Summary statement of fi nancial position
In order to show the statement of financial position by reference to the differing degrees of policyholder and shareholder economic interest of the different types of fund and business, the analysis below is structured to show separately assets and liabilities of the Scottish Amicable Insurance Fund (SAIF), the PAC with-profits sub-fund (WPSF), unit-linked assets and liabilities and annuity (principally PRIL) and other long-term business.
Ł97 billion of the Ł150 billion of investments are held by SAIF and the PAC WPSF. Shareholders are exposed only indirectly to value movements on these assets.
[Graphic Appears Here]
198 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
31 Dec
31 Dec 2012 Łm 2011 Łm Other funds and subsidiaries Unit-Scottish linked Annuity UK UK
Amicable PAC with- assets and other insurance insurance Insurance profi ts and long-term operations operations Fund fund liabilities business Total Total Total
By operating segment note (iii) notes (i), (ii)
Equity and liabilities
Equity
Shareholders’ equity – – – 3,033 3,033 3,033 2,581 Non-controlling interests – 1 – – – 1 33
Total equity – 1 – 3,033 3,033 3,034 2,614
Liabilities
Policyholder liabilities and unallocated surplus of with-profits funds: Contract liabilities (including amounts in respect of contracts classifled as investment contracts under
IFRS 4) 7,878 76,529 22,197 27,308 49,505 133,912 127,024
Unallocated surplus of with-profits funds (reflecting application of ‘realistic’ basis provisions for UK regulated with-profits funds) – 10,526 – – – 10,526 9,165
Total 7,878 87,055 22,197 27,308 49,505 144,438 136,189
Operational borrowings attributable to shareholder-financed operations – – 1 126 127 127 103 Borrowings attributable to with-profits funds 17 1,016 – – – 1,033 972 Deferred tax liabilities 39 663 – 483 483 1,185 1,349 Other non-insurance liabilities 299 4,200 911 3,298 4,209 8,708 9,464
Total liabilities 8,233 92,934 23,109 31,215 54,324 155,491 148,077
Total equity and liabilities 8,233 92,935 23,109 34,248 57,357 158,525 150,691
[Graphic Appears Here]
Notes
(i) For the purposes of this table and subsequent explanation, references to the WPSF also include, for convenience, the amounts attaching to the Defined Charges Participating Sub-fund which comprises 3.3 per cent of the total assets of the WPSF and includes the with-profits annuity business transferred to Prudential from the Equitable Life Assurance Society on 1 December 2007 (with assets of approximately Ł1.7 billion). Profits to shareholders on this with-profits annuity business emerge on a ‘charges less expenses’ basis and policyholders are entitled to 100 per cent of the investment earnings.
Included in the PAC with-profits fund is Ł13.3 billion (2011: Ł12.6 billion) of non-profits annuities liabilities.
(ii) Excluding policyholder liabilities of the Hong Kong branch of PAC.
(iii) SAIF is a separate sub-fund within the PAC long-term business fund.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 199
(iv) Investment properties
At 31 December 2012, the Group’s UK insurance operations had Ł10,852 million (2011: Ł10,712 million) of investment properties. The following table shows the property portfolio by type of investment. The properties are shown at market value below in accordance with the policies described in note A3.
2012 2011
Łm% Łm%
Office buildings 4,195 38.7 4,443 41.5
Shopping centres/commercial 4,389 40.4 4,315 40.3
Retail warehouses/industrial 1,624 15.0 1,406 13.1
Development 465 4.3 383 3.6
Other 179 1.6 165 1.5
Total 10,852 100.0 10,712 100.0
47.6 per cent (2011: 42.9 per cent) of the UK held investment property is located in London and Southeast England with 35.4 per cent (2011: 41.1 per cent) located throughout the rest of the UK and the remaining 17.0 per cent (2011: 16.0 per cent) located overseas.
(v) Loans
The loans of the Group’s UK insurance operations comprise:
2012 Łm 2011 Łm
SAIF and PAC WPSF:
Mortgage loans* 1,311 1,036
Policy loans 16 20
Other loans† 782 917
Total SAIF and PAC WPSF loans 2,109 1,973
Shareholder-backed:
Mortgage loans* 1,259 1,137
Other loans 5 5
Total shareholder-backed loans 1,264 1,142
Total UK insurance operations loans 3,373 3,115
* The mortgage loans are collateralised by properties. By carrying value, 86 per cent of the Ł1,259 million held for shareholder-backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 29 per cent.
† Other loans held by the PAC with-profits fund are all commercial loans and comprise mainly syndicated loans.
(vi) Other investments comprise:
2012 Łm 2011 Łm
Derivative assets* 1,349 1,461
Partnerships in investment pools and other† 3,227 3,107
4,576 4,568
* Aft er including derivative liabilities of Ł1,007 million (2011: Ł1,298 million), which are also included in the statement of fi nancial position, the overall derivative position was a net asset of Ł342 million (2011: Ł163 million). D:
200 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
b Reconciliation of movement in policyholder liabilities and unallocated surplus of with-profi ts funds
A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of UK insurance operations from the beginning of the year to the end of the year is as follows:
Other shareholder-backed
funds and subsidiaries
Annuity
SAIF and PAC and other
with-profits Unit-linked long-term
sub-fund liabilities business Total
Łm Łm Łm Łm
At 1 January 2011 91,773 21,671 22,273 135,717
Comprising:
Policyholder liabilities 81,586 21,671 22,273 125,530
Unallocated surplus of with-profits funds 10,187 – – 10,187
Premiums 3,413 1,854 1,721 6,988
Surrenders(2,285)(1,851)(119)(4,255)
Maturities/Deaths(5,551)(655)(1,607)(7,813)
Net flowsnote (a)(4,423)(652)(5)(5,080)
Shareholders’ transfers post tax(216) – –(216)
Switches(237) 237 – –
Investment-related items and other movementsnote (b) 3,338 25 2,499 5,862
Foreign exchange translation differences(94) – –(94)
At 31 December 2011/1 January 2012 90,141 21,281 24,767 136,189
Comprising:
Policyholder liabilities 80,976 21,281 24,767 127,024
Unallocated surplus of with-profits funds 9,165 – – 9,165
Premiums 4,539 1,775 2,026 8,340
Surrenders(2,200)(2,378)(207)(4,785)
Maturities/Deaths(5,664)(658)(1,687)(8,009)
Net flowsnote (a)(3,325)(1,261) 132(4,454)
Shareholders’ transfers post tax(205) – –(205)
Switches(236) 236 – –
Investment-related items and other movementsnote (b) 8,656 1,941 2,409 13,006
Foreign exchange translation differences(98) – –(98)
At 31 December 2012 94,933 22,197 27,308 144,438
Comprising:
Policyholder liabilities 84,407 22,197 27,308 133,912
Unallocated surplus of with-profits funds 10,526 – – 10,526
Average policyholder liability balances*
2012 82,691 21,739 26,038 130,468
2011 81,281 21,476 23,520 126,277
* Averages have been based on opening and closing balances and exclude unallocated surplus of with-profits funds.
Notes
(a) Net outflows decreased from Ł5,080 million in 2011 to Ł4,454 million in 2012. An improvement in the net outflows of the with-profits business, following increased sales of with-profits bonds in the year, has been greater than the increase in outflows in the unit-linked business. The levels of inflows/outflows for unit-linked business is driven by the activity of corporate pension schemes with transfers in or out from only one or two schemes influencing the level of flows in the year. The net flows of negative Ł1,261 million in unit-linked business was a result of lower single premiums in and higher transfers out of this business in 2012.
(b) Investment-related items and other movements of Ł13,006 million across fund types reflected the continued strong performance of UK equity markets in 2012, as well as investment gains from debt securities following falling bond yields, and other asset classes.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 201
c Information on credit risk of debt securities
The following table summarises by rating the securities held by UK insurance operations as at 31 December 2012 and 2011:
UK insurance operations
31 Dec
31 Dec 2012 Łm 2011 Łm
Other funds and subsidiaries
Other
Scottish PAC annuity
Amicable with- Unit- and
Insurance profits linked long-term
Fund fund assets PRIL business Total Total
S&P – AAA 441 4,716 582 3,023 438 9,200 9,928
S&P – AA+ to AA- 527 4,908 829 3,041 318 9,623 8,647
S&P – A+ to A- 1,031 12,345 1,805 6,934 885 23,000 21,474
S&P – BBB+ to BBB- 911 10,614 1,340 4,210 645 17,720 15,746
S&P – Other 224 2,358 115 307 39 3,043 3,175
3,134 34,941 4,671 17,515 2,325 62,586 58,970
Moody’s – Aaa 241 3,780 1,239 2,557 629 8,446 7,945
Moody’s – Aa1 to Aa3 41 538 106 622 113 1,420 651
Moody’s – A1 to A3 32 505 26 321 43 927 1,008
Moody’s – Baa1 to Baa3 54 818 113 370 30 1,385 1,030
Moody’s – Other 15 224 30 30 8 307 242
383 5,865 1,514 3,900 823 12,485 10,876
Fitch 20 295 26 165 21 527 492
Other 327 5,542 99 2,157 139 8,264 7,615
Total debt securities 3,864 46,643 6,310 23,737 3,308 83,862 77,953
Where no external ratings are available, internal ratings produced by the Group’s asset management operation, which are prepared on the Company’s assessment of a comparable basis to external ratings, are used where possible. The Ł8,264 million total debt securities held at 31 December 2012 (2011: Ł7,615 million) which are not externally rated are either internally rated or unrated. These are analysed as follows:
2012 Łm 2011 Łm
D:
Internal ratings or unrated: Life
AAA to A- 3,150 2,726
BBB to B- 3,752 3,773
Below B- or unrated 1,362 1,116 assurance
Total 8,264 7,615
The majority of unrated debt security investments were held in SAIF and the PAC with-profits sub-fund and relate to convertible debt
and other investments which are not covered by ratings analysts, nor have an internal rating attributed to them. Of the Ł2,296 million
PRIL and other annuity and long-term business investments which are not externally rated, Ł6 million were internally rated AAA,
Ł429 million AA, Ł737 million A, Ł895 million BBB, Ł115 million BB and Ł114 million were internally rated B+ and below or unrated.
During 2011 Standard & Poor’s withdrew its ratings of debt securities issued by a number of sovereigns. Where these are no longer Financial
available Moody’s ratings have been used. This primarily impacts the UK and Asia insurance operations.
As detailed in note D2(h) below, the primary sensitivity of IFRS basis profit or loss and shareholders’ equity relates to non-linked
shareholder-backed business which is represented by ‘PRIL’ and ‘other annuity and long-term business’ in the table above. statements
202 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
d Products and guarantees
Prudential’s long-term products in the UK consist of life insurance, pension products and pension annuities. These products are written primarily in:
One of three separate sub-funds of the PAC long-term fund, namely the with-profits sub-fund (WPSF), SAIF, and the non-profit sub-fund; Prudential Annuities Limited (PAL), which is owned by the PAC with-profits sub-fund; Prudential Retirement Income Limited (PRIL), a shareholder-owned subsidiary; or Other shareholder-backed subsidiaries writing mainly non-profit unit-linked business.
i With-profi ts products and PAC with-profi ts sub-fund
Within the statement of financial position of UK insurance operations at 31 December 2012, as shown in note D2(a), there are policyholder liabilities and unallocated surplus of Ł87.1 billion (2011: Ł81.6 billion) that relate to the WPSF. These amounts
include the liabilities and capital of Prudential Annuities Limited, a wholly-owned subsidiary of the fund. The WPSF mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). The WPSF’s profi ts are apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution is determined via the annual actuarial valuation.
The WPSF held a provision of Ł47 million at 31 December 2012 (2011: Ł90 million) to honour guarantees on a small amount of guaranteed annuity products. SAIF’s exposure to guaranteed annuities is described below.
With-profits products provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘annual’ and ‘fi nal’. Annual bonuses are declared once a year, and once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, fi nal bonuses are guaranteed only until the next bonus declaration. The main factors that influence the determination of bonus rates are the return on the investments of the with-profits fund, infi ation, taxation, the expenses of the fund chargeable to policyholders and the degree to which investment returns are smoothed. The overall rate of return earned on investments and the expectation of future investment returns are the most important influences on bonus rates.
A high proportion of the assets backing the with-profits business are invested in equities and real estate. If the financial strength of the with-profits business is affected, then a higher proportion of fixed interest or similar assets might be held by the fund.
Further details on the determination of the two types of the bonuses: ‘regular’ and ‘fi nal’, the application of signifi cant judgement, key assumptions and the degree of smoothing of investment returns in determining the bonus rates are provided below.
Regular bonus rates
For regular bonuses, the bonus rates are determined for each type of policy primarily by targeting the bonus level at a prudent proportion of the long-term expected future investment return on underlying assets. The expected future investment return is reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers. However, the rates declared may differ by product type, or by the date of payment of the premium, or date of issue of the policy, or if the accumulated annual bonuses are particularly high or low, relative to a prudent proportion of the achieved investment return.
When target bonus levels change the PAC board of directors (PAC Board) has regard to the overall strength of the long-term fund when determining the length of time over which it will seek to achieve the amended prudent target bonus level.
In normal investment conditions, PAC expects changes in regular bonus rates to be gradual over time. However, the PAC Directors retain the discretion whether or not to declare a regular bonus each year, and there is no limit on the amount by which regular bonus rates can change.
Final bonus rates
A final bonus which is normally declared yearly, may be added when a claim is paid or when units of a unitised product are realised. The rates of final bonus usually vary by type of policy and by reference to the period, usually a year, in which the policy commences or each premium is paid. These rates are determined by reference to the asset shares for the sample policies but subject to the smoothing approach as explained below.
In general, the same final bonus scale applies to maturity, death and surrender claims except that:
The total surrender value may be impacted by the application of a Market Value Reduction for accumulating with-profits policies and is the surrender bases for conventional with-profits business; and For the SAIF and Scottish Amicable, the final bonus rates applicable on surrender may be adjusted to reflect expected future bonus rates.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 203
Application of signifi cant judgement
The application of the above method for determining bonuses requires the PAC Board to apply significant judgement in many respects, including in particular the following:
Determining what constitutes fair treatment of customers: Prudential is required by UK law and regulation to consider the fair treatment of its customers in setting bonus levels. The concept of determining what constitutes fair treatment, while established by statute, is not defined; Smoothing of investment returns: This is an important feature of with-profits products. Determining when particular circumstances, such as a significant rise or fall in market values, warrant variations in the standard bonus smoothing limits that apply in normal circumstances requires the PAC Board to exercise significant judgement; and Determining at what level to set bonuses to ensure that they are competitive: The overall return to policyholders is an important competitive measure for attracting new business.
Key assumptions
As noted above, the overall rate of return on investments and the expectation of future investment returns are the most important
infiuences in bonus rates, subject to the smoothing described below. Prudential determines the assumptions to apply in respect of
these factors, including the effects of reasonably likely changes in key assumptions, in the context of the overarching discretionary
and smoothing framework that applies to its with-profits business as described above. As such, it is not possible to specifically
quantify the effects of each of these assumptions, or of reasonably likely changes in these assumptions.
Prudential’s approach, in applying significant judgement and discretion in relation to determining bonus rates, is consistent
conceptually with the approach adopted by other firms that manage a with-profits business. It is also consistent with the
requirements of UK law, which require all UK firms that carry out a with-profits business to define, and make publicly available,
the Principles and Practices of Financial Management (PPFM) that are applied in the management of their with-profits funds.
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 confliicting 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
Provide a knowledgeable observer (eg a financial adviser) with an understanding of the material risks and rewards from starting
and continuing to invest in a with-profits policy with Prudential.
Furthermore, in accordance with industry-wide regulatory requirements, the PAC Board has appointed:
An Actuarial Function Holder who provides the PAC Board with all actuarial advice;
A With-Profits Actuary whose specific duty is to advise the PAC Board on the reasonableness and proportionality of the manner
in which its discretion has been exercised in applying the PPFM and the manner in which any confliicting interests have been
addressed; and
A With-Profits Committee of independent individuals, which assesses the degree of compliance with the PPFM and the manner
in which confliicting rights have been addressed. D:
Life
Smoothing of investment return
In determining bonus rates for the UK with-profits policies, smoothing is applied to the allocation of the overall earnings of the UK
with-profits fund of which the investment return is a significant element. The smoothing approach differs between accumulating assurance
and conventional with-profits policies to reflect the different contract features. In normal circumstances, Prudential does not
expect most payout values on policies of the same duration to change by more than 10 per cent up or down from one year to
the next, although some larger changes may occur to balance payout values between different policies. Greater flexibility may business
be required in certain circumstances, for example, following a significant rise or fall in market values, and in such situations the
PAC Board may decide to vary the standard bonus smoothing limits in order to protect the overall interests of policyholders.
Financial
statements
204 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
The degree of smoothing is illustrated numerically by comparing in the following table the relatively ‘smoothed’ level of policyholder bonuses declared as part of the surplus for distribution, with the more volatile movement in investment return and other items of income and expenditure of the UK component of the PAC with-profi ts fund for each year presented.
2012 Łm 2011 Łm
Net income of the fund:
Investment return 8,350 4,094
Claims incurred(6,857)(6,411)
Movement in policyholder liabilities(3,989)(614)
Add back policyholder bonuses for the year (as shown below) 1,865 1,945
Claims incurred and movement in policyholder liabilities
(including charge for provision for asset shares and excluding policyholder bonuses)(8,981)(5,080)
Earned premiums, net of reinsurance 4,558 3,404
Other income 39 17
Acquisition costs and other expenditure(740)(696)
Tax charge(292)(63)
Net income of the fund before movement in unallocated surplus 2,934 1,676
Movement in unallocated surplus(863) 485
Surplus for distribution 2,071 2,161
Surplus for distribution allocated as follows:
90% policyholders’ bonus (as shown above) 1,865 1,945
10% shareholders’ transfers 206 216
2,071 2,161
ii Annuity business
Prudential’s conventional annuities include level, fi xed-increase and inflation-linked annuities, the link being to the Retail Prices Index (RPI) in the majority of cases. They are mainly written within the subsidiaries PAL, PRIL, the PAC non-profit sub-fund and the PAC with-profits sub-fund, but there are some annuity liabilities in Prudential Pensions Limited and SAIF.
Prudential’s fi xed-increase annuities incorporate automatic increases in annuity payments by fixed amounts over the policyholder’s life. The RPI annuities that Prudential offers provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK RPI.
Prudential’s with-profi ts annuities, which are written in the WPSF, combine the income features of annuity products with the investment smoothing features of with-profits products and enable policyholders to obtain exposure to investment return on the WPSF’s equity shares, property and other investment categories over time. Policyholders select a ‘required smoothed return’ bonus from the specifi c range Prudential offers for the particular product. The amount of the annuity payment each year depends upon the relationship between the required smoothed return bonus rate selected by the policyholder when the product is purchased and the smoothed return bonus rates Prudential subsequently declares each year during the term of the product. If the total bonus rates fall below the anticipated rate, then the annuity income falls.
At 31 December 2012, Ł41.7 billion (2011: Ł38.3 billion) of investments relate to non-profi t annuity business of the PAC WPSF (including PAL) and the annuity business of PRIL. These investments are predominantly in debt securities (including retail price index-linked bonds to match retail price index-linked annuities), loans, deposits and property, and are duration matched with the estimated duration of the liabilities they support.
iii SAIF
SAIF is a ring-fenced sub-fund of the PAC long-term fund formed following the acquisition of the mutually owned Scottish Amicable Life Assurance Society in 1997. No new business may be written in SAIF, although regular premiums are still being paid on policies in force at the time of the acquisition and incremental premiums are permitted on these policies.
The fund is solely for the benefit of policyholders of SAIF. Shareholders have no interest in the profits of this fund although they are entitled to asset management fees on this business.
The process for determining policyholder bonuses of SAIF with-profits policies, which constitute the vast majority of obligations of the funds, is similar to that for the with-profits policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefits ie in excess of those based on asset share.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 205
Provision is made for the risks attaching to some SAIF unitised with-profits policies that have (Market Value Reduction) MVR-free dates and for those SAIF products which have a guaranteed minimum benefit on death or maturity of premiums accumulated at 4 per cent per annum.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of Ł371 million was held in SAIF at 31 December 2012 (2011: Ł370 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefi t of policyholders of SAIF, this provision has no impact on the financial position of the Group’s shareholders’ equity.
iv Unit-linked (non-annuity) and other non-profi t business
Prudential UK insurance operations also have an extensive book of unit-linked policies of varying types and provide a range of other non-profit business such as credit life and protection contracts. These contracts do not contain significant financial guarantees.
There are no guaranteed maturity values or guaranteed annuity options on unit-linked policies except for minor amounts for certain policies linked to cash units within SAIF.
e Process for setting assumptions and determining contract liabilities i Overview
The calculation of the contract liabilities involves the setting of assumptions for future experience. This is done following detailed review of the relevant experience including in particular mortality, expenses, tax, economic assumptions and, where applicable, persistency.
For with-profits business written in the WPSF or SAIF, a market consistent valuation is performed (as described in section (ii)
below). Additional assumptions required are for persistency and the management actions under which the fund is managed.
Assumptions used for a market-consistent valuation typically do not contain margins, whereas those used for the valuation of other
classes of business do.
Mortality assumptions are set based on the results of the most recent experience analysis looking at the experience over recent
years of the relevant business. For non-profit business, a margin for adverse deviation is added. Different assumptions are applied
for different product groups. For annuitant mortality, assumptions for current mortality rates are based on recent experience
investigations and expected future improvements in mortality. The expected future improvements are based on recent experience
and projections of the business and industry experience generally.
Maintenance and, for some classes of business, termination expense assumptions are expressed as per policy amounts. They
are set based on the expenses incurred during the year, including an allowance for ongoing investment expenditure and allocated
between entities and product groups in accordance with the operation’s internal cost allocation model. For non-profit business a
margin for adverse deviation is added to this amount. Expense inflation assumptions are set consistent with the economic basis and
based on the difference between yields on nominal gilts and index-linked gilts.
The actual renewal expenses incurred on behalf of SAIF by other Group companies are recharged in full to SAIF.
The assumptions for asset management expenses are based on the charges specifled in agreements with the Group’s asset
management operations, plus a margin for adverse deviation for non-profit business.
Tax assumptions are set equal to current rates of taxation.
For non-profit business excluding unit-linked business, the valuation interest rates used to discount the liabilities are based on
the yields as at the valuation date on the assets backing the technical provisions. For fixed interest securities the gross redemption D:
yield is used, except for the PAL (including the business recaptured by PAC WPSF in 2011) and PRIL annuity business, where the Life
internal rate of return of the assets backing the liabilities is used. Properties are valued using the rental yield, and for equities it is
the greater of the dividend yield and the average of the dividend yield and the earnings yield. An adjustment is made to the yield
on non risk-free fixed interest securities and property to reflect credit risk. To calculate the non-unit reserves for linked business, assurance
assumptions have been set for the gross unit growth rate and the rate of inflation of maintenance expenses, as well as for the
valuation interest rate as described above. business
ii WPSF and SAIF
The policyholder liabilities reported for the WPSF are primarily for two broad types of business. These are accumulating and
conventional with-profits contracts. The policyholder liabilities of the WPSF are accounted for under FRS 27.
The provisions have been determined on a basis consistent with the detailed methodology included in regulations contained Financial
in the FSA’s rules for the determination of reserves on the FSA’s ‘realistic’ Peak 2 basis. In aggregate, the regime has the effect of
placing a value on the liabilities of UK with-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. statements
The FSA’s Peak 2 calculation under the realistic regime requirement is explained further in note A3(2)(a) under the UK regulated
with-profits section.
The contract liabilities for with-profits business also require assumptions for persistency. These are set based on the results of
recent experience analysis.
206 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations 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. The allowance is reflected in the deduction from the valuation rate of interest for discounting projected future annuity payments to policyholders that would have otherwise applied. Since mid-2007 there has been a significant increase in the actual and perceived credit risk associated with corporate bonds as reflected in the significant widening that has occurred in corporate bond spreads. Although bond spreads over swap rates have narrowed from their peak in March 2009, they are still high compared with the levels seen in the years immediately preceding the start of the dislocated markets in 2007. The allowance that should therefore be made for credit risk remains a particular area of judgement.
The additional yield received on corporate bonds relative to swaps can be broken into the following constituent parts:
(a) The expected level of future defaults;
(b) The credit risk premium that is required to compensate for the potential volatility in default levels;
(c) The liquidity premium that is required to compensate for the lower liquidity of corporate bonds relative to swaps; and
(d) The mark to market risk premium that is required to compensate for the potential volatility in corporate bond spreads (and hence market values) at the time of sale.
The sum of (c) and (d) is often referred to as ‘liquidity premium’.
The allowance for credit risk comprises (i) an amount for long-term best estimate defaults, and (ii) additional provisions for credit risk premium, downgrade resilience and short-term defaults.
The weighted components of the bond spread over swap rates for shareholder-backed fixed and linked annuity business for PRIL at 31 December 2012 and 31 December 2011, based on the asset mix at the relevant balance sheet date are shown below.
Adjustment
Pillar 1 from
regulatory regulatory to
basis IFRS basis IFRS
31 December 2012(bps)(bps)(bps)
Bond spread over swap ratesnote (i) 161 – 161
Credit risk allowance
Long-term expected defaultsnote (ii) 15 – 15
Additional provisionsnote (iii) 50(23) 27
Total credit risk allowance 65(23) 42
Liquidity premium 96 23 119
Adjustment
Pillar 1 from
regulatory regulatory to
basis IFRS basis IFRS
31 December 2011(bps)(bps)(bps)
Bond spread over swap ratesnote (i) 201 – 201
Credit risk allowance
Long-term expected defaultsnote (ii) 15 – 15
Additional provisionsnote (iii) 51(24) 27
Total credit risk allowance 66(24) 42
Liquidity premium 135 24 159
Notes
(i) Bond spread over swap rates reflect market observed data.
(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.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 207
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’.
Movement in the credit risk allowance for PRIL for the year ended 31 December 2012
The movement during 2012 of the average basis points allowance for PRIL on Pillar 1 regulatory and IFRS bases are as follows:
Pillar 1
regulatory
basis IFRS
(bps)(bps)
Total Total
Total allowance for credit risk at 31 December 2011 66 42
Credit rating changes 3 2
Asset trading 1 1
New business and other(5)(3)
Total allowance for credit risk at 31 December 2012 65 42
For periods prior to full year 2011, favourable credit experience was retained in short-term allowances for credit risk on both the
Pillar 1 and IFRS bases. From full year 2011 onwards, the methodology applied is to continue to retain such surplus experience in
the IFRS credit provisions but not for Pillar 1.
Overall the movement has led to the credit allowance for Pillar 1 purposes to be 40 per cent (2011: 33 per cent) of the bond
spread over swap rates. For IFRS purposes it represents 26 per cent (2011: 20 per cent) of the bond spread over swap rates.
The reserves for credit risk allowance at 31 December 2012 for the UK shareholder annuity fund were as follows:
Pillar 1
regulatory
basis IFRS
Łbn Łbn
Total Total
PRIL 1.9 1.2
PAC non-profit sub-fund 0.2 0.1
Total – 31 December 2012 2.1 1.3
Total – 31 December 2011 2.0 1.3
Mortality D:
of The mortality assumptions are set in light of recent population and internal experience. The assumptions used are percentages Life
standard actuarial mortality tables with an allowance for future mortality improvements. Where annuities have been sold on
an enhanced basis to impaired lives an additional age adjustment is made. The percentages of the standard table used are selected
according to the source of business.
In 2009, Prudential’s annuity business liabilities were determined using the Continuous Mortality Investigation (CMI) medium assurance
cohort projections with a floor. Since 2009, new mortality projection models have been released annually by the CMI. The CMI
2009 model was used to produce the 2010 and 2011 results, with calibration to reflect an appropriate view of future mortality
improvements. The CMI 2011 model was used to produce the 2012 results, again with calibration to reflect an appropriate view business
of future mortality improvements.
Financial
statements
208 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
The tables and range of percentages used are set out in the following tables:
Non-profit annuities within the WPSF
(including PAL) PRIL
2012 Males Females Males Females
In payment 93% – 99% PCMA00 89% – 101% PCFA00 92% – 96% PCMA00 84% – 97% PCFA00
with future with future with future with future
improvements in line improvements in line improvements in line improvements in line
with Prudential’s own with Prudential’s own with Prudential’s own with Prudential’s own
calibration of the CMI calibration of the CMI calibration of the CMI calibration of the CMI
2011 mortality model, 2011 mortality model, 2011 mortality model, 2011 mortality model,
with a long-term with a long-term with a long-term with a long-term
improvement rate improvement rate improvement rate improvement rate
of 2.25%. of 1.50%. of 2.25%. of 1.50%.
In deferment AM92 minus 4 years AF92 minus 4 years AM92 minus 4 years AF92 minus 4 years
Non-profit annuities within the WPSF
(including PAL) PRIL
2011 Males Females Males Females
In payment 92% – 98% PCMA00 with 88% – 100% PCFA00 with 93% – 94% PCMA00 with 86% – 96% PCFA00 with
future improvements in future improvements in future improvements in future improvements in
line with Prudential’s line with Prudential’s line with Prudential’s line with Prudential’s
own calibration of the own calibration of the own calibration of the own calibration of the
CMI 2009 mortality CMI 2009 mortality CMI 2009 mortality CMI 2009 mortality
model, with a long-term model, with a long-term model, with a long-term model, with a long-term
improvement rate improvement rate improvement rate improvement rate
of 2.25%. of 1.25%. of 2.25%. of 1.25%.
In deferment AM92 minus 4 years AF92 minus 4 years AM92 minus 4 years AF92 minus 4 years
Non-profit annuities within the WPSF
(including PAL) PRIL
2010 Males Females Males Females
In payment 92% – 98% PCMA00 with 88% – 100% PCFA00 with 94% – 95% PCMA00 with 86% – 97% PCFA00 with
future improvements in future improvements in future improvements in future improvements in
line with Prudential’s line with Prudential’s line with Prudential’s line with Prudential’s
own calibration of the own calibration of the own calibration of the own calibration of the
CMI 2009 mortality CMI 2009 mortality CMI 2009 mortality CMI 2009 mortality
model, with a long-term model, with a long-term model, with a long-term model, with a long-term
improvement rate improvement rate improvement rate improvement rate
of 2.25%. of 1.25%. of 2.25%. of 1.25%.
In deferment AM92 minus 4 years AF92 minus 4 years AM92 minus 4 years AF92 minus 4 years
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 209
iv Unit-linked (non-annuity) and other non-profit business
The majority of other long-term business written in the UK insurance operations is unit-linked business or other business with
similar features. For these contracts, the attaching liability reflects the unit value obligation and provision for expenses and
mortality risk. The latter component is determined by applying mortality assumptions on a basis that is appropriate for the
policyholder profile.
For unit-linked business, the assets covering unit liabilities are exposed to market risk, but the residual risk when considering
the unit-linked liabilities and assets together is limited to the effect on fund-based charges.
For those contracts where the level of insurance risk is insignificant, the assets and liabilities arising under the contracts are
distinguished between those that relate to the financial instrument liability and acquisition costs and deferred income that relate
to the component of the contract that relates to investment management. Acquisition costs and deferred income are recognised
consistent with the level of service provision in line with the requirements of IAS 18.
f Reinsurance
The Group’s UK insurance business cedes only minor amounts of business outside the Group. During 2012, reinsurance
premiums for externally ceded business were Ł135 million (2011: Ł132 million) and reinsurance recoverable assets were Ł608 million
(2011: Ł589 million) in aggregate. The gains and losses recognised in profit and loss for the 2012 and 2011 contracts were immaterial.
g Effect of changes in assumptions used to measure insurance assets and liabilities
Credit risk
There has been no change of approach in the setting of assumption levels.
However, changes in the portfolio have given rise to altered levels of credit risk allowance as set out in note D2 (e)(iii).
2012
Other operating assumption changes
In 2012, for the shareholder-backed business, the net effect of assumption changes, other than the allowance for credit risk described
above was a charge to shareholder results of Ł17 million. This comprises the aggregate effect of strengthening of mortality
assumptions for the annuity business, offsetting releases of margins and altered expenses and other assumptions.
For the with-profits sub-fund, the aggregate effect of assumption changes in 2012 was a net charge to unallocated surplus of
Ł90 million, relating to changes in mortality and offsetting releases of margins, expense, persistency and economic assumptions.
2011
Other operating assumption changes
In 2011, for the shareholder-backed business, the aggregate effect of assumption changes other than the allowance for credit risk
described above, was a net charge to the shareholder results of Ł9 million, comprising a number of individually small assumption
changes.
For the with-profits sub-fund, the aggregate effect of assumption changes in 2011 was a net charge to unallocated surplus of
Ł59 million, relating to changes in mortality, expense, persistency and economic assumptions.
h Exposure and sensitivity of IFRS basis profit or loss and shareholders’ equity to market and other risks D:
i With-profits business Life
SAIF
Shareholders have no interest in the profits of the ring-fenced fund of SAIF but are entitled to the asset management fees paid
on the assets of the fund. assurance
With-profits sub-fund business
Shareholder UK results of UK with-profits business (including non-participating annuity business of the WPSF and of Prudential business
Annuities Limited (PAL), which is owned by the WPSF) are only sensitive to market risk through the indirect effect of investment
performance on declared policyholder bonuses.
The investment assets of PAC with-profits funds are subject to market risk. Changes in their carrying value, net of related
changes to asset-share liabilities of with-profit contracts, affect the level of unallocated surplus of the fund. Therefore, the level of Financial
unallocated surplus is particularly sensitive to the level of investment returns on the portion of the assets that represents surplus.
The effects for 2012 and 2011 are demonstrated in note D5. However, as unallocated surplus is accounted for as a liability under
IFRS, movements in its value do not affect shareholders’ profit and equity. statements
210 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
The shareholder results of the UK with-profits fund correspond to the shareholders’ share of the cost of bonuses declared on the with-profi ts business which is currently one-ninth of the cost of bonuses declared. Investment performance is a key driver of bonuses, and hence the shareholders’ share of the cost of bonuses. Due to the ‘smoothed’ basis of bonus declaration, the sensitivity to investment performance in a single year is low relative to movements in the period to period performance. However, over multiple periods, it is important.
Mortality and other insurance risk are relatively minor factors in the determination of the bonus rates. Adverse persistency experience can affect the level of profitability from with-profits but in any given one year, the shareholders’ share of cost of
bonus may only be marginally affected. However, altered persistency trends may affect future expected shareholder transfers.
ii Shareholder-backed annuity business
The principal items affecting the IFRS results of the UK shareholder-backed annuity business are mortality experience and assumptions, and credit risk. The assets covering the liabilities are principally debt securities and other investments that are held to match the expected duration and payment characteristics of the policyholder liabilities. These liabilities are valued for IFRS reporting purposes by applying discount rates that reflect the market rates of return attaching to the covering assets.
Asset/liability duration matching is reviewed regularly. Except to the extent of any asset/liability duration mismatch and exposure to credit risk, the sensitivity of the Group’s results to market risk for movements in the carrying value of the liabilities and covering assets is broadly neutral on a net basis.
The main market risk sensitivity for the UK shareholder-backed annuity business arises from interest rate risk on the debt securities which substantially represent shareholders’ equity. This shareholders’ equity comprises the net assets held within the long-term fund of the company that cover regulatory basis liabilities that are not recognised for IFRS reporting purposes, for example, contingency reserves and shareholder capital held outside the long-term fund.
In summary, profits from shareholder-backed annuity business are most sensitive to:
The extent to which the duration of the assets held closely matches the expected duration of the liabilities under the contracts; Actual versus expected default rates on assets held; The difference between long-term rates of return on corporate bonds and risk-free rates; The variance between actual and expected mortality experience; The extent to which changes to the assumed rate of improvements in mortality give rise to changes in the measurement of liabilities; and Changes in renewal expense levels.
A decrease in assumed mortality rates of 1 per cent would decrease gross profits by approximately Ł74 million (2011: Ł64 million). A decrease in credit default assumptions of five basis points would increase gross profits by Ł157 million (2011: Ł137 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase gross profi ts by Ł25 million (2011: Ł25 million). The effect on profi ts would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above.
iii Unit-linked and other business
Unit-linked and other business represents a comparatively small proportion of the in-force business of the UK insurance operations.
Due to the matching of policyholder liabilities to attaching asset value movements, the UK unit-linked business is not directly affected by market or credit risk liabilities of other business and are also broadly insensitive to market risk. Profits from unit-linked and similar contracts primarily arise from the excess of charges to policyholders for management of assets under the Company’s stewardship, over expenses incurred. The former is most sensitive to the net accretion of funds under management as a function of new business and lapse and timing of death. The accounting impact of the latter is dependent upon the amortisation of acquisition costs in line with the emergence of margins (for insurance contracts) and amortisation in line with service provision (for the investment management component of investment contracts). By virtue of the design features of most of the contracts which provide low levels of mortality cover, the profits are relatively insensitive to changes in mortality experience.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 211
iv Shareholder exposure to interest rate risk and other market risk
By virtue of the fund structure, product features and basis of accounting, the policyholder liabilities of the UK insurance operations are, except for pension annuity business, not generally exposed to interest rate risk. At 31 December 2012, pension annuity liabilities accounted for 98 per cent (2011: 98 per cent) of UK shareholder-backed business liabilities. For pension annuity business, liabilities are exposed to interest rate risk. However, the net exposure to the PAC WPSF (for PAL) and shareholders (for annuity liabilities of PRIL and the non-profit sub-fund) is very substantially ameliorated by virtue of the close matching of assets with appropriate duration. The level of matching from period to period can vary depending on management actions and economic factors so it is possible for a degree of mis-matching profits or losses to arise.
The close matching by the Group of assets of appropriate duration to annuity liabilities is based on maintaining economic and regulatory capital. The measurement of liabilities under capital reporting requirements and IFRS is not the same with contingency reserves and some other margins for prudence within the assumptions required under the FSA regulatory solvency basis not included for IFRS reporting purposes. As a result, IFRS equity is higher than regulatory capital and therefore, more sensitive to interest rate and credit risk.
The estimated sensitivity of the UK non-linked shareholder-backed business (principally pension annuities business) to a movement in interest rates is as follows:
2012 Łm 2011 Łm
A A An An A A An An
decrease decrease increase increase decrease decrease increase increase
of 2% of 1% of 1% of 2% of 2% of 1% of 1% of 2%
Carrying value of debt securities and
derivatives 9,006 3,993(3,265)(5,983) 7,676 3,426(2,820)(5,178)
Policyholder liabilities(7,878)(3,513) 2,867 5,235(6,842)(3,060) 2,510 4,593
Related deferred tax effects(259)(110) 91 172(208)(91) 77 146
Net sensitivity of profit after tax and
shareholders’ equity 869 370(307)(576) 626 275(233)(439)
In addition the shareholder-backed portfolio of UK non-linked insurance operations covering liabilities and shareholders’ equity includes equity securities and investment property. Excluding any second order effects on the measurement of the liabilities for future cash fl ows to the policyholder, a fall in their value would have given rise to the following effects on pre-tax profit, profi t after tax and shareholders’ equity.
2012 Łm 2011 Łm
A decrease A decrease A decrease A decrease
of 20% of 10% of 20% of 10%
Pre-tax profit(316)(158)(319)(160)
Related deferred tax effects 73 36 80 40 D:
Net sensitivity of profit after tax and shareholders’ equity(243)(122)(239)(120) Life
A 10 or 20 per cent increase in their value would have an approximately equal and opposite effect on profit and shareholders’ assurance
equity to the sensitivities shown above. The market risk sensitivities shown above reflect the impact of temporary market
movements and therefore, the primary effect of such movements would, in the Group’s segmental analysis of profits, be included
within the short-term fiuctuations in investment returns. business
In the equity risk sensitivity analysis shown above, the Group has considered the impact of an instantaneous 20 per cent fall in
equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous
fall, but rather, this would be expected to occur over a period of time during which the Group would be able to put in place
mitigating management actions. Financial
statements
212 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D2: UK insurance operations continued
i Duration of liabilities
With the exception of most unitised with-profits bonds and other whole of life contracts the majority of the contracts of the UK insurance operations have a contract term. However, in effect, the maturity term of contracts reflects the earlier of death, maturity, or lapsation. In addition, with-profits contract liabilities as noted in note D2(e) include projected future bonuses based on current investment values. The actual amounts payable will vary with future investment performance of SAIF and the WPSF.
The tables above show the carrying value of the policyholder liabilities. The tables in the accompanying notes below show the maturity profile of the cash flows for insurance contracts, as defined by IFRS, ie those containing significant insurance risk, and investment contracts, which do not.
2012 Łm
Annuity business
With-profits business(insurance contracts) Other
Non-profit
annuities
within
WPSF
Insurance Investment(including Insurance Investment
contracts contracts Total PAL) PRIL Total contracts contracts Total TOTAL
Policyholders liabilities 37,698 33,486 71,184 13,223 20,114 33,337 13,231 16,160 29,391 133,912
2012 %
Expected maturity:
0 to 5 years 45 39 42 30 26 27 35 28 31 36
5 to 10 years 24 25 24 24 22 22 25 23 24 24
10 to 15 years 13 17 15 18 17 18 17 17 17 16
15 to 20 years 8 11 10 12 13 13 10 12 11 11
20 to 25 years 5 6 5 8 9 9 6 9 8 7
over 25 years 5 2 4 8 13 11 7 11 9 6
2011 Łm
Annuity business
With-profits business(insurance contracts) Other
Non-profit
annuities
within
WPSF
Insurance Investment(including Insurance Investment
contracts contracts Total PAL) PRIL Total contracts contracts Total TOTAL
Policyholder liabilities 38,974 29,365 68,339 12,637 18,236 30,873 12,885 14,927 27,812 127,024
2011 %
Expected maturity:
0 to 5 years 47 32 41 29 25 27 34 28 31 35
5 to 10 years 24 26 25 24 22 22 25 22 24 24
10 to 15 years 13 19 16 18 18 18 18 18 18 17
15 to 20 years 8 14 10 12 13 13 11 12 11 11
20 to 25 years 5 7 6 8 10 9 7 9 7 7
over 25 years 3 2 2 9 12 11 5 11 9 6
Notes
(i) The cash flow projections of expected benefit payments used in the maturity profile table above are from value of in-force business and exclude the value of future new business, including future vesting of internal pension contracts.
(ii) Benefit payments do not reflect the pattern of bonuses and shareholder transfers in respect of the with-profits business.
(iii) Investment contracts under ‘Other’ comprise certain unit-linked and similar contracts accounted for under IAS 39 and IAS 18.
(iv) For business with no maturity term included within the contracts, for example with-profits investment bonds such as Prudence Bonds, an assumption is made as to likely duration based on prior experience.
(v) The maturity tables shown above have been prepared on a discounted basis. Details of undiscounted cash flow for investment contracts are shown in note G2.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 213
D3: US insurance operations
a Summary results and statement of financial position
i Results and movements in shareholders’ equity
2012 Łm 2011* Łm
Operating profit based on longer-term investment returns 964 651
Short-term fiuctuations in investment returns(90)(167)
Amortisation of acquisition accounting adjustments arising on the purchase of REALICI1(19) –
Profit before shareholder tax 855 484
Tax(234)(127)
Profit for the year 621 357
2012 Łm 2011* Łm
Profit for the year (as above) 621 357
Items recognised in other comprehensive income:
Exchange movements(181) 35
Unrealised valuation movements on securities classifled as available-for-sale:
Unrealised holding gains arising during the year 930 912
Deduct net gains included in the income statement(68)(101)
Total unrealised valuation movements 862 811
Related change in amortisation of deferred acquisition costs(270)(275)
Related tax(205)(187)
Total other comprehensive income 206 384
Total comprehensive income for the year 827 741
Dividends, interest payments to central companies and other movements(245)(330)
Net increase in equity 582 411
Shareholders’ equity at beginning of year:
As previously reported 4,271 3,815
Effect of change in accounting policy for deferred acquisition costs*(510)(465)
After effect of change 3,761 3,350
Shareholders’ equity at end of year 4,343 3,761
D:
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy Life
described in note A5.
Included within the movements in shareholders’ equity is a net increase in value of Jackson’s debt securities classifled as assurance
‘available-for-sale’ under IAS 39 of Ł862 million (2011: Ł811 million).
With the exception of debt securities for US insurance operations classifled 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 classifled as business
‘available-for-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 2012, Jackson recorded Ł37 million (2011: Ł62 million) of impairment losses arising from: Financial
2012 Łm 2011 Łm
Residential mortgage-backed securities 8 21
Public fixed income 2 – statements
Other 27 41
37 62
214 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
Jackson’s portfolio of debt securities is managed proactively with credit analysts closely monitoring and reporting on the credit quality of its holdings. Jackson continues to review its investments on a case-by-case basis to determine whether any decline in fair value represents an impairment. In addition, investments in structured securities are subject to a rigorous review of their future estimated cash flows, including expected and stress case scenarios, to identify potential shortfalls in contractual payments (both interest and principal). Impairment charges are recorded on structured securities when the Company forecasts a contractual payment shortfall. Situations where such a shortfall would not lead to a recognition of a loss are rare. However, some structured securities do not have a single determined set of future cash flows and instead, there can be a reasonable range of estimates that could potentially emerge. With this variability, there could be instances where the projected cash flow shortfall under management’s base case set of assumptions is so minor that relatively small and justifi able changes to the base case assumptions would eliminate the need for an impairment loss to be recognised. The impairment loss refi ects the difference between the fair value and book value.
In 2012, there was a movement in the statement of financial position value for debt securities classifled as available-for-sale from a net unrealised gain of Ł2,057 million to a net unrealised gain of Ł2,807 million. The gross unrealised gain in the statement of financial position increased from Ł2,303 million at 31 December 2011 to Ł2,985 million at 31 December 2012, while the gross unrealised loss decreased from Ł246 million at 31 December 2011 to Ł178 million at 31 December 2012.
[Graphic Appears Here]
Included within the movement in gross unrealised losses for the debt securities of Jackson of Ł59 million (2011: Ł122 million) as shown above was a net decrease in value of Ł33 million (2011: Ł12 million increase) relating to the sub-prime and Alt-A securities as referred to in section B5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 215
ii Statement of financial position
31 Dec 2012 Łm 31 Dec 2011* Łm
Variable
annuity
separate
account Fixed annuity,
assets and GIC and other
liabilities business Total † Total
note (i) note (i)
Assets
Intangible assets attributable to shareholders:
Deferred acquisition costs and other intangibles – 3,222 3,222 3,115
Total – 3,222 3,222 3,115
Deferred tax assets – 1,889 1,889 1,392
Other non-investment and non-cash assetsnote (vi) – 6,792 6,792 1,542
Investments of long-term business and other operations:
Investment properties – 24 24 35
Financial investments:
Loansnote (ii) – 6,235 6,235 4,110
Equity securities and portfolio holdings in unit trustsnote (v) 49,298 253 49,551 38,036
Debt securities – 32,993 32,993 27,022
Other investmentsnote (iii) – 2,296 2,296 2,376
Deposits – 211 211 167
Total investments 49,298 42,012 91,310 71,746
Properties held for sale – – – 3
Cash and cash equivalents – 513 513 271
Total assets 49,298 54,428 103,726 78,069
Equity and liabilities
Equity
Shareholders’ equitynote (iii) – 4,343 4,343 3,761
Total equity – 4,343 4,343 3,761
Liabilities
Policyholder:
Contract liabilities (including amounts in respect of contracts D:
classifled as investment contracts under IFRS 4)note (iv) 49,298 42,963 92,261 69,189 Life
Total 49,298 42,963 92,261 69,189
Core structural borrowings of shareholder-financed operations – 153 153 160 assurance
Operational borrowings attributable to shareholder-financed operations – 26 26 127
Deferred tax liabilities – 2,168 2,168 1,818 business
Other non-insurance liabilitiesnote (vi) – 4,775 4,775 3,014
Total liabilities 49,298 50,085 99,383 74,308
Total equity and liabilities 49,298 54,428 103,726 78,069 Financial
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy
described in note A5.
† The statement of financial position at 31 December 2012 includes the assets and liabilities of the acquired REALIC business. Details of the acquisition are
described in note I1. statements
216 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
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
The loans of the Group’s US insurance operations comprise:
2012 Łm 2011 Łm
Mortgage loans* 3,543 3,559
Policy loans† 2,692 551
Total US insurance operations loans 6,235 4,110
* All of the mortgage loans are commercial mortgage loans which are collateralised by properties. The property types are industrial, multi-family residential, suburban office, retail and hotel. The breakdown by property type is as follows:
2012 % 2011 %
Industrial 29 28
Multi-family residential 25 23
Office 19 19
Retail 17 19
Hotels 10 11
100 100
The US insurance operations’ commercial mortgage loan portfolio does not include any single-family residential mortgage loans and is therefore, not exposed to the risk of defaults associated with residential sub-prime mortgage loans. The average loan size is Ł6.3 million (2011: Ł6.6 million). The portfolio has a current estimated average loan to value of 65 per cent (2011: 68 per cent) which provides signifi cant cushion to withstand substantial declines in value.
At 31 December 2012, Jackson had mortgage loans with a carrying value of Ł78 million where the contractual terms of the agreements had been restructured. In addition to the regular impairment review aff orded all loans in the portfolio, restructured loans are also reviewed for impairment. An impairment will be recorded if the expected cash fl ows under the newly restructured terms discounted at the original yield (the pre-structured interest rate) are below the carrying value of the loan.
• The policy loans are fully secured by individual life insurance policies or annuity policies. The increase in 2012 reflects the purchase of REALIC as explained in note I1. The policy loans from the purchase of REALIC amounted to Ł1,842 million at 31 December 2012, and are accounted for at fair value through profit and loss as described above. All other policy loans are accounted for at amortised cost, less any impairment.
(iii) Other investments comprise:
2012 Łm 2011 Łm
Derivative assets*G3 1,546 1,677
Partnerships in investment pools and other† 750 699
2,296 2,376
* In the US, Prudential uses derivatives: – To reduce interest rate risk;
– To facilitate efficient portfolio management to match liabilities under annuity policies; and – For certain equity-based product management activities.
After taking account of the derivative liabilities of Ł645 million (2011: Ł887 million), which are also included in Other non-insurance liabilities, the derivative position for US operations is a net asset of Ł901 million (2011: Ł790 million).
† Partnerships in investment pools and other comprise primarily investments in limited partnerships. These include interests in the PPM America Private Equity Fund and diversifled investments in 167 (2011: 167) other partnerships by independent money managers that generally invest in various equities and fixed income loans and securities.
(iv) Summary policyholder liabilities (net of reinsurance) and reserves at 31 December 2012
The policyholder liabilities, net of reinsurers’ share of Ł6,076 million (2011: Ł907 million), reflect balances in respect of the following:
2012 Łm 2011 Łm
Policy reserves and liabilities on non-linked business:
Reserves for future policyholder benefits and claims payable 7,663 518
Deposits on investment contracts (as defined under IFRS ‘grandfathered’ US GAAP) 27,425 28,314
Guaranteed investment contracts 1,799 1,617
Unit-linked (variable annuity) business 49,298 37,833
86,185 68,282
In addition to the policyholder liabilities above, Jackson has entered into a programme of funding arrangements under contracts which, in substance, are almost identical to GICs. The liabilities under these funding arrangements totalled Ł825 million (2011: Ł1,070 million) and are included in ‘Other non-insurance liabilities’ in the statement of financial position above.
(v) Equity securities and portfolio holdings in unit trusts includes investments in mutual funds, the majority of which are equity based.
(v) Reinsurance balances relating to REALIC
Included within Other non-investment and non-cash assets of Ł6,792 million (2011: Ł1,542 million) were balances of Ł6,076 million (2011: Ł907 million) for reinsurers’ share of insurance contract liabilities. Of the Ł6,076 million as at 31 December 2012, Ł5,234 million related to the reinsurance ceded by the newly acquired REALIC business. REALIC holds collateral for certain of these reinsurance arrangements with a corresponding funds withheld liability.
As of 31 December 2012, the funds withheld liability of Ł2,021 million was recorded within Other non-insurance liabilities.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 217
b Reconciliation of movement in policyholder liabilities
A reconciliation of the total policyholder liabilities of US insurance operations from the beginning of the year to the end of the year is as follows:
US insurance operations
Variable
annuity
separate Fixed annuity,
account GIC and other
liabilities business Total
Łm Łm Łm
At 1 January 2011 31,203 29,320 60,523
Premiums 9,176 3,738 12,914
Surrenders(1,898)(2,372)(4,270)
Maturities/Deaths(300)(520)(820)
Net flowsnote (b) 6,978 846 7,824
Transfers from general to separate account 957(957) –
Investment-related items and other movements(1,735) 1,871 136
Foreign exchange translation differencesnote (a) 430 276 706
At 31 December 2011/1 January 2012 37,833 31,356 69,189
Premiums 10,361 4,546 14,907
Surrenders(2,149)(2,207)(4,356)
Maturities/Deaths(404)(550)(954)
Net flowsnote (b) 7,808 1,789 9,597
Transfers from general to separate account 1,577(1,577) –
Investment-related items and other movementsnote (c) 4,014 227 4,241
Foreign exchange translation differencesnote (a)(1,998)(1,680)(3,678)
Acquisition of REALICnotes (d), I1 64 12,848 12,912
At 31 December 2012 49,298 42,963 92,261
Average policyholder liability balances*
2012 43,549 33,948 77,497
2011 34,518 30,338 64,856
* Averages have been based on opening and closing balances, and adjusted for acquisitions and disposals in the period.
D:
Notes Life
(a) Movements in the year have been translated at an average rate of US$1.58/Ł1.00 (2011: US$1.60/Ł1.00). The closing balances have been translated at closing
rate of US$1.63/Ł1.00 (2011: US$1.55/Ł1.00). Differences upon retranslation are included in foreign exchange translation differences.
(b) Net flows for the year were Ł9,597 million compared with Ł7,824 million in 2011 driven largely by increased new business volumes.
(c) Positive investment-related items and other movements in variable annuity separate account liabilities of Ł4,014 million for 2012 reflects the increase in the
US equity market during the year with the S&P index increasing by 13.4 per cent. Fixed annuity, GIC and other business investment and other movements assurance
primarily reflects the interest credited to policyholder account in the year, net of falls in the technical provisions held for the guarantees issued with variable
annuity business.
(d) The acquisition of REALIC reflects the liabilities, before reduction for reinsurances ceded, acquired at the date of acquisition. business
Financial
statements
218 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
c Information on credit risks of debt securities
Summary 2012 Łm 2011 Łm
Corporate and government security and commercial loans:
Government 4,126 2,163
Publicly traded and SEC Rule 144A* securities 19,699 16,281
Non-SEC Rule 144A* securities 3,542 3,198
Total 27,367 21,642
Residential mortgage-backed securities 2,400 2,591
Commercial mortgage-backed securities 2,639 2,169
Other debt securities 587 620
Total US debt securities 32,993 27,022
* A 1990 SEC rule that facilitates the resale of privately placed securities that are without SEC registration to qualifled institutional investors. The rule was designed to develop a more liquid and efficient institutional resale market for unregistered securities.
i Credit quality
The following table summarises by rating the debt securities, as at 31 December 2012 and 2011 using Standard & Poor’s (S&P), Moody’s, Fitch and implicit ratings of mortgage-backed securities (MBS) based on NAIC* valuations.
2012 Łm 2011 Łm
S&P – AAA 187 133
S&P – AA+ to AA- 6,343 4,476
S&P – A+ to A- 7,728 6,382
S&P – BBB+ to BBB- 10,230 8,446
S&P – Other 1,173 999
25,661 20,436
Moody’s – Aaa 55 62
Moody’s – Aa1 to Aa3 18 15
Moody’s – A1 to A3 21 29
Moody’s – Baa1 to Baa3 56 67
Moody’s – Other 13 17
163 190
Implicit ratings of MBS based on NAIC* valuations (see below)
NAIC 1 2,934 2,577
NAIC 2 207 147
NAIC 3-6 321 368
3,462 3,092
Fitch 184 184
Other† 3,523 3,120
Total debt securities 32,993 27,022
* The Securities Valuation Office of the National Association of Insurance Commissioners (NAIC) classifles debt securities into six quality categories ranging from Class 1 (the highest) to Class 6 (the lowest). Performing securities are designated as Classes 1 to 5 and securities in or near default are designated Class 6.
• The amounts within Other which are not rated by S&P, Moody’s nor Fitch, nor are MBS securities using the revised regulatory ratings, have the following NAIC classifications:
2012 Łm 2011 Łm
NAIC 1 1,453 1,258
NAIC 2 2,022 1,792
NAIC 3-6 48 70
3,523 3,120
For some mortgage-backed securities within Jackson, the table above includes these securities using the regulatory ratings detail issued by the NAIC. These regulatory ratings levels were established by external third parties (PIMCO for residential mortgage-backed securities and BlackRock Solutions for commercial mortgage-backed securities) based on Jackson’s carrying value.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 219
ii Determining the fair value of debt securities when the markets are not active
Under IAS 39, unless categorised as ‘held to maturity’ or ‘loans and receivables’ debt securities are required to be fair valued. Where available, quoted market prices are used. However, where securities do not have an externally quoted price based on regular trades, or where markets for the securities are no longer active as a result of market conditions, IAS 39 requires that valuation techniques be applied. IFRS 7 requires classification of the fair values applied by the Group into a three level hierarchy. Note G1 sets out further details of the Group’s approach to determining fair value and classifi es these fair values into a three level hierarchy as required by IFRS 7. At 31 December 2012, 0.1 per cent of Jackson’s debt securities were classifi ed as level 3 (31 December 2011: 0.1 per cent) comprising of fair values where there are significant inputs which are not based on observable market data.
iii Asset-backed securities funds exposures
Included within the debt securities of Jackson at 31 December 2012, are exposures to asset-backed securities as follows:
2012 Łm 2011 Łm
RMBS:
Sub-prime (2012: 15% AAA, 6% AA) 261 207
Alt-A (2012: 4% AAA, 1% AA) 323 310
Prime including agency (2012: 0% AAA, 75% AA) 1,816 2,074
CMBS (2012: 40% AAA, 24% AA) 2,639 2,169
CDO funds (2012: 0% AAA, 27% AA)*, including Łnil exposure to sub-prime 44 44
Other ABS (2012: 24% AAA, 15% AA), including Łnil exposure to sub-prime 543 576
Total 5,626 5,380
* Including Group’s economic interest in Piedmont and other consolidated CDO funds.
Jackson defines its exposure to sub-prime mortgages as investments in residential mortgage-backed securities in which the
underlying borrowers have a US Fair Isaac Credit Organisation (FICO) credit score of 680 or lower.
iv Debt securities classifled as available-for-sale in an unrealised loss position
The following table shows the fair value of those securities that are in a gross unrealised loss position for various percentages
of book value at 31 December:
2012 Łm 2011 Łm
Unrealised Unrealised
Fair value loss Fair value loss
Between 90% and 100% 4,214(112) 1,829(60)
Between 80% and 90% 85(13) 172(28) D:
Below 80%* 74(53) 208(158) Life
Total 4,373(178) 2,209(246)
* The unrealised losses as at 31 December 2012 include Ł77 million (2011: Ł183 million) relating to mortgage-backed and other debt securities. The unrealised
losses in the portfolio by reference to the length of time of three years or more as at 31 December 2012 are Ł36 million (2011: Ł105 million) in the investment
grade and Ł31 million (2011: Ł61 million) in non-investment grade. business
Financial
statements
220 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
d Products and guarantees
Jackson provides long-term savings and retirement products to retail and institutional customers throughout the US. Jackson offers fixed annuities (interest-sensitive, fixed indexed and immediate annuities), variable annuities (VA), life insurance and institutional products.
i Fixed annuities
Interest-sensitive annuities
At 31 December 2012, interest-sensitive fixed annuities accounted for 13 per cent (2011: 16 per cent) of policy and contract liabilities of Jackson. Interest-sensitive fixed annuities are primarily deferred annuity products that are used for asset accumulation in retirement planning and for providing income in retirement. They permit tax-deferred accumulation of funds andfl exible payout options.
The policyholder of an interest-sensitive fixed annuity pays Jackson a premium, which is credited to the policyholder’s account. Periodically, interest is credited to the policyholder’s account and in some cases administrative charges are deducted from the policyholder’s account. Jackson makes benefi t payments at a future date as specifled in the policy based on the value of the policyholder’s account at that date.
The policy provides that at Jackson’s discretion it may reset the interest rate, subject to a guaranteed minimum. At 31 December 2012, Jackson had fi xed interest rate annuities totalling Ł11.7 billion (US$19.0 billion) (2011: Ł11.5 billion (US$17.8 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a
3.09 per cent average guaranteed rate (2011: 1.0 per cent to 5.5 per cent and a 3.08 per cent average guaranteed rate).
Approximately 50 per cent (2011: 48 per cent) of the interest-sensitive fixed annuities Jackson wrote in 2012 provide for a market value adjustment that could be positive or negative, on surrenders in the surrender period of the policy. This formula-based adjustment approximates the change in value that assets supporting the product would realise as interest rates move up or down. The minimum guaranteed rate is not affected by this adjustment.
Fixed indexed annuities
Fixed indexed annuities (FIA) accounted for 8 per cent (2011: 9 per cent) of Jackson’s policy and contract liabilities at
31 December 2012. Fixed indexed annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of an equity-linked return (based on participation rates and caps) but provide a guaranteed minimum return. These guaranteed minimum rates are generally set between 1.0 per cent and 3.0 per cent. Jackson had fixed indexed annuities allocated to indexed funds totalling Ł5.6 billion (US$9.2 billion) (2011: Ł5.0 billion (US$7.8 billion)) in account value with minimum guaranteed rates on indexed accounts ranging from 1.0 per cent to 3.0 per cent and a 1.82 per cent average guaranteed rate (2011: 1.0 per cent to 3.0 per cent and a 1.76 per cent average guarantee rate). Jackson also offers fixed interest accounts on some fixed indexed annuity products. Fixed interest accounts of fixed indexed annuities totalled Ł1.5 billion (US$2.3 billion) (2011: Ł1.4 billion (US$2.1 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 2.53 per cent average guaranteed rate (2011: 1.0 per cent to 3.0 per cent and a 2.50 per cent average guarantee rate).
Jackson hedges the equity return risk on fixed indexed products using futures and options linked to the relevant index as well as through offsetting equity exposure in the VA product. The cost of these hedges is taken into account in setting the index participation rates or caps. Jackson bears the investment and surrender risk on these products.
Immediate annuities
At 31 December 2012, immediate annuities accounted for 1 per cent (2011: 1 per cent) of Jackson’s policy and contract liabilities. Immediate annuities guarantee a series of payments beginning within a year of purchase and continuing over either a fixed period of years and/or the life of the policyholder. If the term is for the life of the policyholder, then Jackson’s primary risk is mortality risk. The implicit interest rate on these products is based on the market conditions that exist at the time the policy is issued and is guaranteed for the term of the annuity.
ii Variable annuities
At 31 December 2012, VAs accounted for 60 per cent (2011: 63 per cent) of Jackson’s policy and contract liabilities. VAs are deferred annuities that have the same tax advantages and payout options as interest-sensitive and fi xed indexed annuities.
The primary differences between VAs and interest-sensitive or fixed indexed annuities are investment risk and return. If a policyholder chooses a VA, the rate of return depends upon the performance of the selected fund portfolio. Policyholders may allocate their investment to either the fixed or a selection of variable accounts. Investment risk on the variable account is borne by the policyholder, while investment risk on the fixed account is borne by Jackson through guaranteed minimum fixed rates of return. At 31 December 2012, approximately 8 per cent (2011: approximately 10 per cent) of VA funds were in fixed accounts. Jackson had fixed interest rate accounts in variable annuities totalling Ł4.3 billion (US$7.0 billion) (2011: Ł4.3 billion (US$6.7 billion)) in account value with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 1.89 per cent average guaranteed rate (2011: 1.0 per cent to 3.0 per cent and a 1.99 per cent average guarantee rate).
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 221
Jackson issues VA contracts where it contractually guarantees to the contractholder either a) return of no less than total deposits
made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial
withdrawals plus a minimum return, or c) the highest contract value on a specifled anniversary date adjusted for any withdrawals
following the contract anniversary. These guarantees include benefits that are payable in the event of death (guaranteed minimum
death benefit (GMDB)), annuitisation (guaranteed minimum income benefit (GMIB)), or at specifled dates during the accumulation
period (guaranteed minimum withdrawal benefit (GMWB) and guaranteed minimum accumulation benefit (GMAB)). Jackson
hedges these risks using equity options and futures contracts as described in note D3(h). The GMAB was eliminated from
Jackson’s product offerings in 2011. The GMIB is no longer offered, with existing coverage being reinsured.
In March 2012, Jackson launched a new variable annuity product, Elite Access, which has no guaranteed benefits and provides
tax efficient access to alternative investments. Single premium sales in the period since launch were Ł849 million.
iii Aggregate distribution of account values
The table below shows the distribution of account values for fixed annuities (interest sensitive and fixed indexed) and variable
annuities within the range of minimum guaranteed interest rates as described in notes i and ii above as at 31 December 2012
and 2011:
Account value
Minimum guaranteed interest rate 2012 Łm 2011 Łm
1.0% 2,534 1,988
> 1.0% – 2.0% 8,374 8,321
> 2.0% – 3.0% 9,174 9,352
> 3.0% – 4.0% 1,236 841
> 4.0% – 5.0% 1,518 1,425
> 5.0% 209 167
Total 23,045 22,094
iv Life insurance
Jackson’s life insurance products accounted for 15 per cent (2011: 7 per cent) of Jackson’s policy and contract liabilities at
31 December 2012. The increase from 2011 was a result of the acquisition of REALIC. Jackson discontinued new sales of life
insurance products effective 1 August 2012. The life products included term life, universal life and variable universal life. Term
life provides protection for a defined period and a benefit that is payable to a designated beneficiary upon death of the insured.
Universal life provides permanent individual life insurance for the life of the insured and includes a savings element. Variable
universal life is a type of life insurance policy that combines death benefit protection with the ability for the policyholder account
to be invested in separate account funds.
At 31 December 2012, Jackson (including the newly acquired REALIC) had interest sensitive life business in force with
total account value of Ł6.0 billion (US$9.7 billion) (2011: Ł3.3 billion (US$5.1 billion)), with minimum guaranteed interest rates
ranging from 2.5 per cent to 6.0 per cent with a 4.67 per cent average guaranteed rate (2011: 3.0 per cent to 6.0 per cent with D:
a 4.88 per cent average guaranteed rate). The table below shows the distribution of the interest-sensitive life business’ account Life
values within this range of minimum guaranteed interest rates as at 31 December 2012 and 2011:
Account value assurance
Minimum guaranteed interest rate 2012 Łm 2011 Łm
1.0% – – business
> 1.0% – 2.0% – –
> 2.0% – 3.0% 183 130
> 3.0% – 4.0% 2,141 1,145
> 4.0% – 5.0% 2,097 686 Financial
> 5.0% 1,550 1,317
Total 5,971 3,278 statements
222 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
v Institutional products
Jackson’s institutional products consist of GICs, funding agreements (including agreements issued in conjunction with Jackson’s participation in the US Federal Home Loan Bank programme) and medium-term note funding agreements. At 31 December 2012, institutional products accounted for 3 per cent of policy and contract liabilities (2011: 4 per cent). Under a traditional GIC, the policyholder makes a lump sum deposit. The interest rate paid is fixed and established when the contract is issued. If deposited funds are withdrawn earlier than the specifled term of the contract, an adjustment is made that approximates a market value adjustment.
Under a funding agreement, the policyholder either makes a lump sum deposit or makes specifled periodic deposits. Jackson agrees to pay a rate of interest, which may be fixed but which is usually a floating short-term interest rate linked to an external index. The average term of the funding arrangements is one to two years. In 2012 and 2011, there were no funding agreements terminable by the policyholder with less than 90 days’ notice.
Medium-term note funding agreements are generally issued to support trust instruments issued on non-US exchanges or to qualifled investors (as defined by SEC Rule 144A). Through the funding agreements, Jackson agrees to pay a rate of interest, which may be fixed or floating, to the holders of the trust instruments.
e Process for setting assumptions and determining contract liabilities
Under the MSB of reporting applied under IFRS 4 for insurance contracts, providing the requirements of the Companies Act, UK GAAP standards and the ABI SORP are met, it is permissible to reflect the previously applied UK GAAP basis. Accordingly, and consistent with the basis explained in note A3, in the case of Jackson the carrying values of insurance assets and liabilities are consolidated into the Group accounts based on US GAAP.
Under US GAAP, investment contracts (as defined for US GAAP purposes) are accounted for by applying, in the first instance, a retrospective deposit method to determine the liability for policyholder benefits. This is then augmented by potentially three additional amounts. These amounts are for:
Any amounts that have been assessed to compensate the insurer for services to be performed over future periods (ie deferred income); Any amounts previously assessed against policyholders that are refundable on termination of the contract; and Any probable future loss on the contract (ie premium deficiency).
Capitalised acquisition costs and deferred income for these contracts are amortised over the life of the book of contracts. The present value of the estimated gross profits is generally computed using the rate of interest that accrues to policyholder balances (sometimes referred to as the contract rate). Estimated gross profits include estimates of the following elements, each of which will be determined based on the best estimate of amounts of the following individual elements over the life of the book of contracts without provision for adverse deviation for:
Amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances; Amounts expected to be assessed for contract administration less costs incurred for contract administration;
Amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances; Amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender
charges); and Other expected assessments and credits.
VA contracts written by Jackson may, as described above, provide for GMDB, GMIB, GMWB and GMAB 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 persistency assumptions.
In accordance with US GAAP, the ‘grandfathered’ basis for IFRS, which specifi es how certain guarantee features should be accounted for, the GMDB and the ‘for life’ portion of GMWB liabilities are not fair valued but are instead determined each period end by estimating the expected value of benefits in excess of the projected account balance and recognising the excess ratably over the life of the contract based on total expected assessments. At 31 December 2012, these liabilities were valued using a series of deterministic investment performance scenarios, a mean investment return of 8.4 per cent (2011: 8.4 per cent) and assumptions for lapse, mortality and expense that are the same as those used in amortising the capitalised acquisition costs.
The direct GMIB liability is determined by estimating the expected value of the annuitisation benefits in excess of the projected account balance at the date of annuitisation and recognising the excess ratably over the accumulation period based on total expected assessments.
GMIB benefits are essentially fully reinsured, subject to annual claim limits. As this reinsurance benefit is net settled, it is considered to be a derivative under IAS 39, and is therefore recognised at fair value with the change in fair value included as a component of short-term derivative fluctuations.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 223
The assumptions used for calculating the direct GMIB liability at 31 December 2012 and 2011, are consistent with those used for
calculating the GMDB and ‘for life’ GMWB liabilities. The change in these reserves, along with claim payments and associated fees
included in reserves, are included along with the hedge results in short-term fiuctuations, resulting in removal of the market impact
from the operating profit based on longer-term investment returns.
Jackson regularly evaluates, estimates used and adjusts the additional GMDB, GMIB and GMWB ‘for life’ liability balances, with a
related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
GMWB ‘not for life’ features are considered to be embedded derivatives under IAS 39. Therefore, provisions for these benefits are
recognised at fair value, with the change in fair value included in short-term fiuctuations.
For GMWB and GMIB reinsurance embedded derivatives that are fair valued under IAS 39, Jackson bases its volatility assumptions
solely on implied market volatility with no reference to historical volatility levels and explicitly incorporates Jackson’s own credit risk in
determining discount rates.
Volatility assumptions are based on a weighting of available market data on implied volatility for durations up to ten years, at which
point the projected volatility is held constant. Non-performance risk is incorporated into the calculation through the use of discount
interest rates sourced from a AA corporate credit curve. Other risk margins, particularly for market illiquidity and policyholder
behaviour, are also incorporated into the model through the use of explicitly conservative assumptions. On a periodic basis, Jackson
rationalises the resulting fair values based on comparisons to other models and market movements.
With the exception of the GMDB, GMIB, GMWB and GMAB features of VA contracts, the financial guarantee features of Jackson’s
contracts are in most circumstances not explicitly valued, but the impact of any interest guarantees would be reflected as they are
earned in the current account value (ie the US GAAP liability).
For traditional life insurance contracts, provisions for future policy benefits are determined under US GAAP using the net level
premium method and assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse
deviation.
Institutional products are accounted for as investment contracts under IFRS with the liability classifled as being in respect of
financial instruments rather than insurance contracts, as defined by IFRS 4. In practice, there is no material difference between the
IFRS and US GAAP basis of recognition and measurement for these contracts.
Certain institutional products representing obligations issued in currencies other than US dollars have been hedged for changes
in exchange rates using cross-currency swaps. The fair value of derivatives embedded in funding agreements, as well as foreign
currency transaction gains and losses, are included in the carrying value of the trust instruments supported by funding agreements
recorded in other non-insurance liabilities.
Deferred acquisition costs
Under IFRS 4, the Group applies ‘grandfathered’ US GAAP for measuring the insurance assets and liabilities of Jackson. In the
case of Jackson term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and
interest-sensitive life business, acquisition costs are deferred and amortised in line with a combination of historical and future
expected gross profits on the relevant contracts. For fixed and indexed annuity and interest-sensitive life business, the key assumption
is the long-term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual
spread analysis. Expected gross profits also depend on mortality assumptions, assumed unit costs and terminations other than deaths
(including the related charges), all of which are based on a combination of actual experience of Jackson, industry experience and
future expectations. A detailed analysis of actual mortality, lapse and expense experience is performed using internally developed D:
experience studies. Life
As with fixed and indexed annuity and interest-sensitive life business, acquisition costs for Jackson’s variable annuity products are
amortised in line with the emergence of profits. The measurement of the amortisation, in part, reflects current period fees (including
those for guaranteed minimum death, income, or withdrawal benefits) earned on assets covering liabilities to policyholders, and the assurance
historical and expected level of future gross profits which depends on the assumed level of future fees, as well as components related
to mortality, lapse and expense. business
Change of accounting policy
As explained in note A5, the Company has adopted the US Financial Accounting Standards Board requirements in the Emerging Issues
Task Force (EITF) Update No. 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ from
1 January 2012 into Prudential’s Group IFRS reporting for the results of Jackson and those Asia operations whose IFRS insurance Financial
assets and liabilities are measured principally by reference to US GAAP principles. Under the Update, insurers are required to
capitalise only those incremental costs directly relating to successfully acquiring a contract from 1 January 2012. For Group IFRS
reporting, the Company has chosen to apply this new basis retrospectively for the results of these operations.
On application of the new policy for Jackson, the deferred costs balance for business in force at 31 December 2011, was statements
retrospectively reduced from Ł3,880 million to Ł3,095 million.
224 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
Mean reversion technique
For variable annuity products, under US GAAP (as ‘grandfathered’ under IFRS 4) the projected gross profi ts, against which acquisition costs are amortised, refi ect an assumed long-term level of equity return which, for Jackson, is 8.4 per cent after deduction of net external fund management fees. This is applied to the period end level of separate account assets after application of a mean reversion technique that removes a portion of the effect of levels of short-term variability in current market returns.
Under the mean reversion technique applied by Jackson, the projected level of return for each of the next five years is adjusted from period to period, so that in combination with the actual rates of return for the preceding two years and the current year, the
8.4 per cent annual return is realised on average over the entire eight year period. Projected returns after the mean reversion period revert back to the 8.4 per cent assumption.
However, to ensure that the methodology does not over anticipate a reversion to trend following adverse markets, the mean reversion technique has a cap and fi oor feature whereby the projected returns in each of the next five years can be no more than 15 per cent per annum and no less than 0 per cent per annum (both gross of asset management fees) in each year. The capping feature was relevant in late 2008, 2009 and 2010 due to the very sharp market falls in 2008. Notwithstanding this capping feature, the mean reversion technique gave rise to a benefit in 2008 of Ł110 million. This benefi t was effectively ‘paid back’ under the mean reversion technique through charges for accelerated amortisation in 2011, as discussed below.
At 31 December 2012, the projected rate of return for the next five years is materially the same as the long-term assumption of
8.4 per cent, and so the mean reversion technique had little effect at that date.
Sensitivity of amortisation charge
The amortisation charge to the income statement is reflected in operating profit and short-term fiuctuations in investment returns. The amortisation charge to the operating profit in a reporting period comprises:
(i) A core amount that reflects a relatively stable proportion of underlying profit; and
(ii) An element of acceleration or deceleration arising from market movements differing from expectations.
In periods where the cap and floor feature of the mean reversion technique are not relevant, the technique operates to dampen the second element above. Nevertheless, extreme market movements can cause material acceleration or deceleration of amortisation in spite of this dampening effect.
Furthermore, in those periods where the cap or floor is relevant, the mean reversion technique provides no further dampening and additional volatility may result.
2011
In 2011, the DAC amortisation charge to operating profit included Ł190 million of accelerated amortisation. This amount refl ected the combined effect of:
(a) The separate account performance in the year of negative 4 per cent, net of all fees as it compared with the assumed level for the year; and
(b) The reduction in the previously assumed future rates of return for the upcoming five years from 15 per cent, to a level nearer the middle of the corridor (of 0 per cent and 15 per cent), so that, in combination with the historical returns, the eight-year average in the mean reversion calculation was the 8.4 per cent assumption.
The reduction in assumed future rates reflected, in large part, the elimination from the calculation in 2011 of the 2008 negative returns. Setting aside other complications and the growth in the book, the 2011 accelerated amortisation can be broadly equated as ‘paying back’ the benefi t experienced in 2008.
2012
In 2012, the DAC amortisation charge to operating profit of Ł356 million was determined after taking credit for decelerated amortisation of Ł56 million. This amount primarily refl ects the separate account performance of 11 per cent, net of all fees, over the assumed level for the year.
2013
The application of the mean reversion formula has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. It would take a very significant movement in equity
markets in 2013 (outside the range of negative 20 per cent to positive 50 per cent) for the mean reversion assumption to move outside the corridor.
Statement of changes in equity – ‘shadow DAC adjustments’
Consequent upon the positive unrealised valuation movement in 2012 of Ł862 million (2011: positive Ł811 million), there is a debit of Ł270 million (2011: Ł275 million debit) for altered ‘shadow’ DAC amortisation booked within other comprehensive income. These adjustments refl ect movement from period to period, in the changes to the pattern of reported gross profits that would have happened if the assets reflected in the statement of financial position had been sold, crystallising the unrealised gains or losses, and the proceeds reinvested at the yields currently available in the market. At 31 December 2012, the cumulative ‘shadow DAC balance’ was negative Ł952 million (2011: negative Ł720 million).
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 225
f Reinsurance
The reinsurance asset for business ceded outside the Group was Ł6,076 million (2011: Ł907 million). The increase from 2011 is due
to the acquisition of REALIC as described in note I1, whereby certain former REALIC business was retained by Swiss Re through
100 per cent reinsurance agreements. Apart from the reinsurance acquired through the purchase of REALIC, the principal reinsurance
ceded by Jackson outside the Group is on term life insurance, direct and assumed accident and health business and GMIB variable
annuity guarantees. In 2012, the premiums for such ceded business amounted to Ł193 million (2011: Ł72 million). Net commissions
received on ceded business and claims incurred ceded to external reinsurers totalled Ł24 million and Ł123 million respectively during
2012 (2011: Ł9 million and Ł84 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2012
or 2011.
g Effect of changes in assumptions used to measure insurance assets and liabilities
In 2012 and 2011, there were no changes of assumptions that had a material impact on the results of US insurance operations.
h Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks
Jackson’s main exposures are to market risk through its exposure to interest rate risk and equity risk. Approximately 94 per cent
(2011: 92 per cent) of its general account investments support interest-sensitive and fixed indexed annuities, life business and surplus
and 6 per cent (2011: 8 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.
Jackson is exposed primarily to the following risks in the US arising from fiuctuations in interest rates:
The risk of loss related to meeting guaranteed rates of accumulation following a sharp and sustained fall in interest rates;
The risk of loss related to policyholder withdrawals following a sharp and sustained increase in interest rates; and
The risk of mismatch between the expected duration of certain annuity liabilities and prepayment risk and extension risk inherent
in mortgage-backed securities.
Jackson is also exposed to the following risks in the US arising from equity market movements:
The risk of loss related to the incidence of benefits related to guarantees issued in connection with its VA contracts; and
The risk of loss related to meeting contractual accumulation requirements in FIA contracts.
Jackson enters into financial derivative transactions, including those noted below, to reduce and manage business risks. These
transactions manage the risk of a change in the value, yield, price, cash flows or quantity of, or a degree of exposure with respect
to assets, liabilities or future cash flows, which Jackson has acquired or incurred.
Jackson uses free-standing derivative instruments for hedging purposes. Additionally, certain liabilities, primarily trust instruments
supported by funding agreements, fixed indexed annuities, certain GMWB variable annuity features and reinsured GMIB variable
annuity features, contain embedded derivatives as defined by IAS 39, ‘Financial Instruments: Recognition and Measurement’. Jackson
does not account for such derivatives as either fair value or cash flow hedges as might be permitted if the specific hedge
documentation requirements of IAS 39 were followed. Financial derivatives, including derivatives embedded in certain host liabilities
that have been separated for accounting and financial reporting purposes, are carried at fair value.
Value movements on the derivatives are reported within the income statement. In preparing Jackson’s segment profit as shown
in note B1, value movements on Jackson’s derivative contracts, are included within short-term fluctuations in investment returns and D:
excluded from operating results based on longer-term investment returns. Life
The types of derivatives used by Jackson and their purpose are as follows:
Interest rate swaps generally involve the exchange of fixed and floating payments over the period for which Jackson holds the
instrument without an exchange of the underlying principal amount. These agreements are used for hedging purposes; assurance
Put-swaption contracts provide the purchaser with the right, but not the obligation, to require the writer to pay the present value
of a long-duration interest rate swap at future exercise dates. Jackson purchases and writes put-swaptions with maturities up to business
10 years. Put-swaptions hedge against significant movements in interest rates;
Equity index futures contracts and equity index options (including various call, put options and put spreads) are used to hedge
Jackson’s obligations associated with its issuance of fixed indexed immediate and deferred annuities and certain VA guarantees.
These annuities and guarantees contain embedded options which are fair valued for financial reporting purposes;
Total return swaps in which Jackson receives equity returns or returns based on reference pools of assets in exchange for Financial
short-term floating rate payments based on notional amounts, are held for both hedging and investment purposes;
Cross-currency swaps, which embody spot and forward currency swaps and additionally, in some cases, interest rate swaps and
equity index swaps, are entered into for the purpose of hedging Jackson’s foreign currency denominated funding agreements
supporting trust instrument obligations; and statements
Credit default swaps represent agreements under which Jackson has purchased default protection on certain underlying
corporate bonds held in its portfolio. These contracts allow Jackson to sell the protected bonds at par value to the counterparty
if a default event occurs in exchange for periodic payments made by Jackson for the life of the agreement. Jackson does not write
default protection using credit derivatives.
The estimated sensitivity of Jackson’s profit and shareholders’ equity to equity and interest rate risks provided below is net of the
related changes in amortisation of DAC. The effect on the related changes in amortisation of DAC provided is based on the current
‘grandfathered’ US GAAP DAC basis but does not include any effect from an acceleration or deceleration of amortisation of DAC.
Note A5 provides explanation of the new US GAAP DAC basis adopted by the Company from 1 January 2012. Note D3(e) above
provides an explanation of the dynamics that affect the amortisation charge.
226 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
i Sensitivity to equity risk
Variable annuity contract related
At 31 December 2012 and 2011, Jackson had variable annuity contracts with guarantees, for which the net amount at risk (NAR) is generally the amount of guaranteed benefit in excess of current account value, as follows:
Period
Net Weighted until
Minimum Account amount average expected
return value at risk attained age annuitisation
31 December 2012 Łm Łm
Return of net deposits plus a minimum return
GMDB 0-6% 40,964 1,839 64.4 years
GMWB – Premium only 0% 2,213 91
GMWB* 0-5% 3,359 88*
GMAB – Premium only 0% 53 –
Highest specifled anniversary account value minus
withdrawals post-anniversary
GMDB 4,554 324 64.0 years
GMWB – Highest anniversary only 1,880 245
GMWB* 697 137*
Combination net deposits plus minimum return, highest
specifled anniversary account value minus withdrawals
post-anniversary
GMDB 0-6% 2,705 348 66.4 years
GMIB‡ 0-6% 1,588 469 3.3 years
GMWB* 0-8%† 31,167 1,918*
Period
Net Weighted until
Minimum Account amount average expected
return value at risk attained age annuitisation
31 December 2011 Łm Łm
Return of net deposits plus a minimum return
GMDB 0-6% 31,571 2,914 64.2 years
GMWB – Premium only 0% 2,325 195
GMWB* 0-5% 2,582 582*
GMAB – Premium only 0% 54 2
Highest specifled anniversary account value minus
withdrawals post-anniversary
GMDB 4,002 678 63.7 years
GMWB – Highest anniversary only 1,855 423
GMWB* 735 217*
Combination net deposits plus minimum return, highest
specifled anniversary account value minus withdrawals
post-anniversary
GMDB 0-6% 2,098 479 66.1 years
GMIB‡ 0-6% 1,661 575 4.2 years
GMWB* 0-8%† 21,902 2,263*
* Amounts shown for GMWB comprise sums for the ‘not for life’ portion (where the guaranteed withdrawal base less the account value equals to the net amount at risk (NAR)), and a ‘for life’ portion (where the NAR has been estimated as the present value of future expected benefit payment remaining after the amount of the ‘not for life’ guaranteed benefits is zero).
• Ranges shown based on simple interest. The upper limits of 5 per cent, or 8 per cent simple interest are approximately equal to 4.1 per cent and 6 per cent respectively, on a compound interest basis over a typical ten year bonus period. For example 1 + 10 x 0.05 is similar to 1.041 growing at a compound rate of 4.01 per cent for a further nine years.
‡ The GMIB reinsurance guarantees are fully reinsured.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 227
Account balances of contracts with guarantees were invested in variable separate accounts as follows:
2012 Łm 2011 Łm
Mutual fund type:
Equity 38,092 28,902
Bond 5,673 4,251
Balanced 4,601 3,846
Money market 766 677
Total 49,132 37,676
As noted above, Jackson is exposed to equity risk through the options embedded in the fixed indexed liabilities and GMDB and GMWB guarantees included in certain VA benefits. This risk is managed using an equity hedging programme to minimise the risk of a significant economic impact as a result of increases or decreases in equity market levels while taking advantage of naturally offsetting exposures in Jackson’s operations. Jackson purchases external futures and options that hedge the risks inherent in these products, while also considering the impact of rising and falling separate account fees.
As a result of this hedging programme, if the equity markets were to increase further in the future, the net effect on Jackson’s free-standing derivatives would decrease in value. However, over time, this movement would be broadly offset by increased separate account fees and reserve decreases, net of the related changes to amortisation of deferred acquisition costs. Due to the nature of the free-standing and embedded derivatives, this hedge, while highly effective on an economic basis, may not completely mute in the financial reporting the immediate impact of equity market movements as the free-standing derivatives reset immediately, while the hedged liabilities reset more slowly and fees are recognised prospectively. The opposite impact would be observed if the equity markets were to decrease.
At 31 December 2012, the estimated sensitivity of Jackson’s profi t for VA business, and shareholders’ equity to immediate increases and decreases in equity markets is shown below. The sensitivities are shown net of related changes in DAC amortisation.
2012 Łm 2011* Łm
Decrease Decrease Increase Increase Decrease Decrease Increase Increase
of 20% of 10% of 10% of 20% of 20% of 10% of 10% of 20%
Pre-tax profit, net of related changes in
amortisation of DAC (excluding impact
on future separate account fees) 326 120(86)(215) 373 196(242)(539)
Related deferred tax effects(114)(42) 30 75(130)(69) 85 189
Net sensitivity of profit after tax and
shareholders’ equity 212 78(56)(140) 243 127(157)(350)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy D:
described in note A5. Life
The above table provides sensitivity movements as at a point in time, while the actual impact on financial results would vary
contingent upon the volume of new product sales and lapses, changes to the derivative portfolio, correlation of market returns
and various other factors including volatility, interest rates and elapsed time. assurance
The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2012.
Other sensitivity to equity risk business
In addition to the exposure explained above, Jackson is also exposed to equity risk from its holding of equity securities,
partnerships in investment pools and other financial derivatives.
A range of reasonably possible movements in the value of equity securities, partnerships in investment pools and other financial
derivatives have been applied to Jackson’s holdings at 31 December 2012 and 2011. The table below shows the sensitivity to a Financial
10 per cent and 20 per cent fall in value, and the impact that this would have on pre-tax profit, net of related changes in amortisation
of DAC, profit after tax and shareholders’ equity.
2012 Łm 2011* Łm statements
Decrease Decrease Decrease Decrease
of 20% of 10% of 20% of 10%
Pre-tax profit, net of related changes in amortisation of DAC(143)(72)(129)(64)
Related deferred tax effects 50 25 45 23
Net sensitivity of profit after tax and shareholders’ equity(93)(47)(84)(41)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
228 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
A 10 or 20 per cent increase in their value is estimated to have an approximately equal and opposite effect on profit and shareholders’ equity to the sensitivities shown above.
In the equity risk sensitivity analysis shown above, the Group has considered the impact of an instantaneous 20 per cent fall in equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous fall, but rather this would be expected to occur over a period of time during which the Group would be able to put in place mitigating management actions.
ii Sensitivity to interest rate risk
Notwithstanding the market risk exposure previously described, except in the circumstances of interest rate scenarios where the guarantee rates included in contract terms are higher than crediting rates that can be supported from assets held to cover liabilities, the accounting measurement of fixed annuity liabilities of Jackson products is not generally sensitive to interest rate risk. This position derives from the nature of the products and the US GAAP basis of measurement. The GMWB features attaching to variable annuity business (other than ‘for-life’) are accounted for as embedded derivatives which are fair valued and so will be sensitive to changes in interest rate.
Debt securities and related derivatives are marked to fair value. Value movements on derivatives, again net of related changes to amortisation of DAC and deferred tax, are recorded within profit and loss. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease (subject to a floor of zero) and increase in interest rates at 31 December 2012 and 2011 is as follows:
2012 Łm 2011* Łm
A 2% A 1% A 1% A 2% A 2% A 1% A 1% A 2%
decrease decrease increase increase decrease decrease increase increase
Profit and loss
Direct effect
Derivatives value change 1,525 778(625)(1,142) 1,549 736(592)(1,078)
Policyholder liabilities(2,021)(871) 610 970(925)(446) 395 753
Related effect on amortisation of DAC 309 93(39)(14)(132)(61) 33 46
Pre-tax profit effect(187) –(54)(186) 492 229(164)(279)
Related effect on charge for deferred tax 65 – 19 65(172)(80) 57 98
Net profit effect(122) –(35)(121) 320 149(107)(181)
Other comprehensive income
Direct effect on carrying value of debt
securities 3,873 2,175(2,175)(3,873) 2,679 1,513(1,513)(2,679)
Related effect on amortisation of DAC(1,332)(748) 748 1,332(954)(539) 539 954
Related effect on movement in deferred
tax(889)(499) 499 889(604)(341) 341 604
Net effect 1,652 928(928)(1,652) 1,121 633(633)(1,121)
Total net effect on shareholders’ equity 1,530 928(963)(1,773) 1,441 782(740)(1,302)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
These sensitivities are shown only for interest rates in isolation and do not include other movements in credit risk that may affect credit spreads and valuations of debt securities.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 229
iii Currency translation risk
Consistent with the Group’s accounting policies, the profi ts of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2012, the rates were US$1.58 (2011: US$1.60) and US$1.63 (2011: US$1.55) to Ł1.00 sterling, respectively. A 10 per cent increase or decrease in these rates would reduce or increase profi t before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows:
A 10% increase in US$: Ł A 10% decrease in US$: Ł
exchange rates exchange rates
2012 Łm 2011* Łm 2012 Łm 2011* Łm
Profit before tax attributable to shareholders note(78)(44) 95 53
Profit for the year(56)(32) 69 39
Shareholders’ equity attributable to US insurance operations(395)(342) 483 418
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Note
Sensitivity on profit before tax ie aggregate of the operating profit based on longer-term investment returns and short-term fluctuations in investment returns.
In addition, the total profit for Jackson is affected by the level of impairment losses on the debt securities portfolio, net effect
of market risk arising from the incidence and valuation of guarantee features, guaranteed benefit payments and equity index
participation features, offset by variability of benefit related fees and equity derivative hedging performance, short-term value
movements on derivatives held to manage the fixed annuity and other general account business, and other temporary value
movements on portfolio investments classifled as fair value through profit and loss.
iv Other sensitivities
As noted in section D1, total profit is very sensitive to market risk on the assets covering liabilities other than variable annuity
business segregated in the separate accounts.
As with other shareholder-backed business the profit or loss for Jackson is presented by distinguishing the result for the year
between an operating result based on longer-term investment returns and short-term fiuctuations in investment returns. In this
way, the most significant direct effect of market changes that have taken place to the Jackson result are separately identifled.
The principal determinants of variations in operating profit based on longer-term returns are:
Growth in the size of assets under management covering the liabilities for the contracts in force;
Variations in fees and other income, offset by variations in market value adjustment payments and, where necessary,
strengthening of liabilities;
Spread returns for the difference between investment returns and rates credited to policyholders; and
Amortisation of deferred acquisition costs.
D:
For term business, acquisition costs are deferred and amortised in line with expected premiums. For annuity and interest sensitive Life
life business, acquisition costs are deferred and amortised in line with expected gross profits on the relevant contracts. For
interest-sensitive business, the key assumption is the expected long-term spread between the earned rate and the rate credited
to policyholders, which is based on an annual spread analysis. In addition, expected gross profits depend on mortality assumptions,
assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of assurance
actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual experience is measured
by internally developed expense, mortality and persistency studies. business
Except to the extent of mortality experience, which primarily affects profits through variations in claim payments and GMDB
reserves, the profits of Jackson are relatively insensitive to changes in insurance risk.
Jackson is sensitive to lapse risk. However, Jackson uses swaption 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.
For variable annuity business, the key assumption is the expected long-term level of separate account returns, which for 2012 Financial
and 2011 was 8.4 per cent. The impact of using this return is reflected in two principal ways, namely:
Through the projected expected gross profits which are used to determine the amortisation of deferred acquisition costs.
This is applied through the use of a mean reversion technique which is described in more detail in note D3(e) above; and statements
The required level of provision for guaranteed minimum death benefit claims.
230 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D3: US insurance operations continued
i Duration of liabilities
The table below shows the carrying value of policyholder liabilities. The table below also shows the maturity profile of the cash flows for 2012 and 2011:
2012 Łm 2011 Łm
Fixed Fixed
annuity and annuity and
other business other business
(including(including
GICs and GICs and
similar Variable similar Variable
contracts) annuity Total contracts) annuity Total
Policyholder liabilities 42,963 49,298 92,261 31,356 37,833 69,189
2012 % 2011 %
Expected maturity:
0 to 5 years 45 46 46 47 47 47
5 to 10 years 27 31 29 27 30 29
10 to 15 years 12 13 13 11 13 12
15 to 20 years 7 6 6 6 6 6
20 to 25 years 5 2 3 5 2 3
Over 25 years 4 2 3 4 2 3
The maturity tables shown above have been prepared on a discounted basis. Details of undiscounted cash flows for investment contracts are shown in note G2.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 231
[Graphic Appears Here]
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes
(i) The statement of financial position for with-profits business comprises the with-profits assets and liabilities of the Hong Kong, Malaysia and Singapore with-profits operations. Assets and liabilities of other participating business are included in the column for ‘Other business’.
(ii) For the purposes of the presentation of unallocated surplus of with-profits within the statement of financial position, the Hong Kong branch balance is
reported within the unallocated surplus of the PAC with-profits sub-fund of the UK insurance operations.
232 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D4: Asia insurance operations continued
(iii) Asia insurance operations
The loans of the Group’s Asia insurance operations comprise:
2012 Łm 2011 Łm
Mortgage loans* 43 31
Policy loans* 610 572
Other loans† 361 630
Total Asia insurance operations loans 1,014 1,233
* The mortgage and policy loans are secured by properties and life insurance policies respectively.
† The majority of the other loans are commercial loans held by the Malaysia operation and which are all investment graded by two local rating agencies.
Summary policyholder liabilities (net of reinsurance) and unallocated surplus
At 31 December 2012, the policyholder liabilities net of reinsurance of Ł175 million (2011: Ł151 million) and unallocated surplus for Asia operations of Ł34.5 billion (2011: Ł30.8 billion) comprised the following:
2012 Łm 2011 Łm
Singapore 10,731 9,323
Hong Kong 8,610 8,279
Malaysia 3,336 2,829
Indonesia 2,110 1,809
Korea 2,131 1,852
Taiwan 1,931 1,429
Other countries 5,640 5,240
Total Asia operations 34,489 30,761
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 233
b Reconciliation of movement in policyholder liabilities and unallocated surplus of with-profi ts funds
A reconciliation of the total policyholder liabilities and unallocated surplus of with-profits funds of Asia insurance operations from the beginning of the year to the end of the year is as follows:
With-profits Unit-linked Other
business liabilities business Total
Łm Łm Łm Łm
At 1 January 2011 11,024 12,724 4,992 28,740
Comprising:
Policyholder liabilities 10,958 12,724 4,992 28,674
Unallocated surplus of with-profits funds 66 – – 66
Premiums:
New business 162 1,136 723 2,021
In-force 1,110 1,163 785 3,058
1,272 2,299 1,508 5,079
Surrendersnote (c)(502)(1,490)(245)(2,237)
Maturities/Deaths(431)(39)(194)(664)
Net flows note (b) 339 770 1,069 2,178
Shareholders’ transfers post tax(30) – –(30)
Investment-related items and other movements 1,274(1,154) 245 365
Foreign exchange translation differencesnote (a) 36(325)(52)(341)
At 31 December 2011/1 January 2012 12,643 12,015 6,254 30,912
Comprising:
Policyholder liabilities 12,593 12,015 6,254 30,862
Unallocated surplus of with-profits funds 50 – – 50
Premiums:
New business 216 1,336 636 2,188
In-force 1,263 1,292 877 3,432
1,479 2,628 1,513 5,620
Surrenders note (c)(608)(1,675)(258)(2,541)
Maturities/Deaths(432)(30)(196)(658)
Net flows note (b) 439 923 1,059 2,421
Shareholders’ transfers post tax(31) – –(31)
Investment-related items and other movementsnote (d) 639 1,451 88 2,178
D:
Foreign exchange translation differencesnote (a)(239)(361)(216)(816)
Life
At 31 December 2012 13,451 14,028 7,185 34,664
Comprising:
Policyholder liabilities 13,388 14,028 7,185 34,601 assurance
Unallocated surplus of with-profits funds 63 – – 63
Average policyholder liability balances* business
2012 12,990 13,022 6,720 32,732
2011 11,775 12,370 5,623 29,768
* Averages have been based on opening and closing balances and exclude unallocated surplus of with-profits funds.
Notes
(a) Movements in the year have been translated at the average exchange rates for the year ended 31 December 2012. The closing balance has been translated
at the closing spot rates as at 31 December 2012. Differences upon retranslation are included in foreign exchange translation differences.
(b) Net flows have increased by Ł243 million to Ł2,421 million in 2012, compared with Ł2,178 million in 2011, reflecting increased flows from new business and
growth in the in-force books. statements
(c) In 2012 the rate of surrenders for shareholder-backed business (expressed as a percentage of opening liabilities) was 10.6 per cent (2011: 9.8 per cent). Excluding India where the market has been going through a significant period of change following regulatory changes in 2010, the surrender rate in 2012 was at 9.7 per cent (2011: 9.6 per cent). For with-profits business, surrenders have increased from Ł502 million in 2011 to Ł608 million in 2012, primarily as a result of certain products in Hong Kong reaching their five year anniversary, the point at which some product features trigger.
(d) Positive investment-related items and other movements of Ł2,178 million in 2012 primarily reflects improvements in the Asia equity market.
| 234 |
|
Financial statements Prudential plc Annual Report 2012 |
| D: |
|
Life assurance business continued |
| D4: |
|
Asia insurance operations continued |
| c |
|
Information on credit risks of debt securities |
| The |
|
following table summarises the credit quality of the debt securities of the Asia insurance operations as at 31 December 2012 by rating agency ratings: |
| 2012 |
|
Łm 2011 Łm |
| With-profits |
|
Unit-linked Other |
| business |
|
assets business Total Total |
| S&P |
|
– AAA 675 19 91 785 1,423 |
| S&P |
|
– AA+ to AA- 2,960 466 2,097 5,523 3,843 |
| S&P |
|
– A+ to A- 2,059 279 944 3,282 3,055 |
| S&P |
|
– BBB+ to BBB- 1,377 112 417 1,906 1,451 |
| S&P |
|
– Other 1,443 815 874 3,132 2,137 |
| 8,514 |
|
1,691 4,423 14,628 11,909 |
| Moody’s |
|
– Aaa 700 215 474 1,389 1,489 |
| Moody’s |
|
– Aa1 to Aa3 139 34 98 271 128 |
| Moody’s |
|
– A1 to A3 93 14 62 169 304 |
| Moody’s |
|
– Baa1 to Baa3 196 122 57 375 131 |
| Moody’s |
|
– Other 98 12 2 112 59 |
| 1,226 |
|
397 693 2,316 2,111 |
| Fitch |
|
322 93 118 533 351 |
| Other |
|
1,433 1,013 1,479 3,925 3,310 |
| Total |
|
Asia debt securities 11,495 3,194 6,713 21,402 17,681 |
| The |
|
following table analyses debt securities of ‘Other business’ which are not externally rated: |
| 2012 |
|
Łm 2011 Łm |
| Government |
|
bonds 287 244 |
| Corporate |
|
bonds rated as investment grade by local external ratings agencies 1,069 776 |
| Other |
|
123 45 |
| 1,479 |
|
1,065 |
| d |
|
Products and guarantees |
| The |
|
life insurance products offered by the Group’s Asia operations include a range of with-profi ts and non-participating term, whole life, endowment and unit-linked policies. The Asia operations also offer health, disability, critical illness and accident coverage to supplement its core life products. |
| The |
|
terms and conditions of the contracts written by the Asia operations and, in particular, the products’ options and guarantees, vary from territory to territory depending upon local market circumstances. |
| In |
|
general terms, the Asia participating products provide savings and protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund, as determined at the discretion of the insurers. The Asia operations’ non-participating term, whole life and endowment products offer savings and/or protection where the benefits are guaranteed or determined by a set of defined market-related parameters. Unit-linked products combine savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. Health and Protection (H&P) policies provide mortality or morbidity benefits and include health, disability, critical illness and accident coverage. H&P products are commonly offered as supplements to main life policies but can be sold separately. |
| Subject |
|
to local market circumstances and regulatory requirements, the guarantee features described in note D2(d) in respect of UK business broadly apply to similar types of participating contracts written in the Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements. |
| Non-participating |
|
long-term products are the only ones where the Group is contractually obliged to provide guarantees on all benefits. Unit-linked products have the lowest level of guarantee. |
| Product |
|
guarantees in Asia can be broadly classifled into four main categories, namely premium rate, cash value and interest rate guarantees, policy renewability and convertibility options. |
| The |
|
risks on death coverage through premium rate guarantees are low due to appropriate product pricing. |
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 235
Cash value and interest rate guarantees are of three types:
Maturity values
Maturity values are guaranteed for non-participating products and on the guaranteed portion of participating products. Declared annual bonuses are also guaranteed once vested. Future bonus rates and cash dividends are not guaranteed on participating products;
Surrender values
Surrender values are guaranteed for non-participating products and on the guaranteed portion of participating products. The surrender value of declared reversionary bonuses are also guaranteed once vested. Market value adjustments and surrender penalties are used where the law permits such adjustments in cash values; and
Interest rate guarantees
It is common in Asia for regulations or market-driven demand and competition to provide some form of capital value protection and minimum crediting interest rate guarantees. This would be reflected within the guaranteed maturity and surrender values.
The guarantees are borne by shareholders for non-participating and investment-linked (non-investment guarantees only) products. Participating product guarantees are predominantly supported by the segregated life funds and their estates.
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, are written in the Korean life operations, though this is not of a significant extent as Korea has a much higher proportion of linked and health business. The Korean business has non-linked liabilities and linked liabilities at 31 December 2012 of Ł505 million and Ł1,628 million respectively (2011: Ł447 million and Ł1,407 million respectively).
The other area of note in respect of guarantees is the Japanese business, where pricing rates are higher than current bond yields. Lapse risk is a feature in that policyholders could potentially surrender their policies on guaranteed terms if interest rates significantly increased leaving the potential for losses if bond values had depreciated significantly. However, the business is matched to a relatively short realistic liability duration.
The method for determining liabilities of insurance contracts for UK GAAP, and IFRS, purposes for some Asia operations is based on US GAAP principles and this method applies to contracts with cash value and interest rate guarantees. Following standard US GAAP procedure, premium deficiency reserve calculations are performed each year to establish whether the carrying values of the liabilities are sufficient.
On the US GAAP basis the calculations are deterministic, that is to say based on a single set of projections, and expected long-term rates of return are applied.
e Process for setting assumptions and determining liabilities
The future policyholder benefit provisions for Asia businesses in the Group’s IFRS accounts and previously under the MSB,
are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP.
For some countries in Asia where local GAAP is not well established, and in which the business written is primarily
non-participating and linked business, US GAAP is used as the most appropriate reporting basis. This basis is applied in India,
Japan, Taiwan and until 2012, Vietnam. Under this basis, the future policyholder benefit provisions for non-linked business are
determined using the net level premium method, with an allowance for surrenders, maintenance and claims expenses. Rates of
interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to D:
each block of business. In Vietnam, the Company improved its estimation basis for liabilities in 2012 from one determined substantially Life
by reference to US GAAP requirements. After making this change, the estimation basis for Vietnam is aligned substantially with that
used in Singapore, Malaysia and some other Asia operations. assurance
f Reinsurance
The Asia businesses cede only minor amounts of business outside the Group with immaterial effects on reported profit. During
2012, reinsurance premiums for externally ceded business were Ł178 million (2011: Ł226 million) and the reinsurance assets were business
Ł175 million (2011: Ł151 million) in aggregate.
g Effect of changes in bases, estimates and assumptions used to measure insurance assets and liabilities
In 2012, the IFRS operating profit based on longer-term investment returns for Asia insurance operations included a net Ł48 million credit Financial
(2011: Ł38 million) representing a small number of non-recurring items that are not anticipated to re-occur in subsequent periods.
Separately, the IFRS policyholder liabilities of the shareholder-backed non-linked business of the Group’s Hong Kong operation are
measured on a prospective net premium valuation approach with zero allowance for lapses. In 2012, the basis of determining the
valuation rate of interest has been altered to align with a permitted practice of the Hong Kong authorities for regulatory reporting. The statements
main change is to apply a valuation rate of interest that incorporates a reinvestment yield that is weighted by reference to current and
the historical three year average, rather than the year end rate. The change reduced the carrying value of policyholder liabilities at
31 December 2012 by Ł95 million. This benefit is included within the short-term fluctuations in investment returns in the Group’s
supplementary analysis of profit.
236 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D4: Asia insurance operations continued
h Exposure and sensitivity of IFRS basis profi t and shareholders’ equity to market and other risks
The Asia operations sell with-profits and unit-linked policies and, although the with-profits business generally has a lower terminal bonus element than in the UK, the investment portfolio still contains a proportion of equities. Non-participating business is largely backed by debt securities or deposits. The exposure to market risk of the Group arising from its Asia operations is therefore at modest levels. This arises from the fact that the Asia operations have a balanced portfolio of with-profits, unit-linked and other types of business.
In Asia, adverse persistency experience can impact the IFRS profitability of certain business written in the region. This risk is managed at a business unit level through regular monitoring of experience and the implementation of management actions as necessary. These actions could include product enhancements, increased management focus on premium collection, as well as other customer retention efforts. The potential financial impact of lapses is often mitigated through the specific features of the products, eg surrender charges.
(i) Sensitivity of profi t and shareholders’ equity to risks other than currency translation risk
With-profi ts business
Similar principles to those explained for UK with-profits business apply to profit emergence for the Asia with-profits business. Correspondingly, the profit emergence reflects bonus declaration and is relatively insensitive to period by period fiuctuations in insurance risk or interest rate movements.
Unit-linked business
As for the UK insurance operations, for unit-linked business, the main factor affecting the profit and shareholders’ equity of the Asia operations is investment performance through asset management fees. The sensitivity of profits and shareholders’ equity to changes in insurance risk, interest rate risk and credit risk are not material.
Other business
Interest rate risk
Asia operations offer a range of insurance and investment products, predominantly with-profits and non-participating term,
whole life endowment and unit-linked. Excluding with-profit and unit-linked business, the results of the Asia business are sensitive to the vagaries of routine movements in interest rates.
For the purposes of analysing sensitivity to variations in interest rates, reference has been made to the movements in the
10-year government bond rates of the territories. At 31 December 2012, 10-year government bond rates vary from territory to territory and range from 0.60 per cent to 9.50 per cent (2011: 0.99 per cent to 12.88 per cent).
For the sensitivity analysis as at 31 December 2011, as shown in the table below, for the majority of the territories, a movement of 1 per cent in the 10-year government bond rate has been used. Exceptions to this approach are for Japan and Taiwan, where a movement of 0.5 per cent has been used. Following falls in interest rates in many of the territories during 2012, the approach was altered such that the reasonably possible interest rate movement used is 1 per cent for all territories but subject to a floor of zero where the bond rates are currently below 1 per cent. This revised approach was applied in estimating the sensitivity at
31 December 2012.
The estimated sensitivity to the decrease and increase in interest rates at 31 December 2012 and 2011 is as follows:
2012 Łm 2011 Łm
Decrease Increase Decrease Increase
of 1% of 1% of 1%* of 1%*
Pre-tax profit 216(269) 73(159)
Related deferred tax (where applicable)(56) 53(22) 34
Net effect on profit and shareholders’ equity 160(216) 51(125)
* Except for Japan and Taiwan using 0.5 per cent sensitivity.
The pre-tax impacts, if they arose, would mostly be recorded within the category short-term fiuctuations in investments returns in the Group’s segmental analysis of profi t before tax.
The degree of sensitivity of the results of the non-linked shareholder-backed business of the Asia operations to movements in interest rates depends upon the degree to which the liabilities under the ‘grandfathered’ IFRS 4 measurement basis refl ects market interest rates from period to period. For example, for those countries, such as those applying US GAAP, the results can be more sensitive as the effect of interest rate movements on the backing investments may not be offset by liability movements.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 237
Equity price risk
The non-linked shareholder business has limited exposure to equity and property investment (Ł663 million at 31 December 2012). Generally, changes in equity and property investment values are not directly offset by movements in policyholder liabilities.
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 profi t before tax, at 31 December 2012 and 2011 would be as follows:
2012 Łm 2011 Łm
Decrease Decrease Decrease Decrease
of 20% of 10% of 20% of 10%
Pre-tax profit(134)(67)(120)(60)
Related deferred tax (where applicable) 31 15 24 12
Net effect on profit and shareholders’ equity(103)(52)(96)(48)
A 10 per cent or 20 per cent increase in their value would have an approximately equal and opposite effect on profit and
shareholders’ equity to the sensitivities shown above. The market risk sensitivities shown above reflect the impact of temporary
market movements and therefore, the primary effect of such movements would, in the Group’s segmental analysis of profits,
be included within the short-term fiuctuations in investment returns.
In the equity risk sensitivity analysis shown above, the Group has considered the impact of an instantaneous 20 per cent fall in
equity markets. If equity markets were to fall by more than 20 per cent, the Group believes that this would not be an instantaneous
fall but rather this would be expected to occur over a period of time during which the Group would be able to put in place mitigating
management actions.
Insurance risk
Many of the territories in Asia are exposed to mortality/morbidity risk and provision is made within policyholder liabilities on a
prudent regulatory basis to cover the potential exposure. If these prudent assumptions were strengthened by 5 per cent then it is
estimated that post tax profit would be decreased by approximately Ł30 million (2011: Ł27 million). Mortality and morbidity has
a symmetrical effect on the portfolio and any weakening of these assumptions would have a similar equal and opposite impact.
(ii) Sensitivity of IFRS basis profit and shareholders’ equity to currency translation risk
Consistent with the Group’s accounting policies, the profits of the Asia insurance operations are translated at average exchange
rates and shareholders’ equity at the closing rate for the reporting period. For 2012, the rates for the most significant operations
are given in note B4.
A 10 per cent increase or decrease in these rates would have reduced or increased profit before tax attributable to shareholders,
profit for the year and shareholders’ equity, excluding goodwill, attributable to Asia operations respectively as follows:
A 10% increase in local A 10% decrease in local
currency to Ł exchange rates currency to Ł exchange rates D:
2012 Łm 2011 Łm 2012 Łm 2011 Łm Life
Profit before tax attributable to shareholders note(90)(57) 110 70
Profit for the year(75)(46) 92 56 assurance
Shareholders’ equity, excluding goodwill, attributable to Asia operations(243)(228) 297 278
Note business
Sensitivity on profit (loss) before tax ie aggregate of the operating profit based on longer-term investment returns and short-term fluctuations in
investment returns.
i Duration of liabilities
The table below shows the carrying value of policyholder liabilities. The table below also shows the maturity profile of the cash flows, Financial
taking account of expected future premiums and investment returns for 2012 and 2011:
2012 Łm 2011 Łm statements
Policyholder liabilities 34,601 30,862
%%
Expected maturity:
0 to 5 years 23 22
5 to 10 years 19 19
10 to 15 years 17 15
15 to 20 years 13 13
20 to 25 years 9 10
Over 25 years 19 21
238 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D5: Capital position statement for life assurance businesses
The primary purpose of this section is to meet the disclosure requirements of FRS 27, the UK GAAP Standard on Life Assurance. Prudential, together with other major UK life assurers, undertook to the UK Accounting Standards Board in 2004 to adopt this standard for Group IFRS reporting. Under the disclosure requirements of FRS 27 the capital position statement and related footnotes are prepared by reference to local regulation.
a Summary statement
The Group’s estimated capital position for life assurance businesses with reconciliations to shareholders’ equity is shown below. As noted above, available capital for each fund or group of companies has been determined by reference to local regulation at
31 December 2012 and 2011.
D: Life assurance business Financial statements
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 239
2012 Łm Other UK life
Total PAC assurance Asia life Total life with-profi ts subsidiaries assurance assurance SAIF WPSF fund and funds Jackson subsidiaries operations note (i) note (ii)
Policyholder liabilities
With-profits liabilities of UK regulated with-profits funds:
Insurance contracts 7,217 29,353 36,570 – – 6,696 43,266
Investment contracts (with discretionary participation features) 352 33,112 33,464 – – 95 33,559
Total 7,569 62,465 70,034 – – 6,791 76,825
Other liabilities:
Insurance contracts: With-profits liabilities of non-UK regulated funds – – – – – 6,597 6,597 Unit-linked, including variable annuity – 29 29 6,086 49,298 14,028 69,441 Other life assurance business 309 14,013 14,322 27,259 40,894 7,058 89,533
Investment contracts without discretionary participation features (principally unit-linked and similar contracts in the UK and
GIC liabilities of Jackson)note (vi) – 22 22 16,160 2,069 127 18,378
Total 309 14,064 14,373 49,505 92,261 27,810 183,949
Total policyholder liabilities shown in the consolidated statement of fi nancial position 7,878 76,529 84,407 49,505 92,261 34,601 260,774
240 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D5: Capital position statement for life assurance businesses continued
2011* Łm
Parent
company
and share-
Other holders’
Total UK life Asia equity of
PAC assurance life Total life M &G other
with- subsidi- assurance assurance(including subsidi-
profits aries and subsidi- opera- Prudential aries and Group
SAIF WPSF fund funds Jackson aries tions Capital) funds total
note (i) note (ii)
Group shareholders’ equity
Held outside long-term funds:
Net assets – – – 930 3,761 2,071 6,762 229(1,514) 5,477
Goodwill – – – – – 235 235 1,153 77 1,465
Total – – – 930 3,761 2,306 6,997 1,382(1,437) 6,942
Held in long-term fundsnote (iii) – – – 1,622 – – 1,622 – – 1,622
Total Group shareholders’
equity – – – 2,552 3,761 2,306 8,619 1,382(1,437) 8,564
Adjustments to regulatory
basis
Unallocated surplus of
with-profits funds note (v) – 9,165 9,165 – – 50 9,215
Shareholders’ share of realistic
liabilities –(2,394)(2,394) – – –(2,394)
Deferred acquisition costs of
non-participating business
not recognised for
regulatory reporting
purposes and goodwill –(6)(6)(111)(3,095)(929)(4,141)
Jackson surplus notes note (iv) – – – – 160 – 160
Investment and policyholder
liabilities valuation
differences between IFRS
and regulatory basis for
Jackson note (vii) – – – – 1,002 – 1,002
Adjustment from IAS 19 basis
pension deficit attributable
to WPSF to pension liability
for regulatory purposes – 16 16 – – – 16
Valuation difference on PAL
between IFRS basis and
regulatory basis –(640)(640) – – –(640)
Other adjustments to restate
these amounts to a
regulatory basis (with SAIF
and the WPSF on a Peak 2
realistic basis)note (v) –(2)(2)(504) 699 66 259
Total adjustments – 6,139 6,139(615)(1,234)(813) 3,477
Total available capital
resources of life assurance
businesses on local
regulatory bases – 6,139 6,139 1,937 2,527 1,493 12,096
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 241
2011 Łm
Other UK life
Total PAC assurance Asia life Total life
with-profits subsidiaries assurance assurance
SAIF WPSF fund and funds Jackson subsidiaries operations
note (i) note (ii)
Policyholder liabilities
With-profits liabilities of UK
regulated with-profits funds:
Insurance contractsnote (viii) 7,934 30,077 38,011 – – 6,777 44,788
Investment contracts (with
discretionary participation
features) 412 28,936 29,348 – – 397 29,745
Total 8,346 59,013 67,359 – – 7,174 74,533
Other liabilities:
Insurance contracts:
With-profits liabilities
of non-UK regulated funds – – – – – 5,419 5,419
Unit-linked, including variable
annuitynote (viii) 26 26 6,387 37,833 12,015 56,261
Other life assurance business 209 13,365 13,574 24,734 29,445 6,142 73,895
Investment contracts without
discretionary participation
features (principally
unit-linked and similar
contracts in the UK and GIC
liabilities of Jackson)note (vi) – 17 17 14,927 1,911 112 16,967
Total 209 13,408 13,617 46,048 69,189 23,688 152,542
Total policyholder liabilities
shown in the consolidated
statement of financial position 8,555 72,421 80,976 46,048 69,189 30,862 227,075
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 Asia life assurance subsidiaries.
(ii) Excluding PAC shareholders’ equity that is included in ‘parent company and shareholders’ equity of other subsidiaries and funds’.
(iii) The term shareholders’ equity held in long-term funds refers to the excess of assets over liabilities attributable to shareholders of funds which are required D:
by law to be maintained, ring-fenced with segregated assets and liabilities.
(iv) For regulatory purposes the Jackson surplus notes are accounted for as capital. Life
(v) Other adjustments to shareholders’ equity and unallocated surplus include amounts for the value of non-participating business for UK regulated
with-profits funds, deferred tax, admissibility and other items measured differently on the regulatory basis. For Jackson, the principal reconciling item
is deferred tax related to the differences between IFRS and regulatory basis, as shown in the table above, and other methodology differences.
(vi) Insurance business accounted for as financial instruments under IAS 39. assurance
(vii) The investment and policyholder liabilities valuation difference between IFRS and regulatory bases for Jackson is mainly due to not all investments being
carried at fair value under the regulatory basis and also due to the valuation difference on annuity reserves.
(viii) The allocation between the with-profits liabilities and unit-linked liabilities within the WPSF column have been adjusted for those previously published
to align with the basis of presentation applied in 2012. business
Financial
statements
242 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D5: Capital position statement for life assurance businesses continued
b Basis of preparation, capital requirements and management
Each of the Group’s long-term business operations is capitalised to a suffi ciently strong level for its individual circumstances. Details by the Group’s major operations are shown below.
i UK insurance operations
The FSA rules which govern the Prudential regulation of insurance form part of the Prudential Sourcebook for Insurers, the General Prudential Sourcebook and Interim Prudential Sourcebook for Insurers. Overall, the net requirements of the General Prudential Sourcebook are intended to align the capital adequacy requirements for insurance business more closely with those of banking and investment firms and building societies, for example, by addressing tiers of capital, rather than looking at net admissible assets. An insurer must hold capital resources equal at least to the Minimum Capital Requirement (MCR).
The Prudential Sourcebook for Insurers also contains rules on Individual Capital Assessments. Under these rules, and the rules of the General Prudential Sourcebook, all insurers must assess for themselves the amount of capital needed to back their business. If the FSA views the results of this assessment as insufficient, it may draw up its own Individual Capital Guidance for a firm, which can be superimposed as a requirement.
PAC WPSF and SAIF
Under FSA rules, insurers with with-profits liabilities of more than Ł500 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-profi t insurer’s capital requirements, whereas the MCR is, broadly speaking, equivalent to the previous required minimum margin under the Interim Prudential Sourcebook and satisfi es the minimum EU Standards.
Determination of the ECR involves the comparison of two separate measurements of the firm’s resources requirement, which the FSA refers to as the ‘twin peaks’ approach.
The two separate peaks are:
i The requirement comprised by the mathematical reserves plus the ‘Long-Term Insurance Capital Requirement’ (LTICR), together known as the ‘regulatory peak’; and
ii A calculation of the ‘realistic’ present value of the insurer’s expected future contractual liabilities together with projected ‘fair’ discretionary bonuses to policyholders, plus a risk capital margin, together known as the ‘realistic peak’.
Available capital of the WPSF and SAIF of Ł7.0 billion (2011: Ł6.1 billion) represents the excess of assets over liabilities on the FSA realistic basis. Unlike the previously discussed FRS 27 basis, realistic liabilities on the regulatory basis include the shareholders’ share of future bonuses. These amounts are shown before deduction of the risk capital margin (RCM), which is estimated to be
• 1.5 billion at 31 December 2012 (2011: Ł2.0 billion).
The FSA’s basis of setting the RCM is to target a level broadly equivalent to a Standard & Poor’s credit rating of BBB and to judge
this by ensuring there are sufficient assets to absorb a one in 200 year event. The RCM calculation achieves this by setting rules for the determination of margins to cover defined stress changes in asset values and yields for market risk, credit risk and termination risk for with-profits policies.
PAC has discretion in its management actions in the case of adverse investment conditions. Management actions encompass,
but are not conflined to, investment allocation decisions, levels of reversionary bonuses, crediting rates and total claim values.
Other UK life assurance subsidiaries and funds
The available capital of Ł2,370 million (2011: Ł1,937 million) refl ects the excess of regulatory basis assets over liabilities of the subsidiaries and funds, before deduction of the capital resources requirement of Ł1,376 million (2011: Ł1,194 million).
The capital resources requirement for these companies broadly reflects a formula which, for active funds, equates to a percentage of regulatory reserves plus a percentage of death strains. Death strains represent the payments made to policyholders upon death in excess of amounts explicitly allocated to fund the provisions for policyholder’s claims and maturities.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 243
ii Jackson
The regulatory framework for Jackson is governed by the requirements of the US NAIC approved risk-based capital standards.
Under these requirements life insurance companies report using a formula-based capital standard that they calculate by applying
factors to various asset, premium and reserve items and separate model based calculations of risk associated primarily with variable
annuity products. The risk-based capital formula takes into account the risk characteristics of a company, including asset risk,
insurance risk, interest rate risk, market risk and business risk.
The available capital of Jackson shown above of Ł2,899 million (2011: Ł2,527 million) reflects US regulatory basis assets less
liabilities, including asset valuation reserves. The asset valuation reserve is designed to provide for future credit-related losses on
debt securities and losses on equity investments. Available capital includes a reduction for the effect of the interest maintenance
reserve, which is designed by state regulators to defer recognition of non-credit related realised capital gains and losses and to
recognise them rateably in the future.
Jackson’s risk-based capital ratio is significantly in excess of regulatory requirements. At 31 December 2012, Jackson had a
permitted practice in effect as granted by the local regulator allowing Jackson to carry certain interest rate swaps at book value,
as if statutory hedge accounting were in place, instead of at fair value, as would have been otherwise required. Jackson was also
required to demonstrate the effectiveness of its interest rate swap programme pursuant to the Michigan Insurance Code. The total
effect of this permitted practice net of tax was to decrease statutory surplus by Ł357 million at 31 December 2012.
Michigan insurance law specifically allows value of business acquired (VOBA) as an admitted asset as long as certain criteria
are met. US NAIC standards limit the admitted amount of goodwill/VOBA generally to 10 per cent of capital and surplus. At
31 December 2012, Jackson reported Ł289 million of statutory basis VOBA as a result of the REALIC acquisition, which is fully
admissible under Michigan insurance law.
iii Asia operations
The available capital shown above of Ł1,621 million (2011: Ł1,493 million) represents the excess of local regulatory basis assets
over liabilities before deduction of required capital of Ł661 million (2011: Ł608 million). These amounts have been determined
applying the local regulations in each of the operations.
The businesses in Asia are subject to local capital requirements in the jurisdictions in which they operate. The Hong Kong
business branch of PAC and its capital requirements are subsumed within those of the PAC long-term fund. For the other material
Asian operations, the details of the basis of determining regulatory capital and regulatory capital requirements are as follows:
Singapore
A risk-based regulatory framework applies in Singapore.
For participating business, a gross premium reserve, determined using prudent best estimate assumptions and which makes
allowance for future bonus, is held. The amount held is subject to a minimum of the higher of the assets attributed to participating
business and a gross premium reserve calculated on specifled assumptions, but without allowance for future bonus, that include
prescribed provisions for adverse deviations (PADs).
For non-participating business, gross premium reserves are held. For linked business the value of units is held together with a
non-unit reserve calculated in accordance with standard actuarial methodology;
Indonesia D:
Solvency capital is determined using a risk-based capital approach. Insurance companies in Indonesia are expected to maintain Life
the level of net assets above 120 per cent of solvency capital. Due to the 2008 financial crisis, the local regulator provided relief in
solvency capital and the measure continued until 1 January 2012, when it was withdrawn. The withdrawal of this temporary relief
did not have a significant impact on the Group’s Indonesia business; assurance
Japan
Mathematical reserves for traditional business are determined on a net premium basis using prescribed mortality and interest rates. business
Interest rates reflect the original pricing assumptions.
For linked business the value of units is held together with a non-unit reserve calculated in accordance with standard actuarial
methodology.
Solvency capital is determined using a risk-based capital approach. The adjusted solvency capital assets of the Company must Financial
exceed 200 per cent of the risk related capital requirement value at risk. A number of changes to the risk-based capital rules in
Japan were effective in April 2012, but the changes did not have a significant impact on the Group’s Japan business; statements
244 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D5: Capital position statement for life assurance businesses continued
Malaysia
A risk-based capital framework applies in Malaysia.
For participating business, a gross premium reserve on the guaranteed and non-guaranteed benefits determined using best estimate assumptions is held. The amount held is subject to a minimum of a gross premium reserve on the guaranteed benefits, determined using best estimate assumptions along with provisions of risk margin for adverse deviations discounted at the risk-free rate.
For non-participating business, gross premium reserves determined using best estimate assumptions along with provisions of risk margin for adverse deviations discounted at the risk-free rate are held. For linked business, the value of units is held together with a non-unit reserve calculated in accordance with standard actuarial methodology.
Participating fund surplus is not allowed to be used to support deficit (if any) and capital requirement of the non-participating business. The capital requirement is calculated based on a prescribed series of risk charges. The local regulator has set a Supervisory Target Capital Level of 130 per cent below which supervisory actions of increasing intensity
will be taken. Each insurer is also required to set its own Individual Target Capital Level to reflect its own risk profile and this is expected to be higher than the Supervisory Target Capital Level;
Vietnam
Mathematical reserves are calculated using a modifled net premium approach, set using assumptions agreed with the regulator. The capital requirement is determined as 4 per cent of reserves plus a specifled percentage of 0.1 per cent of sums at risk for policies with original term less than or equal to five years or 0.3 per cent of sums at risk for policies with original term of more than five years. An additional capital requirement of Vietnamese Dong 200 billion is also required for companies transacting unit-linked business; and
Korea
Policy reserves for traditional business are determined on net premium reserve basis using pricing mortality and prescribed standard interest rates.
For linked business, the value of units is held together with the non-unit reserves calculated in accordance with regulatory standard actuarial methodology.
A risk-based capital framework applies in Korea. Under this risk-based framework, insurance companies in Korea are expected to maintain a level of free surplus in excess of the capital requirements, with the general target level of solvency margin being in excess of 150 per cent of the risk-based capital.
iv Group capital requirements
In addition to the requirements at individual company level, FSA requirements under the IGD apply additional prudential requirements for the Group as a whole. Discussion of the Group’s estimated IGD position at 31 December 2012, together with market risk sensitivity disclosure provided to key management, is provided in the business review section of the Group’s 2012 Annual Report.
c Movements in total available capital
Total available capital for the Group’s life assurance operations has changed as follows:
2012 Łm
Other
UK life
assurance Asia life
subsidiaries assurance Group
WPSF and funds Jackson subsidiaries Total
note (i) note (iii) note (ii) note (iv)
Available capital at 31 December 2011 6,139 1,937 2,527 1,493 12,096
Changes in assumptions(136)(145) – 30(251)
Changes in management policy 500 – –(24) 476
Changes in regulatory requirements – – – 27 27
New business and other factorsnote (v) 497 578 372 95 1,542
Available capital at 31 December 2012 7,000 2,370 2,899 1,621 13,890
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 245
2011 Łm
Other
UK life
assurance Asia life
subsidiaries assurance Group
WPSF and funds Jackson subsidiaries Total
note (i) note (iii) note (ii) note (iv)
Available capital at 31 December 2010 6,800 1,707 2,907 1,378 12,792
Changes in assumptions(60) 38 –(32)(54)
Changes in management policy(15) – – –(15)
Changes in regulatory requirements – – – 17 17
New business and other factorsnote (v)(586) 192(380) 130(644)
Available capital at 31 December 2011 6,139 1,937 2,527 1,493 12,096
Notes
(i) WPSF
The increase in 2012 of Ł861 million reflects primarily the positive impact of investment returns earned on the opening available capital.
The decrease in 2011 of Ł661 million refl ects primarily the negative eff ect of the lower interest rate used to value projected policyholder benefi t payments, partially off set by the positive impact of investment returns earned on the opening available capital.
(ii) Jackson
The increase of Ł372 million in 2012 reflects an underlying increase of Ł483 million (applying the 2012 year end exchange rate of US$1.63:Ł1.00) and Ł111 million of exchange translation loss.
The decrease of Ł380 million in 2011 refl ects an underlying decrease of Ł402 million (applying the 2011 year end exchange rate of US$1.55:Ł1.00) and Ł22 million of exchange translation gains.
(iii) Other UK life assurance subsidiaries and funds
The effect from the changes in assumptions of valuation interest rates on insurance liabilities is broadly matched by the corresponding effect on assets leaving no significant impact on the available capital.
(iv) Asia life assurance subsidiaries
The increase of Ł128 million in 2012 reflects an underlying increase of Ł177 million (applying the relevant 2012 year end exchange rates) and Ł49 million of exchange translation loss.
The increase of Ł115 million in 2011 refl ected an underlying increase of Ł134 million (applying the relevant 2011 year end exchange rates) and Ł19 million of exchange translation loss.
(v) New business and other factors comprise the effect of changes in new business, valuation interest rate, investment return, foreign exchange and other factors.
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.
Accordingly, the excess of assets over liabilities of the PAC long-term fund is retained within that company. The retention of
the capital enables it to support with-profits and other business of the fund by, for example, providing the benefits associated with D:
smoothing and guarantees. It also provides investment flexibility for the fund’s assets by meeting the regulatory capital requirements Life
that demonstrate solvency and by absorbing the costs of significant events or fundamental changes in its long-term business without
affecting the bonus and investment policies.
For other UK long-term business subsidiaries, the amounts retained within the companies are at levels which provide an assurance
appropriate level of capital strength in excess of the regulatory minimum.
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. business
Furthermore, dividends which exceed the greater of statutory net gain from operations for the prior year, or 10 per cent of Jackson’s
statutory surplus, require prior regulatory approval.
For Asian subsidiaries, the amounts retained within the companies are at levels that provide an appropriate level of capital strength
in excess of the local regulatory minimum. For ring-fenced with-profits funds, the excess of assets over liabilities is retained with
distribution tied to the shareholders’ share of bonuses through declaration of actuarially determined surplus. The Singapore and Financial
Malaysian businesses may, in general, remit dividends to the UK, provided the statutory insurance fund meets the capital adequacy
standard required under local statutory regulations.
Available capital of the non-insurance business units is transferable to the life assurance businesses after taking account of statements
an appropriate level of operating capital, based on local regulatory solvency targets, over and above basis liabilities.
246 Financial statements Prudential plc Annual Report 2012
D: Life assurance business continued
D5: Capital position statement for life assurance businesses continued
e Sensitivity of liabilities and total capital to changed market conditions and capital management policies
Prudential manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities Prudential has in each business. As a result of the diversity of products offered by Prudential, and the different regulatory requirements in which it operates, Prudential employs differing methods of asset/liability and capital management, depending on the business concerned.
Stochastic modelling of assets and liabilities is undertaken in the UK, Jackson and Asia to assess the economic capital requirements. A stochastic approach models the inter-relationship between asset and liability movements, taking into account asset correlation, management actions and policyholder behaviour under a large number of alternative economic scenarios.
In addition, reserve adequacy testing under a range of scenarios and dynamic solvency testing is carried out, including under certain scenarios mandated by the UK, US and Asian regulators.
The sensitivity of liabilities and other components of total capital vary depending upon the type of business concerned and this conditions the approach to asset/liability management.
For example, for businesses that are most sensitive to interest rate changes, such as immediate annuity business, Prudential uses cash flow analysis to create a portfolio of debt securities whose value changes in line with the value of liabilities when interest rates change. This type of analysis helps protect profits from changing interest rates. This type of analysis is used in the UK for annuity business and by Jackson for its interest-sensitive and fixed indexed annuities and stable value products.
For businesses that are most sensitive to equity price changes, Prudential uses stochastic modelling and scenario testing to look at the future returns on its investments under different scenarios which best reflect the large diversity in returns that equities can produce. This allows Prudential to devise an investment and with-profits policyholder bonus strategy that, on the model assumptions, allows it to optimise returns to its policyholders and shareholders over time, while maintaining appropriate financial strength.
Prudential uses this methodology extensively in connection with its UK with-profits business.
f Intragroup arrangements in respect of SAIF
Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations of the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency in the first instance. The directors believe that the probability of either the PAC long-term fund or the Group’s shareholders’ funds having to contribute to SAIF is remote.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 247
E: Asset management (including US broker-dealer) and other operations
E1: Income statement for asset management operations
The Group’s asset management operations are based in the UK, Asia and the US where they operate different models and under
different brands tailored to their markets.
Asset management in the UK and Europe is undertaken through M&G which is made up of three distinct businesses being Retail,
Institutional and Finance. M&G’s investment expertise covers all key asset classes, equities, fixed interest and commercial real estate,
and includes a number of specialist fixed income and real estate strategies. M&G manages its own retail fund operations, funds for
pensions, insurance companies and third-party entities.
Asset management in the US is undertaken through PPM America which manages assets for the Group’s UK, Asia and US affiliates
plus also provides investment services to other affiliated and unaffiliated institutional clients including collateralised debt obligations
(CDOs), private investment funds, institutional accounts and mutual funds. In addition, broker-dealer activities are undertaken in the
US where trades in securities are carried out for both third-party customers and for its own account.
Eastspring Investments in Asia serves both the life companies in Asia by managing the life funds and funds underlying the
investment linked products and third-party customers through mutual fund business. Asia offers mutual fund investment products
in a number of countries within the region, allowing customers to participate in debt, equity and money market investments.
Other operations cover unallocated corporate activities and includes the head office functions.
a The profit included in the income statement in respect of asset management operations for the year is as follows:
2012 Łm 2011 Łm
Eastspring
M&G US Investments Total Total
note (iii)
Revenue (excluding revenue of consolidated investment funds
and NPH broker-dealer fees) 1,234 296 282 1,812 1,583 E:
Revenue of consolidated investment fundsnote (i)(11) – –(11) 9 Asset
NPH broker-dealer feesnote (i) – 435 – 435 405
Gross revenue* 1,223 731 282 2,236 1,997
Charges (excluding charges of consolidated investment funds management
and NPH broker-dealer fees)(713)(257)(207)(1,177)(1,147)
Charges of consolidated investment fundsnote (i) 11 – – 11(9)
NPH broker-dealer feesnote (i) –(435) –(435)(405)(including
Gross charges(702)(692)(207)(1,601)(1,561) US
Profit before tax 521 39 75 635 436 broker
Comprising: -
Operating profit based on longer-term investment returns 371 39 75 485 461 dealer)
Short-term fiuctuations in investment returnsnote (ii) 93 – – 93(29)
Shareholder’s share of actuarial gains and losses on defined and
benefit pension schemes 15 – – 15 4 other
Gain on dilution of Group’s holdings 42 – – 42 –
Profit before tax 521 39 75 635 436 operations
* For 2012, gross revenue includes the Group’s share of results from the associate PPM South Africa. In prior years, PPM South Africa was treated as a subsidiary and
accounted for accordingly.
Notes
(i) Under IFRS, disclosure details of segment revenue are required. The segment revenue of the Group’s asset management operations are required to include
two items that are for amounts which, reflecting their commercial nature, are also wholly reflected as charges within the income statement. After allowing Financial
for these charges, there is no effect on profit from these two items which are:
(a) Investment funds which are managed on behalf of third parties and are consolidated under IFRS in recognition of the control arrangements for the
funds. The gains and losses of these funds are non-recourse to M&G and the Group; and
(b) NPH broker-dealer fees which represent commissions received, that are then paid on to the writing brokers on sales of investment products.
The presentation in the table above shows the amounts attributable to these two items so that the underlying revenue and charges can be seen. statements
(ii) Short-term fluctuations in investment returns for M&G are primarily in respect of unrealised fair value movements on Prudential Capital’s bond portfolio.
(iii) Included within Eastspring Investments revenue and charges are Ł42 million of commissions (2011: Ł44 million).
248 Financial statements Prudential plc Annual Report 2012
E: Asset management (including US broker-dealer) and other operations continued
E1: Income statement for asset management operations continued
b M&G operating profit based on longer-term investment returns:
2012 Łm 2011* Łm
Asset management fee income 728 662
Other income 6 4
Staff costs(289)(270)
Other costs(147)(134)
Underlying profit before performance-related fees 298 262
Share of associate results 13 26
Performance-related fees 9 13
Operating profit from asset management operations 320 301
Operating profit from Prudential Capital 51 56
Total M&G operating profit based on longer-term investment returns 371 357
* Following the divestment in the first half of 2012 of M&G’s holding in PPM South Africa from 75 per cent to 49.99 per cent and its treatment from 2012 as an associate, M&G’s operating income and expense no longer include any element from PPM South Africa, with the share of associates’ results being presented in a separate line. The table above reflects the retrospective application of this basis of presentation for the 2011 results. Total profit remains the same.
The difference between the fees and other income shown above in respect of asset management operations, and the revenue figure for M&G shown (excluding consolidated investment funds) in the main table primarily relates to the total revenue of Prudential Capital (including short-term fiuctuations) of Ł218 million (2011: Ł96 million) and commissions which have been netted off in arriving at the fee income of Ł728 million (2011: Ł662 million) in the table above. The difference in the presentation of commission is aligned with how management reviews the business.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 249
E2: Statement of financial position for asset management operations
Assets, liabilities and shareholders’ equity included in the Group consolidated statement of financial position in respect of asset
management operations are as follows:
2012 Łm 2011 Łm
Eastspring
M&G US Investments Total Total
note (iii)
Assets
Intangible assets:
Goodwill 1,153 16 61 1,230 1,230
Deferred acquisition costs and other intangibles assets 10 2 2 14 16
Total 1,163 18 63 1,244 1,246
Other non-investment and non-cash assets 901 174 83 1,158 1,129
Associate investments accounted for using the equity method 41 – – 41 –
Financial investments:
Loansnote (i) 1,199 – – 1,199 1,256
Equity securities and portfolio holdings in unit trusts 50 – 20 70 594
Debt securitiesnote (ii) 1,839 – 7 1,846 1,842
Other investments 38 6 – 44 78
Deposits 3 33 48 84 89
E:
Total investments 3,170 39 75 3,284 3,859
Cash and cash equivalents 909 48 126 1,083 1,735 Asset
Total assets 6,143 279 347 6,769 7,969
Equity and liabilities management
Equity
Shareholders’ equity 1,545 124 268 1,937 1,783
Non-controlling interests – – – – 5(including
Total equity 1,545 124 268 1,937 1,788
US
Liabilities
Core structural borrowing of shareholder-financed operations 275 – – 275 250 broker
-
Intra-group debt represented by operational borrowings at
Group levelnote (iv) 2,084 – – 2,084 2,956 dealer)
Net consolidated asset value attributable to external holders of and
unit trusts and similar funds 162 – – 162 678
Other non-insurance liabilitiesnote (v) 2,077 155 79 2,311 2,297 other
Total liabilities 4,598 155 79 4,832 6,181
Total equity and liabilities 6,143 279 347 6,769 7,969 operations
Notes
(i) Loans
The M&G loans relate to loans and receivables managed by Prudential Capital. These assets are generally secured but most have no external credit ratings.
Internal ratings prepared by the Group’s asset management operations as part of the risk management process are:
2012 Łm 2011 Łm Financial
Loans and receivables internal ratings:
A+ to A- – 129
BBB+ to BBB- 836 1,000 statements
BB+ to BB- 339 89
B+ to B- 24 38
Total M&G loans 1,199 1,256
250 Financial statements Prudential plc Annual Report 2012
E: Asset management (including US broker-dealer) and other operations continued
E2: Statement of fi nancial position for asset management operations continued
(ii) Debt securities
Of the Ł1,846 million total debt securities at 31 December 2012 (2011: Ł1,842 million) for asset management operations, the following amounts were held by M&G.
2012 Łm 2011 Łm
M&G:
AAA to A- by Standard & Poor’s or Aaa rated by Moody’s 1,493 1,547
Other 346 287
Total M&G debt securities 1,839 1,834
(iii) The M&G statement of financial position includes the assets and liabilities in respect of Prudential Capital.
(iv) Intra-group debt represented by operational borrowings at Group level
Operational borrowings for M&G are in respect of Prudential Capital’s short-term fixed income security programme and comprise:
2012 Łm 2011 Łm
Commercial paper 1,535 2,706
Medium-Term Notes 549 250
Total intra-group debt represented by operational borrowings at Group level 2,084 2,956
(v) Other non-insurance liabilities consists primarily of intra-group balances, derivative liabilities and other creditors.
E3: Regulatory and other surplus for asset management operations
Certain asset management operations are subject to regulatory requirements. The movement in the year of the surplus regulatory capital position of these operations, combined with the movement in the IFRS basis shareholders’ funds for unregulated asset management operations, is as follows:
Asset management operations
2012 Łm 2011 Łm
Eastspring
M&G US Investments Total Total
Regulatory and other surplus
Beginning of year 156 129 127 412 432
Gains during the year 356 8 52 416 326
Movement in capital requirement(3) – 6 3(14)
Capital injection – – 9 9 8
Distributions made(254)(8)(56)(318)(342)
Exchange movement –(5)(4)(9) 2
End of year 255 124 134 513 412
The movement in the year reflects gains driven by profits generated during the year and also changes in regulatory requirements. Distributions consist of dividends paid up to the parent company.
The M&G figures include those for Prudential Capital.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 251
Other operations consist of unallocated corporate activities relating to Group Head Office and the Asia regional head office, with net
expenditure for the year of Ł498 million (2011: Ł483 million) as detailed in note B1. An analysis of the assets and liabilities of other E:
operations is shown in note B5. Asset
The Group holds certain derivatives that are used to manage foreign currency movements and macroeconomic exposures. The fair
value of these derivatives is sensitive to the combined effect of movements in exchange rates, interest rates and inflation rates. The
possible permutations cover a wide range of scenarios. For indicative purposes, a reasonably possible range of fair value movements
could be plus or minus Ł17 million. management
(including
US
broker
-
dealer)
and
other
operations
Financial
statements
252 Financial statements Prudential plc Annual Report 2012
F: Income statement notes
[Graphic Appears Here]
This is represented in the segmental analysis of profit from continuing operations before tax attributable to shareholders in note B1 as follows:
[Graphic Appears Here]
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 253
Year ended 31 December 2011* Łm
Asset management
Insurance operations E1
Eastspring Unallo-
Invest- Total cated Group
UK US Asia M&G US ments segment corporate total
Gross premiums earned 5,678 12,650 7,378 – – – 25,706 – 25,706
Outward reinsurance premiums(131)(72)(226) – – –(429)(429)
Earned premiums, net of reinsurance 5,547 12,578 7,152 – – – 25,277 – 25,277
Investment return note (ii) 7,604 1,447 283 128 1 2 9,465(105) 9,360
Other income 193(62) 155 923 653 290 2,152(283) 1,869
Total revenue, net of reinsurance 13,344 13,963 7,590 1,051 654 292 36,894(388) 36,506
Benefits and claims(12,048)(12,931)(6,081) – – –(31,060) –(31,060)
Outward reinsurers’ share of benefits
and claims note (iv) 290 280 176 – – – 746 – 746
Movement in unallocated surplus of
with-profits funds note (iii) 485 – 540 – – – 1,025 – 1,025
Benefits and claims and movements in
unallocated surplus of with-profits
funds, net of reinsurance(11,273)(12,651)(5,365) – – –(29,289) –(29,289)
Acquisition costs and other operating
expenditureF3(1,239)(815)(1,562)(704)(630)(212)(5,162) 42(5,120)
Finance costs: interest on core structural
borrowings of shareholder-financed
operations –(13) –(15) – –(28)(258)(286)
Total charges, net of reinsurance(12,512)(13,479)(6,927)(719)(630)(212)(34,479)(216)(34,695)
Profit (loss) before tax (being tax
attributable to shareholders’ and
policyholders’ returns) note (i) 832 484 663 332 24 80 2,415(604) 1,811
Tax charge attributable to policyholders’
returns 68 –(51) – – – 17 – 17
Profit (loss) from continuing operations
before tax attributable to shareholders 900 484 612 332 24 80 2,432(604) 1,828
F:
This is represented in the segmental analysis of profit from continuing operations before tax attributable to shareholders in note B1
as follows: Income
Year ended 31 December 2011* Łm
Insurance operations Asset management statement
Eastspring Unallo-
Invest- Total cated Group notes
UK US Asia M&G US ments segment corporate total
Operating profit based on longer-term
investment returns 723 651 704 357 24 80 2,539(512) 2,027
Short-term fiuctuations in investment Financial
returns on shareholder-backed business 159(167)(92)(29) – –(129)(91)(220)
Shareholders’ share of actuarial and
other gains and losses on defined
benefit pension schemes 18 – – 4 – – 22(1) 21 statements
Profit (loss) from continuing operations
before tax attributable to shareholders 900 484 612 332 24 80 2,432(604) 1,828
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
254 Financial statements Prudential plc Annual Report 2012
F: Income statement notes continued
F1: Segmental information continued
Notes
(i) This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders.
(ii) Investment return principally comprises:
• Interest and dividends;
• Realised and unrealised gains and losses on securities and derivatives classifled as fair value through profit and loss under IAS 39; and
• Realised gains and losses, including impairment losses, on securities classifled as available-for-sale under IAS 39.
(iii) The movement in unallocated surplus of with-profits funds for Asia above includes movement relating to the Hong Kong branch of PAC. For the purpose of the presentation of unallocated surplus of with-profits funds within the statement of financial position, the Hong Kong branch balance is shown within the unallocated surplus of the PAC with-profits sub-fund.
(iv) The increase in the credit for outwards reinsurers’ share of benefits and claims for Jackson from 2010 to 2011 arises from the fair value movements on the GMIB reinsurance in 2011. As the GMIB reinsurance is net settled it is considered to be a derivative under IAS 39. The movement was particularly high in 2011 due to the reduction in US interest rates in 2011.
F2: Revenue
2012 Łm 2011 Łm
Long-term business premiums
Insurance contract premiums 27,447 23,705
Investment contracts with discretionary participation feature premiums 2,243 1,861
Inwards reinsurance premiums 220 140
Less: reinsurance premiums ceded(506)(429)
Earned premiums, net of reinsurance note (iv) 29,404 25,277
Investment return
Realised and unrealised gains and losses on securities at fair value through profit and loss 15,338 866
Realised and unrealised losses and gains on derivatives at fair value through profit and loss 75 86
Realised losses on available-for-sale securities, previously recognised in other comprehensive income 68 101
Realised losses on loans(51)(43)
Interest notes (i),(ii) 6,600 6,440
Dividends 1,462 1,304
Other investment return 559 606
Investment return 24,051 9,360
Fee income from investment contract business and asset management notes (iii),(iv) 2,021 1,869
Total revenue 55,476 36,506
Notes
(i) The segmental analysis of interest income is as follows:
2012 Łm 2011 Łm
Insurance operations:
UK 4,310 4,286
US 1,778 1,717
Asia 403 339
Asset management operations:
M&G 114 110
US 1 1
Eastspring Investments 3 3
Total segment 6,609 6,456
Unallocated corporate(9)(16)
Total 6,600 6,440
(ii) Interest income includes Ł13 million (2011: Ł8 million) accrued in respect of impaired securities.
(iii) Fee income includes Ł35 million (2011: Ł13 million) relating to financial instruments that are not held at fair value through profit and loss. These fees primarily related to prepayment fees, late fees and syndication fees.
Notes on the Group financial statements Prudential plc Annual Report 2012 255
(iv) The following table provides additional segmental analysis of revenue from external customers:
2012 Łm
Asia US UK Intragroup Total
Revenue from external customers:
Insurance operations 8,205 14,465 7,098 – 29,768
Asset management 274 725 972(333) 1,638
Unallocated corporate – – 19 – 19
Intragroup revenue eliminated on consolidation(84)(77)(172) 333 –
Total revenue from external customers 8,395 15,113 7,917 – 31,425
2011 Łm
Asia US UK Intragroup Total
Revenue from external customers:
Insurance operations 7,307 12,516 5,740 – 25,563
Asset management 290 653 923(323) 1,543
Unallocated corporate – – 40 – 40
Intragroup revenue eliminated on consolidation(93)(68)(162) 323 –
Total revenue from external customers 7,504 13,101 6,541 – 27,146
Revenue from external customers is made up of the following:
2012 Łm 2011 Łm
Earned premiums, net of reinsurance 29,404 25,277
Fee income from investment contract business and asset management (presented as ‘Other income’) 2,021 1,869
Total revenue from external customers 31,425 27,146
In their capacity as fund managers to fellow Prudential Group subsidiaries, M&G, Eastspring Investments and US asset management businesses generate fees for investment management and related services. These services are charged at appropriate arm’s length prices, typically priced as a percentage of funds under management. Intragroup fees included within asset management revenue were earned by the following asset management segment:
2012 Łm 2011 Łm
Intragroup revenue generated by:
M&G 172 162
Eastspring Investments 84 93
US broker-dealer and asset management (including Curian) 77 68
Total intragroup fees included within asset management segment 333 323 F:
Revenue from external customers of Asia, US and UK insurance operations shown above are net of outwards reinsurance premiums
of Ł178 million, Ł193 million, and Ł135 million respectively (2011: Ł226 million, Ł72 million and Ł131 million respectively).
In Asia, revenue from external customers from no individual country exceeds 10 per cent of the Group total. The largest country statement
is Hong Kong with a total revenue from external customers of Ł1,745 million (2011: Singapore Ł1,383 million).
Due to the nature of the business of the Group, there is no reliance on any major customers. notes
Financial
statements
256 Financial statements Prudential plc Annual Report 2012
F: Income statement notes continued
F3: Acquisition costs and other expenditure
2012 Łm 2011* Łm
Acquisition costs incurred for insurance policies(2,649)(2,264)
Acquisition costs deferred less amortisation of acquisition costs for insurance policies 480 520
Administration costs and other expenditure(3,728)(3,524)
Movements in amounts attributable to external unit holders(158) 148
Total acquisition costs and other expenditure(6,055)(5,120)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes
(i) Acquisition costs in 2012 comprise amounts related to insurance contracts of Ł(1,949) million (2011: Ł(1,679) million), and investment contracts and asset management contracts of Ł(220) million (2011: Ł(65) million).
(ii) There were no fee expenses relating to financial liabilities held at amortised cost included in acquisition costs in 2012 and 2011.
(iii) The total depreciation and amortisation expense of Ł(731) million (2011: Ł(584) million) relates to amortisation of deferred acquisition costs of insurance contracts and asset management contracts.
The segmental analysis of total depreciation and amortisation expense is as follows:
2012 Łm 2011* Łm
Insurance operations:
UK(65)(55)
US(302)(237)
Asia(332)(270)
Asset management operations:
M&G(6)(7)
US(1)(1)
Eastspring Investments(4)(4)
Total segment(710)(574)
Unallocated corporate(21)(10)
Total(731)(584)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
(iv) Interest expense, excluding interest on core structural borrowings of shareholder-financed operations, amounted to Ł(140) million (2011: Ł(123) million) and is included within total acquisition costs and other operating expenditure as part of investment management expenses. The segmental analysis of this interest expense is as follows:
2012 Łm 2011 Łm
Insurance operations:
UK(62)(49)
US(28)(31)
Asia(7)(10)
Asset management operations:
M&G(18)(11)
Total segment(115)(101)
Unallocated corporate(25)(22)
Total(140)(123)
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 257
(v) Movements in amounts attributable to external unit holders are in respect of those OEIC and unit trusts which are required to be consolidated and comprises a charge of Ł(195) million (2011: a credit of Ł28 million) for UK insurance operations and a credit of Ł37 million (2011: Ł120 million) for Asia insurance operations.
(v) The total amounts for acquisition costs and other expenditure shown above includes Corporate expenditure shown in note B1 (Segment disclosure – income statement). The charge for Corporate expenditure comprises:
2012 Łm 2011 Łm
Group Head Office(168)(168)
Asia Regional Head Office:
Gross costs(99)(86)
Recharges to Asia operations 36 35
(63)(51)
Total(231)(219)
F4: Finance costs – Interest on core structural borrowings of shareholder-financed operations
Finance costs of Ł280 million (2011: Ł286 million) comprise Ł251 million (2011: Ł258 million) interest on core debt of the parent
company, Ł13 million (2011: Ł13 million) on US insurance operations’ surplus notes and Ł16 million (2011: Ł15 million) on PruCap’s
bank loan.
F5: Tax
a Total tax charge by nature of expense
An analysis of the total tax benefit (expense) of continuing operations recognised in the income statement by nature of benefit
(expense) is as follows:
2012 Łm 2011* Łm
Current tax expense:
Corporation tax(950)(775)
Adjustments in respect of prior years 143 33
Total current tax(807)(742)
Deferred tax arising from:
Origination and reversal of temporary differences(178) 293
(Expense) credit in respect of a previously unrecognised tax loss, tax credit or temporary difference
from a prior period(6) 57
F:
Total deferred tax (charge) credit(184) 350
Total tax charge(991)(392) Income
The total tax expense arises as follows: statement
2012 Łm 2011* Łm notes
Current tax expense:
UK(393)(475)
Foreign(414)(267) Financial
(807)(742)
Deferred tax (charge) credit:
UK(45) 455
Foreign(139)(105) statements
(184) 350
Total(991)(392)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in the accounting policy described in note A5.
258 Financial statements Prudential plc Annual Report 2012
F: Income statement notes continued
F5: Tax continued
The current tax charge of Ł807 million includes Ł18 million (2011: charge of Ł16 million) in respect of the tax charge for Hong Kong. The Hong Kong current tax charge is calculated as 16.5 per cent for all periods on either (i) 5 per cent of the net insurance premium or
(ii) the estimated assessable profits, depending on the nature of the business written.
In the UK, life insurance companies are taxed on both their shareholders’ profits and on their policyholders’ investment returns on
certain insurance and investment products. Tax on shareholders’ profi ts is calculated at the standard corporation tax rate, and tax on policyholders’ investment returns is calculated at the basic rate of income tax. Although both types of tax are included in the total tax charge in the Group’s consolidated income statement, they are presented separately in the income statement to provide the most relevant information about tax that the Group pays on its profits.
Until the end of 2012 for the Group’s UK life insurance companies, shareholders’ profi ts were calculated using regulatory surplus as a starting point, with appropriate deferred tax adjustments for IFRS. Beginning in 2013, under new UK life tax rules, shareholders’ profi ts will be calculated using accounting profit or loss as a starting point.
The total tax charge comprises tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders as shown below.
2012 Łm 2011* Łm
Current Deferred
Tax charge tax tax Total Total
Tax (charge) credit to policyholders’ returns(488) 110(378) 17
Tax charge attributable to shareholders(319)(294)(613)(409)
Total tax charge(807)(184)(991)(392)
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
The principal reason for the increase in the tax charge attributable to policyholders’ returns is an increase in deferred tax on unrealised gains and losses on investments.
The total deferred tax (charge)/credit arises as follows:
2012 Łm 2011* Łm
Unrealised gains and losses on investments(91) 129
Balances relating to investment and insurance contracts 467 148
Short-term timing differences(226) 66
Capital allowances – 2
Unused tax losses(334) 5
Deferred tax (charge)/credit(184) 350
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
In 2012, a deferred tax charge of Ł198 million (2011: charge of Ł187 million) has been taken through other comprehensive income. Other movements in deferred tax totalling a Ł378 million credit mainly arises as a result of bringing a deferred tax asset in respect of the acquired REALIC business on to the balance sheet. When these amounts are taken with the deferred tax charge shown above there is no signifi cant change in the Group’s net deferred tax liability (2011: decrease of Ł0.1 billion).
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 259
b Reconciliation of effective tax rate
The total tax charge is attributable to shareholders and policyholders as summarised in the income statement.
i Summary of pre-tax profit and tax (charge)
The income statement includes the following items:
2012 Łm 2011* Łm
Profit before tax 3,188 1,811
Tax (charge) credit attributable to policyholders’ returns(378) 17
Profit before tax attributable to shareholders 2,810 1,828
Tax attributable to shareholders’ profits:
Tax charge(991)(392)
Less: tax attributable to policyholders’ returns 378(17)
Tax charge attributable to shareholders’ returns(613)(409)
Profit for the year 2,197 1,419
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
ii Overview
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, as follows:
2012 Łm 2011* Łm
Attributable to Attributable to Attributable to Attributable to
shareholders policyholders† Total shareholders policyholders† Total
Profit (loss) before tax 2,810 378 3,188 1,828(17) 1,811
Taxation charge:
Expected tax rate 27% 100% 36% 28% 100% 28%
Expected tax (charge) credit(763)(378)(1,141)(519) 17(502)
Variance from expected tax charge note v(ii) 150 – 150 110 – 110
Actual tax (charge) credit(613)(378)(991)(409) 17(392)
Average effective tax rate 22% 100% 31% 22% 100% 22%
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy
described in note A5. F:
† 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 Income
policyholders.
statement
notes
Financial
statements
260 Financial statements Prudential plc Annual Report 2012
F: Income statement notes continued
F5: Tax continued
iii Reconciliation of eff ective tax rate
The total tax charge is attributable to shareholders and policyholders as summarised in the income statement.
Reconciliation of tax charge on profit attributable to shareholders for continuing operations:
2012 Łm (except for tax rates)
Asia US UK
insurance insurance insurance Other
2012 operations operations operations operations Total
Operating profit (loss) based on longer-term investment
returns 913 964 736(80) 2,533
Non-operating profit (loss) 76(109) 122 188 277
Profit before tax attributable to shareholders 989 855 858 108 2,810
Expected tax rate:* 23% 35% 25% 25% 27%
Tax at the expected tax rate 227 300 210 26 763
Effects of:
Adjustment to tax charge in relation to prior years(11) 10(26)(10)(37)
Movements in provisions for open tax matters –(3) – 32 29
Income not taxable or taxable at concessionary rates(87) – –(2)(89)
Deductions not allowable for tax purposes 30 – – 3 33
Different local basis of tax on overseas profits –(68) – –(68)
Impact of changes in local statutory tax rates – –(39) 9(30)
Deferred tax adjustments(6) – 8(1) 1
Irrecoverable withholding taxes – – – 14 14
Other 5(5) 8(11)(3)
Total actual tax charge 158 234 161 60 613
Analysed into:
Tax on operating profit based on longer-term
investment returns 142 272 126 42 582
Tax on non-operating profit 16(38) 35 18 31
Actual tax rate:
Operating profit based on longer-term investment returns 16% 28% 17%(53)% 23%
Total profit 16% 27% 19% 56% 22%
* The expected tax rates shown in the table above (rounded to the nearest whole percentage) reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for Other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 261
2011† Łm (except for tax rates)
Asia US UK
insurance insurance insurance Other
operations operations operations operations Total
Operating profit (loss) based on longer-term investment
returns 704 651 723(51) 2,027
Non-operating profit(92)(167) 177(117)(199)
Profit (loss) before tax attributable to shareholders 612 484 900(168) 1,828
Expected tax rate:* 25% 35% 27% 27% 28%
Tax at the expected tax rate 151 170 243(45) 519
Effects of:
Adjustment to tax charge in relation to prior years(7) – 33(19) 7
Movements in provisions for open tax matters – – –(44)(44)
Income not taxable or taxable at concessionary rates(36) –(1) –(37)
Deductions not allowable for tax purposes 12 – – 4 16
Different local basis of tax on overseas profits –(37) – –(37)
Impact of changes in local statutory tax rates – –(32) 1(31)
Deferred tax adjustments 7 – – – 7
Irrecoverable withholding taxes – – – 13 13
Other(3)(6)(14) 19(4)
Total actual tax charge (credit) 124 127 229(71) 409
Analysed into:
Tax on operating profit based on longer-term
investment returns 122 185 190(64) 433
Tax on non-operating profit 2(58) 39(7)(24)
Actual tax rate:
Operating profit based on longer-term investment returns 17% 28% 26% 125% 21%
Total profit 20% 26% 25% 42% 22%
* The expected tax rates shown in the table above (rounded to the nearest whole percentage) reflect the corporation tax rates generally applied to taxable profits of the relevant country jurisdictions. For Asia operations the expected tax rates reflect the corporation tax rates weighted by reference to the source of profits of operations contributing to the aggregate business result. The expected tax rate for Other operations reflects the mix of business between UK and overseas non-insurance operations, which are taxed at a variety of rates. The rates will fluctuate from year to year dependent on the mix of profits.
• The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
F:
c Taxes paid
In 2012 Prudential remitted Ł2.2 billion (2011: Ł1.6 billion) of tax to Revenue authorities, this includes Ł925 million (2011: Ł561 million) Income
of corporation tax, Ł184 million of other taxes and Ł1,078 million collected on behalf of employees, customers and third parties.
The geographical split of taxes remitted by Prudential is as follows:
2012 Łm 2011 Łm statement
Corporation Taxes Corporation Taxes
taxes* v Other taxes† collected‡ Total taxes* v Other taxes† collected‡ Total notes
Asia 221 37 152 410 170 32 64 266
US 181 25 264 470 131 20 221 372
UK 522 121 662 1,305 260 112 595 967 Financial
Other 1 1 – 2 – 1 – 1
Total tax paid 925 184 1,078 2,187 561 165 880 1,606
* In certain countries such as the UK, the corporation tax payments for the Group’s life insurance businesses are based on taxable profits which include statements
policyholder investment returns on certain life insurance products.
† Other taxes paid includes property taxes, withholding taxes, customs duties, stamp duties, employer payroll taxes and irrecoverable indirect taxes.
• Taxes collected are other taxes that Prudential remits to tax authorities which it is obliged to collect from employees, customers and third parties which includes sales/VAT/GST taxes, employee and annuitant payroll taxes.
262 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities
G1: Financial instruments – Designation and fair values
The Group designates all financial assets as at fair value, either through profit and loss or on an available-for-sale, or as loans and receivables on an amortised cost basis, net of impairment basis. Financial liabilities are designated as either fair value through profit and loss, amortised cost, or as investment contracts with discretionary participation features accounted for under IFRS 4 as described in note A3.
2012 Łm
Loans and
Fair value receivables Total
through Available- at amortised carrying
profit and loss for-sale cost value Fair value
Financial assets
Cash and cash equivalents – – 6,384 6,384 6,384
Deposits – – 12,653 12,653 12,653
Equity securities and portfolio holdings in unit trusts 99,958 – – 99,958 99,958
Debt securities note (i) 107,278 32,825 – 140,103 140,103
Loans note (ii) 2,068 – 9,753 11,821 12,333
Other investments note (iii) 7,900 – – 7,900 7,900
Accrued investment income – – 2,798 2,798 2,798
Other debtors – – 1,361 1,361 1,361
217,204 32,825 32,949 282,978
2012 Łm
Fair value IFRS 4 Total
through Amortised basis carrying
profit and loss cost value value Fair value
note (v)
Financial liabilities
Core structural borrowings of shareholder-financed
operations notes (i), H13 – 3,554 – 3,554 4,133
Operational borrowings attributable to
shareholder-financed operations H13 – 2,245 – 2,245 2,245
Borrowings attributable to with-profits funds H13 40 993 – 1,033 1,042
Obligations under funding, securities lending and sale
and repurchase agreements – 2,436 – 2,436 2,455
Net asset value attributable to unit holders of
consolidated unit trust and similar funds 4,345 – – 4,345 4,345
Investment contracts with discretionary
participation features note (iv) – – 33,812 33,812 –
Investment contracts without discretionary
participation features 16,309 2,069 – 18,378 18,419
Other creditors 259 2,522 – 2,781 2,781
Derivative liabilities 2,829 – – 2,829 2,829
Other liabilities 2,021 1,433 – 3,454 3,453
25,803 15,252 33,812 74,867
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 263
2011 Łm
Loans and
Fair value receivables Total
through Available- at amortised carrying
profit and loss for-sale cost value Fair value
Financial assets
Cash and cash equivalents – – 7,257 7,257 7,257
Deposits – – 10,708 10,708 10,708
Equity securities and portfolio holdings in unit trusts 87,349 – – 87,349 87,349
Debt securities note (i) 97,482 27,016 – 124,498 124,498
Loans note (ii) 279 – 9,435 9,714 9,828
Other investments note (iii) 7,509 – – 7,509 7,509
Accrued investment income – – 2,710 2,710 2,710
Other debtors – – 987 987 987
192,619 27,016 31,097 250,732
2011 Łm
Fair value IFRS 4 Total
through Amortised basis carrying
profit and loss cost value value Fair value
note (v)
Financial liabilities
Core structural borrowings of shareholder-financed
operations notes (i), H13 – 3,611 – 3,611 3,815
Operational borrowings attributable to
shareholder-financed operations H13 – 3,340 – 3,340 3,340
Borrowings attributable to with-profits funds H13 39 933 – 972 978
Obligations under funding, securities lending and sale
and repurchase agreements – 3,114 – 3,114 3,144
Net asset value attributable to unit holders of
consolidated unit trust and similar funds 3,840 – – 3,840 3,840
Investment contracts with discretionary
participation features note (iv) – – 29,745 29,745 –
Investment contracts without discretionary
participation features 15,056 1,911 – 16,967 17,008 G:
Other creditors 281 2,263 – 2,544 2,544
Derivative liabilities 3,054 – – 3,054 3,054
Other liabilities – 1,249 – 1,249 1,249 Financial
22,270 16,421 29,745 68,436
Notes
(i) As at 31 December 2012 Ł525 million (2011: Ł523 million) of convertible bonds were included in debt securities and Ł673 million (2011: Ł702 million) were
included in borrowings.
(ii) Loans and receivables are reported net of allowance for loan losses of Ł83 million (2011: Ł89 million).
(iii) See note G3 for details of the derivative assets included. The balance also contains the PAC with-profits fund’s participation in various investment funds liabilities
and limited liability property partnerships.
(iv) It is impractical to determine the fair value of investment contracts with discretionary participation features due to the lack of a reliable basis to measure
such features.
(v) For financial liabilities designated as fair value through profit and loss, the impact on profit from movements in credit risk during 2012 and 2011 was
negligible. Financial
statements
264 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
G1: Financial instruments – Designation and fair values continued
Determination of fair value
The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange-quoted investments, or by using quotations from independent third parties, such as brokers and pricing services or by using appropriate valuation techniques. Investments valued using valuation techniques include financial investments which by their nature do not have an externally quoted price based on regular trades and financial investments for which markets are no longer active as a result of market conditions eg market illiquidity. The valuation techniques used include comparison to recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash fl ow analysis, option adjusted spread models and, if applicable, enterprise valuation. These techniques may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments. When determining the inputs into the valuation techniques used priority is given to publicly available prices from independent sources when available, but overall the source of pricing is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date.
The fair value estimates are made at a specific point in time, based upon available market information and judgements about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Group’s entire holdings of a particular financial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the financial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the financial instrument.
The loans and receivables have been shown net of provisions for impairment. The fair value of loans has been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest.
The estimated fair value of derivative financial instruments reflects the estimated amount the Group would receive or pay in an arm’s length transaction. This amount is determined using quoted prices if exchange listed, quotations from independent third parties or valued internally using standard market practices. In accordance with the Group’s risk management framework, all internally generated valuations are subject to assessment against external counterparties’ valuations.
For investment contracts in the US with fixed and guaranteed terms the fair value is determined based on the present value of future cash flows discounted at current interest rates.
The fair value of other financial liabilities is determined using discounted cash flows of the amounts expected to be paid.
Level 1, 2 and 3 fair value measurement hierarchy of Group financial instruments
The table below includes financial instruments carried at fair value analysed by level of the IFRS 7 ‘Financial Instruments: Disclosures’ defined fair value hierarchy. This hierarchy is based on the inputs to the fair value measurement and reflects the lowest level input that is significant to that measurement.
The classification criteria and its application to Prudential can be summarised as follows:
Level 1 – quoted prices (unadjusted) in active markets for identical assets and liabilities
Level 1 includes financial instruments where there is clear evidence that the valuation is based on a quoted publicly traded price in an active market (eg exchange listed equities, mutual funds with quoted prices and exchange traded derivatives).
Level 2 – inputs other than quoted prices included within level 1 that are observable either directly (ie as prices) or indirectly (ie derived from prices)
Level 2 includes investments where a direct link to an actively traded price is not readily apparent, but which are valued using inputs which are largely observable either directly (ie as prices) or indirectly (ie derived from prices). A significant proportion of the Group’s Level 2 assets are corporate bonds, structured securities and other non-national government debt securities. These assets, in line with market practice, are generally valued using independent pricing services or third-party broker quotes. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances and analysis on prices achieved on subsequent trades.
Pricing services, where available, are used to obtain the third-party broker quotes. Where pricing services providers are used, a single valuation is obtained and applied.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 265
When prices are not available from pricing services, quotes are sourced directly from brokers. Prudential seeks to obtain a number
of quotes from different brokers so as to obtain the most comprehensive information available on their executability. Where quotes
are sourced directly from brokers, the price used in the valuation is normally selected from one of the quotes based on a number of
factors, including the timeliness and regularity of the quotes and the accuracy of the quotes considering the spreads provided. The
selected quote is the one which best represents an executable quote for the security at the measurement date.
Generally, no adjustment is made to the prices obtained from independent third parties. Adjustment is made in only limited
circumstances, where it is determined that the third-party valuations obtained do not reflect fair value (eg either because the value
is stale and/or the values are extremely diverse in range). These are usually securities which are distressed or that could be subject
to a debt restructure or where reliable market prices are no longer available due to an inactive market or market dislocation. In these
instances, prices are derived using internal valuation techniques including those as described above in this note with the objective
of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market
participants on the measurement date. The techniques used require a number of assumptions relating to variables such as credit risk
and interest rates. Examples of such variables include an average credit spread based on the corporate bond universe and the relevant
duration of the asset being valued. Prudential measures the input assumptions based on the best available information at the
measurement dates. Securities valued in such manner are classifled as Level 3 where these significant inputs are not based on
observable market data.
Of the total Level 2 debt securities of Ł105,839 million at 31 December 2012 (31 December 2011: Ł94,378 million), Ł8,248 million
are valued internally (31 December 2011: Ł6,847 million). The majority of such securities are valued using matrix pricing, which is
based on assessing the credit quality of the underlying borrower to derive a suitable discount rate relative to government securities
of a comparable duration. Under matrix pricing, the debt securities are priced taking the credit spreads on comparable quoted public
debt securities and applying these to the equivalent debt instruments factoring in a specifled liquidity premium. The majority of the
parameters used in this valuation technique are readily observable in the market and, therefore, are not subject to interpretation.
Level 3 – Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs)
Level 3 includes investments which are internally valued or subject to a significant number of unobservable assumptions (eg private
equity funds and certain derivatives which are bespoke or long-dated).
At 31 December 2012, the Group held Ł6,660 million (2011: Ł4,565 million), 3 per cent of the fair valued financial investments, net
of derivative liabilities (2011: 2 per cent), within Level 3.
Of these amounts, Ł3,916 million (2011: Ł3,732 million) was held by the Group’s participating funds and therefore shareholders’
profit and equity are not impacted by movements in the valuation of these financial instruments. At 31 December 2012, the
Ł3,916 million (2011: Ł3,732 million) represented 4.3 per cent (2011: 4.3 per cent) of the total fair valued financial instruments,
net of derivative liabilities of the participating funds.
Included within the Ł2,703 million Level 3 fair valued financial investments, net of derivative liabilities at 31 December 2012
(2011: Ł800 million) held to support non-linked shareholder-backed business were loans of Ł1,842 million, attaching to the purchase
of REALIC in 2012 held to back the liabilities for funds withheld under reinsurance arrangement. The funds withheld liability, which
was also accounted for on a fair value basis and classifled as Level 3, amounted to Ł2,021 million at 31 December 2012. This liability
is included within Other financial liabilities held at fair value in the table below. G:
Excluding the financial investments of Ł1,842 million held to back the funds withheld liability under REALIC’s reinsurance
arrangement, the Level 3 fair valued financial investments, net of derivative liabilities, supporting non-linked shareholder-backed
business at 31 December 2012 were Ł861 million (2011: Ł800 million) (representing 1.2 per cent of the total fair valued financial Financial
investments net of derivative liabilities backing this business (2011: 1.3 per cent)). Of this amount, Ł837 million of net assets are
externally valued and Ł24 million of net liabilities are internally valued (2011: net assets of Ł757 million and Ł43 million respectively). assets
Internal valuations, which represent 0.03 per cent of the total fair valued financial investments net of derivative liabilities supporting and
non-linked shareholder-backed business at 31 December 2012 (2011: 0.1 per cent), are inherently more subjective than external
valuations.
If the value of all Level 3 investments backing non-linked shareholder-backed business valued internally was varied downwards by liabilities
10 per cent, the change in valuation would be Ł2 million (2011: Ł4 million), which would reduce shareholders’ equity by this amount
before tax. Of this amount, a Ł1 million increase (2011: Ł1 million decrease) would pass through the income statement substantially
as part of short-term fluctuations in investment returns outside of operating profit and a Ł3 million decrease (2011: Ł3 million decrease)
would be included as part of other comprehensive income, being unrealised movements on assets classifled as available-for-sale. Financial
statements
266 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
G1: Financial instruments – Designation and fair values continued
31 December 2012 Łm
Level 1 Level 2 Level 3 Total
Analysis of financial investments, net of derivative liabilities
by business type
With-profits
Equity securities and portfolio holdings in unit trusts 22,129 2,496 480 25,105
Debt securities 15,910 45,550 542 62,002
Other investments (including derivative assets) 108 1,743 2,894 4,745
Derivative liabilities(61)(1,072) –(1,133)
Total financial investments, net of derivative liabilities 38,086 48,717 3,916 90,719
Percentage of total 42% 54% 4% 100%
Unit-linked and variable annuity separate account
Equity securities and portfolio holdings in unit trusts 73,632 189 39 73,860
Debt securities 3,843 5,659 2 9,504
Other investments (including derivative assets) 47 10 – 57
Derivative liabilities –(1) –(1)
Total financial investments, net of derivative liabilities 77,522 5,857 41 83,420
Percentage of total 93% 7% 0% 100%
Non-linked shareholder-backed
Loans – 226 1,842* 2,068
Equity securities and portfolio holdings in unit trusts 937 7 49 993
Debt securities 13,721 54,630 246 68,597
Other investments (including derivative assets) 31 2,306 761 3,098
Derivative liabilities(16)(1,484)(195)(1,695)
Total financial investments, net of derivative liabilities 14,673 55,685 2,703 73,061
Percentage of total 20% 76% 4% 100%
Group total analysis, including other financial liabilities held at fair value
Group total
Loans – 226 1,842* 2,068
Equity securities and portfolio holdings in unit trusts 96,698 2,692 568 99,958
Debt securities 33,474 105,839 790 140,103
Other investments (including derivative assets) 186 4,059 3,655 7,900
Derivative liabilities(77)(2,557)(195)(2,829)
Total financial investments, net of derivative liabilities 130,281 110,259 6,660 247,200
Borrowings attributable to the with-profits fund held at fair value –(40) –(40)
Investment contracts liabilities without discretionary participation
features held at fair value –(16,309) –(16,309)
Net asset value attributable to unit holders of consolidated unit trusts
and similar funds(3,309)(430)(606)(4,345)
Other financial liabilities held at fair value –(259)(2,021)*(2,280)
Total financial instruments at fair value 126,972 93,221 4,033 224,226
Percentage of total 57% 41% 2% 100%
* The Level 3 loans and other financial liabilities held by the non-linked shareholder-backed business include amounts of Ł1,842 million and Ł(2,021) million, respectively relating to the reinsurance arrangements attaching to the purchase of REALIC as described in note I1.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 267
31 December 2011 Łm
Level 1 Level 2 Level 3 Total
Analysis of financial investments, net of derivative liabilities
by business type
With-profits
Equity securities and portfolio holdings in unit trusts 24,001 1,762 284 26,047
Debt securities 13,298 43,279 655 57,232
Other investments (including derivative assets) 252 1,378 2,793 4,423
Derivative liabilities(214)(1,127) –(1,341)
Total financial investments, net of derivative liabilities 37,337 45,292 3,732 86,361
Percentage of total 43% 53% 4% 100%
Unit-linked and variable annuity separate account
Equity securities and portfolio holdings in unit trusts 59,662 198 30 59,890
Debt securities 4,160 4,698 3 8,861
Other investments (including derivative assets) 18 95 – 113
Derivative liabilities(2)(7) –(9)
Total financial investments, net of derivative liabilities 63,838 4,984 33 68,855
Percentage of total 93% 7% 0% 100%
Non-linked shareholder-backed
Loans – 279 – 279
Equity securities and portfolio holdings in unit trusts 1,175 176 61 1,412
Debt securities 11,753 46,401 251 58,405
Other investments (including derivative assets) 30 2,237 706 2,973
Derivative liabilities(78)(1,408)(218)(1,704)
Total financial investments, net of derivative liabilities 12,880 47,685 800 61,365
Percentage of total 21% 78% 1% 100%
Group total analysis, including other financial liabilities held at fair value
Group total
Loans – 279 – 279
Equity securities and portfolio holdings in unit trusts 84,838 2,136 375 87,349 G:
Debt securities 29,211 94,378 909 124,498
Other investments (including derivative assets) 300 3,710 3,499 7,509
Derivative liabilities(294)(2,542)(218)(3,054) Financial
Total financial investments, net of derivative liabilities 114,055 97,961 4,565 216,581 assets
Borrowings attributable to the with-profits fund held at fair value –(39) –(39)
Investment contracts liabilities without discretionary participation and
features held at fair value –(15,056) –(15,056)
Net asset value attributable to unit holders of consolidated unit trusts liabilities
and similar funds(2,586)(805)(449)(3,840)
Other financial liabilities held at fair value –(281) –(281)
Total financial instruments at fair value 111,469 81,780 4,116 197,365
Percentage of total 57% 41% 2% 100% Financial
Reconciliation of movements in Level 3 financial instruments measured at fair value
The following tables reconcile the value of Level 3 financial instruments at 1 January 2012 to that presented at 31 December 2012 statements
and at 1 January 2011 to that presented at 31 December 2011.
Total investment return recorded in the income statement represents interest and dividend income, realised gains and losses,
unrealised gains and losses on financial instruments classifled at fair value through profit and loss and foreign exchange movements
on an individual entity’s overseas investments.
Total gains and losses recorded in other comprehensive income includes unrealised gains and losses on debt securities held as
available-for-sale within Jackson and foreign exchange movements arising from the retranslation of the Group’s overseas subsidiaries
and branches.
268 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
[Graphic Appears Here]
Of the total gains and losses in the income statement of Ł357 million (2011: Ł225 million), Ł126 million (2011: Ł99 million) relates to fi nancial instruments still held at the end of the year, which can be analysed as follows:
2012 Łm 2011 Łm
Equity securities 27 49
Debt securities 51 20
Other investments 48 176
Derivative liabilities –(68)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds –(78)
Total 126 99
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 269
Transfers between Level 1 and Level 2
During 2012, the transfers between levels within the Group’s portfolio were primarily transfers from Level 1 to Level 2 of Ł600 million (2011: Ł335 million) and transfers from Level 2 to Level 1 of Ł227 million (2011: nil). These transfers which relate to equity securities and debt securities arose to reflect the change in the observability of the inputs used in valuing these securities.
Interest income and expense
The interest income on financial assets not at fair value through profit and loss for the year ended 31 December 2012 from continuing operations was Ł1,886 million (2011: Ł1,814 million).
The interest expense on financial liabilities not at fair value through profit and loss for the year ended 31 December 2012 from continuing operations was Ł420 million (2011: Ł456 million).
G2: Market risk
Interest rate risk
The following table shows an analysis of the classes of financial assets and liabilities except for cash and cash equivalents and their
direct exposure to interest rate risk. Each applicable class of the Group’s financial assets or liabilities is analysed between those
exposed to fair value interest rate risk, cash flow interest rate risk and those with no direct interest rate risk exposure:
2012 Łm
Not directly
Fair value Cash flow exposed to
interest interest interest
rate risk rate risk rate risk Total
Financial assets
Deposits 1,021 11,445 187 12,653
Debt securities 131,732 7,851 520 140,103
Loans 8,992 2,809 20 11,821
Other investments (including derivatives) 1,896 1,126 4,878 7,900
143,641 23,231 5,605 172,477
Financial liabilities
Core structural borrowings of shareholder-financed operations 3,279 275 – 3,554
Operational borrowings attributable to shareholder-financed operations 574 1,670 1 2,245
Borrowings attributable to with-profits funds 379 562 92 1,033
Obligations under funding, securities lending and sale and repurchase
agreements 403 2,033 – 2,436 G:
Investment contracts without discretionary participation features 1,179 894 16,305 18,378
Derivative liabilities 974 576 1,279 2,829 Financial
Other liabilities 165 116 3,173 3,454
6,953 6,126 20,850 33,929 assets
and
2011 Łm
Not directly
Fair value Cash flow exposed to liabilities
interest interest interest
rate risk rate risk rate risk Total
Financial assets
Deposits 790 9,439 479 10,708 Financial
Debt securities 117,988 5,788 722 124,498
Loans 6,424 3,091 199 9,714
Other investments (including derivatives) 1,912 1,077 4,520 7,509 statements
127,114 19,395 5,920 152,429
Financial liabilities
Core structural borrowings of shareholder-financed operations 3,362 249 – 3,611
Operational borrowings attributable to shareholder-financed operations 3,114 213 13 3,340
Borrowings attributable to with-profits funds 120 743 109 972
Obligations under funding, securities lending and sale and repurchase
agreements 580 2,534 – 3,114
Investment contracts without discretionary participation features 1,011 903 15,053 16,967
Derivative liabilities 1,426 615 1,013 3,054
Other liabilities 158 142 949 1,249
9,771 5,399 17,137 32,307
270 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
G2: Market risk continued
Liquidity analysis i Contractual maturities of fi nancial liabilities
The following table sets out the contractual maturities for applicable classes of financial liabilities, excluding derivative liabilities and investment contracts that are separately presented. The financial liabilities are included in the column relating to the contractual maturities at the undiscounted cash flows (including contractual interest payments) due to be paid assuming conditions are consistent with those of year end.
2012 Łm
Total After 1 After 5 After 10 After 15
carrying 1 year year to years to years to years to Over No stated
value or less 5 years 10 years 15 years 20 years 20 years maturity Total
Financial liabilities
Core structural borrowings of
shareholder-financed operations H13 3,554 140 791 603 958 1,038 691 1,753 5,974
Operational borrowings attributable to
shareholder-financed operations H13 2,245 1,708 558 – – – – – 2,266
Borrowings attributable to with-profits
funds H13 1,033 115 542 199 71 12 73 194 1,206
Obligations under funding, securities lending
and sale and repurchase agreements 2,436 2,436 – – – – – – 2,436
Other liabilities 3,453 945 45 5 – – – 2,458 3,453
Net asset value attributable to unit holders of
consolidated unit-trusts and similar funds 4,345 4,345 – – – – – – 4,345
Other creditors 2,781 2,515 23 36 73 70 406 – 3,123
19,847 12,204 1,959 843 1,102 1,120 1,170 4,405 22,803
2011 Łm
Total After 1 After 5 After 10 After 15
carrying 1 year year to years to years to years to Over No stated
value or less 5 years 10 years 15 years 20 years 20 years maturity Total
Financial liabilities
Core structural borrowings of
shareholder-financed operations H13 3,611 245 624 606 840 1,243 737 1,834 6,129
Operational borrowings attributable to
shareholder-financed operations H13 3,340 2,971 394 – – – – – 3,365
Borrowings attributable to with-profits
funds H13 972 199 418 158 100 5 97 139 1,116
Obligations under funding, securities lending
and sale and repurchase agreements 3,114 3,114 – – – – – – 3,114
Other liabilities 1,249 842 106 5 – – – 296 1,249
Net asset value attributable to unit holders of
consolidated unit-trusts and similar funds 3,840 3,840 – – – – – – 3,840
Other creditors 2,544 2,268 20 27 36 45 148 – 2,544
18,670 13,479 1,562 796 976 1,293 982 2,269 21,357
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 271
[Graphic Appears Here]
The majority of derivative assets and liabilities have been included at fair value within the one year or less column, representing
the basis on which they are managed (ie to manage principally asset or liability value exposures). Contractual maturities are not
considered essential for an understanding of the timing of the cash flows for these instruments and, in particular, the Group has
no cash flow hedges. The only exception is certain identifled interest rate swaps which are fully expected to be held until maturity
solely for the purposes of matching cash flows on separately held assets and liabilities. For these instruments the undiscounted
cash flows (including contractual interest amounts) due to be paid under the swap contract assuming conditions are consistent
with those at year end are included in the column relating to the contractual maturity of the derivative.
The table below shows the maturity profile for investment contracts on an undiscounted basis to the nearest Ł billion. This maturity
profile has been based on the cash flow projections of expected benefit payments as part of the determination of the value of
in-force business when preparing EEV basis results.
G:
2012 Łbn
Total
After 1 After 5 After 10 After 15 undis- Total
1 year year to years to years to years to Over counted carrying Financial
or less 5 years 10 years 15 years 20 years 20 years value value
Life assurance investment contracts 4 16 15 11 8 10 64 52 assets
and
2011 Łbn
Total
After 1 After 5 After 10 After 15 undis- Total liabilities
1 year year to years to years to years to Over counted carrying
or less 5 years 10 years 15 years 20 years 20 years value value
Life assurance investment contracts 3 12 13 11 9 10 58 47 Financial
statements
272 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
G2: Market risk continued
Most investment contracts have options to surrender early, albeit these are often subject to surrender or other penalties. It is therefore the case that most contracts could be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts means these are unlikely to be exercised in practice and the more useful information is to present information on expected payment.
The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of Ł12 billion (2011: Ł11 billion) which has no stated maturity but which is repayable on demand.
This table has been prepared on an undiscounted basis and accordingly the amounts shown for life assurance investment contracts differ from those disclosed on the statement of financial position. Durations of long-term business contracts,
covering insurance and investment contracts, on a discounted basis are included in section D.
The vast majority of the Group’s fi nancial assets are held to back the Group’s policyholder liabilities. Although asset/liability matching is an important component of managing policyholder liabilities (both those classifled as insurance and those classifled as investments), this profile is mainly relevant for managing market risk rather than liquidity risk. Within each business unit this asset/liability matching is performed on a portfolio by portfolio basis.
In terms of liquidity risk a large proportion of the policyholder liabilities contain discretionary surrender values or surrender charges, meaning that many of the Group’s liabilities are expected to be held for the long term. Much of the Group’s investment portfolios is in marketable securities, which can therefore be converted quickly to liquid assets.
For the reasons above, an analysis of the Group’s assets by contractual maturity is not considered necessary to evaluate the nature and extent of the Group’s liquidity risk.
Market and other fi nancial risks
The Group’s maximum exposure to credit risk of fi nancial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk. These assets comprise cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note G3 for derivative assets. The collateral in place in relation to derivatives is described in G4. Notes D2a(iv), D3a(ii)(ii) and D4a(iii), describe the security for these loans held by the Group, as disclosed at the start of this note.
Of the total loans and receivables held, Ł25 million (2011: Ł39 million) are past their due date but have not been impaired. Of the total past due but not impaired, Ł18 million is less than one year past their due date (2011: Ł3 million). The Group expects full recovery of these loans and receivables.
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.
Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to Ł86 million (2011: Ł90 million).
In addition, during the year the Group took possession of Ł16 million (2011: Ł13 million) of other collateral held as security, which mainly consists of assets that could be readily convertible into cash.
Further details of collateral and pledges are provided in note G4.
Currency risk
As at 31 December 2012, the Group held 19 per cent (2011: 21 per cent) and 7 per cent (2011: 9 per cent) of its financial assets and financial liabilities respectively, in currencies, mainly US dollar and Euro, other than the functional currency of the relevant business unit.
Financial assets, of which 56 per cent (2011: 55 per cent) are held by the PAC with-profits fund, allow the PAC with-profits fund to obtain exposure to foreign equity markets.
Financial liabilities, of which 28 per cent (2011: 28 per cent) are held by the PAC with-profits fund, mainly relate to foreign currency borrowings.
The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note G3).
The amount of exchange loss recognised in the income statement in 2012, except for those arising on financial instruments measured at fair value through profit and loss, is Ł213 million (2011: Ł1 million gain). This constitutes Ł1 million loss (2011: Ł11 million loss) on Medium Term Notes (MTN) liabilities and Ł212 million of net loss (2011: Ł12 million net gain), mainly arising on investments of the PAC with-profits fund. The gains/losses on MTN liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit and loss.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 273
G3: Derivatives and Hedging
Derivatives
The Group enters into a variety of exchange traded and over-the-counter derivative fi nancial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.
All over-the-counter derivative transactions, with the exception of some Asia transactions, are conducted under standardised ISDA (International Swaps and Derivatives Association Inc) master agreements and the Group has collateral agreements between the individual Group entities and relevant counterparties in place under each of these market master agreements.
The total fair value balances of derivative assets and liabilities as at 31 December 2012 were as follows:
2012 Łm
UK US Asia
insurance insurance insurance Asset Unallocated Group
operations operations operations management to a segment total
Derivative assets 1,349 1,546 927 38 2 3,862
Derivative liabilities(1,007)(645)(837)(150)(190)(2,829)
342 901 90(112)(188) 1,033
2011 Łm
UK US Asia
insurance insurance insurance Asset Unallocated Group
operations operations operations management to a segment total
Derivative assets 1,461 1,677 444 71 2 3,655
Derivative liabilities(1,298)(887)(480)(182)(207)(3,054)
163 790(36)(111)(205) 601
The above derivative assets are included in ‘other investments’ in the primary statements.
These derivatives are used for efficient portfolio management to obtain cost effective and efficient exposure to various markets in
accordance with the Group’s investment strategies and to manage exposure to interest rate, currency, credit and other business risks.
See also note D3 for use of derivatives by the Group’s US operations.
The Group uses various interest rate derivative instruments such as interest rate swaps to reduce exposure to interest rate volatility.
The UK with-profits funds use derivatives for the purposes of efficient portfolio management or reduction in investment risks. For UK
annuity business derivatives are used to assist with asset and liability cash flow matching.
Some of the Group’s products, especially those sold in the US, have certain guarantee features linked to equity indexes. A mismatch
between guaranteed product liabilities and the performance of the underlying assets backing them, exposes the Group to equity G:
index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to match asset
performance with liabilities under equity-indexed products. Financial
The US operations and some of the UK operations hold large amounts of interest-rate sensitive investments that contain credit risks
on which a certain level of defaults is expected. These entities have purchased some swaptions in order to manage the default risk on
certain underlying assets and hence reduce the amount of regulatory capital held to support the assets. assets
and
Hedging
The Group has formally assessed and documented the effectiveness of the following hedges under IAS 39. liabilities
Fair value hedges
The Group has chosen to designate as a fair value hedge certain fixed to floating rate swaps which hedge the fair value exposure
to interest rate movements of certain of the Group’s operational borrowings.
The fair value of the derivatives designated as fair value hedges above at 31 December 2012, was an asset of less than Ł1 million Financial
(2011: asset of Ł3 million). Movements in the fair value of the hedging instruments of a net loss of Ł3 million (2011: net loss of
Ł2 million) and the hedged items of a net gain of Ł3 million (2011: net gain of Ł2 million) are recorded in the income statement
in respect of the fair value hedges above. statements
Net investment hedges
The Group has designated perpetual subordinated capital securities totalling US$2.85 billion (2011: US$2.85 billion) as a net
investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital
securities was Ł1,746 million as at 31 December 2012 (2011: Ł1,823 million). The foreign exchange loss of Ł81 million (2011: loss of
Ł18 million) on translation of the borrowings to pounds sterling at the statement of financial position date is recognised in the
translation reserve in shareholders’ equity.
This net investment hedge was 100 per cent effective.
Cash flow hedges
The Group has no cash flow hedges in place.
274 Financial statements Prudential plc Annual Report 2012
G: Financial assets and liabilities continued
G4: Derecognition and collateral
Securities lending and reverse repurchase agreements
The Group has entered into securities lending (including repurchase agreements) whereby blocks of securities are loaned to third parties, primarily major brokerage firms. The amounts above the fair value of the loaned securities required to be held as collateral by the agreements depend on the quality of the collateral, calculated on a daily basis. The loaned securities are not removed from the Group’s consolidated statement of fi nancial position, rather they are retained within the appropriate investment classification. Collateral typically consists of cash, debt securities, equity securities and letters of credit. At 31 December 2012, the Group had lent Ł3,015 million (2011: Ł7,843 million) of securities of which Ł2,047 million (2011: Ł5,820 million) was lent by the PAC with-profits fund and held collateral under such agreements of Ł3,137 million (2011: Ł8,160 million) of which Ł2,138 million (2011: Ł6,108 million) was held by the PAC with-profits fund.
At 31 December 2012, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities for the purchase price of Ł943 million (2011: Ł1,607 million), together with accrued interest.
Collateral and pledges under derivative transactions
At 31 December 2012, the Group had pledged Ł754 million (2011: Ł840 million) for liabilities and held collateral of Ł1,964 million (2011: Ł1,953 million) in respect of over-the-counter derivative transactions.
These transactions are conducted under terms that are usual and customary to collateralised transactions including, where relevant, standard securities lending and repurchase agreement.
G5: Impairment of fi nancial assets
In accordance with the Group’s accounting policy set out in note A3, impairment reviews were performed for available-for-sale securities and loans and receivables. In addition, impairment reviews were undertaken for the reinsurers’ share of insurance contract liabilities.
During the year ended 31 December 2012, impairment losses of Ł50 million (2011: Ł126 million) were recognised for available-for-sale securities and loans and receivables analysed as shown in the attached table.
2012 Łm 2011 Łm
Available-for-sale securities held by Jackson 37 62
Loans and receivables* 13 64
50 126
* Relates to loans held by the UK with-profi ts fund and mortgage loans held by Jackson
Impairment losses recognised on available-for-sale securities amounted to Ł37 million (2011: Ł62 million). Of this amount, 22 per cent (2011: 34 per cent) has been recorded on structured asset-backed securities, primarily due to reduced cash flow expectations on such securities that are collateralised by diversifled pools of primarily below investment grade securities. Of the losses related to the impairment of fixed maturity securities, the top five individual corporate issuers made up 74 per cent (2011: 75 per cent), reflecting a deteriorating business outlook of the companies concerned. The impairment losses have been recorded in ‘investment return’ in the income statement.
In 2012, the Group realised gross losses on sales of available-for-sale securities of Ł44 million (2011: Ł43 million) with 64 per cent (2011: 64 per cent) of these losses related to the disposal of fixed maturity securities of 10 (2011: 10) individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the Ł44 million (2011: Ł43 million),
• 23 million (2011: Ł32 million) relates to losses on sales of impaired and deteriorating securities.
The effect of those reasonably likely changes in the key assumptions that underpin the assessment of whether impairment has
taken place depends on the factors described in note A4. A key indicator of whether such impairment may arise in future, and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available-for-sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned.
For 2012, the amount of gross unrealised losses for fixed maturity securities classifled as available-for-sale under IFRS in an unrealised loss position was Ł178 million (2011: Ł246 million). Notes B1 and D3 provide further details on the impairment charges and unrealised losses of Jackson’s available-for-sale securities.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 275
H: Other information on statement of fi nancial position items
H1: Intangible assets attributable to shareholders
a Goodwill
2012 Łm 2011 Łm
Cost
At beginning of year 1,585 1,586
Additional consideration paid on previously acquired business 2 –
Exchange differences 2(1)
At end of year 1,589 1,585
Aggregate impairment(120)(120)
Net book amount at end of year 1,469 1,465
Goodwill attributable to shareholders comprises:
M&G 1,153 1,153
Other 316 312
1,469 1,465
‘Other’ represents goodwill amounts across cash generating units (CGUs) in Asia and US operations. Other goodwill amounts are
not individually material.
Impairment testing
Goodwill does not generate cash flows independently of other groups of assets and thus is assigned to CGUs for the purposes of
impairment testing. These CGUs are based upon how management monitors the business and represent the lowest level to which
goodwill can be allocated on a reasonable basis. H:
Assessment of whether goodwill may be impaired Other
Goodwill is tested for impairment by comparing the CGUs’ carrying amount, including any goodwill, with its recoverable amount.
With the exception of M&G, the goodwill attributable to shareholders in the statement of financial position mainly relates to
acquired life businesses. The Company routinely compares the aggregate of net asset value and acquired goodwill on an IFRS basis
of acquired life business with the value of the business as determined using the EEV methodology, as described in note D1. Any excess information
of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine on
whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The assumptions
underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report. statement
of
fi
nancial
position
items
Financial
statements
276 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H1: Intangible assets attributable to shareholders continued
M&G
The recoverable amount for the M&G CGU has been determined by calculating its value in use. This has been calculated by aggregating the present value of future cash flows expected to be derived from the M&G operating segment (based upon management projections).
The discounted cash flow valuation has been based on a three-year plan prepared by M&G, and approved by management, and cash flow projections for later years.
The value in use is particularly sensitive to a number of key assumptions as follows:
i The set of economic, market and business assumptions used to derive the three-year plan. The direct and secondary effects of recent developments, eg changes in global equity markets, are considered by management in arriving at the expectations for the financial projections for the plan;
ii The assumed growth rate on forecast cash flows beyond the terminal year of the plan. A growth rate of 2.5 per cent (2011: 2.5 per cent) has been used to extrapolate beyond the plan period representing management’s best estimate view of the long-term growth rate of the business after considering the future and past growth rates and external sources of data;
iii The risk discount rate. Differing discount rates have been applied in accordance with the nature of the individual component businesses. For retail and institutional business, a risk discount rate of 12 per cent (2011: 12 per cent) has been
applied to post-tax cash flows. The pre-tax risk discount rate was 15 per cent (2011: 15 per cent). Management have determined the risk discount rate by reference to an average implied discount rate for comparable UK listed asset managers calculated by reference to risk-free rates, equity risk premiums of 5 per cent and an average ‘beta’ factor for relative market risk of comparable UK listed asset managers.
A similar approach has been applied for the other component businesses of M&G; and
iv That asset management contracts continue on similar terms.
Management believes that any reasonable change in the key assumptions would not cause the recoverable amount of M&G to fall below its carrying amount.
Japanese life company
The aggregate goodwill impairment of Ł120 million at 31 December 2012 and 2011 relates to the goodwill held in relation to the Japanese life operation which was impaired in 2005.
b Deferred acquisition costs and other intangible assets attributable to shareholders
The deferred acquisition costs (DAC) and other intangible assets in the Group consolidated statement of financial position attributable to shareholders comprise:
2012 Łm 2011* Łm 2010* Łm
Deferred acquisition costs related to insurance contracts as classifled under IFRS 4 3,866 3,805 3,550
Deferred acquisition costs related to investment management contracts, including life
assurance contracts classifled as financial instruments and investment management
contracts under IFRS 4 100 107 110
3,966 3,912 3,660
Present value of acquired in-force policies for insurance contracts as classifled under
IFRS 4 (PVIF) 64 64 70
Other intangibles 237 258 171
301 322 241
Total of deferred acquisition costs and other intangible assets 4,267 4,234 3,901
* The 2011 and 2010 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 277
2012 Łm 2011 Łm 2010 Łm
Deferred acquisition costs
PVIF and
Asset other
manage- intan-
UK US Asia ment gibles Total Total Total
note (i)
Balance at 1 January
As previously reported 111 3,880 744 12 322 5,069 4,667 4,097
Effect of change in accounting policy A5 –(785)(50) – –(835)(766)(651)
After effect of change 111 3,095 694 12 322 4,234 3,901 3,446
Additions 12 798 249 3 31 1,093 1,117 968
Acquisition of REALIC in 2012 and UOB Life
Assurance Ltd in 2010 – – – – 5 5 – 12
Amortisation to the income statement:
Operating profit(20)(356)(277)(5)(51)(709)(792)(515)
Amortisation related to short-term fiuctuations in
investment returns – 76 – – – 76 287 283
(20)(280)(277)(5)(51)(633)(505)(232)
Exchange differences –(144)(12) –(6)(162)(2) 129
Change in shadow DAC related to movement in
unrealised appreciation of Jackson’s securities
classifled as available-for-sale† –(270) – – –(270)(275)(410)
Disposals – – – – – –(2)(5)
Dilution of Group’s holdings – – – – – – –(7)
Balance at 31 December 103 3,199 654 10 301 4,267 4,234 3,901
H:
* The 2011 and 2010 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy
described in note A5. Other
† (See note D3(g) for explanation).
US operations DAC
Summary balances information
The DAC amount in respect of US insurance operations comprises amounts in respect of:
2012 Łm 2011* Łm 2010* Łm on
Variable annuity business 3,330 2,960 2,283
Other business 821 855 980
Cumulative shadow DAC (for unrealised gains/losses booked in other comprehensive income)(952)(720)(434) statement
Total DAC for US operations 3,199 3,095 2,829 of
fi
* The 2011 and 2010 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy nancial
described in note A5.
position
items
Financial
statements
278 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H1: Intangible assets attributable to shareholders continued
Deferred acquisition costs related to insurance and investment contracts attributable to shareholders
The movement in deferred acquisition costs relating to insurance and investments contracts attributable to shareholders are as follows:
2012 Łm 2011* Łm 2010* Łm
Insurance Investment Insurance Investment Insurance Investment
contracts management contracts management contracts management
note note note
DAC at 1 January 3,805 105 3,550 110 3,172 107
Additions 1,048 12 982 17 710 21
Amortisation(563)(17)(450)(20)(19)(18)
Exchange differences(154) – – – 104 –
Change in shadow DAC related to movement
in unrealised appreciation of Jackson’s
securities classifled as available-for-sale(270) –(275) –(410) –
Dilution of holding in PruHealth – – – –(7) –
DAC at 31 December 3,866 100 3,807 107 3,550 110
* The 2011 and 2010 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Note
All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts:
31 December
2012 Łm 2011 Łm 2010 Łm
Gross amount 210 200 183
Accumulated amortisation(110)(93)(73)
Net book amount 100 107 110
Present value of acquired in-force (PVIF) and other intangibles attributable to shareholders
2012 Łm 2011 Łm
Other intangibles Other intangibles
note (ii) note (ii)
Distri- Distri-
bution bution
PVIF rights Software Total PVIF rights Software Total
note (i) note (i)
At 1 January
Cost 212 235 163 610 203 136 144 483
Accumulated amortisation(148)(36)(104)(288)(133)(23)(86)(242)
64 199 59 322 70 113 58 241
Additions (including amounts arising
on acquisition of subsidiaries) 5 – 31 36 – 96 24 120
Amortisation charge(5)(17)(29)(51)(5)(9)(21)(35)
Disposals – – – – – –(2)(2)
Exchange differences –(5)(1)(6)(1)(1) –(2)
At 31 December 64 177 60 301 64 199 59 322
Comprising:
Cost 217 230 193 640 200 235 163 598
Accumulated amortisation(153)(53)(133)(339)(136)(36)(104)(276)
64 177 60 301 64 199 59 322
Notes
(i) All of the PVIF balances relate to insurance contracts and is accounted for under UK GAAP as permitted by IFRS 4. Investment contracts have been fully amortised. Amortisation is charged to the ‘acquisition costs and other operating expenditure’ line in the income statement over the period of provision of asset management services as those profits emerge.
(ii) Other intangibles comprise distribution and software rights. Distribution rights relate to facilitation fees paid in respect of the bancassurance partnership arrangements in Asia for the bank distribution of Prudential’s insurance products for a fixed period of time. The distribution rights amounts are amortised over the term of the distribution contracts. Software is amortised over its useful economic life, which generally represents the licence period of the software acquired. Amortisation is charged to the ‘acquisition costs and other expenditure’ line in the income statement.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 279
H2: Intangible assets attributable to with-profits funds
a Goodwill in respect of acquired investment subsidiaries for venture fund and other investment purposes
2012 Łm 2011 Łm
At 1 January 178 166
Additions in the year – 12
At 31 December 178 178
All the goodwill relates to the UK insurance operations segment.
The venture fund investments consolidated by the Group relates to investments by PAC with-profits fund managed by M&G. The goodwill shown in the table above relates to these venture fund investments. Goodwill is tested for impairment of these investments by comparing the investment’s carrying value including goodwill with its recoverable amount. The recoverable amount of the investments is determined by calculating their fair value less costs to sell. The fair value is determined by using a discounted cash fl ow valuation. The valuations are based on cash flow projections to 2016 prepared by management after considering the historical experience and future growth rates of the business. The key assumption applied in the calculations is the risk discount rate ranging from 10 per cent to 14 per cent derived by reference to risk-free rates and an equity premium risk. In 2012, no goodwill was deemed to be impaired following the impairment testing carried out.
b Deferred acquisition costs and other intangible assets
Other intangible assets in the Group consolidated statement of financial position attributable to with-profits funds consist of:
2012 Łm 2011 Łm
Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund 6 6
Distribution rights attributable to with-profits funds of the Asia insurance operations 70 83
Computer software attributable to with-profits funds of the Asia insurance operations 2 – H:
78 89 Other
Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund
The movement in deferred acquisition costs relating to insurance contracts attributable to the PAC with-profits fund is as follows: information
2012 Łm 2011 Łm on
At 1 January 6 13
Amortisation charge –(7) statement
At 31 December 6 6 of
fi
The above costs relate to non-participating business written by the PAC with-profits sub-fund. nancial
No deferred acquisition costs are established for the participating business.
position
items
Financial
statements
280 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H2: Intangible assets attributable to with-profi ts funds continued
Distribution rights attributable to with-profi t funds of the Asia insurance operations
Distribution rights relate to facilitation fees paid in relation to the bancassurance partnership arrangements in Asia for the bank distribution of Prudential’s insurance products for a fi xed period of time. The distribution rights amounts are amortised over the term of the distribution contracts.
2012 Łm 2011 Łm
At 1 January
Gross amount 96 108
Accumulated amortisation(13)(11)
83 97
Amortisation charge(9)(5)
Exchange differences(4) 1
Reclassification –(10)
At 31 December 70 83
Comprising:
Gross amount 92 96
Accumulated amortisation(22)(13)
70 83
H3: Reinsurers’ share of insurance contract liabilities
2012 Łm 2011 Łm
Insurance contract liabilities 6,079 1,486
Claims outstanding 780 161
6,859 1,647
Comprising amounts in respect of:
UK insurance operations D2 (f) 608 589
US insurance operations D3 (f) 6,076 907
Asia insurance operations D4 (f) 175 151
6,859 1,647
The movement on reinsurers’ share of insurance contract liabilities is as follows:
2012 Łm 2011 Łm
At 1 January 1,486 1,167
Acquisition of REALIC 4,810 –
Other movements in the year(55) 303
Foreign exchange translation differences(162) 16
At 31 December 6,079 1,486
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 281
H4: Tax assets and liabilities
Assets
Of the Ł254 million (2011: Ł546 million) current tax recoverable, the majority is expected to be recovered in one year or less.
Deferred tax asset
2012 Łm 2011 Łm
Unrealised losses on investments 102 297
Balances relating to investment and insurance contracts 1 13
Short-term timing differences 2,097 1,513
Capital allowances 15 15
Unused deferred tax losses 99 438
Total 2,314 2,276
The deferred tax asset at 31 December 2012 and 2011 arises in the following parts of the Group:
2012 Łm 2011 Łm
UK insurance operations:
SAIF 1 1
PAC with-profits fund (including PAL) 113 78
Other 69 153
US insurance operations 1,889 1,392
Asia insurance operations 83 114
Other operations 159 538
H:
Total 2,314 2,276 Other
The increase in the deferred tax asset primarily relates to additional short-term timing differences on US insurance reserves following
the REALIC acquisition partially offset by the utilisation of tax losses across the Group.
Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all information
available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal
of the underlying temporary differences can be deducted. on
The taxation regimes applicable across the Group often apply separate rules to trading and capital profits and losses. The
distinction between temporary differences that arise from items of either a trading or capital nature may affect the recognition of statement
deferred tax assets. Accordingly, for the 2012 results and financial position at 31 December 2012 the possible tax benefit of
approximately Ł158 million (31 December 2011: Ł158 million), which may arise from capital losses valued at approximately Ł0.8 billion of
fi
(31 December 2011: Ł0.7 billion), is sufficiently uncertain that it has not been recognised. In addition, a potential deferred tax asset
of Ł122 million (31 December 2011: Ł147 million), which may arise from trading tax losses and other potential temporary differences nancial
totalling Ł0.5 billion (31 December 2011: Ł0.6 billion) is sufficiently uncertain that it has not been recognised. Of these, losses of
Ł105 million will expire within the next seven years. The remaining losses have no expiry date. Until the end of 2012, for the Group’s
UK life insurance companies, shareholders’ profits were calculated using regulatory surplus as a starting point, with appropriate position
deferred tax adjustments for IFRS. Beginning in 2013, under new UK life tax rules, shareholders’ profits will be calculated using
accounting profit or loss as a starting point. As the 2012 Finance Act had been enacted at the balance sheet date, the effects of these items
changes are reflected in the financial statements for the year ended 31 December 2012 but with no material impact on the Group’s
net assets.
Financial
statements
282 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H4: Tax assets and liabilities continued
The two tables that follow provide a breakdown of the recognised deferred tax assets set out above for both the short-term timing differences and unused tax losses split by business unit. The table also shows the period of estimated recoverability for each respective business unit. For these and each category of deferred tax asset recognised their recoverability against forecast taxable profits is not significantly impacted by any current proposed changes to future accounting standards.
Short-term timing differences 2012 Łm Expected period of recoverability
Asia 42 1 to 3 years
JNL 1,800 With run-off of in-force book
UK long-term business 151 1 to 10 years
Other 104 1 to 10 years
Total 2,097
Unused tax losses 2012 Łm Expected period of recoverability
Asia 36 3 to 5 years
UK long-term business 18 1 to 3 years
Other 45 1 to 3 years
Total 99
Liabilities
The current tax liability decreased to Ł445 million (2011: Ł930 million) refl ecting the settlement of prior year balances in the UK and Asia following the agreement of tax positions.
Deferred tax liability
2012 Łm 2011* Łm 2010* Łm
Unrealised gains on investments 1,814 1,566 1,678
Balances relating to investment and insurance contracts 432 667 801
Short-term timing differences 1,715 1,687 1,477
Capital allowances 9 9 12
Total 3,970 3,929 3,968
* The 2011 and 2010 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Under IAS 12, ‘Income Taxes’, deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled, based on the tax rates (and laws) that have been enacted or are substantively enacted at the end of the reporting periods.
The UK government’s tax rate change to 23 per cent (from the 24 per cent effective from 1 April 2012) has had the effect of reducing the UK with-profi ts and shareholder-backed business element of the net deferred tax balances as at 31 December 2012 by Ł52 million. The tax change to 23 per cent is effective from 1 April 2013 but has been enacted at 31 December 2012.
The subsequent proposed phased rate changes to 21 per cent are expected to have the effect of reducing the UK with-profits and shareholder-backed business elements of the net deferred tax balances at 31 December 2012 by Ł52 million.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 283
H5: Accrued investment income and other debtors
2012 Łm 2011 Łm
Accrued investment income
Interest receivable 2,015 1,919
Other 783 791
Total 2,798 2,710
Other debtors
Amounts due from:
Policyholders 271 227
Intermediaries 27 27
Reinsurers 23 11
Other 1,040 722
Total 1,361 987
Total accrued investment income and other debtors 4,159 3,697
Of the Ł4,159 million (2011: Ł3,697 million) of accrued investment income and other debtors, Ł538 million (2011: Ł162 million) is
expected to be settled after one year or more.
H6: Property, plant and equipment
Property, plant and equipment comprise Group occupied properties and tangible assets. A reconciliation of the carrying amount of
these items from the beginning of the year to the end of the year is as follows: H:
2012 Łm 2011 Łm Other
Group Group
occupied Tangible occupied Tangible
property assets Total property assets Total
At 1 January information
Cost 262 915 1,177 197 764 961 on
Accumulated depreciation(29)(400)(429)(24)(383)(407)
Net book amount 233 515 748 173 381 554 statement
Year ended 31 December of
Opening net book amount 233 515 748 173 381 554 fi
Exchange differences(9)(8)(17)(2)(7)(9) nancial
Depreciation charge(10)(80)(90)(5)(69)(74)
Additions 4 135 139 5 119 124
Arising on acquisitions of subsidiaries –(1)(1) 69 99 168 position
Disposals and transfers(2)(12)(14)(7)(8)(15)
Closing net book amount 216 549 765 233 515 748 items
At 31 December
Cost 255 999 1,254 262 915 1,177
Accumulated depreciation(39)(450)(489)(29)(400)(429) Financial
Net book amount 216 549 765 233 515 748 statements
Capital expenditure: property, plant and equipment by segment
The capital expenditure of Ł135 million (2011: Ł124 million) arose as follows: Ł80 million in UK, Ł24 million in US and Ł20 million in Asia in insurance operations with the remaining balance of Ł11 million arising from asset management operations and unallocated corporate expenditure (2011: Ł69 million in UK, Ł20 million in US, Ł21 million in Asia insurance operations and Ł14 million in other).
284 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H7: Investment properties
Investment properties principally relate to the PAC with-profits fund and are carried at fair value. A reconciliation of the carrying amount of investment properties at the beginning and end of the year is set out below:
2012 Łm 2011 Łm
At 1 January 10,757 11,247
Additions:
Resulting from acquisitions 1,025 393
Resulting from expenditure capitalised 118 45
Disposals(695)(1,439)
Net (loss) gain from fair value adjustments(175) 522
Net foreign exchange differences(53)(41)
Transfers (to)/from held for sale assets(97) 25
Transfers from owner occupied properties – 5
At 31 December 10,880 10,757
The income statement includes the following items in respect of investment properties:
2012 Łm 2011 Łm
Rental income from investment properties 559 606
Direct operating expenses (including repairs and maintenance expenses) arising from
investment properties that generated rental income during the year 64 128
Further information on the investment property held by the UK insurance operations further information is included in note D2(a). Investment properties of Ł3,845 million (2011: Ł3,439 million) are held under fi nance leases. A reconciliation between the total of future minimum lease payments at the statement of financial position date, and their present value is shown below:
2012 Łm 2011 Łm
Future minimum lease payments at 31 December 988 1,071
Future finance charges on finance leases(877)(944)
Present value of minimum lease payments 111 127
Future minimum lease payments are due as follows:
Less than 1 year 6 7
1 to 5 years 23 26
Over 5 years 959 1,038
Total 988 1,071
The present values of these minimum lease payments are:
Less than 1 year 6 6
1 to 5 years 19 23
Over 5 years 86 98
Total 111 127
Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future value of a factor that changes other than with the passage of time. There was no contingent rent recognised as income or expense in 2012 and 2011.
The Group’s policy is to rent investment properties to tenants through operating leases. Minimum future rentals to be received on non-cancellable operating leases of the Group’s freehold investment properties are receivable in the following periods:
2012 Łm 2011 Łm
Less than 1 year 451 430
1 to 5 years 1,541 1,407
Over 5 years 3,785 3,304
Total 5,777 5,141
The total minimum future rentals to be received on non-cancellable sub-leases for the Group’s investment properties held under fi nance leases at 31 December 2012 are Ł2,439 million (2011: Ł2,553 million).
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 285
H8: Investments in associates and joint ventures
Investments in associates
The Group had two associates at 31 December 2012 (31 December 2011: one) that were accounted for under the equity method.
The Group’s associates at 31 December 2012 are a 25 per cent interest in PruHealth Holdings Limited and a 49.99 per cent interest
in PPM South Africa, following the dilution of the Group’s holding in the period (see note I2). The Group’s share of the profit during
the year was a profit of Ł8 million (full year 2011: a loss of Ł3 million). The total carrying value of these associates are Ł113 million
(2011: Ł70 million). This is reflected in the Group’s profit after tax attributable to equity holders during the year.
Associates accounted for using the equity method
A summary of the movements in investments in associates accounted for using the equity method in 2012 and 2011 is set out below:
Share of
share capital Share of Total
and share retained Share of carrying
premium earnings net assets Goodwill value
Łm Łm Łm Łm Łm
Balance at 31 December 2010 101(31) 70 1 71
Capital injection 4 – 4 – 4
Disposals(1) –(1) –(1)
Goodwill write off – – –(1)(1)
Share of loss for the year after tax –(3)(3) –(3)
Balance at 31 December 2011 104(34) 70 – 70
Transfer of PPMSA as an associate I2 – 39 39 – 39
Exchange translation and other movements –(6)(6) –(6)
Share of profit for the year after tax – 10 10 – 10
Balance at 31 December 2012 104 9 113 – 113
H:
There have been no changes recognised in the other comprehensive income of associates that would also be recognised in the other Other
comprehensive income by the Group.
The Group’s share of the assets, liabilities, revenues and profit and loss of associates accounted for using the equity method at
31 December 2012 and 2011 is as follows: information
2012 Łm 2011 Łm on
Financial position
Total assets (excluding goodwill) 162 109 statement
Total liabilities(49)(39)
of
Net assets 113 70 fi
Results of operations nancial
Revenue 96 81
Profit (loss) in the year 10(3) position
There are several minor service agreements in place between the associates and the Group. During 2012, the aggregate amount items
of the transactions was Ł42 million (2011: Ł33 million) and the balance due to the Group as at 31 December 2012 was Ł73.2 million
(2011: Ł74.2 million).
Associates and joint ventures carried at fair value through profit and loss Financial
In addition to the above the Group has associates that are carried at fair value through profit and loss, as allowed under IAS 28, that
comprise investments in open-ended investment companies (OEICs), unit trusts, funds holding collateralised debt obligations,
property unit trusts and venture capital investments of the PAC with-profits funds where the Group has significant infiuence. These
investments are incorporated both in the UK and overseas, and some have year ends which are non-coterminous with that of the statements
Group. In these instances, the investments are recorded at fair value at 31 December 2012 based on valuations or pricing information
at that specific date. The aggregate fair value of associates carried at fair value through profit and loss where there are published price
quotations is approximately Ł0.8 billion (2011: Ł4.8 billion) at 31 December 2012.
The aggregate assets of these associates are approximately Ł2.2 billion (2011: Ł3.4 billion). Aggregate liabilities, excluding
liabilities to unit holders and shareholders for unit trusts and OEICs, are approximately Ł0.8 billion (2011: Ł1.1 billion). Fund revenues,
with revenue arising in unit trusts and OEICs deemed to constitute the investment return for these vehicles, were approximately
Ł0.1 billion (2011: Ł0.3 billion) and net profit in the year, excluding unit trusts and OEICs where all investment returns accrue to unit
holders or shareholders respectively, was approximately Ł0.1 billion (2011: profit of Ł0.2 billion).
286 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H8: Investments in associates and joint ventures continued
Investments in joint ventures
The Group owns a number of joint ventures. Joint ventures represent activities over which the Group exercises joint control through contractual agreement with one or more parties. The Group’s signifi cant joint ventures, which are accounted for using proportionate consolidation, comprise following interests:
Investment% held Principal activity Country
CITIC Prudential Life Insurance Company Limited 50 Life assurance China
CITIC-Prudential Fund Management Company Limited 49 Asset management China
ICICI Prudential Asset Management Company Limited 49 Asset management India
Prudential BSN Takaful Berhad 49 General and life insurance Malaysia
BOCI-Prudential Asset Management Limited 36 Asset management China (Hong Kong)
ICICI Prudential Life Insurance Company Limited 26 Life assurance India
The investments noted in the table above have the same accounting year end as the Group, except for ICICI Prudential Life Insurance Company Limited and ICICI Prudential Asset Management Company Limited. Although these investments have reporting periods ending 31 March, 12 months of financial information up to 31 December is recorded. Accordingly, the information covers the same period as that of the Group.
Joint ventures contributed Ł98 million (31 December 2011: Ł54 million) to profi t after tax attributable to equity holders during the period. The year-on-year movement in these contributions reflect the growth in their operating profit based on longer-term investment returns and the increase in short-term fiuctuations in investment returns by these joint ventures.
Further, in June 2012, the PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, entered into a joint venture to acquire control of Veolia Water RegCo (now renamed Affinity Water), the UK regulated water business of Veolia Environnement S.A. This joint venture investment is carried at fair value through profit and loss in the Group’s fi nancial statements, as allowed under IAS 28. The results of this operation are reflected in the movement in the unallocated surplus of the PAC with-profits fund and therefore do not affect shareholders’ results.
The summarised financial data for the Group’s share of investments in joint ventures is as follows:
2012 Łm 2011 Łm
Financial position
Current assets 442 706
Non-current assets 3,504 2,757
Total assets 3,946 3,463
Current liabilities(375)(301)
Non-current liabilities(3,220)(2,799)
Total liabilities(3,595)(3,100)
Net equity 351 363
2012 Łm 2011 Łm
Results of operations
Revenue 1,040 1,056
Expenses(942)(1,002)
Net profit 98 54
The joint ventures have no significant contingent liabilities or capital commitments to which the Group is exposed nor does the Group have any significant contingent liabilities or capital commitments in relation to its interest in the joint ventures.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 287
H9: Properties held for sale
Investment properties are classifled as held for sale when contracts have been exchanged but the sale has not been completed at the
period end. At 31 December 2012 the value of assets held for sale was Ł98 million (2011: Ł3 million).
Gains on disposal of held for sale assets are recorded in ‘investment return’ within the income statement.
H10: Cash and cash equivalents
Cash and cash equivalents consist of cash at bank and in hand, deposits held at call with banks, treasury bills and other short-term
highly liquid investments with less than 90 days maturity from the date of acquisition. Cash and cash equivalents included in the cash
flow statement comprise the following statement of financial position amounts:
2012 Łm 2011 Łm
Cash 4,884 6,338
Cash equivalents 1,500 919
Total cash and cash equivalents 6,384 7,257
Cash and cash equivalents held centrally are considered to be available for general use by the Group. These funds amount to
Ł482 million and Ł309 million at 31 December 2012 and 2011, respectively. The remaining funds are considered not to be available
for general use by the Group, and include funds held for the benefit of policyholders.
H11: Shareholders’ equity: share capital, share premium and reserves
A summary of the ordinary shares in issue is set out below:
H:
Share capital and share premium Other
Number of
ordinary Share Share
shares capital premium
Łm Łm information
Issued shares of 5p each fully paid:
At 1 January 2011 2,545,594,506 127 1,856 on
Shares issued under share option schemes 2,444,824 – 17
At 31 December 2011 2,548,039,330 127 1,873 statement
Shares issued under share option schemes 9,203,022 1 16 of
fi
At 31 December 2012 2,557,242,352 128 1,889 nancial
Amounts recorded in share capital represent the nominal value of the shares issued. The difference between the proceeds received
on issue of shares, net of issue costs, and the nominal value of shares issued is credited to the share premium account. position
At 31 December 2012, there were options outstanding under Save As You Earn schemes to subscribe for shares as follows:
items
Share price
range
Number of shares Exercisable
to subscribe for from to by year
31 December 2012 9,396,810 288p 629p 2018 Financial
31 December 2011 13,329,709 288p 572p 2017
statements
288 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H11: Shareholders’ equity: share capital, share premium and reserves continued
Transactions by Prudential plc and its subsidiaries in Prudential plc shares
The Group buys and sells Prudential plc (‘own shares’) either in relation to its employee share schemes or via transactions undertaken by authorised investment funds that the Group is deemed to control. Further information about these transactions is set out below. The cost of own shares of Ł97 million as at 31 December 2012 (2011: Ł109 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. At 31 December 2012, 8.0 million (2011: 8.1 million) Prudential plc shares with a market value of Ł69 million (2011: Ł52 million) were held in such trusts. Of this total, 8.0 million (2011: 8.0 million) shares were held in trusts under employee
incentive plans.
In 2012, the Company purchased the following number of shares in respect of employee incentive plans.
Number
of shares
purchased Cost
(in millions)* Łm
2012 9.4 76.1
2011 8.2 54.7
* The maximum number of shares held in 2012 was 8.0 million which was in December 2012.
Of the total shares held in trust no shares were held by a qualifying employee share ownership trust (2011: 0.1 million).
The shares purchased each month are as follows:
2012 share price 2011 share price
Number Number
of shares Low High Cost of shares Low High Cost
Ł Ł Ł Ł Ł Ł
January 15,573 6.40 6.40 99,589 12,723 6.83 6.83 86,834
February 12,678 7.33 7.33 92,930 11,688 7.13 7.13 83,376
March 4,022,002 7.10 8.03 32,058,297 2,106,702 7.04 7.14 15,253,240
April 368,901 7.27 7.67 2,712,460 263,361 7.40 7.49 1,960,300
May 939,541 6.80 7.26 6,407,556 174,614 7.46 7.53 1,307,410
June 482,377 6.61 6.84 3,208,338 1,418,209 7.07 7.18 10,141,069
July 15,047 7.26 7.26 109,166 98,334 6.89 7.34 683,084
August 28,488 7.88 8.12 228,176 1,520,620 5.77 6.32 9,051,804
September 712,649 8.16 8.25 5,829,154 19,273 5.85 6.00 115,022
October 12,549 8.39 8.39 105,329 15,385 6.07 6.07 93,310
November 492,993 8.55 9.15 4,502,129 110,951 6.15 6.33 692,501
December 2,277,012 8.86 9.27 20,706,597 2,456,692 6.07 6.55 15,226,106
Total 9,379,810 76,059,721 8,208,552 54,694,056
The Group has consolidated a number of authorised investment funds where it is deemed to control these funds under IFRS. Some of these funds hold shares in Prudential plc. The total number of shares held by these funds at 31 December 2012 was 4.5 million (2011: 8.6 million) and the cost of acquiring these shares of Ł27 million (2011: Ł52 million) is included in the cost of own shares. The market value of these shares as at 31 December 2012 was Ł39 million (2011: Ł54 million).
During 2012, these funds made net disposals of 4,143,340 Prudential shares (2011: net disposals of 1,171,635) for a net decrease of Ł25.1 million to book cost (2011: net increase of Ł4.8 million).
All share transactions were made on an exchange other than the Stock Exchange of Hong Kong.
Other than set out above the Group did not purchase, sell or redeem any Prudential plc listed securities during 2012 or 2011.
Reserves
The translation reserve of Ł66 million (2011: Ł282 million) represents cumulative foreign exchange translation differences taken directly to equity in accordance with IFRS, net of related tax. In accordance with IFRS 1, cumulative translation differences are deemed to be zero at 1 January 2004, the date of transition to IFRS.
The available-for-sale reserve represents gains or losses arising from changes in the fair value of available-for-sale securities of Jackson, net of the related change in amortisation of deferred income and acquisition costs and of the related tax.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 289
H12: Insurance contract liabilities and unallocated surplus of with-profits funds
Movement in year
Unallocated
Insurance surplus of
contract with-profits
liabilities funds
Łm Łm
At 1 January 2011 171,291 10,253
Income and expense included in the income statement 8,748(1,025)
Foreign exchange translation differences 324(13)
At 1 January 2012 180,363 9,215
Income and expense included in the income statement 32,760 1,381
Foreign exchange translation differences(4,539)(7)
At 31 December 2012 208,584 10,589
Notes B5, D2b, D3b and D4b provide further analysis of the movement in the year of the Group’s policyholder liabilities and
unallocated surplus of the with-profits funds.
H13: Borrowings
Core structural borrowings of shareholder-financed operations
2012 Łm 2011 Łm
Innovative Lower
Tier 1* Tier 2* Senior† Total Total H:
Central operations Other
Subordinated debt:
¤20m Medium Term Subordinated Notes 2023 note (i) 16 16 17
Ł435m 6.125% Subordinated Notes 2031 429 429 428
Ł400m 11.375% Subordinated Notes 2039 386 386 384 information
US$1,000m 6.5% Perpetual Subordinated Capital on
Securities 615 615 644
US$250m 6.75% Perpetual Subordinated Capital
Securities note (ii) 154 154 161 statement
US$300m 6.5% Perpetual Subordinated Capital of
fi
Securities note (ii) 185 185 193
US$750m 11.75% Perpetual Subordinated Capital nancial
Securities 458 458 477
US$550m 7.75% Perpetual Subordinated Capital
Securities note (ii) 334 334 348 position
1,746 831 – 2,577 2,652 items
Senior debt:
Ł300m 6.875% Bonds 2023 300 300 300
Ł250m 5.875% Bonds 2029 249 249 249
– – 549 549 549 Financial
Total central operations 1,746 831 549 3,126 3,201
Ł275m bank loan note (iii) 275 275 250
US$250m 8.15% Surplus Notes 2027 note (iv) 153 153 160 statements
Total notes (v), (vi) 1,746 984 824 3,554 3,611
* These debt classifications are consistent with the treatment of capital for regulatory purposes, as defined in the FSA handbook. In January 2011, the Company issued US$550 million 7.75 per cent Tier 1 subordinated debt, primarily to retail investors. The proceeds, net of costs, were US$539 million (Ł340 million) and were used to finance the repayments of the €500 million Tier 2 subordinated debt in December 2011.
The Group has designated US$2.85 billion (2011: US$2.85 billion) of its Tier 1 subordinated debt as a net investment hedge under IAS 39 to hedge the currency risks related to the net investment in Jackson.
† The senior debt ranks above subordinated debt in the event of liquidation.
290 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H13: Borrowings continued
Notes
(i) The €20 million borrowings were issued at 20-year Euro Constant Maturity Swap (capped at 6.5 per cent). These have been swapped into borrowings of Ł14 million with interest payable at three month ŁLIBOR plus 1.2 per cent.
(ii) The US$250 million 6.75 per cent borrowings, the US$300 million 6.5 per cent borrowings and the US$550 million 7.75 per cent borrowings can be converted, in whole or in part, at the Company’s option and subject to certain conditions, on any interest payment date, into one or more series of Prudential preference shares.
(iii) The PruCap bank loan was increased from Ł250 million to Ł275 million on 20 December 2012. The loan has been made in two tranches: a Ł160 million loan maturing in June 2014, currently drawn at a cost of 12 month ŁLIBOR plus 0.6 per cent and a Ł115 million loan maturing on 20 December 2017 and currently drawn at a cost of 12 month ŁLIBOR plus 0.79 per cent.
(iv) The Jackson borrowings are unsecured and subordinated to all present and future indebtedness, policy claims and other creditor claims of Jackson.
(v) Maturity analysis
The following table sets out the contractual maturity analysis of the Group’s core structural borrowings:
2012 Łm 2011 Łm
Less than 1 year 115 115
1 to 2 years 160 –
2 to 3 years – 135
3 to 4 years – –
4 to 5 years – –
Over 5 years 3,279 3,361
Total 3,554 3,611
(vi) Management analyses the net core structural borrowings position as follows:
2012 Łm 2011 Łm
Total core structural borrowings (as above) 3,554 3,611
Less: Holding company cash and short-term investments (recorded within the consolidated statement of financial position)(1,380)(1,200)
Net core structural borrowings of shareholder-financed operations 2,174 2,411
(vii) In January 2013, the Company issued core structural borrowings of US$700 million Tier 1 perpetual subordinated capital securities. The proceeds, net of costs, were US$689 million.
Operational borrowings attributable to shareholder-financed operations
2012 Łm 2011 Łm
Borrowings in respect of short-term fixed income securities programmes
Commercial paper 1,535 2,706
Medium-Term Notes 2013 note (vi) 250 250
Medium-Term Notes 2015 299 –
2,084 2,956
Borrowings of US operations
Investment subsidiaries (non-recourse) note (i) 19 20
Piedmont and CDO funds (non-recourse) notes (i), (ii) 1 1
20 21
Other borrowings
Bank loans and overdrafts 1 13
Obligations under finance leases 1 1
Other borrowings note (iii) 139 349
141 363
Total 2,245 3,340
Notes
(i) In all instances the holders of the debt instruments issued by these subsidiaries and funds do not have recourse beyond the assets of those subsidiaries and funds.
(ii) Piedmont is an investment trust investing in certain asset-backed and mortgage-backed securities in the US. These borrowings pertain to debt instruments issued to external parties.
(iii) Other borrowings mainly include amounts whose repayment to the lender is contingent upon future surplus emerging from certain contracts specifled under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
The Group has chosen to designate as a fair value hedge under IAS 39 certain fi xed to fl oating rate swaps which hedge the fair value exposures to interest rate movements of these borrowings.
In addition, other borrowings include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson.
(iv) In addition to the debt listed above, Ł200 million Floating Rate Notes were issued by Prudential plc in October 2012 which will mature in April 2013.
These Notes have been wholly subscribed by a Group subsidiary and accordingly have been eliminated on consolidation in the Group financial statements.
These notes were originally issued in October 2008 and have been reissued upon their maturity.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 291
(v) Maturity analysis
The following table sets out the contractual maturity analysis of the Group’s operational borrowings attributable to shareholder-financed operations:
2012 Łm 2011 Łm
Less than 1 year 1,920 3,169
1 to 2 years 6 140
2 to 3 years 309 10
3 to 4 years 9 10
4 to 5 years 1 11
Over 5 years – –
Total 2,245 3,340
(v) In January 2013 the Company repaid on maturity, Ł250 million Medium-Term Notes included within borrowings in respect of short-term fixed income securities in the table above.
Borrowings attributable to with-profits operations
2012 Łm 2011 Łm
Non-recourse borrowings of consolidated investment funds note(i) 823 747
Ł100m 8.5% undated subordinated guaranteed bonds of Scottish Amicable Finance plc note (ii) 100 100
Other borrowings (predominantly obligations under finance leases) 110 125
Total note (iii) 1,033 972
Notes
(i) In all instances the holders of the debt instruments issued by these funds do not have recourse beyond the assets of those funds.
(ii) The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinate
to the entitlements of the policyholders of that fund.
(iii) Maturity analysis
The following table sets out the contractual maturity analysis of the Group’s borrowings attributable to with-profits operations: H:
2012 Łm 2011 Łm Other
Less than 1 year 288 297
1 to 2 years 82 75
2 to 3 years 124 30
3 to 4 years 46 110 information
4 to 5 years 61 31
Over 5 years 432 429 on
Total 1,033 972 statement
of
H14: Provisions and contingencies fi
Provisions nancial
2012 Łm 2011 Łm position
Provision in respect of defined benefit pension schemes:I3
(Surplus) deficit gross of deferred tax, based on scheme assets held, including investments items
in Prudential insurance policies:
Attributable to PAC with-profits fund 37 41
Attributable to shareholder-financed operations(1) 23
36 64 Financial
Add back investments in Prudential insurance policies 169 165
Provision after elimination of investments in Prudential insurance policies and matching
policyholder liabilities from Group statement of financial position 205 229 statements
Other provisions (see below) 396 300
Total provisions 601 529
292 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H14: Provisions and contingencies continued
Analysis of other provisions:
Note 2012 Łm 2011 Łm
At 1 January I3 300 282
Charged to income statement:
Additional provisions 237 144
Unused amounts released(12)(29)
Used during the year(124)(97)
Exchange differences(5) –
At 31 December 396 300
Comprising:
Legal provisions 20 14
Restructuring provisions 27 23
Other provisions 349 263
Total 396 300
Other provisions
The movement in other provisions is shown in the table below:
2012 Łm 2011 Łm
Legal Restructuring Other Legal Restructuring Other
provisions provisions provisions provisions provisions provisions
note (i) note (ii) note (iii) note (i) note (ii) note (iii)
At 1 January 14 23 263 20 26 236
Charged to income statement:
Additional provisions 10 14 213 – 5 139
Unused amounts released(1)(4)(7) –(5)(24)
Used during the year(2)(6)(116)(6)(3)(88)
Exchange differences(1) –(4) – – –
Total at 31 December 20 27 349 14 23 263
Notes
(i) Total legal provisions at 31 December 2012 of Ł20 million related to Jackson. Jackson has been named in civil proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers in the US, alleging misconduct in the sale of insurance products. Of the Ł20 million legal provision as at 31 December 2012, Ł18 million has been established to cover this potential litigation and is expected to be utilised over the next five years.
(ii) Restructuring provisions primarily relate to restructuring activities of UK insurance operations. The provisions pertain to property liabilities resulting from the closure of regional sales centres and branches and staff terminations and other transformation costs to enable streamlining of operations.
(iii) Other provisions comprise staff benefits provisions of Ł286 million, provisions for onerous contracts of Ł61 million and regulatory and other provisions of Ł2 million. Staff benefits are generally expected to be paid out within the next three years.
The provision balance is expected to be paid out within the next five years.
Contingencies and related obligations
In addition to the legal proceedings relating to Jackson mentioned under the legal provisions section above, the Group is involved in other litigation and regulatory issues.
Whilst the outcome of such litigation and regulatory issues cannot be predicted with certainty, the Company believes that their ultimate outcome will not have a material adverse effect on the Group’s fi nancial condition, results of operations, or cash flows.
Pension mis-selling review
The pensions review by the UK insurance regulator of past sales of personal pension policies required all UK life insurance companies to review their cases of potential mis-selling and record a provision for the estimated costs. The Group met the requirement of the FSA to issue offers to all cases by 30 June 2002.
At 31 December 2012 the pension mis-selling provision was Ł306 million (31 December 2011: Ł362 million).
The pension mis-selling provision is included within the liabilities in respect of investment contracts with discretionary participation features under IFRS 4. The pension mis-selling provision at 31 December 2012 of Ł306 million is stochastically determined on a discounted basis. The average discount rate implied in the movement in the year is 2.3 per cent (2011: 2.6 per cent).
The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling including administration costs. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 293
The costs associated with the pension mis-selling review have been met from the inherited estate (see below). Accordingly, these
costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders’ pay-out
values have been unaffected by pension mis-selling.
In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment
policy and it gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder
resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. The assurance was
designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies
while the pension mis-selling review was continuing.
This review was completed on 30 June 2002. The assurance will continue to apply to any policy in force at 31 December 2003, both
for premiums paid before 1 January 2004, and for subsequent regular premiums (including future fixed, retail prices index or salary
related increases and Department for Work and Pensions rebate business). The assurance has not applied to new business since
1 January 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and
single premium top-ups, transfers and switches to existing arrangements. The maximum amount of capital support available under
the terms of the assurance will reduce over time.
The bonus and investment policy for each type of with-profits policy is the same irrespective of whether or not the assurance
applies and this is expected to continue for the foreseeable future. Hence removal of the assurance for new business has had no
impact on policyholder returns.
Guaranteed annuities
Prudential Assurance used to sell guaranteed annuity products in the UK and at 31 December 2012 held a provision of Ł47 million
(2011: Ł90 million) within the main with-profits fund within policyholder liabilities to honour guarantees on these products. The
Group’s main exposure to guaranteed annuities in the UK is through SAIF and at 31 December 2012 a provision of Ł371 million
(2011: Ł370 million) was held in SAIF to honour the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance long-term
business fund, wholly attributable to the policyholders of the fund, the movement in this provision has no impact on shareholders.
Other matters
Inherited estate of the PAC long-term fund
The assets of the with-profits sub-fund (WPSF) within the long-term insurance fund of The Prudential Assurance Company Limited H:
(PAC) comprise the amounts that it expects to pay out to meet its obligations to existing policyholders and an additional amount used
as working capital. The amount payable over time to policyholders from the WPSF is equal to the policyholders’ accumulated asset Other
shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of
the WPSF is called the ‘inherited estate’ and has accumulated over many years from various sources.
The inherited estate, as working capital, enables PAC to support with-profits business by providing the benefits associated with information
smoothing and guarantees, by providing investment flexibility for the fund’s assets, by meeting the regulatory capital requirements
that demonstrate solvency and by absorbing the costs of certain significant events or fundamental changes in its long-term business on
without affecting the bonus and investment policies. The size of the inherited estate fiuctuates from year to year depending on the
investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events. statement
Support for long-term business funds by shareholders’ funds of
As a proprietary insurance company, PAC is liable to meet its obligations to policyholders even if the assets of the long-term funds fi
are insufficient to do so. The assets, represented by the unallocated surplus of with-profits funds, in excess of amounts expected to nancial
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 position
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 items
to provide financial support.
In 1997, the business of Scottish Amicable Life Assurance Society (SALAS), a mutual society, was transferred to PAC. In effecting
the transfer, a separate sub-fund, Scottish Amicable Insurance Fund (SAIF), was established within PAC’s long-term business fund.
This sub-fund contains all the with-profits business and all other pension business that was transferred. No new business has been or Financial
will be written in the sub-fund and the sub-fund is managed to ensure that all the invested assets are distributed to SAIF policyholders
over the lifetime of SAIF policies. With the exception of certain amounts in respect of the unitised with-profits life business, all future
earnings arising in SAIF are retained for SAIF policyholders. Any excess (deficiency) of revenue over expense within SAIF during a
period is attributable to the policyholders of the fund. Shareholders have no interest in the profits of SAIF but are entitled to the asset statements
management fees paid on this business.
SAIF with-profits policies contain minimum levels of guaranteed benefit to policyholders. In addition, as mentioned earlier in this
note, certain pensions products have guaranteed annuity rates at retirement. Should the assets of SAIF be inadequate to meet the
guaranteed benefit obligations of the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency in
the first instance. The directors believe that the probability of either the PAC long-term fund or the Group’s shareholders’ funds having
to contribute to SAIF is remote.
294 Financial statements Prudential plc Annual Report 2012
H: Other information on statement of financial position items continued
H14: Provisions and contingencies continued
Unclaimed property provision
Jackson has received regulatory enquiries on an industry-wide matter relating to claims settlement practices and compliance with unclaimed property laws. Concurrently, some regulators and state legislatures have required and others are considering proposals that would require life insurance companies to take additional steps to identify unreported deceased policy and contract holders. Additionally, numerous states are contracting with independent firms to perform specific unclaimed property audits or targeted market conduct examinations covering claims settlement practices and procedures for escheating unclaimed property. One such firm has been contracted by treasury departments of 26 states to perform an examination of the Jackson’s practices for handling unclaimed property. Any regulatory audits, related examination activity and internal reviews may result in additional payments to benefi ciaries, escheatment of funds deemed abandoned under state laws, administrative penalties and changes in the Jackson’s procedures for the identifi cation of unreported claims and handling of escheatable property.
In 2011, Jackson initiated a project to compare its entire policy master file to vendors’ databases of known deaths and accrued a Ł16 million provision for potential claims at 31 December 2011. In 2012, Jackson recognised a charge of Ł18 million, net of policy reserves released upon death, as a result of the project. At 31 December 2012, based on its current analysis, Jackson
has accrued Ł17 million for estimated remaining claims that have not yet been positively identifi ed.
Guarantees and commitments
Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume and types of business. The Group estimated its reserve for future guarantee fund assessments for Jackson, included within other liabilities, to be Ł31 million at 31 December 2012 (2011: Ł17 million). Similar assessments for the UK businesses were not signifi cant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies.
At 31 December 2012, Jackson has unfunded commitments of Ł325 million (2011: Ł341 million) related to its investments in limited partnerships and of Ł86 million (2011: Ł77 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
Jackson owns debt instruments issued by securitisation trusts managed by PPM America. At 31 December 2012, the support provided by certain forbearance agreements Jackson entered into with the counterparty to certain of these trusts could potentially expose Jackson to maximum losses of Ł31 million (2011: Ł71 million), if circumstances allowed the forbearance period to cease. Jackson believes that, so long as the forbearance period continues, the risk of loss under the agreements is remote.
The Group has provided other guarantees and commitments to third-parties entered into in the normal course of business but the Company does not consider that the amounts involved are significant.
H15: Other liabilities
2012 Łm 2011 Łm
Creditors arising from direct insurance and reinsurance operations 1,134 970
Interest payable 62 67
Other items* 2,258 212
Total 3,454 1,249
* Of the Ł2,258 million other items as at 31 December 2012, Ł2,021 million related to liabilities for funds withheld under reinsurance arrangement of the Group’s US operations from the purchase of REALIC, as discussed in note I1.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 295
I: Other notes
I1: Acquisition of subsidiaries
a Acquisition of Reassure America Life Insurance Company (REALIC)
On 4 September 2012, the Group through its indirect wholly-owned subsidiary, Jackson National Life Insurance Company (JNLI)
completed the acquisition of 100 per cent issued share capital of SRLC America Holding Corp. (SRLC), and its primary operating
subsidiary, Reassure America Life Insurance Company (REALIC). The purchase consideration which remains subject to final
agreement under the terms of the transaction with Swiss Re, is Ł370 million (US$587 million). The acquisition increases the scale of the
Group’s life business in the US, helping Jackson to diversify earnings by increasing the amount of income from underwriting activities
thereby enhancing the quality of earnings in a capital efficient manner. Immediately prior to the acquisition, SRLC entered into a
reinsurance arrangement with Swiss Re, the former ultimate parent company facilitating Swiss Re to retain a portion of the REALIC
business. As collateral for this reinsurance arrangement, REALIC holds Ł2.1 billion of policy loans, bonds and short-term investments,
which are offset by a funds withheld liability.
REALIC was a US-based insurance company whose business model was to acquire, through purchase or reinsurance, closed
blocks of insurance business, primarily life assurance risks. REALIC did not write new business.
The purchase consideration paid is equivalent to the fair value of the identifiable acquired assets and liabilities assumed and
accordingly no goodwill is recognised under IFRS on the date of completion of the acquisition.
In addition to the purchase consideration, the Group incurred Ł9 million of acquisition related costs that have been recognised
as an expense during the year, in the consolidated income statement.
The provisional fair value of the acquired assets and liabilities are shown in the table below.
Fair value
recognised at
acquisition
date
Łm
Identifiable assets
Intangible assets attributable to shareholders:
Acquired value of in-force business 5
Other non-investment and non-cash assets:
Reinsurers’ share of insurance contract liabilities 5,444
Deferred tax 390
Current tax recoverable 44
Accrued investment income 58
Other debtors 38
Investments of long-term business and other operations:
Loans 2,204
Equity securities and portfolio holdings in unit trusts 69
Debt securities 7,177
Cash and cash equivalents 147
I:
Total identifiable assets 15,576 Other
Identifiable liabilities notes
Policyholder liabilities:
Insurance contract liabilities 12,912
Other non-insurance liabilities 2,294 Financial
Total identifiable liabilities 15,206
Net identifiable assets acquired and liabilities assumed 370 statements
Purchase consideration 370
296 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I1: Acquisition of subsidiaries continued
At the date the financial statement were approved, the fair value of the identifiable acquired assets and liabilities and the consideration were subject to finalisation. In accordance with accounting guidance for business combinations, the Company will continue to review the balance sheet and record required adjustments, for up to a 12 month period following the acquisition close date, in order to reflect updated information on certain accruals, related expenses, or other potential valuation adjustments, if further information becomes available about facts and circumstances that existed as of the acquisition date. Any measurement period adjustments determined to be material will be applied retrospectively to the acquisition date in the Company’s consolidated financial statements and depending on the nature of the adjustment, the Company’s results subsequent to the acquisition period could be affected.
Reserves were initially valued consistent with existing IFRS guidance. Accordingly, as for the Group’s measurement of Jackson’s insurance assets and liabilities, under IFRS 4, a ‘grandfathered’ US GAAP basis has been applied. For instance the traditional products were valued using standard modeling techniques with assumptions updated to match current interest rate environment or be consistent with Jackson’s assumptions where appropriate. Base reserves on interest sensitive products were set equal to the account value and the reserves accounted for under FASB ASC Subtopic 944-80 Financial Services – Insurance – Separate Accounts (formerly SOP 03-1) were adjusted to reflect Jackson’s assumptions where appropriate. In addition, provision has been made for the effects of fair valuing the acquired policyholder liabilities and value of in force business in accordance with IFRS 3.
Included within the identifiable assets as shown above are loans and other debtors acquired with fair values of Ł2,204 million and Ł38 million, respectively. These values represent the gross contractual amounts all of which are expected to be collected. The majority of the loans of Ł2,204 million were held to back liabilities for funds withheld under reinsurance arrangements as described above.
The consolidated statement of cash flows contains a Ł224 million net cash outflow in respect of this acquisition representing cash consideration of Ł371 million (based on the preliminary purchase price of Ł417 million with a deferred consideration of Ł46 million) less cash and cash equivalents acquired of Ł147 million.
Impact of acquisition on the results of the Group
Actual Łm Estimated Łm
Post
acquisition
period from
4 Sept to Full Year
31 Dec 2012 2012
note (i)
Revenue 184 695
Operating profit based on longer-term investment returns 67
Short-term fluctuations in investment returns 13
Amortisation of acquisition accounting on the purchase of REALICnote (ii)(19)
Profit before tax 61 123
Notes
(i) Estimation of the REALIC business’ contribution to the Group’s consolidated revenue and profit before tax for the year if the acquisition had occurred on 1 January 2012. In determining these amounts, it has been assumed that the fair value adjustments which arose on the date of acquisition would have been the same if the acquisition had occurred on 1 January 2012.
(ii) The profit of Ł61 million for the period has been determined after a charge of Ł(19) million for amortisation of acquisition accounting adjustments. This charge reflects the net effect of:
(a) The difference between the yield on the acquired debt securities (excluding those held to back funds withheld for reinsurance contracts) determined by reference to their market value at acquisition as required by the IFRS 3 purchase GAAP purposes and the book yield on a historic GAAP basis;
(b) Amortisation of the fair value adjustments on policyholder liabilities; and
(c) Amortisation of the acquired value of in-force business.
This charge has been shown separately within Group’s supplementary analysis of profit, as explained in note B1.
b Acquisition of Thanachart Life Assurance Company Limited
On 5 November 2012, Prudential plc, through its subsidiary Prudential Life Assurance (Thailand) Public Company Limited (Prudential Thailand) entered into an agreement to acquire 100 per cent of Thanachart Life Assurance Company Limited (Thanachart Life), a wholly-owned life insurance subsidiary of Thanachart Bank Public Company limited (Thanachart Bank). The consideration for Thanachart Life is THB 17.5 billion (Ł352 million at the year end exchange rate) settled in cash on completion, with a further payment of THB 0.5 billion (Ł10 million) payable 12 months after completion, subject to a post-completion adjustment to reflect the net asset value as at the completion date. The transaction is subject to regulatory approval and is expected to close in the first half of 2013. Upon completion of the transaction, Thanachart Life will become a wholly-owned subsidiary of Prudential Thailand.
As part of the deal, Prudential Thailand and Thanachart Bank have entered into an agreement to establish an exclusive 15-year partnership to develop jointly their bancassurance business in Thailand. This transaction builds on Prudential’s strategy of focusing on the highly attractive markets of South-east Asia and is in line with the Group’s multichannel distribution strategy.
Notes on the Group financial statements Prudential plc Annual Report 2012 297
c PAC with-profits funds acquisitions
2012:
The PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, has made an acquisition of a joint
venture, see note H8. There were no acquisitions of subsidiaries made during the year.
2011:
The PAC with-profits fund, via its venture fund holdings and as part of its investment portfolio, made acquisitions during the period.
These were acquisitions for a 100 per cent interest of Earth & Wind Energias Renovables SL, a company which invests in solar panel
parks, in March 2011 and a 100 per cent interest of Alticom Holdings BV, a company investing in telecommunication towers, in June
2011. The Earth & Wind portfolio of solar panel parks was further expanded with the acquisition of a 100 per cent interest in
Promociones Fotovoltaicas Betula SL, Promociones Fotovoltaicas Castanea SL, Promociones Fotovoltaicas Corylus SL and
Promociones Fotovoltaicas Fagus SL in July 2011 and a 50 per cent controlling interest in Sarinena Solar SL in October 2011.
As these transactions are within the with-profits fund, they have no impact on shareholders’ profit or equity for the year ended
31 December 2011. The impact on the Group’s consolidated revenue, including investment returns, is not material. Had the
acquisitions been effected at 1 January 2011, the revenue and profit of the Group for the year ended 31 December 2011 would not
have been materially different.
A summary of the consideration, goodwill and net assets acquired relating to these four acquisitions is provided in the table below:
2011
Total
Łm
Cash consideration paid 67
Net assets acquired:
Property, plant and equipment 190
Other non-investment and non-cash assets 16
Cash and cash equivalents 14
Borrowings attributable to with-profits funds(114)
Derivative liabilities(2)
Other non-insurance liabilities(49)
Fair value of net assets acquired 55
Total goodwill arising on acquisition attributable to the with-profits fund 12
I2: Changes to Group’s holdings
PPM South Africa
On 22 February 2012, M&G completed transactions to (i) exchange bonus share rights for equity holdings with the employees of
PPM South Africa and (ii) the sale of a 10 per cent holding in the majority of the business to Thesele Group, a minority shareholder,
for cash. Following these transactions M&G’s majority holding in the business reduced from 75 per cent to 49.99 per cent. Under IFRS
I:
requirements, the divestment is accounted for as the disposal of the 75 per cent holding and an acquisition of a 49.99 per cent holding
at fair value resulting in a reclassification of PPM South Africa from a subsidiary to an associate. As a consequence of the IFRS Other
application, the transactions gave rise to a gain on dilution of Ł42 million. This amount is shown separately and in the Group’s 2012
supplementary analysis of profit excluded from the Group’s IFRS operating profit based on longer-term investment returns. The net notes
cash outflow arising from this change to the Group’s holdings, as shown in the consolidated statement of cash flows, of Ł23 million,
comprised the net effect of cash and cash equivalents no longer consolidated and the cash proceeds received.
Financial statements
298 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans
a Staff and employment costs
The average number of staff employed by the Group during the year was:
2012 2011
Business operations:
Asia operations 18,584 17,001
US operations 4,000 3,785
UK operations 5,035 4,628
Total 27,619 25,414
The costs of employment were:
2012 Łm 2011 Łm 2010 Łm
Business operations:
Wages and salaries 1,204 1,101 1,052
Social security costs 85 75 69
Other pension costs:
Defined benefit schemes*:
Defined benefit schemes – PSPS† 17 22 27
Defined benefit schemes – Other schemes* 21(34) 31
Defined contribution schemes:
Defined contribution schemes – Domestic 12 12 11
Defined contribution schemes – Overseas 35 29 26
Pension actuarial and other (gains) losses charged to income statement*(145)(37) 26
(60)(8) 121
Total 1,229 1,168 1,242
* The derivation of these amounts is shown in note (b)(i)4(i).
• Consistent with the derecognition of the Company’s interest in the underlying IAS 19 surplus of Prudential Staff Pension Scheme (PSPS) as described in note (b)(i)1 below, the other pension costs for PSPS represents the cash cost of contributions for ongoing service of active members and the unwind of discount on the opening provision for deficit funding for PSPS.
b Pension plans
i Defined benefit plans
1 Summary
The Group asset (liability) in respect of defined benefit pension schemes is as follows:
2012 Łm 2011 Łm
Other
PSPS schemes Total Total
Underlying economic surplusnote 4(i) 1,174(36) 1,138 1,543
Less: unrecognised surplus and adjustment for obligation under IFRIC 14
for deficit funding (2011 only)note 4(i)(1,010) –(1,010)(1,607)
Economic surplus (deficit) (including investment in Prudential insurance
policies)note 4(i) 164(36) 128(64)
Attributable to:
PAC with-profits fund 115(37) 78(41)
Shareholder-backed operations 49 1 50(23)
Consolidation adjustment against policyholder liabilities for investment
in Prudential insurance policies –(169)(169)(165)
IAS 19 pension asset (liability) on the Group statement of
financial position* 164(205)(41)(229)
* At 31 December 2012, the PSPS pension asset of Ł164 million and the other schemes’ pension liabilities of Ł205 million were included within ‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position. The comparative liabilities of Ł229 million as at 31 December 2011 were included within ‘Provisions’.
Notes on the Group financial statements Prudential plc Annual Report 2012 299
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), which PSPS accounts for
86 per cent (2011: 86 per cent) of the underlying scheme liabilities of the Group defined benefit schemes.
The Group also operates two smaller defined benefit schemes for UK employees in respect of Scottish Amicable and M&G.
For all three schemes, the projected unit method was used for the most recent full actuarial valuations. There is also a small defined
benefit scheme in Taiwan with a negligible deficit.
Triennial actuarial valuations
Defined benefit schemes in the UK are generally required to be subject to full actuarial valuation every three years in order to
assess the appropriate level of funding for schemes in relation to their commitments. These valuations include assessments of the
likely rate of return on the assets held within the separate trustee administered funds.
The last completed actuarial valuation of PSPS was as at 5 April 2011 by CG Singer, Fellow of the Institute of Actuaries, of
Towers Watson Limited. This valuation was finalised in the first half of 2012 and demonstrated the scheme to be 111 per cent
funded by reference to the Scheme Solvency Target that forms the basis of the scheme’s funding objective. As a result of this
valuation, future contributions into the scheme have been reduced to the minimum level of contributions required under the
scheme rules effective from July 2012.
Excluding expenses, the contributions fell to approximately Ł6 million per annum from the Ł50 million per annum paid
previously. The new contributions are only for ongoing service of current employees that are active members of the scheme. No
deficit type funding is required. Deficit funding for PSPS, where applicable, as applied in 2011, is apportioned in the ratio of 70/30
between the PAC with-profits fund and shareholder-backed operations following detailed consideration in 2005 of the sourcing
of previous contributions. Employer contributions for ongoing service of current employees are apportioned in the ratio relevant
to current activity. In 2012, total contributions paid in the year including expenses were Ł36 million (2011: Ł54 million).
The market value of PSPS scheme assets as at the 5 April 2011 valuation was Ł5,255 million. The actuarial assumptions used
in determining benefit obligations and the net periodic benefit costs for the purposes of the 2011 valuation were as follows:
Rate of increase in salaries Nil
Rate of inflation:
Retail Prices Index (RPI) 3.7
Consumer Prices Index (CPI) 3.0
Rate of increase of pensions in payment for inflation:
Guaranteed (maximum 5%) 3.0
Guaranteed (maximum 2.5%) 2.5
Discretionary Nil
Expected returns on plan assets 4.2
Mortality assumptions:
The tables used for PSPS pensions in payment at 5 April 2011 were:
Base post retirement mortality
I:
For current male (female) pensioners 113% (108%) of the mortality rates of the 2000 series mortality tables (PNMA00/PNFA00),
published by the Continuous Mortality Investigation Bureau (CMI). Other
For male (female) non-pensioners 107% (92%) of the 2000 series rates (PNMA00/PNFA00).
notes
Allowance for future improvements to post retirement mortality
For males (females) 100% (75%) of Medium Cohort subject to a minimum rate of improvement of 2.00% (1.25%) up to the age of 90,
decreasing linearly to zero by age of 120 with a long-term rate of 1.75% pa (1.5% pa) but adjusted as follows:
period improvements are blended between ages 60 to 80 to the long-term improvement rate over a 15 year period (compared Financial
with a 20 year period in the core CMI model) and;
cohort improvements are assumed to dissipate over a 30 year period, or by age 90 if earlier (compared with a 40 year period,
or by age 100 if earlier, in the core CMI model). statements
The last completed actuarial valuation of the Scottish Amicable Pension Scheme (SAPS) was as at 31 March 2011 by Jonathan
Seed, Fellow of the Institute and Faculty of Actuaries, of Xafinity Consulting. This valuation was finalised in the second half of 2012
and demonstrated the scheme to be 85 per cent funded. Based on this valuation, it was agreed with the Trustees that the existing
level of deficit funding of Ł13.1 million per annum continues to be paid into the scheme over the next six years, to eliminate the
actuarial deficit.
The last completed actuarial valuation of the M&G pension scheme was as at 31 December 2011 by Paul Belok, Fellow of the
Institute and Faculty of Actuaries, of AON Hewitt Limited. This valuation was finalised in the second half of 2012 and demonstrated
the scheme to be 83 per cent funded. Based on this valuation, deficit funding amounts designed to eliminate the actuarial deficit
over a three year period are being made from January 2013 of Ł18.6 million per annum for the first two years and Ł9.3 million in the
third year. This compares to the Ł10.5 million of deficit funding paid by the Group in 2012.
300 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans continued
Summary economic and IAS 19 financial positions
Under the IAS 19 ‘Employee Benefits’ valuation basis, the Group applies IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. Under IFRIC 14, a surplus is only recognised to the extent that the Company is able to access the surplus either through an unconditional right of refund to the surplus or through reduced future contributions relating to ongoing service, which have been substantively enacted or contractually agreed. Further, the IFRSfinancial position recorded, reflects the higher of any underlying IAS 19 deficit and any obligation for committed deficit funding where applicable.
For PSPS, the Group does not have an unconditional right of refund to any surplus of the scheme. Accordingly, prior to thefinalisation of the 5 April 2011 triennial valuation, the Group had not recognised the underlying surplus of PSPS (31 December 2011: Ł1,588 million gross of deferred tax) and had recognised an economic liability for defi cit funding (31 December 2011: Ł19 million gross of deferred tax).
The underlying IAS 19 surplus for PSPS at 31 December 2012 was Ł1,174 million. The fi nalisation of the 5 April 2011 triennial valuation was accompanied by an agreement with the Trustees that additional deficit type funding would no longer be necessary and furthermore, the level of contributions for ongoing service of current employees was reduced to the minimum level required by the scheme rules. As a consequence, a portion of the surplus, being Ł164 million, is now recognised as recoverable. The Ł164 million represents the present value of the economic benefi ts available from the reductions to future ongoing contributions to the scheme. Accordingly, a net surplus of Ł164 million gross of deferred tax was recognised at 31 December 2012. Of this amount,
• 115 million was allocated to the PAC with-profits fund and Ł49 million was allocated to the shareholders’ fund.
The IAS 19 deficit of the Scottish Amicable Pension Scheme at 31 December 2012 was Ł74 million (31 December 2011: deficit of
• 55 million) and has been allocated approximately 50 per cent to the PAC with-profits fund and 50 per cent to the shareholders’ fund. The IAS 19 surplus of the M&G pension scheme on an economic basis at 31 December 2012 was Ł38 million
(31 December 2011: surplus of Ł10 million) and is wholly attributable to shareholders. The underlying position on an economic basis reflects the assets (including investments in Prudential insurance policies that are offset against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. As at 31 December 2012, the M&G pension scheme has invested Ł169 million in Prudential insurance policies (31 December 2011: Ł165 million). After excluding these investments that are offset against liabilities to policyholders, the IAS 19 basis position of the M&G pension scheme is a defi cit of Ł131 million (31 December 2011: deficit of Ł155 million).
2 Corporate governance
The rules of the Group’s largest pension arrangement, the defined benefit section of PSPS, a final salary scheme, specify that, in exercising its investment powers, the Trustee’s objective is to achieve the best overall investment return consistent with the security of the assets of the scheme. In doing this, consideration is given to the nature and duration of the scheme’s liabilities. The Trustee sets the benchmark for the asset mix, following analysis of the liabilities by the Scheme’s Actuary and, having taken advice from the Investment Managers, then selects benchmark indices for each asset type in order to measure investment performance against a benchmark return.
The Trustee reviews strategy, the asset mix benchmark and the Investment Managers’ objectives every three years, to coincide with the Actuarial Valuation, or earlier if the Scheme Actuary recommends. Interim reviews are conducted annually based on changing economic circumstances andfinancial market levels.
The Trustee sets the general investment policy and specifies any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegates the responsibility for selection and realisation of specific investments to the Investment Managers. In carrying out this responsibility, the Investment Managers are required by the Pensions Act 1995 to have regard to the need for diversification and suitability of investments. Subject to a number of restrictions contained within the relevant asset management agreements, the Investment Managers are authorised to invest in any class of investment asset. However, the Investment Managers will not invest in any new class of investment asset without prior consultation with the Trustee.
The Trustee consults the Principal Employer, the Prudential Assurance Company, on these investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustee.
The investment policies and strategies for the other two UK defined benefit schemes, the M&G Group Pension Scheme and the Scottish Amicable Staff Pension Scheme, which are bothfinal salary schemes, follow similar principles, but have different target allocations reflecting the particular requirements of the schemes.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 301
3 Assumptions
The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended
31 December were as follows:
2012 % 2011 %
Discount rate* 4.4 4.7
Rate of increase in salaries 2.7 2.9
Rate of inflation†
Retail prices index (RPI) 2.7 2.9
Consumer prices index (CPI) 2.0 1.9
Rate of increase of pensions in payment for inflation:
Guaranteed (maximum 5%) 2.5 2.5
Guaranteed (maximum 2.5%)‡ 2.5 2.5
Discretionary‡ 2.5 2.5
Expected returns on plan assets 3.1 5.1
* The discount rate has been determined by reference to an ‘AA’ corporate bond index, adjusted where applicable, to allow for the difference in duration between the index and the pension liabilities.
† The rate of infl ation refl ects the long-term assumption for the UK RPI or CPI depending on the tranche of the schemes.
• The rates of 2.5 per cent are those for PSPS. Assumed rates of increase of pensions in payments for inflation for all other schemes are 2.7 per cent in 2012 (2011: 2.9 per cent).
The calculations are based on current actuarially calculated mortality estimates with a specific allowance made for future improvements in mortality. The specific allowance for 2012 and 2011 is in line with a custom calibration of the 2009 mortality model from the Continuous Mortality Investigation Bureau of the Institute and Faculty of Actuaries (CMI). The tables used for PSPS immediate annuities in payment at 31 December 2012 and 2011 were:
Male: 108.6 per cent PNMA00 with improvements in line with a custom calibration of the CMI’s 2009 mortality model, with a long-term mortality improvement rate of 1.75 per cent per annum; and
Female: 103.4 per cent PNFA00 with improvements in line with a custom calibration of the CMI’s 2009 mortality model, with a long-term mortality improvement rate of 1.00 per cent per annum.
The assumed life expectancies on retirement at age 60, based on the mortality table used was:
2012 years 2011 years
Male Female Male Female
Retiring today 28.0 29.1 27.8 29.0
Retiring in 20 years’ time 30.6 31.2 30.5 31.1
The mean term of the current PSPS liabilities is around 17 years.
Using external actuarial advice provided by the scheme actuaries being Towers Watson for the valuation of PSPS, Xafinity
Consulting for SAPS and Aon Hewitt Limited for the M&G scheme, the most recent full valuations have been updated to I:
31 December 2012, applying the principles prescribed by IAS 19. Other
4 Group economic and IAS 19 financial position notes
This section illustrates the financial position of the Group’s defined benefit pension schemes on an economic basis and the IAS 19
basis. The underlying position on an economic basis reflects the assets (including investments in Prudential policies that are offset
against liabilities to policyholders on the Group consolidation) and the liabilities of the schemes. At 31 December 2012, the
investments in Prudential insurance policies comprise Ł123 million (2011: Ł112 million) for PSPS and Ł169 million (2011: Ł165 million)
for the M&G scheme. Financial
Separately, the economic financial position also includes the effect of the application of IFRIC 14, ‘IAS 19 – The Limit on a
Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. For PSPS, where there are constraints in the trust
deed to prevent the company access, the surplus is not recognised and a liability to additional funding is established, where statements
relevant (as previously described).
302 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans continued
(i) Estimated pension scheme deficit – economic basis
Movements on the pension scheme deficit (determined on the economic basis) are as follows, with the effect of the application of IFRIC 14 being shown separately:
2012 Łm
(Charge) credit to income
statement
Operating
Surplus results Surplus
(deficit) in(based on(deficit)
scheme at longer-term Actuarial and in scheme
1 January investment other gains Contributions at 31 Dec
2012 returns) and losses paid 2012
All schemes
Underlying position (without the effect of IFRIC 14)
Surplus 1,543(166)(311) 72 1,138
Less: amount attributable to PAC with-profits fund(1,083) 105 222(31)(787)
Shareholders’ share:
Gross of tax surplus 460(61)(89) 41 351
Related tax(117) 25 20(9)(81)
Net of shareholders’ tax 343(36)(69) 32 270
Effect of IFRIC 14
Derecognition of surplus and set up of additional funding
obligation (1 Jan 2012 only)(1,607) 136 461 –(1,010)
Less: amount attributable to PAC with-profits fund 1,124(93)(322) – 709
Shareholders’ share:
Gross of tax deficit(483) 43 139 –(301)
Related tax 123(22)(32) – 69
Net of shareholders’ tax(360) 21 107 –(232)
With the effect of IFRIC 14
(Deficit) surplus(64)(30) 150 72 128
Less: amount attributable to PAC with-profits fund 41 12(100)(31)(78)
Shareholders’ share:
Gross of tax (deficit) surplus(23)(18) 50 41 50
Related tax 6 3(12)(9)(12)
Net of shareholders’ tax(17)(15) 38 32 38
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 303
Underlying investments and liabilities of the schemes
On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the plan’s net assets at 31 December comprise the following investments and liabilities:
2012 Łm 2011 Łm
Other Other
PSPS schemes Total PSPS schemes Total
Łm Łm Łm% Łm Łm Łm%
Equities 43 321 364 5 210 273 483 7
Bonds 5,440 418 5,858 81 5,547 407 5,954 83
Properties 290 40 330 5 297 20 317 4
Other assetsnote (i) 627 18 645 9 378 31 409 6
Total value of assets 6,400 797 7,197 100 6,432 731 7,163 100
Note
(i) The PSPS scheme has entered into a derivatives based strategy to match the duration and inflation profile of its liabilities. This involved a reallocation from other investments to other assets with an interest and inflation swap overlay. In broad terms, the scheme is committed to making a series of payments related to LIBOR on a nominal amount and in return the scheme receives a series of fixed and inflation-linked payments which match a proportion of its liabilities. As at 31 December 2012, the nominal value of the interest and inflation-linked swaps amounted to Ł0.9 billion (2011: Ł0.9 billion) and Ł2.0 billion (2011: Ł2.0 billion) respectively.
(ii) IAS 19 basis financial position as consolidated
The movements in the pension schemes’ surplus and defi cit between scheme assets and liabilities as consolidated in thefinancial statements were:
[Graphic Appears Here]
304 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans continued
2011 Łm
PSPS Other schemes Total Total
Adjust for
Economic investments
Provision Present value basis net in Prudential IAS 19
of deficit Plan of benefit surplus insurance basis net
funding assets obligations(deficit) policies deficit
Net deficit, beginning of year(47) 653(826)(220)(227)(447)
Current service cost(13)(13)(13)
Negative past service cost (RPI to CPI
inflation measure change) 66 66 66
Other finance income 41(45)(4)(15)(19)
Cash costs and unwind of discount on
opening provision for deficit funding
for PSPS(22)(22)(22)
Benefit payments(15) 15 5 5
Contributions 54 40(1) 93(21) 72
Actuarial and other gains and losses(4) 12 28 36 1 37
Transfer out of investment in Prudential
insurance policies 92 92
Net deficit, end of year(19) 731(776)(64)(165)(229)
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 305
The IAS 19 basis pensions deficit can be summarised as follows:
2012 2011 2010 2009 2008
Łm% Łm% Łm% Łm% Łm%
Plan assets
(IAS 19 basis before effect of IFRIC 14):
Equities 202 5 336 5 610 11 917 18 875 17
Bonds 5,728 84 5,826 85 4,095 72 3,587 69 2,619 52
Properties 330 5 317 4 206 4 278 5 290 6
Other assets 645 6 407 6 748 13 442 8 1,273 25
Fair value of plan assets, end
of year* 6,905 100 6,886 100 5,659 100 5,224 100 5,057 100
Present value of benefit obligation(6,059)(5,620)(5,438)(4,951)(4,493)
Funded status (wholly or partly
funded) 846 1,266 221 273 564
Present value of unfunded
obligations (M&G scheme)† – –(254)(223)(180)
846 1,266(33) 50 384
Effect of the application of IFRIC 14
for pension schemes
Derecognition of PSPS’ surplus(1,010)(1,588)(485)(513)(728)
Set up obligation for deficit funding
for PSPS –(19)(47)(75)(65)
Adjustment in respect of investment
of PSPS in Prudential policies 123 112 118 101 103
Deficit recognised in the statement
of financial position(41)(229)(447)(437)(306)
Experience adjustments:
Experience adjustments on scheme
liabilities‡(4) 314(4) 76 145
Percentage of scheme liabilities at
31 December(0.07)%(5.59)%(0.07)% 1.47% 3.10%
Experience adjustments on scheme
assets (IAS 19 basis)(39) 998 287 100(277)
Percentage of scheme assets at
31 December(0.57)% 14.49% 5.07% 1.91%(5.48)%
I:
* The IAS 19 basis plan assets at 31 December 2012 of Ł6,905 million is different from the economic basis plan assets of Ł7,197 million as show in section 4(i)
above due to the exclusion of investment in Prudential insurance policies of Ł292 million comprising Ł123 million for PSPS and Ł169 million for the M&G Other
scheme.
† The M&G pension scheme invests in Prudential insurance policies. On Prudential Group consolidation these assets are eliminated against liabilities in the notes
statement of financial position of UK insurance operations. Up until 2011 all of the M&G scheme assets were invested in this way thus giving rise to an
unfunded status on a Prudential Group consolidated basis. At 31 December 2012 and 2011, only Ł169 million (2011: Ł165 million) out of the M&G scheme assets
of Ł297 million (2011: Ł257 million) was invested in Prudential insurance policies, thereby switching its status to a partly funded scheme.
‡ The experience adjustments on scheme liabilities in 2011 of Ł314 million related mainly to the ‘true-up’ reflecting improvements in data consequent upon
the ongoing 2011 triennial valuations of PSPS and the Scottish Amicable pension scheme. The experience adjustments on scheme liabilities in 2008 of a gain
of Ł145 million related mainly to the ‘true up’ reflecting improvements in data consequent upon the 2008 triennial valuation of PSPS. Financial
statements
306 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans continued
The long-term expected rate of return has been taken to be the weighted average (by market value) of the long-term expected rates of return on each major asset class shown above.
2012 % 2011 %
Long-term expected rate of return:
Equity 6.8 8.2
Bonds 3.0 4.6
Properties 5.6 6.9
Other assets 2.0 4.8
Weighted average long-term expected rate of return 3.1 5.1
The expected rates of return have been determined by reference to long-term expectations, the carrying value of the assets and equity and other market conditions at the statement offinancial position date.
The actual return on scheme assets was a gain of Ł189 million (gain of 2011: Ł1,290 million) on an IAS 19 basis. None of the scheme assets included shares in Prudential plc or property occupied by the Prudential Group.
(iii) Credit (charge) to the income statement
The components of the credit (charge) for the net periodic pension cost (comprising amounts attributable to the PAC with-profits fund and shareholder-backed operations) are as follows:
2012 Łm 2011 Łm
Pension cost
Current service cost(32)(35)
Past service cost:note (a)
RPI to CPI inflation measure change in 2011 – 282
Exceptional discretionary pension increase for PSPS in 2012(106) –
Finance (expense) income:
Interest cost(263)(299)
Expected return on assets – IAS 19 basis 227 283
Add: expected return on investments of scheme assets in Prudential insurance policies 8 25
Expected return on assets – economic basis 235 308
Total (charge) credit without the effect of IFRIC 14(166) 256
Effect of the application of IFRIC 14 136(229)
Pension cost – economic basisnote (i) above and note (b)(30) 27
Adjustment for investments in Prudential insurance policiesnote (d)(8)(15)
Pension cost – IAS 19 basis (as recognised in the income statement and referred to in note I3a)(38) 12
Actuarial and other gains and losses
Actual less expected return on assets(34) 982
Losses on changes of assumptions for plan liabilities(273)(414)
Experience (losses) gains on liabilities(4) 314
Total (charge) credit without the effect of IFRIC 14(311) 882
Effect of the application of IFRIC 14 461(846)
Actuarial gains and losses – economic basisnote (i) above and note (c) 150 36
Adjustment for investments in Prudential insurance policiesnote (d)(5) 1
Actuarial gains and losses – IAS 19 basis (as recognised in the income statement and referred to in
note I3a) 145 37
Net periodic pension cost (included within acquisition and other operating expenditure in the
income statement) 107 49
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 307
Notes
(a) Past service cost
– RPI/CPI inflation measure change in 2011
During 2011 the Group altered its inflation measure basis for future statutory increases to pension payments for certain tranches of its UK defined benefit pension schemes. This reflected the UK Government’s decision to replace the basis of indexation from RPI with CPI.
The Ł282 million credit in 2011 shown above comprised Ł216 million for PSPS and Ł66 million for other schemes. As noted earlier, the PSPS scheme surplus was not recognised for accounting purposes due to the application of IFRIC 14. The Ł66 million for other schemes was allocated as Ł24 million to PAC with-profi ts fund and Ł42 million to shareholders as referred to in note C.
– Exceptional discretionary pension increase for PSPS in 2012
During the fi rst half of 2012, an exceptional discretionary increase to pensions in payment of PSPS was awarded which resulted in a past service cost of Ł106 million.
As the PSPS scheme surplus is substantially not recognised for accounting purposes, these two items had negligible impact on the Group’s results.
(b) Consistent with the derecognition of a substantial portion of the Company’s interest in the underlying IAS 19 surplus of PSPS, the charge to operating profit based on longer-term investment returns for PSPS reflects the cash cost of contributions for ongoing service of active members (2012: Ł17 million; 2011: Ł20 million). In addition, the charge to the operating results also includes a charge for the unwind of discount on the opening provision for deficit funding for PSPS (2012: Łnil; 2011:Ł2 million).
(c) The net credit (charge) for actuarial and other gains and losses is recorded within the income statement. Within the Group’s supplementary analysis of profit, the shareholders’ share of actuarial and other gains and losses (ie net of allocation of the share to the PAC with-profits funds) of Ł50 million as shown in note ii above (2011:Ł21 million) is excluded from operating profit based on longer-term investment returns as shown in note B1.
The 2012 actuarial and other gains refl ects the positive impact of infl ation rate movements in the period, off set by lower discount rates as interest rate falls, and partial recognition of actuarial surplus in PSPS described above.
(d) The adjustments for investments in Prudential insurance policies are consolidation adjustments with no net impact to the operating results.
Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2012 amounts to Ł56 million (2011: Ł94 million).
5 Sensitivity of the pension scheme liabilities to key variables
The total underlying Group pension scheme liabilities of Ł6,059 million (2011: Ł5,620 million) comprise Ł5,226 million
(2011: Ł4,844 million) for PSPS and Ł833 million (2011: Ł776 million) for the other schemes. The table below shows the sensitivity
of the underlying PSPS and the other scheme liabilities at 31 December 2012 and 2011 to changes in discount rates, inflation rates
and mortality rates.
Assumption applied
Impact of sensitivity on
Sensitivity change in scheme liabilities on IAS 19
2012 2011 assumption basis 2012 2011
Discount rate 4.4% 4.7% Decrease by 0.2% Increase in scheme
liabilities by:
PSPS 3.3% 3.3%
Other schemes 4.9% 4.8%
Discount rate 4.4% 4.7% Increase by 0.2% Decrease in scheme
liabilities by:
PSPS 3.1% 3.1%
Other schemes 4.6% 4.5%
Rate of inflation RPI: 2.7% RPI: 2.9% RPI: Decrease by 0.2% Decrease in scheme
liabilities by: I:
PSPS 0.6% 0.6% Other
CPI: 2.0% CPI: 1.9% CPI: Decrease by 0.2%
with consequent notes
reduction in
salary increases Other schemes 4.3% 4.1%
Mortality rate Increase life expectancy Increase in scheme
by 1 year liabilities by:
PSPS 2.6% 2.7% Financial
Other schemes 2.4% 2.4%
The sensitivity of the underlying pension scheme liabilities to changes in discount, inflation and mortality rates as shown above statements
does not directly equate to the impact on the profit or loss attributable to shareholders or shareholders’ equity due to the effect
of the application of IFRIC 14 on PSPS and the allocation of a share of the interest in financial position of the PSPS and Scottish
Amicable schemes to the PAC with-profits fund as described above.
The sensitivity to the changes in the key variables as shown in the table above has no significant impact on the pension costs
included in the Group’s operating results. This is due to the pension costs charged in each of the periods presented being derived
largely from market conditions at the beginning of the period. After applying IFRIC 14 and to the extent attributable to
shareholders, any residual impact from the changes to these variables is reflected as actuarial gains and losses on defined benefit
pension schemes within the supplementary analysis of profits.
308 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I3: Staff and pension plans continued
6 Transfer value of PSPS scheme
At 31 December 2012, it is estimated that the assets of the scheme are broadly sufficient to cover the liabilities of PSPS on a ‘buy-out’ basis including an allowance for expenses. The ‘buyout’ basis refers to a basis that might apply in the circumstance of a transfer to another appropriatefinancial institution. In making this assessment, it has been assumed that a more conservative investment strategy applies together with a more prudent allowance for future mortality improvements and no allowance for discretionary pension increases.
ii Other pension plans
The Group operates various defined contribution pension schemes including schemes in Jackson and Asia. The cost of the Group’s contributions for continuing operations to these schemes in 2012 was Ł47 million (2011: Ł40 million).
I4: Share-based payments
a Description of the plans
The Group maintains a number of main share award and share option plans relating to Prudential plc shares, which are described below.
(i) Group Performance Share Plan, previously Restricted Share Plan
The Group Performance Share Plan (GPSP) is the incentive plan in which all executive directors and other senior executives within the Group can participate. This scheme was established as a replacement for the Restricted Share Plan (RSP) under which no further awards could be made after March 2006. Awards are granted either in the form of a nil cost option, conditional right over shares, or such other form that shall confer to the participant an equivalent economic benefit, with a vesting period of three years. The performance measure for the awards is that Prudential’s Total Shareholder Return (TSR) outperforms an index comprising of peer companies. Vesting of the awards between each performance point is on a straight-line sliding-scale basis. Participants are entitled to the value of reinvested dividends that would have accrued on the shares that vest. Beginning in 2010, newly issued shares have been used in settling the awards that vest and are released.
The RSP was, until March 2006, the Group’s long-term incentive plan for executive directors and other senior executives designed to provide rewards linked to shareholder return. Each year participants were granted a conditional option to receive a number of shares. There was a deferment period of three years, at the end of which the award vested to an extent that depended on the performance of the Group’s shares including notional reinvested dividends and on the Group’s underlying fi nancial performance. After vesting, the option may be exercised at zero cost at any time, subject to closed period rules, in the balance of a 10-year period. Shares are purchased in the open market by a trust for the benefit of qualifying employees.
(ii) Business Unit Performance Plan
The Business Unit Performance Plan (BUPP) is an incentive plan created to provide a common framework under which awards would be made to senior employees in the UK, Jackson and Asia, including the chief executive officers. Awards under this plan were based on growth in shareholder capital value on the European Embedded Value basis with performance measured over three years. All awards made are settled in shares after vesting. Participants are entitled to receive the value of reinvested dividends over the performance period for those shares that vest. The growth parameters for the awards are relevant to each region, and vesting of the awards between each performance point is on a straight-line sliding-scale basis. Beginning in 2010, newly issued shares will be used in settling the awards that vest and are released. The BUPP awards for the UK business unit are based on the same relative TSR measure applied to GPSP awards. As a result, awards made under the UK BUPP reflect those TSR conditions applied to GPSP awards.
(iii) Savings-related options
The Group maintains four share option schemes satisfied by the issue of new shares: UK-based executive directors and eligible employees are eligible to participate in the Prudential HM Revenue & Customs (HMRC) approved UK savings-related share option scheme. Asia-based executive directors and eligible employees can participate in the
equivalent International savings-related share option scheme. Dublin-based employees are eligible to participate in the Prudential International Assurance sharesave plan and Hong Kong-based agents can participate in the non-employee savings-related share option scheme.
The options are normally exercisable during the six month period following either the third orfifth anniversary of the start of the relevant savings contract. 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.
(iv) Share Incentive Plan
UK-based executive directors and employees are also eligible to participate in the Company’s HMRC-approved Share Incentive Plan (SIP), which allows all UK-based employees to purchase shares of Prudential plc (partnership shares) on a monthly basis out of gross salary. For every four partnership shares bought, an additional matching share is awarded, purchased on the open market. Dividend shares accumulate while the employee participates in the plan. Partnership shares may be withdrawn from the scheme at any time. If the employee withdraws from the plan withinfive years, the matching shares are forfeit, and if within three years, dividend shares are forfeit.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 309
(v) Performance-related share awards
Jackson operates a performance-related share award which, subject to the prior approval of the Jackson Remuneration Committee, may grant share awards to eligible Jackson employees in the form of a contingent right to receive shares or a conditional allocation of shares. These share awards have vesting periods of four years and are at nil cost to the employee. Award holders do not have any right to dividends or voting rights attaching to the shares. The shares are held in the employee share trust in the form of American Depository Receipts which are tradable on the New York Stock Exchange.
(vi) Long-term Incentive Plan
The Prudential Corporation Asia Long-Term Incentive Plan (PCA LTIP) is an incentive plan created in 2008 for senior employees and chief executive officers. Awards under this plan will vest after three years subject to the employee being in employment at the time of vesting without any performance conditions. Awards are discretionary and on a year-by-year basis determined by Prudential’s full year fi nancial results and the employee’s contribution to the business. All awards will be in Prudential shares except for countries where share awards are not feasible due to securities and/or tax reasons, where awards will be replaced by the cash value of the shares that would otherwise have been transferred.
(vii) Annual Incentive Plan
Certain senior executives have Annual Incentive Plans (AIP) with awards paid in cash up to the target level of their plan. The portion of any award for above-target performance is made in the form of awards of shares deferred for three years, with the release of shares subject to close periods. The shares are held in the employee share trust and shares equivalent to dividends otherwise payable will accumulate for the benefit of award holders during the deferral period up to the release date.
(viii) Other Share awards
In addition, there are other share awards, including the Prudential Corporation Asia Deferred Bonus Plan (PCA DBP), Prudential Capital Deferred Bonus Plan (PruCap DBP) and other arrangements. There are no performance conditions attaching to these deferred bonus plans, and awards vest in full subject to the individual being employed by Prudential at the end of the vesting period. The other arrangements relate to various awards that have been made without performance conditions to individual employees, typically in order to secure their appointment or ensure retention.
b Outstanding options and awards
The following table shows movement in options outstanding under the Group’s share-based compensation plans at
31 December 2012 and 2011:
2012 2011
Weighted Weighted
average average
Number exercise Number exercise
of options price of options price
Options outstanding under SAYE schemes millions Ł millions Ł
Beginning of year: 13.3 3.55 12.8 3.4
Granted 2.4 6.29 2.1 4.66
Exercised(5.7) 2.99(0.6) 3.98
Forfeited(0.2) 4.29(0.2) 3.17
Cancelled(0.2) 4.32(0.4) 3.56 I:
Lapsed(0.2) 4.39(0.4) 3.94 Other
End of year 9.4 4.54 13.3 3.55
Options immediately exercisable, end of year 0.2 3.88 0.4 4.54 notes
The weighted average share price of Prudential plc for the year ended 31 December 2012 was Ł7.69 compared to Ł6.86 for the
year ended 31 December 2011. Financial
Movements in share awards outstanding under the Group’s share-based compensation plans relating to Prudential plc shares
at 31 December 2012 and 2011 were as follows:
2012 2011 statements
Number Number
of awards of awards
Awards outstanding under incentive plans including conditional options millions millions
Beginning of year: 26.7 23.9
Granted 8.8 10.3
Exercised(9.4)(4.2)
Forfeited(1.4)(0.1)
Expired(1.0)(3.2)
End of year 23.7 26.7
310 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I4: Share-based payments continued
The following table provides a summary of the range of exercise prices for Prudential plc options outstanding at 31 December 2012.
Outstanding Exercisable
Weighted
average Weighted Weighted
remaining average average
Number contractual exercise Number exercise
Outstanding life prices exercisable prices
Range of exercise prices millions years Ł millions Ł
Between Ł 2 and Ł 3 2.8 2.0 2.88 0.1 2.88
Between Ł 4 and Ł 5 4.1 2.3 4.61 0.1 4.24
The following table provides a summary of the range of exercise prices for Prudential plc options outstanding at 31 December 2011.
Outstanding Exercisable
Weighted
average Weighted Weighted
remaining average average
Number contractual exercise Number exercise
Outstanding life prices exercisable prices
Range of exercise prices millions years Ł millions Ł
Between Ł2 and Ł3 8.2 1.6 2.88 – –
Between Ł3 and Ł4 – 0.8 3.73 – 3.43
Between Ł4 and Ł5 5.0 3.1 4.58 0.3 4.40
Between Ł5 and Ł6 0.1 0.9 5.58 0.1 5.53
13.3 2.2 3.55 0.4 4.54
The years shown above for weighted average remaining contractual life include the time period from end of vesting period to
expiration of contract.
c Fair value of options and awards
The weighted average fair values of Prudential plc options and awards granted during the period are as follows:
2012 Ł 2011 Ł
Weighted average fair value Weighted average fair value
SAYE SAYE
GPSP Options Awards GPSP Options Awards
3.91 2.28 6.72 3.88 2.63 6.28
The fair value amounts estimated on the date of grant relating to all options including conditional nil cost options above were
determined using the Black-Scholes and the Monte Carlo option-pricing models using the following assumptions:
2012 2011
SAYE SAYE
GPSP Options GPSP Options
Dividend yield (%) – 3.63 – 3.33
Expected volatility (%) 33.03 34.33 28.90 62.67
Risk-free interest rate (%) 0.31 0.39 1.32 0.89
Expected option life (years) – 3.24 – 3.48
Weighted average exercise price (Ł) – 6.29 – 4.66
Weighted average share price (Ł) 6.78 8.26 7.32 6.06
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 311
Compensation costs for all share-based compensation plans are determined using the Black-Scholes model, Monte Carlo model or other market consistent valuation methods. The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black-Scholes model to value
all options and awards other than the GPSP and UK BUPP, for which the Group uses a Monte Carlo model in order to allow for the impact of the TSR performance conditions. These models are used to calculate fair values for share options and awards at the grant date based on the quoted market price of the stock at the measurement date, the amount, if any, that the employees are required to pay, the dividend yield, expected volatility, risk-free interest rates and exercise prices.
For the SAYE options, the expected volatility is based on the market implied volatilities for Prudential shares as quoted on Bloomberg. This change (from an estimate based on historic volatility) brings the methodology into line with the approach used to determine the volatility for the GPSP and UK BUPP awards. The Prudential specific at-the-money implied volatilities are adjusted to allow for the different term and discounted exercise price on SAYE options by using information on the volatility surface of the FTSE 100.
Risk-free interest rates are UK gilt rates with projections for three-year andfive-year terms to match corresponding vesting periods. Dividend yield is determined as the average yield over a period of 12 months up to and including the date of grant. For the GPSP, volatility and correlation between Prudential and an index constructed from a simple average of the TSR growth of 10 companies is required. For grants in 2012, an average index volatility and correlation of 32 per cent and 76 per cent respectively, were used. For the GPSP, market implied volatilities are used for both Prudential and the components of the index. Changes to the subjective input assumptions could materially affect the fair value estimate.
d Share-based payment expense charged to the income statement
Total expense recognised in the year in the consolidated financial statements related to share-based compensation is as follows:
2012 Łm 2011 Łm
Share-based compensation expense 58 48
Amount accounted for as equity-settled 42 44
Carrying value at 31 December of liabilities arising from share-based payment transactions 24 15
Intrinsic value of above liabilities for which rights had vested at 31 December 16 6
I5: Key management remuneration
Key management constitutes the directors of Prudential plc as they have authority and responsibility for planning, directing and
controlling the activities of the Group.
Total key management remuneration can be broken down in the following table:
2012 Ł 2011 Ł
Salaries and short-term benefits 13,793,000 12,192,000
Post-employment benefits 1,206,000 1,189,000
Share-based payments 11,787,000 9,734,000
26,786,000 23,115,000
Post-employment benefits comprise the change in the transfer value of the accrued benefit relating to directors’ defined benefit
pension schemes in the year and the total contributions made to directors’ other pension arrangements. Other
The share-based payments charge is the sum of Ł7,992,000 (2011: Ł6,571,000), which is determined in accordance with IFRS 2,
‘Share-based payments’ (see note I4) and Ł3,795,000 (2011: Ł3,163,000) of deferred share awards. notes
Total key management remuneration includes total directors’ emoluments of Ł18,505,000 (2011: Ł16,212,000) as shown in the
directors’ remuneration table and related footnotes in the directors’ remuneration report, and additional amounts in respect of
pensions and share-based payments. Further information on directors’ remuneration is given in the directors’ remuneration report. Financial
statements
312 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I6: Fees payable to auditor
2012 Łm 2011 Łm
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts 2.0 2.1
Fees payable to the Company’s auditor and its associates for other services:
Audit of subsidiaries pursuant to legislation 6.5 6.1
Audit-related assurance services 3.2 2.6
Tax compliance services 0.5 0.6
Other assurance services 0.5 0.5
Services relating to corporate finance transactions 0.4 0.5
All other services 1.2 0.3
Total 14.3 12.7
In addition, there were fees incurred of Ł0.1 million (2011: Ł0.1 million) for the audit of pension schemes.
The above audit fees for 2012 and 2011, reflect the new disclosure requirements of SI2011/2198 – The Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) (Amendment) Regulations 2011.
The Audit Committee regularly monitors the non-audit services provided to the Group by its auditor and has developed a formal Auditor Independence Policy which sets out the types of services that the auditor may provide, consistent with the guidance in Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’ and with the provisions of the US Sarbanes-Oxley Act.
The Audit Committee annually reviews the auditor’s objectivity and independence. More information on these issues is given in the corporate governance report within this Annual Report.
I7: Related party transactions
Transactions between the Company and its subsidiaries are eliminated on consolidation.
In addition, the Company has transactions and outstanding balances with certain unit trusts, Open-Ended Investment Companies (OEICs), collateralised debt obligations and similar entities which are not consolidated and where a Group company acts as manager. These entities are regarded as related parties for the purposes of IAS 24. The balances are included in the Group’s statement of fi nancial position sheet at fair value or amortised cost in accordance with their IAS 39 classifications. The transactions are included in the income statement and include amounts paid on issue of shares or units, amounts received on cancellation of shares or units and paid in respect of the periodic charge and administration fee. Further details of the aggregate assets, liabilities, revenues, profits or losses and reporting dates of entities considered to be associates under IFRS are disclosed in note H8.
Executive officers and directors of the Company may from time to time purchase insurance, asset management or annuity products marketed by Group companies in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with other persons.
In 2012 and 2011, other transactions with directors were not deemed to be significant both by virtue of their size and in the context of the directors’ fi nancial positions. As indicated above, all of these transactions are on terms broadly equivalent to those that prevail in arm’s length transactions.
Apart from these transactions with directors, 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 I5.
Notes on the Group fi nancial statements Prudential plc Annual Report 2012 313
I8: Subsidiary undertakings
i Principal subsidiaries
The principal subsidiary undertakings of the Company at 31 December 2012, all wholly owned were:
Main activity Country of incorporation
The Prudential Assurance Company Limited Insurance England and Wales
Prudential Annuities Limited* Insurance England and Wales
Prudential Retirement Income Limited (PRIL)* Insurance Scotland
M&G Investment Management Limited* Asset management England and Wales
Jackson National Life Insurance Company* Insurance US
Prudential Assurance Company Singapore (Pte) Limited* Insurance Singapore
* Owned by a subsidiary undertaking of the Company.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for PRIL which operates
mainly in England and Wales.
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.
ii Dividend restrictions and minimum capital requirements
Certain Group subsidiaries are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or
otherwise to the parent company. UK insurance companies are required to maintain solvency margins which must be supported by
capital reserves and other resources, including unrealised gains on investments. Jackson can pay dividends on its capital stock only
out of earned surplus unless prior regulatory approval is obtained. Furthermore, without the prior regulatory approval, dividends
cannot be distributed if all dividends made within the preceding 12 months exceed the greater of Jackson’s statutory net gain from
operations or 10 per cent of Jackson’s statutory surplus for the prior year. In 2013, the maximum amount of dividends that could be
paid by the US insurance sub-group, subject to the availability of earned surplus, without prior regulatory approval is US$352 million
(Ł216 million) (in 2012: US$411 million (Ł264 million)). The Group’s subsidiaries in Asia may remit dividends to the Group, in general,
provided the statutory insurance fund meets the capital adequacy standard required under local statutory regulations and has
sufficient distributable reserves.
The Group capital position statement for life assurance businesses is set out in note D5, showing the available capital reflecting
the excess of regulatory basis over liabilities for each fund or group of companies determined by reference to the local regulation
of the subsidiaries. In addition, disclosure is also provided in note D5 of the local capital requirement of each of the fund or group
of companies.
I9: Commitments
i Operating leases
The Group leases various offices to conduct its business. Leases in which a significant portion of the risks and rewards of ownership
are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received
from the lessor) are charged to the income statement on a straight-line basis over the period of the lease. I:
2012 Łm 2011 Łm Other
Future minimum lease payments for non-cancellable operating leases fall due during the following notes
periods:
Not later than 1 year 74 66
Later than 1 year and not later than 5 years 199 173
Later than 5 years 116 72 Financial
The total minimum future sublease rentals to be received on non-cancellable operating leases for land and buildings for the
year ended 31 December 2012 were Ł18 million (2011: Ł18 million). statements
Minimum lease rental payments for the year ended 31 December 2012 of Ł73 million (2011: Ł74 million) are included in the
consolidated income statement.
ii Capital commitments
The Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. The contractual obligations to purchase or develop investment properties at 31 December 2012 were Ł5 million (2011: Ł9 million).
314 Financial statements Prudential plc Annual Report 2012
I: Other notes continued
I10: Cash fl ows
Structural borrowings of shareholder-financed operations comprise of core debt of the parent company, the PruCap bank loan and Jackson surplus notes. Core debt excludes borrowings to support short-termfixed income securities programmes, non-recourse borrowings of investment subsidiaries of shareholder-financed operations and other borrowings of shareholder-financed operations. Cash fl ows in respect of these borrowings are included within cashflows from operating activities.
Structural borrowings of with-profits operations relate solely to the Ł100 million 8.5 per cent undated subordinated guaranteed bonds which contribute to the solvency base of the Scottish Amicable Insurance Fund (SAIF), a ring-fenced sub-fund of the PAC with-profi ts fund. Cash fl ows in respect of other borrowings of with-profits funds, which principally relate to consolidated investment funds, are included within cash fl ows from operating activities.
I11: Post balance sheet events
In January 2013, the Company issued US$700 million 5.25 per cent Tier 1 perpetual subordinated capital securities. The proceeds, net of costs, were US$689 million. The Company also repaid on maturity, the Ł250 million Medium-Term Notes 2013, included within operational borrowings in note H13 in January 2013.
Parent company fi nancial statements Prudential plc Annual Report 2012 315
Balance sheet of the parent company
31 December 2012 Note 2012 Łm 2011 Łm
Fixed assets
Investments:
Shares in subsidiary undertakings 5 11,929 10,902
Loans to subsidiary undertakings 5 1,164 1,200
13,093 12,102
Current assets
Debtors:
Amounts owed by subsidiary undertakings 3,208 6,122
Deferred tax 6 47 364
Other debtors 3 11
Derivative assets 8 3 3
Cash at bank and in hand 193 152
3,454 6,652
Less liabilities: amounts falling due within one year
Commercial paper 7(1,535)(2,706)
Other borrowings 7(450)(200)
Derivative liabilities 8(190)(207)
Amounts owed to subsidiary undertakings(1,705)(1,049)
Tax payable(103)(198)
Sundry creditors(19)(19)
Accruals and deferred income(46)(46)
(4,048)(4,425)
Net current (liabilities) assets(594) 2,227
Total assets less current liabilities 12,499 14,329
Less liabilities: amounts falling due after more than one year
Subordinated liabilities 7(2,577)(2,652)
Debenture loans 7(549)(549)
Other borrowings 7(299)(250)
Amounts owed to subsidiary undertakings(2,576)(3,560)
(6,001)(7,011)
Total net assets (excluding pension) 6,498 7,318
Pension asset (net of related deferred tax) 9 38 39
Total net assets (including pension) 6,536 7,357 Parent
Capital and reserves
Share capital 10 128 127 company
Share premium 10 1,889 1,873
Profit and loss account 11 4,519 5,357
Shareholders’ funds 11 6,536 7,357 Financial
The financial statements of the parent company on pages 315 to 323 were approved by the Board of directors on 12 March 2013 and
signed on its behalf. statements
[Graphic Appears Here]
Paul Manduca Tidjane Thiam Nic Nicandrou
Chairman Group Chief Executive Chief Financial Officer
316 Financial statements Prudential plc Annual Report 2012
Notes on the parent company fi nancial statements
1 Nature of operations
Prudential plc (the Company) is a parent holding company. The Company together with its subsidiaries (collectively, the Group) is an internationalfinancial services group with its principal operations in Asia, the US and the UK. In Asia, the Group has operations in Hong Kong, Malaysia, Singapore, Indonesia and other Asian countries. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company. In the UK, the Group operates through its subsidiaries, primarily The Prudential Assurance Company Limited, Prudential Annuities Limited, Prudential Retirement Income Limited and M&G Investment Management Limited. The Company is responsible for thefinancing of each of its subsidiaries.
2 Basis of preparation
Thefinancial statements of the Company, which comprise the balance sheet and related notes, are prepared in accordance with Part 15 of the Companies Act 2006, which applies to companies generally. The Company has taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profit and loss account.
Thefinancial statements are prepared in accordance with applicable accounting standards under UK Generally Accepted Accounting Practice (UK GAAP), including Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP).
The Company has not prepared a cash flow statement on the basis that its cash flow is included within the cash flow statement in the consolidatedfinancial statements. The Company has also taken advantage of the exemption within FRS 29, ‘Financial Instruments: Disclosures’, from the requirements of this standard on the basis that the Company’s results are included in the publicly available consolidatedfinancial statements of the Group that include disclosures that comply with IFRS 7, ‘Financial Instruments: Disclosures’, which is equivalent to FRS 29.
The Company adopted the ‘Amendment to FRS 29 (IFRS 7) – Financial Instruments: Disclosures – Transfers of Financial Assets’ in 2012. The adoption of this amendment did not have an impact on the fi nancial statements of the Company.
3 Signifi cant accounting policies
Shares in subsidiary undertakings
Shares in subsidiary undertakings are shown at the lower of cost and estimated realisable value.
Loans to subsidiary undertakings
Loans to subsidiary undertakings are shown at cost, less provisions.
Derivatives
Derivativefinancial instruments are held to manage interest rate and currency profiles. Derivativefinancial instruments are carried at fair value with changes in fair value included in the profit and loss account.
Under FRS 26, ‘Financial Instruments: Recognition and Measurement’, hedge accounting is permissible only if certain criteria are met regarding the establishment of documentation and continued measurement of hedge effectiveness. For derivative fi nancial instruments designated as fair value hedges, the movements in the fair value are recorded in the profit and loss account with the accompanying change in fair value of the hedged item attributable to the hedged risk.
Borrowings
Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profit and loss account to the date of maturity, or, for hybrid debt, over the expected life of the instrument.
Dividends
Interim dividends are recorded in the period in which they are paid. Final dividends are recorded in the period in which they are approved by shareholders.
Share premium
The difference between the proceeds received on issue of shares and the nominal value of the shares issued is credited to the share premium account.
Notes on the parent company fi nancial statements Prudential plc Annual Report 2012 317
Foreign currency translation
Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas
subsidiaries are translated at year end exchange rates. The impact of these currency translations is recorded within the profit and loss
account for the year.
Other assets and liabilities denominated in foreign currencies are also converted at year end exchange rates with the related
foreign currency exchange gains or losses reflected in the profit and loss account for the year.
Tax
Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of
taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year, they can
be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19, ’Deferred tax’. The Company has
chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to reflect the time value of
money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed
by the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be
recovered.
The Group’s UK subsidiaries each file separate tax returns. In accordance with UK tax legislation, where one domestic UK company
is a 75 per cent owned subsidiary of another UK company or both are 75 per cent owned subsidiaries of a common parent, the
companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses
arising in the same accounting period may be offset for the purposes of determining current and deferred taxes.
Pensions
The Company assumes a portion of the pension surplus or deficit of the Group’s main pension scheme, the Prudential Staff Pension
Scheme (PSPS) and applied the requirements of FRS 17, ‘Retirement Benefits’ (as amended in December 2006) to its interest in the
PSPS surplus or deficit. Further details are disclosed in note 9.
A pension surplus or deficit is recorded as the difference between the present value of the scheme liabilities and the fair value of
the scheme assets. The Company’s share of pension surplus is recognised to the extent that the Company is able to recover a surplus
either through reduced contributions in the future or through refunds from the scheme.
The assets and liabilities of the defined benefit pension schemes of the Prudential Group are subject to a full triennial actuarial
valuation using the projected unit method. Estimated future cash flows are then discounted at a high quality corporate bond rate,
adjusted to allow for the difference in duration between the bond index and the pension liabilities where appropriate, to determine
its present value. These calculations are performed by independent actuaries.
The aggregate of the actuarially determined service costs of the currently employed personnel and the unwind of the discount
on liabilities at the start of the period, gains and losses on settlements and curtailments, less the expected investment return on the
scheme assets at the start of the period, is recognised in the profit and loss account. To the extent that part or all of the Company’s
interest in the pension surplus is not recognised as an asset, the unrecognised surplus is initially applied to extinguish any past service
costs, losses on settlements or curtailments that would otherwise be included in the profit and loss account. Next, the expected
investment return on the scheme’s assets is restricted so that it does not exceed the total of the current service cost, interest cost
and any increase in the recoverable surplus. Any further adjustment for the unrecognised surplus is treated as an actuarial gain or loss.
Actuarial gains and losses as a result of the changes in assumptions, the difference between actual and expected investment return
on scheme assets and experience variances are recorded in the statement of total recognised gains and losses. Actuarial gains and
losses also include adjustment for unrecognised pension surplus as described above. Parent
Share-based payments
The Group offers share award and option plans for certain key employees and a SAYE plan for all UK and certain overseas employees.
The share-based payment plans operated by the Group are mainly equity-settled plans with a few cash-settled plans. company
Under FRS 20, ‘Share-based payment’, where the Company, as the parent company, has the obligation to settle the options or
awards of its equity instruments to employees of its subsidiary undertakings, and such share-based payments are accounted for as
equity-settled in the Group financial statements, the Company records an increase in the investment in subsidiary undertakings for
the value of the share options and awards granted with a corresponding credit entry recognised directly in equity. The value of the Financial
share options and awards granted is based upon the fair value of the options and awards at the grant date, the vesting period and the
vesting conditions. statements
318 Financial statements Prudential plc Annual Report 2012
Notes on the parent company fi nancial statements continued
4 Reconciliation from UK GAAP to IFRS
The Companyfinancial statements are prepared in accordance with UK GAAP and the consolidatedfinancial statements are prepared in accordance with IFRS as issued by the IASB and endorsed by the EU. The tables below provide a reconciliation between UK GAAP and IFRS.
2012 Łm 2011 Łm
Profit after tax
(Loss) profit for the financial year of the Company in accordance with UK GAAP(216) 3,720
IFRS adjustment* 71(5)
(Loss) profit for the financial year of the Company (including dividends from subsidiaries) in accordance
with IFRS(145) 3,715
Share in the IFRS result of the Group, net of distributions to the Company† 2,342(2,300)
Profit after tax of the Group attributable to shareholders in accordance with IFRS 2,197 1,415
2012 Łm 2011 Łm
Net equity
Shareholders’ equity of the Company in accordance with UK GAAP 6,536 7,357
IFRS adjustment* –(44)
Shareholders’ equity of the Company in accordance with IFRS 6,536 7,313
Share in the IFRS net equity of the Group† 3,823 1,251
Shareholders’ equity of the Group in accordance with IFRS 10,359 8,564
* ‘IFRS adjustment’ in the above tables represent the diff erence in the accounting treatment for pension schemes between UK GAAP and IFRS.
† The ‘shares in the IFRS result and net equity of the Group’ lines represent the Company’s equity in the earnings and net assets of its subsidiaries and associates.
The (loss) profit for thefinancial year of the Company in accordance with UK GAAP and IFRS includes dividends declared in the year from subsidiary undertakings of Ł501 million and Ł4,002 million for the years ended 31 December 2012 and 2011, respectively.
As stated in note 3, under UK GAAP, the Company accounts for its investments in subsidiary undertakings at the lower of cost and estimated realisable value. For the purpose of this reconciliation, no adjustment is made to the Company in respect of any valuation adjustments to shares in subsidiary undertakings which would be eliminated on consolidation.
5 Investments of the Company
2012 Łm
Shares in Loans to
subsidiary subsidiary
undertakings undertakings
At 1 January 10,902 1,200
Transfer of investment in subsidiary undertaking(3,889) –
Investment in subsidiary undertaking 4,930 –
Other movements(14) –
Foreign exchange movement –(36)
At 31 December 11,929 1,164
In January 2012, as part of an internal restructuring, the Company transferred at fair value, interests of Ł3,889 million in shares in a central subsidiary undertaking and Ł2,007 million of loans to a second such subsidiary to another central subsidiary in exchange for shares issued by that subsidiary of Ł4,930 million, and settlement of an amount owed to that subsidiary of Ł966 million. No profi t or loss arose on the transfer.
Other movements comprise Ł6 million in respect of share-based payments refl ecting the value of payments settled by the Company for employees of its subsidiary undertakings in 2012 offset by cash of Ł20 million received from those subsidiaries.
The principal subsidiary undertakings of the Company at 31 December 2012 are disclosed in note I8(i) ‘Subsidiary undertakings –Principal subsidiaries’ of the Group fi nancial statements.
Notes on the parent company fi nancial statements Prudential plc Annual Report 2012 319
| 6 |
|
Deferred tax asset |
2012 Łm 2011 Łm
Short-term timing differences 3 6
Unused deferred tax losses 44 358
Total 47 364
Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all
available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal
of the underlying temporary differences can be deducted.
For each category of deferred tax asset recognised, its recoverability against forecast taxable profits is not significantly impacted
by expected changes to accounting standards.
The UK government’s tax rate change to 23 per cent has had the effect of reducing the Company’s net deferred tax balance
at 31 December 2012 by Ł3 million. The change to 23 per cent is effective from 1 April 2013 but is substantively enacted as at
31 December 2012. The subsequent proposed rate change to 21 per cent by 1 April 2014 is not expected to have a material effect
on the deferred tax balance recognised at 31 December 2012.
| 7 |
|
Borrowings |
Core structural borrowings Other borrowings Total
2012 Łm 2011 Łm 2012 Łm 2011 Łm 2012 Łm 2011 Łm
Core structural borrowingsnotes (i) and (v) 3,126 3,201 – – 3,126 3,201
Other borrowings:
Commercial paper note (ii) – – 1,535 2,706 1,535 2,706
Floating Rate Notes 2013note (iii) – – 200 200 200 200
Medium-Term Notes 2013notes (ii) and (v) – – 250 250 250 250
Medium-Term Notes 2015note (ii) – – 299 – 299 –
Total borrowings 3,126 3,201 2,284 3,156 5,410 6,357
Borrowings are repayable as follows:
Within 1 year or on demand – – 1,985 2,906 1,985 2,906
Between 1 and 5 years – – 299 250 299 250
After 5 years 3,126 3,201 – – 3,126 3,201
3,126 3,201 2,284 3,156 5,410 6,357
Recorded in the balance sheet as: Parent
Subordinated liabilitiesnote (iv) 2,577 2,652
Debenture loans 549 549
3,126 3,201 company
Notes
(i) Further details on the core structural borrowings of the Company of Ł3,126 million (2011: Ł3,201 million) are provided in note H13 ‘Borrowings’ of the
Group financial statements.
(ii) These borrowings support a short-term fixed income securities programme. Financial
(iii) The Company issued Ł200 million Floating Rate Notes in 2012 which mature in April 2013. All Notes have been subscribed to by a Group subsidiary and
accordingly have been eliminated on consolidation in the Group financial statements. These Notes were originally issued in October 2008 and have been
reissued upon their maturity.
(iv) The interests of the holders of the subordinated liabilities are subordinate to the entitlements of other creditors of the Company. statements
(v) In January 2013, the Company issued core structural borrowings of US$700 million 5.25 per cent Tier 1 perpetual subordinated capital securities.
The proceeds, net of costs, were US$689 million. Also in January 2013, the Company repaid the Ł250 million Medium-Term Notes 2013 on maturity.
320 Financial statements Prudential plc Annual Report 2012
Notes on the parent company fi nancial statements continued
8 Derivative financial instruments
2012 Łm 2011 Łm
Fair value Fair value Fair value Fair value
assets liabilities assets liabilities
Cross-currency swap 3 – 3 –
Inflation-linked swap – 190 – 207
Total 3 190 3 207
Derivativefinancial instruments are held to manage interest rate and currency profiles. The change in fair value of the derivative
• nancial instruments of the Company was a gain before tax of Ł17 million (2011: loss before tax of Ł75 million).
The derivative financial instruments are valued internally using standard market practices. In accordance with the Company’s risk
management framework, all internally generated valuations are subject to independent assessment against external counterparties’ valuations.
9 Pension scheme fi nancial position
The majority of UK Prudential staff are members of the Group’s pension schemes. The largest scheme is the Prudential Staff Pension Scheme (the ‘Scheme’) which is primarily a closed defi ned benefit scheme.
For the purpose of preparing consolidatedfinancial statements, the Group applies IFRS basis accounting including IAS 19,
‘Employee Benefi ts’ as described further in note I3 ‘Staff and pension plans’ of the Group fi nancial statements (note I3). Although the individual accounts of the Company continue to follow UK GAAP, the disclosures under FRS 17, ‘Retirement Benefi ts’ are aligned with IAS 19.
At 31 December 2005, the allocation of surpluses and deficits attaching to the Scheme between the Company and the unallocated surplus of the The Prudential Assurance Company Limited (PAC) with-profits fund was apportioned in the ratio 30/70 following detailed consideration of the sourcing of previous contributions. This ratio was applied to the base deficit position at 1 January 2006 and for the purpose of determining the allocation of the movements in that position up to 31 December 2012. The FRS 17 service charge and ongoing employer contributions are allocated by reference to the cost allocation for current activity.
The last completed triennial actuarial valuation of the Scheme was as at 5 April 2011. Further details on the results of this valuation and the total employer contributions to the Scheme for the year are provided in note I3, together with the key assumptions adopted, including mortality assumptions.
Using external actuarial advice provided by the professionally qualified actuaries, Towers Watson, for the valuation of the Scheme, the most recent full valuations have been updated to 31 December 2012 applying the principles prescribed by FRS 17. The long-term expected rates of return have been determined after applying due consideration to the requirements of paragraph 54 of FRS 17, in particular, taking account of the values of the assets, and are set out below:
Prospectively
for 2013 % 2012 % 2011 %
Equities 6.7 6.8 8.2
Bonds 2.8 3.0 4.6
Properties 5.5 5.55 6.9
Other assets 2.0 2.0 4.75
Weighted average long-term expected rate of return 2.9 3.1 5.1
Notes on the parent company fi nancial statements Prudential plc Annual Report 2012 321
The assets and liabilities of the Scheme were:
31 Dec 2012 31 Dec 2011 31 Dec 2010 31 Dec 2009 31 Dec 2008
Łm% Łm% Łm% Łm% Łm%
Equities 43 0.7 210 3.3 548 10.3 830 16.8 823 17.1
Bonds 5,440 81.2 5,547 86.2 3,864 72.2 3,406 68.8 2,430 50.6
Properties 290 4.5 297 4.6 199 3.7 272 5.5 283 5.9
Other assets 627 13.6 378 5.9 740 13.8 441 8.9 1,267 26.4
Total value of assets 6,400 100.0 6,432 100.0 5,351 100.0 4,949 100.0 4,803 100.0
Present value of Scheme
liabilities(5,226)(4,844)(4,866)(4,436)(4,075)
Underlying surplus in the
Scheme 1,174 1,588 485 513 728
Surplus in the Scheme
recognised by the
Company 49 52 56 52 50
Amounts reflected in the balance sheet of the Company, net of deferred tax 38 39 41 37 36
The surplus in the Scheme recognised in the balance sheet of the Company represents the element of the amount which is recoverable through reduced future contributions and is net of the apportionment to the PAC with-profits fund.
Underlying Scheme liabilities and assets
The change in the present value of the underlying Scheme liabilities and the change in the fair value of the underlying Scheme assets are as follows:
2012 Łm 2011 Łm
Present value of Scheme liabilities, at 1 January 4,844 4,866
Current service cost 21 22
Past service cost* 106(216)
Interest cost 227 254
Employee contributions 1 1
Actuarial losses 252 131
Benefit payments(225)(214)
Present value of Scheme liabilities, at 31 December 5,226 4,844 Parent
* The past service cost in 2012 of Ł106 million resulted from an exceptional discretionary increase to pensions in payment of the Scheme awarded during the year.
The negative past service cost in 2011 of Ł216 million related to the effect of the change of the basis of indexation from Retail Price Index to Consumer Price Index. company
2012 Łm 2011 Łm
Fair value of Scheme assets, at 1 January 6,432 5,351
Expected return on Scheme assets 201 267
Employee contributions 1 1 Financial
Employer contributions† 36 54
Actuarial (losses) gains(45) 973
Benefit payments(225)(214) statements
Fair value of Scheme assets, at 31 December 6,400 6,432
† The contributions include defi cit funding, ongoing service contributions and expenses.
322 Financial statements Prudential plc Annual Report 2012
Notes on the parent company fi nancial statements continued
9 Pension scheme financial position continued
Pension (charge) credit and actuarial (losses) gains of the Scheme and attributable to the Company
The pension (charge) credit of the Scheme and the charge recognised in the Company’s profit and loss account are as follows:
Pension (charge) credit: 2012 Łm 2011 Łm
Operating charge:
Current service cost(21)(22)
Past service cost(106) 216
Finance (expense) income:
Interest on Scheme liabilities(227)(254)
Expected return on Scheme assets 201 267
(26) 13
Total pension (charge) credit of the Scheme(153) 207
Pension charge attributable to the Company(53)(10)
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. In 2011, an amount of Ł65 million was applied to extinguish the negative past service cost attributable to the Company from the unrecognised portion of the pension surplus at 31 December 2011. No adjustment was made to the pension charge in 2012 relating to the unrecognised portion of the Scheme’s surplus.
Actuarial (losses) gains: 2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm
Actual less expected return on Scheme assets (1% (2011: 15%)
(2010: 5%) (2009: 2%) (2008: 5%) of assets)(45) 973 275 85(259)
Experience (losses) gains on Scheme liabilities (0% (2011: 6%)
(2010: 0%) (2009: 1%) (2008: 3%) of liabilities)(19) 295 1 59 127
Changes in assumptions underlying the present value of
Scheme liabilities(233)(426)(370)(374) 200
Total actuarial (losses) gains (6% (2011: 17%) (2010: 2%)
(2009: 5%) (2008: 2%) of the present value of
Scheme liabilities)(297) 842(94)(230) 68
Actuarial gains (losses) attributable to the Company before tax 35(16)(14)(3)(143)
The total actual return on Scheme assets was a gain of Ł156 million (2011: Ł1,240 million).
The experience gains on Scheme liabilities in 2011 of Ł295 million related mainly to the ‘true-up’ refl ecting improvements in data consequent upon the 2011 triennial valuation of the Scheme. Similarly, the experience gains of Ł127 million in 2008 were related mainly to the improvements in the data consequent to the 2008 triennial valuation.
The actuarial gains (losses) attributable to the Company are net of the apportionment to the PAC with-profits fund and are related to the surplus recognised in the balance sheet of the Company. In 2012, the actuarial losses attributable to the Company included an amount credited of Ł124 million (2011: amount charged of Ł268 million) for the adjustment to the unrecognised portion of surplus which has not been deducted from the pension charge.
The actuarial gains before tax of Ł35 million (2011: losses of Ł16 million) attributable to the Company are recorded in the statement of total recognised gains and losses. Cumulative actuarial gains as at 31 December 2012 amount to Ł93 million (2011: Ł58 million).
Total employer contributions expected to be paid into the Scheme for the year ending 31 December 2013 amount to Ł11 million, refl ecting the annual accrual cost and expenses.
Notes on the parent company fi nancial statements Prudential plc Annual Report 2012 323
10 Share capital and share premium
A summary of the ordinary shares in issue and the options outstanding to subscribe for the Company’s shares at 31 December 2012 is set out in note H11 ‘Shareholders’ equity: share capital, share premium and reserves’ of the Group fi nancial statements.
11 Profi t of the Company and reconciliation of the movement in shareholders’ funds
The loss after tax of the Company for the year was Ł216 million (2011: profi t of Ł3,720 million). After dividends of Ł655 million (2011: Ł642 million), actuarial gains net of tax in respect of the pension scheme of Ł27 million (2011: losses of Ł12 million) and share-based payment credits of Ł6 million (2011: Ł7 million), retained profi t at 31 December 2012 amounted to Ł4,519 million (2011: Ł5,357 million). Retained profi t includes Ł2,734 million relating to gains made by an intermediate holding company following the transfer at fair value of certain of its subsidiaries to other parts of the Group as part of an internal restructuring exercise in 2011. Because the gains relate to intragroup transactions, the amount of Ł2,734 million is not able to be regarded as part of the distributable reserves of the parent company. Under English company law, Prudential may pay dividends only if suffi cient distributable reserves of the Company are available for the purpose and if the amount of its net assets is greater than the aggregate of its called up share capital and undistributable reserves (such as for example the share premium account) and the payment of the dividend does not reduce the amount of its net assets to less than that aggregate. At 31 December 2012, the UK GAAP retained earnings of the holding company from which distributable reserves may be derived were Ł4,519 million.
A reconciliation of the movement in shareholders’ funds of the Company for the years ended 31 December 2012 and 2011 is given below:
2012 Łm 2011 Łm
(Loss) profit for the year note 4(216) 3,720
Dividends(655)(642)
(871) 3,078
Actuarial gains (losses) recognised in respect of the pension scheme, net of related taxnote 9 27(12)
Share-based paymentsnote 5 6 7
New share capital subscribed 17 17
Net (decrease) increase in shareholders’ funds(821) 3,090
Shareholders’ funds at beginning of year 7,357 4,267
Shareholders’ funds at end of year note 4 6,536 7,357
12 Other information
a Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note I5
‘Key management remuneration’ of the Group financial statements.
b Information on transactions of the directors with the Group is given in note I7 ‘Related party transactions’ of the Group financial
statements.
c The Company employs no staff. Parent
d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were Ł0.1 million (2011: Ł0.1 million) and
for other services were Ł0.6 million (2011: Łnil).
e In certain instances the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment. company
13 Post balance sheet events Financial
In January 2013, the Company issued US$700 million 5.25 per cent Tier 1 perpetual subordinated capital securities. The proceeds,
net of costs, were US$689 million. Also in January 2013, the Company repaid Ł250 million Medium-Term Notes 2013 on maturity.
Subject to shareholders’ approval, in May 2013 the Company will pay a final dividend for the year ended 31 December 2012.
Further details are provided in note B3 ‘Dividends’ of the Group financial statements. statements
324 Financial statements Prudential plc Annual Report 2012
Statement of directors’ responsibilities in respect of the annual report and the fi nancial statements
The directors are responsible for preparing the Annual Report and the Group and parent company fi nancial statements in accordance with applicable law and regulations.
Company law requires the directors to prepare Group and parent companyfinancial statements for eachfinancial year. Under that law the directors are required to prepare the Groupfinancial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and applicable law and have elected to prepare the parent companyfinancial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice).
Under company law the directors must not approve thefinancial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In preparing each of the Group and parent companyfinancial statements, the directors are required to:
Select suitable accounting policies and then apply them consistently; Make judgements and estimates that are
reasonable and prudent; For the Groupfinancial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; For the parent companyfinancial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent companyfinancial statements; and Prepare thefinancial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business.
The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the parent company’s transactions and disclose with reasonable accuracy at any time thefinancial position of the parent company and enable them to ensure that itsfinancial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.
Under applicable law and regulations, the directors are also responsible for preparing a directors’ report, directors’ remuneration report and corporate governance statement that comply with that law and those regulations.
The directors are responsible for the maintenance and integrity of the corporate andfinancial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of fi nancial statements may differ from legislation in other jurisdictions.
The directors of Prudential plc, whose names and positions are set out on pages 88 to 92 confirm that to the best of their knowledge:
Thefinancial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities,financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and The directors’ report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
Statement of directors’ responsibilities/Independent auditor’s report Prudential plc Annual Report 2012 325
Independent auditor’s report to the members of Prudential plc
We have audited the financial statements of Prudential Opinion on other matters prescribed by the Companies
plc for the year ended 31 December 2012 set out on Act 2006
pages 147 to 323. The financial reporting framework In our opinion:
that has been applied in the preparation of the Group
financial statements is applicable law and The part of the Directors’ Remuneration Report to be audited
International Financial Reporting Standards (IFRSs) as has been properly prepared in accordance with the
adopted by the EU. The financial reporting framework Companies Act 2006; and
that has been applied in the preparation of the parent The information given in the Directors’ Report for the financial
company financial statements is applicable law and year for which the financial statements are prepared is
UK Accounting Standards (UK Generally Accepted consistent with the financial statements.
Accounting Practice).
This report is made solely to the Company’s members, as a body,
in accordance with Chapter 3 of Part 16 of the Companies Act
2006. Our audit work has been undertaken so that we might
state to the Company’s members those matters we are required
to state to them in an auditor’s report and for no other purpose.
To the fullest extent permitted by law, we do not accept or
assume responsibility to anyone other than the Company and
the Company’s members, as a body, for our audit work, for this
report, or for the opinions we have formed.
Respective responsibilities of directors and auditor
As explained more fully in the Directors’ Responsibilities
Statement set out on page 324, the directors are responsible for
the preparation of the financial statements and for being satisfied
that they give a true and fair view. Our responsibility is to audit,
and express an opinion on, the financial statements in accordance
with applicable law and International Standards on Auditing
(UK and Ireland). Those standards require us to comply with the
Auditing Practices Board’s (APB’s) Ethical Standards for Auditors.
Scope of the audit of the financial statements
A description of the scope of an audit of financial statements is
provided on the APB’s website at www.frc.org.uk/apb/scope/
private.cfm
Directors’
Opinion on financial statements
Matters on which we are required to report by exception
We have nothing to report in respect of the following:
Under the Companies Act 2006 we are required to report
to you if, in our opinion:
Adequate accounting records have not been kept by the
parent company, or returns adequate for our audit have
not been received from branches not visited by us; or
The parent company financial statements and the part of
the Directors’ Remuneration Report to be audited are not
in agreement with the accounting records and returns; or
Certain disclosures of directors’ remuneration specified
by law are not made; or
We have not received all the information and explanations
we require for our audit.
Under the Listing Rules we are required to review:
The directors’ statement, set out on page 110, in relation
to going concern;
The part of the Corporate Governance Statement set out in
the Governance report relating to the Company’s compliance
with the nine provisions of the UK Corporate Governance
Code specified for our review; and
Certain elements of the report to shareholders by the Board
on directors’ remuneration.
In our opinion:
The financial statements give a true and fair view of the state
of the Group’s and of the parent company’s affairs as at
31 December 2012 and of the Group’s profit for the year then
ended;
The Group financial statements have been properly prepared responsibilities/auditor’s
in accordance with IFRSs as adopted by the EU;
The parent company financial statements have been properly report
prepared in accordance with UK Generally Accepted
Accounting Practice; and
The financial statements have been prepared in accordance
with the requirements of the Companies Act 2006; and, Financial
as regards the Group financial statements, Article 4 of the
IAS Regulation. statements
Rees Aronson
Senior Statutory Auditor
for and on behalf of KPMG Audit Plc, Statutory Auditor
Chartered Accountants
London
12 March 2013
326 Financial statements Prudential plc Annual Report 2012
European Embedded Value (EEV) basis results
Operating profit based on longer-term investment returnsnote (i)
Results analysis by business area
Note 2012 Łm 2011 Łm
note (v)
Asia operations
New business 2 1,266 1,076
Business in force 3 694 688
Long-term business 1,960 1,764
Eastspring Investments 75 80
Development expenses(7)(5)
Total 2,028 1,839
US operations
New business 2 873 815
Business in force 3 737 616
Long-term business 1,610 1,431
Broker-dealer and asset management 39 24
Total 1,649 1,455
UK operations
New business 2 313 260
Business in force 3 553 593
Long-term business 866 853
General insurance commission 33 40
Total UK insurance operations 899 893
M&G 371 357
Total 1,270 1,250
Other income and expenditure
Investment return and other income 13 22
Interest payable on core structural borrowings(280)(286)
Corporate expenditure(231)(219)
Unwind of expected asset management marginnote (ii)(56)(53)
Total(554)(536)
RPI to CPI inflation measure change on defined benefit pension schemesnote (iii) – 45
Solvency II implementation costsnote (iv)(50)(56)
Restructuring costsnote (iv)(22)(19)
Operating profit based on longer-term investment returnsnote (i) 4,321 3,978
Analysed as profits (losses) from:
New business 2 2,452 2,151
Business in force 3 1,984 1,897
Long-term business 4,436 4,048
Asset management 485 461
Other results(600)(531)
Total 4,321 3,978
European Embedded Value (EEV) basis results Prudential plc Annual Report 2012 327
Notes
(i) EEV basis operating profit based on longer-term investment returns excludes the recurrent items of short-term fluctuations in investment returns, the mark to market value movements on core borrowings, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, and the effect of changes in economic assumptions. In addition for 2012, operating profit excludes the gain arising on the acquisition of REALIC and the dilution of the Group’s holding in PPM South Africa. The amounts for these items are included in total EEV profit attributable to shareholders. The Company believes that operating profit, as adjusted for these items, better reflects underlying performance. Profit before tax and basic earnings per share include these items together with actual investment returns.
(ii) The value of future profits or losses from asset management and service companies that support the Group’s covered insurance businesses are included in the profits for new business and the in-force value of the Group’s long-term business. The results of the Group’s asset management operations include the profits from the management of internal and external funds. For EEV basis reporting, Group shareholders’ other income is adjusted to deduct the unwind of the expected margin for the year arising from the management of the assets of the covered business (as defined in note 1(a)) by the Group’s asset management businesses. The deduction is on a basis consistent with that used for projecting the results for covered insurance business. Group operating profit accordingly includes the variance between actual and expected profit in respect of management of the covered business assets.
(iii) During 2011, the Group altered its inflation measure basis for future statutory increases to pension payments for certain tranches of its UK defined benefit pension schemes. This reflected the UK Government’s decision to replace the basis of indexation from RPI with CPI. This resulted in a credit to operating profit for 2011 on an IFRS basis of Ł42 million and an additional Ł3 million recognised on the EEV basis.
(iv) Restructuring costs comprise the charge of Ł(19) million recognised on an IFRS basis and an additional Ł(3) million recognised on the EEV basis for the shareholders’ share of restructuring costs incurred by the PAC with-profits fund. Solvency II implementation costs comprise the charge of Ł(48) million recognised on an IFRS basis and an additional Ł(2) million recognised on the EEV basis.
(v) The comparative results have been prepared using previously reported average exchange rates for the year.
EEV basis supplementary information Financial statements
328 Financial statements Prudential plc Annual Report 2012
European Embedded Value (EEV) basis results continued
Summarised consolidated income statement
Note 2012 Łm 2011 Łm
Operating profit based on longer-term investment returns
Asia operations 2,028 1,839
US operations 1,649 1,455
UK operations:
UK insurance operations 899 893
M&G 371 357
1,270 1,250
Other income and expenditure(554)(536)
RPI to CPI inflation measure change on defined benefit pension schemes – 45
Solvency II implementation costs(50)(56)
Restructuring costs(22)(19)
Operating profit based on longer-term investment returns 4,321 3,978
Short-term fluctuations in investment returns 6 538(907)
Mark to market value movements on core borrowings 10(380)(14)
Shareholders’ share of actuarial and other gains and losses on defined benefit
pension schemes 7 62 23
Effect of changes in economic assumptions 8(16)(158)
Gain on dilution of Group’s holdings 4 42 –
Gain on acquisition of REALIC 5 453 –
Profit before tax attributable to shareholders (including actual investment returns) 5,020 2,922
Tax attributable to shareholders’ profit 12(1,207)(776)
Profit for the year 3,813 2,146
Attributable to:
Equity holders of the Company 3,813 2,142
Non-controlling interests – 4
Profit for the year 3,813 2,146
Earnings per share (in pence)
Note 2012 2011
Based on operating profit including longer-term investment returns, after related tax and
non-controlling interests of Ł3,176 million (2011: Ł2,930 million) 13 125.0p 115.7p
Based on profit after tax and non-controlling interests of Ł3,813 million
(2011: Ł2,142 million) 13 150.1p 84.6p
Dividends per share (in pence)
2012 2011
Dividends relating to reporting year:
Interim dividend 8.40p 7.95p
Final dividend 20.79p 17.24p
Total 29.19p 25.19p
Dividends declared and paid in reporting year:
Current year interim dividend 8.40p 7.95p
Final dividend for prior year 17.24p 17.24p
Total 25.64p 25.19p
European Embedded Value (EEV) basis results Prudential plc Annual Report 2012 329
Movement in shareholders’ equity (excluding non-controlling interests)
Note 2012 Łm 2011 Łm
Profit for the year attributable to equity shareholders 3,813 2,142
Items taken directly to equity:
Exchange movements on foreign operations and net investment hedges:
Exchange movements arising during the year(467)(90)
Related tax(2)(68)
Dividends(655)(642)
New share capital subscribed 17 17
Reserve movements in respect of share-based payments 42 44
Treasury shares:
Movement in own shares in respect of share-based payment plans(13)(30)
Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS 36(5)
Mark to market value movements on Jackson assets backing surplus and required capital:
Mark to market value movements arising during the year 53 96
Related tax(18)(34)
Net increase in shareholders’ equity 11 2,806 1,430
Shareholders’ equity at beginning of year (excluding non-controlling interests) 11 19,637 18,207
Shareholders’ equity at end of year (excluding non-controlling interests) 11 22,443 19,637
31 December 2012 Łm 31 December 2011 Łm
Asset Asset
Long-term management Long-term management
business and other business and other
Comprising: operations operations Total operations operations Total
Asia operations:
Net assets of operations 9,462 207 9,669 8,510 211 8,721
Acquired goodwill 239 61 300 235 61 296
9,701 268 9,969 8,745 272 9,017
US operations:
Net assets of operations 6,032 108 6,140 5,082 113 5,195 EEV
Acquired goodwill – 16 16 – 16 16 basis
6,032 124 6,156 5,082 129 5,211
UK insurance operations:
Net assets of operations 6,772 25 6,797 6,058 29 6,087
M&G: supplementary
Net assets of operations – 392 392 – 229 229
Acquired goodwill – 1,153 1,153 – 1,153 1,153
– 1,545 1,545 – 1,382 1,382 information
6,772 1,570 8,342 6,058 1,411 7,469
Other operations:
Holding company net borrowings Financial
at market value –(2,282)(2,282) –(2,188)(2,188)
Other net assets – 258 258 – 128 128
–(2,024)(2,024) –(2,060)(2,060) statements
Shareholders’ equity at end of year
(excluding non-controlling interests) 22,505(62) 22,443 19,885(248) 19,637
Representing:
Net assets (liabilities) 22,266(1,292) 20,974 19,650(1,478) 18,172
Acquired goodwill 239 1,230 1,469 235 1,230 1,465
22,505(62) 22,443 19,885(248) 19,637
330 Financial statements Prudential plc Annual Report 2012
European Embedded Value (EEV) basis results continued
Net asset value per share (in pence)
31 December 31 December
2012 2011
Based on EEV basis shareholders’ equity of Ł22,443 million (2011: Ł19,637 million) 878p 771p
Number of issued shares at year end (millions) 2,557 2,548
Return on embedded value* 16% 16%
* Return on embedded value is based on EEV operating profit after related tax and non-controlling interests, as shown in note 13, as a percentage of opening EEV basis shareholders’ equity.
Summary statement of financial position
31 December 31 December
2012 2011
Note Łm Łm†
Total assets less liabilities, before deduction for insurance funds 274,863 243,207
Less insurance funds:*
Policyholder liabilities (net of reinsurers’ share) and unallocated
surplus of with-profits funds(264,504)(234,643)
Less shareholders’ accrued interest in the long-term business 12,084 11,073
(252,420)(223,570)
Total net assets 11 22,443 19,637
Share capital 128 127
Share premium 1,889 1,873
IFRS basis shareholders’ reserves 8,342 6,564
Total IFRS basis shareholders’ equity 11 10,359 8,564
Additional EEV basis retained profit 11 12,084 11,073
Total EEV basis shareholders’ equity (excluding non-controlling interests) 11 22,443 19,637
* Including liabilities in respect of insurance products classifi ed as investment contracts under IFRS 4.
• For IFRS reporting purposes, the Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the IFRS elements and additional EEV basis shareholders’ interest for the comparative results for 2011 have been adjusted from those previously published for the retrospective application of the change as if the new accounting policy had always applied. This has resulted in a reallocation of Ł553 million for 2011 from IFRS basis shareholders’ reserves to shareholders’ accrued interest in the long-term business, with no overall effect on the EEV basis results.
The supplementary information on pages 326 to 362 was approved by the Board of directors on 12 March 2013 and signed on its behalf.
[Graphic Appears Here]
Paul Manduca
Tidjane Thiam
Nic Nicandrou
Chairman
Group Chief Executive
Chief Financial Officer
Notes on the EEV basis results Prudential plc Annual Report 2012 331
Notes on the EEV basis results
1 Basis of preparation, methodology and accounting presentation
The EEV basis results have been prepared in accordance with the EEV Principles issued by the European Insurance CFO Forum in May 2004 and expanded by the Additional Guidance on EEV disclosures published in October 2005. Where appropriate, the EEV basis results include the effects of adoption of International Financial Reporting Standards (IFRS).
The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles. Except for the consequential effects of the change in accounting policy for deferred acquisition costs for IFRS reporting, as described in the footnotes to the summary statement offinancial position, the 2011 results have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2011.
a Covered business
The EEV results for the Group are prepared for ‘covered business’, as defi ned by the EEV Principles. Covered business represents the Group’s long-term insurance business for which the value of new and in-force contracts is attributable to shareholders. The EEV basis results for the Group’s covered business are then combined with the IFRS basis results of the Group’s other operations. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management.
The definition of long-term business operations is consistent with previous practice and comprises those contracts falling under the definition for regulatory purposes together with, for US operations, contracts that are in
substance the same as guaranteed investment contracts (GICs) but do not fall within the technical definition.
With two principal exceptions, covered business comprises the Group’s long-term business operations. The principal exceptions are for the closed Scottish Amicable Insurance Fund (SAIF) and for the presentational treatment of the fi nancial position of the Group’s principal defi ned benefit pension scheme, the Prudential Staff Pension Scheme (PSPS), as described in note 1(c)(vi). A small amount of UK group pensions business is also not modelled for EEV reporting purposes.
SAIF is a ring-fenced sub-fund of the Prudential Assurance Company (PAC) long-term fund, established by a Court approved Scheme of Arrangement in October 1997. SAIF is closed to new business and the assets and liabilities of the fund are wholly attributable to the policyholders of the fund.
b Methodology
(i) Embedded value
Overview
The embedded value is the present value of the shareholders’ interest in the earnings distributable from assets allocated to covered business after sufficient allowance has been made for the aggregate risks in that business. The shareholders’ interest in the Group’s long-term business comprises:
Present value of future shareholder cash flows from in-force covered business (value of in-force business), less deductions for:
– the cost of locked-in required capital;
– the time value of cost of options and guarantees; EEV
Locked-in required capital; and
Shareholders’ net worth in excess of required capital (free surplus). basis
The value of future new business is excluded from the embedded value.
Notwithstanding the basis of presentation of results (as explained in note 1(c)(iv)) no smoothing of market or account balance
values, unrealised gains or investment return is applied in determining the embedded value or profit before tax. Separately, the
analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items supplementary
(as explained in note 1(c)(i)).
Valuation of in-force and new business
The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of information
future investment returns, expenses, persistency and mortality. These assumptions are used to project future cash flows. The
present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the
non-diversifiable risks associated with the cash flows that are not otherwise allowed for.
Best estimate assumptions Financial
Best estimate assumptions are used for the cash flow projections, where best estimate is defined as the mean of the distribution
of future possible outcomes. The assumptions are reviewed actively and changes are made when evidence exists that material
changes in future experience are reasonably certain. statements
Assumptions required in the calculation of the value of options and guarantees, for example relating to volatilities and
correlations, or dynamic algorithms linking liabilities to assets, have been set equal to the best estimates and, wherever material
and practical, reflect any dynamic relationships between the assumptions and the stochastic variables.
332 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
1 Basis of preparation, methodology and accounting presentation continued
Principal economic assumptions
The EEV basis results for the Group’s operations have been determined using economic assumptions where the long-term expected rates of return on investments and risk discount rates are set by reference to year end rates of return on government bonds.
Expected returns on equity and property asset classes and corporate bonds are derived by adding a risk premium, based on the Group’s long-term view, to the risk-free rate.
The total profit that emerges over the lifetime of an individual contract as calculated using the embedded value basis is the same as that calculated under the IFRS basis. Since the embedded value basis reflects discounted future cashflows, under this methodology the profit emergence is advanced, thus more closely aligning the timing of the recognition of profits with the efforts and risks of current management actions, particularly with regard to business sold during the year.
New business
In determining the EEV basis value of new business, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out for statutory basis reporting.
New business premiums reflect those premiums attaching to covered business, including premiums for contracts classified as investment products for IFRS basis reporting. New business premiums for regular premium products are shown on an annualised basis. Internal vesting business is classified as new business where the contracts include an open market option.
The contribution from new business represents profits determined by applying operating assumptions as at the end of the year. For UK immediate annuity business and single premium Universal Life products in Asia, primarily Singapore, the new business contribution is determined by applying economic assumptions reflecting point of sale market conditions. This is consistent with how the business is priced as crediting rates are linked to yields on specific assets and the yield locked-in when the assets are purchased at the point of sale of the policy. For other business within the Group, end of period economic assumptions are used.
New business profitability is a key metric for the Group’s management of the development of the business. In addition, new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP) and are calculated as the ratio of the value of new business profit to APE and PVNBP. APE are calculated as the aggregate of regular new business amounts and one-tenth of single new business amounts. PVNBP are calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
Valuation movements on investments
With the exception of debt securities held by Jackson, investment gains and losses during the year (to the extent that changes in capital values do not directly match changes in liabilities) are included directly in the profit for the year and shareholders’ equity as they arise.
The results for any covered business conceptually reflect the aggregate of the IFRS results and the movements on the additional shareholders’ interest recognised on the EEV basis. Thus the start point for the calculation of the EEV results for Jackson, as for other businesses, refl ects the market value movements recognised on the IFRS basis.
However, in determining the movements on the additional shareholders’ interest, the basis for calculating the Jackson EEV result acknowledges that, for debt securities backing liabilities, the aggregate EEV results refl ect the fact that the value of in-force business instead incorporates the discounted value of future spread earnings. This value is not affected generally by short-term market movements on securities that broadly speaking, are held for the longer-term.
Fixed income securities backing the free surplus and required capital for Jackson are accounted for at fair value. However, consistent with the treatment applied under IFRS for Jackson securities classified as available-for-sale, movements in unrealised appreciation on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity.
Cost of capital
A charge is deducted from the embedded value for the cost of capital supporting the Group’s long-term business. This capital is referred to as required capital. The cost is the difference between the nominal value of the capital and
the discounted value of the projected releases of this capital allowing for investment earnings (net of tax) on the capital.
The annual result is affected by the movement in this cost from year-to-year which comprises a charge against new business profit and generally a release in respect of the reduction in capital requirements for business in force as this runs off.
Where required capital is held within a with-profits long-term fund, the value placed on surplus assets in the fund is already discounted to reflect its release over time and no further adjustment is necessary in respect of required capital.
Financial options and guarantees
Nature offinancial options and guarantees in Prudential’s long-term business
Asia operations
Subject to local market circumstances and regulatory requirements, the guarantee features described below in respect of UK business broadly apply to similar types of participating contracts principally written in the PAC Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements.
There are also various non-participating long-term products with guarantees. The principal guarantees are those for whole of life contracts withfioor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions.
Notes on the EEV basis results Prudential plc Annual Report 2012 333
US operations (Jackson)
The principal financial options and guarantees in Jackson are associated with the fixed annuity and variable annuity (VA) lines
of business.
Fixed annuities provide that, at Jackson’s discretion, it may reset the interest rate credited to policyholders’ accounts, subject
to a guaranteed minimum. The guaranteed minimum return varies from 1.0 per cent to 5.5 per cent for 2012 and 2011, depending
on the particular product, jurisdiction where issued, and date of issue. For 2012, 86 per cent (2011: 85 per cent) of the account
values on fixed annuities are for policies with guarantees of 3 per cent or less. The average guarantee rate is 2.8 per cent for 2012
and 2011.
Fixed annuities also present a risk that policyholders will exercise their option to surrender their contracts in periods of rapidly
rising interest rates, possibly requiring Jackson to liquidate assets at an inopportune time.
Jackson issues VA contracts where it contractually guarantees to the contract holder either: a) return of no less than total
deposits made to the contract adjusted for any partial withdrawals; b) total deposits made to the contract adjusted for any partial
withdrawals plus a minimum return; or c) the highest contract value on a specified anniversary date adjusted for any withdrawals
following the specified contract anniversary. These guarantees include benefits that are payable at specified dates during the
accumulation period (Guaranteed Minimum Withdrawal Benefit (GMWB)), as death benefits (Guaranteed Minimum Death
Benefits (GMDB)) or as income benefits (Guaranteed Minimum Income Benefits (GMIB)). These guarantees generally protect the
policyholder’s value in the event of poor equity market performance. Jackson hedges the GMDB and GMWB guarantees through
the use of equity options and futures contracts, and fully reinsures the GMIB guarantees.
Jackson also issues fixed index annuities that enable policyholders to obtain a portion of an equity-linked return while providing
a guaranteed minimum return. The guaranteed minimum returns would be of a similar nature to those described above for fixed
annuities.
UK insurance operations
For covered business the only significant financial options and guarantees in the UK insurance operations arise in the
with-profits fund.
With-profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses –
annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the
particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The with-profits
fund also held a provision on the Pillar I Peak 2 basis of Ł47 million at 31 December 2012 (31 December 2011: Ł90 million) to honour
guarantees on a small number of guaranteed annuity option products.
The only material guaranteed surrender values relate to investments in the PruFund range of with-profits funds. For these
products the policyholder can choose to pay an additional management charge. In return, at the selected guarantee date, the fund
will be increased if necessary to a guaranteed minimum value (based on the initial investment adjusted for any prior withdrawals).
The with-profits fund held a reserve of Ł52 million at 31 December 2012 (31 December 2011: Ł59 million) in respect of this
guarantee.
The Group’s main exposure to guaranteed annuity options in the UK is through the non-covered business of SAIF. A provision EEV
on the Pillar I Peak 2 basis of Ł371 million was held in SAIF at 2012 (2011: Ł370 million) to honour the guarantees. As described in basis
note 1(a) above, the assets and liabilities are wholly attributable to the policyholders of the fund. Therefore the movement in the
provision has no direct impact on shareholders.
Time value
The value of financial options and guarantees comprises two parts. One is given by a deterministic valuation on best estimate supplementary
assumptions (the intrinsic value). The other part arises from the variability of economic outcomes in the future (the time value).
Where appropriate, a full stochastic valuation has been undertaken to determine the time value of the financial options and
guarantees.
The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations. information
Assumptions specific to the stochastic calculations reflect local market conditions and are based on a combination of actual market
data, historic market data and an assessment of long-term economic conditions. Common principles have been adopted across the
Group for the stochastic asset models, for example, separate modelling of individual asset classes but with an allowance for
correlation between the various asset classes. Details of the key characteristics of each model are given in notes 17(iv), (v) and (vi). Financial
In deriving the time value of financial options and guarantees, management actions in response to emerging investment and
fund solvency conditions have been modelled. Management actions encompass, but are not confined to investment allocation
decisions, levels of reversionary and terminal bonuses and credited rates. Bonus rates are projected from current levels and varied
in accordance with assumed management actions applying in the emerging investment and fund solvency conditions. statements
In all instances, the modelled actions are in accordance with approved local practice and therefore reflect the options actually
available to management. For the PAC with-profits fund, the actions assumed are consistent with those set out in the Principles and
Practices of Financial Management which explains how regular and final bonus rates within the discretionary framework are
determined, subject to the general legislative requirements applicable.
334 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
1 Basis of preparation, methodology and accounting presentation continued
(ii) Level of required capital
In adopting the EEV Principles, Prudential has based required capital on its internal targets for economic capital subject to it being at least the local statutory minimum requirements. Economic capital is assessed using internal models but, when applying the EEV
Principles, Prudential does not take credit for the significant diversification benefits that exist within the Group. For with-profits business written in a segregated life fund, as is the case in Asia and the UK, the capital available in the fund is sufficient to meet the required capital requirements. For shareholder-backed business the following capital requirements apply:
Asia operations: the level of required capital has been set at the higher of local statutory requirements and the economic capital requirement; US operations: the level of required capital has been set to an amount at least equal to 235 per cent of the risk-based capital required by the National Association of Insurance Commissioners (NAIC) at the Company Action Level (CAL); and UK insurance operations: the capital requirements are set at the higher of Pillar I and Pillar II requirements for shareholder-backed business of UK insurance operations as a whole.
(iii) Allowance for risk and risk discount rates
Overview
Under the EEV Principles, discount rates used to determine the present value of future cash fl ows are set equal to risk-free rates plus a risk margin. The risk margin should reflect any non-diversifiable risk associated with the emergence of distributable earnings that is not allowed for elsewhere in the valuation. Prudential has selected a granular approach to better refiect differences in market risk inherent in each product group. The risk discount rate so derived does not reflect an overall Group market beta but instead refiects the expected volatility associated with the cash fl ows for each product category in the embedded value model.
Since financial options and guarantees are explicitly valued under the EEV methodology, discount rates under EEV are set excluding the effect of these product features.
The risk margin represents the aggregate of the allowance for market risk, additional allowance for credit risk where appropriate, and allowance for non-diversifiable non-market risk. No allowance is required for non-market risks where these are assumed to be fully diversifiable.
Market risk allowance
The allowance for market risk represents the beta multiplied by an equity risk premium. Except for UK shareholder-backed annuity business (as explained below) such an approach has been used for all of the Group’s businesses.
The beta of a portfolio or product measures its relative market risk. The risk discount rates reflect the market risk inherent in each product group and hence the volatility of product cash fl ows. These are determined by considering how the profits from each product are affected by changes in expected returns on various asset classes. By converting this into a relative rate of return it is possible to derive a product specific beta.
Product level betas reflect the most recent product mix to produce appropriate betas and risk discount rates for each major product grouping.
Additional credit risk allowance
The Group’s methodology is to allow appropriately for credit risk. The allowance for total credit risk is to cover:
Expected long-term defaults;
Credit risk premium (to reflect the volatility in downgrade and default levels); and Short-term downgrades and defaults.
These allowances are initially reflected in determining best estimate returns and through the market risk allowance described above. However, for those businesses which are largely backed by holdings of debt securities these allowances in the projected returns and market risk allowances may not be sufficient and an additional allowance may be appropriate.
The practical application of the allowance for credit risk varies depending upon the type of business as described below.
Asia operations
For Asia operations, the allowance for credit risk incorporated in the projected rates of return and the market risk allowance are sufficient. Accordingly, no additional allowance for credit risk is required.
In 2012, the basis of determining projected rates of return for holdings of corporate bonds was refined so as to comprise the risk-free rate plus an assessment of long-term spread over the risk-free rate. Previously, market spreads at the reporting date, rather than long-term spreads, were applied. The main effects of this change are for holdings in Hong Kong, Korea, Malaysia and Singapore. The new basis aligns with the approach for UK with-profit holdings of corporate bonds and, more generally, is consistent with the use of long-term risk premiums for holdings of other categories of investments across the Group’s operations.
Notes on the EEV basis results Prudential plc Annual Report 2012 335
US operations (Jackson)
For Jackson business, the allowance for long-term defaults is reflected in the risk margin reserve (RMR) charge which is deducted in determining the projected spread margin between the earned rate on the investments and the policyholder crediting rate.
The risk discount rate incorporates an additional allowance for credit risk premium and short-term downgrades and defaults. In determining this allowance a number of factors have been considered. These factors, in particular, include:
How much of the credit spread on debt securities represents an increased credit risk not reflected in the RMR long-term default assumptions, and how much is liquidity premium (which is the premium required by investors to compensate for the risk of longer-term investments which cannot be easily converted into cash, and converted at the fair market value). In assessing this effect, consideration has been given to a number of approaches to estimating the liquidity premium by considering recent statistical data; and Policyholder benefits for Jacksonfixed annuity business are notfixed. It is possible in adverse economic scenarios to pass on a component of credit losses to policyholders (subject to guarantee features) through lower investment return rates credited to policyholders. Consequently, it is only necessary to allow for the balance of the credit risk in the risk discount rate.
After taking these and related factors into account and based on market conditions, the risk discount rate for general account business includes an additional allowance of 150 basis points (2011: 200 basis points) for credit risk. For VA business, the additional allowance has been set at one-fifth (equivalent to 30 basis points (2011: 40 basis points)) of the non-VA business to reflect the proportion of the VA business that is allocated to holdings of general account debt securities. The level of the additional allowance is assessed at each reporting period to take account of prevailing credit conditions and as the business in force alters over time.
The level of allowance differs from that for UK annuity business for investment portfolio differences and to take account of the management actions available in adverse economic scenarios to reduce crediting rates to policyholders, subject to guarantee features of the products.
UK operations
(1) Shareholder-backed annuity business
For Prudential’s UK shareholder-backed annuity business, Prudential has used a market consistent embedded value (MCEV)
approach to derive an implied risk discount rate which is then applied to the projected best estimate cash flows.
In the annuity MCEV calculations, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity
premium based on Prudential’s assessment of the expected return on the assets backing the annuity liabilities after allowing for
expected long-term defaults, a credit risk premium, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and
an allowance for short-term defaults. For the purposes of presentation in the EEV results, the results on this basis are reconfigured.
Under this approach the projected earned rate of return on the debt securities held is determined after allowing for expected
long-term defaults and, where necessary, an additional allowance for an element of short-term downgrades and defaults to bring
the allowance in the earned rate up to best estimate levels. The allowances for credit risk premium, 1 notch downgrade and the
remaining element of short-term downgrade and default allowances are incorporated into the risk margin included in the discount
rate, as shown in note 17(iii). EEV
(2) With-profits fund non-profit annuity business basis
For UK non-profit annuity business including that written by Prudential Annuities Limited (PAL) the basis for determining the
aggregate allowance for credit risk is consistent with that applied for UK shareholder-backed annuity business (as described
above). The allowance for credit risk in PAL is taken into account in determining the projected cash flows to the with-profits fund,
which are in turn discounted at the risk discount rate applicable to all of the projected cash flows of the fund. supplementary
(3) With-profits fund holdings of debt securities
The UK with-profits fund holds debt securities as part of its investment portfolio backing policyholder liabilities and unallocated
surplus. The assumed earned rate for with-profit holdings of corporate bonds is defined as the risk-free rate plus an assessment information
of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and
properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
Allowance for non-diversifiable non-market risks Financial
The majority of non-market and non-credit risks are considered to be diversifiable. Finance theory cannot be used to determine the
appropriate component of beta for non-diversifiable non-market risks since there is no observable risk premium associated with it
that is akin to the equity risk premium. Recognising this, a pragmatic approach has been applied.
A base level allowance of 50 basis points is applied to cover the non-diversifiable non-market risks associated with the Group’s statements
businesses. For the Group’s US business and UK business other than shareholder-backed annuity, no additional allowance is
necessary. For UK shareholder-backed annuity business a further allowance of 50 basis points is used to reflect the longevity risk
which is of particular relevance. For the Group’s Asia operations in China, India, Indonesia, the Philippines, Taiwan, Thailand and
Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points.
(iv) With-profits business and the treatment of the estate
The proportion of surplus allocated to shareholders from the PAC with-profits fund has been based on the present level of
10 per cent. The value attributed to the shareholders’ interest in the estate is derived by increasing final bonus rates (and related
shareholder transfers) so as to exhaust the estate over the lifetime of the in-force with-profits business. In any scenarios where
the total assets of the life fund are insufficient to meet policyholder claims in full, the excess cost is fully attributed to shareholders.
Similar principles apply, where appropriate, for other with-profits funds of the Group’s Asia operations.
336 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
1 Basis of preparation, methodology and accounting presentation continued
(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.
(v) Foreign currency translation
Foreign currency profits and losses have been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange. The purpose of translating the profits and losses at average exchange rates, notwithstanding the fact that EEV profit represents the incremental value added on a discounted cash flow basis, is to maintain consistency with the methodology applied for IFRS basis reporting.
c Accounting presentation
(i) Analysis of profit before tax
To the extent applicable, the presentation of the EEV profit for the year is consistent with the basis that the Group applies for analysis of IFRS basis profits before shareholder taxes between operating and non-operating results. Operating results reflect the underlying results including longer-term investment returns (which are determined as described in note 1(c)(ii) below) and incorporate the following:
New business contribution, as defined in note 1(b)(i);
Unwind of discount on the value of in-force business and other expected returns, as described in note 1(c)(iv) below; The impact of routine changes of estimates relating to non-economic assumptions, as described in note 1(c)(iii) below; and Non-economic experience variances, as described in note 1(c)(v) below.
Non-operating results comprise the recurrent items of short-termfluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, the mark to market value movements on core borrowings and the effect of changes in economic assumptions.
In addition, for 2012 the gain recognised on the acquisition of REALIC and the gain on dilution of the Group holdings in PPM South Africa have been shown separately from operating profits based on longer-term investment returns.
(ii) Operating profi t
For the investment element of the assets covering the net worth of long-term insurance business, investment returns are recognised in operating results at the expected long-term rate of return. These expected returns are calculated by reference to the asset mix of the portfolio. For the purpose of calculating the longer-term investment return to be included in the operating result of the PAC with-profits fund of UK operations, where assets backing the liabilities and unallocated surplus are subject to market volatility, asset values at the beginning of the reporting period are adjusted to remove the effects of short-term market movements as explained in note 1(c)(iv) below.
For the purpose of determining the long-term returns for debt securities of US operations forfixed annuity and other general account business, a risk margin charge is included which reflects the expected long-term rate of default based on the credit quality of the portfolio. For Jackson, interest-related realised gains and losses are amortised to the operating results over the maturity period of the sold bonds and for equity-related investments, a long-term rate of return is assumed, which reflects the aggregation of end of year risk-free rates and equity risk premium. For US variable annuity separate account business, operating profit includes the unwind of discount on the opening value of in-force adjusted to reflect end of year projected rates of return with the excess or deficit of the actual return recognised within non-operating profit, together with the related hedging activity.
For UK annuity business, rebalancing of the asset portfolio backing the liabilities to policyholders may, from time to time, take place to align it more closely with the internal benchmark of credit quality that management applies. Such rebalancing will result in a change in the projected yield on the asset portfolio and the allowance for default risk. The net effect of these changes is included in the result for the year.
(iii) Eff ect 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.
(iv) Unwind of discount and other expected returns
The unwind of discount and other expected returns is determined by reference to the value of in-force business, required capital and surplus assets at the start of the period as adjusted for the effect of changes in economic and operating assumptions reflected in the current period.
For UK insurance operations the amount included within operating results based on longer-term investment returns represents the unwind of discount on the value of in-force business at the beginning of the period (adjusted for the effect of current period assumption changes), the unwind of discount on additional value representing the shareholders’ share of smoothed surplus assets retained within the PAC with-profits fund (as explained in note 1(c)(ii) above), and the expected return on shareholders’ assets held in other UK long-term business operations. Surplus assets retained within the PAC with-profi ts fund are smoothed for this purpose to remove the effects of short-term investment volatility from operating results. In the summary statement offinancial position and for total profit reporting, asset values and investment returns are not smoothed. At 31 December 2012, the shareholders’ interest in the smoothed surplus assets used for this purpose only, were Ł121 million lower (31 December 2011: Ł39 million higher) than the surplus assets carried in the statement offinancial position.
Notes on the EEV basis results Prudential plc Annual Report 2012 337
(v) Operating experience variances
Operating profits include the effect of experience variances on non-economic assumptions, which are calculated with reference to the embedded value assumptions at the end of the reporting year, such as persistency, mortality and morbidity, expenses and other factors. Further details of these assumptions are shown in notes 17(vii), (viii) and (ix).
(vi) Pension costs
Profi t before tax
Movements on the shareholders’ share of surpluses (to the extent not restricted by IFRIC 14) and defi cits of the Group’s defi ned benefit pension schemes adjusted for contributions paid in the year are recorded within the income statement. Consistent with the basis of distribution of bonuses and the treatment of the estate described in notes 1(b)(i) and (iv), the shareholders’ share incorporates 10 per cent of the proportion of the fi nancial position attributable to the PAC with-profits fund. Thefinancial position is determined by applying the requirements of IAS 19.
Actuarial and other gains and losses of defi ned benefi t pension schemes
For the Group’s defi ned benefit pension schemes the EEV results reflect the IAS 19 position booked for IFRS reporting. Consistent with this approach, to the extent of recognition of any surplus, the actuarial and other gains and losses include:
The difference between actual and expected return on the scheme assets; Experience gains and losses on scheme liabilities;
The impact of altered economic and other assumptions on the discounted value of scheme liabilities; and
For pension schemes where the IAS 19 position reflects a deficit funding obligation, actuarial and other gains and losses includes the movement in estimates of deficit funding requirements.
In addition, this item includes the effect of partial recognition of the Prudential Staff Pension Scheme surplus that arose in 2012. This partial recognition refiects the impact of the 5 April 2011 triennial valuation that was completed in 2012. Under that valuation there was sufficient actuarial surplus to permit a reduction in employer contributions to the minimum level under the trust deed rules, thereby allowing recoverability of part of the surplus in future years.
These items are recorded in the income statement but, consistent with the IFRS basis of presentation, are excluded from operating results based on longer-term investment returns.
(vii) Eff ect of changes in economic assumptions
Movements in the value of in-force business at the beginning of the period caused by changes in economic assumptions, net of the related change in the time value of cost of option and guarantees, are recorded in non-operating results.
(viii) Taxation
The profit for the year for covered business is in most cases calculated initially at the post-tax level. The post-tax profit for covered
business is then grossed up for presentation purposes at the rates of tax applicable to the countries and periods concerned. In the EEV
UK, the rate applied for 2012 is 23 per cent (2011: 25 per cent). For Jackson, the US federal tax rate of 35 per cent is applied to gross basis
up movements on the value of in-force business. The overall tax rate includes the impact of tax effects determined on a local
regulatory basis. For Asia, similar principles apply subject to the availability of taxable profits. Tax payments and receipts included
in the projected cash flows to determine the value of in-force business are calculated using rates that have been substantively
enacted by the end of the reporting period. Possible future changes of rate are not anticipated. See note 17(ix) for further details. supplementary
(ix) Inter-company arrangements
The EEV results for covered business incorporate the effect of the reinsurance arrangement of non-profit immediate pension
annuity liabilities of SAIF (which is not covered business) to PRIL. In addition, the analysis of free surplus and value of in-force
business takes account of the impact of contingent loan arrangements between Group companies. information
(x) Foreign exchange rates
Foreign currency results have been translated as discussed in note 1(b)(vi), for which the principal exchange rates are as follows: Financial
Closing rate at Average rate Closing rate at Average rate Opening rate
Local currency: Ł 31 Dec 2012 for 2012 31 Dec 2011 for 2011 at 1 Jan 2011
China 10.13 10.00 9.78 10.37 10.32
Hong Kong 12.60 12.29 12.07 12.48 12.17 statements
India 89.06 84.70 82.53 74.80 70.01
Indonesia 15,665.76 14,842.01 14,091.80 14,049.41 14,106.51
Korea 1,740.22 1,785.07 1,790.32 1,775.98 1,776.86
Malaysia 4.97 4.89 4.93 4.90 4.83
Singapore 1.99 1.98 2.02 2.02 2.01
Taiwan 47.20 46.88 47.06 47.12 45.65
Vietnam 33,875.42 33,083.59 32,688.16 33,139.22 30,526.26
US 1.63 1.58 1.55 1.60 1.57
338 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
2 Analysis of new business contribution
2012
Annual Present value
premium and of new
New business premiums New business margin
contribution business Pre-tax new
equivalents premiums business
Single Regular(APE)(PVNBP) contribution(APE)(PVNBP)
Łm Łm Łm Łm Łm%%
Asia operations 1,568 1,740 1,897 10,544 1,266 67 12.0
US operations 14,504 12 1,462 14,600 873 60 6.0
UK insurance operations 6,286 207 836 7,311 313 37 4.3
Total 22,358 1,959 4,195 32,455 2,452 58 7.6
2011
Annual Present value
premium and of new
New business premiums New business margin
contribution business Pre-tax new
equivalents premiums business
Single Regular(APE)(PVNBP) contribution(APE)(PVNBP)
Łm Łm Łm Łm Łm%%
Asia operations 1,456 1,514 1,660 8,910 1,076 65 12.1
US operations 12,562 19 1,275 12,720 815 64 6.4
UK insurance operations 4,871 259 746 6,111 260 35 4.3
Total 18,889 1,792 3,681 27,741 2,151 58 7.8
New business contribution
2012 Łm 2011 Łm
Asia operations:
China 26 27
Hong Kong 210 218
India 19 20
Indonesia 476 314
Korea 26 43
Taiwan 48 28
Other 461 426
Total Asia operations 1,266 1,076
Notes on the EEV basis results Prudential plc Annual Report 2012 339
3 Operating profit from business in force
(i) Group summary
2012 Łm
UK
Asia US insurance
operations operations operations Total
note (ii) note (iii) note (iv)
Unwind of discount and other expected returns 599 412 482 1,493
Effect of changes in operating assumptions* 20 35 87 142
Experience variances and other items 75 290(16) 349
Total 694 737 553 1,984
2011 Łm
UK
Asia US insurance
operations operations operations Total
note (ii) note (iii) note (iv)
Unwind of discount and other expected returns 613 349 485 1,447
Effect of changes in operating assumptions* 10 14 79 103
Experience variances and other items 65 253 29 347
Total 688 616 593 1,897
* As shown below.
(ii) Asia operations
2012 Łm 2011 Łm
Unwind of discount and other expected returnsnote (a) 599 613
Effect of changes in operating assumptions:
Mortality and morbiditynote (b) 94 126
Persistency and withdrawalsnote (c)(34)(140)
Expensenote (d)(48) 11 EEV
Other 8 13
20 10 basis
Experience variance and other items:
Mortality and morbiditynote (e) 57 58
Persistency and withdrawalsnote (f) 50 10
Expensenote (g)(30)(31) supplementary
Other note (h)(2) 28
75 65
Total Asia operations 694 688 information
Notes
(a) The decrease in unwind of discount and other expected returns of Ł(14) million from Ł613 million in 2011 to Ł599 million in 2012 mainly reflects the
Ł(43) million effect of lower risk discount rates driven by the reduction in interest rates, partly offset by the Ł29 million effect of the growth in the opening
in-force value (adjusted for assumption changes), on which the discount rates are applied.
(b) The credit of Ł94 million in 2012 for mortality and morbidity assumption changes primarily reflects mortality improvements in Hong Kong and Singapore Financial
and revised assumptions for critical illness business in Singapore in line with recent experience. In 2011, the Ł126 million reflected Ł69 million arising in
Malaysia, Ł33 million in Indonesia and a net Ł24 million for other operations.
(c) The charge of Ł(140) million for 2011 principally arose in Malaysia for partial withdrawals. The 2012 charge reflects a number of offsetting items including
further adjustments to partial withdrawals in Malaysia.
(d) The charge of Ł(48) million for expense assumption changes in 2012 principally arises in Malaysia and reflects changes to the pension entitlements of statements
agents.
(e) The favourable effect of mortality and morbidity experience in 2012 of Ł57 million (2011: Ł58 million) reflects continued better than expected experience, principally arising in Hong Kong, Indonesia, Malaysia and Singapore.
(f) The positive persistency and withdrawals experience variance of Ł50 million in 2012 (2011: Ł10 million) reflects a combination of favourable experience in Hong Kong and Indonesia.
(g) The negative expense experience variance of Ł(30) million in 2012 (2011: Ł(31) million) principally reflects expense overruns for operations which are currently sub-scale (China, Malaysia Takaful and Taiwan) and in India where the business model is being adapted in response to the regulatory changes introduced in recent years.
(h) The charge of Ł(2) million in 2012 for other items reflects the broadly offsetting effects of the realised gain on the sale of the Group’s 7.74 per cent stake in China Life of Taiwan and charges for other non-recurrent items.
340 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
3 Operating profit from business in force continued
(iii) US operations
2012 Łm 2011 Łm
Unwind of discount and other expected returnsnote (a) 412 349
Effect of changes in operating assumptions:
Persistencynote (b) 45 29
Variable annuity (VA) feesnote (c)(19) 24
Mortalitynote (d) 33(36)
Othernote (e)(24)(3)
35 14
Experience variances and other items:
Spread experience variancenote (f) 205 152
Amortisation of interest-related realised gains and lossesnote (g) 91 84
Other(6) 17
290 253
Total US operations 737 616
Notes
(a) The increase in unwind of discount and other expected returns of Ł63 million from Ł349 million for 2011 to Ł412 million for 2012 includes the Ł67 million effect of the increase in opening value of in-force business (after economic assumption changes), an impact of Ł19 million relating to the post-acquisition
unwind of discount for REALIC, partly off set by the Ł(23) million eff ect of lower risk discount rates driven by the 0.1 per cent reduction in the 10-year US treasury rate together with the decrease in additional allowance for credit risk as explained in note 1(b) (iii).
(b) The effect of changes in persistency assumptions of Ł45 million in 2012 primarily relate to VA business.
(c) The effect of the change of assumption for VA fees represents the capitalised value of the change in the projected level of policyholder advisory fees, which vary according to the current size and mix of VA funds.
(d) The credit of Ł33 million in 2012 for the effect of updated mortality assumptions principally relates to life business, representing a credit of Ł86 million for the modelling of projected mortality improvement, partially offset by a charge of Ł(53) million for other regular mortality updates to reflect recent experience.
In 2011, the charge of Ł(36) million for updated mortality assumptions primarily arose on variable annuity business.
(e) The charge of Ł(24) million in 2012 for other operating assumption changes includes a charge of Ł(12) million for the impact of altered assumptions for Guaranteed Minimum Withdrawal Benefit utilisation and Ł(12) million for other items.
(f) The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults. The spread experience variance in 2012 of Ł205 million (2011: Ł152 million) includes the positive effect of transactions undertaken to more closely match the overall asset and liability duration.
(g) The amortisation of interest-related gains and losses reflects the fact that when bonds that are neither impaired nor deteriorating are sold and reinvested there will be a consequent change in the investment yield. The realised gain or loss is amortised into the result over the period when the bonds would have otherwise matured to better reflect the long-term returns included in operating profits.
(iv) UK insurance operations
2012 Łm 2011 Łm
Unwind of discount and other expected returnsnote (a) 482 485
Effect of change in UK corporate tax ratenote (b) 87 79
Other itemsnote (c)(16) 29
Total UK insurance operations 553 593
Notes
(a) The decrease in unwind of discount and other expected returns of Ł(3) million from Ł485 million in 2011 to Ł482 million for 2012 reflects the Ł(17) million effect of lower risk discount rates driven by the reduction in interest rates, partly offset by the Ł14 million effect of an increase in the opening in-force value (after economic assumption changes) on which the discount rates are applied.
(b) The effect of the change in tax rate of Ł87 million in 2012 represents the benefit of the reduction in tax rate from 25 per cent to 23 per cent. Consistent with the Group’s approach of grossing up the movement in the net of tax value of in-force for shareholder tax, the Ł87 million benefit is presented gross (2011: Ł79 million, 27 per cent to 25 per cent).
(c) Other items in 2012 of Ł(16) million includes a charge of Ł(52) million for the strengthening of mortality assumptions, net of reserve releases and the effects of portfolio rebalancing for annuity business.
Notes on the EEV basis results Prudential plc Annual Report 2012 341
4 Changes to Group’s holdings
PPM South Africa
On 22 February 2012, M&G completed transactions to (i) exchange bonus share rights for equity holdings with the employees of PPM South Africa, and (ii) the sale of a 10 per cent holding in the majority of the business to Thesele Group, a minority shareholder, for cash. Following these transactions M&G’s majority holding in the business reduced from 75 per cent to 49.99 per cent. Under IFRS requirements, the divestment is accounted for as the disposal of the 75 per cent holding and an acquisition of a 49.99 per cent holding at fair value resulting in a reclassification of PPM South Africa from a subsidiary to an associate. As a consequence of the IFRS application, the transactions gave rise to a gain on dilution of Ł42 million. Consistent with the Group’s treatment for IFRS reporting, this amount has been treated as a gain on dilution of holdings which is shown separately from operating profit based on longer-term investment returns in the Group’s supplementary analysis of profi t.
5 Acquisition of Reassure America Life Insurance Company (REALIC)
On 4 September 2012, the Group through its indirect wholly-owned subsidiary, Jackson National Life Insurance Company, completed the acquisition of 100 per cent issued share capital of SRLC America Holding Corp. (SRLC), and its primary operating subsidiary, Reassure America Life Insurance Company (REALIC). The purchase consideration, which remains subject tofinal agreement under the terms of the transaction with Swiss Re, is Ł370 million (US$587 million). The Embedded value of REALIC on the date of acquisition, calculated in accordance with the Group’s methodology and assumptions as set out in note 1 was Ł823 million. The acquisition increases the scale of the Group’s life business in the US, helping Jackson to diversify earnings by increasing the amount of income from underwriting activities thereby enhancing the quality of earnings in a capital efficient manner. The earnings of REALIC are derived from seasoned, long duration cash flows, generated principally from term life, whole life and basic universal life products.
The gain arising from the acquisition of REALIC is excluded from the Group’s EEV operating profi t based on longer-term investment returns and is calculated as follows:
Total EEV
2012 Łm
note (ii)
Embedded value of acquired businessnote (i) 823
Total purchase consideration(370)
Gain arising on acquisition 453
Notes
(i) The embedded value of the acquired business has been determined by applying the same methodology as applied for Jackson’s non-variable annuity
business. A risk discount rate of 4.3 per cent at the date of acquisition on 4 September 2012 has been used. EEV
(ii) The amounts shown above have been translated at the 4 September 2012 exchange rate of US$1.59/Ł.
basis
6 Short-term fluctuations in investment returns
Short-term fluctuations in investment returns, net of the related change in the time value of cost of options and guarantees, arise as
follows: supplementary
(i) Group summary
2012 Łm 2011 Łm information
Insurance operations:
Asianote (ii) 395(155)
USnote (iii)(254)(491)
UKnote (iv) 315(141) Financial
456(787)
Other operations:
Economic hedge value movementnote (v)(32) – statements
Other note (vi) 114(120)
Total 538(907)
342 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
6 Short-term fl uctuations in investment returns continued
(ii) Asia operations
For 2012, the positive short-termfluctuations in investment returns of Ł395 million in Asia operations were driven by unrealised gains on bonds and higher equity markets, principally arising in Hong Kong of Ł139 million mainly relating to positive returns on bonds backing participating business, Singapore of Ł114 million, primarily relating to increasing future expected fee income for unit-linked business and unrealised gains on bonds, Taiwan of Ł56 million for unrealised gains on bonds and CDOs and India of Ł30 million.
For 2011, short-termfluctuations in investment returns of Ł(155) million were driven by lower equity markets reducing future expected fee income, mainly arising in Singapore of Ł(105) million and Korea of Ł(22) million. The 2011 short-term fl uctuations in investment returns also included Ł(28) million of adverse variance arising in other territories. This principally comprises fl uctuations arising in India of Ł(53) million refl ecting lower equity market returns, in Vietnam of Ł(33) million for unrealised losses on bonds and equities and Taiwan of Ł(30) million for losses on bonds and CDOs, partially offset by a credit in Hong Kong of Ł96 million primarily relating to positive returns on bonds backing participating business.
(iii) US operations
The short-term fluctuations in investment returns for US operations comprise the following items:
2012 Łm 2011 Łm
Investment return related experience on fixed income securitiesnote (a)(99)(74)
Investment return related impact due primarily to changed expectation of profits on in-force variable
annuity business in future periods based on current period equity returns, net of related hedging
activity for equity related productsnote (b)(183)(418)
Actual less long-term return on equity based investments and other items 28 1
Total Jackson(254)(491)
Notes
(a) The charge relating to fixed income securities comprises the following elements:
• the excess of actual realised losses over the amortisation of interest related realised gains and losses recorded in the profit and loss account;
• credit loss experience (versus the longer-term assumption); and
• the impact of de-risking activities within the portfolio.
(b) This item reflects the net impact of:
• variances in projected future fees arising from the effect of market fluctuations on the growth in separate account asset values in the current reporting period; and
• related hedging activity.
In 2012, there was a 14.8 per cent rate of return for the variable annuity separate account assets compared with an assumed longer-term rate of return of
5.3 per cent. Consequently, the asset values and therefore projected future fees at 31 December 2012 were higher than assumed. However, net of the impact of related hedging eff ects there is a short-term fl uctuation of Ł(183) million.
In 2011, there was a negative 0.5 per cent rate of return for the variable annuity separate account assets. This compared with an assumed longer-term rate of return of 5.4 per cent. Consequently, the asset values and therefore projected future fees at 31 December 2011 were lower than assumed.
(iv) UK insurance operations
The short-term fluctuations in investment returns for UK insurance operations arise from the following types of business:
2012 Łm 2011 Łm
With-profitsnote (a) 285(201)
Shareholder-backed annuitynote (b)(3) 56
Unit-linked and other 33 4
315(141)
Notes
(a) For with-profits business the amounts reflect the excess (deficit) of the actual investment return on the investments of the PAC with-profits fund (covering policyholder liabilities and unallocated surplus) against the assumed long-term rate for the year. For 2012, the credit of Ł285 million reflects the actual investment return of 9.8 per cent against the assumed long-term rate of 5.0 per cent for the year.
For 2011, the charge of Ł(201) million refl ects the actual investment return of 3.2 per cent against the assumed long-term rate of 5.1 per cent, primarily refl ecting the fall in equity markets and widening of corporate bond credit spreads, partially off set by the increase in asset values as a result of the reduction in bond yields.
(b) Short-term fluctuations in investment returns for shareholder-backed annuity business comprise: (1) gains on surplus assets reflecting reductions in corporate bond and gilt yields; (2) the difference between actual and expected default experience; and (3) the effect of mismatching for assets and liabilities of different durations and other short-term fluctuations in investment returns.
(v) Economic hedge value movements
This item represents the costs on short-dated hedge contracts taken out in thefirst half of 2012 to provide downside protection against severe equity market falls through a period of particular uncertainty with respect to the Eurozone. The hedge contracts were terminated in the second half of 2012.
(vi) Other
Short-termfluctuations of Other operations in 2012 of Ł114 million primarily represent unrealised fair value movements on Prudential Capital’s bond portfolio. Short-term fl uctuations of Other operations in 2011 of Ł(120)
million represent unrealised value movements on investments, including centrally held swaps to manage foreign exchange and certain macroeconomic exposures of the Group.
Notes on the EEV basis results Prudential plc Annual Report 2012 343
7 Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes
The credit for the shareholders’ share of actuarial and other gains and losses comprises:
2012 Łm 2011 Łm
IFRS basis 50 21
Additional shareholders’ interest note (1(c)(vi)) 12 2
EEV basis total 62 23
8 Effect of changes in economic assumptions
The effect of changes in economic assumptions for in-force business, net of the related change in the time value of cost of options and
guarantees, included within profit before tax (including actual investment returns) arise as follows:
(i) Group summary
2012 Łm 2011 Łm
Asia operationsnote (ii)(149) 279
US operationsnote (iii) 85(144)
UK insurance operationsnote (iv) 48(293)
Total(16)(158)
(ii) Asia operations
The effect of changes in economic assumptions for Asia operations in 2012 of Ł(149) million principally arises in Hong Kong of
Ł(320) million, primarily reflecting the effect on projected cash flows of de-risking the asset portfolio and the reduction in fund earned
rates on participating business, driven by the very low interest rate environment, and in Vietnam of Ł(47) million, following the fall in
bond yields. There are partial offsets which in total are Ł218 million, principally arising in Malaysia and Indonesia, mainly reflecting
the positive impact of discounting projected health and protection profits at lower rates, driven by the decrease in risk discount rates.
The effect of changes in economic assumptions for 2011 of a credit of Ł279 million principally arose in Singapore of Ł160 million,
Malaysia of Ł97 million and Indonesia of Ł94 million, primarily reflecting the positive impact of discounting projected health and
protection profits at lower rates, driven by the decrease in risk-free rates. There is a partial offset arising in Hong Kong of Ł(57) million,
primarily reflecting the reduction in fund earned rates for participating business. EEV
(iii) US operations basis
The effect of changes in economic assumptions for US operations reflects the following:
2012 Łm 2011 Łm
Effect of changes in 10-year treasury rates, beta and equity risk premium:note (a) supplementary
Fixed annuity and other general account business 20 282
Variable annuity (VA) business(83)(333)
Decrease (increase) in additional allowance for credit risknote (b) 148(93) information
85(144)
Notes
(a) For Jackson, the effect of changes in economic assumptions represents the aggregate of the effects of changes to projected returns and the risk discount rate.
The risk discount rate, as discussed in note 1(b)(iii), represents the aggregate of the risk-free rate and margin for market risk, credit risk and non-diversifiable Financial
non-market risk.
For fixed annuity and other general account business the effect of changes to the risk-free rate, which is defined as the 10-year treasury rate, is reflected
in the risk discount rate. This discount rate is in turn applied to projected cash flows which principally reflect projected spread, which is largely insensitive
to changes in the risk-free rate. Secondary effects on the cash flows also result from changes to assumed future yield and resulting policyholder behaviour.
For VA business, changes to the risk-free rate are also reflected in determining the risk discount rate. However, the projected cash flows are also reassessed statements
for altered investment returns on the underlying separate account assets on which fees are charged. In 2012, for fixed annuity and other general account
business the credit of Ł20 million principally arises from the effect of a lower discount rate on the opening value of the in-force book, driven by the
10 basis points reduction in the risk-free rate (as shown in note 17(ii)), partially offset by the effect for the acquired REALIC book, reflecting the 20 basis point
increase in the risk-free rate from the 4 September acquisition date.
For 2011, the credit of Ł282 million reflected the 140 basis points reduction in the risk-free rate. For VA business, the charge of Ł(83) million
(2011: Ł(333) million) reflects the 10 basis points reduction (2011: a reduction of 140 basis points) in the risk-free rate (as shown in note 17(ii)).
(b) For 2012, the Ł148 million effect of the decrease in the additional allowance within the risk discount rate for credit risk reflects the reduction in credit spreads and represents a 50 basis points decrease for spread business, including the acquired REALIC business (from 200 basis points in 2011 to 150 basis points in 2012), and 10 basis points decrease for VA business (from 40 basis points in 2011 to 30 basis points in 2012), representing the proportion of business invested in the general account (as described in note 1(b)(iii)).
For 2011, the eff ect of Ł(93) million for the increase in the risk margin allowance within the risk discount rate for credit risk represented a 50 basis points increase for spread business and 10 basis points increase for VA business.
344 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
8 Eff ect of changes in economic assumptions continued
(iv) UK insurance operations
The effect of changes in economic assumptions of a credit of Ł48 million for UK insurance operations for 2012 comprises the effect of:
2012 Łm 2011 Łm
Shareholder-backed annuity businessnote (a)
Effect of change in:
Expected long-term rates of return, risk discount rates and other changes 140 278
Tax regimenote (b)(46) –
94 278
With-profits and other businessnote (c)
Effect of changes in expected long-term rates of return(62)(1,113)
Effect of changes in risk discount rates 24 627
Other changes(8)(84)
(46)(570)
48(292)
Notes
(a) For shareholder-backed annuity business the overall effect of changes in expected long-term rates of return and risk discount rates for the years shown above reflect the combined effects of the changes in economic assumptions, which incorporate a default allowance for both best estimate defaults and in respect of the additional credit risk provisions (as shown in note 17(iii)).
(b) The change in the insurance tax regime was enacted on 17 July 2012. The effect of Ł(46) million reflects the change in pattern of taxable profits for shareholder-backed annuity business arising from the acceleration of tax payments due to the altered timing of relief on regulatory basis provisions.
(c) For with-profits and other business the total charge in 2012 of Ł(46) million reflects the changes in fund earned rates and risk discount rate (as shown in note 17(iii)), driven by the 20 basis points decrease in the gilt rate.
For 2011, the charge of Ł(1,113) million for the eff ect of changes in expected long-term rates of return arises from the reduction in fund earned rates, driven by the 1.5 per cent decrease in gilt rates and reduction in additional returns assumed on corporate bonds, refl ecting changes in asset mix. The credit of Ł627 million for the eff ect of changes in risk discount rates refl ects the 1.35 per cent reduction in the risk discount rate, driven by the 1.5 per cent decrease in gilt rates, partly off set by the impact of an increase in beta for with-profi ts business. Beta allowances are explained in note 1(b)(iii).
Notes on the EEV basis results Prudential plc Annual Report 2012 345
9 Analysis of movement in free surplus
Free surplus is the excess of the net worth over the capital required to support the covered business. Where appropriate, adjustments
are made to the regulatory basis net worth from the local regulatory basis so as to include backing assets movements at fair value
rather than cost so as to comply with the EEV Principles.
2012 Łm
Free surplus
of long-term
Asset business, asset
management management
and UK and UK
general general
Long-term insurance insurance
business commission commission
Long-term business and asset management operationsnote (i) note 14 note (iii)
Underlying movement:
Investment in new businessnote (ii)(618) –(618)
Business in force:
Expected in-force cash flows (including expected return on net assets) 2,019 386 2,405
Effects of changes in operating assumptions, operating experience variances and
other operating items 295 – 295
1,696 386 2,082
Changes in non-operating itemsnote (iv)(163) 84(79)
Gain on dilution of Group’s holdingsnote 4 – 42 42
Effect of acquisition of REALICnotes 5 and (v)(169) –(169)
1,364 512 1,876
Net cash flows to parent companynote (vi)(921)(279)(1,200)
Exchange movements, timing differences and other itemsnote (vii)(325)(83)(408)
Net movement in free surplus 118 150 268
Balance at 1 January 2012 2,839 582 3,421
Balance at 31 December 2012 2,957 732 3,689
Representing:
Asia operations 974 207 1,181 EEV
US operations 1,211 108 1,319 basis
UK operations 772 417 1,189
2,957 732 3,689
Balance at 1 January 2012
Representing: supplementary
Asia operations 1,067 211 1,278
US operations 1,220 113 1,333
UK operations 552 258 810 information
2,839 582 3,421
Notes
(i) All figures are shown net of tax.
(ii) Free surplus invested in new business is for the effects of setting aside required capital and incurring acquisition costs. Financial
(iii) For the purposes of this analysis, free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis
shareholders’ equity.
(iv) Changes in non-operating items
This represents short-term fluctuations in investment returns, the shareholders’ share of actuarial and other gains and losses on defined benefit pension
schemes and the effect of changes in economic assumptions for long-term business operations. statements
Short-term fluctuations in investment returns primarily reflect temporary market movements on the portfolio of investments held by the Group’s
shareholder-backed operations.
(v) The effect on free surplus of the purchase of REALIC reflects the difference between the consideration of Ł370 million and the free surplus of REALIC at the acquisition date.
(v) Net cash flows to parent company for long-term business operations reflect the flows as included in the holding company cash flow at transaction rates.
346 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
[Graphic Appears Here]
Notes on the EEV basis results Prudential plc Annual Report 2012 347
[Graphic Appears Here]
348 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
[Graphic Appears Here]
Notes
(i) For the purposes of the table above, goodwill related to Asia long-term operations is included in Other operations.
(ii) Intra-group dividends (including statutory transfers) represent dividends that have been declared in the year and amounts accrued in respect of statutory transfers. For long-term business operations, the difference between the net amount of Ł999 million for intra-group dividends (including statutory transfers) and investment in operations shown above and the net cash flows to parent company of Ł921 million (as shown in note 9) primarily relates to intra-group loans, timing differences arising on statutory transfers and other non-cash items.
(iii) The additional retained profit on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of Ł(536) million (2011: Ł(187) million) (as shown in note 10).
Notes on the EEV basis results Prudential plc Annual Report 2012 349
12 Tax attributable to shareholders’ profit
The tax charge comprises:
2012 Łm 2011 Łm
Tax charge on operating profit based on longer-term investment returns:
Long-term business:
Asia operations 420 402
US operations 513 487
UK insurance operations 168 221
1,101 1,110
Other operations 44(66)
Total tax charge on operating profit based on longer-term investment returns 1,145 1,044
Tax charge (credit) on items not included in operating profit:
Tax charge (credit) on short-term fluctuations in investment returns 44(210)
Tax charge on shareholders’ share of actuarial and other gains and losses on defined benefit
pension schemes 14 6
Tax charge (credit) on effect of changes in economic assumptions 4(64)
Total tax charge (credit) on items not included in operating profit 62(268)
Tax charge on profit attributable to shareholders (including tax on actual investment returns) 1,207 776
13 Earnings per share (EPS)
2012 Łm 2011 Łm
Operating Total* Operating Total
Profit before tax 4,321 5,020 3,978 2,922
Tax(1,145)(1,207)(1,044)(776)
Non-controlling interests – –(4)(4)
Profit after tax and non-controlling interests 3,176 3,813 2,930 2,142 EEV
EPS (pence) 125.0p 150.1p 115.7p 84.6p
Average number of shares (millions) 2,541 2,541 2,533 2,533 basis
* Total profit in 2012 includes a gain of Ł453 million relating to the acquisition of REALIC – see note 5. supplementary
information
Financial
statements
350 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
14 Reconciliation of net worth and value of in-force for long-term businessnote(i)
2012 Łm
Total
Value of long-term
Free Required Total net in-force business
surplus capital worth business operations
note 9 note (vi)
Group
Shareholders’ equity at 1 January 2012 2,839 3,447 6,286 13,364 19,650
New business contributionnotes (iii), (iv)(618) 454(164) 1,955 1,791
Existing business – transfer to net worth 1,923(324) 1,599(1,599) –
Expected return on existing business 96 85 181 929 1,110
Changes in operating assumptions and experience variances 295 50 345 51 396
Changes in non-operating assumptions and experience
variances(163) 109(54) 409 355
Gain on acquisition of REALICnotes 5 and (v)(169) 169 – 453 453
Profit after tax from long-term business 1,364 543 1,907 2,198 4,105
Exchange movements on foreign operations and net
investment hedges(92)(92)(184)(339)(523)
Intra-group dividends (including statutory transfers) and
investment in operationsnote (ii)(1,187) –(1,187) 188(999)
Mark to market value movements on Jackson assets backing
surplus and required capital 35 – 35 – 35
Other transfers from net worth(2) –(2) –(2)
Shareholders’ equity at 31 December 2012 2,957 3,898 6,855 15,411 22,266
Representing:
Asia operations
Shareholders’ equity at 1 January 2012 1,067 860 1,927 6,583 8,510
New business contributionnote (iv)(292) 97(195) 1,177 982
Existing business – transfer to net worth 635(3) 632(632) –
Expected return on existing business 56 – 56 413 469
Changes in operating assumptions and experience variances 80 25 105(23) 82
Changes in non-operating assumptions and experience
variances 114 16 130 92 222
Profit after tax from long-term business 593 135 728 1,027 1,755
Exchange movements on foreign operations and net
investment hedges(38)(25)(63)(208)(271)
Intra-group dividends (including statutory transfers)
and investment in operationsnote (ii)(656) –(656) 116(540)
Other transfers to net worth 8 – 8 – 8
Shareholders’ equity at 31 December 2012 974 970 1,944 7,518 9,462
Notes on the EEV basis results Prudential plc Annual Report 2012 351
2012 Łm
Total
Value of long-term
Free Required Total net in-force business
surplus capital worth business operations
note 9 note (vi)
US operations
Shareholders’ equity at 1 January 2012 1,220 1,371 2,591 2,491 5,082
New business contributionnote (iv)(281) 271(10) 578 568
Existing business – transfer to net worth 777(242) 535(535) –
Expected return on existing business 40 48 88 180 268
Changes in operating assumptions and experience variances 219 19 238 21 259
Changes in non-operating assumptions and experience
variances(330) 31(299) 164(135)
Gain on acquisition of REALICnotes 5 and (v)(169) 169 – 453 453
Profit after tax from long-term business 256 296 552 861 1,413
Exchange movements on foreign operations and net
investment hedges(54)(67)(121)(131)(252)
Intra-group dividends (including statutory transfers)(252) –(252) –(252)
Mark to market value movements on Jackson assets backing
surplus and required capital 35 – 35 – 35
Other transfers to net worth 6 – 6 – 6
Shareholders’ equity at 31 December 2012 1,211 1,600 2,811 3,221 6,032
UK insurance operations
Shareholders’ equity at 1 January 2012 552 1,216 1,768 4,290 6,058
New business contributionnote (iv)(45) 86 41 200 241
Existing business – transfer to net worth 511(79) 432(432) –
Expected return on existing business – 37 37 336 373
Changes in operating assumptions and experience variances(4) 6 2 53 55
Changes in non-operating assumptions and experience
variances 53 62 115 153 268
Profit after tax from long-term business 515 112 627 310 937 EEV
Intra-group dividends (including statutory transfers)note (ii)(279) –(279) 72(207) basis
Other transfers from net worth(16) –(16) –(16)
Shareholders’ equity at 31 December 2012 772 1,328 2,100 4,672 6,772 supplementary
information
Financial
statements
352 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
14 Reconciliation of net worth and value of in-force for long-term businessnote(i) continued
Notes
(i) All figures are shown net of tax.
(ii) The amounts shown in respect of free surplus and the value of in-force business for Asia and UK insurance operations for intra-group dividends (including statutory transfers) and investment in operations include the repayment of contingent loan funding. Contingent loan funding represents amounts whose repayment to the lender is contingent upon future surpluses emerging from certain contracts specified under the arrangement. If insufficient surplus emerges on those contracts, there is no recourse to other assets of the Group and the liability is not payable to the degree of shortfall.
(iii) The movements arising from new business contribution are as follows:
2012 Łm 2011 Łm
Free surplus invested in new business(618)(553)
Increase in required capital 454 406
Reduction in total net worth(164)(147)
Increase in the value associated with new business 1,955 1,683
Total post-tax new business contribution 1,791 1,536
(iv) Free surplus invested in new business is as follows:
2012 Łm 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
Pre-tax new business contributionnote 2 1,266 873 313 2,452 1,076 815 260 2,151
Tax(284)(305)(72)(661)(265)(285)(65)(615)
Post-tax new business contribution 982 568 241 1,791 811 530 195 1,536
Free surplus invested in new business(292)(281)(45)(618)(297)(202)(54)(553)
Post-tax new business contribution per
Ł1 million free surplus invested 3.4 2.0 5.4 2.9 2.7 2.6 3.6 2.8
(v) The effect on free surplus of the purchase of REALIC reflects the difference between the consideration of Ł370 million and the free surplus of REALIC at the acquisition date. The REALIC free surplus represents the excess of net worth over required capital. The incremental value of in-force of Ł453 million represents the amount which is recognised on the EEV reporting basis over and above the net worth.
(v) The value of in-force business includes the value of future margins from current in-force business less the cost of holding required capital and represents:
31 December 2012 Łm 31 December 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
note
Value of in-force business before deduction of
cost of capital and time value of guarantees 7,903 3,992 4,916 16,811 6,922 3,222 4,598 14,742
Cost of capital(352)(121)(244)(717)(317)(135)(241)(693)
Cost of time value of guarantees(33)(650) –(683)(22)(596)(67)(685)
Net value of in-force business 7,518 3,221 4,672 15,411 6,583 2,491 4,290 13,364
Note
A provision for the cost of time value of options and guarantees for UK insurance operations is no longer required.
Notes on the EEV basis results Prudential plc Annual Report 2012 353
15 Expected transfer of value of in-force business to free surplus
The discounted value of in-force business and required capital can be reconciled to the 2012 and 2011 totals in the tables below for the emergence of free surplus as follows:
2012 Łm
2011 Łm
Required capitalnote 14
3,898
3,447
Value of in-force (VIF)note 14
15,411
13,364
Add back: deduction for cost of time value of guaranteesnote 14
683
685
Other itemsnote
(1,401)
(1,214)
18,591
16,282
Note
‘Other items’ represent amounts incorporated into VIF where there is no defi nitive timeframe for when the payments will be made or receipts received. In particular, other items includes the deduction of the value of the shareholders’ interest in the estate, the value of which is derived by increasing fi nal bonus rates so as to exhaust the estate over the lifetime of the in-force with-profi ts business. This is an assumption to give an appropriate valuation. To be conservative this item is excluded from the expected free surplus generation profi le below.
Cashflows are projected on a deterministic basis and are discounted at the appropriate risk discount rate. The modelled cashflows use the same methodology underpinning the Group’s embedded value reporting and so is subject to the same assumptions and sensitivities.
The table below shows how the VIF generated by the in-force business and the associated required capital is modelled as emerging into free surplus over future years.
2012 Łm
Expected period of conversion of future post-tax distributable earnings and
required capital flows to free surplus
2012 total as
shown above 1-5 years 6 -10 years 11-15 years 16 -20 years 21-40 years 40+ years
Asia operations 8,410 2,987 1,873 1,181 840 1,297 232
US operations 5,439 2,723 1,607 698 301 110 –
UK insurance operations 4,742 1,890 1,185 756 456 445 10
Total 18,591 7,600 4,665 2,635 1,597 1,852 242
100% 41% 25% 14% 9% 10% 1% EEV
2011 Łm basis
Expected period of conversion of future post-tax distributable earnings and
required capital flows to free surplus
2011 total as
shown above 1-5 years 6 -10 years 11-15 years 16 -20 years 21-40 years 40+ years supplementary
Asia operations 7,387 2,582 1,596 1,012 732 1,262 203
US operations 4,267 2,241 1,287 490 173 76 –
UK insurance operations 4,628 1,864 1,166 743 453 394 8
Total 16,282 6,687 4,049 2,245 1,358 1,732 211 information
100% 41% 25% 14% 8% 11% 1%
Financial
statements
354 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
16 Sensitivity of results to alternative assumptions
(a) Sensitivity analysis – economic assumptions
The tables below show the sensitivity of the embedded value as at 31 December 2012 (31 December 2011) and the new business contribution after the effect of required capital for 2012 and 2011 to:
1 per cent increase in the discount rates;
1 per cent increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values offixed interest assets, risk discount rates); 1 per cent rise in equity and property yields; 10 per cent fall in market value of equity and property assets (embedded value only); Holding company statutory minimum capital (by contrast to required capital), (embedded value only); 5 basis point increase in UK long-term expected defaults; and 10 basis point increase in the liquidity premium for UK annuities.
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions.
New business contribution
2012 Łm 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
New business contributionnote 2 1,266 873 313 2,452 1,076 815 260 2,151
Discount rates – 1% increase(163)(40)(38)(241)(139)(45)(36)(220)
Interest rates – 1% increase 33 104 6 143 2 81 5 88
Interest rates – 1% decrease(106)(161)(11)(278)(72)(117)(6)(195)
Equity/property yields – 1% rise 48 97 13 158 50 92 11 153
Long-term expected defaults – 5 bps increase – –(10)(10) – –(8)(8)
Liquidity premium – 10 bps increase – – 20 20 – – 16 16
Embedded value of long-term business operations
31 December 2012 Łm 31 December 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
Shareholders’ equitynote 11 9,462 6,032 6,772 22,266 8,510 5,082 6,058 19,650
Discount rates – 1% increase(879)(209)(482)(1,570)(771)(147)(443)(1,361)
Interest rates – 1% increase(218)(124)(328)(670)(376)(106)(343)(825)
Interest rates – 1% decrease 85 49 399 533 253 58 400 711
Equity/property yields – 1% rise 328 230 202 760 329 185 205 719
Equity/property market values – 10% fall(159)(69)(309)(537)(159) 16(326)(469)
Statutory minimum capital 108 89 4 201 114 92 4 210
Long-term expected defaults – 5 bps increase – –(112)(112) – –(98)(98)
Liquidity premium – 10 bps increase – – 224 224 – – 196 196
The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long-term business operations and include the combined effect on the value of in-force business and net assets at the balance sheet dates indicated. If the change in assumption shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profi t analysis for the following year. These are for the effect of economic assumption changes and, to the extent that asset value changes are included in the sensitivities, within short-termfluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profi t for the following year would be calculated by reference to the altered assumptions, for example new business contribution and unwind of discount, together with the effect of other changes such as altered corporate bond spreads. In addition for Jackson, the fair value movements on assets backing surplus and required capital which are taken directly to shareholders’ equity would also be affected by changes in interest rates.
Notes on the EEV basis results Prudential plc Annual Report 2012 355
(b) Sensitivity analysis – non-economic assumptions
The tables below show the sensitivity of the embedded value as at 31 December 2012 (31 December 2011) and the new business contribution after the effect of required capital for 2012 and 2011 to:
10 per cent proportionate decrease in maintenance expenses (a 10 per cent sensitivity on a base assumption of Ł10 per annum would represent an expense assumption of Ł9 per annum); 10 per cent proportionate decrease in lapse rates (a 10 per cent sensitivity on a base assumption of 5 per cent would represent a lapse rate of 4.5 per cent per annum); and 5 per cent proportionate decrease in base mortality and morbidity rates (ie increased longevity).
New business contribution
2012 Łm 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
New business contributionnote 2 1,266 873 313 2,452 1,076 815 260 2,151
Maintenance expenses – 10% decrease 32 13 4 49 26 11 7 44
Lapse rates – 10% decrease 95 26 7 128 92 24 10 126
Mortality and morbidity – 5% decrease 76 5(11) 70 60 9(9) 60
Change representing effect on:
Life business 76 5 3 84 60 9 3 72
UK annuities – –(14)(14) – –(12)(12)
Embedded value of long-term business operations
31 December 2012 Łm 31 December 2011 Łm
Total Total
UK long-term UK long-term
Asia US insurance business Asia US insurance business
operations operations operations operations operations operations operations operations
Shareholders’ equitynote 11 9,462 6,032 6,772 22,266 8,510 5,082 6,058 19,650
Maintenance expenses – 10% decrease 137 50 56 243 117 44 52 213
Lapse rates – 10% decrease 333 225 66 624 342 157 65 564 EEV
Mortality and morbidity – 5% decrease 387 178(273) 292 289 92(227) 154 basis
Change representing effect on:
Life business 387 178 13 578 289 92 12 393
UK annuities – –(286)(286) – –(239)(239)
(c) Effect of proposed change in UK corporation tax rate
The proposed rate change from 23 per cent to 22 per cent announced in the 2012 Budget on 21 March 2012 has been reduced by
a further 1 per cent to 21 per cent in the Autumn Statement on 5 December 2012. The change from 23 per cent to 21 per cent is
expected to be effective 1 April 2014 and when substantively enacted it would have the impact of increasing the net of tax value
of in-force business of UK insurance operations at 31 December 2012 by around Ł65 million. information
Financial
statements
356 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
17 Assumptions
Deterministic assumptions
The tables below summarise the principalfinancial assumptions:
Assumed investment returns reflect the expected future returns on the assets held and allocated to the covered business at the valuation date.
[Graphic Appears Here]
Equity risk premiums in Asia range from 3.25 per cent to 8.8 per cent for 2012 (2011: 3.25 per cent to 8.7 per cent).
Notes
(a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each country’s risk discount rates by reference to the EEV basis new business result and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix.
(b) For Hong Kong the assumptions shown are for US dollar denominated business. For other territories, the assumptions are for local currency denominated business.
(c) The risk discount rate for Malaysia reflects both the Malaysia life and Takaful operations.
(d) The mean equity return assumptions for the most significant equity holdings in the Asia operations were:
31 Dec 2012 % 31 Dec 2011 %
Hong Kong 5.8 5.9
Malaysia 9.5 9.7
Singapore 7.35 7.7
Notes on the EEV basis results Prudential plc Annual Report 2012 357
(ii) US operations
31 Dec 2012 % 31 Dec 2011 %
Assumed new business spread margins:notes (a), (c)
Fixed annuity business*:
January to June issues 1.4† 1.75†
July to December issues 1.1† 1.75†
Fixed index annuity business:
January to June issues 1.75† 2.25
July to December issues 1.35† 2.25
Institutional business 1.25 1.0
Risk discount rate:note (d)
Variable annuity 6.5 6.7
Non-variable annuity 4.0 4.6
Weighted average total:note (b)
New business 6.3 6.5
In force 5.6 6.0
US 10-year treasury bond rate at end of year 1.8 1.9
Pre-tax expected long-term nominal rate of return for US equities 5.8 5.9
Equity risk premium 4.0 4.0
Expected long-term rate of inflation 2.5 2.0
* Including the proportion of variable annuity business invested in the general account.
† Grading up linearly by 25 basis points to a long-term assumption over five years.
Notes
(a) The assumed new business spread margins shown above are the rates at inception. For fixed annuity business (including the proportion of variable annuity
business invested in the general account) in both years the assumed spread margin grades up linearly by 25 basis points to the long-term assumption over
five years. In 2012, for fixed index annuity business the assumed spread margin also grades up linearly by 25 basis points to the long-term assumption over
five years. For fixed index annuity business in 2011 and institutional business in both years the assumption applies from inception (ie no grading).
(b) The weighted average risk discount rates reflect the mix of business between variable annuity and non-variable annuity business. The decrease in the
weighted average risk discount rates from 2011 to 2012 primarily reflects the decrease in the US 10-year treasury bond rate of 10 basis points together with
the effect of the decrease in additional allowance for credit risk (as described in note (d) below).
(c) Credit risk treatment
The projected cash flows incorporate the expected long-term spread between the earned rate and the rate credited to policyholders. The projected earned
rates reflect book value yields which are adjusted over time to reflect projected reinvestment rates. Positive net cash flows are assumed to be reinvested in a EEV
mix of corporate bonds, commercial mortgages and limited partnerships. The yield on those assets is assumed to grade from the current level to a yield that
allows for a long-term assumed credit spread on the reinvested assets of 1.25 per cent over 10 years. The yield also reflects an allowance for a risk margin
reserve which for 2012 is 28 basis points (2011: 27 basis points) for long-term defaults (as described in note 1(b)(iii)), which represents the allowance as at the basis
valuation date applied in the cash flow projections of the value of the in-force business.
In the event that long-term default levels are higher, then unlike for UK annuity business where policyholder benefits are not changeable, Jackson has
some discretion to adjust crediting rates, subject to contract guarantee levels and general market competition considerations.
(d) For US operations, the risk discount rates shown above include an additional allowance for a combination of credit risk premium and short-term downgrade
and default allowance for general account business of 150 basis points (2011: 200 basis points) and for variable annuity business of 30 basis points
(2011: 40 basis points) to reflect the fact that a proportion of the variable annuity business is allocated to the general account (as described in note 1(b)(iii)). supplementary
information
Financial
statements
358 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
17 Assumptions continued
(iii) UK insurance operations
31 Dec 2012 % 31 Dec 2011 %
Shareholder-backed annuity business:note (d)
Risk discount rate:
New businessnote (a) 6.9 7.7
In forcenote (b) 7.95 8.6
Pre-tax expected long-term nominal rate of return for shareholder-backed annuity business:
New business 4.2 4.85
In forcenote (b) 3.9 4.4
Other business:note (d)
Risk discount rate:note (c)
New business 5.2 5.3
In force 5.6 5.65
Equity risk premium 4.0 4.0
Pre-tax expected long-term nominal rates of investment return:
UK equities 6.3 6.5
Overseas equities 5.8 to 9.6 5.9 to 9.9
Property 5.1 5.2
Gilts 2.3 2.5
Corporate bonds 3.9 4.0
Expected long-term rate of inflation 2.9 3.0
Post-tax expected long-term nominal rate of return for the PAC with-profits fund:
Pension business (where no tax applies) 5.0 5.1
Life business 4.35 4.4
Notes
(a) The new business risk discount rate for shareholder-backed annuity business incorporates an allowance for best estimate defaults and additional credit risk provisions, appropriate to the new business assets, over the projected lifetime of this business. These additional provisions comprise of a credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults.
(b) For shareholder-backed annuity business, the movements in the pre-tax long-term nominal rates of return and the risk discount rates for in-force business mainly reflect the effect of changes in asset yields.
(c) The risk discount rates for new business and business in force for UK insurance operations other than shareholder-backed annuities reflect weighted rates based on the type of business.
(d) Credit spread treatment
For with-profits business, the embedded value reflects the discounted value of future shareholder transfers. These transfers are directly affected by the level of projected rates of return on investments, including debt securities. The assumed earned rate for with-profit holdings of corporate bonds is defined as the risk-free rate plus an assessment of the long-term spread over gilts, net of expected long-term defaults. This approach is similar to that applied for equities and properties for which the projected earned rate is defined as the risk-free rate plus a long-term risk premium.
For UK shareholder-backed annuity business, diff erent dynamics apply both in terms of the nature of the business and the EEV methodology applied. For this type of business the assets are generally held to maturity to match long duration liabilities. It is therefore appropriate under EEV methodology to include a liquidity premium in the economic basis used. The appropriate EEV risk discount rate is set in order to equate the EEV with a ‘market consistent embedded value’ including liquidity premium. The liquidity premium in the ‘market consistent embedded value’ is derived from the yield on the assets held aft er deducting an appropriate allowance for credit risk. For Prudential Retirement Income Limited, which has approximately 90 per cent of UK shareholder-backed annuity business, the allowance for credit risk for the in-force business at 31 December 2012 is made up of:
(1) 15 basis points in respect of long-term expected defaults 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 and Poor’s and Fitch; and
(2) 50 basis points in respect of additional provisions which comprise a credit risk premium, which is derived from Moody’s data from 1970 to 2009, an allowance for a 1 notch downgrade of the portfolio subject to credit risk and an allowance for short-term defaults.
The credit assumptions used and the residual liquidity premium element of the bond spread over swap rates is as follows:
31 December 31 December
2012 2011
New business*(bps)(bps)
Bond spread over swap rates 150 139
Total credit risk allowance† 35 35
Liquidity premium 115 104
In-force business
Bond spread over swap rates 161 201
Total credit risk allowance 65 66
Liquidity premium 96 135
* The new business liquidity premium is based on the weighted average of the point of sale liquidity premia.
† Specifi c assets are allocated to the new business for the period with the appropriate allowance for credit risk which was 35 basis points for 2012 and 2011.
The overall allowance for credit risk is prudent by comparison with historic rates of default and would be suffi cient to withstand a wide range of extreme credit events over the expected lifetime of the annuity business.
Notes on the EEV basis results Prudential plc Annual Report 2012 359
Stochastic assumptions
The economic assumptions used for the stochastic calculations are consistent with those used for the deterministic calculations described above. Assumptions specifi c to the stochastic calculations, such as the volatilities of asset returns, refi ect local market conditions and are based on a combination of actual market data, historic market data and an assessment of longer-term economic conditions. Common principles have been adopted across the Group for the stochastic asset models, for example, separate modelling of individual asset classes but with allowance for correlation between the various asset classes.
Details are given below of the key characteristics and calibrations of each model.
(iv) Asia operations
The same asset return models as described for UK insurance operations below, appropriately calibrated, have been used for Asia operations. The principal asset classes are government and corporate bonds. Equity holdings are much lower than in the UK whilst property holdings do not represent a signifi cant investment asset; The stochastic cost of guarantees is primarily only of signifi cance for the Hong Kong, Korea, Malaysia and Singapore operations; and The mean stochastic returns are consistent with the mean deterministic returns for each country. The expected volatility of equity returns ranges from 18 per cent to 35 per cent, and the volatility of government bond yields ranges from 0.9 per cent to 2.3 per cent (2011: 0.9 per cent to 2.4 per cent).
(v) US operations (Jackson)
Interest rates are projected using a log-normal generator calibrated to historical US treasury yield curves;
Corporate bond returns are based on treasury securities plus a spread that has been calibrated to current market conditions and varies by credit quality; and Variable annuity equity returns and bond interest rates have been stochastically generated using a log-normal model with parameters determined by reference to historical data. The volatility of equity fund returns ranges from 19 per cent to 32 per cent for all periods throughout these results, depending on the risk class and the class of equity, and the standard deviation of interest rates ranges from 2.2 per cent to 2.5 per cent (2011: 2.1 per cent to 2.4 per cent).
(v) UK insurance operations
Interest rates are projected using a two-factor model calibrated to the initial market yield curve; The risk premium on equity assets is assumed to follow a log-normal distribution;
The corporate bond return is calculated as the return on a zero-coupon bond plus a spread. The spread process is a mean reverting stochastic process; and Property returns are modelled in a similar fashion to corporate bonds, namely as the return on a risk-free bond, plus a risk premium, plus a process representative of the change in residual values and the change in value of the call option on rents.
Mean returns have been derived as the annualised arithmetic average return across all simulations and durations. EEV
For each projection year, standard deviations have been calculated by taking the square root of the annualised variance of the basis
returns over all the simulations. These have been averaged over all durations in the projection. For equity and property, the standard
deviations relate to the total return on these assets. The standard deviations applied for both years are as follows:
31 Dec 2012 % 31 Dec 2011 %
Equities: supplementary
UK 20 20
Overseas 18 18
Property 15 15 information
Financial
statements
360 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
17 Assumptions continued
(vii) Demographic assumptions
Persistency, mortality and morbidity assumptions are based on an analysis of recent experience but also refi ect expected future experience. Where relevant, when calculating the time value offinancial options and guarantees, policyholder withdrawal rates vary in line with the emerging investment conditions according to management’s expectations.
(viii) Expense assumptions
Expense levels, including those of service companies that support the Group’s long-term business operations, are based on internal expense analysis investigations and are appropriately allocated to acquisition of new business and renewal of in-force business. Exceptional expenses are identifi ed and reported separately. For mature business, it is Prudential’s policy not to take credit for future cost reduction programmes until the savings have been delivered. For businesses which are currently sub-scale (China, Malaysia Takaful and Taiwan) and India (where the business model is being adapted in response to the regulatory changes introduced in recent years), expense overruns are permitted provided these are short-lived.
For Asia operations, the expenses comprise costs borne directly and recharged costs from the Asia regional head offi ce, that are attributable to covered business. The assumed future expenses for these operations also include projections of these future recharges. Development expenses are charged as incurred.
Corporate expenditure comprises:
Expenditure for Group head offi ce, to the extent not allocated to the PAC with-profi ts funds, together with Solvency II implementation and restructuring costs, which are charged to the EEV basis results as incurred; and
Expenditure of the Asia regional head offi ce that is not allocated to the covered business or asset management operations, and is charged as incurred. These costs are primarily for corporate related activities and included within corporate expenditure.
(ix) Taxation and other legislation
Current taxation and other legislation have been assumed to continue unaltered except where changes have been announced and substantively enacted in the year.
The sensitivity of the embedded value as at 31 December 2012 to the effect of the forthcoming change in the UK corporate tax rates is shown in note 16(c).
Notes on the EEV basis results Prudential plc Annual Report 2012 361
18 New business premiums and contributionsnote (i)
Annual premium and Present value of new
contribution business premiums
Single Regular equivalents (APE)(PVNBP)
2012 Łm 2011 Łm 2012 Łm 2011 Łm 2012 Łm 2011 Łm 2012 Łm 2011 Łm
Group insurance operations
Asia 1,568 1,456 1,740 1,514 1,897 1,660 10,544 8,910
US 14,504 12,562 12 19 1,462 1,275 14,600 12,720
UK 6,286 4,871 207 259 836 746 7,311 6,111
Group total 22,358 18,889 1,959 1,792 4,195 3,681 32,455 27,741
Asia insurance operations
Hong Kong 157 180 380 313 396 331 2,316 2,023
Indonesia 359 250 410 338 446 363 2,097 1,435
Malaysia 98 79 208 215 218 223 1,388 1,225
Philippines 172 95 28 20 45 30 254 153
Singapore 399 371 261 198 301 235 2,314 1,855
Thailand 12 11 36 26 37 27 140 102
Vietnam 1 1 44 42 45 42 159 143
SE Asia operations including Hong Kong 1,198 987 1,367 1,152 1,488 1,251 8,668 6,936
Chinanote (ii) 37 46 53 54 56 59 277 294
Korea 94 71 86 94 95 101 438 542
Taiwan 172 217 138 126 156 148 723 672
Indianote (iii) 67 135 96 88 102 101 438 466
Total Asia operations 1,568 1,456 1,740 1,514 1,897 1,660 10,544 8,910
US insurance operations
Fixed annuities 581 472 – – 58 47 581 472
Fixed index annuities 1,094 934 – – 109 93 1,094 934
Life 6 10 12 19 12 20 102 168
Variable annuities 12,445 10,909 – – 1,245 1,091 12,445 10,909
Wholesale 378 237 – – 38 24 378 237 EEV
Total US insurance operations 14,504 12,562 12 19 1,462 1,275 14,600 12,720 basis
UK and Europe insurance operations
Direct and partnership annuities 297 328 – – 30 33 297 328
Intermediated annuities 653 241 – – 65 24 653 241
Internal vesting annuities 1,456 1,223 – – 146 122 1,456 1,223 supplementary
Total individual annuities 2,406 1,792 – – 241 179 2,406 1,792
Corporate pensions 303 184 159 215 189 233 1,045 1,224
Onshore bonds 2,275 1,779 – – 228 178 2,277 1,781
Other products 894 780 48 44 137 122 1,175 978 information
Wholesale 408 336 – – 41 34 408 336
Total UK and Europe insurance operations 6,286 4,871 207 259 836 746 7,311 6,111
Group total 22,358 18,889 1,959 1,792 4,195 3,681 32,455 27,741 Financial
Notes
(i) The tables shown above are provided as an indicative volume measure of transactions undertaken in the reporting period that have the potential to
generate profits for shareholders. The amounts shown are not, and not intended to be, reflective of premium income recorded in the IFRS income statement. statements
(ii) New business in China is included at Prudential’s 50 per cent interest in the China life operation.
(iii) New business in India is included at Prudential’s 26 per cent interest in the India life operation.
362 Financial statements Prudential plc Annual Report 2012
Notes on the EEV basis results continued
19 Other developments
Acquisition of Thanachart Life Assurance Company Limited
On 5 November 2012, Prudential plc, through its subsidiary Prudential Life Assurance (Thailand) Public Company Limited (Prudential Thailand) entered into an agreement to acquire 100 per cent of Thanachart Life Assurance Company Limited (Thanachart Life), a wholly-owned life insurance subsidiary of Thanachart Bank Public Company limited (Thanachart Bank). The consideration for Thanachart Life is THB 17.5 billion (Ł352 million at the year end exchange rate) settled in cash on completion, with a further payment of THB 0.5 billion (Ł10 million) payable 12 months after completion, subject to a post-completion adjustment to refl ect the net asset value as at the completion date. The transaction is subject to regulatory approval and is expected to close in thefirst half of 2013. Upon completion of the transaction, Thanachart Life will become a wholly-owned subsidiary of Prudential Thailand.
As part of the deal, Prudential Thailand and Thanachart Bank have entered into an agreement to establish an exclusive 15-year partnership to develop jointly their bancassurance business in Thailand. This transaction builds on Prudential’s strategy of focusing on the highly attractive markets of South-east Asia and is in line with the Group’s multichannel distribution strategy.
Notes on the EEV basis results/Statement of directors’ responsibilities Prudential plc Annual Report 2012 363
Statement of directors’ responsibilities
in respect of the European Embedded Value
(EEV) basis supplementary information
The directors have chosen to prepare supplementary information
in accordance with the EEV Principles issued in May 2004 by
the European CFO Forum as supplemented by the Additional
Guidance on EEV Disclosures issued in October 2005.
When compliance with the EEV Principles is stated, those
principles require the directors to prepare supplementary
information in accordance with the Embedded Value
Methodology (EVM) contained in the EEV Principles and to
disclose and explain any non-compliance with the EEV guidance
included in the EEV Principles.
In preparing the EEV supplementary information, the directors
have:
Prepared the supplementary information in accordance with
the EEV Principles;
Identifi ed and described the business covered by the EVM;
Applied the EVM consistently to the covered business;
Determined assumptions on a realistic basis, having regard
to past, current and expected future experience and to any
relevant external data, and then applied them consistently;
Made estimates that are reasonable and consistent; and
Described the basis on which business that is not covered
business has been included in the supplementary information,
including any material departures from the accounting
framework applicable to the Group’s fi nancial statements.
EEV basis supplementary information/Directors’ responsibilities Financial statements
364 Financial statements Prudential plc Annual Report 2012
Independent auditor’s report to
Prudential plc on the European Embedded Value (EEV) basis supplementary information
We have audited the EEV basis supplementary information (the supplementary information) of Prudential plc (the Company) for the year ended 31 December 2012 set out on pages 326 to 362. Thefinancial reporting framework that has been applied in the preparation of the supplementary information is the European Embedded Value Principles issued in May 2004 by the European CFO Forum as supplemented by the Additional Guidance on European Embedded Value Disclosures issued in October 2005 together ‘the EEV Principles’ using the methodology and assumptions set out on pages 331 to 336 and 356 to 360 respectively. The supplementary information should be read in conjunction with the Groupfinancial statements which are on pages 147 to 314.
This report is made solely to the Company in accordance with the terms of our engagement. Our audit work has been undertaken so that we might state to the Company those matters we have been engaged to state in this report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company for our audit work, for this report, or for the opinions we have formed.
Respective responsibilities of directors and auditor
As explained more fully in the Directors’ Responsibilities Statement set out on page 363, the directors have accepted responsibility for the preparation of the supplementary information on the EEV basis in accordance with the EEV Principles.
Our responsibility is to audit, and express an opinion on, the supplementary information in accordance with the terms of our engagement and in accordance with International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
Scope of the audit of the supplementary information
An audit involves obtaining evidence about the amounts and disclosures in the supplementary information suffi cient to give reasonable assurance that the supplementary information is free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to Group’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of signifi cant accounting estimates made by the directors; and the overall presentation of the supplementary information. In addition, we read all thefinancial and non-fi nancial information in the annual report and accounts to identify material inconsistencies with the audited supplementary
information. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Opinion on supplementary information
In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2012 has been properly prepared, in all material respects, in accordance with the EEV Principles using the methodology and assumptions set out on pages 331 to 336 and 356 to 360 respectively.
[Graphic Appears Here]
Rees Aronson for and on behalf of KPMG Audit Plc Chartered Accountants London
12 March 2013
Independent auditor’s report/Additional unaudited fi nancial information Prudential plc Annual Report 2012 365
Index to the additional unaudited fi nancial information
I. Selected historical financial information of Prudential
366 Selected historical financial information of Prudential
II. IFRS profit and loss information
369 a Analysis of long-term insurance business pre-tax IFRS
operating profit based on longer-term investment returns
by driver
374 b Asia operations – analysis of IFRS operating profit by
territory
375 c Analysis of asset management operating profit based on
longer-term investment return
III. Other information
376 a Funds under management
378 b Reconciliation of expected transfer of value of in-force
(VIF) and required capital business to free surplus
382 c Option schemes
Independent auditor’s report/Additional unaudited fi nancial information Financial statements
366 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information
I: Selected historical fi nancial information of Prudential
The following table sets forth Prudential’s selected consolidated fi nancial data for the periods indicated. Certain data is derived from Prudential’s audited consolidated fi nancial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and as adopted by the European Union (EU) and European Embedded Value (EEV).
This table is only a summary and should be read in conjunction with Prudential’s consolidated fi nancial statements and the related notes included elsewhere in this document.
Income statement data
Year ended 31 December*
2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm
IFRS basis results
Gross premium earned 29,910 25,706 24,568 20,299 18,993
Outward reinsurance premiums(506)(429)(357)(323)(204)
Earned premiums, net of reinsurance 29,404 25,277 24,211 19,976 18,789
Investment return 24,051 9,360 21,769 26,889(30,202)
Other income 2,021 1,869 1,666 1,234 1,146
Total revenue, net of reinsurance 55,476 36,506 47,646 48,099(10,267)
Benefits and claims and movement in unallocated surplus
of with-profits funds, net of reinsurance(45,953)(29,289)(40,518)(41,195) 10,824
Acquisition costs and other expenditure(6,055)(5,120)(4,989)(4,756)(2,457)
Finance costs: interest on core structural borrowings
of shareholder-financed operations(280)(286)(257)(209)(172)
Loss on sale of Taiwan agency business – – –(559) –
Total charges, net of reinsurance(52,288)(34,695)(45,764)(46,719) 8,195
Profit (loss) before tax (being tax attributable to
shareholders’ and policyholders’ returns) note (1) 3,188 1,811 1,882 1,380(2,072)
Tax (charge) credit attributable to policyholders’ returns(378) 17(611)(818) 1,624
Profit (loss) before tax attributable to shareholders 2,810 1,828 1,271 562(448)
Tax (charge) credit attributable to shareholders’ returns(613)(409) 40 10 58
Profit (loss) from continuing operations after tax 2,197 1,419 1,311 572(390)
Discontinued operations (net of tax) – – –(14) –
Profit (loss) for the year 2,197 1,419 1,311 558(390)
Based on profit (loss) for the year attributable to the equity
holders of the Company:
Basic earnings per share (in pence) 86.5p 55.8p 51.8p 22.3p(16.0)p
Diluted earnings per share (in pence) 86.4p 55.7p 51.7p 22.2p(16.0)p
Dividend per share declared and paid in reporting period
(in pence) note (6) 25.64p 25.19p 20.17p 19.20p 18.29p
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2008 to 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied.
Additional unaudited financial information Prudential plc Annual Report 2012 367
Supplementary IFRS income statement data
Year ended 31 December*
2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm
Operating profit based on longer-term investment returns note (2) 2,533 2,027 1,826 1,428 1,248
Short-term fluctuations in investment returns
on shareholder-backed business 204(220)(198)(171)(1,684)
Shareholders’ share of actuarial and other gains and losses
on defined benefit pension schemes 50 21(10)(74)(13)
Costs of terminated AIA transaction – –(377) – –
Gain on dilution of Group’s holdings 42 – 30 – –
Amortisation of acquisition accounting adjustments arising on
the purchase of REALIC(19) – – – –
Loss on sale and results of Taiwan agency business – – –(621) 1
Profit (loss) from continuing operations before tax
attributable to shareholders note (2) 2,810 1,828 1,271 562(448)
Operating earnings per share (reflecting operating profit
based on longer-term investment returns after related
tax and non-controlling interests and excluding 2010
exceptional tax credit) (in pence) 76.8p 62.8p 59.0p 44.0p 39.0p
Operating earnings per share (reflecting operating profit
based on longer-term investment returns after related
tax and non-controlling interests and including 2010
exceptional tax credit) (in pence) 76.8p 62.8p 65.3p 44.0p 39.0p
| * |
|
The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2008 to 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied. |
Supplementary EEV income statement data
Year ended 31 December
2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm Additional
Operating profit based on longer-term investment returns note (2) 4,321 3,978 3,696 3,090 2,865
Short-term fluctuations in investment returns
on shareholder-backed business 538(907)(30) 351(4,967) unaudited
Mark to market value movements on core borrowings(380)(14)(164)(795) 656 fi
Shareholders’ share of actuarial and other gains and losses nancial
on defined benefit pension schemes 62 23(11)(84)(14)
Effect of changes in economic assumptions(16)(158)(10)(910)(398)
Costs of terminated AIA transaction – –(377) – –
Gain on dilution of Group’s holdings 42 – 3 – – information
Gain on acquisition of REALIC 453 – – – –
Profit on sale and results of Taiwan agency business – – – 91(248)
Profit (loss) from continuing operations before tax
attributable to shareholders 5,020 2,922 3,107 1,743(2,106) Financial
Operating earnings per share (reflecting operating profit
based on longer-term investment returns after related
tax and non-controlling interests and excluding 2010 statements
exceptional tax credit) (in pence) 125.0p 115.7p 106.9p 88.8p 85.1p
Operating earnings per share (reflecting operating profit
based on longer-term investment returns after related
tax and non-controlling interests and including 2010
exceptional tax credit) (in pence) 125.0p 115.7p 113.2p 88.8p 85.1p
368 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
I: Selected historical financial information of Prudential continued
New business data
New business excluding Japan note (3)
Year ended 31 December
2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm
Annual premium equivalent (APE) sales:
Asia note (3) 1,897 1,660 1,501 1,209 1,174
US 1,462 1,275 1,164 912 716
UK 836 746 820 723 947
Total APE sales 4,195 3,681 3,485 2,844 2,837
EEV new business profit (NBP) 2,452 2,151 2,028 1,619 1,205
NBP margin (% APE) 58% 58% 58% 57% 42%
Statement of financial position data
As of and for the year ended 31 December* 2012 Łm 2011 Łm 2010 Łm 2009 Łm 2008 Łm
Total assets 310,253 272,745 260,040 227,103 214,858
Total policyholder liabilities and unallocated surplus
of with-profits funds 271,363 236,290 224,980 196,417 182,391
Core structural borrowings of shareholder-financed
operations 3,554 3,611 3,676 3,394 2,958
Total liabilities 299,889 264,138 252,475 221,230 210,193
Total equity 10,364 8,607 7,565 5,873 4,665
* The Group has adopted updated US GAAP requirements for deferred acquisition costs as an improvement to its accounting policy under IFRS 4 for those operations of the Group which measure insurance assets and liabilities substantially by reference to US GAAP principles. Accordingly, the 2008 to 2011 comparative results have been adjusted from those previously published for the retrospective application of the improvement as if the new accounting policy had always applied.
Other data
As of and for the year ended 31 December 2012 Łbn 2011 Łbn 2010 Łbn 2009 Łbn 2008 Łbn
Funds under management note (4) 405 351 340 290 249
EEV shareholders’ equity, excluding non-controlling interests 22.4 19.6 18.2 15.3 15.0
Insurance Groups Directive capital surplus (as adjusted) note (5) 5.1 4.0 4.3 3.4 1.5
Notes
1 This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders.
2 Operating profits are determined on the basis of including longer-term investment returns. EEV and IFRS operating profits are stated after excluding the effect of short-term fluctuations in investment returns against long-term assumptions, the shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes, gain on dilution of the Group’s holdings and in 2010 costs associated with the terminated AIA transaction. In addition, for EEV basis results, operating profit excludes the effect of changes in economic assumptions, the market value movement on core borrowings and in 2012, the gain arising on the acquisition of REALIC. Separately, on the IFRS basis, operating profit also excludes amortisation of accounting adjustments on the acquisition of REALIC.
3 Asia comparative APE new business sales prior to 2011 exclude the Japanese insurance operations, which ceased writing new business from 15 February 2010.
4 Funds under management comprise funds of the Group held in the statement of financial position and external funds that are managed by Prudential asset management operations.
5 The surpluses shown are before allowing for the final dividends for each year, which are paid in the following year. The 2012 surplus is estimated.
Additional unaudited fi nancial information Prudential plc Annual Report 2012 369
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns
by driver
This classifi es the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profi ts, using the following categories:
i Spread income represents the difference between net investment income (or premium income in the case of the UK annuities new business) and amounts credited to policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets;
ii Fee income represents profits driven by net investment performance, being asset management fees that vary with the size of the underlying policyholder funds net of investment management expenses;
iii With-profits results represents the shareholders’ transfer from the with-profits fund in the period;
iv Insurance margin primarily represents profits derived from the insurance risks of mortality, morbidity and persistency;
v Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses;
v Acquisition costs and administration expenses represent expenses incurred in the period attributable to shareholders. It excludes items such as restructuring costs and Solvency II costs which are not included in the segment profit for insurance as well as items that are more appropriately included in other source of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate); and
vii DAC adjustments comprises DAC amortisation for the period, excluding amounts related to short-term fluctuations, net of costs deferred in respect of new business.
Analysis of pre-tax IFRS operating profit by source
2012 Łm
Asia US UK Unallocated Total
Spread income 106 702 266 – 1,074
Fee income 141 875 61 – 1,077
With-profits result 39 – 272 – 311
Insurance margin 594 399 39 – 1,032
Margin on revenues 1,453 – 216 – 1,669
Expenses:
Acquisition costs(903)(972)(122) –(1,997) Additional
Administration expenses(583)(537)(128) –(1,248)
DAC adjustments(28) 442(8) – 406
Expected return on shareholder assets 43 55 107 – 205 unaudited
Gain on China Life (Taiwan) shares 51 – – – 51 fi
Long-term business operating profit 913 964 703 – 2,580 nancial
Asset management operating profit 75 39 371 – 485
GI commission – – 33 – 33
Other income and expenditure* – – –(565)(565) information
Total operating profit based on longer-term investment returns 988 1,003 1,107(565) 2,533
* Including restructuring and Solvency II implementation costs. Financial
statements
370 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns
by driver continued
2011 Łm
Asia US UK Unallocated Total
Spread income 88 730 247 – 1,065
Fee income 131 680 59 – 870
With-profits result 38 – 293 – 331
Insurance margin 477 232 27 – 736
Margin on revenues 1,199 – 226 – 1,425
Expenses:
Acquisition costs(766)(890)(127) –(1,783)
Administration expenses(503)(412)(128) –(1,043)
DAC adjustments* 14 228(5) – 237
Expected return on shareholder assets 26 83 91 – 200
Long-term business operating profit 704 651 683 – 2,038
Asset management operating profit 80 24 357 – 461
GI commission – – 40 – 40
RPI to CPI inflation measure change on defined benefit schemes – – – 42 42
Other income and expenditure† – – –(554)(554)
Total operating profit based on longer-term investment returns 784 675 1,080(512) 2,027
* DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in note A5 of the IFRS fi nancial statements.
† Including restructuring and Solvency II implementation costs.
Margin analysis of long-term insurance business
The following analysis expresses certain of the Group’s sources of operating profi t as a margin of policyholder liabilities or other suitable driver. Details of the Group’s average policyholder liability balances are given in D2(b), D3(b), D4(b).
2012 2011
Average Average
Profit liability Margin Profit liability Margin
note (iv) note (iii) note (iv) note (iii)
Long-term business Łm Łm bps Łm Łm bps
Spread income 1,074 62,174 173 1,065 57,417 185
Fee income 1,077 78,807 137 870 68,298 127
With-profits result 311 95,681 33 331 93,056 36
Insurance margin 1,032 736
Margin on revenues 1,669 1,425
Expenses:
Acquisition costs note (i)(1,997) 4,195(48)%(1,783) 3,681(48)%
Administration expenses(1,248) 143,321(87)(1,043) 125,715(83)
DAC adjustments note (ii) 406 237
Expected return on shareholder assets 205 200
Gain on China Life (Taiwan) shares 51 –
Operating profit 2,580 2,038
Pp
Additional unaudited fi nancial information Prudential plc Annual Report 2012 371
Asia
2012 2011
Average Average
Profit liability Margin Profit liability Margin
note (iii) note (iii)
Long-term business Łm Łm bps Łm Łm bps
Spread income 106 6,720 158 88 5,623 157
Fee income 141 13,022 108 131 12,370 106
With-profits result 39 12,990 30 38 11,775 32
Insurance margin 594 477
Margin on revenues 1,453 1,199
Expenses:
Acquisition costs note (i)(903) 1,897(48)%(766) 1,660(46)%
Administration expenses(583) 19,742(295)(503) 17,993(280)
DAC adjustments note (ii)(28) 14
Expected return on shareholder assets 43 26
Gain on China Life (Taiwan) shares 51 –
Operating profit 913 704
Notes
(i) The ratio for acquisition costs is calculated as a percentage of APE including with-profits sales. Acquisition costs include only those relating to shareholders.
(ii) DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in note A5 of the IFRS financial statements.
(iii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus.
(iv) For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as this is seen as a good proxy for average balances throughout the year. The calculation of average liabilities for Jackson is derived from month-end balances throughout the year as opposed to opening and closing balances only. Liabilities held in the general account for variable annuity living and death guaranteed benefits together with other amounts on which no spread income is earned (eg REALIC liabilities) are excluded from the calculation of the average. In addition for REALIC, which are included in the average liability to calculate the administration expense margin, the calculation excludes the liabilities reinsured to (and in essence retained by) Swiss Re immediately prior to the acquisition by Jackson.
Analysis of Asia IFRS operating profit drivers
Spread income has increased by Ł18 million from Ł88 million in 2011 to Ł106 million in 2012, an increase of 20 per cent that
predominantly reflects the growth of the Asian non-linked policyholder liabilities.
Fee income has increased from Ł131 million in 2011 to Ł141 million in 2012, broadly in line with the increase in movement in
average unit-linked liabilities, following the recovery in equity markets in 2012.
Insurance margin has increased by Ł117 million from Ł477 million in 2011 to Ł594 million in 2012 predominantly reflecting
the continued growth of the in-force book, which contains a relatively high proportion of risk-based products. Insurance margin Additional
includes non-recurring items of Ł48 million (2011: Ł38 million), reflecting assumption changes and other items that are not
expected to reoccur in the future.
Margin on revenues has increased by Ł254 million from Ł1,199 million in 2011 to Ł1,453 million in 2012 primarily reflecting unaudited
the on-going growth in the size of the portfolio and higher premium income recognised in the year. fi
Acquisition costs have increased by 18 per cent from Ł766 million in 2011 to Ł903 million in 2012, compared to the 14 per cent
increase in sales, resulting in a marginal increase in the acquisition cost ratio. The analysis above has been prepared applying nancial
shareholder acquisition costs as a proportion of total APE. If with-profits sales were excluded from the denominator the acquisition
cost ratio would become 63 per cent (2011: 59 per cent) reflecting changes to product and country mix.
Administration expenses have increased from Ł503 million in 2011 to Ł583 million in 2012 as the business continues to expand.
Expressed as a ratio of policyholder liabilities, administration costs have increased from 280 basis points to 295 basis points due information
to changes in business mix.
Expected return on shareholder assets has increased from Ł26 million in 2011 to Ł43 million in 2012 primarily due to higher
income from increased shareholder assets. Financial
statements
372 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
II(a): Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns
by driver continued
US
2012 2011
Average Average
Profit liability Margin Profit liability Margin
note (iii) note (iii)
Long-term business Łm Łm bps Łm Łm bps
Spread income 702 29,416 239 730 28,274 258
Fee income 875 44,046 199 680 34,452 197
Insurance margin 399 232
Expenses:
Acquisition costs note (i)(972) 1,462(66)%(890) 1,275(70)%
Administration expenses(537) 75,802(71)(412) 62,726(66)
DAC adjustments note (ii) 442 228
Expected return on shareholder assets 55 83
Operating profit 964 651
Notes
(i) The ratio for acquisition costs is calculated as a percentage of APE.
(ii) DAC adjustments have been adjusted for the retrospective application of the accounting policy change described in note A5 of the IFRS financial statements.
(iii) The calculation of average liabilities for Jackson is derived from month-end balances throughout the year as opposed to opening and closing balances only. Liabilities held in the general account for variable annuity living and death guaranteed benefits together with other amounts on which no spread income is earned (eg REALIC liabilities) are excluded from the calculation of the average. In addition for REALIC, which is included in the average liability to calculate the administration expense margin, the calculation excludes the liabilities reinsured to (and in essence retained by) Swiss Re immediately prior to the acquisition by Jackson.
The 2010 balances have been amended for consistency albeit impacts are minimal.
Analysis of US operating profi t drivers
Spread income was Ł702 million in 2012, down Ł28 million from the Ł730 million earned in 2011. 2012 benefi ted by Ł156 million from the effect of transactions entered into during 2011 and 2010 to more closely match the overall asset and liability duration (2011: Ł113 million). Excluding this effect, the spread margin would have been 186 basis points (2011: 218 basis points).
The reported spread margin decreased as a result of downward pressure on yields caused by the low interest rate environment, the effect of which was only partly mitigated by reductions in crediting rates.
Fee income has increased by 29 per cent to Ł875 million in 2012, compared to Ł680 million in 2011 as a result of the growth in separate account balances primarily due to positive netflows from variable annuity business. Fee income margin has increased slightly to 199 basis points (2011: 197 basis points) primarily refi ecting changes to business mix.
Insurance margin represents operating profi ts from insurance risks, including variable annuity guarantees and other sundry items. Positive netflows into variable annuity business with life contingent and other guarantee fees, coupled with the benefi t in the period of repricing actions, have increased the insurance margin from Ł232 million in 2011 to Ł399 million in 2012. This includes the benefi ts of four months’ profi ts amounting to Ł87 million from the life business of REALIC, following its acquisition by Jackson in September 2012.
Acquisition costs, which are commissions and general expenses incurred to acquire new business, have increased in absolute terms compared to 2011 due largely to an increase in sales volumes. However, acquisition costs as a percentage of APE have decreased to 66 per cent for 2012, compared to 70 per cent in 2011, due to the continued increase in producers selecting asset based commission which is treated as an administrative expense in this analysis, rather than front end commissions.
Administration expenses increased to Ł537 million in 2012 compared to Ł412 million in 2011, primarily as a result of higher asset based commissions paid on the larger 2012 separate account balance. Asset based commissions are paid upon policy anniversary dates and are treated as an administration expense in this analysis as opposed to a cost
of acquisition and are offset by higher fee income. The administration expense margin was higher at 71 basis points (2011: 66 basis points). Excluding these trail commission amounts, the resulting administration expense margin would be 48 basis points (2011: 46 basis points ). The increase arises as a result of the effect of the REALIC acquisition on the administration expense margin together with the impact in 2012 of non recurring expenditures.
DAC adjustments increased to Ł442 million in 2012 compared to Ł228 in 2011. 2011 was lowered by Ł190 million of accelerated DAC amortisation as a result of the reversal of the benefi t received in 2008 from the mean reversion formula. Market movements in 2012 resulted in deceleration of DAC amortisation of Ł56 million which was offset by higher amortisation as a result of higher gross profi ts. Following the adoption of the updated US GAAP principles for deferred acquisition costs, as described in note A5 of the IFRSfinancial statements, certain acquisition costs are no longer fully deferrable resulting in new business strain of Ł174 million for 2012 (2011: Ł156 million).
Additional unaudited fi nancial information Prudential plc Annual Report 2012 373
Analysis of pre-tax operating profi t before and aft er acquisition costs and DAC adjustments
2012 £m 2011 £m Other Acquisition costs Other Acquisition costs operating operating profi ts Incurred Deferred Total profi ts Incurred Deferred Total
Total operating pro? t before acquisition costs and DAC adjustments 1,494 1,494 1,313 1,313 Less new business strain (972) 798 (174) (890) 734 (156) Other DAC adjustments – amortisation of previously deferred acquisition costs Normalnote (412) (412) (316) (316) Decelerated (accelerated) 56 56 (190) (190)
Total 1,494 (972) 442 964 1,313 (890) 228 651
UK
2012 2011 Average Average
Profi t liability Margin Profi t liability Margin Long-term business £m £m bps £m £m bps
Spread income 266 26,038 102 247 23,520 105 Fee income 61 21,739 28 59 21,476 27 With-pro? ts result 272 82,691 33 293 81,281 36 Insurance margin 39 27 Margin on revenues 216 226 Expenses: Acquisition costsnote (122) 836 (15)% (127) 746 (17)% Administration expenses (128) 47,777 (27) (128) 44,996 (28) DAC adjustments (8) (5) Expected return on shareholder assets 107 91
Operating pro? t 703 683
Note
The ratio for acquisition costs is calculated as a percentage of APE including with-profi ts sales. Acquisition costs include only those relating to shareholders.
Analysis of UK IFRS operating profi t drivers
Spread income has increased from £247 million in 2011 to £266 million in 2012 principally due to increased new business profi ts from higher annuity sales. The margin has fallen slightly from 105 basis points to 102 basis points.
Fee income has increased in line with the growth in unit-linked liabilities. Expressed as an asset management charge it is equivalent to 28 basis points (2011: 27 basis points).
With-pro? ts income has decreased by £21 million from £293 million in 2011 to £272 million in 2012 principally due to a 50 basis point reduction in annual bonus rates. This has contributed to the reduction in the with-pro? ts margin from 36 basis points in 2011 to 33 basis points in 2012.
Insurance margin has increased by £12 million from £27 million in 2011 to £39 million in 2012, mainly due to increased profi ts from our protection business.
Margin on revenues represents premiums charges for expenses and other sundry net income received by the UK. 2012 income was £216 million (2011: £226 million).
Acquisition costs as a percentage of new business sales have improved from 17 per cent in 2011 to 15 per cent in 2012. The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. It is therefore impacted by the level of with-pro? t sales in the year. Acquisition costs as a percentage of shareholder-backed new business sales were 33 per cent for 2012 (2011: 33 per cent).
Expected return on shareholder has increased from £91 million in 2011 to £107 million in 2012 principally due to higher IFRS shareholders’ funds.
374 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
II(b): Asia operations – analysis of IFRS operating profit by territory
2012 Łm 2011* Łm
China 19 11
Hong Kong 88 69
India 54 47
Indonesia 260 212
Japan(2) 2
Korea 16 17
Malaysia 120 104
Philippines 15 5
Singapore 206 167
Taiwan bancassurance business 18 2
Thailand 7 4
Vietnam 25 30
Other(5) 1
Non-recurrent items: note (ii)
Gain on China Life (Taiwan) shares 51 –
Other non-recurrent items 48 38
Total insurance operations note (i) 920 709
Development expenses(7)(5)
Total long-term business operating profit 913 704
Eastspring Investments 75 80
Total Asia operations 988 784
Notes
(i) Analysis of operating profit between new and in-force business
The result for insurance operations comprises amounts in respect of new business and business in-force as follows:
2012 Łm 2011* Łm
New business strain(51)(70)
Business in force 872 741
Non-recurrent items: note (ii)
Gain on China Life (Taiwan) shares 51 –
Other non-recurrent items 48 38
Total 920 709
The IFRS new business strain corresponds to approximately 3 per cent of new business APE premiums for 2012 (2011: approximately 4 per cent of new business APE). The improvement is driven by a shift in overall sales mix to lower strain products and countries.
The strain refl ects the aggregate of the pre-tax regulatory basis strain to net worth aft er IFRS adjustments for deferral of acquisition costs and deferred income where appropriate.
(ii) During 2012, the Group sold its 7.74 per cent stake in China Life (Taiwan) for Ł97 million crystallising a gain of Ł51 million. Other non-recurrent items of Ł48 million in 2012 (2011: Ł38 million) represent a small number of items that are not anticipated to reoccur in subsequent periods.
* The 2011 comparative results have been adjusted from those previously published for the retrospective application of the change in accounting policy described in note A5.
Additional unaudited fi nancial information Prudential plc Annual Report 2012 375
II(c): Analysis of asset management operating profit based on longer-term investment returns
2012 Łm
Eastspring
M&G Investments PruCap US Total
note (i),(ii) note (ii)
Operating income before performance-related fees 734 201 120 296 1,351
Performance-related fees 9 2 – – 11
Operating income* 743 203 120 296 1,362
Operating expense(436)(128)(69)(257)(890)
Share of associate’s results 13 – – – 13
Operating profit based on longer-term investment returns 320 75 51 39 485
Average funds under management (FUM), including 49.99%
proportional share of PPM South Africa† Ł209.0 bn
Average funds under management (FUM), excluding PPM
South Africa† Ł205.1 bn Ł55.0 bn
Margin based on operating income† 36 bps 37 bps
Cost/income ratio‡ 59% 64%
2011 Łm
Eastspring
M&G Investments PruCap US Total
note (i),(ii) note (ii)
Operating income before performance-related fees 666 196 122 249 1,233
Performance-related fees 13 6 – – 19
Operating income* 679 202 122 249 1,252
Operating expense(404)(122)(66)(225)(817)
Share of associate’s results 26 – – – 26
Operating profit based on longer-term investment returns 301 80 56 24 461 Additional
Average funds under management (FUM), including 49.99%
proportional share of PPM South Africa† Ł195.1 bn
Average funds under management (FUM), excluding PPM unaudited
South Africa† Ł190.9 bn Ł51.4 bn
fi
Margin based on operating income† 35 bps 38 bps
Cost/income ratio‡ 61% 62% nancial
Notes
(i) Following the divestment in the first half of 2012 of M&G’s holding in PPM South Africa from 75 per cent to 49.99 per cent and its treatment from 2012 as an
associate, M&G’s operating income and expense no longer includes any element from PPM South Africa. In order to avoid period on period distortion, in the
table above the 2011 operating income, margin and cost/income ratio reflect the retrospective application of this basis of presentation for the 2011 results. information
(ii) M&G and Eastspring Investments can be further analysed as follows:
Financial
P
statements
376 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
II(c): Analysis of asset management operating profit based on longer-term investment returns continued
M&G
Operating income*
Margin Margin Margin
Retail of FUM† Institutional§ of FUM† Total of FUM†
Łm bps Łm bps Łm bps
2012 438 91 297 19 734 36
2011 396 97 270 18 666 35
Eastspring Investments
Operating income*
Margin Margin Margin
Retail of FUM† Institutional§ of FUM† Total of FUM†
Łm bps Łm bps Łm bps
2012 118 64 83 24 201 37
2011 120 62 76 24 196 38
* Operating income is net of commissions. M&G’s operating income excludes any contribution from M&G’s associate, PPM South Africa.
• Margin represents operating income before performance related fees as a proportion of the related funds under management (FUM), excluding PPM South Africa. 2011 comparatives have been amended to be on a comparable basis. Monthly funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations which are managed by third parties outside of the Prudential Group are
excluded from these amounts.
• Cost/income ratio represents cost as a percentage of operating income before performance related fees. In order to avoid period on period distortion, M&G’s operating income and expense excludes any contribution from M&G’s associate, PPM South Africa.
§ Institutional includes internal funds.
III(a): Funds under management
i Summary
2012 Łbn 2011 Łbn
Business area:
Asia operations 38.9 32.6
US operations 91.4 71.9
UK operations 153.3 146.3
Internal funds under management 283.6 250.8
External funds note 121.4 99.8
Total funds under management 405.0 350.6
Note
External funds shown above for 2012 of Ł121.4 billion (2011: Ł99.8 billion) comprise Ł133.5 billion (2011: Ł111.2 billion) of funds managed by Eastspring Investments and M&G (as shown in note (iii) below) less Ł12.1 billion (2011: Ł11.4 billion) that are classifi ed within internal funds.
Additional unaudited fi nancial information Prudential plc Annual Report 2012 377
ii Internal funds under management – analysis by business area
Asia operations US operations UK operations Total
2012 2011 2012 2011 2012 2011 2012 2011
Łbn Łbn Łbn Łbn Łbn Łbn Łbn Łbn
Investment propertiesnote – – 0.1 0.1 11.0 10.9 11.1 11.0
Equity securities 14.3 12.0 49.6 38.1 36.1 37.3 100.0 87.4
Debt securities 21.4 17.7 33.0 27.0 85.7 79.8 140.1 124.5
Loans and receivables 1.0 1.2 6.2 4.1 4.6 4.4 11.8 9.7
Other investments and deposits 2.2 1.7 2.5 2.6 15.9 13.9 20.6 18.2
Total 38.9 32.6 91.4 71.9 153.3 146.3 283.6 250.8
Note
As included in the investments section of the consolidated statement of financial position at 31 December 2012 except for Ł0.2 billion (2011: Ł0.2 billion)
investment properties which are held for sale or occupied by the Group and, accordingly under IFRS, are included in other statement of financial
position captions.
iii Investment products – funds under management
2012 Łm
Market
exchange
Market translation
1 Jan gross and other 31 Dec
2012 inflows Redemptions movements 2012
Eastspring Investments 19,221 60,498(59,098) 1,013 21,634
M&G 91,948 36,463(19,582) 3,039 111,868
Group total 111,169 96,961(78,680) 4,052 133,502
2011 Łm
Market
exchange
Market translation
1 Jan gross and other 31 Dec
2011 inflows Redemptions movements 2011
Eastspring Investments 22,048 63,726(63,605)(2,948) 19,221 Additional
M&G 89,326 25,981(21,596)(1,763) 91,948
Group total 111,374 89,707(85,201)(4,711) 111,169 unaudited
fi
nancial
information
Financial
statements
378 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
III(b): Reconciliation of expected transfer of value of in-force (VIF) and required capital business to free surplus
The tables below show how the VIF generated by the in-force long-term business and the associated required capital is modelled as emerging into free surplus over the next 40 years. Although a small amount (less than 2 per cent) of the Group’s embedded value emerges after this date, analysis of cashflows emerging in the years shown in the tables is considered most meaningful. The modelled cashflows use the same methodology underpinning the Group’s embedded value reporting and so are subject to the same assumptions and sensitivities.
In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in-force business at 31 December 2012, the tables also present the expected future free surplus to be generated from the investment made in new business during 2012 over the same 40 year period.
Expected transfer of value of in-force (VIF) and required capital business to free surplus
2012 Łm
Undiscounted expected generation from Undiscounted expected generation from
all in-force business at 31 December* 2012 long-term new business written*
Expected period of emergence Asia US UK Total Asia US UK Total
2013 719 785 446 1,950 105 269 27 401
2014 761 572 483 1,816 129 108 23 260
2015 724 600 464 1,788 129 113 23 265
2016 686 557 444 1,687 99 37 20 156
2017 654 587 430 1,671 98 115 23 236
2018 628 551 415 1,594 86 77 22 185
2019 617 514 401 1,532 91 64 18 173
2020 610 524 389 1,523 94 115 18 227
2021 598 445 380 1,423 89 95 18 202
2022 585 390 372 1,347 95 78 18 191
2023 557 353 365 1,275 85 73 17 175
2024 538 298 356 1,192 85 56 17 158
2025 525 229 349 1,103 80 45 17 142
2026 521 204 343 1,068 82 39 17 138
2027 510 179 330 1,019 107 33 17 157
2028 506 154 317 977 80 27 17 124
2029 492 134 309 935 77 22 17 116
2030 478 126 299 903 76 18 17 111
2031 453 106 289 848 71 14 17 102
2032 437 117 281 835 82 14 17 113
2033 to 2037 1,911 145 1,170 3,226 307 19 77 403
2038 to 2042 1,554(21) 916 2,449 234(25) 78 287
2043 to 2047 1,251 – 514 1,765 187 – 51 238
2048 to 2052 926 – 300 1,226 141 – 36 177
Total free surplus expected to emerge
in the next 40 years 17,241 7,549 10,362 35,152 2,709 1,406 622 4,737
* The analysis excludes amounts incorporated into VIF at 31 December 2012 where there is no definitive timeframe for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the estate. It also excludes any free surplus emerging after 2052.
The above amounts can be reconciled to the new business amounts as follows:
2012 Łm
New business Asia US UK Total
Undiscounted expected free surplus generation for years 2013 to 2052 2,709 1,406 622 4,737
Less: discount effect(1,499)(406)(348)(2,253)
Discounted expected free surplus generation for years 2013 to 2052 1,210 1,000 274 2,484
Discounted expected free surplus generation for years 2052+ 41 – 3 44
Less: free surplus investment in new business(292)(281)(45)(618)
Other items* 23(151) 9(119)
Post-tax EEV new business profit 982 568 241 1,791
Tax 284 305 72 661
Pre-tax EEV new business profit 1,266 873 313 2,452
* Other items represent the impact of the time value of options and guarantees on new business, foreign exchange effects and other non-modelled items. Foreign exchange effects arise as EEV new business profit amounts are translated at average exchange rates and the expected free surplus generation uses year end closing rates.
Additional unaudited fi nancial information Prudential plc Annual Report 2012 379
The undiscounted expected free surplus generation from all in-force business at 31 December 2012 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2011 as follows:
2012 2013 2014 2015 2016 2017 Other Total
Group Łm Łm Łm Łm Łm Łm Łm Łm
2011 expected free surplus generation for years
2012 to 2051 1,777 1,634 1,556 1,512 1,502 1,414 24,667 34,062
Less: amounts expected to be realised in the
current year(1,777) – – – – – –(1,777)
Add: expected free surplus to be generated in
year 2052* – – – – – – 175 175
Foreign exchange differences –(45)(42)(41)(42)(38)(594)(802)
New business – 401 260 265 156 236 3,419 4,737
Acquisition of REALIC – 45 35 44 38 41 738 941
Operating movements –(2) 28 32 24 17
Non-operating and other movements† –(83)(21)(24) 9 1(2,165)(2,184)
2012 expected free surplus generation for years
2013 to 2052 – 1,950 1,816 1,788 1,687 1,671 26,240 35,152
2012 2013 2014 2015 2016 2017 Other Total
Asia Łm Łm Łm Łm Łm Łm Łm Łm
2011 expected free surplus generation for years
2012 to 2051 674 647 634 595 590 564 13,998 17,702
Less: amounts expected to be realised in the
current year(674) – – – – – –(674)
Add: expected free surplus to be generated in
year 2052* – – – – – – 135 135
Foreign exchange differences –(24)(22)(20)(20)(18)(460)(564)
New business – 105 129 129 99 98 2,149 2,709
Operating movements –(21) – 9 –(6)
Non-operating and other movements – 12 20 11 17 16(2,125)(2,067)
2012 expected free surplus generation for years
2013 to 2052 – 719 761 724 686 654 13,697 17,241 Additional
2012 2013 2014 2015 2016 2017 Other Total
US Łm Łm Łm Łm Łm Łm Łm Łm unaudited
2011 expected free surplus generation for years fi
2012 to 2051 680 485 450 480 484 438 2,996 6,013
Less: amounts expected to be realised in the nancial
current year(680) – – – – – –(680)
Add: expected free surplus to be generated in
year 2052* – – – – – – – –
Foreign exchange differences –(21)(20)(21)(22)(20)(134)(238) information
New business – 269 108 113 37 115 764 1,406
Acquisition of REALIC – 45 35 44 38 41 738 941
Operating movements –(4) 7 14 20 18
Non-operating and other movements – 11(8)(30) –(5) 84 107 Financial
2012 expected free surplus generation for years
2013 to 2052 – 785 572 600 557 587 4,448 7,549 statements
* Excluding 2012 new business.
• Includes an adjustment of Ł102 million to the cashflows for which there is no definitive timeframe for their emergence and therefore which have been removed from the cashflows presented at 31 December 2012.
380 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
III(b): Reconciliation of expected transfer of value of in-force (VIF) and required capital business to free surplus continued
2012 2013 2014 2015 2016 2017 Other Total
UK Łm Łm Łm Łm Łm Łm Łm Łm
2011 expected free surplus generation for years
2012 to 2051 423 502 472 437 428 412 7,673 10,347
Less: amounts expected to be realised in the
current year(423) – – – – – –(423)
Add: expected free surplus to be generated in
year 2052* – – – – – – 40 40
New business – 27 23 23 20 23 506 622
Operating movements – 23 21 9 4 5
Non-operating and other movements† –(106)(33)(5)(8)(10)(124)(224)
2012 expected free surplus generation for years
2013 to 2052 – 446 483 464 444 430 8,095 10,362
* Excluding 2012 new business.
• Includes an adjustment of Ł102 million to the cash flows for which there is no definitive timeframe for their emergence and therefore which have been removed from the cash flows presented at 31 December 2012.
At 31 December 2012, the total free surplus expected to be generated over the nextfive years (years 2013 to 2017 inclusive), using the same assumptions and methodology as underpin our embedded value reporting was Ł8.9 billion, an increase of Ł1.3 billion from the
• 7.6 billion expected over the same period at the end of 2011.
This increase primarily reflects the new business written in 2012, which is expected to generate Ł1,318 million of free surplus over
the nextfive years. Operating movements contributed positive Ł99 million. The acquisition of REALIC contributed positive expected cash fl ows of Ł203 million over the next fi ve years. Non-operating and other items, including foreign exchange movements, reduced expected free surplus generation for the nextfive years by Ł326 million.
At 31 December 2012, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is Ł35 billion, up from the Ł34 billion expected at end of 2011. This is after allowing for adverse market movements in
the period, with a Ł0.8 billion reduction due to foreign exchange and negative market movements in Asia as a result of lower fund earned rates. A signifi cant proportion of these market movements arise in Hong Kong refi ecting both the projected derisking of the asset portfolio for participating business and lower local government bond yields (fall of 90 basis points) and Singapore where government bond yields have fallen by 30 basis points. The overall growth in the undiscounted value of free surplus, notwithstanding these impacts, reflects both our ability to write new business on attractive economics and to manage the in-force book for value.
Actual underlying free surplus generated in 2012 from life business in-force at the end of 2011 was Ł2.3 billion inclusive of
Ł0.3 billion of changes in operating assumptions and experience variances. This compares with the expected 2012 realisation at the end of 2011 of Ł1.8 million. This can be analysed further as follows:
Asia US UK Total
Łm Łm Łm Łm
Transfer to free surplus in 2012 635 777 511 1,923
Expected return on free assets 56 40 – 96
Changes in operating assumptions and experience variances 80 219(4) 295
Underlying free surplus generated from in-force life business in 2012 771 1,036 507 2,314
2012 free surplus expected to be generated at 31 December 2011 674 680 423 1,777
Additional unaudited fi nancial information Prudential plc Annual Report 2012 381
The equivalent discounted amounts of the undiscounted totals shown previously are outlined below:
2012 Łm
Discounted expected generation from Discounted expected generation from
all in-force business at 31 December long-term 2012 new business written
Expected period of emergence Asia US UK Total Asia US UK Total
2013 687 766 418 1,871 101 260 26 387
2014 679 526 426 1,631 113 98 21 232
2015 604 520 385 1,509 106 96 19 221
2016 537 455 346 1,338 76 30 16 122
2017 480 456 315 1,251 69 87 17 173
2018 434 404 284 1,122 57 55 15 127
2019 401 352 258 1,011 56 44 12 112
2020 375 344 234 953 55 74 11 140
2021 345 277 213 835 48 58 11 117
2022 318 230 196 744 48 45 10 103
2023 282 210 180 672 40 39 9 88
2024 255 168 164 587 37 27 8 72
2025 232 124 150 506 32 21 8 61
2026 215 106 138 459 30 17 8 55
2027 197 90 124 411 36 14 7 57
2028 198 75 110 383 28 10 7 45
2029 181 64 100 345 26 8 6 40
2030 167 59 91 317 23 6 6 35
2031 153 50 81 284 21 5 6 32
2032 141 53 74 268 22 5 5 32
2033 to 2037 545 77 246 868 77 5 20 102
2038 to 2042 359 33 133 525 49(4) 15 60
2043 to 2047 240 – 47 287 33 – 7 40
2048 to 2052 153 – 19 172 27 – 4 31
Total discounted free surplus expected to emerge
in the next 40 years 8,178 5,439 4,732 18,349 1,210 1,000 274 2,484 Additional
The above amounts can be reconciled to the Group’s financial statements as follows:
Total Łm unaudited
Discounted expected generation from all in-force business for years 2013 to 2052 18,349 fi
Discounted expected generation from all in-force business for years after 2052 242 nancial
Discounted expected generation from all in-force business at 31 December 2012 18,591
Add: Free surplus of life operations held at 31 December 2012 2,957
Less: Time value of guarantees(683)
Other non-modelled items* note 15 1,401 information
Total EEV for life operations 22,266
* These relate to items where there is no definitive timeframe for when the payments will be made or receipts received and are, consequently, excluded from the
amounts incorporated into the tables above showing the expected generation of free surplus from in-force business at 31 December 2012. In particular it excludes Financial
the value of the shareholders’ interest in the estate.
statements
382 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
III(c): Option schemes
The Group maintains four share option schemes satisfi ed by the issue of new shares. UK-based executive directors are eligible to participate in the UK savings-related share option scheme, and executives based in Asia can participate in the International savings-related share option scheme. Dublin-based employees are eligible to participate in the Prudential International Assurance sharesave plan, and Hong Kong based agents can participate in the Non-employee savings-related share option scheme. Further details of the schemes and accounting policies are detailed in note I4 of the IFRS basis consolidatedfinancial statements.
All options were granted at Łnil consideration. No options have been granted to substantial shareholders, suppliers of goods or services (excluding options granted to agents under the Non-employee savings-related share option scheme) or in excess of the individual limit for the relevant scheme.
The options schemes will terminate as follows, unless the directors resolve to terminate the plans at an earlier date:
UK savings-related share option scheme: 8 May 2013;
International savings-related share option scheme: 31 May 2021; Prudential International Assurance sharesave plan: 3 August 2019; and
Prudential International savings-related share option scheme for non-employees 2012: 17 May 2022.
The weighted average share price of Prudential plc for the year ended 31 December 2012 was Ł7.69 (2011:
Ł6.86). Particulars of options granted to directors are included in the Directors’ Remuneration Report on page 113.
The closing price of the shares immediately before the date on which the options were granted during the current period was Ł8.22. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2012.
UK Savings Related Share Option Scheme
Exercise period Number of options
Exercise Beginning End of
Date of grant price Ł Beginning End of period Granted Exercised Cancelled Forfeited Lapsed period
30 Sep 2004 3.43 01 Dec 2011 31 May 2012 3,852 –(3,852) – – – –
12 Apr 2005 3.87 01 Jun 2012 30 Nov 2012 8,528 –(8,528) – – – –
29 Sep 2005 4.07 01 Dec 2012 31 May 2013 9,072 –(5,292) – – – 3,780
20 Apr 2006 5.65 01 Jun 2013 30 Nov 2013 7,322 – – – – – 7,322
28 Sep 2006 4.75 01 Dec 2011 31 May 2012 11,029 –(11,029) – – – –
28 Sep 2006 4.75 01 Dec 2013 31 May 2014 13,325 – – – – – 13,325
26 Apr 2007 5.72 01 Jun 2010 30 Nov 2010 2,865 – – – –(2,865) –
26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 7,191 –(7,191) – – – –
26 Apr 2007 5.72 01 Jun 2014 30 Nov 2014 503 – – – – – 503
27 Sep 2007 5.52 01 Dec 2012 31 May 2013 17,264 –(12,156) – – – 5,108
27 Sep 2007 5.52 01 Dec 2014 31 May 2015 1,668 – – – – – 1,668
25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 27,099 –(453) – –(137) 26,509
25 Apr 2008 5.51 01 Jun 2015 30 Nov 2015 1,544 – – – – – 1,544
25 Sep 2008 4.38 01 Dec 2011 31 May 2012 40,617 –(38,162) – –(2,455) –
25 Sep 2008 4.38 01 Dec 2013 31 May 2014 47,353 –(2,674) – –(1,305) 43,374
25 Sep 2008 4.38 01 Dec 2015 31 May 2016 11,371 –(90) – –(76) 11,205
27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 2,767,654 –(2,738,947)(4,694)(10,783)(7,521) 5,709
27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 1,789,848 –(27,164)(6,944)(16,820)(19,715) 1,719,205
27 Apr 2009 2.88 01 Jun 2016 30 Nov 2016 178,968 –(352)(795) –(329) 177,492
25 Sep 2009 4.25 01 Dec 2012 31 May 2013 224,295 –(173,784)(5,721)(2,433)(1,372) 40,985
25 Sep 2009 4.25 01 Dec 2014 31 May 2015 90,865 –(2,027) –(117)(2,070) 86,651
28 Sep 2010 4.61 01 Dec 2013 31 May 2014 271,969 –(1,408)(7,644)(4,875)(1,322) 256,720
28 Sep 2010 4.61 01 Dec 2015 31 May 2016 134,304 –(1,569)(1,339)(5,021)(2,514) 123,861
16 Sep 2011 4.66 01 Dec 2014 31 May 2015 485,420 –(2,373)(12,818)(4,516)(7,514) 458,199
16 Sep 2011 4.66 01 Dec 2016 31 May 2017 197,637 –(15)(5,357)(7,580)(115) 184,570
21 Sep 2012 6.29 01 Dec 2015 31 May 2016 – 995,343 –(3,148)(5,294) – 986,901
21 Sep 2012 6.29 01 Dec 2017 31 May 2018 – 152,281 –(4,772) – – 147,509
6,351,563 1,147,624 (3,037,066)(53,232)(57,439)(49,310) 4,302,140
The total number of securities available for issue under the scheme is 4,302,140 which represents 0.168 per cent of the issued share capital at 31 December 2012.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was Ł7.13.
The weighted average fair value of options granted under the plan in the period was Ł2.28.
Additional unaudited fi nancial information Prudential plc Annual Report 2012 383
International Savings Related Share Option Scheme
Exercise period Number of options
Exercise Beginning End of
Date of grant price Ł Beginning End of period Granted Exercised Cancelled Forfeited Lapsed period
20 Apr 2006 5.65 01 Jun 2011 30 Nov 2011 820 – – – –(820) –
28 Sep 2006 4.75 01 Dec 2011 31 May 2012 709 – – – –(709) –
26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 17,847 –(2,778) –(580) – 14,489
27 Sep 2007 5.52 01 Dec 2010 31 May 2011 22,185 – – – –(22,185) –
25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 8,928 – – – –(8,928) –
25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 4,192 – – – – – 4,192
25 Sep 2008 4.38 01 Dec 2011 31 May 2012 195,889 –(28,952)(418)(85) (166,434) –
25 Sep 2008 4.38 01 Dec 2013 31 May 2014 6,951 – – – – – 6,951
27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 1,740,780 –(1,652,468)(20,966)(3,454)(418) 63,474
27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 81,218 – –(1,748)(1,337) – 78,133
25 Sep 2009 4.25 01 Dec 2012 31 May 2013 110,422 –(59,246)(5,541)(3,945)(149) 41,541
25 Sep 2009 4.25 01 Dec 2014 31 May 2015 2,682 – – – – – 2,682
28 Sep 2010 4.61 01 Dec 2013 31 May 2014 157,107 –(699)(17,743)(19,502) – 119,163
28 Sep 2010 4.61 01 Dec 2015 31 May 2016 6,130 – – – – – 6,130
16 Sep 2011 4.66 01 Dec 2014 31 May 2015 410,756 –(52)(20,880)(36,983) – 352,841
16 Sep 2011 4.66 01 Dec 2016 31 May 2017 25,739 – – – – – 25,739
21 Sep 2012 6.29 01 Dec 2015 31 May 2016 – 691,531 –(3,228)(6,935) – 681,368
21 Sep 2012 6.29 01 Dec 2017 31 May 2018 – 34,701 – – – – 34,701
2,792,355 726,232(1,744,195)(70,524)(72,821) (199,643) 1,431,404
The total number of securities available for issue under the scheme is 1,431,404 which represents 0.056 per cent of the issued share capital at 31 December 2012.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was Ł7.01.
The weighted average fair value of options granted under the plan in the period was Ł2.28.
Prudential International Assurance Sharesave Plan
Exercise period Number of options Additional
Exercise Beginning End of
Date of grant price Ł Beginning End of period Granted Exercised Cancelled Forfeited Lapsed period
25 Sep 2008 4.38 01 Dec 2011 31 May 2012 691 –(691) – – – – unaudited
27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 30,320 –(26,516) – –(158) 3,646 fi
27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 6,567 – – – – – 6,567 nancial
25 Sep 2009 4.25 01 Dec 2012 31 May 2013 2,426 –(1,627) – –(160) 639
40,004 –(28,834) – –(318) 10,852
The total number of securities available for issue under the scheme is 10,852 which represents 0.001 per cent of the issued share
capital at 31 December 2012.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the
current period was Ł7.00. Financial
statements
384 Financial statements Prudential plc Annual Report 2012
Additional unaudited fi nancial information continued
III(c): Option schemes continued
Non-employee Savings Related Share Option Scheme
Exercise period Number of options
Exercise Beginning End of
Date of grant price Ł Beginning End of period Granted Exercised Cancelled Forfeited Lapsed period
28 Sep 2006 4.75 01 Dec 2011 31 May 2012 5,386 –(3,366) – –(2,020) –
26 Apr 2007 5.72 01 Jun 2012 30 Nov 2012 15,557 –(2,778) – – – 12,779
27 Sep 2007 5.52 01 Dec 2010 31 May 2011 7,607 – –(7,607) – – –
27 Sep 2007 5.52 01 Dec 2012 31 May 2013 2,970 – – – – – 2,970
25 Apr 2008 5.51 01 Jun 2011 30 Nov 2011 4,589 – –(4,589) – – –
25 Apr 2008 5.51 01 Jun 2013 30 Nov 2013 3,834 – – – – – 3,834
25 Sep 2008 4.38 01 Dec 2011 31 May 2012 40,488 –(37,857)(2,631) – – –
25 Sep 2008 4.38 01 Dec 2013 31 May 2014 13,708 – – – – – 13,708
27 Apr 2009 2.88 01 Jun 2012 30 Nov 2012 874,201 –(846,669) – – – 27,532
27 Apr 2009 2.88 01 Jun 2014 30 Nov 2014 714,326 – –(14,564)(13,396) – 686,366
25 Sep 2009 4.25 01 Dec 2012 31 May 2013 46,446 –(29,770) – – – 16,676
25 Sep 2009 4.25 01 Dec 2014 31 May 2015 11,717 – – – – – 11,717
28 Sep 2010 4.61 01 Dec 2013 31 May 2014 1,118,575 – –(10,141)(11,692) – 1,096,742
28 Sep 2010 4.61 01 Dec 2015 31 May 2016 375,352 – –(6,502) – – 368,850
16 Sep 2011 4.66 01 Dec 2014 31 May 2015 644,407 – –(14,491)(20,973) – 608,943
16 Sep 2011 4.66 01 Dec 2016 31 May 2017 266,624 – –(3,942) – – 262,682
21 Sep 2012 6.29 01 Dec 2015 31 May 2016 – 443,315 – – – – 443,315
21 Sep 2012 6.29 01 Dec 2017 31 May 2018 – 97,731 –(1,431) – – 96,300
4,145,787 541,046(920,440)(65,898)(46,061)(2,020) 3,652,414
The total number of securities available for issue under the scheme is 3,652,414 which represents 0.143 per cent of the issued share capital at 31 December 2012.
The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was Ł7.11.
The weighted average fair value of options granted under the plan in the period was Ł2.28.
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Risk factors |
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Shareholder information |
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Appears Here] |
386 Additional information Prudential plc Annual Report 2012
Risk factors
A number of factors (risk factors) affect Prudential’s operating
results and fi nancial condition and, accordingly, the trading price of its shares. The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this document, is not updated, and any forward-looking statements are made subject to the reservations specifi ed below under ‘Forward-looking statements’.
Prudential’s approaches to managing risks are explained in the ‘Business review’ section under ‘Risk and capital management’.
Risks relating to Prudential’s business
Prudential’s businesses are inherently subject to market fl uctuations and general economic conditions
Prudential’s businesses are inherently subject to marketfluctuations and general economic conditions. Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profi tability. Since 2008, Prudential has had to operate against a challenging background of periods of signifi cant volatility in global capital and equity markets, interest rates and liquidity, and widespread economic uncertainty. Government interest rates have also fallen to historic lows in the US and UK and some Asia countries in which Prudential operates. These factors have, at times during this period, had a material adverse effect on Prudential’s business and profi tability.
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 signifi cant volumes of new business and would have a negative impact on its assets under management and profi t;
higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses;
Prudential in the normal course of business enters into a variety of transactions with counterparties, including derivative transactions. Failure of any of these counterparties to discharge their obligations, or where adequate collateral is not in place, could have an adverse impact on Prudential’s results; and
estimates of the value offinancial instruments being diffi cult because in certain illiquid or closed markets, determining the value at whichfinancial instruments can be realised is highly subjective. Processes to ascertain value and estimates of value require substantial elements of judgment, assumptions and estimates (which may change over time). Increased illiquidity also adds to uncertainty over the accessibility offinancial resources and may reduce capital resources as valuations decline.
Globalfinancial markets have experienced, and continue to experience, signifi cant uncertainty brought on, in particular, by concerns over European and US sovereign debt, as well as concerns about a general slowing of global demand refi ecting an increasing lack of confi dence among consumers, companies and governments. Upheavals in thefinancial markets may affect general levels of economic activity, employment and customer behaviour. For example, insurers may experience an elevated incidence of claims, lapses, or surrenders of policies, and some policyholders may choose to defer or stop paying
insurance premiums. The demand for insurance products may also be adversely affected. If sustained, this environment is likely to have a negative impact on the insurance sector over time and may consequently have a negative impact on Prudential’s business and profi tability. New challenges related to marketfluctuations and general economic conditions may continue to emerge.
For some non-unit-linked investment products, in particular those written in some of the Group’s Asia operations, it may not be possible to hold assets which will provide cash fl ows to match exactly those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets where regulated surrender values are set with reference to the interest rate environment prevailing at the time of policy issue. This results in a mismatch due to the duration and uncertainty of the liability cashflows and the lack of suffi cient assets of a suitable duration. While this residual asset/liability mismatch risk can be managed, it cannot be eliminated. Where interest rates in these markets remain lower than interest rates used to calculate surrender values over a sustained period, this could have an adverse impact on Prudential’s reported profi t.
In the US,fluctuations in prevailing interest rates can affect results from Jackson, which has a signifi cant spread-based business, with the majority of its assets invested infixed income securities. In particular,fixed annuities and stable value products written by Jackson expose Prudential to the risk that changes in interest rates, which are not fully refi ected in the interest rates credited to customers, will reduce spread. The spread is the difference between the rate of return Jackson is able to earn on the assets backing the policyholders’ liabilities and the amounts that are credited to policyholders in the form of benefi t increases, subject to minimum crediting rates.
Declines in spread from these products or other spread businesses that Jackson conducts could have a material impact on its businesses or results of operations. Jackson also writes a signifi cant amount of variable annuities that offer capital or income protection guarantees. There could be market circumstances where the derivatives that it enters into to hedge its market risks may not fully offset its losses, and any cost of the guarantees that remain unhedged will also affect Prudential’s results.
A signifi cant part of the profi t from Prudential’s UK insurance operations is related to bonuses for policyholders declared on with-profi ts products, which are broadly based on historical and current rates of return on equity, real estate andfixed income securities, as well as Prudential’s expectations of future investment returns. This profi t could be lower in a sustained low interest rate environment.
Prudential is subject to the risk of potential sovereign debt credit deterioration owing to the amounts of sovereign debt obligations held in its investment portfolio
Prudential is subject to the risk of potential sovereign debt credit deterioration on the amounts of sovereign debt obligations, principally for UK, other European, US and Asia countries held in its investment portfolio. In recent years, rating agencies have downgraded the sovereign debt of some Continental European countries, the UK and the US. There is a risk of further downgrades for these countries. In addition, for some European
countries the risk of default has also increased. Investing in such instruments creates exposure to the direct or indirect consequences of political, social or economic changes (including changes in governments, heads of states or monarchs) in the countries in which the issuers are located and the creditworthiness of the sovereign. Investment in sovereign debt obligations involves risks not present in debt obligations of corporate issuers. In addition, the issuer of the debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due in accordance with the terms of such debt, and Prudential may have limited recourse to compel payment in the event of a default. A sovereign debtor’s willingness or ability to repay principal and to pay interest in a timely manner may be affected by, among other factors, its cashfi ow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of suffi cient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward local and international lenders, and the political constraints to which the sovereign debtor may be subject. Periods of economic uncertainty may affect the volatility of market prices of sovereign debt to a greater extent than the volatility inherent in debt obligations of other types of issuers. If a sovereign were to default on its obligations, this could have a material adverse effect on Prudential’s fi nancial condition and results of operations.
Prudential is subject to the risk of exchange rate fl uctuations owing to the geographical diversity of its businesses
Due to their geographical diversity, Prudential’s businesses are subject to the risk of exchange ratefluctuations. Prudential’s operations in the US and Asia, which represent a signifi cant proportion of operating profi t based on longer-term investment returns and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fl uctuations on local operating results, it can lead to signifi cantfluctuations in Prudential’s consolidated fi nancial statements upon translation of results into pounds sterling. The currency exposure relating to the translation of reported earnings is not currently separately managed. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within other comprehensive income. Consequently, this could impact on Prudential’s gearing ratios (defi ned as debt over debt plus shareholders’ funds).
Risk factors Prudential plc Annual Report 2012 387
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the eff ects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates
Changes in government policy, legislation (including tax) or regulatory interpretation applying to companies in thefinancial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, profi tability, capital requirements and, consequently, reported results andfinancing requirements. Also, regulators in jurisdictions in which
Prudential operates may change the level of capital required to be held by individual businesses or could introduce possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. Furthermore, as a result of the recent interventions by governments in response to global economic conditions, it is widely expected that there will be a substantial increase in government regulation and supervision of thefinancial services industry, including the possibility of higher capital requirements, restrictions on certain types of transaction structure and enhanced supervisory powers.
Current EU directives, including the EU Insurance Groups Directive (IGD) require Europeanfinancial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the group level in respect of shareholder-owned entities. The test is a continuous requirement, so that Prudential needs to maintain a higher amount of regulatory capital at the group level than otherwise necessary in respect of some of its individual businesses to accommodate, for example, short-term movements in global foreign exchange rates, interest rates, deterioration in credit quality and equity markets. The EU is also developing a regulatory framework for insurance companies, referred to as ‘Solvency II’. The approach is based on the concept of three pillars. Pillar 1 consists of the quantitative requirements, for example, the amount of capital an insurer should hold. Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers. Pillar 3 focuses on disclosure and transparency requirements.
Risk factors Additional information
388 Additional information Prudential plc Annual Report 2012
Risk factors continued
The Solvency II Directive covers valuations, the treatment of insurance groups, the defi nition of capital and the overall level of capital requirements. A key aspect of Solvency II is that the assessment of risks and capital requirements are intended to be aligned more closely with economic capital methodologies, and may allow Prudential to make use of its internal economic capital models, if approved by the Financial Services Authority (FSA) or other relevant supervisory authority. The Solvency II Directive was formally approved by the Economic and Financial Affairs Council in November 2009. Representatives from the European Parliament, the European Commission and the Council of the European Union are currently discussing the Omnibus II Directive which, once approved, will amend certain aspects of the original Solvency II Directive. In addition, the European Commission is continuing to develop the detailed rules that will complement the high-level principles of the Directive, referred to as ‘implementing measures’. The Omnibus II Directive is not currently scheduled to be fi nalised until late 2013, while the implementing measures cannot befinalised until after Omnibus II. There is a signifi cant uncertainty regarding thefinal outcome of this process. In particular, the Solvency II rules relating to the determination of the liability discount rate and to the treatment of the US business remain unclear. As a result there is a risk that the effect of the measuresfinally adopted could be adverse for Prudential, including potentially a signifi
cant increase in capital required to support its business and that Prudential may be placed at a competitive disadvantage to other European and non-Europeanfinancial services groups.
Currently there are also a number of other prospective global regulatory developments which could impact the way in which Prudential is supervised in its many jurisdictions. These include the Dodd-Frank Act in the US, the work of the Financial Stability Board (FSB) on Globally Systemically Important Financial Institutions (G-SIFIs) and the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) being developed by the International Association of Insurance Supervisors (IAIS).
The Dodd-Frank Act represents a comprehensive overhaul of thefinancial services industry within the United States that, among other reforms tofinancial services entities, products and markets, may subjectfinancial institutions designated as systematically important to heightened prudential and other requirements intended to prevent or mitigate the impact of future disruptions in the USfinancial 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.
As part of a global initiative to identify G-SIFIs, in May 2012, the IAIS published proposed assessment methodology for designating Globally Systemically Important Insurers (G-SIIs). For those groups that are designated by the FSB as G-SII, additional policy measures including enhanced supervision and higher loss absorbency requirements could be proposed. Further detail of the proposals is expected during 2013 and implementation is likely to be over a period of years.
Furthermore, the FSA is considering the designation of a Domestically Systemically Important Insurer (D-SII) for those UK insurers that are signifi cant in UK terms. It is not yet clear what the impact of this designation may be.
ComFrame is also being developed by the IAIS to provide common global requirements for the supervision of insurance groups. The framework is designed to develop common principles for supervision and so may increase the focus of regulators in some jurisdictions. It is also possible that some prescriptive requirements, including regarding group capital, could be proposed. Further clarity on ComFrame is expected during the second half of 2013.
Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event of a failure of a market participant. As a major participant in the majority of its chosen markets, circumstances could arise where Prudential, along with other companies, may be required to make such contributions.
The Group’s accounts are prepared in accordance with current International Financial Reporting Standards (IFRS) applicable to the insurance industry. The International Accounting Standards Board (IASB) introduced a framework that it described as Phase I, which permitted insurers to continue to use the statutory basis of accounting for insurance assets and liabilities that existed in their jurisdictions prior to January 2005. In July 2010, the IASB published an Exposure Draft for its Phase II on insurance
accounting, which would introduce signifi cant changes to the statutory reporting of insurance entities that prepare accounts according to IFRS. The IASB continues its deliberation on the exposure draft principles but it remains uncertain whether the proposals in the Exposure Draft will become thefinal IASB standard. The timing of the changes taking effect is uncertain but not expected to be before 2017.
Any changes or modifi cation of IFRS accounting policies may require a change in the future results or a restatement of reported results.
The resolution of several issues aff ecting the fi nancial services industry could have a negative impact on Prudential’s reported results or on its relations with current and potential customers
Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the UK and internationally. These actions could involve a review of business sold in the past under acceptable market practices at the time, such as the requirement in the UK to provide redress to certain past purchasers of pension and mortgage endowment policies, changes to the tax regime affecting products and regulatory reviews on products sold and industry practices, including, in the latter case, businesses it has closed.
Regulators are increasingly interested in the approach that product providers use to select third party distributors and to monitor the appropriateness of sales made by them. In some cases, product providers can be held responsible for the defi ciencies of third-party distributors.
In the US, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund,fixed index annuity and insurance product industries. This focus includes new regulations in respect of the suitability of sales of certain products. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.
In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. There is a risk that new requirements are introduced that challenge current practices, or are retrospectively applied to sales made prior to their introduction.
Litigation, disputes and regulatory investigations may adversely aff ect Prudential’s profi tability and fi nancial 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 specifi c to Prudential, or that are common to companies that operate in Prudential’s markets. Legal actions and disputes may arise under contracts, regulations (including tax) or from a course of conduct taken by Prudential, and may be class actions. Although Prudential believes that it has adequately provided in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such provisions are suffi cient. Given the large or
indeterminate amounts of damages sometimes sought, other sanctions that might be applicable and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could, from time to time, have an adverse effect on Prudential’s reputation, results of operations or cash fl ows.
Risk factors Prudential plc Annual Report 2012 389
Prudential’s businesses are conducted in highly competitive environments with developing demographic trends and continued profi tability depends on management’s ability to respond to these pressures and trends
The markets forfinancial services in the UK, US and Asia are highly competitive, with several factors affecting Prudential’s ability to sell its products and continued profi tability, including price and yields offered,financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance, historical bonus levels, developing demographic trends and customer appetite for certain savings products. In some of its markets, Prudential faces competitors that are larger, have greaterfinancial resources or a greater market share, offer a broader range of products or have higher bonus rates or claims-paying ratios. Further, heightened competition for talented and skilled employees and agents with local experience, particularly in Asia, may limit Prudential’s potential to grow its business as quickly as planned.
In Asia, the Group’s principal competitors in the region are international fi nancial companies, including Allianz, AXA, ING, AIA and Manulife. In a number of markets, local companies have a very signifi cant market presence.
Within the UK, Prudential’s principal competitors in the life market include many of the major retail fi nancial services companies including, in particular, Aviva, Legal & General, Lloyds Banking Group and Standard Life.
Jackson’s competitors in the US include major stock and mutual insurance companies, mutual fund organisations, banks and other fi nancial services companies such as AIG, AXA Financial Inc., Hartford Life Inc., Prudential Financial, Lincoln National, MetLife and TIAA–CREF.
Prudential believes competition will intensify across all regions in response to consumer demand, technological advances, the impact of consolidation, regulatory actions and other factors. Prudential’s ability to generate an appropriate return depends signifi cantly upon its capacity to anticipate and respond appropriately to these competitive pressures.
Risk factors Additional information
390 Additional information Prudential plc Annual Report 2012
Risk factors continued
Downgrades in Prudential’s fi nancial strength and credit ratings could signifi cantly impact its competitive position and hurt its relationships with creditors or trading counterparties
Prudential’s fi nancial strength and credit ratings, which are
used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confi dence in most of Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings, as a result of, for example, decreased profi tability, increased costs, increased indebtedness or other concerns, could have an adverse effect on its ability to market products; retain current policyholders; and on the Group’s fi nancialfiexibility. In addition, the interest rates Prudential pays on its borrowings are affected by its debt credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations.
Prudential’s long-term senior debt is rated as A2 by Moody’s, A+ by Standard & Poor’s and A by Fitch. The Moody’s and Fitch ratings are on stable outlook and the Standard & Poor’s rating is on negative outlook.
Prudential’s short-term debt is rated as P-1 by Moody’s, A-1 by Standard & Poor’s and F1 by Fitch.
The Prudential Assurance Company Limited’s fi nancial strength is rated Aa2 by Moody’s, AA by Standard & Poor’s and AA by Fitch. The Moody’s and Fitch ratings are on stable outlook and the Standard & Poor’s rating is on negative outlook.
Jackson’s fi nancial strength is rated AA by Standard & Poor’s and Fitch, A1 by Moody’s, and A+ by AM Best. The Moody’s, Fitch and AM Best ratings are on stable outlook and the Standard & Poor’s rating is on negative outlook.
In addition, changes in methodologies and criteria used by rating agencies could result in downgrades that do not refi ect changes in the general economic conditions or Prudential’sfinancial condition.
Adverse experience in the operational risks inherent in Prudential’s business could have a negative impact on its results of operations
Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. Further, because of the long-term nature of much of the Group’s business, accurate records have to be maintained for signifi cant periods. These factors, among others, result in signifi cant reliance on and require signifi cant investment in information technology, compliance and other systems, personnel and processes. In addition, Prudential outsources several operations, including a signifi cant part of its UK back offi ce and customer-facing functions as well as a number of IT functions, resulting in reliance upon the operational processing performance of its outsourcing partners.
Although Prudential’s systems and processes incorporate controls designed to manage and mitigate the operational risks associated with its activities, there can be no assurance that such controls will always be effective. For example, although the business has not experienced a material failure or breach in relation to IT systems and processes to date, failures or breaches of this sort, including a cyber-security attack, could harm its ability to perform necessary business functions and hurt 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. Prudential has not experienced or identifi ed any operational risks in its systems or processes during 2012, which have subsequently caused, or are expected to cause, a signifi cant negative impact on its results of operations.
Adverse experience relative to the assumptions used in pricing products and reporting business results could signifi cantly aff ect 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 signifi cantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected.
A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its UK annuity business. Prudential’s persistency assumptions refl ect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also refi ected in the assumption. If actual levels of future persistency are signifi cantly lower than assumed (that is, policy termination rates are signifi cantly higher than assumed), the Group’s results of operations could be adversely affected.
Another example is the impact of epidemics and other effects that cause a large number of deaths. Signifi cant infi uenza epidemics have occurred three times in the last century, but the likelihood, timing, or the severity of future epidemics cannot be predicted. The effectiveness of external parties, including governmental and non-governmental organisations, in combating the spread and severity of any epidemics could have a material impact on the Group’s loss experience.
In common with other life insurers, the profi tability of the Group’s businesses depends on a mix of factors including mortality and morbidity trends, policy surrender rates, investment performance and impairments, unit cost of administration and new business acquisition expense.
As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments
The Group’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 long-term funds and any amounts that may be raised through the issuance of equity, debt and commercial paper. Certain of the subsidiaries are restricted by applicable insurance, foreign exchange and tax laws, rules and regulations that can limit the payment of dividends, which in some circumstances could limit the ability to pay dividends to shareholders or to make available funds held in certain subsidiaries to cover operating expenses of other members of the Group.
Prudential operates in a number of markets through joint ventures and other arrangements with third parties (including in China and India), involving certain risks that Prudential does not face with respect to its consolidated subsidiaries
Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures (including in China and India). For the Group’s joint venture operations, management control is exercised jointly with the venture participants. The level of control exercisable by the Group depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued cooperation between, the joint venture participants. Prudential may also face fi nancial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encountersfinancial diffi culty. In addition, a signifi cant proportion of the Group’s product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could adversely affect the results of operations of Prudential.
Risk factors Prudential plc Annual Report 2012 391
Prudential’s Articles of Association contain an exclusive jurisdiction provision
Under Prudential’s Articles of Association, certain legal proceedings may only be brought in the courts of England and Wales. This applies to legal proceedings by a shareholder (in its capacity as such) against Prudential and/or its directors and/or its professional service providers. It also applies to legal proceedings between Prudential and its directors and/or Prudential and Prudential’s professional service providers that arise in connection with legal proceedings between the shareholder and such professional service provider. This provision could make it diffi cult for US and other non-UK shareholders to enforce their shareholder rights.
Changes in tax legislation may result in adverse tax consequences
Tax rules, including those relating to the insurance industry, and their interpretation, may change, possibly with retrospective effect, in any of the jurisdictions in which Prudential operates. Signifi cant tax disputes with tax authorities, and any change in the tax status of any member of the Group or in taxation legislation or its scope or interpretation could affect Prudential’s fi nancial condition and results of operations.
Risk factors Additional information
392 Additional information Prudential plc Annual Report 2012
Glossary
AER
Actual Exchange Rates are actual historical exchange rates for the specifi c accounting period, being the average rates over the period for the income statement and the closing rates for the balance sheet at the balance sheet date.
Annual premium equivalent or APE
A measure of new business activity that is calculated as the sum of annualised regular premiums from new business plus 10 per cent of single premiums on new business written during the period.
Asset backed security
A security whose value and income payments are derived from and collateralised (or ‘backed’) by a specifi ed pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually.
Available for sale (AFS)
Securities that have been acquired neither for short-term sale nor to be held to maturity. Shown at fair value on the statement offinancial position and changes in value are taken straight to equity instead of the income statement.
Bonuses
Bonuses refer to the non-guaranteed benefi t added to participating life insurance policies and are the way in which policyholders receive their share of the profi ts of the policies. There are normally two types of bonus:
Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and
Final bonus – an additional bonus expected to be paid when policyholders take money from the policies. If investment return has been low over the lifetime of the policy, afinal bonus may not be paid. Final bonuses may vary and are not guaranteed.
Cash surrender value
The amount of cash available to a policyholder on the surrender of or withdrawal from a life insurance policy or annuity contract.
CER
Constant Exchange Rate – Prudential plc reports its results at both actual exchange rates (AER) to refi ect actual results and also constant exchange rates so as to eliminate the impact from exchange translation.
Core structural borrowings
Borrowings which Prudential considers to form part of its core capital structure and exclude operational borrowings.
Credit risk
The risk of loss if another party fails to meet its obligations, or fails to do so in a timely fashion.
Currency risk
The risk that asset or liability values, cashflows, income or expenses will be affected by changes in exchange rates. Also referred to as foreign exchange risk.
Deferred acquisition costs or DAC
Acquisition costs are expenses of an insurer which are incurred in connection with the acquisition of new insurance contracts or the renewal of existing insurance policies. They include commissions and other variable sales inducements and the direct costs of issuing the policy, such as underwriting and other policy issue expenses. Typically, under IFRS, an element of acquisition costs are deferred, ie not expensed in the year incurred, and instead amortised in the income statement in line with the emergence of surpluses on the related contracts.
Deferred annuities
Annuities or pensions due to be paid from a future date or when the policyholder reaches a specifi ed age.
Discretionary participation features or DPF
A contractual right to receive, as a supplement to guaranteed benefi ts, additional benefi ts:
That are likely to be a signifi cant portion of the total contractual benefi ts;
Whose amount or timing is contractually at the discretion of the issuer; and
That are contractually based on asset, fund, company or other entity performance as discussed in IFRS 4.
Dividend cover
Dividend cover is calculated as operating profi t after tax on an IFRS basis, divided by the current year interim dividend plus the proposedfinal dividend.
Endowment product
An ordinary individual life insurance product that provides the insured party with various guaranteed benefi ts if it survives specifi c maturity dates or periods stated in the policy. Upon the death of the insured party within the coverage period, a designated benefi ciary receives the face value of the policy.
European Embedded Value or EEV
Financial results prepared in accordance with a set of Principles issued by the Chief Financial Offi cers Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance of EEV Disclosures published in October 2005.
Fixed annuities
Fixed annuity contracts written in the US which allow for tax-deferred accumulation of funds, are used for asset accumulation in retirement planning and for providing income in retirement and offerfiexible payout options. The contract holder pays the insurer a premium, which is credited to the contract holder’s account. Periodically, interest is credited to the contract holder’s account and administrative charges are deducted, as appropriate.
Fixed indexed annuities
These are similar tofixed annuities in that the contract holder pays the insurer a premium, which is credited to the contract holder’s account, and periodically, interest is credited to the contract holder’s account and administrative charges are
deducted, as appropriate. An annual minimum interest rate may be guaranteed, although actual interest credited may be higher and is linked to an equity index over its indexed option period.
Funds under management
These comprise funds of the Group held in the statement offinancial position and external funds that are managed by Prudential asset management operations.
Guaranteed annuities
Policies that pay out afixed amount of benefi t for a defi ned period.
Guaranteed investment contract (GIC) (US)
An investment contract between an insurance company and an institutional investor, which provides a stated rate of return on deposits over a specifi ed period of time. They typically provide for partial or total withdrawals at book value if needed for certain liquidity needs of the plan.
Guaranteed minimum accumulation benefi t (GMAB) (US)
A guarantee that ensures that the contract value of a variable annuity contract will be at least equal to a certain minimum amount after a specifi ed number of years.
Guaranteed minimum death benefi t (GMDB) (US)
The basic death benefi t offered under variable annuity contracts, which specifi es that if the owner dies before annuity income payments begin, the benefi ciary will receive a payment equal to the greater of the contract value or purchase payments less withdrawals.
Glossary Prudential plc Annual Report 2012 393
Guaranteed minimum income benefi t (GMIB) (US)
A guarantee that ensures, under certain conditions, that the owner may annuitise the variable annuity contract based on the greater of (a) the actual account value or (b) a payout base equal to premiums credited with some interest rate, or the maximum anniversary value of the account prior to annuitisation.
Guaranteed minimum withdrawal benefi t (GMWB) (US)
A guarantee in a variable annuity that promises that the owner may make annual withdrawals of a defi ned amount for the life of the owner or until the total guaranteed amount is recovered, regardless of market performance or the actual account balance.
Group free surplus
Group free surplus at the end of the period comprises free surplus for the insurance businesses, representing the excess of the net worth over the required capital included in the EEV results, and IFRS net assets for the asset management businesses excluding goodwill. The free surplus generated during the period comprises the movement in this balance excluding foreign exchange, capital movements, and other reserve movements. Specifi cally, it includes amounts maturing from the in-force operations during the period less the investment in new business, the effect of market movements and other one-off items.
Health and protection
These comprise health and personal accident insurance products, which provide morbidity or sickness benefi ts and include health, disability, critical illness and accident
coverage. Health and protection products are sold both as standalone policies and as riders that can be attached to life insurance products. Health and Protection riders are presented together with ordinary individual life insurance products for purposes of disclosure offinancial information.
IGD surplus
The Prudential Group’s solvency surplus measured in accordance with the EU Insurance Groups Directive.
Immediate annuity
An annuity in which payments to the annuitant or benefi ciary start at once upon establishment of the annuity plan or scheme. Such annuities are almost always purchased with a single (lump sum) payment.
In-force
An insurance policy or contract refi ected on records that has not expired, matured or otherwise been surrendered or terminated.
Glossary Additional information
394 Additional information Prudential plc Annual Report 2012
Glossary continued
Inherited estate
For life insurance proprietary companies, surplus capital available on top of what is necessary to cover policyholders’ reasonable expectations. An inherited (orphan) estate is effectively surplus capital on a realistic basis built over time and not allocated to policyholders or shareholders.
Internal rate of return (IRR)
The IRR is equivalent to the discount rate at which the present EEV value of the post-tax cashflows expected to be earned over the lifetime of the business written in shareholder-backed life funds is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is equal to the amount required to pay acquisition costs and set up reserves less premiums received, plus encumbered capital. The impact of the time value of options and guarantees is included in the calculation.
Investment grade
Investments rated BBB- or above for S&P, Baa3 or above for Moody’s. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.
Investment-linked products or contracts
Insurance products where the surrender value of the policy is linked to the value of underlying investments (such as collective investment schemes, internal investment pools or other property) orfluctuations in the value of underlying investment or indices. Investment risk associated with the product is usually borne by the policyholder. Insurance coverage, investment and administration services are provided for which the charges are deducted from the investment fund assets. Benefi ts payable will depend on the price of the units prevailing at the time of surrender, death or the maturity of the product, subject to surrender charges. These are also referred to
as unit-linked products or unit-linked contracts.
Market value reduction (MVR)
A reduction applied to the payment on with-profi ts bonds when policyholders surrender in adverse market conditions.
Money Market Fund (MMF)
An MMF is an open-ended mutual fund that invests in short-term debt securities such as US treasury bills and commercial paper. The purpose of an MMF is to provide investors with a safe place to invest easily accessible cash-equivalent assets characterised as a low-risk, low-return investment.
Mortality rate
Rate of death, varying by such parameters as age, gender and health, used in pricing and computing liabilities for future policyholders of life and annuity products, which contain mortality risks.
Net premiums
Life insurance premiums net of reinsurance premiums ceded to third-party reinsurers.
Net worth
Regulatory basis net assets for EEV reporting purposes, these net assets are sometimes subject to minor adjustment to achieve consistency with the IFRS treatment of certain items.
New business contribution
The profi ts, calculated in accordance with European Embedded Value Principles, from business sold in thefinancial reporting period under consideration.
New business margin
The value of new business on an EEV basis expressed as a percentage of the present value of new business premiums expected to be received from the new business.
Non-participating business
A life insurance policy where the policyholder is not entitled to a share of the Company’s profi ts and surplus, but receives certain guaranteed benefi ts. Also known as non-profi t in the UK. Examples include pure risk policies (egfixed annuities, term insurance, critical illness) and unit-linked insurance contracts.
Operational borrowings
Borrowings which arise in the normal course of the business.
Open ended investment company (OEIC)
A collective investment fund structured as a limited company in which investors can buy and sell shares.
Participating funds
Distinct portfolios where the policyholders have a contractual right to receive at the discretion of the insurer additional benefi ts based on factors such as the performance of a pool of assets held within the fund, as a supplement to any guaranteed benefi ts. The insurer may either have discretion as to the timing of the allocation of those benefi ts to participating policyholders or may have discretion as to the timing and the amount of the additional benefi ts. For Prudential, the most signifi cant participating funds are with-profi ts funds for business written in the UK, Hong Kong, Malaysia and Singapore.
Participating policies or participating business
Contracts of insurance where the policyholders have a contractual right to receive, at the discretion of the insurer, additional benefi ts based on factors such as investment performance, as a supplement to any guaranteed benefi ts. This is also referred to as with-profi ts business.
Present value of new business premiums (PVNBP)
The present value of new business premiums is calculated as equalling single premiums plus the present value of expected premiums of new regular premium business, allowing for lapses and other assumptions made in determining the EEV new business contribution.
Regular premium product
A life insurance product with regular periodic premium payments.
Rider
A supplemental plan that can be attached to a basic insurance policy, with payment of additional premium.
Risk margin reserve (RMR) charge
An RMR is included within operating profi t based on longer-term investment returns and represents a charge for long-term expected defaults of debt securities, determined by reference to the credit quality of the portfolio.
Scottish Amicable Insurance Fund (SAIF)
SAIF is a ring-fenced sub-fund of the Prudential Assurance Company’s long-term fund following the acquisition of the mutually owned Scottish Amicable Life Assurance Society in 1997. The fund is solely for the benefi t of policyholders of SAIF. Shareholders of Prudential plc have no interest in the profi ts of this fund although they are entitled to asset management fees on this business.
Separate account
A separate account is a pool of investments held by an insurance company not in, or ‘separate’ from, its general account. The returns from the separate account generally accrue to the policyholder. A separate account allows an investor to choose an investment category according to his individual risk tolerance, and desire for performance.
Single premiums
Single premium policies of insurance are those that require only a single lump sum payment from the policyholder.
Stochastic techniques
Stochastic techniques incorporate results from repeated simulations using keyfinancial parameters which are subject to random variations and are projected into the future.
Subordinated debt
Afixed interest issue or debt that ranks below other debt in order of priority for repayment if the issuer is liquidated. Holders are compensated for the added risk through higher rates of interest. Under EU insurance regulation, subordinated debt is not treated as a liability and counts towards the coverage of the required minimum margin of solvency, with limitations.
Surrender
The termination of a life insurance policy or annuity contract at the request of the policyholder after which the policyholder receives the cash surrender value, if any, of the contract.
Surrender charge or surrender fee
The fee charged to a policyholder when a life insurance policy or annuity contract is surrendered for its cash surrender value prior to the end of the surrender charge period.
Takaful
Insurance that is compliant with Islamic principles.
Glossary Prudential plc Annual Report 2012 395
Time value of options and guarantees
The value offinancial options and guarantees comprises two parts, the intrinsic value and the time value. The intrinsic value is given by a deterministic valuation on best estimate assumptions. The time value is the additional value arising from the variability of economic outcomes in the future.
Total shareholder return (TSR)
TSR represents the growth in the value of a share plus the value of dividends paid, assuming that the dividends are reinvested in the Company’s shares on the ex-dividend date.
Unallocated surplus
Unallocated surplus is recorded wholly as a liability and represents the excess of assets over policyholder liabilities for Prudential’s with-profi ts funds. The balance retained in the unallocated surplus represents cumulative income arising on the with-profi ts business that has not been allocated to policyholders or shareholders.
Unit-linked products or unit-linked contracts
See ‘investment-linked products or contracts’ above.
Universal life
An insurance product where the customer paysfiexible premiums, subject to specifi ed limits, that are accumulated in an account and are credited with interest (at a rate either set by the insurer or refi ecting returns on a pool of matching assets). The customer may vary the death benefi t and the contract may permit the customer to withdraw the account balance, typically subject to a surrender charge.
Variable annuity (VA) (US)
An annuity whose value is determined by the performance of underlying investment options that frequently includes securities. A variable annuity’s value is not guaranteed and will fl uctuate, depending on the value of its underlying investments. The holder of a variable annuity assumes the investment risk and the funds backing a variable annuity are held in the insurance company’s separate account. VAs are similar to unit-linked annuities in the UK.
Value of new business (VNB)
Embedded value of new insurance contracts written in the year.
Whole of life
A type of life insurance policy that provides lifetime protection; premiums must usually be paid for life. The sum assured is paid out whenever death occurs. Commonly used for estate planning purposes.
With-profi ts funds
See ‘participating funds’ above.
Yield
A measure of the income received from an investment compared to the price paid for the investment. Normally expressed as Glossary a percentage.
Additional information
396 Additional information Prudential plc Annual Report 2012
Shareholder information
Analysis of shareholder accounts as at 31 December 2012
% of total
Number of number of% of total
shareholder shareholder Number of number of
Size of shareholding accounts accounts shares shares
1,000,001 upwards 281 0.46 2,228,388,165 87.14
500,001–1,000,000 152 0.25 108,886,675 4.26
100,001–500,000 466 0.77 108,837,221 4.26
10,001–100,000 1,810 2.99 47,851,960 1.87
5,001–10,000 2,432 4.02 16,863,068 0.66
1,001–5,000 15,931 26.32 35,314,408 1.38
1–1,000 39,450 65.19 11,100,855 0.43
Total 60,522 100.00 2,557,242,352 100.00
Dividend information
Shareholders
with ordinary
Shareholders shares standing
registered on Shareholders Holders of to the credit of
the UK register registered on US American their CDP
and Irish the Hong Kong Depositary securities
2012 final dividend branch register branch register Receipts accounts
Ex dividend date 27 March 2013 28 March 2013 27 March 2013 28 March 2013
Record date 2 April 2013 2 April 2013 2 April 2013 2 April 2013
On or about On or about
Payment date 23 May 2013 23 May 2013 3 June 2013 30 May 2013
Shareholder enquiries Annual General Meeting
The 2013 Annual General Meeting (AGM) will be held on
For enquiries about shareholdings, 16 May 2013 at 11.00am in the Churchill Auditorium at
including dividends and lost share The Queen Elizabeth II Conference Centre, Broad Sanctuary,
certificates, please contact the Westminster, London SW1P 3EE. The directors believe the
Company’s registrars: AGM is an important opportunity to communicate directly
By post with shareholders. The Notice of Meeting and all other details
Equiniti Limited for the AGM are available on our website at
Aspect House www.prudential.co.uk/investors/AGM information
Spencer Road
Lancing Dividend mandates
West Sussex BN99 6DA
Shareholders may have their dividends paid directly to their bank
By telephone or building society account. If you wish to take advantage of this
Tel: 0871 384 2035 facility, please call Equiniti and request a Cash Dividend Mandate
Fax: 0871 384 2100 form. Alternatively, shareholders may download the form from
Textel: 0871 384 2255
(for the hard of hearing) www.prudential.co.uk/prudential-plc/investors/shareholder_
services/forms
Calls to 0871 numbers are charged at
8p per minute plus network extras. Cash dividend alternative
Lines are open from 8.30am to 5.30pm
(UK), Monday to Friday. Other telephone The Company operates a Dividend Re-investment Plan (DRIP).
providers’ costs may vary. Shareholders who have elected for the DRIP will automatically
receive shares for all future dividends in respect of which a
International shareholders DRIP alternative is offered. The election may be cancelled at
tel: +44 (0)121 415 7026 any time by the shareholder. Further details of the DRIP and
the timetable are available on the Company’s website at
www.prudential.co.uk/prudential-plc/investors
Electronic communications
Shareholders are encouraged to elect to receive shareholder documents electronically by registering with Shareview at www.shareview.co.uk – this will save on printing and distribution costs, and create environmental benefi ts. Shareholders who have registered will be sent an email notifi cation whenever shareholder documents are available on the Company’s website and a link will be provided to that information. When registering, shareholders will need their shareholder reference number which can be found on their share certifi cate or proxy form. The option to receive shareholder documents electronically is not available to shareholders holding shares through The Central Depository (Pte) Limited (CDP). Please contact Equiniti if you require any assistance or further information.
Share dealing services
The Company’s Registrars, Equiniti, offer a postal dealing facility for buying and selling Prudential plc ordinary shares: please see the Equiniti address on page 396 or telephone 0871 384 2248. They also offer a telephone and internet dealing service, Shareview, which provides a simple and convenient
way of selling Prudential plc shares. For telephone sales call 0871 384 2020 between 8.30am and 4.30pm, Monday to Friday, and for internet sales log on to www.shareview.co.uk/dealing
ShareGift
Shareholders who have a only small number of shares, the value of which makes them uneconomic to sell, may wish to consider donating them to ShareGift (Registered Charity 1052686). The relevant share transfer form may be downloaded from our website www.prudential.co.uk/prudential-plc/ investors/shareholder_services/forms or from Equiniti.
Further information about ShareGift may be obtained on +44 (0)20 7930 3737 or from www.ShareGift.org There are no implications for capital gains tax purposes (no gain or loss) on gifts of shares to charity and it is also possible to obtain income tax relief.
Shareholder information Prudential plc Annual Report 2012 397
Irish branch register
The Company operates a branch register for shareholders in Ireland. All enquiries regarding Irish branch register accounts should be directed to Capita Registrars (Ireland) Limited,
2 Grand Canal Square, Dublin 2. Telephone: +353 1 553 0050
Hong Kong branch register
The Company operates a branch register for shareholders in Hong Kong. All enquiries regarding Hong Kong branch register accounts should be directed to Computershare Hong Kong Investor Services Limited, 17M Floor, Hopewell Centre, 183 Queen’s Road East, Wan Chai, Hong Kong.
Telephone: +852 2862 8555
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, PO Box 64504, St. Paul, MN 55164-0504, USA. Telephone: +1 800 990 1135 or from outside the US: +1 651 453 2128 or log on to www.adr.com
Singapore shareholder enquiries
Shareholders who have shares standing to the credit of their securities accounts with CDP in Singapore may refer queries to the CDP at 4 Shenton Way, #02-01, SGX Centre 2, Singapore 068807. Telephone: +65 6535 7511. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker.
398 Additional information Prudential plc Annual Report 2012
How to contact us
Prudential plc Jackson National Life
Laurence Pountney Hill Insurance Company
London EC4R 0HH 1 Corporate Way
Tel: +44 (0)20 7220 7588 Lansing
www.prudential.co.uk Michigan 48951
USA
Paul Manduca Tel: +1 517 381 5500
Chairman www.jackson.com
Tidjane Thiam Mike Wells
Group Chief Executive President & Chief Executive Officer
Nic Nicandrou Institutional Analyst and
Chief Financial Officer Investor Enquiries
Tel: +44 (0)20 7548 3300
Margaret Coltman E-mail: investor.relations@prudential.co.uk
Group General Counsel
UK Register
John Foley Private Shareholder Enquiries
Group Chief Risk Officer Tel: 0871 384 2035
International shareholders
Peter Goerke Tel: +44 (0) 121 415 7026
Group Human Resources Director
Irish Branch Register
John Murray Private Shareholder Enquiries
Group Communications Director Tel: +353 1 553 0050
Prudential UK & Europe Hong Kong Branch Register
3 Sheldon Square Private Shareholder Enquiries
London W2 6PR Tel: +852 2862 8555
Tel: +44 (0)800 000 000
www.pru.co.uk US American Depositary Receipts
Holder Enquiries
Rob Devey Tel: +1 651 453 2128
Chief Executive
The Central Depository (Pte) Limited
M&G Shareholder Enquiries
Laurence Pountney Hill Tel: +65 6535 7511
London EC4R 0HH
Tel: +44 (0)20 7626 4588 Media Enquiries
www.mandg.co.uk Tel: +44 (0)20 7548 3559
E-mail: media.relations@prudential.co.uk
Michael McLintock
Chief Executive
Prudential Corporation Asia
13th Floor
One International Finance Centre
1 Harbour View Street
Central
Hong Kong
Tel: +852 2918 6300
www.prudentialcorporation-asia.com
Barry Stowe
Chief Executive
Prudential public limited company
Incorporated and registered in England and Wales
Registered offi ce
Laurence Pountney Hill
London EC4R 0HH
Registered number 1397169
www.prudential.co.uk
Prudential plc is a company incorporated, subsidiaries of which are authorised and regulated, as applicable, by the Prudential Regulation Authority and the Financial Conduct Authority. The Prudential Regulation Authority and the Financial Conduct Authority replaced the Financial Services Authority on 1 April 2013.
Forward-looking statements
This document may contain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its goals and expectations relating to its future fi nancial condition, performance, results, strategy and objectives. Statements that are not historical facts, including statements about Prudential’s beliefs and expectations and including, without limitation, statements containing the words ‘may’, ‘will’, ‘should’, ‘continue’, ‘aims’, ‘estimates’, ‘projects’, ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward-looking statements. These statements are based on plans, estimates and projections as at the time they are made, and therefore undue reliance should not be placed on them. By their nature, all forward-looking statements involve risk and uncertainty. A number of important factors could cause Prudential’s actual future fi nancial condition or performance or other indicated results to differ materially from those indicated
in any forward-looking statement. Such factors include, but are not limited to: future market conditions, includingfluctuations in interest rates and exchange rates and the potential for a sustained low-interest rate environment, and the performance offinancial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives related to thefinancial crisis and the effect of the European Union’s ‘Solvency II’ requirements on Prudential’s capital maintenance requirements; the impact of competition, economic growth, infi ation, and defi ation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; the impact of changes in capital, solvency standards, accounting standards or relevant regulatory frameworks, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affi liates operate; and the impact of legal actions and disputes. These, and other important factors may, for example, result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefi ts. Further discussion of these and other important factors that could cause
Prudential’s actual future fi nancial condition or performance or other indicated results to differ, possibly materially, from those anticipated in Prudential’s forward-looking statements can be found under the ‘Risk factors’ heading in this document.
Any forward-looking statements contained in this document speak only as of the date on which they are made. Prudential expressly disclaims any obligation to update any of the forward-looking statements contained in this document or any other forward-looking statements it may make, whether as a result of future events, new information or otherwise except as required pursuant to the UK Prospectus Rules, the UK Listing Rules, the UK Disclosure and Transparency Rules, the Hong Kong Listing Rules, the SGX-ST listing rules or other applicable laws and regulations.
400 Prudential plc Annual Report 2012
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Prudential public limited company Incorporated and registered in England and Wales
Registered office Laurence Pountney Hill London EC4R 0HH Registered number 1397169 www.prudential.co.uk
Prudential plc is a holding company, subsidiaries of which are authorised and regulated, as applicable, by the Prudential Regulation Authority and the Financial Conduct Authority.
The Prudential Regulation Authority and the Financial Conduct Authority replaced the Financial Services Authority on 1 April 2013.