Prudential Bancorp Annual Report 2016

Plain-text annual report

P r u d e n t i a l p l c A n n u a l R e p o r t 2 0 1 6 Adding more to life Prudential plc Annual Report 2016 H K S t o c k C o d e : 2 3 7 8 By helping to take the financial risk out of life’s big decisions, Prudential creates long-term value for our customers, our shareholders and the communities we serve. Adding more to life. Full-year ordinary dividend 43.5 pence +12% (2015: 38.78 pence9) Employees volunteered 83,284 hours Contents 1 Group overview 02 4 Directors’ remuneration report 109 02 Chairman’s statement 04 Group Chief Executive’s report 2 Strategic report 09 10 At a glance 12 Our business model 14 Our distribution 16 Our performance 18 Our businesses and their performance 37 Chief Financial Officer’s report on the 2016 financial performance 50 Group Chief Risk Officer’s report of the risks facing our business and how these are managed 62 Corporate responsibility review 3 Governance 75 76 Chairman’s introduction 77 Board of Directors 82 How we operate 89 Further information on Directors 90 Risk management and internal control 92 Committee reports 106 Statutory and regulatory disclosures 107 Additional information 108 Index to principal Directors’ report disclosures 110 Annual statement from the Chairman of the Remuneration Committee 112 Our Executive Directors’ remuneration at a glance 114 Summary of the current Directors’ remuneration policy 118 Annual report on remuneration 135 New Directors’ remuneration policy 153 Supplementary information 5 Financial statements 6 European Embedded Value (EEV) basis results 7 Additional information 365 Additional unaudited financial information 392 Risk factors 398 Glossary 402 Shareholder information 405 How to contact us 159 323 363 The Directors’ Report of Prudential plc for the year ended 31 December 2016 is set out on pages 2 to 7, 76 to 108 and 364 to 406, and includes the sections of the Annual Report referred to in these pages. Our year in numbers IFRS operating profit based on longer-term investment returns 1 Underlying free surplus generated 1,2,3 Life new business profit 1,3,4 IFRS profit after tax 5 Net cash remittances from business units IFRS shareholders’ funds EEV shareholders’ funds 6 Group Solvency II capital surplus 7,8 2016 £m 2015 £m Change on actual exchange rate basis10 Change on constant exchange rate basis10 4,256 3,588 3,088 1,921 1,718 3,969 3,043 2,492 2,579 1,625 7% 18% 24% (26)% 6% (2)% 10% 11% (32)% n/a 2016 £bn 2015 £bn 14.7 39.0 12.5 13.0 31.9 9.7 Change on actual exchange rate basis10 13% 22% 29% 1 Following its reclassification to held for sale during 2016, operating results exclude the contribution of the Korea life business. The 2015 comparative results have been similarly adjusted. 2 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. Further information is set out in note 9 of the EEV basis results. 3 The 2016 EEV basis results for UK insurance operations have been prepared on a basis that reflect the Solvency II regime, effective from 1 January 2016. The 2015 comparative results for UK insurance operations reflect the Solvency I basis. 4 Excluding UK bulk annuities from 2015 comparative results as 5 Prudential has withdrawn from this market. IFRS profit after tax reflects the combined effects of operating results, negative short-term investment variances, (loss)/profit on the sale of Korea life business and the total tax charge for the year. 6 Includes adjustment for opening EEV shareholders’ funds of negative £0.5 billion for the impact of Solvency II as at 1 January 2016. 7 Estimated. Before allowing for second interim ordinary dividend. 8 The Group Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date, which has reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. 9 Excluding 2015 special dividend of 10.00 pence per share. 10 Further information on actual and constant exchange rates basis is set out in note A1 of the IFRS financial statements. 1 www.prudential.co.ukAnnualReport2016 Prudential plc Chairman’s statement – Paul Manduca A well balanced business creating value for customers and shareholders I am pleased to introduce Prudential’s 2016 Annual Report. The Company has once again produced a strong set of results over a year of great change and challenge. Mike Wells has made substantial progress in his first full year as Group Chief Executive and, while economic and political events across the globe bring uncertainty to our operating environment, we will continue to focus on building a sustainable business by providing our customers around the world with quality products and services. The stability we have created at Board level has enabled us to continue to strengthen our governance framework – for example, by building closer relationships between our material subsidiary boards and the plc Board, with regular communication established between the newly appointed material subsidiary board, Risk and Audit Committee Chairs and their Group counterparts. Our shareholders and stakeholders A well governed company engages regularly and effectively with its shareholders. At Prudential, we have an active programme of engagement. It is important to us that we hear the views of our investors and have an open and constructive dialogue with them. As Chairman, I have found this regular engagement particularly helpful and receiving shareholders’ input has ensured high-quality and well informed Board discussions. Regulators and policymakers remain important stakeholders for Prudential, and have a legitimate interest in how we treat our customers and run our business. Prudential engages regularly with our regulators around the world and we place great importance on having an effective relationship with those who supervise us and our markets. Our customers’ interests are best served when we work constructively with our regulators. Global context 2016 was a year that saw volatile markets in China, the UK’s decision to leave the European Union and a change of administration in the US. Against that backdrop, Prudential has demonstrated that we have the right strategy, management team, geographic mix and business diversity to succeed. Our robust governance and decision-making processes have enabled us to react swiftly to the unexpected and unpredictable. With strong customer propositions in the UK, Asia and the US, our business is well balanced and well placed to thrive. Most importantly, it is during times of great uncertainty that Prudential adds most value for our customers. We look to provide financial peace of mind to customers, whatever the external environment. Our expertise in reducing risk allows customers to plan for the future with confidence; whether by protecting them against ill health in Asia, helping them save for retirement in the UK or managing their retirement income in the United States. The capital we generate from these activities then allows us to invest in companies across the globe, driving economic activity and growth. All of this is possible because the Board is focused on building a sustainable business. This focus ensures we are able to keep the vital promises that we have made to our customers. Customers have been at the heart of Prudential for 168 years. It is by serving all our customers well that we are able to generate strong returns for our shareholders, provide rewarding roles for our people and invest in our local communities. Alongside acknowledging these benefits, the Board also ensures it engages with our regulators and wider civil society to promote the interests of our customers more broadly. Performance and dividend Despite the challenging global environment, Prudential has delivered another strong operating and financial performance, driven in particular by our Asian operations. The Board has decided to increase the full-year ordinary dividend by 12 per cent to 43.5 pence per share, reflecting our strong 2016 financial performance and our confidence in the future prospects of the Group. In line with this, the Directors have approved a second interim ordinary dividend of 30.57 pence per share (2015: 26.47 pence per share). In 2015, a special dividend of 10 pence per share was also awarded. Governance In order to keep the promises we make to our customers Prudential needs to be well run, which means it must display robust governance in supporting an outstanding executive team. While this has long been the focus of our Board, policymakers have continued to highlight the importance of effective governance. We welcomed Anne Richards as Chief Executive of M&G in June 2016. The Chair of our Audit Committee, Ann Godbehere, is in her ninth year of service, and hence will not stand for re-election at this year’s AGM. Ann has been a valuable asset to the Board and we are most grateful for her contribution and wise counsel. We are delighted that David Law will be taking over as Audit Committee Chair from the next AGM. 2 Prudential plc Annual Report 2016 www.prudential.co.uk0 1 G r o u p o v e r v e w i Chairman’s Challenge Prudential Malaysia The PRUkasih programme offers financial aid to the urban poor, covering the basic needs of food and shelter and providing social protection for families. Prudential volunteers are actively involved in manning information booths, undertaking door-to-door visits and assisting with financial literacy sessions. Over 8,000 children have benefited from the education sessions, and over 20,600 families from 12 communities have had access to PRUkasih’s unique protection plan. By 2018, the programme aims to equip 50,000 children with money management skills. Gan Leong Hin, CEO of Prudential Assurance Malaysia Berhad, says, ‘Financial protection and education are very close to our hearts. We have first-hand experience of seeing how devastating the impact can be on the lives of families living without financial security when something unfortunate happens to the main breadwinners. That is what led us to create PRUkasih. We are also committed to promoting financial literacy and inculcating the right values to raise our next generation in becoming financially literate. This is in line with our mission of providing financial freedom and peace of mind to all Malaysians.’ Our people In each of our markets we have teams focused on delivering for our customers. It is the diligence, creativity and hard work of these teams that enable Prudential to succeed. Their contribution is vital and it is the responsibility of the Board to consider their interests in every decision we make. Our people ensure we can continue to respond to the changing external environment and in 2016, their resilience and enthusiasm were critical to our achieving the excellent set of results we have reported. Their commitment to our customers provides me with great confidence for the future. Our communities The most obvious benefits that result from Prudential’s activities are the peace of mind we bring to our customers and the long-term capital we provide to companies and governments. It is, however, also in our customers’ and shareholders’ interests for Prudential to be a responsible business which invests in and gives back to our local communities, alongside the jobs, growth and tax revenue we provide. We are proud of our work in financial education, disaster preparedness and social inclusion. The Cha-Ching programme that we launched in Asia in 2011 is now the first truly global financial education programme. Cha-Ching has now been launched in Poland, the UK and Africa and will shortly launch in the US. The Prudence Foundation’s Safe Steps is a first-of-its-kind pan-Asian public service initiative to enhance disaster preparedness and awareness through the dissemination of educational survival tips for natural disasters – with a potential reach of 200 million people. In the UK, over the past four years, Prudential RideLondon has raised £41 million for charity and become one of the largest fundraising events in the country. In 2016 alone, more than 740 charities benefited from riders’ fundraising. I am particularly proud of the direct contribution made by our people to the communities in which they live and participate. In 2016, Prudential colleagues volunteered over 80,000 hours of their time. I support this personally via our flagship international volunteering programme, the Chairman’s Challenge. The programme continues to appeal to colleagues, with the number of volunteers signing up increasing year-on-year. From its launch in 2006, when 2,603 employees signed up, volunteer numbers have increased by 208 per cent to 8,011 in 2016, benefiting 92,720 individuals across the world. In conclusion, while the events of 2016 caused some uncertainty in our operating environment around the world, Prudential’s performance has been strong. It is a testament to the commitment and calibre of our people and the quality of the products and services we provide to customers that we were able to achieve these results. As I look to the future, I am confident that our people, our customer proposition and our culture will enable us to continue to grow. Paul Manduca Chairman 3 www.prudential.co.ukAnnualReport2016 Prudential plc01 Group overview Group Chief Executive’s report – Mike Wells Strong performance based on long-term opportunities I am pleased to report significant progress in 2016, reflecting our successful strategy and the growing capabilities of the Group. Our global scale, close understanding of our markets and constant drive to improve are continuing to create shared value for our customers and our shareholders. diversity of the Group’s global platform, the disciplined execution of our strategy and the strength of the opportunities in our target markets. Prudential exists to de-risk people’s lives. Saving for a child’s education, protecting people against the financial cost of ill-health or the death of a family’s primary income earner, turning hard-earned savings into secure retirement income – across all these areas we help to remove uncertainty from life’s biggest financial events. Our strategy is shaped around meeting those needs where they are greatest and where we have the capabilities to make the most significant impact. That is among the increasingly affluent population of Asia, who have a growing demand for the health and protection products we provide, and the ageing populations of the US and the UK, who are looking for ways to invest their savings to produce income for retirement. This was another year of innovation, as we continue to improve and personalise our products to ensure they are tailored to the diverse financial needs of our customers. At the same time, we remain focused on the expansion of our distinctive distribution platforms, allowing us to reach new customers and better serve existing ones. Meanwhile, we continue to develop the investment capabilities of our asset management businesses and to invest in the systems and people to manage the risks we assume on behalf of our customers. We are also sowing the seeds for our future growth by investing in new markets. Group performance Prudential has delivered a strong financial performance in 2016, led by growth in Asia. In a year that has seen continued low interest rates, market volatility and dramatic political change, our results continue to benefit from the scale and Our operational agility and broad business mix mean we are able to continually flex our approach in response to local market conditions and opportunities without compromising our overall near-term financial performance. These characteristics have recently been particularly evident in our businesses in Asia, which continue to drive the growth of the Group and in 2016 achieved double- digit increases across all of our major metrics. This was despite pricing and product actions to protect profitability of some market segments where returns were no longer sufficiently attractive given the low-interest-rate environment. We always seek the appropriate balance between value and volume. As in previous years, we comment on our performance in local currency terms (expressed on a constant exchange rate basis) to show the underlying business trends in a period of significant currency movements. New business profit1,3 increased by 11 per cent2,4 to £3,088 million (up 24 per cent on an actual exchange rate basis), driven by growth of 22 per cent2 in Asia and 33 per cent4 in our UK retail business. In the US, a 13 per cent reduction in new business profit mainly reflected lower industry volumes due to the sector-wide disruption that followed the announcement in April 2016 of the Department of Labor’s fiduciary reform, the implementation of which is presently uncertain under the Trump administration. Group IFRS operating profit6 based on longer-term investment returns was 2 per cent2 lower at £4,256 million (up 7 per cent on an actual exchange rate basis). Our businesses in Asia and the US generated growth of 15 per cent2 and 7 per cent respectively, while the contribution from our UK-based businesses reduced by 23 per cent. Here, as expected, the overall result was impacted by the effect of negative fund flows at M&G, our deliberate withdrawal from the UK bulk annuity market as returns ceased to be attractive and a lower contribution from UK capital optimisation actions. The result also includes a provision for the cost of undertaking a review in the UK of past non-advised annuity sales practices and related potential redress. Prudential’s growing in-force business continues to support our overall cash generation. Free surplus generation3,7 rose by 10 per cent2 to £3,588 million (up 18 per cent on an actual exchange rate basis). Cash remittances to the Group were also higher at £1,718 million, supporting the 12 per cent increase in the 2016 full year ordinary dividend to 43.5 pence per share. Since 2012 Prudential has made total payments to shareholders of £4.6 billion, highlighting the underlying growth and cash-generative nature of the business. The Group continues to operate with a strong capital position, ending the year with a Solvency II cover ratio9 of 201 per cent8. Over the period, IFRS shareholders’ funds increased by 13 per cent to £14.7 billion after taking into account profit after tax of £1,921 million (2015: £2,579 million on an actual exchange rate basis) and other movements including positive foreign exchange movements of £1.2 billion. EEV shareholders’ funds increased by 22 per cent to £39.0 billion, equivalent to 1,510 pence per share. During 2016, we have strengthened our position as a diversified global Group, delivering long-term value to customers and shareholders. In Asia, we are developing our operations, through the quality of our business and 4 Prudential plc Annual Report 2016 www.prudential.co.uk0 1 G r o u p o v e r v e w i Thanh Tam and Thi Tam’s story Prudential Vietnam Thanh Tam and Thi Tam have held policies with Prudential Vietnam since 2004, protecting their son, Thanh Tai, and his education, their parents and their home. The premiums are low, but the policies hold very special value for the family, both financially and emotionally. Prudential supports the family in achieving their goals, and creates investment opportunities through various loans and bonds. Prudential has been able to help the family prepare for a peaceful future, and receive protection from terminal illnesses once they reach retirement age. Understanding that Prudential will take care of the family and protect them from the unexpected risks in life, they can live safely and peacefully. through our scale. Underpinning the outlook for Asia earnings, our new regular-premium income is up 20 per cent to £3,359 million and life in-force weighted premium income is up 20 per cent to £9.1 billion. In addition, our Asian asset manager, Eastspring Investments, has grown, with overall assets under management reaching £117.9 billion at the year end, a new high. In the US we are well positioned to navigate a period of significant regulatory change, including the currently scheduled introduction of the Department of Labor’s fiduciary duty rule. The product innovation that is in train to address the new regulatory requirements, coupled with our sector- leading IT and servicing capabilities, enables us to access sizeable retirement asset pools that were previously not open Diversification advantage IFRS operating profit*6 by business and currency, full year 2016 9% 17% GBP 14% Other 17% 33% Our broad diversification by geography, products and distribution channels remains a primary source of strength and resilience for the Group’s earnings. US$ linked 21% US$ 48% 41% Asia United States United Kingdom M&G *Segmental earnings of key businesses and excludes Prudential Capital and other income and expenditure. 5 www.prudential.co.ukAnnualReport2016 Prudential plc Group Chief Executive’s report – Mike Wells Continued to Jackson. The demographic shift occurring in the US is a significant long-term driver of demand for the types of products that we offer. In 2016, through this period of disruption, Jackson’s separate account assets relating to its variable annuity business, and the main driver of earnings, increased by 11 per cent to US$148.8 billion. In the UK, where we are seeing a large amount of change in the marketplace along with the introduction of new capital rules, we are also adapting well. PruFund sales growth continues to outperform the market, and our retail sales are now higher than before the Retail Distribution Review. During this period of change we remain focused on delivering high-quality products to meet our customers’ evolving needs. The FCA’s thematic review of non-advised annuity sales practices showed that, in a portion of annuity sales that the UK business made since July 2008, it was not adequately explained to customers that they may have been eligible for an enhanced annuity. We are continuing to work to ensure we put things right. Also in the UK, at M&G, we are focused on careful management of costs and improving performance. In 2016, assets managed by M&G on behalf of external clients increased by 8 per cent to £137 billion, with internal assets taking the total to £265 billion (2015: £246 billion). We have made good progress towards our 2017 objectives, which we announced in December 2013. Asia life and asset management pre-tax operating profit has grown at a compound annual rate of 17 per cent over the period 2012 to 2016. We are therefore on track to meet the objective of growing this measure at a compound annual rate of at least 15 per cent over the period 2012 to 2017. In 2016, Asia delivered underlying free surplus generation of £859 million, demonstrating that we are on course to meet the objective of £900 million to £1.1 billion for full-year 2017. Collectively the Group has so far delivered underlying free surplus generation from the beginning of 2014 to 2016 of £9.2 billion, close to our objective for the period 2014 to the end of 2017 of at least £10 billion. Our strategy We have a clear, consistent strategy focused on three parts of the world where the needs of customers for the products we provide are not fully met. In Asia we aim to meet the savings, accumulation, health and protection needs of the fast-growing and increasingly 6 affluent middle class. As this group of people grows, so does their demand for goods and services. As an example, three-quarters of China’s total population is forecast to be defined as middle income by 2030. The growing purchasing power of this section of the society is evident today. To illustrate, 60 million people left China for leisure travel purposes in 2011, but by last year this had doubled to 120 million and by 2020 is expected to top 200 million. Similarly last year Asian consumers bought around half of all the cars sold in the world, up from an average of less than 20 per cent during the 1990s. The region’s consumer spending growth is remarkable, but what is closest to the hearts of people in Asia, as anywhere else, is providing a secure and more prosperous future for their loved ones. This is creating a powerful – and largely unmet – demand for the products we provide. Asia has low insurance penetration, high out-of-pocket healthcare spend and rapidly growing private wealth. The working age population in the region is predicted to rise by 178 million by 2030. Mutual fund penetration rates are currently just 12 per cent in Asia, compared with 75 per cent in Europe and 96 per cent in the US, and there is a significant mortality protection gap. We are a leading pan-regional franchise in Asia, we hold top-three positions in nine of our 12 life markets in the region, and we are the number one Asian retail asset manager10. We have the presence, scale, distribution and product capabilities to tap into the growing needs of our Asian customers. The US is the largest11 retirement savings market in the world, and over the next 20 years Americans will be retiring at a rate of 10,000 per day12. At the same time, private defined-benefit pension plans are disappearing and government plans are underfunded, life expectancy at age 65 has increased significantly, and individual investors struggle to capture returns and are exposed to volatile equity markets. The confluence of these trends is precipitating an expansion of the retirement market and a flight to quality that is aligned with Jackson’s capabilities. In the UK, an ageing population that does not have enough saved for the future is driving increasing demand for savings and retirement income products, and this demand has been reinforced by the pensions freedom changes. This is creating significant opportunities for our UK businesses that both Prudential UK and M&G are addressing through their long-term savings solutions and investment strategies. Our capabilities We believe we have a great strategy, but any strategy is only as good as its implementation. We are executing our strategy with discipline and continually developing our capabilities. Across our markets, we are constantly innovating to improve the way we do business. During 2016, we added a number of new products and services to the successful range we offer around the world. In Asia, to take just two examples, Prudential Singapore became the first insurer in its market to launch an online community portal, where customers can share ideas and suggestions to help us improve our products and services, and Prudential Hong Kong gave customers access to an innovative DNA-based health and nutrition programme, demonstrating how we are building our capabilities to partner with customers to help improve their long-term health and well-being. We also expanded our reach in the region during 2016, by launching a new operation in Laos. In the US, Jackson launched its first fee-based variable annuity, designed to meet the need for products compatible with the Department of Labor’s fiduciary duty rule. In the UK retail market we introduced the Prudential Retirement Account, an online account-based plan that offers both accumulation and decumulation for customers near retirement and has proved extremely popular. M&G added a number of new funds, including its Global Target Return Fund and Absolute Return Bond Fund, helping customers deal with market volatility. Our distribution capability is another of our key strengths. In 2016, we made good progress in improving our distribution platform throughout our markets. In Asia, productivity within our network of agents improved, with average case sizes rising by 30 per cent14. The total number of agents across all our Asian markets is more than 500,000. We also continued to leverage the strength of our relationships with our bank partners, which has allowed us to ensure the appropriate balance between value and volume. We have access to more than 10,000 active bank branches through a total of three regional, five strategic and a variety of local partnerships. In the US, our variable annuity wholesale distribution platform is now more than 60 per cent larger13 than that of our nearest competitor, and our wholesaler productivity is 24 per cent greater13. In the UK, the number of our adviser firms has grown by 37 per cent since 2013, and Prudential plc Annual Report 2016 www.prudential.co.ukPrudential Financial Planning, our UK advisory business, has grown to become a top-10 UK advisory business, from its inception in 2012. In 2016 M&G, whose products are now registered in 23 jurisdictions around the world, established a new SICAV fund range in Luxembourg as a platform for future international distribution. At the same time, we entered Zambia, our fourth market in Africa. In less than three years, we have built our African business to the point where it has 1,750 agents, is active in 181 bank branches and has over 160,000 customers, with a further 1.5 million micro-insurance customers through partnerships with mobile phone operators and micro-finance institutions. Our proven investment performance track record is another vital part of our capability. Across our asset management businesses we offer a range of funds that give investors the opportunity to benefit from a long-term, diversified approach, helping to deliver sustainable investment performance regardless of short-term market fluctuations. M&G has a long-standing track record of superior investment performance, with 85 per cent15 of retail assets under management above median over the tenure of the fund manager. Likewise, the proportion of Eastspring’s funds outperforming the median on a three-year period basis was 65 per cent16. In the UK, over the last 10 years our highly regarded PruFund investment option has delivered growth of 75 per cent, compared with a total return of 39 per cent for a benchmark ABI mixed investment fund. In the US, the number of funds within Jackson’s living benefit variable annuity product that delivered a three-year annualised return, over the period 2014 to 2016, of over 7 per cent was twice the number of funds within the top 12 peer products combined 5. We are also using the Group’s scale to improve our risk management capabilities, including investing in new technology. In 2016 this included commencing implementation of Aladdin, a global risk and portfolio management platform for our Notes 1 Embedded value reporting provides investors with a measure of the future profit streams of the Group. The EEV basis results have been prepared in accordance with EEV principles discussed in note 1 of EEV basis results. A reconciliation between IFRS and the EEV shareholder funds is included in note C of the Additional EEV financial information. Following its reclassification to held for sale during 2016, operating results exclude the contribution of the Korea life business. The 2015 comparative results have been similarly adjusted. The 2016 EEV basis results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime, effective from 1 January 2016. The 2015 comparative results for UK insurance reflect the Solvency I basis. Excluding UK bulk annuities as Prudential has withdrawn from this market. Jackson analysis based on Morningstar fund performance information as at 4Q YTD 2016, ranked by sales as of end Q3 2016. ©2017 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 2 3 4 5 Prudential’s Group Executive Committee Mike Wells is advised and assisted by the Group Executive Committee, which comprises the heads of our four business units and a team of functional specialists. The members of the Group Executive Committee and their roles are set out on page 405. Standing, left to right: Tim Rolfe, Julian Adams, Al-Noor Ramji, John Foley, Anne Richards, Jonathan Oliver, Raghu Hariharan, Alan Porter. Seated, left to right: Barry Stowe, Penny James, Mike Wells, Nic Nicandrou, Tony Wilkey. asset management businesses, which will help to simplify reporting systems and support future growth. Our outlook Our growth prospects are based on clear long-term opportunities in the three markets we are targeting. There are historic demographic shifts taking place in these economies, and we are focused on ensuring that our capabilities develop in line with the evolving needs and preferences of our customers. We have demonstrated our ability to manage through times of economic uncertainty and market volatility, conditions that appear likely to prevail for some time. Our strategy is clear, the demand from customers for our products is strong and our execution is good and getting better. We are well positioned to continue to deliver value for both our customers and our shareholders. 6 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. Morningstar www.AnnuityIntel.com. IFRS operating profit is management’s primary measure of profitability and provides an underlying operating result based on longer-term investment returns and excludes non-operating items. Further information on its definition and reconciliation to profit for the period is set out in note B1 of the IFRS financial statements. 8 7 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. Further information is set out in notes 9 of the EEV basis results. Estimated before allowing for second interim ordinary dividend. The Group Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date, which has 9 Mike Wells Group Chief Executive reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. 10 Source: Asia asset management September 2016 (Ranked according to participating regional players only). Based on assets sourced from the region, excluding Japan, Australia and New Zealand as at June 2016. 11 Cerulli Associates – Advisor Metrics 2016. 12 Social Security Administration, Annual Performance Plan for FY 2012 and Revised Final Performance Plan for FY 2011. 13 Market Metrics – Variable Annuity Sales, Staffing and Productivity Report: Q3 2016. 14 Excluding India. 15 Investment performance is to 31 December 2016 and reflects 33 retail funds, representing 85 per cent of M&G retail funds under management, which have delivered top or upper quartile performance over fund manager tenure which is an average of six years. Quartile rankings are based on returns which are net of fees. 16 Blended score representing 50 per cent by number of funds and 50 per cent assets under management outperforming benchmark or in top two quartiles over three-year period. 7 www.prudential.co.ukAnnualReport2016 Prudential plc01 Group overview02 Strategic report 10 At a glance 10 Our strategy 10 What we offer 11 Where we operate 12 Our business model 14 Our distribution 16 Our performance 18 Our businesses and their performance 18 Asia 24 United States 28 United Kingdom and Europe – Insurance and investments 33 United Kingdom and Europe – Asset management 37 Chief Financial Officer’s report on the 2016 financial performance 50 Group Chief Risk Officer’s report of the risks facing our business and how these are managed 62 Corporate responsibility review 0 2 S t r a t e g i c r e p o r t At a glance Our strategy We meet the long-term savings and protection needs of an increasingly self-reliant population. We focus on three markets – Asia, the US and the UK – where the need for our products is strong and growing and we use our capabilities, footprint and scale to meet that need. s , h e a lth & prote c ti o n Savin g Asia Significant protection gap and investment needs of the middle class s g n i v a S US Transition of ‘baby boomers’ into retirement UK ‘Savings gap’ and ageing population in need of returns/income S a v i n g s We aim to capture three long-term opportunities across our key geographical markets: — serving the protection and investment needs of the growing middle class in Asia; — providing asset accumulation and retirement income products to US baby boomers; and — meeting the savings and retirement needs of an ageing British population. Together with capturing the scale and diversification benefits of our global presence, we aim to generate attractive returns, enabling us to provide financial security to our customers, invest in growth opportunities and meet our customers’ high expectations. What we offer We focus on long-term opportunities in each of our geographical markets, understanding the needs of local customers and offering innovative products to meet those needs. Life insurance 24m+ life customers worldwide Asset management £383bn total funds under management We provide our customers with savings products and financial protection against ill-health, loss of income and other adverse events, helping them to de-risk their lives. We provide a range of opportunities across asset classes, generating valuable returns for our customers through a long-term approach to investment. 10 Prudential plc Annual Report 2016 www.prudential.co.ukWhere we operate We identify markets where the needs we meet are underserved. Our business is organised into four geographic regions, with a focus on Asia, the US and the UK, where we see structural demand for our products. In recent years we have expanded into Africa, taking advantage of the emerging demand for our products in the region. Asia US Prudential Corporation Asia Prudential Corporation Asia has leading insurance and asset management operations across 14 markets and serves the families of the region’s high-potential economies. We have been operating in Asia for over 90 years and have built high-performing businesses with multichannel distribution, a product portfolio centred on regular savings and protection, award-winning customer services and a widely recognised brand. Eastspring Investments is a leading asset manager in Asia and provides investment solutions across a broad range of asset classes. Jackson Jackson provides retirement savings and income strategies aimed at the large number of people approaching retirement in the United States. Jackson’s pursuit of excellence in product innovation and distinctive distribution capabilities have helped us forge a solid reputation for meeting the needs of customers. Jackson’s variable annuities offer a distinctive retirement solution designed to provide a variety of investment choices to help customers pursue their financial goals. Leading pan-regional franchise Premier retirement income player 93% £118bn of APE sales are regular premium total funds under management 8x premium growth since 1995 £120bn of separate account assets, grown 3x since 2010 UK Prudential UK & Europe Prudential is a leading provider of savings and retirement income products in the UK. Our particular strength lies in investments that help customers meet their long-term goals, while also protecting them against short-term market fluctuations. We provide long-term savings solutions for UK customers, meeting people’s needs through our core strengths in with-profits and retirement, underpinned by our expertise in areas such as longevity, risk management and multi-asset investment. M&G M&G Investments is an international asset manager with more than 85 years’ experience of investing on behalf of individuals and institutions. Our goal is to help our customers prosper by securing long-term returns from their savings. For individual investors, we offer funds across diverse geographies, asset classes and investment strategies, aimed at growing their long-term savings or producing regular income. For institutional investors, we offer investment strategies to meet their clients’ long-term needs for capital growth or income. Well recognised brand with strong track record Long-term and conviction-led approach £118bn invested assets in with-profits funds2 +75% PruFund investment performance growth since 2006 (vs +39% in ABI sector comparative)1 15 locations across Europe and Asia £137bn external funds under management Africa We entered Africa in 2014 to offer products to new customers in one of the fastest-growing regions in the world. We aim to provide products that meet their needs towards saving for future expenses, such as education for their children, and to de-risk their financial lives. Notes 1 ABI mixed investment 20 per cent to 60 per cent shares, total return; performance from 29 December 2006 to 30 December 2016. 2 Represents financial assets and investment properties in with-profits funds. 11 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic report Our business model Creating shared value Our trusted brands and strong distribution channels enable us to understand the growing needs of our customers for long-term savings and financial security, and to design innovative products that meet those needs. By helping to build better lives and stronger communities and to fuel the growth cycle, we create long-term value for both our customers and our shareholders. Understanding our markets Driving our business Asia Customers — Low life insurance and mutual fund penetration — Significant health and protection gap — Growing working age population — Increasing consumer affluence Our businesses and their performance page 18 United States — Retiring ‘baby boomer’ generation — Large and growing retirement asset pools — Growing demand for guaranteed income Our businesses and their performance page 24 United Kingdom — Ageing population — Large and growing retirement asset pools — Growing demand for savings and income Customers are at the heart of our strategy. We proactively listen to both new and existing customers to understand and respond to their changing needs. This allows us to propose financial solutions customised for different groups, whether that is young and middle-aged people or those in retirement. Products We offer solutions for customers as they face the biggest financial challenges of their lives. We consistently develop our product portfolio, designing it around our customers’ needs and providing them with peace of mind, whether that be in relation to saving for retirement or insuring against risks of illness, death or critical life events. Distribution Distribution plays a key role in our ability to reach, attract and retain customers in different parts of the world. Building out and diversifying our distribution capabilities helps ensure that we fully capitalise on the opportunities available to us in each of our markets. Investment for growth We focus on strategic investment in long-term opportunities and capabilities to drive future growth and value for our stakeholders. We invest to improve relationships with our customers and distributors, to create innovative products, to improve our operating platforms, and to capture new opportunities and build new relationships. Risk management We generate value by selectively taking exposures to risks that are adequately rewarded and that can be appropriately quantified and managed. Balance sheet strength and proactive risk management enable us to make good our promises to our customers and create long-term value for our stakeholders. Our businesses and their performance page 28 Group Chief Risk Officer’s report page 50 12 Prudential plc Annual Report 2016 www.prudential.co.ukDriving our business Creating value… …for our stakeholders Growth New business profit £3,088m +11%1 on 2015 (CER) +24% on 2015 (AER) IFRS operating profit £4,256m –2%1 on 2015 (CER) +7% on 2015 (AER) EEV value per share2 1,510 p +22% on 2015 Cash Free surplus generation £3,588m +10%3 on 2015 (CER) +18% on 2015 (AER) Remittances £1,718m +6% on 2015 Capital Solvency II surplus3,4 £12.5bn +29% on 2015 The Group has a number of key performance indicators internally to measure financial performance. Read more on page 16 We create financial benefits for our investors and deliver economic and social benefits for our customers, our employees and the societies in which we operate. Customers Providing financial security and wealth creation. Read more on pages 62 to 64 Investors Growing dividends and share price performance enhance shareholder value. Read more on pages 16 to 72 Employees Providing an environment with equal opportunities, career potential and rewards enables us to attract and retain high-quality individuals to deliver our strategy. Read more on pages 68 and 69 Societies Supporting societies where we operate, through investment in business and infrastructure, tax revenues and community support activities. Read more on pages 64 to 68 Notes 1 2 3 4 Excluding UK bulk annuities as Prudential has withdrawn from this market. Includes adjustment for opening EEV shareholders’ funds of negative £0.5 billion for the impact of Solvency II as at 1 January 2016. Estimated. Before allowing for second interim ordinary dividend. The Group Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date, which has reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. 13 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportOur distribution Our global distribution strength Our trusted brands and strong distribution channels enable us to understand the diverse needs of our customers, and respond to those needs. Prudential UK Diversified distribution model underpinned by strong brand 37% growth in adviser firms from 2013 (post-RDR) +2,700 adviser firms dealing with Prudential c300 Prudential Financial Planning partners M&G Preferred distribution partnerships with both global and local financial institutions Products registered in 23 jurisdictions around the world Jackson Strength and flexibility of our distribution network give us a distinctive advantage 62% larger wholesale distribution1 than nearest competitor 24% greater wholesaler productivity than nearest competitor1 624 broker dealers’ selling agreements covering +238,000 (77%) of total US advisers2 #1 selling variable annuity contract3 in the independent channel since 2003 14 Prudential plc Annual Report 2016 www.prudential.co.ukPrudential Corporation Asia Pan-regional multi- channel network +500,000 agents 3 5 regional strategic and a variety of local bank partnerships Active in +10,000 bank branches Eastspring Investments is present in 10 major Asia markets and has distribution offices in US and Europe Prudential Africa Establishing network with market-leading initiatives +1,750 agents 4 bank partners Active in 181 bank branches 1 Market Metrics – Variable Annuity Sales, Staffing and Productivity Report Q3 2016. The Cerulli Report adviser metrics 2015 and Jackson research. 2 3 ©2017 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. Morningstar www.AnnuityIntel.com Sales by Contract and by Distribution Channel full year 2003-2015. 15 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportOur performance Measuring our performance To create sustainable economic value for our shareholders we focus on delivering growth and cash while maintaining appropriate capital. We aim to demonstrate how we generate profits under different accounting bases, reflecting the returns we generate on capital invested, and highlight the cash generation of our business. What we measure and why Performance1 IFRS operating profit based on longer-term investment returns2,3 £m The Group’s business involves entering into long-term contracts with customers, and hence the Group manages its associated assets and liabilities over a longer-term time horizon. This enables the Group to manage a degree of short-term market volatility. Therefore IFRS operating profit based on longer-term investment returns gives a more relevant measure of the performance of the business. Other items are excluded from IFRS operating profit to allow more relevant period-on-period comparisons of the trading operations of the Group, for example the effects of material corporate transactions are excluded. EEV new business profit3,4,5,6 £m Life insurance products are, by their nature, long-term and generate profit over a number of years. Embedded value reporting provides investors with a measure of the future profit streams of the Group. EEV new business profit reflects the value of future profit streams which are not fully captured in the year of sale under IFRS reporting. EEV operating profit3,4,5 £m EEV operating profit is provided as an additional measure of profitability. This measure includes EEV new business profit, the change in the value of Group’s long-term in-force business, and profit from our asset management and other businesses. As with IFRS, EEV operating profit reflects the underlying results based on longer-term investment returns. Group free surplus generation3,5,7 £m Free surplus generation is used to measure the internal cash generation of our business units. For insurance operations it represents amounts maturing from the in-force business during the period less investment in new business and excludes other non-operating items. For asset management it equates to post-tax IFRS operating profit for the year. 16 CAGR +14% 3,969 4,256 2,937 3,154 2,504 2012 2013 2014 2015 2016 — Group IFRS operating profit in 2016 is 2 per cent lower on a constant exchange rate basis (+7 per cent on an actual exchange rate basis), compared with 2015, reflecting resilient performance in our life businesses, with Asia up 15 per cent (28 per cent on an actual exchange rate basis), and the US up 8 per cent (21 per cent on an actual exchange rate basis), mitigating the lower profit from the UK, down 32 per cent. CAGR +14% 3,088 2,492 2,077 2,021 1,767 — EEV new business profit in 2016 increased by 11 per cent on a constant exchange rate basis (24 per cent on an actual exchange rate basis), compared with 2015, driven by higher, new business sale volumes and pricing and product actions to increase profitably. 2012 2013 2014 2015 2016 CAGR +15% 5,497 4,840 4,225 4,108 3,161 2012 2013 2014 2015 2016 — Group EEV operating profit in 2016 increased by 3 per cent on a constant exchange rate basis (14 per cent on an actual exchange rate basis), compared with 2015, driven by higher new business profits and higher contributions from the in-force business. CAGR +15% 3,588 3,043 2,454 2,586 2,064 2012 2013 2014 2015 2016 — Underlying free surplus in 2016 increased by 10 per cent, on a constant exchange rate basis (18 per cent on an actual exchange rate basis), compared with 2015, driven by growth of the in-force portfolio, and continued disciplined allocation of free surplus to new business opportunities. Prudential plc Annual Report 2016 www.prudential.co.ukWhat we measure and why Performance1 Business unit remittances8 £m Remittances measure the cash transferred from business units to the Group. Cash flows across the Group reflect our aim of achieving a balance between ensuring sufficient net remittances from business units to cover the dividend (after corporate costs) and the use of cash for reinvestment in profitable opportunities available to the Group. Group Solvency II capital surplus9,10,13 £bn Replacing the IGD capital regime, from 1 January 2016, Prudential is subject to the risk sensitive solvency framework required under European Solvency II Directives (Solvency II) as implemented by the Prudential Regulation Authority in the UK. The Solvency II surplus represents the aggregated capital (own funds) held by the Group less solvency capital requirements. 2017 objectives11 We are making good progress towards the objectives we announced in December 2013: Asia objectives12 Asia IFRS operating profit, £m Asia life and asset management pre-tax IFRS operating profit to grow at a compound annual rate of at least 15 per cent over the period 2012 to 2017. CAGR +9% 1,482 1,625 1,718 — Business unit remittances increased by 6 per cent in 2016, compared with 2015, with significant contributions from each of our four major business units. 1,341 1,200 2012 2013 2014 2015 2016 IGD surplus Solvency II surplus 12.5 9.7 5.1 5.1 4.7 2012 2013 2014 2015 2016 — The high quality and recurring nature of our operating capital generation, beneficial effects of debt issued and disciplined approach to managing balance sheet risks is reflected in the solvency capital surplus, which increased to 12.5 billion at 31 December 2016. +17% 16% 16% 15% 1,228 1,108 1,430 1,286 20% 16% 1,058 884 909 >£1,826m 1,641 1,644 2012 2013 2014 2015 FY16 24% 18% 565 16% 13% 15% 669 599 758 666 872 859 2017 objective £1.1bn £0.9bn Key Expressed at Dec 2013 FX rates Comparative stated at reported currency basis 2017 objective Asia underlying free surplus, £m Asia underlying free surplus generation7 of £0.9 billion to £1.1 billion in 2017. 454 468 2012 2013 2014 2015 FY16 Group objective Group cumulative underlying free surplus, £m Cumulative Group underlying free surplus generation of at least £10 billion over the four year period from 2014 to end-2017. > £10bn 9.2 £9.2bn 2014-2017 objective 2014-2016 Notes: 1 2 The comparative results shown above have been prepared using actual exchange rates (AER) basis except where otherwise stated. Comparative results on a constant exchange rate (CER) basis are also shown in financial tables in the Chief Financial Officers’ report on our 2016 financial performance. CAGR is Compound Annual Growth Rate. IFRS operating profit is management’s primary measure of profitability and provides an underlying operating result based on longer-term investment returns and excludes non-operating items. Further information on its definition and reconciliation to profit for the period is set out in note B1 of the IFRS financial statements. 3 Following its reclassification to held for sale during 2016, operating results exclude the contribution of the Korea life business. The 2015 comparative results have been similarly adjusted. 4 Embedded value reporting provides investors with a measure of the future profit streams of the Group. The EEV basis results have been prepared in accordance with EEV principles discussed in note 1 of the EEV basis results. A reconciliation between IFRS and the EEV shareholder funds is included in note C of the Additional EEV financial information. 5 The 2016 EEV basis results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime, effective from 1 January 2016. The 2015 comparative results for UK insurance reflects the Solvency I basis. 6 Excluding UK bulk annuities as Prudential has withdrawn from this market. 7 Free surplus generation represents ‘underlying free surplus’ based on operating movements, including the general insurance commission earned during the period and excludes market movement, foreign exchange, capital movements, shareholders’ other income and expenditure and centrally arising restructuring and Solvency II implementation costs. Further information is set out in note 11 of the EEV basis results. 8 Cash remitted to the Group forms part of the net cash flows of the holding company. A full holding company cash flow is set out in note II (a) of Additional IFRS financial information. This differs from the IFRS Consolidated Statement of Cash Flows which includes all cash flows relating to both policyholders and shareholders’ funds. The holding company cash flow is therefore a more meaningful indicator of the Group’s central liquidity. Estimated before allowing for second interim ordinary dividend. 9 10 Excludes surplus in ring-fenced policyholder funds. The methodology and assumptions used in calculating the Group Solvency II capital results are set out in note II (c) of the additional financial information. 11 The objectives assume exchange rates at December 2013 and economic assumptions made by Prudential in calculating the EEV basis supplementary information for the half year ended 30 June 2013, and are based on regulatory and solvency regimes applicable across the Group at the time the objectives were set. The objectives assume that the existing EEV, IFRS and free surplus methodology at December 2013 will be applicable over the period. 12 Following the announcement of the proposed sale of the Korea life business in November 2016, amounts for all years exclude the results of the Korea life business, as this sale is expected to complete in 2017. The 2017 Asia objectives have been adjusted accordingly. 13 The Group Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date, which has reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. 17 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportAsia Supporting—Asia’s—rapidly—growing—middle—classes—with—solutions— for—their—financial—protection,—savings—and—investment—needs 2016 performance highlights —— Continued—delivery—across—key— value—creation—metrics:—new— business—profit—up—22—per—cent*,— IFRS—operating—profit—up—15—per—cent*— and—free—surplus—generation—up— 15—per—cent* —— Solid—improvement—in—agency— productivity,—up—31—per—cent10 —— Strong—bancassurance—new— business—profit—growth—of— 15—per—cent* —— Record—funds—under—management— at—£117.9—billion,—up—13—per—cent —— Now—operating—in—67—cities—in— mainland—China,—where—APE—sales— are—up—31—per—cent* —— On—track—to—deliver—2017—financial— objectives —— Eastspring—Investments—was— named—largest—retail—manager—in— Asia—in—20167 *On—a—constant—exchange—rate—basis. Asia’s—economic—transformation—started—in— the—1980s—and—the—momentum—remains— strong.—Although—growth—rates—on—a— period-by-period—basis—can—fluctuate—due—to— the—influence—of—macroeconomic—and— geopolitical—factors,—the—unprecedented— increases—in—personal—wealth—enjoyed—by— the—growing—number—of—Asian—families—will— continue—into—the—foreseeable—future.— Between—2010—and—2020—it—is—estimated—that— there—will—be—over—700—million—people—who— will—have—risen—from—rural—subsistence—to— more—affluent—lifestyles.—Family—profiles—are— changing—too.—Being—able—to—finance— children’s—education—is—a—realistic—goal,—life— expectancies—are—lengthening—dramatically,— the—incidence—of—chronic—diseases—is— increasing—significantly—and—traditional— family—and—community—support—networks— are—breaking—down.—All—these—factors—can— place—significant—stress—on—a—family’s— finances. The—provision—of—personal—financial—security— is—one—of—the—hallmarks—of—a—successful— society.—Governments—in—the—region— appreciate—this—but—typically—only—have— appetites—to—provide—rudimentary—levels—of— state-sponsored—healthcare—and—other— social—services.—Consequently—they—are— keen—for—individuals—to—take—responsibility— for—their—own—financial—well-being,—address— the—health—and—protection—gaps—and— establish—savings—plans—towards—their— financial—security. While—basic—medical—services—may—be— provided—by—the—state,—there—can—be—a—high— level—of—out-of-pocket—expenses.—Around— 42—per—cent—of—healthcare—spend—in—the— region—is—out-of-pocket,—with—this—figure—as— high—as—56—per—cent—in—some—markets,— compared—with—12—per—cent—in—the—US—and— 9—per—cent—in—the—UK.—This—creates—strong—— demand—for—financial—solutions—to—protect— Understanding our markets Working age population3,4 Out-of-pocket healthcare spend2 Insurance penetration1 +1m a month 42% Asia Private financial wealth5 +US$4tr a year US$64tr 2.5bn 2030 12% US 9% UK 2.4% Asia UK 7.5% $42tr 2014 2019 Population Health gap Penetration Wealth 2.3bn 2015 18 Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performance Paul’s story PruLife—UK,—the—Philippines ‘Cooking—has—always—been—my—happy—place—–—through—the—years,—I—strove—to—make— my—own—fantastic—food,—from—lamb—racks—to—cured—hams.—However,—this—was—a— hobby,—not—a—career—path. ‘At—33,—I—was—an—IT—practitioner—with—no—background—in—what—I—dreamed—of—being:—— a—chef.—I—knew—leaving—my—profession—could—leave—us—financially—unstable.—But— because—of—my—PRUlink—exact—10—policy,—I—finally—mustered—the—courage—and—took— the—big—leap—of—following—my—dreams.—Now,—at—35,—I—am—a—graduate—of—the—prestigious— Le—Cordon—Bleu—in—Tokyo,—with—both—arms—wide—open—for—the—exciting—times—ahead.’ The opportunities for growth in our sector are well understood and remain compelling, but delivering value for customers and shareholders over the long term requires focus and discipline. Prudential Corporation Asia has a number of advantages, including scale and diversification in geography, distribution and products, together with a well respected brand. Tony Wilkey Chief Executive Prudential Corporation Asia against—the—potentially—devastating—impact— of—health-related—incidents—on—a—family’s— finances.—Critical—illness—and—medical—riders— are—popular—additions—to—life—insurance— policies—in—the—region. Insurance—penetration—remains—low—and— prospects—for—protection-oriented— insurance—products—remain—high.— Penetration—rates—vary—by—market—in—the— region,—which—includes—under-served— markets—such—as—Indonesia,—the—Philippines,— Vietnam—and—Thailand,—and—better-served— ones—like—Singapore—and—Malaysia.—While— customer—needs—vary—in—each—market,—our— product—solutions—are—manufactured—to— serve—the—bespoke—needs—of—each—market— and—are—distributed—by—our—multi-channel— distribution—network. As—an—individual’s—personal—wealth— increases,—demand—is—created—for—savings— and—investment—solutions—that—enable—the— individual—to—increase—that—wealth—and—plan— towards—financial—security.—Around— 60—per—cent—of—Asians’—savings—are—held—in— unproductive—cash,—and—the—loss—of— compounded—investment—income—that— could—be—earned—from—putting—these—savings— to—work—in—the—capital—markets—is—material.— Prudential—has—been—successful—in— identifying—these—opportunities—and— executing—strategies—in—Asia—that—enable—us— to—grow—the—business—materially,—meet— customers’—needs—and—consistently—deliver— value—to—shareholders.— Prudential—has—been—operating—in—Asia—for— over—90—years—and—since—1994—has—built— high-performing—businesses—with—a—product— portfolio—centred—on—regular—savings—and— protection,—multi-channel—distribution,— award-winning—customer—services—and—a— widely—recognised—brand.—Eastspring— Investments—is—a—leading—asset—manager—in— Asia—and—provides—our—clients—with—access—to— investment—management—expertise—across—a— broad—range—of—asset—classes. Although—there—are—common—elements—such— as—our—focus—on—regular—premium,—protection— and—capital-efficient—products,—each—market— in—our—portfolio—has—unique—characteristics— and—we—adapt—our—participation—strategies— accordingly.—For—example,—in—Vietnam—and— Indonesia,—life—insurance—awareness—and— penetration—rates—are—very—low—and—our— priority—is—building—nationwide—distribution— scale—that—reaches—potential—customers—and— provides—them—with—their—first,—relatively— simple—life—insurance—cover.— 19 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportServing a diverse continent Prudential—Corporation—Asia—is—a—powerful—franchise—with—a—wide—footprint—in—the— right—markets,—established—go-to-market—capabilities—and—superior—brand—strength— in—protection—and—long-term—savings. Compounding growth, delivering diversified earnings The—compound—effect—of—growth—in—our—customer—base—and—case—size—over—time—increases—our— sales—for—the—life—insurance—business,—while—satisfied—customers—become—advocates—of—our—asset— management—products,—growing—our—funds—under—management.—This,—combined—with—a— relentless—focus—on—regular-premium—business,—produces—diversified—earnings—growth—in—Asia. Life Asset management India Life weighted premium income1,2 £bn CER 12.6 9.1 10.4 7.6 8.8 6.6 Funds under management4 £bn 118 Life insurance Market—ranking6—.................................. 1st Population—...................................... 1.3bn Penetration8..................................... 2.7% Eastspring Funds—under—management9—............ £13.3bn 7.5 5.5 6.4 4.7 5.6 4.1 4.8 3.5 3.6 2.5 4.0 2.9 1.1 1.1 1.3 1.5 1.7 2.0 2.2 3.1 2.1 1.0 3.5 2.8 29 +4.1x 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2006 2016 Diversification—(%) IFRS operating profit by region, full year 2016, % 11 10 9 8 7 6 5 £1,644m +15% 4 3 1 2 1— Indonesia—— 26%— 2— Singapore—— 14%— 3— Hong—Kong—— 14%— 9%— 4— Malaysia—— 7%— 5— Vietnam—— 6%— 6— Thailand—— 7— China—— 4%— 8— Philippines—— 2%— 2%— 9— Taiwan—— 10—Others—— 7%— 11—Eastspring—— 9%— Growth rate vs 2015 constant exchange rates ➜6% ➜3% ➜40% ➜15% ➜21% ➜21% ➜83% ➜9% ➜25%— ➜8%— ➜10% 20 Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceContinuedChina Life insurance Market—ranking6—..................................5th Population—...................................... 1.4bn Penetration8..................................... 2.0% Eastspring Funds—under—management9—.............. £5.1bn Korea Eastspring Funds—under—management9—..............£8.8bn Laos Hong Kong Japan Life insurance Market—ranking6—................................. 3rd Population—..........................................7m Penetration8..................................... 0.0% Life insurance Market—ranking6—.................................2nd Population—..........................................7m Penetration8....................................13.3% Eastspring Funds—under—management9—.............. £3.1bn Eastspring Funds—under—management9—.............. £7.0bn Thailand Life insurance Market—ranking6—................................. 9th Population—........................................69m Penetration8..................................... 3.7% Malaysia Life insurance Market—ranking6—.................................. 1st Population—........................................ 32m Penetration8..................................... 3.4% Eastspring Funds—under—management9—.............. £6.6bn Singapore Life insurance Market—ranking6—.................................2nd Population—..........................................6m Penetration8..................................... 5.6% Eastspring Funds—under—management9—............ £62.2bn Vietnam Life insurance Market—ranking6—.................................2nd Population—........................................ 93m Penetration8..................................... 0.8% Eastspring Funds—under—management9—.............. £1.8bn Cambodia Life insurance Market—ranking6—.................................. 1st Population—........................................ 16m Penetration8..................................... 0.0% Taiwan Life insurance Market—ranking6—................................13th Population—........................................ 24m Penetration8....................................15.7% Eastspring Funds—under—management9—.............. £5.3bn Philippines Life insurance Market—ranking6—................................. 3rd Population—...................................... 104m Penetration8......................................1.4% Indonesia Life insurance Market—ranking6—.................................. 1st Population—...................................... 259m Penetration8..................................... 1.3% Eastspring Funds—under—management9—.............. £3.5bn 21 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportIn—Singapore,—by—contrast,—we—have—more— sophisticated—financial—planners—providing— advice—to—customers—on—a—more—complex— variety—of—protection,—savings—and— investment—options,—either—directly—or—via—our— bank—partners. One—of—Prudential’s—core—strengths—is—the— diversity—of—our—portfolio—–—by—geography,— by—distribution—channel—and—by—product—–— and—the—flexibility—this—gives—us—in— responding—to—particular—opportunities—and— managing—our—participation—in—areas—where— markets—have—become—more—challenging.— Consequently,—while—the—headline— performance—of—Prudential—Corporation— Asia—remains—relatively—stable—and— predictable—over—time—–—we—are—on—track—to— deliver—the—five-year—performance— objectives—announced—in—2013—–—the— individual—components—are—likely—to—flex— period—by—period.—For—example,—we—have— recently—seen—strong—demand—from— customers—in—mainland—China—for—our— participating—and—critical—illness—products—in— Hong—Kong,—while—in—Indonesia—the— emerging—middle—class—is—under—pressure— from—systemic—challenges—in—the—economy— and—so—demand—for—our—regular-premium,— protection-orientated—life—insurance—has— been—temporarily—depressed—in—that—market.— We—always—seek—the—appropriate—balance— between—value—and—volume. Customers With—more—than—14.6—million—life—customers— in—Asia,—Prudential—has—one—of—the—largest— pan-regional—insurance—customer—bases,— with—a—retention—rate—of—over—90—per—cent.— To—illustrate—the—scale—of—our—growth—and— effectiveness—of—our—execution,—during—2016— renewal—premium—collected—from—our— existing—customers—increased—by—20—per—cent— to—£9.1—billion—and—we—paid—claims—of—nearly— £5—billion—to—our—customers. Driving our business Customers In—Asia,—we—focus—our—efforts—on—helping—new—and—existing—customers—build— better—futures—for—themselves—and—their—families,—by—helping—to—fill—the—savings— and—protection—gap—that—exists—in—many—countries—in—the—region. 14.6m life—customers Products With—all-season—product—solutions,—we—always—listen—to—and—understand— our—customers—to—tailor—products—and—services—to—meet—their—changing—needs.— For—example:—PRUhealth—cancer—multi-care—was—launched—to—address—the—impact— of—multiple—cancer—strikes—in—Hong—Kong—and—the—region. 93% of—APE—sales—in—regular—premium 80% brand—awareness (average—93%—in—top—four—markets) Distribution We—are—well—positioned—in—terms—of—the—scale—and—diversity—of—our—distribution—to— reach—and—serve—our—customers’—needs.—At—the—core—of—our—distribution—model—is— face-to-face—interaction—with—customers—that—delivers—high-quality,— needs-based—advice. >500,000 tied—agents 10,000 bank—branches Investment for growth Building—on—our—strong—track—record,—we—are—incubating—for—future—growth—by— investing—in—new—opportunities—and—capabilities. 67—cities—in—China 400+—agency—offices—in—Indonesia £117.9bn—total—funds— under—management—with— Eastspring—Investments 22 Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceContinuedYona’s story Prudential Indonesia ‘I realised how crucial it is to be insured when I was diagnosed with a cerebral abscess last year. I needed to have surgery and spent one-and-a-half months in intensive care at the hospital, so I’m thankful that I was covered by my Prudential hospitalisation rider. Today, I’m grateful to have my health back again and feel blessed that I’ll soon be able to welcome into the world my own little bundle of joy.’ Products Our life product suite has three main categories: participating, linked and protection. Although the protection component remains relatively consistent in the mix, reflecting our focus on this core customer need, the products within this category continue to evolve. For example, in Hong Kong we recently added a new feature that covers customers in the event of multiple diagnoses of cancer. For the savings component of our insurance policies, we have seen softer demand for unit-linked products, given the recent volatility in capital markets, and correspondingly increased demand for participating products and their smoothed returns. The markets do have strong demand for products with high levels of guaranteed return but, although these can generate significant APE sales volumes, we only participate in this sector in a very controlled way. We maintain our balance sheet discipline and are unconcerned by any temporary erosion in market share. Distribution Prudential Corporation Asia is well positioned in terms of our scale and diversity of distribution. Each market is unique and our overarching regional distribution strategy reflects our comprehensive approach to building pan-regional distribution capabilities, underpinned by effective platforms, comprehensive product solutions and the highest level of customer experience. The scale, reach and quality of our life insurance distribution are evidenced by our productivity, persistency and customer satisfaction across the region. At the core of our distribution model is face-to-face interaction with customers, which delivers high-quality, needs-based advice. Supporting this approach is our continuous investment in enhancing customer experiences, such as the PRUcustomer friend customer servicing model in Indonesia and the PRU for you online community in Hong Kong. Tied agency remains the most popular distribution channel in the region. For Prudential Corporation Asia, this produced 65 per cent of APE sales in 2016. At 31 December we had more than 500,000 agents, up 10 per cent on the previous year. Excluding India, the productivity of our active agents increased by 31 per cent. Bancassurance is our other main distribution channel, generating 25 per cent of APE sales for Prudential Corporation Asia in 2016. Prudential Corporation Asia works with a number of partner banks, including international groups such as Standard Chartered Bank, regionals such as UOB, domestic banks such as Thailand’s Thanachart Bank and the retail banks of our partners CITIC in China and ICICI in India. Eastspring Investments Our regional asset management division, Eastspring Investments, is one of the region’s largest asset managers7, with a presence in 10 major Asian markets as well as distribution offices in the US and Europe. It has £117.9 billion in assets under management, managing funds across a range of asset classes, including equities and fixed income, distributed through bank partners, brokers and online platforms. Eastspring has a stable and steadily growing core of funds under management from Prudential Corporation Asia’s life businesses, including the majority of its unit-linked funds. Its Asian focus and performance track record have also enabled it to secure sizeable institutional mandates, both in Asia and more broadly. The retail arm includes the attractive Japanese, Korean and Taiwanese markets. In Japan, our Asia Oceania High Dividend Equity Fund, with funds under management of £3.2 billion, is one of the largest in its sector. Investing for growth Prudential’s platform is well established and we continue to invest in growing the business through expansion into new markets such as Laos and opening up in new cities in existing markets such as China, Indonesia and the Philippines. We are also investing in expanding our agency network in the region and we are enhancing our operating capabilities, particularly leveraging new technologies. At Eastspring we are investing in the brand, in the operating model and in talent development, in order to ensure that we expand our regional capabilities to capture the opportunities available from the growth of the retail mutual funds markets in Asia. Tony Wilkey Chief Executive Prudential Corporation Asia Notes 1 Insurance penetration source Swiss Re Sigma 2015. Insurance penetration calculated as premiums in per cent of GDP. Asia penetration calculated on a weighted population basis. 2 World Health Organisation – Global Health Observatory data repository (2013). Out of pocket as a percentage of Total Health Expenditure Asia calculated as average out of pocket. 3 United Nations, Department of Economic and Social Affairs. Population Division (2015) World Population Prospects The 2015 Revision, DVD Edition 15. Source: BCG Global Wealth 2015 Winning the growth game. 4 Working age population 15-64 years. 5 6 Based on FY16 or the latest information available. Source includes formal (eg Competitors results release, local regulators and insurance association) and informal (industry exchange) market share data. Ranking based on new business (APE sales on weighted full-year premium depending on availability of data). The ranking for China is among foreign players and India is among private life insurers. Source: Asia asset management September 2016 (ranked according to participating regional players only). Based on assets sourced from the region, excluding Japan, Australia and New Zealand as at June 2016. 7 8 Based on latest market data available. Laos penetration is based on Swiss Re 2016 Sigma Report – Insuring the Frontier Markets. FUM reported based on the country where the funds are managed. 10 Excluding India. 9 23 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportUnited States Providing—an—ageing—American—population—with—financial— strategies—for—stable—retirements— 2016 performance highlights —— Cash—remittance—of—£420—million —— Total—IFRS—operating—profits—of— £2—billion—–—up—7—per—cent—(20—per—cent— on—an—actual—exchange—rate—basis) —— Variable—annuity—total—net—flows—of— £4.9—billion —— Strong—separate—account—asset— growth—–—up—11—per—cent—at— US$148.8—billion—(£120.4—billion) —— Awarded—‘Contact—Center—World— Class—FCR—Certification’—and— ‘Highest—Customer—Service—for— the—Financial—Industry’—awards—by— The—Service—Quality—Measurement— Group,—Inc.—–—the—10th—consecutive— year—of—recognition—for—customer— service—performance—in—both— categories The—US—is—the—world’s—largest—retirement— savings—market,—currently—worth—a—total—of— US$16—trillion4,—and—approximately—40—million— Americans—will—reach—retirement—age—over—the— next—decade—alone.—This—transition—will—trigger— the—need—for—an—unprecedented—shift—of— trillions—of—dollars—from—savings—accumulation— to—retirement—income—generation. However,—these—Americans—face—unique— challenges—in—planning—for—life—after—work.—— For—many—members—of—this—generation,—a— financially—secure—retirement—is—at—risk—due—to— insufficient—accumulation—of—savings—during— their—working—years—and—the—current— combination—of—low—yields—and—market— volatility.—Employer-based—pensions—are— disappearing—and—government—plans—are— underfunded.—Social—security—was—never— intended—to—be—a—primary—retirement—solution— and—today—its—long-term—funding—status—is—in— question.—Additionally,—the—life—expectancy— of—an—average—retiree—has—significantly— increased,—lengthening—the—number—of—years— for—which—retirement—funding—is—required.— Understanding our markets Baby boomer population by age1 (m) Turned 65 in 2015 4.5 4.0 3.5 3.0 2.5 +40m reach retirement in next decade American retirement crisis Significant retirement opportunity Median net worth (US$000)2 Life expectancy at 653 Low VA penetration 165.9 19.3 105.3 14.3 US$14tr US$16tr US$2tr VA assets Retirement adviser assets4 65 60 Age 55 45-54 55-64 1960 2013 Retirement wave Under-saved Increased longevity 24 Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceDoris and Doug’s story Jackson In—the—next—few—years,—Doris—and—Doug,—Jackson—annuity—holders—in—their—mid-sixties,— will—be—phasing—into—semi-retirement—near—Olympia,—Washington.—Both—are—lifelong— educators—–—Doris—a—teacher—and—college—instructor,—and—Doug—the—director—of—a— non-profit—organisation. ‘We’re—not—looking—for—a—beach—and—we—don’t—plan—to—sit—under—an—umbrella—all—day.— Doris—and—I—want—to—work—together,—write—together—and—continue—our—life’s—purpose— –—helping—people—grow—and—identify—their—gifts,—whether—in—a—classroom,—congregation— or—weekend—retreat.— ‘Our—retirement—dream—really—became—a—plan—when—we—partnered—with—our—financial— professional.—As—a—financial—life—coach,—he—connected—with—our—vision,—enabling—us—to—maximise— our—savings—and—investment—resources.—With—the—guarantees—offered—in—our—Jackson—annuity— product,—we—feel—more—secure,—and—ready—to—focus—on—people,—rather—than—fight—for—financial— survival.’—11 Jackson continues its long-term disciplined approach to our business, with a sharp focus on delivering products and services that meet the needs of our stakeholders. This discipline has historically enabled us to navigate market disruption, producing positive outcomes amid adversity. The looming retirement crisis for an under- saved generation of retirees, combined with significant regulatory change and political uncertainty, presents an opportunity to redefine the retirement marketplace. Jackson is well positioned to articulate the issues and provide leadership in addressing them, with a focus on creating value for consumers and shareholders. Barry Stowe Chairman and Chief Executive Officer, North American Business Unit To—overcome—these—challenges,—Americans— need—retirement—strategies—that—offer—them— the—opportunity—to—grow—and—protect—the— value—of—their—existing—assets,—as—well—as—the— ability—to—provide—guaranteed—income—that— will—last—throughout—their—extended—lifetimes.— Annuities—can—do—just—that. Through—its—distribution—partners,—Jackson— provides—products,—including—variable,—fixed— and—fixed—index—annuities,—which—offer— Americans—the—strategies—they—need.—A— variable—annuity—with—investment—freedom— represents—an—attractive—option—for—retirees,— providing—both—access—to—equity—market— appreciation—in—a—tax-deferred—wrapper—and— guaranteed—lifetime—income.—However,— penetration—of—variable—annuity—sales—into— the—retirement—market—remains—low,— accounting—for—less—than—15—per—cent—of—total— US—retirement—assets. 25 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportCustomers and products Jackson—has—a—proven—track—record—in—this— market—with—its—market-leading—flagship— variable—annuity—product,—Perspective.— Jackson’s—success—has—been—built—on—its— quick-to-market—product—innovation,—as— demonstrated—by—the—development—and— launch—of—Elite—Access,—our—first—investment- only—variable—annuity,—in—2012.—By—the—first— quarter—of—2013,—sales—of—Elite—Access— ranked—in—the—top—108—of—all—variable—annuity— contract—sales—in—the—US,—a—position—it—still— holds8.—Further—demonstrating—Jackson’s— flexibility—and—manufacturing—capabilities,— in—the—past—six—months,—Jackson—has— launched—Perspective—Advisory—and—Elite— Access—Advisory—to—serve—distributors—with— a—preference—for—fee-based—products.— Distribution Jackson’s—distribution—strength—also—sets—us— apart—from—our—competitors.—Our— wholesaling—force—is—the—largest9—in—the— variable—annuity—industry—and—is—instrumental— in—supporting—the—independent—advisers—who— help—the—growing—pool—of—American—retirees— develop—effective—retirement—strategies.— Our—wholesalers—provide—extensive—training— to—thousands—of—advisers—about—the—range—of— our—products—and—the—investment—strategies— that—are—available—to—support—their—clients.— Based—on—the—latest—available—data,—Jackson’s— wholesalers—achieved—gross—variable—annuity— sales—that—on—average—were—24—per—cent— higher—than—the—nearest—competitor9.— National—Planning—Holdings—(NPH),—an— affiliate—of—Jackson,—is—a—top-10—broker-dealer 9— network—in—the—US.—NPH—serves—the—three—key— distribution—channels—of—independent— Driving our business Customers Many—retirees,—or—soon—to—be—retirees,—face—a—reality—of—under-saving,—having— no—guaranteed—income—source—and—the—prospect—of—living—longer—than—any— prior—generation.—Jackson’s—focus—is—to—provide—solutions—to—help—address—these— concerns—for—the—millions—of—baby—boomers—currently—transitioning—to—and— through—retirement. Products Jackson’s—products—provide—needed—access—to—equity—market—growth,— protection—of—principal,—and—a—way—of—converting—retirees’—savings—into— retirement—income—with—a—degree—of—certainty.—With—a—long—history—of—disciplined— product—design—and—prudent—risk—management,—Jackson—has—earned,—and— continues—to—earn,—trust—from—its—key—stakeholders. Distribution Jackson’s—distribution—teams—set—us—apart—from—our—competitors.—Jackson’s— wholesaling—force—is—the—largest,—most—productive—in—the—industry,—supporting— thousands—of—advisers—across—multiple—channels—and—distribution—outlets. Investment for growth Jackson—continues—to—invest—in—technology—and—innovative—products—to— efficiently—and—effectively—adapt—to—what—our—customers—and—environment— require.—Jackson—has—recently—launched—a—fee-based—version—of—our—flagship— product—Perspective—and—our—innovative—Elite—Access—product—to—allow—for— penetration—into—untapped—distribution—channels. 26 10,000 baby—boomers—retire—per—day—on— average5 Assisting 4 million customers—with—their—financial—needs 2 of—the top 10 variable—annuity—contracts—by—premium6 Perspective—II—is—the #1 selling—variable—annuity—contract6 Top 10 broker—dealer—network7 Largest—and—most—productive—VA— wholesaling—force—in—the—industry Corporate—Insight—Annuity—Monitor— Awards—for—excellence—in—the—online— and—offline—experience—offered—to— prospects,—clients—and—advisers Quickly—and—efficiently—launched— fee-based—version—of—Perspective—and— Elite—Access—variable—annuity—products Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceContinuedrepresentatives, financial institutions and tax and accounting professionals, through access to industry-leading mutual fund/ asset management companies, insurance carriers and thousands of brokerage products. The strength of this network and the market insight it offers, combined with Jackson’s proven manufacturing capabilities, provide a distinct advantage as we continue to navigate the ever-changing regulatory landscape. Regulatory landscape Since the financial crisis in 2008, the industry has continued to manage through an ever-changing regulatory landscape. In April 2016, the US Department of Labor (DoL) released a final version of its Fiduciary Duty Rule (Rules), with initial application starting in April 2017 and full implementation required by January 2018. The Rules would, as currently written, subject many advisers who work with qualified retirement plans and Individual Retirement Accounts to the fiduciary requirements of the Employee Retirement Income Security Act, including obligations to avoid conflicts of interest. Those conflict of interest rules are incompatible with many compensation structures that have historically been permissible. However, with the change in the US administration and the release of various Executive Orders, the final form of the Rules remains unclear. As a result of the DoL regulatory initiative and the uncertainties regarding the application and implementation of the Rules, the annuity industry saw material impacts on sales in 2016. Sales in the variable annuity industry as of the third quarter of 2016 at US$79 billion10 were down 22 per cent compared with the same period last year. Conversely, sales of fixed index (US$47 billion)10 and fixed annuity (US$45 billion)10 products were higher as of the third quarter of 2016 at 22 per cent and 28 per cent respectively, compared with the same period last year. In recent years, some competitors have begun to offer fixed index annuities with benefits that resemble those of variable annuities, leading to a shift in sales away from variable annuities to fixed index annuities. However, this trend has an uncertain future due to the unexpected inclusion of fixed index annuities within the current rules on par with the treatment of variable annuities. Total annuity industry sales were down approximately 2 per cent10 as of the third quarter of 2016. Barry Stowe Chairman and Chief Executive Officer North American Business Unit Regardless of the outcome of the Rules, the regulatory disruption has challenged the industry to review the ways in which investment advice is provided to American investors. Manufacturers will need to have the ability to provide product and system adaptations in order to support the success of various distribution partners in their delivery of invaluable retirement strategies that investors need. Investment for growth From disruption, opportunities can appear. With the tens of trillions of dollars of adviser-distributed assets across distribution platforms that have not historically been a focus, such as the hybrid registered investment adviser channel, there is significant opportunity to reach even more American retirees and serve their needs with annuity products going forward. The industry will need to remain flexible and cost-effective in making changes to products, systems and processes. We continue to ensure that we understand and make the necessary adjustments to support the needs and demands of American retirees into the future. Jackson and NPH have begun to implement changes necessary to meet the requirements of the Rules. Jackson will continue to evaluate its product offerings in order to meet the long-term needs of investors in search of effective retirement strategies. Additionally, Jackson remains committed to supporting its distribution partners throughout this industry transition. Jackson’s competitive strengths are even more critical during periods of disruption. Our best-in-class distribution team, our agility and success in launching well designed products, the continued success through many economic cycles of our risk management and hedging programmes and our effective technology platforms and award-winning customer service will provide Americans with the retirement strategies they so desperately need, and will enable us to be positioned to capture additional growth during times of transition and into the future. Notes 1 US Census Bureau Population division 2014 estimate of population. 2 2013 Federal Reserve Board’s triennial Survey of Consumer Finances. 3 US Department of Health and Human Services, ‘Health, United States 2015’, May 2016. 4 Cerulli Associates – Advisor Metrics 2016. 5 Social Security Administration, Annual Performance Plan for FY 2012 and Revised Final Performance Plan for FY 2011. 6 © 2017 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. Morningstar www.AnnuityIntel.com. Total Sales by Contract 3Q YTD 2016. Jackson’s Perspective II for base states ranks #1 and Elite Access for base states ranks #9 for Total VA Sales out of 864 VA contracts with reported sales to Morningstar’s quarterly sales survey as of 3Q YTD 2016. Investment News – April 2016. 7 8 © 2017 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. Morningstar www.AnnuityIntel.com. Elite Access for base states ranked #10 and #9 for Total VA Sales by Contract at 1Q 2013 and 3Q 2016 respectively. 9 Market Metrics – Variable Annuity Sales, Staffing and Productivity Report: Q3 2016. 10 LIMRA/Secure Retirement Institute, US Individual Annuity Participants Report 3Q YTD 2016. 11 Guarantees are backed by the claims-paying ability of Jackson National Life Insurance Company. 27 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportUnited Kingdom and Europe Insurance and investments Serving the savings and retirement needs of the ageing population in the UK 2016 performance highlights — Retail new business sales and new business profit both up 33 per cent — Significant sales momentum securing record business volumes — Market-leading distribution capability focused on intermediary advisers, an in-house direct advice service − Prudential Financial Planning − and a direct-to-customer telephone franchise — Significant investment to develop digital distribution capabilities — Launch of the Prudential Retirement Account – an online account-based pension saving and retirement plan — Two Five Star ratings for excellent service2, achieved for the sixth consecutive year — Biggest winner at the Investment Life & Pensions MoneyFacts Awards in 2016, with top awards for the Best Investment Service, Best Investment Bond Provider and Best Online Service The fundamentals underpinning the UK’s retirement market are changing. Risk and responsibility for retirement provision continue to transfer away from the state and corporates to individuals. As customers adjust to the reforms introduced by pensions freedom in 2015, the new flexible arrangements to control their own pensions have been accompanied by significant complexity, which is adding to the burden of personal responsibility to secure an income in retirement. Investment risk, longevity risk and inflation risk are the risks to be mitigated by today’s retirement saver. Over 70 per cent of liquid assets in the UK are owned and controlled by the over 50s and this demographic is expected to grow by 2.1 million between 2016 and 2030. More people, with more savings, will live longer. This provides significant new opportunities for Prudential as the demand for risk-managed investments to fund retirement is predicted to rise accordingly. To meet these opportunities, our product and distribution profile has evolved by increasing the range of product options to mirror the flexibilities of the pensions Understanding our markets Retirement market growth Flows into retail investment products (£bn, annual) 2016 2020 2016 to 2030 13 CAGR: +9% 11 43 58 Individual investments (individual pensions, bonds, SIPPs, drawdown) Workplace savings (group pensions) Risk products (annuities, protection) CAGR 2016-20 -5% 63 +10% 89 +11% 1.3% pa growth in population aged 50+ >70% of liquid assets held by those aged 50+ 2/3rds fall in defined benefits scheme membership ‘Pensions freedom’ era – growing demand for risk-managed investments to fund retirement Structural growth underpinned by: risk transfer from corporates and state to individuals demographics – growing number of retirees and increased life expectancy means more saving 28 Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceHelen’s story Prudential UK & Europe ‘Thanks to my adviser, I can sleep easy at night knowing that I should be able to achieve my future plans because of the financial security my investments with Prudential should provide. Our annual review meeting is really important because it lets me know if my investments are on track, takes account of any changes in my financial circumstances and gives me a chance to check if there is anything else I can do to get the best from my savings. I chose the PruFund because I don’t really like the fluctuations of shares, but getting better returns compared with a bank savings account is very important to me and the with-profits fund has given me that steady secure growth. ‘I know Prudential will help secure my financial future because I have known them all my life.’ The Prudential brand resonates strongly with customers and advisers navigating through recent retirement market reforms. When combined with an enviable product and distribution capability, the emerging retirement savings marketplace presents an opportunity that few others are capable of serving better than Prudential. John Foley Chief Executive Officer, Prudential UK & Europe freedom era. There has been a shift away from a reliance on capital-intensive annuity business to a focus on bond, ISA, pension and income drawdown products across a range of tax-efficient solutions. Customers and products The Prudential brand benefits from a heritage that stretches back 168 years and a franchise that is based on long-term thinking, longevity experience, market- leading multi-asset investment capability and financial strength – the core attributes that customers continue to seek in the pension freedoms era. Customer expectations are higher than ever. Increased life expectancy in retirement has put increased demands on long-term product performance, and technology is revolutionising the ways in 29 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportwhich company and customer interact. In this changing environment, our brand franchise is strong, resonating with retirement savers. We continue to focus on meeting these customers’ needs through: — Extending our product range and servicing capability to help customers take full advantage of the flexibility introduced to the retirement saving marketplace through pension freedoms; — Extending availability of our investment and retirement solutions by maintaining strong relationships with financial adviser intermediaries, accelerating the growth of our Prudential Financial Planning advisory business and through investing in our direct-to-consumer channels, including telephone and online services; — Enhancing access to our market-leading PruFund proposition across a range of investment and tax wrappers; and — Continually investing in customer service improvement, acknowledged by two Five Star ratings received for the sixth consecutive year in the Life & Pensions and Investment categories of the Financial Adviser Service Awards. Most notably in 2016, we responded to changes in the market following the introduction of pension freedoms by launching the Prudential Retirement Account – an online account-based plan Driving our business Customers Strong brand franchise with clear focus on providing retirement saving and income solutions that meet customers’ needs in the pensions freedom era. Products Product range enhanced, including extended access to our market-leading range of PruFund investments. Distribution Multi-channel distribution model based on strong relationships with intermediaries and customers. 11 per cent (CAGR) increase in advisers recommending Prudential since 2013. Prudential Financial Planning is now advising over 50,000 customers. Investment for growth Significant investment in product, service and technology to maintain the growth momentum created by recent structural changes in the retirement market. 30 168 years of providing financial security Long track record of managing longevity 74 of 99 public sector authorities’ schemes 75% PruFund growth since 2006 5* ratings for excellent service 2,700+ adviser firms dealing with Prudential UK c300 Prudential Financial Planning partners 20% increase in 2016 sales generated through Prudential Financial Planning Prudential plc Annual Report 2016 www.prudential.co.ukOur businesses and their performanceContinuedPruFund PruFund Growth PruFund Cautious PruFund 0%-30% PruFund 10%-40% PruFund 20%-55% PruFund 40%-80% Range of six funds with risk-rating Global diversification: over 25 asset classes in one investment Award-winning asset allocation 100% 80% 60% 40% 20% 0% -20% PruFund growth ABI sector comparator +75% +39% Smoothing of investment returns 2006 2008 2010 2012 2014 2016 A unique customer proposition PruFund investment performance1 that provides customers with the flexibility to save for their retirement, provide an income in retirement and facilitate access to their fund as they save. At its core is PruFund, our unique customer proposition managed by the Prudential Portfolio Management Group, our award-winning and market-leading multi-asset management team. From a single fund when launched in 2004, PruFund today comprises six risk-rated funds, offers global investment diversification across 25 different asset classes and delivers smoothing through the strength of the Prudential with-profits fund. The success of PruFund and its popularity among financial advisers and customers is evidenced in investments worth £24.7 billion in funds under management at the end of 2016. In corporate pensions, we continue to focus on securing new scheme members and supporting existing members to meet their retirement goals. In the public sector, where Prudential is the market leader, providing schemes for 74 of the 99 local authorities in the UK, our focus is on additional voluntary contribution plans. Having identified a number of alternative capital deployment opportunities within the Group and following the introduction of Solvency II we did not write any bulk annuity business in 2016. We have now withdrawn from this market. Our appetite for individual annuity business has also diminished and we took steps to curtail retail sales by establishing an annuity panel arrangement with a number of firms to provide annuities to our retiring customers. This new service will be phased in over the course of 2017. Distribution The foundations of every strong brand are trust and confidence, common denominators in Prudential’s multi-channel distribution capability. The model is centred on the core intermediary channel and direct-to-consumer channels, including Prudential Financial Planning. Number of adviser firms dealing with Prudential +CAGR: +11% RDR PF1 2,777 2,469 1,948 2,185 2,021 2,134 2011 2012 2013 2014 2015 2016 1. PF = 2014 budget announcement of pensions freedom. Monthly averages At the heart of the intermediary model is ‘the power of three’, a combination of regional account manager, telephone account manager and sales support, all working together as a regional sales unit team. There are 65 regional sales units across the UK, giving 100 per cent nationwide coverage, and each having account managers qualified to at least the same standards as the professional advisers they deal with. This model gives third-party financial advisers the support they need, how and when they need it, through dedicated points of contact either in the field or by phone. This approach delivered an 11 per cent compound increase since 2013 in advisory firms recommending Prudential products to their clients. Sales through our intermediary business have also doubled since 2013. Prudential Financial Planning reinforces Prudential’s industry reputation as an innovator and has been central to the continued sales growth achieved by the business in 2016. From its inception in 2012, and against a background of industry-wide retrenchment, Prudential Financial Planning is now a top-10 UK advisory business, with close to 300 partners advising more than 50,000 clients. Our direct-to-consumer customer telephony team is central to our ambitions to grow our direct-to-customers business and in 2016 we strengthened its capability ahead of a range of forthcoming proposition and service developments. The roll-out of our business in Poland continued in 2016, with sales increasing by 86 per cent in local currency terms. Significant milestones during the year included increasing the number of financial planning consultants to 721, entering the multi-agency market and securing three affinity distribution deals with Polish telecommunications companies. 31 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportOur businesses and their performance Continued Investment for growth We are focused on maintaining the growth momentum created by the structural changes to retirement provision in the UK and on delivering a growth strategy underpinned by investment in product, service and distribution capabilities to meet the evolving needs of customers. In addition to enhancing access to our market-leading PruFund proposition, we continue to innovate by bringing new and exciting products to the market, such as the Prudential Retirement Account, for our customers who want to use the pensions freedom provisions to their fullest. Investment in technology is also enabling customers to engage more flexibly with us digitally and online. Easier access to product information for customers is provided by the My Pru app, while our Retirement Ready Guide App was created to provide clear and easy-to-understand information for those coming up to retirement. Technology has also helped us improve online services for advisers and enhance our tele-underwriting service for the Prudential Investment Plan, reducing the amount of time advisers spend on administration and freeing up time to spend with their clients. We have also focused on deepening our already-strong relationships with independent financial advisers. An important part of our service offering is the ongoing hands-on support for intermediary advisers from our regional sales units, technical helpline and business development and consultancy team. Our adviser webinars attracted more than 10,000 attendees in 2016 while we also hosted 58 adviser seminars across the UK, covering a range of topical and technical subjects, to help these advisers deal with a changing regulatory landscape. We will also accelerate the growth of Prudential Financial Planning, which currently has close to 300 advisers delivering face-to-face advice in customers’ homes and has introduced a telephone advice service to reflect the additional ways in which customers want to receive financial advice. The evolving nature of how we interact with customers is also driving our ambitions to grow our direct-to-consumer business, where we have strengthened our capability ahead of a range of forthcoming developments, including launch of a direct-to-consumer ISA. John Foley Chief Executive Officer Prudential UK & Europe Notes 1 ABI mixed investment 20 per cent to 60 per cent shares, total return; performance from 29 December 2006 to 30 December 2016. 2 Ratings in the Life and pensions and Investment categories of the Financial Advisers Service Awards. Sandra and Colin’s story Prudential UK & Europe ‘On both occasions when our Prudential Financial Planning Partner visited us, we found the meetings to be very informative, helpful and most importantly honest. He carefully advised and helped us to select the products that best suited our individual needs. ‘We know for a fact that we would never have received the customer care and attention from most other organisations, as we are so remote here in the Western Isles, so it was truly a breath of fresh air to do business with Prudential.’ 32 Prudential plc Annual Report 2016 www.prudential.co.uk United Kingdom and Europe Asset management Serving retail and institutional investors through a conviction-led and long-term approach 2016 performance highlights — External funds under management up 8 per cent to £137 billion — 2016 IFRS operating profit of £425 million — Institutional external funds under management growth of 11 per cent — New SICAV platform to offer Luxembourg-domiciled funds — Implementation of new global risk and portfolio management platform underway The world’s population is ageing: by 2020, there will be more people aged 65 and above than children under five, according to the US Census Bureau. The United Nations estimates that this trend will continue, with over 15 per cent of the global population being aged over 65 by 2050. This demographic shift coincides with changes in retirement planning as governments and employers shift more responsibility to individuals, resulting in growing demand for asset management services. The European asset management market is already the second-largest in the world, with net assets of £8.2 trillion, while the UK – M&G’s core market – is the second- largest national market, with £1.2 trillion, and is a global centre of excellence for investment management. As the appetite for long-term savings products grows, demand for alternative investment strategies and solutions, such as direct lending and long-term investment in infrastructure equity, is expected to grow. M&G is well placed to benefit from this trend, given its expertise across a diverse range of assets, a record of innovation and strong distribution relationships. Market backdrop in 20161 Economic pessimism, political risk and central bank quantitative easing saw many government bonds offering negative real yields in the first half of 2016. There was a significant shift mid-year in investor sentiment, as assets flowed away from bonds and bond proxies back towards equities, particularly financial, energy and materials stocks. This trend accelerated following the US election, and the possibility of looser US fiscal policy boosting economic growth in 2017: over ¤22 billion was withdrawn from fixed income funds by European investors in November alone. An exception was the inflation-linked bond sector, which attracted net flows of over ¤10 billion in 2016 as investors sought protection from the inflationary impact of higher growth expectations in 2017. Funds, excluding money market funds, in the UK ended 2016 strongly, with net inflows double those of the next-largest European market during the last two months of 2016. Total net sales of Investment Association-registered UK mutual funds were £13 billion during 2016, down from £22 billion in the previous year. In Europe, net sales were ¤213 billion, down from ¤498 billion in the previous year. Customers Throughout our 85-year history, M&G has maintained its purpose: to help our customers prosper by putting their long-term savings to work. Our customers have always been at the heart of what we do. Today we manage the savings of millions of people in the UK, Europe and the rest of the world. These include direct or intermediated investors in our open-ended investment funds, members of pension schemes or other long-term savings schemes who invest through financial institutions, and Jackson and Prudential policyholders, including the Prudential UK with-profits fund. All our customers benefit from our conviction-led, long-term approach to asset management, applied across the full range of asset types: cash, equities, bonds, property and alternatives. We are constantly developing our capabilities to offer our customers strategies that meet their needs, whatever the market conditions. Products M&G has a range of 59 open-ended funds domiciled in the UK and is developing a similar range of funds domiciled in Luxembourg. We aim to offer customers attractive long-term investment returns from a broad choice of products across diverse geographies, asset classes and strategies. Some of our products offer solutions to very specific investor needs. The M&G Episode Income Fund, for example, aims to deliver high and rising levels of income from a diverse range of different assets, which is important to 33 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportPatrick’s story M&G ‘I’ve enjoyed a long and very varied working life, adapting my skills to several industries including the Civil Service, banking and even managing funeral homes in my later career, all while working for 40 years as a minister with my local Congregational church. ‘My savings and investments have given me the security to manage life’s ups and downs, pressures and expenditures. You never know what challenges life may bring you. The job you have today may not be there tomorrow and, even in retirement, you don’t always know how long you’ll have to support yourself and your family. Saving for the future is part of my DNA, which is why investing with a company like M&G is important to me. I know that looking after customers’ money is part of their DNA too.’ 2016 was a year of political and economic turmoil which prompted many of our customers to reassess their investment portfolios. As performance of our open- ended funds recovered in the second half of the year, we saw a much improved trend in flows in the fourth quarter, while appetite remained strong from institutional customers for our alternative investment strategies. Overall, the diversity of our asset classes, strategies and client base has allowed us once more to deliver value for money for our customers and a sizeable cash contribution to the Group. Anne Richards Chief Executive Officer, M&G 34 Prudential plc Annual Report 2016 www.prudential.co.ukmany investors at a time of historically low interest rates and negative bond yields. We also manage segregated mandates on behalf of pension schemes, wealth funds and other institutional investors, as well as a number of alternative investment strategies. Equities: throughout our long history, we have favoured a stock selection approach, building portfolios from the bottom up. We are known for our long-term investment views, which give us credibility and influence when representing the views and interests of our end investors to company management. Fixed income: M&G is one of Europe’s largest fixed income investors, with one of the biggest, most experienced in-house credit research teams. Our end investors benefit from our expertise in the full range of fixed income investments, ranging from sovereign debt to private loans. Among our best-known and most successful strategies are the M&G Optimal Income Fund, which celebrated the 10th anniversary of its UK launch in 2016, and the M&G Alpha Opportunities Fund. Multi-asset: M&G’s range of multi-asset funds, designed for investors seeking to spread risk across a mix of assets, has again proven popular with customers in 2016. The M&G Prudent Allocation Fund, launched in 2015 to cater specifically for European investors with a lower appetite for risk, was one of our bestselling funds in 2016. In December, we launched the M&G Global Target Return Fund, a new multi-asset fund aimed at investors seeking reasonable returns with managed volatility. Real estate: M&G invests in, and manages, property around the globe. Our £26 billion portfolio covers the three commercial sectors of retail, office and industrial. We have a growing franchise in UK Residential Property. M&G Real Estate’s core Asia property fund celebrated its 10th anniversary in 2016 and is one of the largest and most diversified Asia property portfolios. There are now investments of more than US$1.7 billion in the Asia Property Fund. Alternative assets: M&G is a leading investor in a diverse range of private and illiquid assets such as commercial real estate debt, infrastructure debt and equity and direct lending, collectively known as alternatives. These are attractive options for institutional investors looking to match long-term liabilities with long-term returns, either at fixed or floating rates. They are also a key source of funding for public and private infrastructure projects and businesses that might otherwise struggle to access competitive financing. Driving our business Customers We believe our active approach to investment – selecting investments on a conviction basis rather than following a market index – produces superior returns for our customers over the longer term. We offer our customers the ability to invest in a diverse range of assets: not only equities and fixed income but also unlisted investments such as property and private equity. Products M&G operates a range of UK-domiciled retail funds, which are now distributed in 23 jurisdictions across Europe and Asia. In the institutional market, M&G provides a range of strategies that help pension funds, sovereign wealth funds and other large institutional investors match liabilities and achieve growth targets. Distribution M&G provides market insights to clients, intermediaries and others through a number of channels, including a programme of roadshows and events. The M&G Client Council offers customers who invest directly with M&G an opportunity to help shape our products and services, in line with their needs. Investment for growth M&G is making significant investment in technology, operating model and portfolio management platforms to advance our operational efficiencies and data capabilities. £64.2 billion retail funds under management £264.9 billion total funds under management One of Europe’s largest fixed-income investors Range of 59 open-ended funds across diverse geographies, asset classes and investment strategies 14 funds have assets under management of >£1 billion £64.2 billion 58 billion retail funds under management held in equity investments £264.9 billion 138 roadshows in 2016 from our total funds under management retail fund managers reaching 42,000 One of Europe’s largest fixed income clients in 16 countries investors Implementation of new portfolio management platform (Aladdin) New SICAV platform in Luxembourg 35 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportOur businesses and their performance Continued Distribution Withofficesin16countries2,M&Gisable tostayclosetoourcustomersandthe intermediarieswhodistributeourproducts. Ouropen-endedretailfundsareregistered fordistributionin23jurisdictions3inEurope andAsia,whileourinstitutionalinvestment strategiesareavailabletoinvestorsin manymarketsaroundtheworld,including NorthAmerica. Wearealsoinvestinginonlinedistribution intheUK,buildingontheinsightswegain fromtheClientCouncil,agroupof500 customerswhoinvestdirectlywithusand whohelpusdevelopourproducts, servicesandinvestorcommunications. Investment for growth M&Gisinvestingintechnologyand operationalinfrastructuresowecan takefulladvantageoftheopportunities inthefast-evolvingdistributionand regulatorylandscapeinwhichweoperate. In2016,webeganimplementationof Aladdin,anewglobalriskandportfolio managementplatform,whichisbeing adoptedacrossthePrudentialGroup’s assetmanagementbusinesses.Thiswill significantlyadvanceourdatacapabilities andoperationalefficiency. Wealsoopenedanewinvestmentplatform inLuxembourg,whichgivesusnew capacitytodistributeourfundstoEuropean customersbasedoutsidetheUK. Anne Richards Chief Executive Officer M&G Notes 1 Source:BroadridgeFundFileasat31December2016in GBPandEUR.Wherereferenced,theEuropeanasset managementmarketreferstobothcrossborderand domesticmarketsandnetsalesdataisbasedonestimated netsalesdata,AllUKdataissourcedfromtheInvestment Associationasat31December2016andbasedontheUK onshoreandoffshoredata. IncludestheUKheadofficeandPPMSouthAfrica. EuropeincludestheUK.Restricteddistributionin Singapore. 2 3 Graham and Gemma’s story M&GandPrudentialUK AlderHeyintheParkChildren’sHospitalinLiverpool,officiallyopened byHMTheQueeninJune2016,wasbuiltusingfinancearrangedbythe M&Ginfrastructuredebtteam,workinginpartnershipwithPrudential asleaddebtinvestor. ConsultantpaediatricsurgeonGrahamLamontsaysthenewbuildingis transformingbothpatientexperienceandthewayhisteamworks. ‘BuildingthenewAlderHeyfromscratchhasallowedustoredesignthe wayourday-patientsflowthroughthebuilding.Nowwehavenocomplaints aboutwaitingtimes,andwe’llbeabletoincreasethenumberofpatients we’reabletotreatfromabout7,000day-casesayeartoabout8,000.’ Gemma,motherofone-year-oldHarry,whohasbeentreatedfor craniosynostosisatAlderHey,agrees:‘There’ssomuchcleverdesignand technologyatthehospitaltomakepatientsfeelcomfortable,frombarcode scannersthatcheckyouinforappointments,tospeciallightinginthe children’srooms–itreallyisahospitalofthefuture!’ www.prudential.co.uk Chief Financial Officer’s report on the 2016 financial performance – Nic Nicandrou Showcasing the resilience of our earnings, cash and capital The Group’s performance has once again been led by Asia, with double digit growth across new business profit, IFRS operating profit and free surplus generation for the seventh year in a row. Nic Nicandrou Chief Financial Officer I am particularly pleased to be able to report that Prudential’s financial performance in 2016 has showcased the resilience of our earnings, cash and capital. While these are qualities I have mentioned in previous reports, the external events of 2016 have seen them tested repeatedly across our businesses during a year of significant uncertainty, market volatility and unexpected political and regulatory events. By remaining focused on our strategy and on disciplined execution, our business withstood the effect of these events and successfully adapted to changes in market conditions, regulatory intervention and shifts in consumer preference, to deliver a strong operating performance in 2016 and an improved capital position. Prudential’s financial attributes and multiple, diverse levers of growth have enabled the Group to absorb not only the areas of earnings pressure known at the beginning of the year, but also the fluctuations of both equity markets and yields. New business profit, IFRS operating profit and free surplus generation, the three financial measures that we use to track delivery of our ‘growth and cash’ agenda, have all increased in 2016 when expressed on an actual exchange rate basis. This achievement demonstrates the benefits of our scale and the strength of our business model which is well diversified by geography, currency and source of earnings. The 2016 results also highlight the earnings power of our growing in-force book of business and our ability to add large new business volumes which are an important store of future value. The year-on-year trends of the three ‘growth and cash’ measures are also positive when expressed on a constant exchange rate basis, except for IFRS operating profit, where we have seen a marginal fall due to the effect of one-off impacts in our UK Life operations. The Group’s performance has once-again been led by Asia, with double digit growth across new business profit, IFRS operating profit and free surplus generation for the seventh year in a row. This underlines the scale and quality of our regional franchise, characterised by the high proportion of recurring income and bias for protection business that is uncoupled from market effects. In our insurance and asset management businesses in the UK and US, we have continued to build our earnings base with growth in assets managed on behalf of our customers. 2016 has seen sterling weakening against most global currencies, which is positive for the translation of results from our sizeable non-sterling operations. However, to aid understanding of the underlying progress in these businesses, we continue to express and comment on the performance trends of our Asia and US operations on a constant currency basis. The key financial highlights in 2016 were as follows: — New business profit1 was 11 per cent2,3 higher at £3,088 million (up 24 per cent on an actual exchange rate basis), primarily as a result of higher volumes with APE sales up 8 per cent2,3. Growth was strongest in Asia, where new business profit increased 22 per cent on a 19 per cent uplift in APE sales and improvements in country and channel mix. The contribution to new business profit from Jackson declined by 13 per cent, reflecting lower variable annuity sales volumes. UK life retail new business profit grew by 33 per cent, driven by strong consumer demand for products offering access to our PruFund investment option, which resulted in a 33 per cent increase in retail APE sales. There was no bulk annuity new business profit as we withdrew from this market in 2016. — IFRS operating profit based on longer-term investment returns (IFRS operating profit) was 2 per cent3 lower at £4,256 million (up 7 per cent on an actual exchange rate basis). IFRS operating profit from our Asia life insurance and asset management businesses grew by 15 per cent3 to £1,644 million, reflecting continued business momentum. In the US, Jackson’s total IFRS operating profit increased by 7 per cent, mainly due to growth in fee income on higher asset balances, which outweighed the anticipated reduction in spread earnings. In the UK, total IFRS operating profit was 31 per cent lower than the prior year, as a result of significantly reduced profits from annuity new business following our withdrawal from the bulk annuity market, the lower contribution from actions to support solvency and a provision for the cost of undertaking a review of past non- advised annuity sales practices and related potential redress. M&G’s operating profit was 4 per cent lower, reflecting the earnings impact of the recent period of net fund outflows. — Underlying free surplus generation1,4, our preferred measure of cash generation from our life and asset management businesses, increased by 10 per cent3 to £3,588 million (up 18 per cent on an actual exchange rate basis), after financing new business growth. The increase reflects a higher contribution from our growing in-force book of business, as we continue to focus on high-return new business with fast payback periods and includes the benefit from capital actions in the UK and the US. — Group shareholders’ Solvency II capital surplus7 was estimated at £12.5 billion at 31 December 2016, equivalent to a cover ratio of 201 per cent6 (1 January 2016: £9.7 billion, 193 per cent). The improvement in the period primarily reflects the continuing strength of the Group’s operating capital generation in excess of growing dividend payments to shareholders, and also includes the benefit of debt issued in the year. 37 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic report — Full year ordinary dividend increased by 12 per cent to 43.5 pence per share, reflecting our strong 2016 performance and our confidence in the future prospects of our Group. Global investment market movements during 2016 were dominated by the sharp drop in long-term yields over the first three- quarters, and the subsequent recovery into the end of the year prompted by more favourable growth expectations in the US. Equity market performance was notably stronger in the second half of the year, contributing to a generally positive movement for 2016 overall in the countries in which we operate. Over the full year, the US S&P 500 index was up 10 per cent, the UK FTSE 100 index up 12 per cent and the MSCI Asia ex-Japan index up 5 per cent. We have taken steps to reduce the investment market sensitivity of our earnings and balance sheet, but remain significant long-term holders of financial assets to back the commitments that we have made to our customers. Short-term fluctuations in both these assets and related liabilities are reported outside the operating result, which is based on long-term investment return assumptions. These short- term fluctuations were overall negative in 2016, primarily as a result of movements in the value of derivatives used by Jackson to protect the economics of its business from adverse market shocks. As a result, total IFRS post tax profit was £1,921 million (2015: £2,579 million on an actual exchange rate basis) and total EEV post-tax profit was £4,516 million (2015: £3,951 million on an actual exchange rate basis). Reflecting the combined effects of improved operating results on an actual exchange rate basis, negative short-term investment fluctuations and positive currency movements of £1.2 billion, IFRS shareholders’ equity was 13 per cent higher at £14.7 billion. Similarly, EEV basis shareholders’ equity was up 22 per cent5 at £39.0 billion. As at 31 December 2016, the Group’s Solvency II capital surplus7 was £12.5 billion, equivalent to a cover ratio of 201 per cent6 (1 January 2016: £9.7 billion, 193 per cent). IFRS profit Actual exchange rate Constant exchange rate 2016 £m 2015 £m Change % 2015 £m Change % Operating profit before tax based on longer-term investment returns Long-term business: Asia3 US UK Long-term business operating profit3 UK general insurance commission Asset management business: M&G Prudential Capital Eastspring Investments US Other income and expenditure8 Total operating profit based on longer-term investment returns before tax3 Non-operating items: (Loss)/Profit attaching to held for sale Korea business Other non-operating items8 Profit before tax attributable to shareholders Tax charge attributable to shareholders’ returns Profit for the year attributable to shareholders IFRS earnings per share 1,503 2,052 799 4,354 29 425 27 141 (4) (716) 1,171 1,691 1,167 4,029 28 442 19 115 11 (675) 28 21 (32) 8 4 (4) 42 23 (136) (6) 1,303 1,908 1,167 4,378 28 442 19 128 13 (675) 4,256 3,969 7 4,333 (227) (1,754) 2,275 (354) 1,921 56 (877) 3,148 (569) 2,579 n/a (100) (28) 38 (26) 62 (958) 3,437 (621) 2,816 15 8 (32) (1) 4 (4) 42 10 (131) (6) (2) n/a (83) (34) 43 (32) Basic earnings per share based on operating profit after tax Basic earnings per share based on total profit after tax 131.3 75.0 124.6 101.0 5 (26) 136.0 110.1 (3) (32) Actual exchange rate Constant exchange rate 2016 pence 2015 pence Change % 2015 pence Change % 38 Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinuedIFRS operating profit based on longer-term investment returns Total IFRS operating profit declined by 2 per cent3 (7 per cent increase on an actual exchange rate basis) in 2016 to £4,256 million, with increases in Asia and the US offset by anticipated declines in the contribution from our UK businesses. — Asia total operating profit of £1,644 million was 15 per cent3 higher than the previous year (28 per cent on an actual exchange rate basis), with strong growth in both life insurance and asset management through Eastspring Investments. — US total operating profit at £2,048 million increased by 7 per cent (20 per cent increase on an actual exchange rate basis), driven by higher fee income from growth in Jackson’s separate account asset base and lower amortisation of deferred acquisition costs, which together exceeded the anticipated reduction in spread income. At the beginning of the year, we expected that earnings would contract in a few discrete areas of the business: at M&G, due to the impact of outflows on funds under management and the corresponding fee income; in Jackson’s spread business portfolio as a result of persistently low interest rates; and in our UK life business given our withdrawal from the bulk annuity market. These identified effects have emerged largely as expected. However, our focus on cost control and the effective management of our in-force book of business have mitigated the overall impact of these anticipated adverse effects. Earnings have also benefited from continued growth in the premium base in Asia and the level of aggregate assets managed by our life and asset management operations across the Group, which together underpin the longer-term earnings progression of our business. Life insurance operations: Taken together, IFRS operating profit from our life insurance operations in Asia, the US and the UK was 1 per cent3 lower at £4,354 million (8 per cent increase on an actual exchange rate basis). IFRS operating profit in our life insurance operations in Asia was 15 per cent3 higher at £1,503 million (up 28 per cent on an actual exchange rate basis), reflecting our ability to translate top-line growth into shareholder value. The performance is underpinned by the recurring premium income nature of our in-force book and the highly diverse nature of our earnings by geography and by source. Insurance income was up 24 per cent, reflecting our continued focus on health and protection business. At a country level, we have seen double-digit growth in six markets, led by — UK total operating profit was 31 per cent lower at £828 million. This decline reflects lower profit from new annuity business, down from £123 million to £41 million in 2016 as we scale down our participation in the annuity market, a lower contribution from management actions to support solvency, down from £400 million to £332 million, and the establishment of a £175 million provision for the cost of undertaking a review of past non- advised annuity sales practices and related potential redress. — M&G operating profit was 4 per cent lower at £425 million. The impact of recent asset outflows from retail funds on overall funds under management has been partially offset by the benefit of positive market movements. IFRS operating profit by business £m (% vs 2015) (16)% 10% 39% 19% £4,256m -2% (+7% AER) 48% Asia £1,644m, +15% (+28% AER) US £2,048m, +7% (+20% AER) UK £828m, -31% M&G £425m, -4% Others £(689)m, -6% Hong Kong (up 40 per cent), China (up 83 per cent) and growth of 15 per cent or more from Malaysia, Thailand, Vietnam and Taiwan. These markets have more than compensated for the impact of lower earnings growth in Indonesia and Singapore, following deliberate actions taken to improve the quality of new business flows. In the US, life IFRS operating profit was 8 per cent higher at £2,052 million (up 21 per cent on an actual exchange rate basis), reflecting the resilient performance of Jackson’s franchise in an environment of market volatility and sector-wide disruption following the announcement of the Department of Labor’s fiduciary duty rule in April 2016. Average separate account balances increased by 5 per cent, resulting in a 3 per cent rise in fee income, while the result also benefited from scale efficiencies. As expected, lower yields in the year have impacted spread income, which decreased by 5 per cent. UK life IFRS operating profit declined by 32 per cent to £799 million (2015: £1,167 million). Within this total, the contribution from our core in-force with-profits and annuity business was £601 million (2015: £644 million), including an unchanged transfer to shareholders from the with-profits funds of £269 million. The balance of the result reflects the contribution from other activities which are either non-core or are not expected to recur to the same extent going forward. Profit from new annuity business reduced from £123 million in 2015 to £41 million, as we scaled down our participation in the annuity market. In response to the volatile investment market environment during 2016, we took a number of asset and liability actions to improve the solvency position of our UK life operations and further mitigate market risk, generating combined profits of £332 million (2015: £400 million). Of this amount, £197 million related to profit from longevity reinsurance transactions (2015: £231 million) and £135 million (2015: £169 million) from the effect of repositioning the fixed income asset portfolio. In response to the findings of the FCA’s thematic review of non- advised annuity sales practices, the UK business will review internally vesting annuities sold without advice after 1 July 2008. Reflecting this, the UK life 2016 result includes a provision of £175 million for the cost of this review and related potential redress. The provision does not include potential insurance recoveries of up to £175 million. We track the progress that we make in growing our life insurance business by reference to the scale of our obligations to our customers, which are referred to in the financial statements as policyholder liabilities. Each year these increase as we write new business and collect regular premiums from existing customers and decrease as we pay claims and policies mature. The overall scale of these policyholder liabilities is relevant in the evaluation of our profit potential in that it reflects, for example, our ability to earn fees on the unit-linked element and indicates the scale of the insurance element, another key source of profitability for the Group. 39 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportShareholder-backed policyholder liabilities and net liability flows9 £m Net liability flows10 7,649 208,165 1,867 8,476 (2,694) 3,767 26,410 126,746 55,009 1 Jan 2015 Asia life US life UK life Market and other movements Net liability flows10 3,638 5,198 2,086 2,086 (3,646) 266,635 46,228 32,851 177,626 Asia life11 US life UK life Market and other movements 56,158 31 Dec 2016 216,769 (2,812) 27,844 138,913 52,824 31 Dec11 2015 UK life US life Asia life Market and other movements Reclassification of Korea life business held for sale Focusing on the business supported by shareholder capital, which generates over 90 per cent of the life profit, in 2016 net flows into our businesses were overall positive at £3.6 billion, reflecting our focus on both retaining our existing customers and attracting new business to drive long-term value creation. The weakening of sterling during the year contributed a total £32.4 billion positive foreign exchange movement which, together with favourable investment and other movements, led to a £46.2 billion increase in policyholder liabilities, with much of this arising in the second half of the year. Policyholder liabilities and net liability flows in with-profits business9,25 2016 £m Actual Exchange Rate Net liability flows10 Market and other movements 3,696 1,119 4,815 5,303 11,958 17,261 At 1 January 2016 20,934 100,069 121,003 At 31 December 2016 29,933 113,146 143,079 At 1 January 2015 18,612 99,427 118,039 2015 £m Actual Exchange Rate Net liability flows10 Market and other movements 2,102 (968) 1,134 220 1,610 1,830 At 31 December 2015 20,934 100,069 121,003 Asia UK Total Group The 18 per cent increase in policyholder liabilities in our with-profits business to £143.1 billion (2015: £121.0 billion), reflects the growing popularity with consumers seeking protection from the impact of volatile market conditions. In the course of 2016, net liability flows increased to £4.8 billion across our Asian and UK operations. As returns from these funds are smoothed and shared with customers, the emergence of shareholder profit is more gradual. This business, nevertheless, remains an important source of future shareholder value. Alongside growing our overall level of life operating profit, we continue to maintain our bias for higher-quality sources of income such as insurance margin and fee income. We favour insurance margin because it is relatively insensitive to the equity and interest rate cycle and prefer fee 40 Analysis of long-term insurance business IFRS operating profit by driver3,10 £m (% vs 2015) £4,029m £4,378m 400 538 1,153 1,671 400 551 1,267 1,858 £4,354m 157 538 -2% 1,171 -8% 1,991 +7% 1,888 2,118 2,175 +3% (1,621) 2015 AER (1,816) 2015 CER (1,678) 8% 2016 Fee income Life expenses (net of DAC adjustments and margin on revenues) Insurance margin Spread income Other income Growth vs FY15 UK one-off items Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinued income to spread income because it is more capital-efficient. In line with this approach, on a constant exchange rate basis, insurance margin has increased by 7 per cent (up 19 per cent on an actual exchange rate basis) and fee income by 3 per cent (up 15 per cent on an actual exchange rate basis), while spread income decreased by 8 per cent (up 2 per cent on an actual exchange rate basis). Asset management: Movements in asset management operating profit are also primarily influenced by changes in the scale of these businesses, as measured by funds managed on behalf of external institutional and retail customers and our internal life insurance operations. In 2016, IFRS operating profit from our asset management businesses was marginally lower at £589 million (2015: £602 million on a constant exchange rate basis), primarily due to the impact of negative net flows in M&G. M&G’s IFRS operating profit declined by 4 per cent to £425 million (2015: £442 million), reflecting the impact on revenues of lower average assets under management during the year, following the net outflows experienced since the second quarter of 2015. As these net outflows were primarily from the higher margin retail business, they had a disproportionately adverse impact on earnings. The same dynamics have seen the cost-income ratio move up 2 percentage points to 59 per cent. Despite continued outflows in 2016, external assets under management at 31 December 2016 were 8 per cent higher than a year ago at £136.8 billion, benefitting from positive investment market movements, particularly in the second half of the year and a return to positive net flows for retail business in the fourth quarter of £942 million. Including the assets managed for internal life operations, M&G’s total assets under management rose to £264.9 billion (2015: £246.1 billion). Our Asia-based asset manager, Eastspring Investments, increased IFRS operating profit by 10 per cent (up 23 per cent on an actual exchange rate basis) to £141 million, reflecting the positive effect on average assets under management of favourable market movements and £2.2 billion net inflows in the second half of the year. Although a shift in the mix of assets away from higher-margin equity funds has moderated the overall revenue margin, scale efficiencies have resulted in an improvement in the cost-income ratio to 56 per cent (2015: 58 per cent). External assets under management at 31 December 2016 increased to £38.0 billion (31 December 2015: £30.3 billion). Including money market funds and the assets managed for internal life operations, Asset management external net flows and external funds under management13,14 £m Net flows (1,037) (7,008) 5,971 1,065 (4,516) 167,180 4,800 4,800 25,333 137,047 Net flows (6,255) 25,679 (8,090) 1,835 403 182,519 7,714 38,042 136,763 162,692 6,006 30,281 126,405 1 Jan 2015 M&G Eastspring Investments MMF Market and other movements 1 Jan 2016 M&G Eastspring Investments MMF Market and other movements 31 Dec 2016 M&G Eastspring15 Asia Money Market Funds Market and other movements Eastspring Investment’s total assets under management rose to a record £117.9 billion (2015: £89.1 billion). IFRS non-operating items8 IFRS non-operating items consist of short-term fluctuations, the results attaching to the held for sale life business in Korea and other non-operating items. Short-term investment fluctuations represent the most significant component of non-operating items and are discussed further below. The result of the held for sale Korea life business, a loss of £227 million, comprises both the write down of the IFRS net assets to sales proceeds (net of costs) and the profits for the year. The comparative profits for the year have been similarly reclassified as non-operating for consistency of presentation. Other non-operating items of negative £76 million mainly represent the amortisation of acquisition accounting adjustments arising principally on the acquisition of the REALIC business in 2012 (2015: negative £76 million on an actual exchange rate basis). Additionally, 2015 non-operating items included a loss of £46 million from the recycling of exchange losses on the sale of the Japan business. IFRS short-term investment fluctuations IFRS operating profit is based on longer- term investment return assumptions. The difference between actual investment returns recorded in the income statement and the assumed longer-term returns is reported within short-term fluctuations in investment returns. In 2016, the total short-term fluctuations in investment returns relating to the life operations were negative £1,482 million and comprised negative £225 million for Asia, negative £1,455 million in the US and positive £198 million in the UK. The Asia negative £225 million short-term fluctuations principally reflected the net impact of changes in interest rates and equity markets across the region. In the US, Jackson provides certain guarantees on its annuity products, the value of which would typically rise when equity markets fall and long-term interest rates decline. Jackson charges fees for these guarantees which are in turn used to purchase downside protection in the form of options and futures to mitigate the effect of equity market falls, and swaps and swaptions to cushion the impact of drops in long-term interest rates. Under IFRS, accounting for the movement in the valuation of these derivatives, which are all fair valued, is asymmetrical to the movement in guarantee liabilities, which are not fair valued in all cases. Jackson designs its hedge programme to protect the economics of the business from large movements in investment markets and accepts the variability in accounting results. The negative short-term fluctuations of £1,455 million in the year mainly reflect the effect of the increase in equity markets on net value movements on the guarantees and associated derivatives with the S&P 500 index closing at 10 per cent higher than at the start of the year. While the resulting negative mark-to-market movements on these hedging instruments are recorded in 2016, the related increases in fee income that arise from the higher asset values managed, will be recognised and reported in future years. 41 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportThe UK non-operating profit of positive £198 million mainly reflects gains on bonds backing annuity capital and shareholders’ funds following the 70 basis points fall in 15-year UK gilt yields in 2016. The negative short-term fluctuations in investment returns for other operations of negative £196 million (2015: negative £61 million) include unrealised value movements on financial instruments. IFRS effective tax rates In 2016, the effective tax rate on IFRS operating profit based on longer-term investment returns was 21 per cent, (2015: 20 per cent), reflecting a larger contribution to operating profit from Jackson which attracts a higher rate of tax. The 2016 effective tax rate on the total IFRS profit was 16 per cent (2015: 18 per cent), reflecting a smaller contribution to the total profit from Jackson which attracts higher rate of tax. The main driver of the Group’s effective tax rate is the relative mix of the profits between countries with higher tax rates (such as the US, Indonesia, and Malaysia), and countries with lower tax rates (such as Hong Kong, Singapore and the UK). The UK has enacted legislation to reduce the corporation tax rate in stages from 20 per cent to 17 per cent from 1 April 2020. The effect of reductions to 17 per cent is reflected in the full year 2016 results. Following the US elections, there is the prospect of significant tax reform occurring in the US, which potentially could reduce the US corporate income tax rate from the current 35 per cent. A number of Asian countries, most notably Indonesia, have indicated they are considering reducing corporation tax rates, but no legislative proposals have been announced to date. We do not expect that changes being introduced in the UK and other countries to implement recommendations made by the OECD’s base erosion and profit shifting project to reform the international tax New business performance Life EEV new business profit1 and APE new business sales (APE sales) regime to have any significant impact on the Group. Total tax contribution The Group continues to make significant tax contributions in the countries in which it operates, with £2,890 million remitted to tax authorities in 2016. This was lower than the equivalent amount of £3,004 million in 2015, reflecting lower corporation tax payments, partly offset by increases in other taxes borne and taxes collected. In the US a change of basis for taxing derivatives which affects the timing but not the quantum of tax payable accelerated tax payments from 2016 into 2015. Publication of tax strategy In 2017, a new UK requirement for large UK businesses to publish their tax strategy will take effect. Prudential’s tax strategy, together with further details of the tax payments made in 2016, will be available on the Group’s website before 30 June 2017. Actual exchange rate Constant exchange rate 2016 £m 2015 £m Change % 2015 £m Change % New business profit APE sales 3,599 1,561 1,160 6,320 – 6,320 2,030 790 268 3,088 – 3,088 APE sales 2,712 1,729 874 5,315 151 5,466 New business profit 1,482 809 201 2,492 117 2,609 APE sales 33 (10) 33 19 (100) 16 New business profit 37 (2) 33 24 (100) 18 APE sales 3,020 1,950 874 5,844 151 5,995 New business profit 1,660 913 201 2,774 117 2,891 APE sales 19 (20) 33 8 (100) 5 New business profit 22 (13) 33 11 (100) 7 Asia3 US UK retail2 Total Group excluding bulk annuities2,3 UK bulk annuities Total Group3 42 Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinuedNew business performance £m (% vs 2015) Split of APE new business sales £6,320m +8% (+19% AER) Asia £3,599, +19% (+33% AER) US £1,561m, -20% (-10% AER) UK £1,160m, (+33%) 18% 25% 9% Split of new business profit £3,088m (+11%) Asia £2,030, +22% (+37% AER) US £790m, -13% (-2% AER) UK £268m, +33% 25% 66% 57% Life insurance new business profit1 was up 11 per cent2,3 (24 per cent on an actual exchange rate basis) to £3,088 million, reflecting the net outcome from strong growth in Asia and in UK retail business and reduced contribution from our US operations. Life insurance new business APE sales increased by 8 per cent2,3 (19 per cent on an actual exchange rate basis) to £6,320 million led by Asia and the UK. In Asia new business profit was 22 per cent3 higher at £2,030 million, outpacing new business APE sales in the region which increased by 19 per cent3 to £3,599 million (up 37 per cent and 33 per cent respectively on an actual exchange rate basis). APE sales progression has been strongest in the agency channel, up 23 per cent, as we continue to drive improvements in productivity and invest in recruitment initiatives to underpin future sales prospects. The fourth quarter saw an acceleration in the positive trends observed earlier in the year; overall APE increased to over £1 billion for the first time in a discrete quarter, with eight of our markets in the region growing by 20 per cent or more. Despite the strength of this growth our focus on quality is undiminished, with regular premiums on long-term contracts accounting for over 93 per cent of APE sales and a continuing high proportion of new business from health and protection coverage (62 per cent of new business profit). This favourable mix provides a high level of recurring income and an earnings profile that is significantly less correlated to investment markets. Our businesses in China and Hong Kong have performed well in 2016, with APE sales increasing by 31 per cent and 40 per cent, respectively, and demonstrating the extent of the opportunity in these markets. In Hong Kong, we continue to generate business from both Mainland China residents and local customers, with a strong bias for regular premiums (94 per cent of APE sales) and an increasing contribution from health and protection business (up 43 per cent). 2016 saw increased intervention by the Chinese authorities in relation to capital controls and we continue to monitor developments, which to date have not had a meaningful impact on our business in Hong Kong. In China, we have pivoted the business towards higher quality regular premium business driven by our increased scale in the agency channel, and sales of single premiums have reduced as we de-emphasised further new spread-based business across the region in 2016. In Indonesia, trading conditions remain challenging, and in such an environment we have retained our more cautious approach to new business, resulting in a 25 per cent reduction in APE sales. However, sales performance in the fourth quarter was more encouraging with a more modest period-on-period decline in APE sales of 3 per cent and a return to growth in the month of December. In Malaysia, APE sales were up 8 per cent, driven by improvements in the conventional agency channel and increased contributions from our bancassurance partners. In Singapore, where APE sales were up 1 per cent in 2016, new business performance has improved through the year which saw APE sales in the second half increase by 12 per cent relative to the equivalent period last year, driven by increased agent activation and a recovery in bancassurance sales. The 22 per cent increase in new business profit primarily reflects the effect of higher APE sales volumes (up 19 per cent) and positive effects from changes in country mix and channel mix. In the US, uncertainty following the announcement of the Department of Labor’s fiduciary duty rule on the distribution of retirement market products has contributed to a marked decline of 22 per cent16 in industry sales of variable annuities. Jackson’s APE sales from all our variable annuity products were also lower as a result, down 25 per cent. Notwithstanding this reduction in sales, net inflows into Jackson’s separate account asset balances, which drive fee-based earnings on variable annuity business, remained positive at £4.4 billion. More favourable market conditions in the institutional product market provided Jackson with the opportunity to write APE sales of £184 million compared to £138 million in 2015. Jackson’s new business profit of £790 million declined by 13 per cent overall, although this represents a smaller decrease than the reduction in sales volumes, demonstrating the benefit of improved business mix and a modest uplift from higher interest rates. The economics on new business in variable annuities remain extremely attractive, with high internal rates of return and short payback periods. In our UK life business, our strategy of extending customer access to PruFund’s with-profits investment option via additional product wrappers continues to drive growth in retail APE sales, which increased 33 per cent to £1,160 million. In the current low interest rate environment, consumers are attracted to PruFund’s smoothed multi-asset fund returns and the financial security attaching to its strong capitalisation. We have seen notable success with the build out of PruFund through individual pensions (up 104 per cent), income drawdown (up 62 per cent) and ISAs (up 70 per cent), although our more established PruFund investment bonds also increased 21 per cent. Reflecting this strong performance, total PruFund assets under management of £24.7 billion as at 31 December 2016 were 50 per cent higher than at the start of the year. UK’s retail new business profit of £268 million increased by 33 per cent reflecting the increased sales volume and positive effects from changes in product mix. 43 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportFree surplus generation Free surplus generation is the financial metric we use to measure the internal cash generation of our business operations. For life insurance operations it represents amounts maturing from the in-force business during the year, net of amounts reinvested in writing new business. For asset management it equates to post-tax IFRS profit for the period. This metric is based on the capital regimes which apply locally in the various jurisdictions in which our life businesses operate. The introduction of Solvency II with effect from 1 January 2016 has altered the regime locally applied to our UK life business, so the 2016 UK life free surplus figures reflect this change. The 2015 UK life comparatives are unchanged as they reflect the regime that applied at that time. Solvency II does not directly impact the way capital is generated locally in the US and in our Asian life operations, so there is no change in the way free surplus is calculated for these businesses. In 2016 underlying free surplus generation, after investment in new business, increased by 10 per cent2 to £3,588 million. Free surplus generation Free surplus generation1,4 Asia3 US UK M&G Prudential Capital Underlying free surplus generated from in-force life business and asset management3 Investment in new business3 Underlying free surplus generated3 Market related movements, timing differences and other movements Net cash remitted by business units Total movement in free surplus Free surplus at end of year1,17 Actual exchange rate Constant exchange rate 2016 £m 2015 £m Change % 2015 £m Change % 27 30 3 (5) 22 19 (26) 18 1,176 1,616 900 358 18 4,068 (792) 3,276 14 15 3 (5) 22 10 (14) 10 1,335 1,863 930 341 22 4,491 (903) 3,588 (588) (1,718) 1,282 6,575 1,052 1,433 900 358 18 3,761 (718) 3,043 289 (1,625) 1,707 5,293 The 10 per cent3 increase in free surplus generated1 by our life insurance and asset management businesses to £4,491 million (up 19 per cent3 on an actual exchange rate basis) reflects our growing scale and the highly capital-generative nature of our business model. In 2016, a key contributor to this growth has been derived from the positive momentum of Asia’s in-force life insurance portfolio, which provides an important underpin to this metric and helps absorb cyclicality elsewhere in the Group. We drive this metric by targeting markets and products that have low-strain, high-return and fast payback profiles and by delivering both good service and value to improve customer retention. Our ability to generate both growth and cash is a distinctive feature of Prudential. The closing value of free surplus in our life and asset management operations was £6.6 billion at 31 December 2016, after financing reinvestment in new business and funding cash remittances from the business units to Group. In Asia, growth in the in-force life portfolio, combined with post-tax asset management profits from Eastspring Investments, contributed to free surplus generation of £1,335 million, up 14 per cent. In the US, in-force free surplus generation increased 15 per cent, reflecting higher expected returns and a benefit of £236 million from contingent financing of specific US statutory reserves, which strengthened Jackson’s local statutory capital position. In the UK, free surplus generation1 was 3 per cent higher at £930 million, including a net contribution of £206 million (2015: £275 million) from management actions taken in the year to improve solvency, net of the provision for the cost of undertaking a review of past non-advised annuity sales practices and related potential redress. We invested £903 million of the free surplus generated1 during the period in writing new business (2015: £792 million, including bulk annuities) equivalent to an increase of 14 per cent. 44 Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinuedAsia remains the primary destination for reinvestment of capital given its higher margin organic growth opportunities. Investment of free surplus in new business was 12 per cent3 higher at £476 million, which is lower than the 19 per cent3 growth in APE sales, mainly due to positive mix effects. We continue to generate internal rates of return in excess of 20 per cent, with an average payback period of three years. In the US, new business investment was broadly consistent with 2015 at £298 million, reflecting a greater proportion of variable annuity premiums being directed to the fixed account option and higher institutional volumes. At just 2 per cent of new business single premium sales, Jackson’s overall strain remains low, supporting the generation of high returns on capital. New business economics on Jackson’s sales remain extremely attractive, with business written at an overall internal rate of return in excess of 20 per cent and payback periods averaging two years. The new business investment1 in the UK was £129 million (2015: £65 million), although comparisons are distorted by the application of different capital regimes in the two periods, with investment in 2016 including a significantly higher strain for new non-profit annuities under the new Solvency II regime, despite the much reduced sales. Following our decision in June 2016 to stop writing annuity business in the open market and our action in early February 2017 to direct internal vestings to a panel of providers, UK new business strain is expected to reduce significantly in 2017. We continue to manage cash flows across the Group with a view to achieving a balance between ensuring sufficient remittances are made to service central requirements (including paying the external dividend) and maximising value to shareholders through retention and reinvestment of capital in business opportunities. Business unit remittance18 Net cash remitted by business units: Asia US UK M&G Prudential Capital Other UK Net cash remitted by business units Holding company cash at 31 December Movement in central cash £m 1,718 (1,267) (257) (1,010) 516 Asia 420 US 300 UK 290 M&G PruCap 45 Other UK 147 2,173 (416) 418 2,626 Actual exchange rate 2016 £m 2015 £m 516 420 300 290 45 147 1,718 2,626 467 470 301 302 55 30 1,625 2,173 1 Jan 2016 Cash remitted to Group Dividends paid Central costs Corporate activities/ other 31 Dec 2016 FY15 special dividend FY15 second interim dividend and FY16 first interim dividend Cash remitted to the corporate centre in 2016 amounted to £1,718 million, driven by higher remittances from Asia (up 21 per cent, after adjusting for £42 million of proceeds in 2015 from the sale of our Japan life business). Jackson made sizeable remittances of £420 million, albeit lower than last year when more supportive markets enhanced capital formation. The remittance from UK Life of £300 million was in line with 2015, while the remittance from M&G of £290 million was lower than last year reflecting lower levels of post-tax earnings in the year. Actions completed in the period, including internal restructuring that has enabled us to access central resources previously held at intermediary holding and other companies, contributed a further £147 million. Cash remitted to the Group in 2016 was used to meet central costs of £416 million (2015: £354 million), pay the 2015 second interim ordinary, 2015 special and 2016 first interim dividends and finance the final up-front payment for the renewal of the distribution agreement with Standard Chartered Bank. These movements combined with the net proceeds of debt raised in the year and other corporate cash flows led to holding company cash increasing from £2,173 million to £2,626 million over 2016. 45 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportEEV profit1 Post-tax operating profit based on longer-term investment returns Long-term business: Actual exchange rate Constant exchange rate 2016 £m 2015 £m Change % 2015 £m Change % Asia3 US UK Long-term business post-tax operating profit3 UK general insurance commission Asset management business: M&G Prudential Capital Eastspring Investments US Other income and expenditure19 3,074 1,971 643 5,688 23 341 22 125 (3) (699) 2,280 1,808 863 4,951 22 358 18 101 7 (617) Post-tax operating profit based on longer-term investment returns3 5,497 4,840 Non-operating items: (Loss)/Profit attaching to held for sale Korea business Other non-operating items19 Post-tax profit for the year attributable to shareholders (410) (571) 39 (928) 4,516 3,951 Earnings per share1 35 9 (25) 15 5 (5) 22 24 (143) (13) 14 n/a 38 14 2,555 2,040 863 5,458 22 358 18 112 8 (617) 5,359 42 (1,057) 4,344 20 (3) (25) 4 5 (5) 22 12 (138) (13) 3 n/a 46 4 Basic earnings per share based on post-tax operating profit3 Basic earnings per share based on post-tax total profit 214.7 176.4 189.6 154.8 13 14 209.9 170.2 2 4 Actual exchange rate Constant exchange rate 2016 pence 2015 pence Change % 2015 pence Change % business profit1 of £2,600 million, which was 1 per cent3 higher than prior year (up 11 per cent on an actual exchange rate basis). Experience and assumptions changes were positive at £706 million (2015: £741 million), reflecting our ongoing focus on managing the in-force book for value. EEV operating profit by business £m (% vs FY15) (13)% 9% 12% 36% £5,497m 3% (+14% AER) 56% Asia life £3,074m, +20% (+35% AER) US life £1,971m, -3% (+9% AER) UK life £643m, -25% Asset management and GI £508m (2015: £506m) Other £(699)m, -13% EEV operating profit On an EEV basis, Group post-tax operating profit based1 on longer-term investment return increased by 3 per cent3 (up 14 per cent on an actual exchange rate basis) to £5,497 million in 2016. Prudential adopts an active basis of setting the future return assumptions used to calculate the Group’s EEV basis operating profit. These assumptions are therefore based on the 31 December 2016 long-term interest rates which were lower in our key markets of the UK, Indonesia and Singapore, and higher in other markets including US, Hong Kong and Malaysia. The impact of these movements in the full year results broadly offset. The EEV operating profit includes new business profit1 from the Group’s life business, which increased by 11 per cent3 (up 24 per cent on an actual exchange rate basis) to £3,088 million and in-force life 46 Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinuedCapital position, financing and liquidity Capital position With effect from 1 January 2016, the Group is required to adopt Solvency II as its consolidated capital regime. This was developed by the EU in order to harmonise the various regimes previously applied across EU member states. As the regime was primarily designed with European life products in mind, it is a poor fit with Prudential’s business given the predominantly non-EU footprint of the Group. The one year value at risk nature of the Solvency II test, which has its roots in banking regulation where risk positions can be priced and readily traded, runs counter to the multi-year nature of life insurance business, where the illiquid nature of liabilities renders such potential market solutions theoretical and not grounded in established sector practices. It also means that solvency capital will be highly volatile. While Solvency II does not fully recognise the economic capital strength of the Group, we implemented it in 2016 having received internal model approval from the Prudential Regulation Authority in December 2015. Analysis of movement in Group shareholder Solvency II surplus20 Estimated Solvency II surplus at 1 January/economic capital surplus at 1 January Operating experience Non-operating experience (including market movements) Other capital movements Subordinated debt issuance Foreign currency translation impacts Dividends paid Methodology and calibration changes Estimated Solvency II surplus at 31 December 2016 £bn 2015 £bn 9.7 2.7 (1.1) 1.2 1.6 (1.3) (0.3) 12.5 9.7 2.4 (0.6) 0.6 0.2 (1.0) (1.6) 9.7 The high quality and recurring nature of our operating capital generation and our disciplined approach to managing balance sheet risk enabled us to enter the new Solvency II regime on 1 January 2016 with a strong Group shareholders’ capital surplus of £9.7 billion. These factors also provided meaningful protection against the significant adverse market-driven effects on this metric in the first half of 2016. Reflecting the improvement in long-term yields during the last three months of the year, combined with strong operating capital generation and the beneficial effects of debt issued, the Group shareholders’ Solvency II capital surplus was estimated at £12.5 billion at 31 December 2016, equivalent to a cover ratio of 201 per cent6,7 (1 January 2016: 193 per cent). Solvency II surplus £bn 12.5 9.7 193% 201% 31 Dec 2015 31 Dec 2016 Solvency II capital ratio In July 2013, Prudential plc was listed by the Financial Stability Board as one of nine companies to be designated as a Global Systemically Important Insurer, a classification that was reaffirmed in November 2016. Prudential is monitoring the development and potential impact of the related framework of policy measures and is engaging closely with the Prudential Regulation Authority on the implications of this designation. Local statutory capital All of our subsidiaries continue to hold appropriate capital levels on a local regulatory basis. In the UK, at 31 December 2016 the Prudential Assurance Company Limited and its subsidiaries had an estimated Solvency II shareholder surplus21 of £4.6 billion (equivalent to a cover ratio of 163 per cent) and a with-profits surplus22 of £3.7 billion (equivalent to a cover ratio of 179 per cent). In the US, the combination of a high start of year capital level coupled with strong operational capital formation in the year and specific actions taken to strengthen further Jackson’s local statutory capital position led to an increase in its Risk Based Capital ratio to 485 per cent (2015: 481 per cent). Debt portfolio The Group continues to maintain a high-quality defensively positioned debt portfolio. Shareholders’ exposure to credit is concentrated in the UK annuity portfolio and the US general account, mainly attributable to Jackson’s fixed annuity portfolio. The credit exposure is well diversified, with investment grade securities representing 96 per cent of our UK portfolio and 98 per cent of our US portfolio at end-2016. During 2016, default losses were minimal and reported impairments of £35 million across these two portfolios were in line with those in 2015. Net core structural borrowings £bn (EEV basis) 4,594 422 4,172 22% 2016 3,246 408 2,838 18% 2015 IFRS basis of value of net core structural borrowings Mark to market value Gearing ratio* * Net core structural borrowings as proportion of IFRS shareholders’ funds plus net debt. Financing and liquidity Our financing and central liquidity position remained strong throughout the year. Our central cash resources amounted to £2.6 billion at 31 December 2016 (31 December 2015: £2.2 billion). Total core structural borrowings increased by £1.8 billion to £6.8 billion following the issue of US$1 billion (£800 million at 31 December 2016) 5.25 per cent tier 2 perpetual subordinated debt in June 2016, US$725 million (£580 million at 31 December 2016) 4.38 per cent tier 2 perpetual subordinated debt in September 2016 and the impact of currency movements. In addition to its net core structural borrowings of shareholder-financed 47 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportoperations set out above, the Group also has access to funding via the money markets and has in place an unlimited global commercial paper programme. As at 31 December 2016, we had issued commercial paper under this programme totalling £70 million and US$1,213 million, to finance non-core borrowings. Prudential’s holding company currently has access to £2.6 billion of syndicated and bilateral committed revolving credit facilities provided by 19 major international banks, expiring in 2021 and 2022. Apart from small drawdowns to test the process, these facilities have never been drawn, and there were no amounts outstanding at 31 December 2016. The medium-term note programme, the SEC registered shelf programme, the commercial paper 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 flexible funding capacity. Shareholders’ funds Profit after tax for the year Exchange movements, net of related tax Unrealised gains and losses on Jackson fixed income securities classified as available for sale23 Dividends Market to market value movements on Jackson assets backing surplus and required capital Other Net increase in shareholders’ funds Shareholders’ funds at 1 January Shareholders’ funds at 31 December Effect of implementation of Solvency II at 1 January 2016 Revised shareholders’ funds at 1 January 2016 Shareholders’ value per share Return on shareholders’ funds24 IFRS EEV 2016 £m 2015 £m 2016 £m 2015 £m 1,921 1,161 31 (1,267) – (135) 1,711 12,956 14,667 2,579 118 (629) (974) – 50 1,144 11,812 12,956 4,516 4,211 – (1,267) (11) (367) 7,082 31,886 38,968 568p 26% 504p 27% 1,510p 17% 3,951 244 – (974) (76) 53 3,198 29,161 32,359 (473) 31,886 1,240p 17% IFRS shareholders’ funds £bn EEV shareholders’ funds £bn +13% +22% 14.7 39.0 13.0 31.9 31 Dec 2015 31 Dec 2016 31 Dec 2015 31 Dec 2016 EEV value per share 1,240p 1,510p In 2016, UK sterling weakened relative to the US dollar and various Asian currencies. With approximately 49 per cent of the Group’s IFRS net assets (71 per cent of the Group’s EEV net assets) denominated in non-sterling currencies this generated a positive foreign exchange movement on net assets in the period. This movement, together with profit after tax, movement in other comprehensive income and dividends paid, has led to the Group’s IFRS shareholders’ funds at 31 December 2016 increasing by 13 per cent to £14.7 billion (31 December 2015: £13.0 billion on an actual exchange rate basis). The introduction of Solvency II at the start of 2016 changed the capital dynamics of our UK life operations which are directly impacted by this change. In overview, it permitted the inclusion of future profits in the available capital of the business but 48 CHARTS UPDATED TO REFLECT CHANGES TO TABLE Prudential plc Annual Report 2016 www.prudential.co.ukChief Financial Officer’s report on the 2016 financial performance – Nic NicandrouContinued increased the statutory capital requirements. Factoring these and other consequential methodology changes in the EEV calculations of the UK life business produced a net charge of £473 million, equivalent to 5 per cent of the UK’s embedded value (just over 1 per cent of the Group’s embedded value at the start of the year). For our operations in Asia and the US, there is no impact on the EEV results since Solvency II does not act as the local constraint on the ability to distribute capital to the Group. The Group’s EEV basis shareholders’ funds also increased by 22 per cent5 to £39.0 billion (31 December 2015: £31.9 billion on an actual exchange rate basis), equivalent of 1,510 pence per share, up from 1,240 pence per share5 at 31 December 2015. Corporate transactions Sale of Korea life insurance business In November 2016 we announced the sale of our Korea life insurance business, PCA Life Insurance Co., Ltd. to Mirae Asset Life Insurance Co., Ltd., for KRW170 billion (equivalent to £114 million at 31 December 2016 closing exchange rate) cash consideration. The completion of this sale is subject to regulatory approval. Consistent with the classification of the business as held for sale, the IFRS and EEV carrying values have been set to £105 million, representing the estimated proceeds, net of related expenses of £9 million. The IFRS loss of £227 million and EEV loss of £410 million comprises the 2016 reduction on writing down the carrying value of the business to the agreed sale proceeds (net of costs) together with its profits for the year. The comparative profits for the year have been similarly Notes 1 The 2016 EEV basis results for UK insurance operations have been prepared on a basis that reflect the Solvency II regime, effective from 1 January 2016. The 2015 comparative results for UK insurance operations reflect the Solvency I basis. Excluding UK bulk annuities as Prudential has withdrawn from this market. Following its reclassification to held for sale during 2016, operating results exclude the results of the Korea life business. The 2015 comparative results have been similarly adjusted. Free surplus represents ‘underlying free surplus’ based on operating movements, including the general insurance commission earned during the year and excludes market movements, foreign exchange, capital movements, shareholders’ other income and expenditure and centrally arising restructuring and Solvency II implementation costs. Includes adjustment for opening EEV shareholders’ funds of negative £0.5 billion for the impact of Solvency II as at 1 January 2016. 2 3 4 5 6 Before allowing for second interim ordinary dividend. 7 The Group Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date, which has reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. 8 Refer to note B1.1 in IFRS financial statements for the breakdown of other income and expenditure and other non-operating items. reclassified as non-operating for consistency of presentation. Entrance into Zambia In June 2016 we completed the acquisition of Professional Life Assurance of Zambia, increasing Prudential’s insurance business footprint in Africa to four markets. Across Ghana, Kenya, Uganda and now Zambia we are gradually laying the foundations for what we hope will become a meaningful component of the Group in the years to come. Our current focus in these businesses is on growing our distribution; at 31 December we had 1,750 agents and were active in 181 branches of our four local bank partners (three exclusive) across these businesses. Dividend During 2016 the Group’s dividend policy was updated. The Board will maintain its focus on delivering a growing ordinary dividend. In line with this policy, Prudential aims to grow the ordinary dividend by 5 per cent per annum. The potential for additional distributions will continue to be determined after taking into account the Group’s financial flexibility across a broad range of financial metrics and our assessment of opportunities to generate attractive returns by investing in specific areas of the business. The Board has decided to increase the full-year ordinary dividend by 12 per cent to 43.5 pence per share, reflecting our strong 2016 financial performance and our confidence in the future prospects of the Group. In line with this, the Directors have approved a second interim ordinary dividend of 30.57 pence per share (2015: 26.47 pence per share). In 2015, a special dividend of 10 pence per share was also awarded. 9 Includes Group’s proportionate share of the liabilities and associated flows of the insurance joint ventures and associates in Asia. 10 Defined as movements in policyholder liabilities arising from premiums (net of charges), surrenders/withdrawals, maturities and deaths. 11 Following its reclassification to held for sale during 2016, the shareholder-backed policyholder liabilities for Korea exclude the value of policyholder liabilities held at 1 January 2016 and 2016 net liability flows for Korea life business. 12 For basis of preparation see note I (a) of Additional 13 unaudited IFRS financial information. Includes Group’s proportionate share in PPM South Africa and the Asia asset management joint ventures. 14 For our asset management business the level of funds managed on behalf of third parties, which are not therefore recorded on the balance sheet, is a driver of profitability. We therefore analyse the movement in the funds under management each period, focusing between those which are external to the Group and those held by the insurance business and included on the Group balance sheet. This is analysed in note II(b) of the Additional IFRS financial information. 15 Net inflows exclude Asia Money Market Fund (MMF) inflows of £403 million (2015: net inflows £1,065 million). External funds under management exclude Asia MMF balances of £7,714 million (2015: £6,006 million). 16 LIMRA/Secure Retirement Institute, US Individual Annuity Participants Report 3Q YTD 2016. 17 The 2015 comparative includes an adjustment to opening free surplus representing the impact of Solvency II at 1 January 2016, together with the effect of a reclassification between long-term business and other operations, as discussed in note 9(v) of the EEV basis results. Nic Nicandrou Chief Financial Officer 18 Net cash remitted by business units are included in the Holding company cash flow, which is disclosed in detail in note II(a) of Additional unaudited IFRS financial information. 19 Refer to the EEV basis supplementary information – Post-tax operating profit based on longer-term investment returns and Post-tax summarised consolidated income statement, for the breakdown of other income and expenditure, and other non-operating items. 20 The methodology and assumptions used in calculating the Solvency II capital results are set out in note II (c) of Additional unaudited financial information. 21 The UK Solvency II surplus represents the shareholder capital position excluding the contribution to Own Funds and the Solvency Capital Requirement from ring fenced with-profits funds and staff pension scheme in surplus. The estimated solvency position includes the impact of recalculated transitionals at the valuation date. 22 The with-profits Solvency II surplus represents the contribution to Own Funds and the Solvency Capital Requirement from ring fenced funds. The estimated solvency position includes the impact of recalculated transitionals at the valuation date. 23 Net of related charges to deferred acquisition costs and tax. 24 Operating profit after tax and non-controlling interests as percentage of opening shareholders’ funds. Includes Unallocated surplus of with-profits business. 25 49 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Generating value through selective exposure to risk Our Risk Management Framework is designed to ensure the business remains strong through stress events so we can continue to deliver on our long-term commitments to our customers and shareholders. 2016 has been a year of extraordinary global uncertainty and the financial strength of our Group has remained robust throughout. Penny James Group Chief Risk Officer Introduction 2016 has been a year of extraordinary global change, starting with market turbulence in China, followed by the UK’s vote to leave the EU and ending with the election of a new president in the US. Even in such a year, we have maintained a strong and sustained focus on planning for the possibility of, and ultimately managing, the market volatility and macroeconomic uncertainty arising from these events. Our Risk Management Framework and risk appetite have allowed us to control successfully our risk exposure throughout the year. Our strong governance, processes and controls enable us to deal with the uncertainty ahead in order to continue helping our customers achieve their long-term financial goals. For our shareholders, we generate value by selectively taking exposure to risks that are adequately rewarded and that can be appropriately quantified and managed. We retain risks within a clearly defined risk appetite, where we believe doing so contributes to value creation and the Group is able to withstand the impact of an adverse outcome. For our retained risks, we ensure that we have the necessary capabilities, expertise, processes and controls to manage appropriately the exposure. In my report, I seek to explain the main risks inherent in our business and how we manage these evolving risks, with the aim of ensuring we maintain an appropriate risk profile. Risk governance, culture and our risk management cycle Prudential defines ‘risk’ as the uncertainty that we face in successfully implementing our strategies and objectives. This includes all internal or external events, acts or omissions that have the potential to threaten the success and survival of the Group. As such, material risks will be retained selectively where we think there is value to do so, and where it is consistent with the Group’s risk appetite and philosophy towards risk taking. The following section provides more detail on our risk governance, culture and risk management process. Risk governance Risk management cycle Identified major risk categories s B o a r d a n d committ e e s i o n t a Risk ide n tif i c Risk an d a m e a s s s e u s r s e m m e e n n t t l o r t n e a n d co M o n i t o r a n Risk management cycle d r e port g M a n a ss opera ti o s n Str a e g i c t Marke t R is k s f r o m e n i s u b r u o m o r s s e n i s u B nt e m n o r i v n e O p Group risk profile f e s k s i R r a t i o n al Insura n c e Risks from o u r business pr o d u c t o u r i n v e s t m e n ts C r e d i t y Liq uidit s Risk culture R R i s k i s R is k a k policies a n d s t a ppetite, lim i t s n a anageme n t m n dards d triggers e m a r f w ork 50 Prudential plc Annual Report 2016 www.prudential.co.uk Risk appetite, limits and triggers The extent to which we are willing to take risk in the pursuit of our objective to create shareholder value is defined by a number of risk appetite statements, operationalised through measures such as limits, triggers and indicators. The Group risk appetite is approved by the Board and is set with reference to economic and regulatory capital, liquidity and earnings volatility. The Group risk appetite is aimed at ensuring that we take an appropriate level of aggregate risk and covers all risks to shareholders, including those from participating and third party business. We have no appetite for material losses (direct or indirect) suffered as a result of failing to develop, implement and monitor appropriate controls to manage operational risks. Group limits operate within the risk appetite to constrain the material risks, while triggers and indicators provide further constraint and ensure escalation. The Group Chief Risk Officer determines the action to be taken upon any breaches. The Group Risk function is responsible for reviewing the scope and operation of these measures at least annually, to determine that they remain relevant. The Board approves all changes made to the Group’s Risk Appetite Framework. We define and monitor aggregate risk limits based on financial and non-financial stresses for our earnings volatility, liquidity and capital requirements. Earnings volatility The objectives of the aggregate risk limits seek to ensure that: — The volatility of earnings is consistent with the expectations of stakeholders; — The Group has adequate earnings (and cash flows) to service debt, expected dividends and to withstand unexpected shocks; and — Earnings (and cash flows) are managed properly across geographies and are consistent with funding strategies. The two measures used to monitor the volatility of earnings are IFRS operating profit and EEV operating profit, although IFRS and EEV total profits are also considered. Risk governance Our risk governance comprises the organisational structures, reporting relationships, delegation of authority, roles and responsibilities, and risk policies that the Group head office and the business units establish to make decisions and control their activities on risk-related matters. This encompasses individuals, Group-wide functions and committees involved in the management of risk. Risk committees and governance structure Our Risk governance structure is led by the Group’s Risk Committee, supported by independent non-executives on risk committees of major subsidiaries. These committees monitor the development of the risk management framework, and the Group’s risk appetites, limits, and policies as well as its risk culture. We have in place a comprehensive risk management cycle to identify, measure, manage and monitor our risk exposures. In addition to the risk committees mentioned, there are various executive risk forums to ensure risk issues are shared and considered across the Group. These are led by the Group Executive Risk Committee which is supported by a number of specific committees including in relation to security and information security where specialist skills are required. Risk Management Framework The Group’s Risk Management Framework has been developed to monitor and manage the risk of the business at all levels and is owned by the Board. The aggregate Group exposure to the key risk drivers is monitored and managed by the Group Risk function whose responsibility it is to review, assess and report on the Group’s risk exposure and solvency position from the Group economic, regulatory and ratings perspectives. The Framework requires that all our businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group – the ‘Risk Management Cycle’ (see below) and is based on the concept of the ‘three lines of defence’, comprising risk taking and management, risk control and oversight, and independent assurance. A major part of the Risk Management Cycle is the annual assessment of the Group’s risks which are considered key. These key risks range from risks associated with the economic, market, political and regulatory environment; those that we assume when writing our insurance products and by virtue of the investments we hold; and those that are inherent in our business model and its operation. This is used to inform risk reporting to the risk committees and the Board for the year. Liquidity The objective is to ensure that the Group is able to generate sufficient cash resources to meet financial obligations as they fall due in business as usual and stressed scenarios. Risk appetite with respect to liquidity risk is measured using a Liquidity Coverage Ratio which considers the sources of liquidity versus liquidity requirements under stress scenarios. Capital requirements The limits aim to ensure that: — The Group meets its internal economic capital requirements; — The Group achieves its desired target rating to meet its business objectives; and — Supervisory intervention is avoided. The two measures used at the Group level are Solvency II capital requirements and internal economic capital requirements. In addition, capital requirements are monitored on local statutory bases. 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 from our local business units to calculate the Group’s aggregated position (allowing for diversification effects between local business units) relative to the aggregate risk limits. Risk policies These set out the specific requirements which cover the fundamental principles for risk management within the Group Risk Framework. Policies are designed to give some flexibility so that business users can determine how best to comply with policies based on their local expertise. There are core risk policies for credit, market, insurance, liquidity and operational risks and a number of internal control policies covering internal model risk, underwriting, dealing controls and tax risk management. They form part of the Group Governance Manual, which was developed to make a key contribution to the sound system of internal control that we maintain in line with the UK Corporate Governance Code and the Hong Kong Code on Corporate Governance Practices. Group Head Office and business units must confirm that they have implemented the necessary controls to evidence compliance with the Group Governance Manual on an annual basis. 51 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Continued Risk standards The Group-wide Operating Standards provide supporting detail to the higher level risk policies. In many cases they define the minimum requirements for compliance with Solvency II regulations which in some areas are highly prescriptive. The standards are more detailed than policies. Our risk culture Culture is a strategic priority of the Board who recognise the importance of good culture in the way that we do business. Risk culture is a subset of broader organisational culture, which shapes the organisation- wide values that we use to prioritise risk management behaviours and practices. An evaluation of risk culture is part of the Risk Management Framework and in particular seeks to identify evidence that: — Senior management in business units articulate the need for good risk management as a way to realise long-term value and continuously support this through their actions. — Employees understand and care about their role in managing risk – they are aware of and openly discuss risk as part of the way they perform their role; and — Employees invite open discussion on the approach to the management of risk. Key aspects of risk culture are also communicated through the Code of Conduct and the policies in the Group Governance Manual, including the commitments to the fair treatment of our customers and staff. The approach to the management of risk is also a key part of the evaluation of the remuneration of executives. Risk culture is an evolving topic across the financial services industry and we will be continuing work to evaluate and embed a strong risk culture through 2017. The risk management cycle The risk management cycle comprises processes to identify, measure and assess, manage and control, and monitor and report on our risks. Risk identification Group-wide risk identification takes place throughout the year, and includes processes such as our Own Risk and Solvency Assessment (ORSA) and the horizon-scanning performed as part of our emerging risk management process. On an annual basis, a top-down identification of the Group’s key risks is performed which considers those risks that have the greatest potential to impact the Group’s operating results and financial condition. A bottom-up process of risk identification is performed by the business units who identify, assess and document risks, with appropriate coordination and challenge from the risk functions. The Group ORSA report pulls together the analysis performed by a number of risk and capital management processes, which are embedded across the Group, and provides quantitative and qualitative assessments of the Group’s risk profile, risk management and solvency needs on a forward-looking basis. The scope of the report covers the full known risk universe of the Group. In accordance with provision C.2.1 of the UK Code, the Directors have performed a robust assessment of the principal risks facing the Company, through the Group ORSA report and the risk assessments done as part of the business planning review, including how they are managed and mitigated. Risk identification covers Group-wide: — Top down risk identification — Bottom up risk identification — Emerging risk identification Risk reports provide monthly updates to the Group Executive Risk Committee, Group Risk Committee and Board on exposure against Board-approved risk appetite statements and limits. Risk reports also provide updates on the Group top risks. 52 i o n t a Risk ide n tif i c M o n i t o r a n Risk management cycle d r e port g M a n a Risk an d a m e a s s s e u s r s e m m e e n n t t l o r t n e a n d co Risks are assessed in terms of materiality. Material risks which are modelled are included in capital models, including E-Cap. Risks which cannot be quantified are assessed qualitatively. Risk processes that support the management and controlling of risk exposures include: — Risk appetite and limits — Financial incidents procedures — Large risk approval process — Global counterparty limit framework — Own risk and solvency assessment — Reverse stress testing Prudential plc Annual Report 2016 www.prudential.co.uk Reverse stress testing, which requires us to work backwards from an assumed point of business model failure, is another tool that helps us to identify the key risks and scenarios that may materially impact the Group. Our emerging risk management process identifies potentially material risks which have a high degree of uncertainty around timing, magnitude and propensity to evolve. The Group holds emerging risk sessions over the year to identify emerging risks which includes input from local subject matter and industry experts. We maintain contacts with thought leaders and peers to benchmark and refine our process. The risk profile is a key output from the risk identification and risk measurement processes, and is used as a basis for setting Group-wide limits, management information, assessment of solvency needs, and determining appropriate stress and scenario testing. The risk identification processes support the creation of our annual set of key risks, which are then given enhanced management and reporting focus. Risk measurement and assessment All identified risks are assessed based on an appropriate methodology for that risk. All quantifiable risks which are material and mitigated by holding capital are modelled in the Group’s internal model, which is used to determine capital requirements under Solvency II and our own economic capital basis. Governance arrangements are in place to support the internal model, including independent validation and process and controls around model changes and limitations. Risk management and control The control procedures and systems established within the Group are designed to manage reasonably the risk of failing to meet business objectives and are detailed in the Group risk policies. This can of course only provide reasonable and not absolute assurance against material misstatement or loss. They focus on aligning the levels of risk taking with the achievement of business objectives. The management and control of risks are set out in the Group risk policies, and form part of the holistic risk management approach under the Group’s ORSA. These risk policies define: — The Group’s risk appetite in respect of material risks, and the framework under which the Group’s exposure to those risks is limited; — The processes to enable Group senior management to effect the measurement and management of the Group material risk profile in a consistent and coherent way; and — The flows of management information required to support the measurement and management of the Group material risk profile and to meet the needs of external stakeholders. The methods and risk management tools we employ to mitigate each of our major categories of risks are detailed in section 4 below. Risk monitoring and reporting The identification of the Group’s key risks informs the management information received by the Group risk committees and the Board. Risk reporting of key exposures against appetite is also included, as well as ongoing developments in other key and emerging risks. Summary risks The table below is a summary of the key risks facing the Group, which can be grouped into those which apply to us because of the global environment in which we operate, and those which arise as a result of the business that we operate – including risks arising from our investments, the nature of our products and from our business operations. ‘Macro’ risks Some of the risks that we are exposed to are necessarily broad given the external influences which may impact on the Group. These risks include: Global economic conditions Changes in global economic conditions can impact us directly; for example by leading to poor returns on our investments and increasing the cost of promises we have made to our customers. They can also have an indirect impact; for example economic pressures could lead to decreased savings, reducing the propensity for people to buy our products. Global economic conditions may also impact on regulatory risk for the Group by changing prevailing political attitudes towards regulation. Geopolitical risk The geopolitical environment is increasingly uncertain with political upheaval in the UK, the US and the Eurozone. Uncertainty in these regions, combined with conflict in the Middle East and increasing tensions in east Asia underline that geopolitical risks are truly global and their potential impacts are wide-ranging; for example through increased regulatory risk. The geopolitical and economic environments are increasingly closely linked, and changes in the political arena may have direct or indirect impacts on our Group. Digital disruption The emergence of advance technologies such as artificial intelligence and block chain is providing an impetus for companies to rethink their existing operating models and how they interact with their customers. Prudential is embracing the opportunities presented by digitalisation and is closely monitoring any risks which arise. 53 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Continued Risks from our investments Risks from our products Risks from our business operations Operational risks As a Group, we are dependent on the appropriate and secure processing of a large number of transactions by our people, IT infrastructure and outsourcing partners, which exposes us to operational risks and reputational risks. Information security risk is a significant consideration within operational risk, including both the risk of malicious attack on our systems as well as risks relating to data security and integrity and network disruption. The size of Prudential’s IT infrastructure and network, our move toward digitisation and the increasing number of high-profile cyber security incidents across industries means that this will continue to be an area of high focus. Regulatory risk We also operate under the ever-evolving requirements set out by diverse regulatory and legal regimes (including tax), as well as utilising a significant number of third parties to distribute products and to support business operations; all of which add to the complexity of the operating model if not properly managed. The number of regulatory changes under way across Asia, in particular those focusing on consumer protection means that regulatory change in the region is also considered a key risk. Both Jackson and the UK operate in highly regulated markets. Regulatory reforms could materially impact our businesses, and regulatory focus continues to be high. Global economic conditions – see above – have a large impact on those risks from our investments. Our fund investment performance is a fundamental part of our business in providing appropriate returns for our customers and shareholders, and so is an important area of focus. Credit risk Is the potential for reduced value of our investments due to the uncertainty around investment returns arising from the potential for defaults of our investment counterparties. Invested credit risk arises from our asset portfolio. We increase sector focus where necessary. The assets backing the UK and Jackson’s annuity business mean credit risk is a significant focus for the Group. Market risk Is the potential for reduced value of our investments resulting from the volatility of asset prices as driven by fluctuations in equity prices, interest rates, foreign exchange rates and property prices. In our Asia business, our main market risks arise from the value of fees from our fee-earning products. Insurance risks The nature of the products offered by the Group exposes it to insurance risks, which are a significant part of our overall risk profile. The insurance risks that we are exposed to by virtue of our products include longevity risk (policyholders living longer than expected); mortality risk (policyholders with life protection dying); morbidity risk (policyholders with health protection becoming ill) and persistency risk (customers lapsing their policies). From our health protection products, increases in the costs of claims (including the level of medical expenses) increasing over and above price inflation (claim inflation) is another risk. The processes that determine the price of our products and reporting the results of our long-term business operations require us to make a number of assumptions. Where experience deviates from these assumptions our profitability may be impacted. Across our business units, persistency and morbidity risks are among the largest insurance risks for our Asia business given our strong focus on health protection products in the region. In the US, Jackson’s fixed and variable annuity books are exposed to a variety of market risks due to the assets backing these policies. For the UK and Jackson, the most significant insurance risk is longevity risk driven by their annuity businesses. In the UK, exposure relates to the valuation of the proportion of the with-profits fund’s future profits which is transferred to the shareholders (future transfers), which is dependent on equity, property and bond values. M&G invests in a broad range of asset classes and its income is subject to the price volatility of global financial and currency markets. Liquidity risk Is the risk of not having sufficient liquid assets to meet our obligations as they fall, and incorporates the risk arising from funds composed of illiquid assets. It results from a mismatch between the liquidity profile of assets and liabilities. 54 Prudential plc Annual Report 2016 www.prudential.co.ukFurther risk information In reading the sections below, it is useful to understand that there are some risks that our policyholders assume by virtue of the nature of their products, and some risks that the Company and its shareholders assume. Examples of the latter include those risks arising from assets held directly by and for the Company, or the risk that policyholder funds are exhausted. This report is focused mainly on risks to the shareholder, but will include those which arise indirectly through our policyholder exposures. Risks from our investments Market risk The main drivers of market risk in the Group are: — Investment risk (including equity and property risk); — Interest rate risk; and — Given the geographical diversity of our business, foreign exchange risk. With respect to investment risk, equity and property risk arises from our holdings of equity and property investments, the prices of which can change depending on market conditions. The valuation of our assets (particularly the bonds that we invest in) and liabilities are also dependent on market interest rates and exposes us to the risk of those moving in a way that is detrimental for us. Given our global business, we earn our profits and hold assets in various currencies. The translation of those into our reporting currency exposes us to movements in foreign exchange rates. Our main investment risk exposure arises from the portion of the profits from the UK with-profits fund to which we are entitled to receive; the value of the future fees from our fee-earning products in our Asia business; and from the asset returns backing Jackson’s variable annuities business. Our interest rate risk is driven in the UK by our need to match our assets and liabilities; from the guarantees of some non unit- linked investment products in Asia; and the cost of guarantees in Jackson’s fixed, fixed index and variable annuity business. The methods that we use to manage and mitigate our market risks include the following: — Our market risk policy; — Risk appetite statements, limits and triggers that we have in place; — The monitoring and oversight of market risks through the regular reporting of management information; — Our asset and liability management programmes; — Use of derivative programmes, including, for example, interest rate swaps, options and hybrid options for interest rate risk; — Regular deep dive assessments; and — Use of currency hedging. Investment risk (Audited) In the UK business, our main investment risk arises from the assets held in the with-profits funds. Although this is mainly held by our policyholders, a proportion of the fund’s profit (one tenth) is transferred to us and so our investment exposure relates to the future valuation of that proportion (future transfers). This investment risk is driven mainly by equities in the fund, although there is some risk associated with other investments such as property and bonds. Some hedging to protect from a reduction in the value of these future transfers against falls in equity prices is performed outside the fund using derivatives. The with-profits funds’ large Solvency II own funds – estimated at £8.4 billion as at 31 December 2016 (31 December 2015: £7.6 billion) – helps to protect against market fluctuations and helps the fund to maintain appropriate solvency levels. The with-profits funds’ Solvency II own funds are partially protected against falls in equity markets through an active hedging programme within the fund. In Asia, our shareholder exposure to equity price movements results from unit-linked products, where our fee income is linked to the market value of the funds under management. Further exposure arises from with-profits businesses where bonuses declared are broadly based on historical and current rates of return on equity. In Jackson, investment risk arises from the assets backing customer policies. In the case of spread-based business, including fixed annuities, these assets are generally bonds, and shareholder exposure comes from the minimum returns needed to meet the guaranteed rates that we offer to policyholders. For our variable annuity business, these assets include both equities and bonds. In this case, the main risk to the shareholder comes from the guaranteed benefits that can be included as part of these products. Our exposure to this kind of situation is reduced by using a derivative hedging programme, as well as through the use of reinsurance to pass on the risk to third-party reinsurers. Interest rate risk (Audited) While long-term interest rates in advanced economies have broadly increased since mid-2016, they remain close to historical lows. Some products that we offer are sensitive to movements in interest rates. We have already taken a number of actions to reduce the risk to the in-force business, as well as re-pricing and restructuring new business offerings in response to these historically low interest rates. Nevertheless, we still retain some sensitivity to interest rate movements. Interest rate risk arises in our UK business from the need to match cash payments to meet annuity obligations with the cash we receive from our investments. To minimise the impact on our profit, we aim to match the duration (a measure of interest rate sensitivity) of assets and liabilities as closely as possible and the position is monitored regularly. Under the Solvency II regulatory regime, additional interest rate risk results from the way the balance sheet is constructed, such as the requirement for us to include a risk margin. The UK business continually assesses the need for any derivatives in managing its interest rate sensitivity. The with-profits business is exposed to interest rate risk because of underlying guarantees in some of its products. Such risk is largely borne by the with-profits fund itself but shareholder support may be required in extreme circumstances where the fund has insufficient resources to support the risk. In Asia, our exposure to interest rate risk arises from the guarantees of some non unit-linked investment products. This exposure exists because it may not be possible to hold assets which will provide cash payments to us which match exactly those payments we in turn need to make to policyholders – this is known as an asset and liability mismatch and although it is small and appropriately managed, it cannot be eliminated. Jackson is exposed to interest rate risk in its fixed, fixed index and variable annuity books. Movements in interest rates can impact on the cost of guarantees in these products, in particular the cost of guarantees may increase when interest rates fall. We actively monitor the level of sales of variable annuity products with guaranteed living benefits, and together with the risk limits we have in place this helps us to ensure that we are comfortable with the interest rate and market risks we incur as a result. The Jackson hedging programme in place includes hybrid derivatives to protect us from a combined fall in interest rates and equity markets since Jackson is exposed to the combination of these market movements. Foreign exchange risk (Audited) The geographical diversity of our businesses means that we have some exposure to the risk of exchange rate fluctuations. Our operations in the US and Asia, which represent a large proportion of our operating profit and shareholders’ funds, generally write policies and invest in assets in local currencies. Although this limits the effect of exchange rate 55 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Continued movements on local operating results, it can lead to fluctuations in our Group financial statements when results are reported in UK sterling. We retain revenues locally to support the growth of our business and capital is held in the local currency of the business to meet local regulatory and market requirements. We accept the foreign exchange risk this can produce when reporting our Group balance sheet and income statement. In cases where a surplus arises in an overseas operation which is to be used to support Group capital, or where a significant cash payment is due from an overseas subsidiary to the Group, this foreign exchange exposure is hedged where we believe it is economically favourable to do so. Generally, we do not have appetite for significant direct shareholder exposure to foreign exchange risks in currencies outside local territories, but we do have some controlled appetite for this on fee income and on non-sterling investments within the with-profits fund. Where foreign exchange risk arises outside our appetite, currency borrowings, swaps and other derivatives are used to manage our exposure. Credit risk We invest in bonds that provide a regular, fixed amount of interest income (fixed income assets) in order to match the payments we need to make to policyholders. We also enter into reinsurance and derivative contracts with third parties to mitigate various types of risk, as well as holding cash deposits at certain banks. As a result, we are exposed to credit risk and counterparty risk across our business. Credit risk is the potential for reduction in the value of our investments which results from the perceived level of risk of an investment issuer being unable to meet its obligations (defaulting). Counterparty risk is a type of credit risk and relates to the risk that the counterparty to any contract we enter into being unable to meet their obligations causing us to suffer loss. 56 We use a number of risk management tools to manage and mitigate this credit risk, including the following: — Our credit risk policy; — Risk appetite statements and limits that we have defined on issuers, counterparties and the average credit quality of the portfolio; — Collateral arrangements we have in place for derivative transactions; — The Group Credit Risk Committee’s oversight of credit and counterparty credit risk and sector and/or name- specific reviews. During 2016, it has conducted sector reviews in the banking (UK and Asia) and energy sectors; — Regular deep dive assessments; and — Close monitoring or restrictions on investments that may be of concern. Debt and loan portfolio (Audited) Our UK business is mainly exposed to credit risk on fixed income assets in the shareholder-backed portfolio. At 31 December 2016, this portfolio contained fixed income assets worth £38.6 billion. Credit risk arising from a further £55.2 billion of fixed income assets is largely borne by the with-profits fund, to which the shareholder is not directly exposed although under extreme circumstances shareholder support may be required if the fund is unable to meet payments as they fall due. The value of our debt portfolio in our Asia business was £36.5 billion at 31 December 2016. The majority (69 per cent) of the portfolio is in unit-linked and with-profits funds and so exposure of the shareholder to this component is minimal. The remaining 31 per cent of the debt portfolio is held to back the shareholder business. Shareholder exposure by rating Shareholder exposure by sector AAA AA A BBB BB or below or non-rated assets 7% 26% 35% 28% 4% Financial Government Real estate Utilities Consumer, non-cyclical Mortgage securities Industrial Energy Communications Consumer, cyclical Asset-backed securities Other 19.63% 18.71% 8.52% 8.34% 8.23% 3.85% 4.69% 4.41% 3.61% 2.56% 3.32% 14.13% Prudential plc Annual Report 2016 www.prudential.co.ukCredit risk also arises in the general account of the Jackson business, where £40.7 billion of fixed income assets are held to support shareholder liabilities including those from our fixed annuities, fixed index annuities and life insurance products. The shareholder-owned debt and loan portfolio of the Group’s asset management business of £2.3 billion as at 31 December 2016 mostly belongs to our Prudential Capital (PruCap) operations. Certain sectors have been under pressure during 2016, including the European banking sector. Most of the focus on the latter was around UK banks due to Brexit concerns, Italian banks and certain banks at risk of fines for the mis-selling of mortgage securities leading up to the 2008 financial crisis. We subject these sectors to ongoing monitoring and regular management information reporting to the Group’s risk committees. Certain sectors are also subject to our watch list and early warning indicator monitoring processes. Further details of the composition and quality of our debt portfolio, and exposure to loans, can be found in the IFRS financial statements. Group sovereign debt (Audited) We also invest in bonds issued by national governments, that are traditionally seen as safer investments. This sovereign debt represented 19 per cent or £17.1 billion of the shareholder debt portfolio as at 31 December 2016 (31 December 2015: 17 per cent or £12.8 billion). 4 per cent of this was rated AAA and 92 per cent was considered investment grade (31 December 2015: 94 per cent investment grade). At 31 December 2016, the Group’s shareholder holding in Eurozone sovereign debt1 was £767 million. 75 per cent of this was rated AAA (31 December 2015: 75 per cent rated AAA). We do not have any sovereign debt investments in Greece. The particular risks associated with holding sovereign debt are detailed further in our disclosures on risk factors. The exposures held by the shareholder- backed business and with-profits funds in sovereign debt securities at 31 December 2016 are given in Note C3.2(f) of the Group’s IFRS financial statements. Bank debt exposure and counterparty credit risk (Audited) Our exposure to banks is a key part of our core investment business, as well as being important for the hedging and other activities we undertake to manage our various financial risks. Given the importance of our relationship with our banks, exposure to the sector is a considered a key risk for the Group with an appropriate level of management information provided to the Group’s Risk Committees and the Board. Our risk management and mitigation of liquidity risk include: The exposures held by the shareholder- backed business and with-profits funds in bank debt securities at 31 December 2016 are given in Note C3.2(f) of the Group’s IFRS financial statements. Our exposure to derivative counterparty and reinsurance counterparty credit risk is managed using an array of risk management tools, including a comprehensive system of limits. Where appropriate, we reduce our exposure, buy credit protection or use additional collateral arrangements to manage our levels of counterparty credit risk. At December 2016, shareholder exposures by rating and sector are shown below: — 96 per cent of the shareholder portfolio is investment grade rated. In particular, 53 per cent of the portfolio is rated A- and above; and — The Group’s shareholder portfolio is well diversified: no individual sector makes up more than 10 per cent of the total portfolio (excluding the financial and sovereign sectors). Liquidity risk Our liquidity risk arises from the need to have sufficient liquid assets to meet policyholder and third-party payments as they fall due. This incorporates the risk arising from funds composed of illiquid assets and results from a mismatch between the liquidity profile of assets and liabilities. Liquidity risk may arise, for example, where external capital is unavailable at sustainable cost, increased liquid assets are required to be held as collateral under derivative transactions or redemption requests are made against Prudential issued illiquid funds. We have significant internal sources of liquidity, which are sufficient to meet all of our expected cash requirements for at least 12 months from the date the financial statements are approved, without having to resort to external sources of funding. In total, the Group has £2.6 billion of undrawn committed facilities that we can make use of, expiring in 2020. We have access to further liquidity by way of the debt capital markets, and also have in place an unlimited commercial paper programme and have maintained a consistent presence as an issuer in this market for the last decade. Liquidity uses and sources are assessed at a Group and business unit level under both base case and stressed assumptions. We calculate a Liquidity Coverage Ratio (LCR) under stress scenarios as one measure of our liquidity risk, and this ratio and the liquidity resources available to us are regularly monitored and are assessed to be sufficient. — Our liquidity risk policy; — The risk appetite statements, limits and triggers that we have in place; — The monitoring of liquidity risk we perform through regular management information to committees and the Board; — Our Liquidity Risk Management Plan, which includes details of the Group Liquidity Risk Framework as well as gap analysis of our liquidity risks and the adequacy of our available liquidity resources under normal and stressed conditions; — Regular stress testing; — Our established contingency plans and identified sources of liquidity; — Our ability to access the money and debt capital markets; — Regular deep dive assessments; and — The access we enjoy to external sources of finance through committed credit facilities. Risks from our products Insurance risk Insurance risk makes up a significant proportion of our overall risk exposure. The profitability of our businesses depends on a mix of factors including levels of, and trends in, mortality (policyholders dying), morbidity (policyholders becoming ill) and persistency (customers lapsing their policies), and increases in the costs of claims, including the level of medical expenses increases over and above price inflation (claim inflation). The key drivers of the Group’s insurance risks are persistency and morbidity risk in the Asia business; and longevity risk in the Jackson and Prudential UK & Europe businesses. We manage and mitigate our insurance risk using the following: — Our insurance and underwriting risk policies; — The risk appetite statements, limits and triggers we have in place; — Using longevity, morbidity and persistency assumptions that reflect recent experience and expectation of future trends, and industry data and expert judgement where appropriate; — We use reinsurance to mitigate longevity and morbidity risks; — Morbidity risk is also mitigated by appropriate underwriting when policies are issued and claims are received; 57 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Continued — Persistency risk is mitigated through the quality of sales processes and with initiatives to increase customer retention; — Medical expense inflation risk mitigated through product re-pricing; and — Regular deep dive assessments. Longevity risk is an important element of our insurance risks for which we need to hold a large amount of capital under Solvency II regulations. Longevity reinsurance is a key tool for us in managing our risk. The enhanced pensions freedoms introduced in the UK during 2015 greatly reduced the demand for retail annuities and further liberalisation is anticipated. Although we have scaled down our participation in the annuity market by reducing new business acquisition, given our significant annuity portfolio the assumptions we make about future rates of improvement in mortality rates remain key to the measurement of our insurance liabilities and to our assessment of any reinsurance transactions. We continue to conduct research into longevity risk using both experience from our annuity portfolio and industry data. Although the general consensus in recent years is that people are living longer, there is considerable volatility in year-on-year longevity experience, which is why we need expert judgement in setting our longevity basis. Our morbidity risk is mitigated by appropriate underwriting when policies are issued and claims are received. Our morbidity assumptions reflect our recent experience and expectation of future trends for each relevant line of business. In Asia, we write significant volumes of health protection business, and so a key assumption for us is the rate of medical inflation, which is often in excess of general price inflation. There is a risk that the expenses of medical treatment increase more than we expect, so the medical claim cost passed on to us is higher than anticipated. Medical expense inflation risk is best mitigated by retaining the right to re-price our products each year and by having suitable overall claim limits within our policies, either limits per type of claim or in total across a policy. 58 Our persistency assumptions similarly reflect a combination of recent past experience for each relevant line of business and expert judgement, especially where a lack of relevant and credible experience data exists. Any expected change in future persistency is also reflected in the assumption. Persistency risk is mitigated by appropriate training and sales processes and managed locally post-sale through regular experience monitoring and the identification of common characteristics of business with high lapse rates. Where appropriate, we make allowance for the relationship (either assumed or historically observed), between persistency and investment returns and account for the resulting additional risk. Modelling this dynamic policyholder behaviour is particularly important when assessing the likely take-up rate of options embedded within certain products. The effect of persistency on our financial results can vary but mostly depends on the value of the product features and market conditions. Risks from our business operations Operational risk Operational risk is the risk of loss (or unintended gain or profit) arising from inadequate or failed internal processes, personnel and systems, or from external events. This includes employee error, model error, system failures, fraud or some other event which disrupts business processes. We manage and mitigate our operational risk using the following: An important element of operational risk relates to compliance with changing regulatory requirements. The high rate of global regulatory change, in an already complex regulatory landscape, increases the risk of non-compliance due to a failure to identify, correctly interpret, implement and/or monitor regulations. Legislative developments over recent years, together with enhanced regulatory oversight and increased capability to issue sanctions, have resulted in a complex regulatory environment that may lead to breaches of varying magnitude if the Group’s business- as-usual operations are not compliant. As well as prudential regulation, we focus on conduct regulation, including regulations related to anti-money laundering, bribery and corruption, and sales practices. We have a particular focus on these regulations in newer/emerging markets. The performance of core activities places reliance on the IT infrastructure that supports day-to-day transaction processing. Our IT environment must also be secure and we must address an increasing cyber risk threat as our digital footprint increases – see separate Cyber risk section below. The risk that our IT infrastructure does not meet these requirements is a key area of focus, particularly the risk that legacy IT infrastructure supporting core activities/ processes affects business continuity or impacts on business growth. As well as the above, other key areas of focus within operational risk include: — The risk of a significant failure of a third-party outsourcing partner impacting critical services; — Operational risk and outsourcing and third-party supply policies; — The risk of trading or transaction errors having a material cost across Group; — Corporate insurance programmes to limit the impact of operational risks; — Scenario analysis for operational risk capital requirements, which focus on extreme, yet plausible, events; — Internal and external review of cyber security capability; and — Regular testing of elements of the disaster-recovery plan. — The risk that errors within models and user-developed applications used by the Group result in incorrect or inappropriate transactions being instructed; — Departure of key persons or teams resulting in disruption to current and planned business activities; — The risk that key people, processes and systems are unable to operate (thus impacting on the on-going operation of the business) due to a significant Prudential plc Annual Report 2016 www.prudential.co.ukunexpected external event; for example pandemic, terrorist attack, natural disaster, or political unrest; — The risk that a significant project fails or partially fails to meet its objectives, leading to financial loss; and — The risk of inadequate or inappropriate controls, governance structures or communication channels in place to support the desired culture and ensure that the business is managed in line with the core business values, within the established risk appetite and in alignment with external stakeholder expectations. Global regulatory and political risk Our risk management and mitigation of regulatory and political risk includes the following: — A Risk and Capital Plan that includes considerations of current strategies; — Close monitoring and assessment of our business environment and strategic risks; — Board strategy sessions that consider risk themes; — A Systemic Risk Management Plan that details the Group’s strategy and Risk Management Framework; and — A Recovery Plan covering corporate and risk governance for managing risks in a distressed environment, a range of recovery options, and scenarios to assess the effectiveness of these recovery options In June 2016, the UK voted to leave the EU. The potential outcome of the negotiations on UK withdrawal and any subsequent negotiations on trade and access to major trading markets, including the single EU market, is currently highly uncertain. The ongoing uncertainty and likelihood of a lengthy negotiation period may increase volatility in the markets where we operate, creating the potential for a general downturn in economic activity and for further or prolonged falls in interest rates in some jurisdictions due to easing of monetary policy and investor sentiment. We have several UK-domiciled operations, including Prudential UK and M&G, and these may be impacted by a UK withdrawal from the EU. However, our diversification by geography, currency, product and distribution should reduce some of the potential impact. Contingency plans were developed ahead of the referendum by business units and operations that may be immediately impacted by a vote to withdraw the UK from the EU, and these plans have been enacted since the referendum result. The EU’s Solvency II directive came into effect on 1 January 2016; however, the UK’s vote to leave the EU has the potential to result in changes to future applicability of the regime in the UK. In September 2016, following the Brexit vote, the UK Treasury published terms of reference of its consultation into Solvency II to consider the options for British insurers and to assess the impact of the regime on the competitiveness of the UK insurance industry, the needs of UK consumers and the wider UK business economy. The outcome is likely to be dependent on the overall Brexit agreement reached between the UK and EU. Separately, the European Commission has commenced a review of some elements of the application of the Solvency II legislation with a particular focus on the Solvency Capital Requirement calculated using the standard formula. National and regional efforts to curb systemic risk and promote financial stability are also underway in certain jurisdictions in which Prudential operates, including the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US, and other European Union legislation related to the financial services industry. There are a number of ongoing policy initiatives and regulatory developments that are having, and will continue to have, an impact on the way Prudential is supervised. These include addressing Financial Conduct Authority (FCA) reviews, ongoing engagement with the Prudential Regulation Authority (PRA), and the work of the Financial Stability Board (FSB) and standard-setting institutions such as the International Association of Insurance Supervisors (IAIS). Decisions taken by regulators, including those related to solvency requirements and capital allocation may have an impact on our business. The IAIS’s Global Systematically Important Insurers (G-SII) regime form additional compliance considerations for us. Groups designated as a G-SIIs are subject to additional regulatory requirements, including enhanced group-wide supervision, effective resolution planning, development of a Systemic Risk Management Plan, a Recovery Plan and a Liquidity Risk Management Plan. Prudential’s designation as a G-SII was reaffirmed by the IAIS in November 2016, based on the updated methodology published in June 2016. Prudential is monitoring the development and potential impact of the policy measures and is continuing to engage with the PRA on the implications of the policy measures and Prudential’s designation as a G-SII. We continue to engage with the IAIS on developments in capital requirements for groups with G-SII designation. The IAIS is also developing a Common Framework (ComFrame) which is focused on the supervision of Internationally Active Insurance Groups. ComFrame will establish a set of common principles and standards designed to assist regulators in addressing risks that arise from insurance groups with operations in multiple jurisdictions. As part of this, work is underway to develop a global Insurance Capital Standard that is intended to apply to Internationally Active Insurance Groups. Once the development of the Insurance Capital Standard (ICS) has been concluded, it is intended to replace the Basic Capital Requirement as the minimum group capital requirement for G-SIIs. A consultation on the ICS was concluded in 2016 and the IAIS intends to publish an interim version of ICS in 2017. Further field testing, consultations and private reporting to group-wide supervisors on the interim version of the ICS are expected over the coming years. It is currently planned to be adopted as part of ComFrame by the IAIS in late 2019. The IAIS’s Insurance Core Principles, which provide a globally-accepted framework for the supervision of the insurance sector and ComFrame evolution, are expected to create continued development in both prudential and conduct regulations over the next two to three years. In the US, the Department of Labor proposal in April 2016 to introduce new fiduciary obligations for distributors of investment products to holders of regulated accounts, which could dramatically reshape the distribution of retirement products. Jackson’s strong relationships with distributors, history of product innovation and efficient operations should help mitigate any impacts. The US National Association of Insurance Commissioners (NAIC) is currently conducting an industry consultation with the aim of reducing the complexity in the variable annuity statutory balance sheet and risk management. Following an industry quantitative impact study, changes have been proposed to the current framework; however, these are considered to be at an early stage of development. Jackson continues to be engaged in the consultation and testing process. The proposal is currently planned to be effective from 2018. With the new US administration having taken office in January 2017, the potential uncertainty as to the timetable and status of these key US reforms has increased given preliminary indications from Washington. Our preparations to manage the impact of these reforms will continue until further clarification is provided. 59 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportGroup Chief Risk Officer’s report of the risks facing our business and how these are managed – Penny James Continued In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. New requirements could be introduced in these and other regulatory regimes that challenge legal structures and current sales practices. Cyber risk Cyber risk is an area of increased scrutiny for global regulators after a number of recent high profile attacks and data losses. The growing maturity and industrialisation of cyber-criminal capability, together with an increasing level of understanding of complex financial transactions by criminal groups are two reasons why risks to the financial services industry are increasing. Given this, cyber security is seen as a key risk for the Group. Our current threat assessment is that, while we are not individually viewed as a compelling target for a direct cyber-attack, we are at risk of suffering attacks as a member of the global financial services industry, with potentially significant impact on business continuity, our customer relationship and our brand reputation. The Board receives periodic updates on cyber risk management throughout the year. The current Group-wide Cyber Risk Management Strategy and the associated Group-wide Coordinated Cyber Defence Plan were approved by the Board in 2016. The Cyber Risk Management Strategy includes three core objectives: to develop a comprehensive situational awareness of our business in cyberspace; to proactively engage cyber attackers to minimise harm to our business and to enable the business to grow confidently and safely in cyberspace. The Cyber Defence Plan consists of a number of work-streams, including developing our ability to deal with incidents; alignment with our digital transformation strategy; and increasing cyber oversight and assurance to the Board. Protecting our customers remains core to our business, and the successful delivery of the Cyber Defence Plan will reinforce our capabilities to continue doing so in cyberspace as we transition to a digital business. period. Such assumptions include foreign exchange rates, interest rates, economic growth rates and the impact on the business environment for events such as the exit of the United Kingdom from the European Union. Group functions work with each of the business units to address cyber risks locally within the national and regional context of each business, following the strategic direction laid out in the Cyber Risk Management Strategy and managed through the execution of the Cyber Defence Plan. The Group Information Security Committee, which consists of senior executives from each of the businesses and meets on a regular basis, governs the execution of the Cyber Defence Plan and reports on delivery and cyber risks to the Group Executive Risk Committee. Both committees also receive regular operational management information on the performance of controls. Viability statement In accordance with provision C.2.2 of the UK code, the Directors have assessed the prospects of the Company and the Group for a period longer than the 12 months required by the going concern statement. Period of assessment The Directors performed the assessment by reference to the three-year period to December 2019. Three years is considered an appropriate period as it represents the period covered by the detailed business plan that is prepared annually on a rolling three-year basis. In approving the business plan the Director’s review the Group’s projected performance with regards to profitability, cash generation and capital position, together with the parent company’s liquidity over this three-year period. As well as implementing the Group’s strategic objectives, this projection involves setting a number of economic and other assumptions that are inherently volatile over a much longer reporting Although three years is regarded as an appropriate period for the assessment of the Group’s viability, the Directors regularly consider strategic matters that may affect the longer-term prospects of the Group. Further, the Group as a whole and each of its life assurance operations are subject to extensive regulation and supervision, which are designed primarily to reinforce the company’s management of its long-term solvency, liquidity and viability to ensure that it can continue to meet obligations to policyholders. In particular, the Group and UK insurance subsidiaries are subject to the capital adequacy requirements of the European Union Solvency II regulatory basis as implemented by the Prudential Regulation Authority in the UK. Capital requirements for the Group’s other subsidiaries are also monitored on their local regulatory bases. In addition to these external capital metrics, the Group uses an internal economic capital assessment to monitor its capital requirements across the Group. Further details on the capital strength of the Group are provided on pages 47 and 48. Assessment of risks over the period Assessment of the risks to achieving the projected performance remains an integral part of the planning process. The Group’s risk teams identify key risks to the delivery of the plan and set out mitigating actions where applicable. The Group’s business activities and the factors likely to affect its future development, successful performance and position in the current economic climate are set out on pages 4 to 36. The risks facing the Group’s capital and liquidity positions and their sensitivities are referred to on pages 50 to 60. 60 Prudential plc Annual Report 2016 www.prudential.co.ukThe impact on the business of known areas of regulatory change whose financial implications can be reasonably quantified is also considered as part of the plan. As well as known areas of regulatory change the Group is exposed to the risk of sudden and unexpected changes in regulatory requirements at the Group and local level. The risk of regulatory change is mitigated by capital held by the Group and its subsidiaries in excess of Group and local regulatory requirements, the Group’s ability to generate significant capital annually through its operational delivery and the availability of compensating actions designed to restore key capital and solvency metrics. Conclusion on viability Based on this assessment, the Directors have a reasonable expectation that the Company and the Group will be able to continue in operation and meet their liabilities as they fall due over the three- year plan period to December 2019. For the purposes of assessing the Group’s viability, the Directors further considered those risks where the impact of possible adverse external developments could be of such speed and severity to present a shock to the Group’s financial position. The risks further considered, from those detailed on page 54, are: market risk, credit risk, liquidity risk and regulatory risk. To evaluate the Group’s resilience to significant deteriorations in market and credit conditions and other shock events, these risks are grouped together into severe but plausible scenarios which are then applied to the assumptions underlying the business plan. For example, the impacts of scenarios assuming a disorderly transition to a more normalised interest rate environment and an international recession were considered in the preparation of the most recent business plan, together with the impact on Group liquidity of a scenario assuming the closure of short-term debt markets for three months. In addition, the Group conducts an annual reverse stress test which gives the Directors an understanding of the maximum resilience of the Group to extremely severe adverse scenarios. In considering these scenarios the impacts of mitigating management actions designed to maintain or restore key capital, liquidity and solvency metrics to the Group’s approved risk appetite are considered. In the scenarios tested, sufficient actions were available to management to maintain the viability of the Group over the three year period under assessment. Penny James Group Chief Risk Officer Note 1 Excludes Group’s proportionate share in joint ventures and unit-linked assets and holdings of consolidated unit trust and similar funds. 61 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportBuilding stronger and more sustainable communities Through our Group-wide corporate responsibility programmes around the world, we help to build stronger and more sustainable communities, supporting our customers, our colleagues and the environment. This review gives an overview of our activities and progress in 2016. More detailed information is available online at www.prudential.co.uk/corporate-responsibility and in our first environment, social and governance (ESG) report to be published later in 2017. Performance highlights — £20 million total community investment — 83,284 hours volunteered by employees across the Prudential Group — £460,167 donated by employees through payroll giving across the Group It is in our customers’ and shareholders’ interests for Prudential to be a responsible business which invests in and gives back to our local communities, alongside the jobs, growth and tax revenue we provide. Paul Manduca Chairman 62 Serving our customers Prudential has been meeting people’s needs for 168 years and today provides long-term savings and protection products to around 24 million customers in markets on four continents, enabling them to look to the future with confidence. Asia In Asia, the demand for savings and protection products continues to grow as people seek greater financial security and peace of mind. We continue to broaden our offering to help meet the distinct individual needs of our customers. Prudential Hong Kong’s new Customer, Digital and Innovation Centre enables the business to embed customer insights into multiple business initiatives, including product, service and technology. The Centre is equipped with state-of-the-art focus group facilities, fully networked to allow for real-time user testing of our digital platforms. These include the myPrudential online portal where customers can manage their insurance policies, the PRUmobile app for on-the-go information and policy access, and the PRUone integrated sales and advisory platform. There is increasing customer awareness of the impact of lifestyle choices on their well-being in many markets across Asia and 2016 marked Prudential Hong Kong’s first time to offer customers access to an innovative DNA-based nutrigenomic test. The health and protection promotion campaign included access to a nutrigenomic test, ‘myDNA’, offering individual DNA-based insights into how genetics affects an individual’s nutrition needs, dietary sensitivity and well-being. The offer also provided online access to nutrition experts through a mobile app for personalised recommendations. Our customers can personalise their approach to diet and nutrition according to their unique genome in order to achieve their health goals. Prudential Singapore became the first insurer in Singapore to launch an online community portal for customers to share ideas and to provide direct feedback on products and services. Through Pru-for-you, regular dialogue with customers allows the business to better understand their needs and in turn, create an offering that is tailored to their financial and lifestyle requirements. US Prudential’s US operation, Jackson, provides retirement income strategies aimed at the 75 million baby boomers in the US. Jackson offers a diverse range of variable, fixed and fixed-index annuity products, designed with a variety of custom options to fit different financial goals. In 2016, Jackson launched Perspective Advisory, the company’s first fee-based variable annuity. Perspective Advisory offers the same investments and optional benefits, for an additional charge, as Perspective II®, Jackson’s flagship commission-based variable annuity. The introduction of the new product was designed to meet increased market demand for products compatible with fee-based accounts and platforms as a result of the 2016 US Department of Labor Fiduciary Rules. The addition of Perspective Advisory to Jackson’s suite of products also allows the business to expand into advisory distribution channels where insurance products historically have not been widely utilised. Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility review Rob’s story Chairman’s Challenge, Jakarta The first week of the 2016 Chairman’s Challenge saw more than 200 employees from Prudential Indonesia head to Taman Mataram in south Jakarta. Every Saturday for four weeks, the volunteers worked with Prestasi Junior Indonesia and the local community to regenerate an under-utilised park into a green community space incorporating fun activities and a financial education theme. Rob Gardiner, Management Advisor Prestasi Junior Indonesia said, ‘The 2016 Chairman’s Challenge was just what the name suggests – a very challenging undertaking. The initiative required both Prestasi Junior Indonesia and Prudential Indonesia to move outside of their “comfort zones” and combine financial literacy resources with the rejuvenation of the Taman Mataram city park. The end result was, however, beyond our expectations. The corporation has set exceptionally high standards in its efforts to improve the welfare of those within the communities in which it operates.’ Jackson is committed to providing education, service support and digital tools to increase the ease of doing business. The Center for Financial Insight is a resource designed to help investors and employees gain a better understanding of important financial and investing topics. The mission of the Center is to raise the overall level of financial education and confidence in the US by providing useful content framed in a way that is relevant, consumable and engaging for the modern customer. Since the re-launch of the site in July 2016, more than 70,000 unique visitors have visited the content on the Center, 55,000 of whom are new visitors to Jackson.com. In addition, the most viewed articles on the site are seeing average viewing times of up to five minutes, showing a sustained level of interest. UK and Europe Following reform of the UK’s pension and retirement income system in 2015 Prudential has continued to develop both products and processes to meet an evolving set of customer expectations and requirements that increasingly include having to manage and take responsibility for their own savings and the associated risks of longevity, inflation and investment. Most notably in 2016, we responded to changes in the market following the introduction of pension freedoms by launching the Prudential Retirement Account – an online account based plan that provides customers with the flexibility to save for their retirement, provide an income in retirement and facilitate access to their fund as they save. Our PruFund franchise provides a unique range of investment fund options for advisers and savers, across the risk spectrum. From ISA and bond, to pension and income drawdown, the range of six different funds continues to flourish, with assets under management reaching £24.7 billion in 2016. An important part of our service offering is the ongoing hands-on support for intermediary advisers from our regional sales units, technical helpline and business development and consultancy teams. In 2016, Prudential hosted a series of national seminars covering over 20 locations nationwide, and a structured WebEx programme covered a range of topical and technical subjects, to help these advisers deal with the changing regulatory landscape. Our financial planning business, Prudential Financial Planning, also grew significantly in 2016, increasing its number of advisers to 288. 63 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportA number of technology improvements were delivered in 2016, including the introduction of a fully flexible online application process for the popular Prudential ISA product. Additionally, improvements were made to the tele- underwriting service for the Prudential Investment Plan, reducing the amount of time advisers spend on administration and giving them more time with their clients. Prudential UK & Europe’s success in the Financial Adviser Service Awards continued in 2016, with the retention of the coveted Five Star ratings in the Life and Pensions and Investments categories for the sixth consecutive year. Prudential was the biggest winner at the Investment Life & Pensions MoneyFacts Awards in 2016, scooping the top awards for the Best Investment Service, Best Investment Bond Provider and Best Online Service, once again achieving incredible success at one of the most sought-after awards in our industry. Asset management M&G, Prudential’s UK and European asset management business, is a long-term investor that takes seriously its responsibilities as a steward of clients’ assets, often working closely with the management of the companies in which we invest. M&G’s investment teams incorporate environmental, social and governance (ESG) factors into investment analysis and decision-making processes, wherever they have a meaningful impact on risk or return: www.mandg.com/en/ corporate/about-mg/responsible- investment/ Active voting is an integral part of the investment approach, both adding value and protecting our interests as shareholders. The M&G website provides an overview of voting history: www. mandg.com/en/corporate/about-mg/ investment-philosophy/voting-history/ Reflecting this approach, M&G is a signatory to the UN Principles for Responsible Investment (UNPRI), an international network of investors working together to promote responsible investment practices. 64 M&G provides market insights to clients, intermediaries and direct investors through a number of channels, including a programme of roadshows and events and multiple digital platforms. To better reflect the diversity of our customer base, during 2016 we significantly increased the size of our M&G Client Council, the panel of our direct investors that helps us design products, services and communications to better meet their needs. Members of our Client Council played a key role in the early stage of product concept testing for our two newest retail funds: the M&G Absolute Return Bond Fund and the M&G Global Target Return Fund, which we launched just before the end of the year. Supporting local communities The inherent long-term social value of our business is complemented by investments in communities in each of the markets in which we operate. We provide support to charitable organisations through both funding and the experience and expertise of our employees. Our investments in communities are designed to support the communities in which we operate and deepen engagement with colleagues. As such, our community investment programme is linked to our strategy and is focused around four principal areas: — Social inclusion; — Education and life skills; — Disaster preparedness; and — Employee engagement. 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. Education and life skills Cha-Ching – the first global financial education programme We have a long-standing commitment to financial literacy and Cha-Ching is our flagship financial education programme. Launched in Asia in partnership with the Cartoon Network in 2011, it is a multi- media programme built around three- minute animated music videos aimed at children aged seven to 12. Developed with Cartoon Network and Dr Alice Wilder, an award-winning children’s education specialist, the programme helps children learn the fundamental money management concepts of earn, save, spend and donate. The programme has gained international recognition for promoting financial literacy and has won several industry awards. Over the past few years it has grown to become one of the top-rated children’s television programmes in Asia. Cha-Ching is now available in 10 languages and reaches 54.3 million households a day across Asia through the Cartoon Network. The Cha-Ching School Contact Programme brings Cha-Ching directly to schoolchildren across Asia and has reached more than 200,000 schoolchildren in nine Asian countries to date. Now a Group-wide programme, Cha- Ching has been launched in Poland, the US, the UK and Africa. In the US, Jackson plans to distribute Cha-Ching with national educational partners and via social media to increase financial literacy with youth. In addition, partnering with Junior Achievement USA, Jackson plans to distribute a five-week teaching curriculum using the Cha-Ching topics and characters to help students engage with personal finance topics. In the UK work will continue to roll out the Cha-Ching education website, which provides teachers with financial education resources built around the animated music videos, with supporting lesson plans and teacher’s guidance designed to improve the financial capability of Key Stage 2 pupils. The online educational resource will also support expansion across our African markets. First Read – developing children’s skills The Prudence Foundation has funded and supported the First Read programme since 2013, partnering with Save the Children to focus on investing in early childhood care and development in Cambodia and the Philippines. First Read is a unique programme that helps parents to develop their children’s numeracy and literacy skills by providing books in the local language or dialect, and encouraging them to read, sing Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility reviewContinuedandcounttogether.Italsohelpsparents understandtheimportanceofhealthyand nutritiousfoodforchildren’sdevelopment. Overthelastthreeyearsofthepartnership, over220,000childrenandadultshave benefiteddirectlyandover483,000 communitymembersindirectly.In2017, thepartnershipwillcontinuewithSavethe Children,withaparticularaimtoconduct long-termresearchanduseevidenceof FirstRead’simpacttoadvocatefor replicationandgreaterscaleatthe nationallevel. Teen Zone at the Boys & Girls Club InSeptember2016,theBoys&GirlsClub ofLansingopenedtheJacksonTeenZone. Thisrenovationand4,680-square-foot expansionwasfundedbysupportfromthe businessandindividualemployees.The newJacksonTeenZoneallowedtheBoys& GirlsClubtorepurposethepreviousTeen Roomsintoinnovativetutoringand educationalspaces,providingmuch- neededquietspaceforhomework,college prepandfinancialliteracysupport.The Boys&GirlsClubofLansingannually servesmorethan5,200at-riskyouths, agedsevento18. Supporting young people with employability and financial skills in London IntheUK,oneofthecoreareasoffocusis ensuringthatyoungpeoplehavethe employabilityandfinancialskillstheyneed togetoninlife.PrudentialUK&Europe hasbeendirectlyinvolvedinbuildingthe knowledgeandskillsofyoungpeople throughthreesecondaryschool partnershipsinPaddington,Readingand Stirling.DeliveredaspartofBusinessinthe Community’sBusinessClassandthe ScottishGovernment’sDevelopingthe YoungWorkforceprogrammes,the partnershipshavesupportedover3,550 youngpeoplesince2013,with336 employeesgivingtheirtimeandsharing theirknowledgeandskills.Prudential’s partnershipwithMyBnk,whichdelivers financialliteracyprogrammesinsecondary schoolsinLondon,helpsdevelopmoney skillsfor5,000youngpeopleeveryyearin deprivedareasofthecapital. Learning with Magic Bus in India InIndia,PrudentialUK&Europe’s employeesworkinpartnershipwithMagic Bus,whichprovideschildrenfrom marginalisedcommunitieswith opportunitiesforlearning,leadingand earningthroughasport-focusedactivity curriculum,mentorshipandemployability programmes.Thisyearthebusinessin Mumbaihelped1,826studentsinrural areastakemoreinterestandgainmoreby introducingamechanismforlearningby seeinganddoingratherthanjustlearning frombooks. Secondary school scholarships across Africa InournewmarketsinAfricawehave committedtoprovidesupportfor academicallyablebutfinancially disadvantagedhighschoolstudents,and tohelpbuildcapacityfortrainingin actuarialsciencesatlocaluniversities. Prudentialhasworkedwithanumberof charitiesoperatinginGhana,Kenya, UgandaandZambiabyfunding educationalprogrammesandprojects since2014.Theseprogrammeshave focusedonallowingvulnerablechildrenin thesecountriestoaccessquality education,throughtheprovisionof scholarshipawards. Disaster readiness and relief Regional commitment to disaster preparedness with Safe Steps Asalifeinsuranceandassetmanagement company,ourcorebusinessistheprovision ofprotection,securityandriskmitigationto individualsandfamilies.Wefocuson disasterreliefandpreparednessinourAsia markets,asAsiaPacificistheworld’smost disaster-proneregion.Prudence FoundationisworkingwithNGOsand governmentstohelpcommunitiesbetter prepareforsuchdisastersbeforethey strike,aswellasprovidingsupportattimes ofemergencyresponseandrecovery. SafeStepsNationalDisasterswaslaunched in2014,andisafirst-of-its-kindpan-Asian publicserviceinitiativetoenhancedisaster preparednessandawarenessthroughthe disseminationofeducationalsurvivaltips fornaturaldisasters.Itisamulti-platform programmeincludingon-airvideo messages,aninformativewebsiteand educationalcollateralthatcanbeshared amongcommunities.Coretothe programmeisaseriesof60-second educationalvideosthatadviseindividuals andhouseholdsonwhattheyshoulddo 0 2 S t r a t e g i c r e p o r t Amy’s story PrudentialSkillsforLifeprogramme InpartnershipwiththeTransformationTrust,anationaleducation charity,staffvolunteersforthePrudentialSkillsforLifeprogramme providedmentoringsupporttodisadvantagedyoungpeopleaged 16to17astheypreparedtomoveintofurthereducationorthe worldofwork.Thevolunteerssharedtheirskillsandexpertiseon topicsincludingCVwriting,bodylanguage,communicationand preparingforaninterview. AmyBrocklehurst,DirectorofGroupStrategyandCorporate DevelopmentatPrudentialsaid‘TheTransformationTrustisa fantasticcharitygivingrealopportunitiestodisadvantagedyoung peopleasdemonstratedbythePrudentialSkillsforLife programme.Thestudentswerearealinspirationanditwas fantastictoseethemgrowinconfidence’. Studentsdescribedhowthesupporthashelpedthempreparefor furthereducationandtheworkplace,andaccordingtothe TransformationTrust,86percentofstudentsfelttheprogramme helpedpreparethembetterforlifeaftersixthform. www.prudential.co.uk AnnualReport2016 Prudential plc 65 when disasters strike. In 2015, Prudence Foundation launched its second Safe Steps programme, Safe Steps Road Safety, in partnership with National Geographic Channel and the Fédération Internationale de L’Automobile and endorsed by the International Federation of the Red Cross. The programme has been well received and a number of partnerships across Asia have spread the campaign, including free-to-air channels, radio stations and cinema. Through these partnerships, Safe Steps currently has a potential reach of 200 million people a day in Asia. Safe Schools programme Prudence Foundation continues its support of the Safe Schools programme, partnering with Plan International and Save the Children in Cambodia, Indonesia, the Philippines, Thailand and Vietnam. The programme focuses on capacity-building for students, teachers and local community members on disaster preparedness, placing schools at the heart of building a culture of disaster preparedness within communities. The programme trains students and their teachers in key disaster management skills and supporting the organisation of disaster simulations and evacuation drills for students and their community. Since 2013, more than 70,000 students and 18,000 teachers have participated. In 2017, the Prudence Foundation will continue to support this programme and explore further partnerships to increase its scale. Volunteering to build disaster- resilient homes Prudence Foundation continues to provide support to major emergency relief efforts across the region. In 2016, support was provided in Cambodia to emergency drought response efforts. The long-term commitment of the business to the Typhoon Haiyan recovery efforts in Bantayan Island was demonstrated by sending a team of volunteers to continue the building of new houses for the community. The first 64 houses have been completed and families have now moved in. Around 80 volunteers in June supported the construction of the final 62 houses, which were due to be completed by the end of the first quarter in 2017. In September, over 50 regional volunteers 66 spent time in Vietnam to support the construction of a new school in Quang Binh province. This formed part of Prudential Vietnam’s partnership with Plan International and the Vietnamese government, which are collaborating together to build new disaster-resilient schools in poor regions throughout the country. Emergency fund relief Prudential has also been a Group-level supporter of Save the Children since 2010 and is one of the Children’s Emergency Fund’s major supporters. This allows us to act swiftly when disasters occur in any of our markets and provides an instant, effective fundraising mechanism for employees when needed. In 2016 more than 98 allocations from the Fund were made to more than 46 countries and we will continue to support this partnership in 2017. Social inclusion Prudential RideLondon – social inclusion in the UK In the past four years Prudential RideLondon has raised £41 million for charity and become one of the UK’s largest fundraising events. In 2016 alone, more than 740 charities benefited from riders’ fundraising. We have renewed our sponsorship for a further three years to 2018. As title sponsor, in 2016 we partnered with three charities – Teach First, Greenhouse Sports and the Invictus Games Foundation – to provide aspirational challenges for 62 young people and injured service personnel tackling Prudential RideLondon for the first time. We provided support including bikes, equipment and training as well as employability and coaching workshops. Over £500,000 was raised as a result of fundraising from Prudential rider places by our charity partners and our employees. Prudential RideLondon has inspired many to take control of their health and well- being. A BBC2 documentary called Fixing Dad featured Geoff Whitington, who was encouraged and supported by his sons to regain his health and reverse his Type 2 diabetes through significant changes to his diet and lifestyle, including taking on the challenge of riding the Prudential RideLondon-Surrey 100. The Fixing Challenge will continue in 2017. We are developing a new Prudential RideLondon programme for 2017 in partnership with Teach First, which will use the event as a focal point to promote inclusion and help eradicate educational inequality. The new PruGOals programme will have national reach, working with more than 15 schools with an increased focus on well-being and mental health. Employee fundraising Jackson employees are actively engaged in our commitment to communities by taking part in programmes such as the Jackson National Community Fund Advisory Committee and the employee-nominated matching programme. The Jackson National Community Fund supports charities that help the elderly and children through quarterly grants in communities where Jackson’s four largest offices are located. Jackson’s matching programme offers a two-to-one match on all employee donations made to approved charities. This programme ensures that causes important to employees are given charitable consideration and that Jackson’s support is received by responsible organisations where funding will create a significant impact. The elderly in the community Prudential UK is a long-standing partner of Age UK, working to make a difference to the lives of the elderly. Building on the successful Planning for Later Life programme the business has launched a new programme – Later Life Links. This is focused on supporting older people in six communities across the UK to become more involved in their communities, through the provision of long-term companionship, advice and practical support. Apprenticeships in the UK Youth unemployment is a huge social challenge. As one of the most respected brands in the UK, Prudential is taking a major role in helping to shape future job prospects for young people. Over the past three years we have recruited 178 young people to our apprenticeship programme, providing them with important work and Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility reviewContinuedJackline’s story Prudential Scholarship programme, Kenya Jackline is the sixth of eight siblings. She lives in rural Oloitokitok, and is the first child in her family to go to school, which is something she is very proud of. She was fortunate to attend primary school, as Masai children are normally expected to take on herding and childcare responsibilities, but did not anticipate that it would be possible for her to continue her education, as her mother is the sole provider for the whole family. Through the Prudential Scholarship programme with the Kenya Education Fund, Jackline now attends St. Clare Girls’ High School, where she has taken a keen interest in civil engineering and wants to continue her studies so that she is able to support her community and country by advancing infrastructure. ‘My friend Beatrice was married when she finished class eight because her parents did not have the money for fees and she now has a child. I know I was also very close to sharing the same story. That is why words can’t possibly explain how grateful I am to Prudential, because now I know my dreams will come to life.’ life skills and starting them on the first step of their careers. Support for disadvantaged communities M&G continues to care for and enable disadvantaged communities near to its offices and during 2016 more than 200 charities received support either by donation or as a result of employee volunteering. In 2016, M&G held its first City Giving Week, an onsite event which each day showcased and highlighted the services provided by charities that had received support. The Lord Mayor of the City of London attended M&G’s event as part of his initiative to promote the varied charitable activities undertaken by City businesses. Colleague engagement Successful volunteering programme – Chairman’s Challenge Many of our employees play an active role in their communities through volunteering, charitable donations and fundraising. In the UK, the US and Asia we offer our employees the opportunity to support charities through payroll giving. Chairman’s Challenge is our flagship international volunteering programme, bringing together people from across the Group to help in their communities. Colleagues from across the Group give their time and skills to support our global charity partners, including Plan International, Help Age International and Junior Achievement. The programme continues to appeal to colleagues, with the number of volunteers signing up increasing year-on-year. From its launch in 2006, when 2,603 employees signed up, volunteer numbers have increased by 208 per cent. Last year, 8,011 colleagues around the world took part, volunteering over 27,000 hours to support 30 projects, benefiting over 92,000 individuals across the world. Each volunteering project focuses on one or more of our CR priorities and allows us to support both large, well established charities and innovative, smaller-scale activities with volunteers as well as financial support. Prudential donates £150 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 are involved in the voting process to decide on the most innovative projects, which receive extra funding towards their charitable objectives. Volunteering across the Group As well as volunteering efforts on behalf of the Chairman’s Challenge, employees around the Group volunteered on a huge range of other charitable projects, from providing relief following disasters to mentoring schoolchildren, supporting the elderly and skills-sharing. In 2016, employees across the Group volunteered in their communities on a range of projects, providing a total of 83,284 hours of volunteering, up from 51,979 hours in 2015. This includes the Chairman’s Challenge hours. We recognise that employee volunteering brings benefit not only to the charities but also to the development of our people, and we actively encourage colleagues to participate in our programmes. Charitable donations We calculate our community investment spend using the internationally recognised London Benchmarking Group (LBG) standard. This includes cash donations to registered charitable organisations, as well as a cash equivalent for in-kind contributions. In 2016, the Group spent £20 million supporting community activities. The direct cash donations to charitable organisations amounted to £16 million, of which approximately £5 million came from our UK and EU operations, which are principally our UK insurance operation and M&G. The remaining £11 million was contributed to charitable organisations by Jackson National Life Insurance Company, Prudential Corporation Asia and Prudential Africa. The cash contribution to charitable organisations from our UK and EU operations is broken down as follows: education £2,667,000; social, welfare and environment £2,036,000; cultural £142,000; and staff volunteering £88,000. The balance includes in-kind donations and is prepared in accordance with LBG guidelines. This included more than 10,675 67 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportemployees (including 8,011 who volunteered for the Chairman’s Challenge) who dedicated more than 83,284 hours of volunteer service in their communities. Furthermore, over £460,000 was donated across the Group by our employees through our payroll giving scheme. Political donations It is the Group’s policy neither to make donations to political parties nor to incur political expenditure, within the meaning of those expressions as defined in the UK Political Parties, Elections and Referendums Act 2000. The Group did not make any such donations or incur any such expenditure in 2016. Valuing our people At Prudential we encourage an inclusive working environment where we develop our talent, reward great performance and recognise our differences in order to continue to deliver outstanding results for our customers, shareholders and communities. This is achieved through our continued focus on diversity and inclusion, talent development and performance and reward. Diversity and inclusion Prudential believes that diversity of experience, thought and background is vital to success, both today and in the future. The Board has therefore decided to make diversity and inclusion one of the strategic objectives for Prudential and appointed Penny James, Group Chief Risk Officer, to act as executive sponsor for diversity and inclusion. Our policies and plans support an inclusive culture sensitive to the needs of all employees. We protect all our employees against discrimination and provide opportunities for our people regardless of their age, caring responsibilities, disability status, ethnicity, gender, religion or sexual orientation. We make appropriate disability adjustments as required, and provide training and career development opportunities for all. We give full and fair consideration and encouragement to all applicants with suitable aptitude and abilities. We aim to foster a working environment where individuals are empowered and differences recognised. We aspire that over time our senior management better represents the experiences and background of our customers and stakeholders. The Board monitors progress on diversity and inclusion through quarterly updates and the annual talent review process. We have a strategic, long-term approach to diversity and inclusion at Group level and in each business unit and we invest in targeted activity across 10 priority areas ranging from diversity and inclusion- focused development through support for various affinity groups, including, among others, ethnicity/nationality, gender, LGBT, disability, age, social mobility, parenting and care. Across our businesses, our commitment to diversity and inclusion is supported by initiatives such as reviews of pay and performance management consistency, providing training to staff and engaging with recruitment firms to mitigate unconscious bias, and awareness campaigns to diversify the pool of potential candidates. For example, in 2016, PCA rolled out the PRU+YOU programme to help colleagues to achieve personal well-being goals and promote family-friendly practices. Our North America business has expanded the existing College Relations initiative with the addition of partnerships with Morehouse College, Spelman College and Clark Atlanta University in order to support diversity of ethnicity at entry level. The apprenticeship programme offered within our UK insurance business continued to demonstrate its success and has recruited its fourth cohort. M&G further improved the nationality, academic and social diversity of its graduate schemes and for the first time ensured 50 per cent women on investments schemes. Group Head Office has increased its focus on gender diversity through development of talented women, with 46 per cent female participation in available talent programmes. Africa’s scholarship programme has supported the education of 628 children in Ghana and Kenya. We have further developed affinity networks: M&G Pride for LGBT employees and allies, and the UK-based Prudential Women’s Network. As part of our broad diversity and inclusion agenda, we have publicly committed to having at least 30 per cent of women in senior management by the end of 2021 and we have signed the HM Treasury Women in Finance Charter. As an important step in this direction, we aim to achieve 27 per cent female representation in senior management by the end of 2019. Gender diversity within the senior leadership 76% 83% Male Female 2016 2016 24% 2012 2012 17% 68 68 Prudential plc Annual Report 2016 www.prudential.co.uk Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility reviewContinuedHeadcount Notes Total Male Female Chairman and Independent Non-executive Directors Executive Directors Group Executive Committee (GEC) Includes Executive Directors Senior managers Excludes the Chairman, all Directors and GEC members 9 7 13 93 Whole company 1 Includes the Chairman, all Directors and GEC 23,673 members = = = = = 7 5 11 71 2 2 2 22 11,139 12,534 1 Excludes PCA joint ventures. We believe in supporting human rights and acting responsibly and with integrity. Our 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 into our Group Code of Business Conduct, which sets out the Group values and expected standards of behaviour for all employees, and in our Group Outsourcing and Third Party Supply Policy. Talent development People development is essential to deliver our strategy. The quality of leadership across the Group is fundamental to the future growth and success of the business and we therefore review our talent annually, and offer a range of programmes that enable our people to continue to grow and develop. The majority of our programmes are managed by our business units, while Group Human Resources focuses on tailored programmes for senior leaders across the organisation, succession planning for senior roles and development of our leadership talent pipeline. We invest in succession planning for our leaders and critical specialists, and segment our talent to identify short-, medium- and long-term successors. We support them with the appropriate development and career planning, to ensure that we maintain an appropriate balance of internal progression and external hires. Individually tailored development offerings are provided for our most senior executives so they are well prepared to deliver the long-term ambitions of the Group. In 2016, more than 143 senior high-potential individuals participated in our Group-wide leadership development programmes ‘Impact’ and ‘Agility’. These programmes have been developed in partnership and co-delivered with world-leading academic institutions. Within our businesses there are many examples of our continuing commitment to talent development. Prudential Corporation Asia develops CEOs with programmes such as cross-company experience, which are continually reviewed, incorporating new thinking and future capabilities as required. In the US, Jackson University provides a highly customisable approach for associates’ personal development and professional learning; and Prudential UK provides a fully differentiated management development offering, distinguishing the requirements of aspiring managers and experienced leaders. M&G Real Estate supports career development through a fund manager job-shadowing programme; and Group Head Office provides innovative programmes designed in partnership with top academic institutions, which offer leadership development and the opportunity to gain valuable experience through relevant business projects. Employee engagement An array of initiatives are in place within our different businesses to drive employee engagement. Depending on the business this engagement can start as soon as a new employee joins us, with an induction programme to learn about the history and strategy of the Group. Throughout the employee’s career, additional opportunities may include being offered a number of high impact training sessions as well as workshops on resilience, managing energy and enhancing productivity. Each of our businesses manages its own intranet, providing all employees with access to regular updates, articles and internal and external news items relevant to the business and its geographical location. Each intranet also gets updated with material news from across the Group. Some of our businesses hold regular employee open-forums with senior management, conduct yearly engagement surveys or organise away-days to discuss the business, our performance and internal management. Any highlighted issues are then used to improve the way in which we work. In addition, there are informal opportunities to meet senior managers and facilities to network with both peers and senior leaders across functions; and well-being programmes to support sustainable high performance. We also have policies to encourage and support volunteering for charitable causes. The success of our efforts has again been recognised internally and externally. In addition, our businesses in the UK have a long-standing relationship with the union Unite. We encourage volunteering through which our employees can support our communities and acquire new skills. See page 67 for further details. Performance and reward Our reward packages are designed to attract, motivate and retain high-calibre people across all levels. Each individual contributes to the success of the Group and should be rewarded accordingly. We recognise and reward high performance while operating a fair and transparent system of reward. Reward is linked to the delivery of business goals and expected behaviours and we ensure that rewards for our people are consistent with our values and do not incentivise inappropriate risk taking. To enable this, employees are not only regularly assessed on ‘what’ they have achieved, but also on ‘how’ they did so. There are recognition initiatives running across our businesses, such as the Prudential Stars awards at Group Head Office, which are made to individuals nominated by their colleagues for outstanding examples of execution, impact and engagement. We also believe in the importance of giving employees the opportunity to benefit from the Group’s success through share ownership, and operate employee share plans for employees in the UK and Asia. This includes PruSharePlus, which enables employees in Asia to share in the longer- term success of the business, and actively encourages share ownership and engagement. Protecting the environment We carefully monitor our environmental impact and the management of environmental issues is an integral part of managing the total risks faced by our business. We have processes in place to measure and report on our global greenhouse gas (GHG) emissions, together with waste and water data for the 12 months, October through to September. In 2016, we increased our absolute GHG emissions from our occupied estate and company- owned vehicles by 1 per cent to 72,568 TCO2-e (2015: 71, 704 TCO2-e). The 69 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic reportincrease was driven by growth in our business and increased data centre activity. When normalised against net lettable floor area, our GHG emissions efficiency metric improved by 7 per cent to 123 kgCO2-e/m2 in 2016 (2015: 132 kgCO2-e/m2) and 12 per cent over the past three years (2013: 139 kgCO2-e/m2) driven through our energy efficiency efforts focusing on the larger properties in the portfolio. This data refers to Scope 1 and 2 only. We continue to deploy energy management strategies across our business. A new 100 per cent renewable energy contract for electricity purchased for our UK occupied property estate was introduced during the year, replacing an earlier low carbon energy contract. Our US business increased the Energy Star performance score for its Corporate Head Office in Lansing by 80 per cent over the year, placing it in the top 20 per cent of its type in the country https://www. energystar.gov/buildings/about-us following an earlier energy efficient re-fit. In Asia, we delivered our first LEED Gold certified refurbishment for our One Island East offices in Hong Kong through LED lighting, daylight sensors, energy and water-efficient appliances and a green ‘living’ wall in reception. We maintained our sector positioning in key benchmarks, including the Carbon Disclosure Project, with a B rating in 2016 (level with our peers), and ClimateWise, the insurance sector climate initiative managed by the Cambridge Institute for Sustainability Leadership, maintaining our position of ninth out of 19 participants www.cisl.cam.ac.uk/business-action/ sustainable-finance/climatewise. Our performance in ClimateWise against six core principles is independently audited. M&G Real Estate forms part of the M&G group of companies, the asset management arm of Prudential plc in the UK and Europe. Its approach to responsible property investment enables it to manage and respond to the growing range of environmental and social issues that can impact property values. It also helps M&G Real Estate to protect and enhance fund and asset performance for its clients. Responsible property investment is integrated within M&G Real Estate’s day-to-day investment practices. Carbon emissions from the investment portfolio of M&G Real Estate have halved over the past four years. It has achieved six Green Stars (2015: four Green Stars) in the 2016 Global Real Estate Sustainability Benchmark survey out of eight participating funds. M&G Real Estate’s progress can be found in its annual Responsible Property Investment report at www.mandg.co.uk/ institutions/realestate/responsible- investing/ We expect continued developments on environmental factors in the years ahead, including increasing disclosure of climate-related risks and opportunities for financial companies. The work of the Financial Stability Board in particular could be a major development in the transition to a low-carbon economy, with its guidance on strategy, risk management, metrics and reporting on climate risks www.fsb.org/2016/12/fsb-welcomes- task-force-consultation-on- recommendations-for-climate-change- disclosure/ Michele’s story Jackson, US Michele Fedewa, Jackson’s Strategic Support programme manager, has championed the adoption of recycling and composting programmes as part of Jackson Smartcycle in its Lansing offices. ‘There has been a tremendous amount of interest for more recycling options in the office. The business sent approximately 1,138,000lbs of refuse in Lansing to landfill in 2015 and the aim of this new programme is to reduce waste sent to the landfill to zero. Many of our associates are students at Michigan State University and already recycle on campus. I’ve had numerous employees reach out to me with ideas and questions about how we can make more of a difference environmentally. We’re thrilled to support this programme and see it make an impact on reducing our carbon footprint.’ 70 Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility reviewContinuedPrudential plc greenhouse gas emissions statement We have compiled our greenhouse gas emissions data in accordance with the Companies Act 2006 (Strategic and Directors’ Reports) Regulations 2013. We have included full reporting for Scope 1 (direct emissions such as combustion of gas for heating fugitive emissions and emissions from owned vehicles) and Scope 21 (indirect emissions for consumption of electricity, heat or steam) emissions where operational control of the emissions of the sources concerned was demonstrated. We have also reported on a number of Scope 3 emissions as a matter of best practice. These are emissions arising as a consequence of the activities of the company, but occur from sources not owned or controlled by the company. For the purpose of 2016 report, these Scope 3 emissions include: business travel booked from the UK, global water consumption (occupied and investment properties) and waste. The waste reporting covers, all investment properties with operational control, UK and US occupied properties. We do not currently collect waste data for our occupied buildings in Asia and continental Europe. We are continuously working with our business units to review the extent of our Scope 3 reporting and increase where practicable. Assessment parameters Baseline year: 1 October 2014 to 30 September 2015 Reporting year: 1 October 2015 to 30 September 2016 Assurance Deloitte LLP has provided limited assurance over selected environmental metrics in accordance with the International Auditing and Assurance Standards Board’s (ISAE3000 (Revised)) international standard. www.prudential.co.uk/responsibility/performance/external-assurance-of-responsibility- reporting Consolidation approach Operational control. Boundary summary All entities and all facilities under operational control (including those owned) are included. Consistency with the financial statements The reporting period (1 October 2015 to 30 September 2016) does not correspond with the Directors’ Report period (1 January 2016 to 31 December 2016). The reporting period was brought forward by three months to improve the availability of invoice data (which often lags by one month or more after the usage period) and reduce the reliance on estimated data. Prudential owns assets, which are held on its balance sheet in the financial statements, over which it does not have operational control. These are excluded from the data below. Assets not included on the balance sheet but held under an operating lease and where we have operational control are included. Emission factor data source We have used the UK DEFRA 2016 GHG Conversion Factors for Scope 1 and 3 reporting and the IEA GHG 2016 conversion factors for global Scope 2 reporting. Assessment methodology The Greenhouse Gas Protocol Corporate Accounting and Reporting Standard 2004. In 2016 Prudential reviewed its reporting methodology for Scope 2 (electricity) emissions in recognition of the release of the revised GHG Protocol Scope 2 Guidance that requires both location and market-based reporting. As the Group operates in a number of mature and emerging markets, the availability of market-based factors that met the necessary quality criteria was deemed insufficient for reporting, and as such our 2016 reporting continues to use the location-based factors already available. Materiality threshold 5 per cent. Intensity ratio Kilograms of Carbon Dioxide Equivalent per metre squared (net lettable area). Note 1 This is calculated using location-based methodology (GHG protocol). 71 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic report Emissions source Scope 1 (tonnes CO2-e) Scope 2 (tonnes CO2-e) Scope 1 and Scope 2 (tonnes CO2-e) Occupied Estate Investments Occupied Estate Investments Occupied Estate Investments 2016 10,155 7,559 62,413 20,973 72,568 28,532 2015 8,409 8,845 62,695 28,691 71,104 37,536 2014 8,486 10,044 61,550 39,573 70,036 49,617 2013 6,019 13,062 65,730 42,079 71,749 55,141 Total Scope 1 and 2 (tonnes CO2-e) 101,100 108,640 119,653 126,890 Normalised Scope 1 and 2 (kg CO2-e/sq.m)1 Occupied Estate Investments Total Scope 1 and 2 (kg CO2-e/sq.m) 123 14 38 132 18 42 135 13 28 Scope 3 (tonnes CO2-e) Occupied Estate Investments 11,253 386 13,664 418 10,069 387 139 15 31 9,583 840 Total Scope 3 (tonnes CO2-e) 11,639 14,082 10,456 10,423 Total Scope 1, 2 and 3 (tonnes CO2-e) Occupied Estate Investments 83,821 28,918 84,768 37,954 80,105 50,004 81,332 55,981 Total Scope 1,2 and 3 (tonnes CO2-e) 112,739 122,722 130,109 137,313 Normalised Scope 1, 2 and 3 (kg CO2-e/sq.m) Occupied Estate Investments Total Scope 1, 2 and 3 (kg CO2-e/sq.m)1 142 14 43 157 18 47 154 13 30 157 16 33 Note 1 Comparative 2015 data for normalised emissions have been restated due to a methodology change for accounting for floor area. Please refer to the Basis of reporting at www.prudential.co.uk/responsibility/performance/greenhouse-gas-emissions for further detail. Due to the changing size and nature of the investment portfolio, absolute and normalised comparisons between years are not comparative. Net lettable area is reported for all properties held within the reporting period. In line with best practice, environmental data is collected for properties at acquisition and at date of divestment therefore comparisons for absolute change and normalised change are not directly comparative. 72 Prudential plc Annual Report 2016 www.prudential.co.ukCorporate responsibility reviewContinued Risk assessment For more information on the risks facing our business see page 50. Supply chain management It is our policy to work in partnership with third parties 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. Prudential will publish its Modern Slavery statement later in the year. Accountability and governance for corporate responsibility The Board The Board regularly reviews the Group’s corporate responsibility performance and scrutinises and approves the Group corporate responsibility report and strategy on an annual basis. Local governance We believe that CR is best managed on the ground by our people running the businesses. In M&G, Jackson and Prudential UK there are governance committees in place – with senior management representation – that agree strategy and spend. In Asia, the Prudence Foundation has been established as a unified charitable platform to align and maximise the impact of community efforts across the region. The Prudence Foundation is governed by a statutory Board of Directors, under which a Board of Trustees operates as a decision-making forum, directing the management of the programmes in collaboration with our local markets, and ensuring that we maximise the value of our spend to local communities. 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 69 for more information. Strategic report approval by the Board of Directors The strategic report set out on pages 9 to 73 is approved by the Board of Directors. Signed on behalf of the Board of Directors Mike Wells Group Chief Executive 13 March 2017 73 www.prudential.co.ukAnnualReport2016 Prudential plc 02 Strategic report03 Governance 76 Chairman’s introduction 77 Board of Directors 82 How we operate 82 Board roles and governance 84 Board decision making 86 Board effectiveness 88 Diversity 88 Shareholder engagement 89 Further information on Directors 90 Risk management and internal control 92 Committee reports 106 Statutory and regulatory disclosures 107 Additional information 108 Index to principal Directors’ report disclosures 0 3 G o v e r n a n c e 01 Group overview 02 Strategic report 03 Governance 04 Directors’ remuneration report 05 Financial statements 06 European Embedded Value (EEV) basis results 07 Additional information Chairman’s introduction Strong, effective and transparent governance Governance We keep our governance structures under constant review to ensure they suit the needs of our business and our stakeholders. This year we have increased the remit of the Nomination and Governance Committee to provide oversight of our material subsidiary boards. In 2015 we identified Prudential Corporation Asia Limited, The Prudential Assurance Company Limited, Jackson National Life Insurance Company (Jackson) and M&G Group Limited as material subsidiaries of our principal business units. Over the first half of 2016, we appointed independent non-executive directors to their boards, including board chairs and chairs of the subsidiary audit and risk committees. To support our new independent directors, we designed a reporting and governance framework. The focus in 2016 was on embedding this framework. Howard Davies, Ann Godbehere and I have established good communication links with our new material subsidiary chairs and material subsidiary risk and audit committee chairs. We continue to see benefits from the greater alignment of the governance within our subsidiary businesses. Looking forward We have also focused further on the quality of our Environmental, Social and Governance Reporting in 2016 and I am pleased to announce that we will be publishing our first dedicated ESG report later this year. This report provides important information on our approach to managing the business in a sustainable fashion. It explains the actions to support this approach and the benefits we bring to our customers and stakeholders. We firmly believe this information, coupled with stakeholder engagement, improves the quality of the decisions we make. However, we need to remain vigilant not only to our internal needs but also to external factors that may require decisions from the Board. It remains critical for the Board to have an understanding of and respond to policy debates in all markets in which we operate. Culture of the Group While the Board can ensure good decision making at an executive level, it is important that the same approach is taken throughout the organisation. The best way to achieve this is to ensure that we have a culture where managers at every level are accountable, stakeholder views are taken seriously and colleagues feel free to challenge decision making. We firmly believe the Board determines culture and the Board aims to exhibit the behaviour we expect from all. Stakeholders I also oversee the balance of Board consideration between the interests of our shareholders, customers, employees and our other key stakeholders. An important part of this is the active shareholder engagement that we participate in every year. We were pleased to welcome 186 shareholders to our Annual General Meeting in 2016 as well as holding frequent meetings with our institutional investors. The quality of our people is a key driver of our success. At Prudential, we create an environment in which our people find value and meaning in their work, and create shared value for our customers, shareholders and communities. The financial peace of mind that we help to provide to our customers remains the focus of Prudential’s purpose as a business. Finally, I believe that good governance is based on the right level of oversight and challenge. I hope that reading the reports of my Committee Chairs that follow will demonstrate to you the work we have done this year to ensure that oversight and challenge are in place, and, more importantly, the tangible and positive impact it has had on our business. The methodology and results of our 2016 Board evaluation are also set out on page 87. Paul Manduca Chairman Dear Shareholder I am pleased to introduce our 2016 Governance report, in which we update you on our governance of Prudential during the year. Good governance ensures decisions are made in the interests of the business and take into account the views of stakeholders, including our employees and our customers. Our strategy aims to achieve just this by ensuring we have a responsive governance framework that supports and challenges our executives’ decision making. Board operations As Chairman, I have responsibility for ensuring the Board process operates effectively and that we establish an appropriate ethos and culture at Board level, which set the tone from the top around the Group. Driving that culture means that, when we meet as a Board, I ensure that there is open debate and constructive and effective challenge of the issues under discussion. We test issues rigorously and we have a robust decision-making process. I am pleased to say that we have strong contribution from all Board members and challenge from our Non-executive Directors, and the diversity of experience in our Boardroom comes through in the discussions. This ensures our decisions are balanced and all the risks are considered. Supporting our strategy I also ensure that our governance supports our strategy and the long-term success of Prudential. This year specifically, the Board has overseen major transactions in support of our strategy: the initial public offering of our Indian joint venture, ICICI Prudential Life; commencing the divestment of our Korean life business; the launch of a global risk and portfolio management platform for our asset management businesses; and growing our African business to include Zambia. Every major transaction, including those in the smaller parts of our business such as Africa, is brought to the Board. In each case, management and the Board worked closely together to ensure the right information was provided and key risks were robustly challenged. 76 Prudential plc Annual Report 2016 www.prudential.co.ukBoard of Directors Paul Manduca Chairman Appointment: October 2010 Chairman: July 2012 Committees: Nomination and Governance (Chair) Age: 65 Relevant skills and experience Paul has held a number of senior leadership roles. Notable appointments include serving as Chairman of the Association of Investment Companies (1991 to 1993), acting as founding CEO of Threadneedle Asset Management Limited (1994 to 1999), directorships of Eagle Star and Allied Dunbar, holding the offices of European CEO of Deutsche Asset Management (2002 to 2005), global CEO of Rothschild Asset Management (1999 to 2002), Chairman of Bridgewell Group plc and a director of Henderson Smaller Companies Investment Trust plc. Other previous appointments include the chairmanship of Aon UK Limited and JPM European Smaller Companies Investment Trust Plc. From September 2005 until March 2011, Paul was a non-executive director of Wm Morrison Supermarkets Plc, including as Senior Independent Director, Audit Committee Chairman and Remuneration Committee Chairman. He was also a non-executive director and Audit Committee Chairman of KazMunaiGas Exploration & Production until the end of September 2012. Other appointments Paul is a member of the Securities Institute and Chairman of Henderson Diversified Income Limited and of the Templeton Emerging Markets Investment Trust (TEMIT). Paul is also Chairman of TheCityUK’s Advisory Council. Mike began his career at the brokerage house Dean Witter, going on to become a managing director at Smith Barney Shearson. Michael Wells Group Chief Executive Appointment: January 2011 Group Chief Executive: June 2015 Age: 56 Relevant skills and experience Mike joined Jackson in 1995 and became Chief Operating Officer and Vice- Chairman of Jackson in 2003. In 2011, he was appointed President and Chief Executive Officer of Jackson, and joined the Board of Prudential. During his leadership of Jackson, Mike was responsible for the establishment of the broker-dealer network National Planning Holdings and the development of Jackson’s market-leading range of variable annuities. He was also part of the Jackson teams that purchased and successfully integrated a savings institute, three broker-dealers and two life companies. 77 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceBoard of Directors Continued Executive Directors 78 Nicolaos Nicandrou ACA Chief Financial Officer Appointment: October 2009 Age: 51 Relevant skills and experience Nic started his career at PricewaterhouseCoopers. Before joining Prudential, he worked at Aviva, where he held a number of senior finance roles, including Norwich Union Life Finance Director and Board Member, Aviva Group Financial Control Director, Aviva Group Financial Management and Reporting Director and CGNU Group Financial Reporting Director. Other appointments Nic is the Chairman of the European Insurance CFO Forum. Penelope James ACA Group Chief Risk Officer Appointment: September 2015 Age: 47 Relevant skills and experience Penny qualified as a chartered accountant with Coopers & Lybrand Deloitte (now part of PwC) and then joined Zurich Financial Services, where she held a number of senior finance positions over 12 years. Before joining Prudential, Penny was Group Chief Financial Officer of Omega Insurance Holdings (formerly listed on the London Stock Exchange). Penny joined Prudential in 2011 as the Director of Group Finance, a position she held until her appointment to the Board in 2015. During that time, she was leading on the implementation of Solvency II. Other appointments Penny serves as a non-executive director of Admiral Group plc and is a member of Admiral’s Audit and Nomination Committees. John Foley Chief Executive of Prudential UK & Europe Appointment: January 2016 Age: 60 Relevant skills and experience John spent over 20 years at Hill Samuel & Co, where he worked in every division of the bank, culminating in senior roles in risk, capital markets and treasury of the combined TSB and Hill Samuel Bank. He joined Prudential as Deputy Group Treasurer in 2000 and became Managing Director of Prudential Capital and Group Treasurer in 2001. During his career at Prudential, John has held the offices of Chief Executive of Prudential Capital, Group Chief Risk Officer, Group Investment Director and, since 2015, Chief Executive of Prudential UK & Europe. John first joined the Board of Prudential plc in 2011 and was reappointed in January 2016, having stepped down during his time as Group Investment Director. Prudential plc Annual Report 2016 www.prudential.co.ukAnne Richards Chief Executive, M&G Appointment: June 2016 Age: 52 Relevant skills and experience Anne became an analyst for Alliance Capital in 1992 and then moved into portfolio management roles at JP Morgan Investment Management and Mercury Asset Management. She joined the Board of Edinburgh Fund Managers plc as Chief Investment Officer and Joint Managing Director in 2002 and continued in this role following Aberdeen Asset Management PLC’s acquisition of Edinburgh Fund Managers in 2003. Anne was Chief Investment Officer and Head of the EMEA region for Aberdeen Asset Management PLC, positions she held until February 2016. Other appointments Anne is Chair of the Court of Edinburgh University and the CERN & Society Foundation, and a member of the Financial Conduct Authority Practitioner Panel. Barry Stowe Chairman and Chief Executive Officer of the North American Business Unit Appointment: November 2006 Age: 59 Relevant skills and experience Barry joined Prudential in October 2006 and was the Chief Executive of Prudential Corporation Asia until June 2015, leading Prudential’s Asian business through a period of major growth and development. Before joining Prudential, Barry was President, Accident & Health Worldwide for AIG Life Companies. He joined AIG in 1995 after having held senior positions at Pan-American Life and Willis in the United States. Other appointments Barry is a member of the Board of Directors of the International Insurance Society. Tony Wilkey Chief Executive, Prudential Corporation Asia Appointment: June 2015 Age: 57 Relevant skills and experience Tony joined Prudential in 2006 as Chief Executive of Prudential Corporation Asia’s network of life insurance operations in Asia across 12 markets, a position he held until his appointment to the Board. Before joining Prudential, he served as Chief Operating Officer of American International Assurance (AIA), based in Hong Kong, overseeing AIA’s life companies in South-east Asia. 79 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceBoard of Directors Continued Non-executive Directors The Hon. Philip Remnant CBE FCA Senior Independent Director Appointment: January 2013 Committees: Audit, Nomination and Governance, Remuneration Age: 62 Relevant skills and experience Philip was a senior adviser at Sir Howard Davies Appointment: October 2010 Committees: Audit, Nomination and Governance, Risk (Chair) Age: 66 Relevant skills and experience Sir Howard has a wealth of experience in the financial services industry, across the Credit Suisse, a Vice Chairman of Credit Suisse First Boston (CSFB) Europe and Head of the UK Investment Banking Department. He was twice seconded to the role of Director General of the Takeover Panel. Philip also served on the board of Northern Rock plc and as Chairman of the Shareholder Executive. Other appointments Philip is a Deputy Chairman of the Takeover Panel, a non- executive director of Severn Trent plc and the Senior Independent Director of UK Financial Investments Limited. Philip is also Chairman of City of London Investment Trust plc and Chairman of M&G Group Limited, a subsidiary of Prudential plc. Civil Service, consultancy, asset management, regulatory and academia. Sir Howard was previously Chairman of the Phoenix Group and an independent director of Morgan Stanley Inc. Other appointments Sir Howard is Chairman of the Royal Bank of Scotland and a Professor at Institut d’Études Politiques (Sciences Po). He is Chairman of the International Advisory Board of the China Securities Regulatory Commission and a member of the International Advisory Board of the China Banking Regulatory Commission. Other appointments Ann is a non-executive director of British American Tobacco p.l.c., Rio Tinto plc, Rio Tinto Limited, UBS Group AG and UBS AG. Ann Godbehere FCPA FCGA Appointment: August 2007 Committees: Audit (Chair), Nomination and Governance, Risk Age: 61 Relevant skills and experience Ann began her career in 1976 with Sun Life of Canada. Between 1996 and 2003, she held a number of CFO and CEO posts in different businesses within Swiss Re, including Chief Financial Officer of the Swiss Re Group. Ann also held directorships at Northern Rock, Atrium Underwriting Group Limited and Atrium Underwriters Limited, as well as Arden Holdings Limited. David Law ACA Appointment: September 2015 Committees: Audit Age: 56 Relevant skills and experience David was the Global Leader of PwC’s insurance practice, a Partner in PwC’s UK firm, and worked as the Lead Audit Partner for multi-national insurance companies until his retirement in 2015. David has also been responsible for PwC’s insurance and investment management assurance practice in London and the firm’s Scottish assurance division. Other appointments David is a Director and Chief Executive of L&F Holdings Limited and its subsidiaries, the professional indemnity captive insurance group that serves the PwC network and its member firms. 80 Prudential plc Annual Report 2016 www.prudential.co.ukKaikhushru Nargolwala FCA Appointment: January 2012 Committees: Remuneration, Risk Age: 66 Relevant skills and experience Kai spent 19 years at Bank of America and was based in Hong Kong in roles as Group Executive Vice President and Head of the Asia Wholesale Banking Group during 1990 to 1995. He spent 10 years working for Standard Chartered PLC in Singapore as Group Executive Director responsible for Asia Governance and Risk during 1998 to 2007. Kai was Chief Executive Officer of the Asia Pacific Region of Credit Suisse AG during 2008 to 2010. Kai previously served on the Board of Singapore Telecommunications Limited, Standard Chartered plc, Credit Suisse’s Executive Board, the Board of Tate and Lyle plc and Visa International’s Asia Pacific Advisory Board. Other appointments Kai is the Chairman of Clifford Capital Pte. Ltd., a company supported by the Singapore government to facilitate the financing of long-term cross-border projects of Singapore-based companies. He is also a non-executive Director of Credit Suisse Group AG and a non-executive Director of PSA International Pte Ltd. Additionally, Kai is the Chairman of the Governing Board of the Duke-NUS Medical School. He serves on the Board of the Casino Regulatory Authority of Singapore. He is also Chairman of Prudential Corporation Asia Limited, a subsidiary of Prudential plc. Anthony Nightingale CMG SBS JP Appointment: June 2013 Committees: Nomination and Governance, Remuneration (Chair) Age: 69 Relevant skills and experience Anthony spent his career in Asia, where he joined the Jardine Matheson Group in 1969, holding a number of senior positions before joining the Board of Jardine Matheson Holdings in 1994. He was Managing Director of the Jardine Matheson Group from 2006 to 2012. Other appointments Anthony is a non-executive director of Jardine Matheson Holdings and a number of other Jardine Matheson group companies. Other directorships include Schindler Holding Limited, Vitasoy International Holdings Limited and Shui On Land Limited. Notable appointments include: Hong Kong representative to the APEC Business Advisory Council, Chairman of The Hong Kong-APEC Trade Policy Study Group, member of the Securities and Futures Commission Committee on Real Estate Investment Trusts, member of the UK-ASEAN Business Council Advisory Panel, and non-official member of the Commission on Strategic Development in Hong Kong. Alice Schroeder Appointment: June 2013 Committees: Audit Age: 60 Relevant skills and experience Alice began her career as a qualified accountant at Ernst & Young. She joined the Financial Accounting Standards Board as a manager in 1991, overseeing the issuance of several significant insurance accounting standards. From 1993, she led teams of analysts specialising in property- casualty insurance as a Managing Director at CIBS Oppenheimer, PaineWebber (now UBS) and Morgan Stanley. Alice was also an independent board member of the Cetera Financial Group. Other appointments Alice is a non-executive director of Bank of America Merrill Lynch International. She is also CEO and Chairman of WebTuner Corp. Lord Turner FRS Appointment: September 2015 Committees: Risk Age: 61 Relevant skills and experience Lord Turner began his career with McKinsey & Co, advising companies across a range of industries. He has served as Director-General of the Confederation of British Industry, Vice-Chairman of Merrill Lynch Europe, Chairman of the Pensions Commission and as a non- executive director of Standard Chartered Bank. Lord Turner was Chairman of the UK’s Financial Services Authority (FSA), a member of the international Financial Stability Board and a non-executive director of the Bank of England. Other appointments Lord Turner has been a crossbench member of the House of Lords since 2005. Other appointments include OakNorth Bank, Chairman of the Institute for New Economic Thinking, Chair of the Energy Transition Commission, and Visiting Professor at both the London School of Economics and the Cass Business School. The Board appointed John Foley as Executive Director and Chief Executive of Prudential UK & Europe in January 2016 and Anne Richards as Executive Director and Chief Executive, M&G in June 2016. Alistair Johnston retired as a Non-executive Director at the conclusion of the 2016 Annual General Meeting and Michael McLintock retired as an Executive Director and Chief Executive, M&G in June 2016. All Directors will stand for election or re-election at the 2017 Annual General Meeting except Ann Godbehere, who will have served for nine years since her election by shareholders in 2008. Proposals for elections and re-elections are supported by the annual review of the performance of each Director, which concluded that all Directors continue to perform effectively. 81 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow we operate Board roles and governance Prudential has dual primary listings in the UK and Hong Kong, and has therefore adopted a governance structure based on the UK Corporate Governance Code and the Hong Kong Corporate Governance Code. Responsibility for governance lies with the Board. The descriptions below explain Board roles and how duties are fulfilled. Chairman Paul Manduca — Overall responsibility for leadership of the Board and ensuring its effectiveness — Responsible for setting the Board’s agenda, ensuring the right focus and promoting constructive debate — Responsible for making recommendations to the Nomination and Governance Committee for the appointment of Directors, and ensuring appropriate induction and ongoing development of Board members — Leading the Board in determining appropriate corporate governance and business values — Meeting regularly with the Non-executive Directors, without the Executive Directors present — Key contact point for the independent chairs of the Group’s material subsidiaries — Representing the Company with external stakeholders and acting as key contact for shareholders and regulators to ensure effective communication on governance and strategy — Paul works closely with the Group Chief Executive and the Company Secretary to ensure effective Board governance and operation. This included ensuring that Board meetings have the right focus, that enough time is allocated for the discussion of agenda items, in particular strategic issues, and that Directors receive timely and relevant information — Paul plays a leading part in the identification of potential candidates for Board succession, working closely with the Group Chief Executive in the succession planning process for Executive Directors — Paul focuses on promoting a culture of openness and debate among Directors, helping to build and maintain constructive relationships between the Executive and Non-executive Directors. When chairing Board meetings, Paul ensures that all views are heard and that the Non- executive Directors have an opportunity to challenge management constructively — During the year, Paul met with the Non-executive Directors without the Executive Directors being present, on five occasions — Paul meets regularly with the independent chairs of the Group’s material subsidiaries — Externally, Paul has a regular programme of meetings with major shareholders throughout the year — Paul plays a key role in the Group’s engagement with regulators 82 Prudential plc Annual Report 2016 www.prudential.co.ukGroup Chief Executive Senior Independent Director Mike Wells — Responsible for the operational management of the Philip Remnant — Acting as sounding board for the Chairman Group, on behalf of the Board — Leading the Executive Directors and other senior executives in the management of all aspects of the day-to-day business of the Group — Responsible for implementation of the Board’s decisions — Establishing processes to ensure operations are compliant with regulatory requirements — Mike sets policies, provides day-to-day leadership and makes decisions on matters affecting the operation, performance and strategy of the Group, seeking Board approval for matters reserved to the Board — Mike chairs the Group Executive Committee (GEC), which comprises the Executive Directors and the Group functional heads. The Executive Committee supports Mike in the operational management of the Group, providing the expertise to fulfil the strategic objectives set by the Board — Mike works closely with the Executive Directors in developing the Operating Plan, for approval by the Board — Mike keeps in close contact with the Chairman and ensures he is briefed on key issues — Mike meets with the Group’s key regulators worldwide — Leading the Non-executive Directors in conducting the Chairman’s annual evaluation — Being available to shareholders to address concerns not resolved through normal channels — Philip kept in close contact with the Chairman throughout the year — Philip held meetings in Q1 2017 with the Non-executive Directors to review the Chairman’s performance — Philip holds meetings throughout the year with Non- executive Directors as needed, without management being present — In 2016, Philip offered meetings to Prudential’s key shareholders to provide them with an additional channel of communication Committee Chairs Non-executive Directors — Responsible for leadership and governance of the Board’s — Responsible for providing constructive and effective principal Committees challenge — Responsible for setting the agenda for Committee — Contributing to the development of proposals on Group meetings and reporting on the Committees’ activities to the Board strategy, offering input based on individual and collective experience — Audit and Risk Committee Chairs act as key contact points — Responsible for scrutinising the performance of for the independent chairs of the audit and risk committees of the Group’s material subsidiaries — The Committee Chairs worked closely with the Company Secretary and management to ensure Committee governance continued to be effective throughout the year — Each Committee Chair provided a written update of Committee business to the Board, followed by a verbal update after each Committee meeting — Ann Godbehere, the Audit Committee Chair, and Howard Davies, the Risk Committee Chair, commenced quarterly meetings with chairs of the audit and risk committees of the material subsidiaries during 2016 and provided updates to the Audit and Risk Committees respectively management in meeting agreed goals and objectives — Serving on principal Board Committees — The Non-executive Directors have engaged throughout the year with the Executive Directors and management, at Board and Committee meetings, as part of site visits, through training sessions and on an informal basis — They contributed to the development of strategic options through one-to-one meetings with the Group Strategy team and participated in the annual Strategy Away Day — All Non-executive Directors serve on at least one of the principal Board Committees 83 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow we operate Continued Board decision making — The Board is collectively responsible: – To shareholders for the long-term success of the Company and, in particular, for setting the Group’s strategy and risk appetite; – For providing leadership within a framework of effective controls; and – For monitoring management’s performance against strategic goals and ensuring appropriate resources are available to achieve these goals. — When making decisions, the Board has due regard to the balance of interests between shareholders, employees, customers and community. — The Board operates in accordance with relevant corporate governance codes and has established a number of principal committees comprising Non-executive Directors to ensure Board duties are appropriately allocated between members. — The Group has established and regularly reviews a governance framework designed to promote appropriate behaviours across the Group to ensure prudent management and protection of the interests of shareholders, customers and other key stakeholders. — As part of the governance framework, the Board has established a control framework to identify significant risks and apply appropriate measures to manage and mitigate them (described more fully on pages 90 and 91). — The framework sets out the behaviours expected of the Group’s employees and requires all business units to seek delegated authority from the Board to carry out actions exceeding pre-determined limits or which could have a material effect on the Group. — Specific key decisions have been reserved to the Board for decision. These include strategic decisions, determination of interim dividends and recommendation of final dividends to shareholders, approval of major transactions, approval of key financial reporting, approval of the overall risk appetite and capital and liquidity positions, and responsibility for the effectiveness of the system of internal control and risk management. Board Nomination and Governance Committee Audit Committee Risk Committee Remuneration Committee Paul Manduca — Ensures that the Board retains an appropriate balance of skills to support the strategic objectives of the Group Ann Godbehere — Responsible for the integrity of the Group’s financial reporting, including scrutinising accounting policies — Ensures that an — Monitors the effective framework for senior succession planning is in place — Recommends appointments to the Board and its principal Committees and appointments of non-executive directors to the boards of material subsidiaries — Oversees the governance of material subsidiaries effectiveness of internal control and risk management systems, including compliance arrangements — Monitors the effectiveness and objectivity of internal and external auditors — Approves the internal audit plan and recommends the appointment of the external auditor Howard Davies — Leads on and oversees the Group’s overall risk appetite, risk tolerance and strategy — Approves the Group’s risk management framework and monitors its effectiveness — Supports the Board and management in embedding and maintaining a supportive culture in relation to the management of risk Anthony Nightingale — Recommends the Directors’ Remuneration Policy for approval by shareholders — Approves the individual remuneration packages of the Chairman, the Executive Directors, other senior executives and the non-executive directors of material subsidiaries — Determines the overall Remuneration Policy for the Group — Reviews the design and development of share plans requiring shareholder approval and approves and assesses performance targets where applicable See Nomination and Governance Committee report on pages 92 to 94 See Audit Committee report on pages 95 to 102 See Risk Committee report on pages 103 to 105 See Directors’ remuneration report on pages 111 to 157 Terms of reference for the principal Committees can be accessed at www.prudential.co.uk Each Committee reviews its terms of reference at least annually and recommends changes to the Board for its approval. 84 Prudential plc Annual Report 2016 www.prudential.co.ukAuthority for the operational management of the Group’s businesses in order to implement Board strategy and decisions has been delegated to the Group Chief Executive for execution or further delegation by him. The Group Chief Executive is supported by the Group Executive Committee, which receives reports on performance and implementation of strategy for each business unit and discusses major projects and other activities related to the attainment of strategy. The members of the Group Executive Committee and their roles are set out on page 405. To manage the Group’s delegated authorities and to monitor material expenditure, the Group Chief Executive has established a Chief Executive’s Committee, which meets on a weekly basis. The Chief Executive of each business unit has responsibility for the management of that business unit. Key areas of focus – how the Board spent its time The Board met on 10 occasions during the year, which included meetings in Kuala Lumpur, Malaysia and Lansing, USA. At the overseas meetings, additional sessions were held outside of the formal Board meetings, to allow the Board to focus on the regional business operations and to spend time meeting local senior management. The Board also held a separate strategy event over two days during the year. The table below gives an overview of how the Board spent its time in 2016 and its key areas of focus. Feb Apr May Jun Jul Sep Nov Dec Strategy and implementation Full review of strategy Strategic conclusions finalised Operating plan review Strategic objectives monitoring Major projects Review of operational performance Report from Committee Chairs Financial reporting and dividends Full year Half year Review of financial performance Business unit reviews PCA Jackson M&G UK&E PPMG Africa Regulation ORSA, Solvency II, IMAP CRO report Regulatory and compliance update Governance and stakeholders Board evaluation tracking Succession planning Corporate responsibility report Diversity and inclusion Talent review Feedback from Chair/NED investor meetings Investor conference planning Notes 1 Audit Committee. 2 Nomination and Governance Committee. 3 Remuneration Committee. 4 Risk Committee. 5 Including meeting with regulators. 1,2,3,4 1,3,4 1,4 3 1,4 2,3,4 1,2,4 1,3,4 5 At a number of meetings, the Board considered, and where appropriate approved, major projects. These included Prudential Africa’s opening in Zambia, with its acquisition of Professional Life Assurance; the listing of ICICI Prudential Life Insurance Company Limited, Prudential’s Indian joint venture with ICICI Bank; commencement of the sale of Prudential’s life business in Korea and the implementation of a global risk and portfolio management platform for the Group’s asset management businesses, working with BlackRock. In addition to the eight full meetings outlined above, two further meetings were held to approve the final full and half year financial reports. 85 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow we operate Continued Individual Directors’ attendance at meetings throughout the year is set out in the table below. Board and Committee meeting attendance during 2016 Number of meetings held Chairman Paul Manduca Executive Directors Mike Wells Nic Nicandrou Penny James John Foley Michael McLintock1 Anne Richards2 Barry Stowe Tony Wilkey Non-executive Directors Philip Remnant Howard Davies Ann Godbehere Alistair Johnston3 David Law Kai Nargolwala Anthony Nightingale Alice Schroeder Lord Turner Board 10 Audit Committee 10* Nomination and Governance Committee 4 Remuneration Committee 6 Risk Committee 8* General Meeting 1 10 10 10 10 10 4/4 6/6 10 10 10 10 10 4/4 10 10 10 10 9/10 – – – – – – – – – 10 10 10 6/6 9/10 – – 10 – 4 – – – – – – – – 4 4 4 – – – 4 – – – – – – – – – – – 6 – – – – 6 6 – – – – – – – – – – – – 8 8 – – 8 – – 7/8 1 1 1 1 1 1 – 1 1 1 1 1 1 1 1 1 1 1 * The Audit and Risk Committees held a joint meeting in addition to those listed, which was attended by all members from both Committees. Notes 1 Michael McLintock retired as a Director on 6 June 2016. 2 Anne Richards was appointed as a Director on 7 June 2016. 3 Alistair Johnston retired as a Director from the conclusion of the Annual General Meeting held on 19 May 2016. Board and Committee papers are usually provided one week in advance of a meeting. Where a Director is unable to attend a meeting, his or her views are canvassed in advance by the Chairman of that meeting where possible. Board effectiveness Actions during 2016 arising from the 2015 review During the year, the action points identified in respect of the 2015 evaluation were addressed and the Board received an update on progress against those actions in September 2016 and February 2017. The key themes of the 2015 evaluation are set out below. Governance of subsidiary boards – The 2015 Board evaluation recognised that, following the decision to appoint independent non-executive directors to certain of the Group’s larger subsidiaries, referred to as the material subsidiaries, more formal oversight of the governance arrangements for the material subsidiary boards would be required. In addition, a process for appointing the material subsidiary independent directors and the relationship between them and the 86 Chairman and Chairs of the Group Audit and Risk Committees would need to be implemented. In the first half of 2016, governance processes were established for the Chairman and the Audit and Risk Committee Chairs to meet with their material subsidiary counterparts and keep the Board appropriately updated. In addition, the Audit and Risk Committees receive written updates outlining the business discussed by the material subsidiary audit and risk committees. The Nomination and Governance Committee played a key part in the establishment and embedding of these governance processes. Regular progress updates were provided to the Board, which tracked alignment to regulatory expectations. Post action reviews – The 2015 evaluation noted that the Board should continue to analyse past decisions closely, testing assumptions and projections made in the past. Reviews of certain past transactions were undertaken by the Risk Committee and the outcome was considered by the Board during its strategy discussions in June. The Board also discussed a full report of the Group’s past actions in Africa which allowed them to confirm the rationale behind the Group’s decision to invest in that region and the acquisitions made to date. Board papers – On Board processes, the 2015 feedback highlighted the progress made during the year, in particular improvements in clarity of papers. This was another area of focus during 2016, with work undertaken to ensure that the right balance continued to be struck regarding the level of detail provided in papers, especially for technically complex matters. Concise papers assisted the Board in managing a growing agenda. Prudential plc Annual Report 2016 www.prudential.co.ukDuring the year, updates were issued to senior staff explaining the rationale for Board paper content guidelines, including a reminder of best practices and timelines. The review process for papers is designed to ensure all relevant aspects of Directors’ duties are addressed and consideration is given to risk, legal, regulatory and other appropriate stakeholder aspects. Products and customers – The Board continued holding in-depth focus sessions on products and customers of the Group, primarily through Board visits to the business units. In 2016, these focus sessions took place when the Board visited its overseas operations, as more fully described below. 2016 review and actions for 2017 The performance evaluation of the Board and its principal Committees for 2016 was conducted internally at the end of 2016 and beginning of 2017, through a questionnaire. The findings were presented to the Board in February 2017 and an action plan agreed to address areas of focus identified by the evaluation. The review confirmed that the Board continued to operate effectively during the year and no major areas requiring improvement were highlighted. The performance during 2016 of the Non-executive Directors and the Group Chief Executive was evaluated by the Chairman in individual meetings. Philip Remnant, the Senior Independent Director, led the Non-executive Directors in a performance evaluation of the Chairman. Executive Directors are subject to regular review and the Group Chief Executive individually appraised the performance of each of the Executive Directors as part of the annual Group-wide performance evaluation of all staff. The following themes were identified as areas for focus in 2017: Subsidiary governance – The Board evaluation recognised that the appointment of independent non-executive chairs and directors to the Group’s material subsidiaries had been well executed, and a good governance framework established. The Board’s focus for 2017 would be on ensuring good subsidiary governance was maintained and best governance practices were shared between the material subsidiaries. Ensuring that reporting by the material subsidiaries to the Board and its Committees continued to be of a high standard would also be emphasised. Board agenda – The Board agreed to continue to ensure time spent at its meetings reflected the Group’s strategic and operational priorities. One of the primary ways to achieve constructive debate is to ensure pre-Board preparation is of a very high standard with papers continuing to be delivered on time with succinctly presented facts creating, where needed, a clear decision path. The Board also agreed to build on the work done in 2016 to further increase the Board’s focus on products and customers. Senior employee focus – The Board evaluation noted the number of successful internal promotions over 2015 and 2016, and that management’s focus was now on rebuilding strength in the senior management teams around the Group below GEC level. In 2017, the Board will ensure it remains properly updated in this area and that it continues to have opportunities to meet senior management across all the Group’s businesses. Remuneration – The Board evaluation noted the growing complexity of remuneration across all UK-listed companies and also the pace of changes in these areas as a result of focus by government and institutional investor groups over recent months. The Board will implement an annual training session for any Non-executive Directors not on the Remuneration Committee to discuss the Directors’ Remuneration Policy and the remuneration structures contained in it, as well as broader market practice information. The Board will track its progress in addressing these themes at its meetings throughout the course of 2017 and report on actions taken in its next Annual Report. Directors’ development The Chairman is responsible for ensuring that induction programmes are provided for all new Directors. These are tailored to reflect the experience of each Director and their position as either Executive or Non-executive Directors. Anne Richards’ induction was carried out by both Group and M&G, and included updates on the Group’s results, the role of the Board and its Committees, the Group’s key risks and the risk management framework, as well as the compliance environment in which the Group operates. M&G provided a detailed briefing on product range, the markets in which it operates and the overall competitive environment. The Chairman is also responsible for ensuring that all Directors update their skills, knowledge and familiarity with the Group. Directors regularly receive reports on the Group’s businesses and the regulatory and industry-specific environments in which it operates. All Directors have the opportunity to discuss their development needs as part of the annual Board effectiveness review and Directors are asked to provide a record of training received externally on an annual basis. In 2016, the Board took time for particular focus on the Group’s US and Asian businesses. During visits to the US and Malaysia, the Board received updates on key products and distribution, risks and performance in the US and in the Asian businesses, including regulatory developments and their potential impact on future business. The Board’s overseas visits also allowed the Directors to meet with the local senior management teams. Kuala Lumpur, Malaysia — Prudential Malaysia – Overview of life insurance industry and comparative position in the marketplace – Products and strategy – Financial performance – Update on Takaful business: governance, performance, strategy — Asia financial performance, strategy and growth update, risk profile and risk function development, and HR planning — Overview of Eastspring Investments Lansing, USA — Regulatory update – impact of the Department of Labor’s fiduciary rule on Jackson and the industry — Jackson: – Comparative position in the marketplace and marketing – Products and operating environment – Financial performance – Risk function development — PPM America performance — Cyber security within the North American business 87 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow we operate Continued The Board was kept updated on key political and regulatory developments, including Solvency II implementation and reporting, the US Department of Labor fiduciary rule, the Senior Insurance Managers Regime, the UK regulator’s thematic review of annuity sales and the implementation of the Market Abuse Regulation. In addition, Directors were provided with updates at each Board meeting on other legal and regulatory changes and developments that could impact the industry or the Group. Committee members received updates at Committee meetings on areas of particular relevance to the respective Committees and were kept updated on ongoing developments in regulations, as well as the impact these have on the Group. The Risk Committee received in-depth information on a number of business areas and products in 2016, focusing on the particular risks arising and how these are managed. Some of those topics were also shared with the Audit Committee to ensure it was appropriately briefed to assess any impact on financial reporting and internal control. In 2016, the Audit Committee and Risk Committee held a joint session in which they were provided with an update on the impact of Solvency II on the 2015 results. Diversity Given the global reach of the Group’s operations, and our business strategy and long-term focus, the Board makes every effort to ensure it is able to recruit directors from different backgrounds, with diverse experience, perspective and skills. This diversity not only contributes towards Board effectiveness but is essential for successfully delivering the strategy of an international Group, as reflected in our Group Diversity and Inclusion Policy. The Board is committed to recruiting the best available talent and appointing the most appropriate candidate for each role, while at the same time aiming for appropriate diversity on the Board. This approach informed the Nomination and Governance Committee’s ongoing activities carried out during 2016 in respect of succession planning for Executive and Non-executive Directors. The Board does not endorse quotas as these may generate unintended consequences, but continues to commit to developing a robust and diverse talent pipeline and increasing representation of women in senior positions in the Group and on the Board. As part of this commitment, the Board may endorse relevant measurable objectives for increasing diversity. For example, in 2016 the Board decided to sign the HM Treasury Women in Finance Charter, with the aim to have in place at least 30 per cent women in senior management positions by the end of 2021. Shareholder engagement As a major institutional investor, the Board recognises the importance of maintaining an appropriate level of two-way communication with shareholders. The Company holds an ongoing programme of regular contact with major shareholders, conducted by the Chairman, to discuss their views on the Company’s governance. The Senior Independent Director offers meetings to major shareholders as needed and other Non-executive Directors are available to meet with major shareholders on request. Shareholder feedback from these meetings is communicated to the Board. In addition, a full programme of engagement with shareholders, potential investors and analysts, in the UK and overseas, is conducted each year by the Group Chief Executive and the Chief Financial Officer, led by the Director of Strategy and Capital Market Relations. As part of this, a conference for investors and analysts has been held on a regular basis since 2010, with in-depth business presentations and opportunities for attendees to meet with members of the Board and senior management through the course of the event. Most recently, the Group held a conference for investors in November 2016. The Group Chief Executive, Chief Financial Officer and investor relations team also attend major financial services conferences to present to and meet with the Company’s shareholders. In 2016, as part of the investor relations programme, over 360 meetings were held with approximately 800 individual institutional investors across the UK, in continental Europe, the US and Asia. The Annual General Meeting is an opportunity for further shareholder engagement, for the Chairman to explain the Company’s progress and, along with other members of the Board, to answer any questions. All Directors then in office attended the 2016 Annual General Meeting. Details of the 2017 Annual General Meeting are available on www.Prudential.co.uk under ‘Investors’. 88 Prudential plc Annual Report 2016 www.prudential.co.ukFurther information on Directors Information on a number of regulations and processes relevant to Directors, and how these are addressed by Prudential, is given below. Area Prudential’s approach Rules governing appointment and removal — The appointment and removal of Directors is governed by the provisions in the Articles of Association (the Articles), the UK Corporate Governance Code (the UK Code), the Hong Kong Corporate Governance Code (HK Code) as appended to the Hong Kong Listing Rules (the HK Listing Rules) and the Companies Act 2006. Terms of appointment — Non-executive Directors are appointed for an initial term of three years. — Subject to review by the Nomination and Governance Committee and re-election by shareholders, it would be expected that Non-executive Directors serve a second term of three years. — After six years, Non-executive Directors may be appointed for a further year, up to a maximum of three years in total. Reappointment is subject to rigorous review as well as re-election by shareholders at the Annual General Meeting. — The Directors’ remuneration report sets out the terms of the Non-executive Directors’ letters of appointment on page 133. — The Directors’ remuneration report sets out the terms of Executive Directors’ service contracts on page 132. Independence — Prudential is one of the UK’s largest institutional investors. The Board does not believe that this 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. — The independence of the Non-executive Directors is determined by reference to the UK Code and HK Listing Rules. Prudential is required to affirm annually the independence of all Non-executive Directors under the HK Listing Rules and the independence of its Audit Committee members under Sarbanes-Oxley legislation. — For the purposes of the UK Code, throughout the year, all Non-executive Directors were considered by the Board to be independent in character and judgement and to have met the criteria for independence as set out in the UK Code. — All the Non-executive Directors are considered independent for the purposes of the Company’s Hong Kong listing, and each Non-executive Director provides an annual confirmation of his or her independence as required under the HK Listing Rules. The Company has considered David Law’s position and has deemed him to be independent from 1 July 2016, being the date one year following his retirement from PwC, for the purposes of the HK Listing Rules and HK Code. — There were no other material factors that were deemed to affect the Non-executive Directors’ independence. — In relation to the provisions of the UK Corporate Governance Code and HK Listing Rules, the Board is satisfied that Ann Godbehere and David Law have recent and relevant financial experience. — The Board has determined that Ann Godbehere and David Law qualify as audit committee financial experts under the requirements of Form 20-F and that both Ms Godbehere and Mr Law are independent within the meaning of Rule 10A-3 under the Exchange Act. — The Board does not consider that Mr Law’s previous position at PwC affects his status as an independent Director for the purposes of the UK Code or in relation to his membership of the Audit Committee, under applicable Sarbanes-Oxley legislation. Audit Committee experience and independence Indemnities, protections and legal advice — Subject to the provisions of the Companies Act 2006, the Company’s Articles permit the Directors and officers of the Company to be indemnified in respect of liabilities incurred as a result of their office. — Suitable insurance cover is in place in respect of legal action against directors and senior managers of companies within the Group. — Qualifying third party indemnity provisions are also available for the benefit of the Directors of the Company and certain other such persons, including certain directors of other companies within the Group. — Qualifying pension scheme indemnity provisions are also in place for the benefit of certain pension trustee directors within the Group. — These indemnities were in force during 2016 and remain so. — Directors have the right to seek independent professional advice at the Group’s expense. Significant contracts — At no time during the year did any Director hold a material interest in any contract of significance with the Company or any subsidiary undertaking. 89 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceSecond line of defence (risk control and oversight) — Assists the Board to formulate and then implement the approved risk appetite and limit framework, risk management plans, risk policies, risk reporting and risk identification processes; and — Reviews and assesses the risk-taking activities of the first line of defence and where appropriate, challenges the actions being taken to manage and control risks and approves any significant changes to the controls in place. Third line of defence (independent assurance) — Provides independent assurance on the design, effectiveness and implementation of the overall system of internal control, including risk management and compliance. Risk management and internal control Risk management A key component of the Manual is the Group Risk Framework, which requires all business units to establish processes for identifying, evaluating and managing the risks facing the business. The Board determines the nature and extent of the principal risks it is willing to take in achieving its strategic objectives. It has delegated authority to the Risk Committee to review and approve changes to the Group Risk Framework and risk policies and approve changes to risk limits within the overall Board approved risk appetite. The Risk Committee reviews compliance with the Group Risk Framework and risk policies through its regular activities detailed in the report on pages 103 to 105. The Group’s risk governance arrangements, which support the Board, the Risk Committee and the Audit Committee, are based on the principles of the ‘three lines of defence’ model: risk taking and management, risk control and oversight, and independent assurance. First line of defence (risk taking and management) — Takes and manages risk exposures in accordance with the risk appetite, mandate and limits set by the Board; — Identifies and reports the risks that the Group is exposed to, and those that are emerging; — Promptly escalates any limit breaches or any violations of risk management policies, mandates or instructions; — Identifies and promptly escalates significant emerging risk issues; and — Manages the business to ensure full compliance with the Group risk management framework as set out in the Manual, which includes the Group Risk Framework and risk policies as well as approvals requirements, among other requirements. The Board is responsible for ensuring that an appropriate and effective system of internal control and risk management is in place across the Group. The framework of risk management and internal controls centres on clear delegated authorities to ensure Board oversight and control of important decisions. The framework is underpinned by the Group Code of Business Conduct, which sets out the ethical standards the Board requires of itself, employees, agents and others working in the Group. The framework is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable and not absolute assurance against material misstatement or loss. Internal control The Group Governance Manual (the Manual) sets out the delegated authorities and establishes the requirements for subsidiaries to seek approvals from or report to Group Head Office. Group-wide standards are established through policies and other governance arrangements, which are also included in the Manual. Internal controls and processes, based on the provisions established in the Manual, are in place across the Group. These include controls for the preparation of financial reporting. The operation of these controls and processes facilitates the preparation of reliable financial reporting and the preparation of local and consolidated financial statements in accordance with the applicable accounting standards and requirements of the Sarbanes-Oxley Act. These controls include certifications by the Chief Executive and Chief Financial Officer of each business unit regarding the accuracy of information provided for use in preparation of the Group’s consolidated financial reporting and the assurance work carried out in respect of US reporting requirements. The Board has delegated authority to the Audit Committee to review the framework and effectiveness of the Group’s systems of internal control. The Audit Committee is supported in this responsibility by the assurance work carried out by Group-wide Internal Audit and the work of the business unit audit committees, which oversee the effectiveness of controls in each respective business unit. Details of how the Audit Committee oversees the framework of controls and their effectiveness on an ongoing basis, is set out more fully in the report on pages 95 to 102. 90 Prudential plc Annual Report 2016 www.prudential.co.ukThe three lines of defence model is adopted at the Group level as follows: Board Board Nomination Committee Remuneration Committee Risk Committee Audit Committee 1st line of defence 2nd line of defence 3rd line of defence Executives Group CEO CEC GEC BSCMC Management GERC Group CFO Group Regulatory Director Group CRO TAC GCRC ERAC GSC GISC STOC Group Finance Group Compliance Group Security Group Risk Group-wide Internal Audit Key Board-level committees Executive personnel Exec/Management committees GHO functions Direct reporting line Regular communication and escalation CEC GEC BSCMC GERC TAC Chief Executive’s Committee Group Executive Committee Balance Sheet & Capital Management Committee Group Executive Risk Committee Technical Actuarial Committee GCRC ERAC GSC GISC STOC Group Credit Risk Committee Emerging Risk Assessment Committee Group Security Committee Group Information Security Committee Solvency II Technical Oversight Committee Formal review of controls A formal evaluation of the systems of internal control and risk management is carried out at least annually. The report is considered by the Audit Committee and Risk Committee prior to the Board reaching a conclusion on the effectiveness of the systems in place. This evaluation takes place prior to the publication of the Annual Report. As part of the evaluation, the Chief Executive and Chief Financial Officer of each business unit, including Group Head Office, certify compliance with the Group’s governance policies and the risk management and internal control requirements. The Group Risk function facilitates a review of the matters identified by this certification process. This includes the assessment of any risk and control issues reported during the year, risk and control matters identified and reported by the other Group oversight functions and the findings from the reviews undertaken by Group-wide Internal Audit, which carries out risk-based audit plans across the Group. Issues arising from any external regulatory engagement are also taken into account. For the purposes of the effectiveness review, the Group has followed the FRC Guidance on Risk Management, Internal Control and Related Financial and Business Reporting. In line with this 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. Effectiveness of controls In accordance with provision C.2.3 of the UK Corporate Governance Code and provision C.2.1 of the HK Corporate Governance Code, the Board reviewed the effectiveness and performance of the system of risk management and internal control during 2016. This review covered 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, internal audit and financial reporting functions. The review identified a number of areas for improvement and the necessary actions have been or are being taken. 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, and confirms that the system remains effective. 91 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceThe principal Committees of the Board are the Nomination and Governance, Audit, Risk, and Remuneration Committees. These Committees form a key element of the Group governance framework, facilitating effective independent oversight of the Group’s activities by the Non-executive Directors. Each Committee Chairman provides an update to the Board of each Committee meeting, supported by a short written summary of the Committee business considered. Nomination and Governance Committee report Dear Shareholder As Chairman of the Nomination and Governance Committee, I am pleased to report on the Committee’s activities and areas of focus during 2016. In 2016, we met on four occasions. Our focus was on ensuring we have suitable succession plans in place for the Board and senior executives. Particular emphasis this year was on succession planning for our Non-executive Directors given that Ann Godbehere is in her ninth year of service and will not stand for re-election at our next Annual General Meeting. Ann has been an asset to the Board and we are most grateful for her contribution, especially as Chair of our Audit Committee. Our work on succession planning is based on an assessment of skills needed to fulfil our strategy and a rolling programme of progressively refreshing the skills on our Board. During 2016 and to date, we particularly focused on skills required to replace Ann’s expertise in the context of the overall balance of skills on the Board and the main markets in which we operate, now and in the medium term. We also reviewed the membership of the Board’s principal committees to ensure all committees continue to be appropriately composed, taking into account the time commitment required of each Non- executive Director role. As part of our regular year-end related work at our February meeting, we reviewed the performance and independence of our Non-executive Directors, we confirmed that our Audit Committee has the required levels of financial expertise, we reviewed and confirmed conflicts of interest for all Board members and recommended all Non- executive Directors for re-election at the forthcoming Annual General Meeting, except Ann Godbehere. The Committee expanded its remit in 2016, following the appointment of independent non-executive directors to the boards of our material subsidiaries. During the year, we approved the appointment of independent chairs to the boards of these companies. As part of our new governance duties, we reviewed the governance framework for our material subsidiaries and terms of reference for their boards and chairs. Going forward, the Committee will review the performance of the non- executive directors of the material subsidiaries, starting in early 2017. As Chairman of the Committee, I have responsibility for ensuring the Committee operates effectively. To ensure we do so and provide constructive challenge to management, I encourage open debate and contributions from all Committee members. An annual review of our effectiveness was carried out as part of the Board evaluation, described in more detail on page 87. The Committee was found to be functioning effectively. Paul Manduca Chairman of the Nomination and Governance Committee Committee members — Paul Manduca (Chairman) — Howard Davies — Ann Godbehere — Anthony Nightingale — Philip Remnant Regular attendees — Group Chief Executive — Group Human Resources Director — Group General Counsel and Company Secretary Number of meetings in 2016: four 92 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsHow the Committee spent its time during 2016 The table below provides an overview of how the Committee spent its time in 2016. Re-election of Directors, Non-executive Directors’ performance and independence Succession planning Membership review of principal Board Committees Material subsidiary governance Committee terms of reference Note 1 Two meetings were held in February. Key matters considered during the year Matter considered How the Committee addressed the matter Feb1 Sep Nov Succession planning — Appointments The Committee kept succession plans for executive and non-executive Board roles under continuous review. This review takes account of the size, structure and composition of the Board and its Committees, including the overall knowledge, experience and diversity of the Board. The Committee makes recommendations to the Board based on its review as necessary. – Non-executive Directors During 2016, the Committee considered information about potential candidates who might be appointed to the Board as Non-executive Directors to keep the Board composition progressively refreshed in the future, assisted by Russell Reynolds as search consultant. − Executive Directors — Re-election of Directors John Foley and Anne Richards were appointed during 2016. The work of the Committee in respect of those appointments, which was supported by Egon Zehnder as search consultant, is described in the Annual Report for 2015. The Committee received details of the succession plans in place for Executive Directors and other senior management positions. The development and renewal of these plans was led by the Group HR Director, who was supported by Egon Zehnder in identifying candidates who could be considered successors for key roles. Russell Reynolds has no additional connection with Prudential. In addition to acting as search consultant for certain executive hires, Egon Zehnder also provides support for senior development assessments. As part of its ongoing work on Board succession planning, the Committee considered the terms of appointment for the Chairman, Committee Chairmen and Non-executive Directors taking into account time commitment and the general balance of skills, experience and knowledge on the Board, assessing length of service in their roles. Having reviewed the performance of relevant Non-executive Directors in office at the time, the Committee recommended to the Board that those Non-executive Directors should stand for re-election at the 2017 Annual General Meeting. The Committee considered the term of appointment of Ann Godbehere, who has been a Non- executive Director since 2007 and Chairman of the Audit Committee since 2010. In line with corporate governance guidelines, Ms Godbehere does not intend to stand for re-election in 2017. Philip Remnant completed his first term of three years following his initial appointment by shareholders at the 2013 Annual General Meeting. Following performance evaluation by the Committee and re-election by shareholders in 2016, he was invited to serve a further term of three years, expiring at the conclusion of the 2019 Annual General Meeting. Independence The Committee considered the independence of the Non-executive Directors against relevant requirements as outlined on page 89. 93 www.prudential.co.ukAnnualReport2016 Prudential plc 03 Governance Key matters considered during the year continued Matter considered How the Committee addressed the matter Conflicts of interest The Board has delegated authority to the Committee to consider, and authorise where necessary, any actual or potential conflicts of interest in accordance with relevant legislation, the provisions in the Company’s Articles and the procedures approved by the Board. In February 2016, the Committee considered the external appointments of all Directors and reviewed existing conflict authorisations, reaffirming or updating any terms or conditions attached to authorisations where required. No other conflict matters were brought to the Committee. New external positions were reviewed during the year as they arose. The Board considers that the procedure set out above for dealing with conflicts of interests has operated effectively. Governance — Group subsidiaries In February, the Committee expanded its remit to include oversight of the material subsidiary governance and independent directors. During the year, the Committee approved the appointments of the material subsidiary chairs (including Philip Remnant and Kai Nargolwala), reviewed the material subsidiary governance arrangements, approved the terms of reference for the material subsidiary boards and board chairs, and monitored the embedding of governance processes. 94 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinuedAudit Committee report Dear Shareholder As Chairman of the Audit Committee, I am pleased to report on the Committee’s activities and areas of focus over the course of 2016. The Committee met on 10 occasions during the year. The Committee works closely with the Risk Committee to ensure both Committees are updated on matters which impact on their responsibilities. Where a matter requires input from both Committees, joint meetings are held with the Risk Committee. In 2016, one joint meeting with the Risk Committee took place to discuss the Solvency II capital position as at 31 December 2015 and associated governance processes. We maintained our focus during the year on monitoring the integrity of financial reporting and ensuring suitable accounting policies were adopted and applied consistently. We reviewed management’s annual process for setting assumptions underpinning the Group’s European Embedded Value (EEV) results and IFRS insurance liabilities and requested additional analysis and information where we felt this was required. Clarity of the Group’s external disclosures is an important consideration of the Committee and we assessed whether the financial report for 2016 was fair, balanced and understandable before making a recommendation to the Board. Additional consideration was given to the Group’s disclosure of alternative performance measures in light of new regulatory guidance and the Committee reviewed and agreed the resulting refinements to the Group’s disclosures. We also reviewed the Group’s external Solvency II disclosures following the formal introduction of the Solvency II framework for European insurers at the start of 2016. We approved all non-audit services, as well as audit services, to ensure our auditor remains independent. We continued with our annual process of monitoring auditor effectiveness through a Group-wide questionnaire of senior finance personnel. We meet privately with both the internal and external auditors to ensure they are able to operate effectively and to satisfy ourselves that management are responsive to their findings and recommendations. We continued to monitor second and third line of defence functions to ensure their effectiveness. During 2016, the Audit Committee commissioned an external review to provide an independent assessment of compliance monitoring and internal audit reviews. Recommendations from this work have been approved and integrated into the respective functional plans going forward. The focus of the compliance plan is on strengthening the Compliance framework and further enhancing monitoring arrangements and mitigation of key risks. The internal audit plan provides risk-based coverage of financial, business change, regulatory and operational risk drivers and of customer outcomes. We also refined our governance processes during the year to enhance the information the Committee receives on the activities of our business unit audit committees and to ensure key issues are escalated appropriately. I maintain regular contact with the audit committee chairs of our material subsidiaries and report to the Committee on the issues we discuss. As Chairman of the Committee, I have responsibility for ensuring the Committee operates effectively. To ensure we do so and provide constructive challenge to management, I encourage open debate and contributions from all Committee members. An annual review of our effectiveness was carried out as part of the Board evaluation, described in more detail on page 87. The Committee was found to be functioning effectively. This will be my last report as Audit Committee Chairman and Non-executive Director. Having served nine years on the Board, I will not offer myself for re-election at the 2017 Annual General Meeting. It has been my pleasure to serve as chairman of Prudential’s Audit Committee and I am confident that I leave the Committee functioning well with a clear mandate of its priorities for the future. I would like to take this opportunity to thank my fellow committee members for their diligence and to thank everyone on the Prudential team who have supported me and the Committee over the years with such dedication and professionalism. Ann Godbehere Chairman of the Audit Committee Committee members — Ann Godbehere (Chairman) — Howard Davies — Alistair Johnston (until May 2016) — David Law — Philip Remnant — Alice Schroeder Regular attendees — Chairman of the Board — Group Chief Executive — Chief Financial Officer — Group Chief Risk Officer — Director of Group Finance — Group Regulatory and Government Relations Director — Group General Counsel and Company Secretary — Director of Group Compliance — Director of Group-wide Internal Audit — External Audit Partner Number of meetings in 2016: 10 (in addition, a joint meeting was held with the Risk Committee) 95 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow the Committee spent its time during 2016 The table below provides an overview of how the Committee spent its time in 2016. Jan Feb Mar1 Apr May Jul Aug Nov Dec Financial reporting and external auditor Periodic financial reporting including: — key accounting judgements and disclosures, — Solvency II results and governance processes, and — associated audit reports Developments in tax disclosures Audit planning, fees, effectiveness, independence and re-appointment Internal control framework effectiveness Internal control framework effectiveness Internal auditors Status updates and effectiveness Internal audit plan for 2017 Compliance Status updates Compliance plan for 2017 Financial crime and whistleblowing Update on whistleblowing issues raised Anti-money laundering report Security and resilience development plan Governance Internal framework effectiveness/ refresh Planning for ESG governance and reporting Business unit audit committee effectiveness and terms of reference Committee terms of reference Note 1 Two meetings were held in March. 96 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinued Key matters considered during the year Matter considered How the Committee addressed the matter Financial reporting and tax Overview Key assumptions and judgements One of the Committee’s key responsibilities is to monitor the integrity of the financial statements. The Committee assessed whether appropriate accounting policies had been adopted throughout the accounting period and whether management had made appropriate estimates and judgements over the recognition, measurement and presentation of the financial results. There were no new or altered accounting standards in 2016 that had a material effect on the Group’s financial statements. The Committee also reviewed the accounting for the planned disposal of the Korea life business, together with the presentation in the financial statements. The Committee considered compliance with accounting standards and obligations under applicable laws, regulations and governance codes. Particular areas on which the Committee focused during the year included the fair, balanced and understandable requirement under the UK Corporate Governance Code, providing advice to the Board in respect of this requirement. This included consideration of any resulting changes to disclosures following the decision by the UK to leave the European Union in June. The Committee also focused on the guidance issued by the European Securities and Markets Authority on Alternative Performance Measures that was effective for the first time in 2016. The Committee reviewed and agreed the refinements to the Group’s disclosures as a result of that new guidance. The Committee reviewed the key assumptions and judgements made in valuing the Group’s investments, insurance liabilities and deferred acquisition costs under IFRS, together with reports on the operation of internal controls to derive these amounts. It also reviewed the assumptions underpinning the Group’s European Embedded Value (EEV) metrics. The Committee considered information, including peer comparisons if relevant and available, on the following key assumptions: — Persistency, mortality, morbidity and expense assumptions within the Asia life businesses; — Economic and policyholder behaviour assumptions affecting the measurement of Jackson guaranteed liabilities and amortisation of deferred acquisition costs; and — Mortality, expense and credit risk assumptions for the UK annuity business. 2016 saw the formal introduction of the Solvency II framework for European insurers. The Committee reviewed the Group’s external disclosures of its Solvency II position, together with the consistency of assumptions with those used for IFRS and EEV reporting where relevant. In addition, given the adoption of Solvency II as the local regulatory requirement for the UK business, it reviewed the impact of the change in local capital regime on the EEV results for the UK insurance operations. The Committee also received information on the nature of goodwill and intangible asset values and the carrying value of investments in the Group’s balance sheet. It considered what factors might give rise to an impairment of the Group’s intangibles and whether those factors had arisen in the period. The Committee was satisfied that there was no impairment of the Group’s intangibles at 31 December 2016. Following the UK referendum in June, where the majority voted in favour of leaving the European Union, and the resulting suspension of trading by some property funds, the Committee reviewed the Group’s valuation basis for property investments and property funds at 30 June. The Committee satisfied itself that these and other investments were valued appropriately. Solvency II results and associated governance processes were considered in a separate meeting held jointly with the Risk Committee. No significant issues arose in respect of these items. 97 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceKey matters considered during the year continued Matter considered How the Committee addressed the matter The Committee considered various analyses from management regarding Group and subsidiary capital and liquidity prior to recommending to the Board that it could conclude that the financial statements should continue to be prepared on the going-concern basis and the disclosures on the Group’s longer-term viability were both reasonable and appropriate. The Committee reflected on how the viability statement could be enhanced to give more insight on the conclusions reached and updates were made accordingly. As part of its assessment of the description of performance within the Annual Report, the Committee considered judgemental aspects of the Group’s reporting across the Group’s IFRS and EEV metrics. This assessment included a review to ensure that the allocation of items between operating and non-operating profit was in accordance with the Group’s accounting policy. The Committee considered the impact of equity and interest rate movements on the IFRS results of the Group’s US business and after discussion, the Committee was satisfied that the presentation and disclosure of such impacts was appropriate and consistent with prior periods. The Audit Committee also considered judgemental matters regarding provisions for certain open tax items including tax matters in litigation. The Committee received information on the Group’s annual risk rating meeting with HM Revenue & Customs. The Committee reviewed the Group’s preparations for new country-by-country reporting disclosure requirements to tax authorities, and the Group’s preparations for public disclosure of the Group’s tax strategy. The Committee was satisfied that management’s approach was reasonable in these areas. For all the above areas, the Committee received input from management and the external auditor prior to reaching its conclusions. In addition to these reporting matters, the Committee also received and considered regular updates from management on the status and implications for the Group of financial reporting developments, including updates on discussions by the International Accounting Standards Board on the development of the IFRS 17 Insurance Standard (known previously as “IFRS 4 Phase II”) and the permitted deferral of IFRS 9 by insurers. The Group’s external auditor is KPMG LLP and oversight of the relationship with them is one of the Committee’s key responsibilities. The Committee approved KPMG’s terms of engagement for the statutory audit, and approved fees for both audit and non-audit services in accordance with the Group’s policy. To assess the effectiveness of the auditor, the Committee reviewed the audit approach and strategy, and received an internal report on their performance. The separate internal evaluation of the auditor was conducted using a questionnaire which was circulated to the Committee, the Chief Financial Officer and the Group’s senior financial leadership for completion. In total, 89 people provided input on the performance of the auditor. The feedback provided was reviewed and compiled into a report for the Committee which covered areas such as the knowledge and expertise of the partners and team members, their understanding of the Group, the resourcing applied to the audit and continuity of the team, liaison with Group-wide Internal Audit and approach to resolution of issues, as well as factors such as their coordination across the Group’s multiple jurisdictions and quality of their written and oral communication. The degree of challenge and robustness of approach to the audit were key components of the evaluation. The Committee Chairman invited other Group stakeholders to provide their views on the performance of the auditor, and KPMG was given the opportunity to respond to the findings in the report. In addition to the usual auditor effectiveness process, early in 2016 the Committee also considered KPMG’s response to a report issued by the Financial Reporting Council’s Audit Quality Review team following inspection of KPMG’s 2014 audit. The Committee discussed the actions undertaken by KPMG as part of their 2015 audit to address the matters raised. It agreed that any identified areas for further improvement had been addressed or had appropriate action plans in place. On completion of the activities outlined above, the Committee concluded that the audit had been effective and the challenge appropriately robust across all parts of the Group. Other financial reporting matters and tax reporting External audit, review of effectiveness, non-audit services and auditor reappointment External audit effectiveness 98 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinuedMatter considered How the Committee addressed the matter Auditor independence and objectivity The Committee has responsibility for monitoring auditor independence and objectivity and is supported in doing so by the Group’s Auditor Independence Policy (the Policy). The Policy is updated annually and approved by the Committee. It sets out the circumstances in which the external auditor may be permitted to undertake non-audit services and is based on four key principles which specify that the auditor should not: Fees paid to the auditor Reappointment Audit tender — Audit its own firm’s work; — Make management decisions for the Group; — Have a mutuality of financial interest with the Group; or — Be put in the role of advocate for the Group. The Policy has two permissible service types: those that require specific approval by the Committee on an engagement basis and those that are pre-approved by the Committee with an annual monetary limit. In accordance with the Policy, the Committee approved these permissible services, classified as either audit or non-audit services, and monitored the usage of the annual limits on a quarterly basis. All non-audit services undertaken by KPMG were agreed prior to the commencement of work and were confirmed as permissible for the external auditor to undertake under the provisions of the Sarbanes- Oxley Act. In November 2016, the Committee considered and approved revisions to the Policy with effect from 1 January 2017, to reflect final rules and guidance issued by the Financial Reporting Council, in connection with the implementation of broader European Union (EU) reforms to the audit market. The most significant change was to reduce the annual monetary limits for services that are pre-approved by the Committee. These revisions build on the previous year’s updates, where amendments to the Policy were made to ensure the schedule of prohibited non-audit services was in line with the EU reforms referenced above. These changes were effective throughout 2016. In keeping with professional ethical standards, KPMG also confirmed their independence to the Committee and set out the supporting evidence for their conclusion in a report that was considered by the Committee prior to publication of the financial results. The fees paid to KPMG for the year ended 31 December 2016 amounted to £16.2 million (2015: £16.6 million) of which £2.8 million (2015: £4.3 million) was payable in respect of non-audit services. Non-audit services accounted for 17 per cent of total fees payable (2015: 26 per cent). A breakdown of the fees paid to KPMG can be found in Note B3.4 to the financial statements on page 193. Of the £2.8 million of non-audit services, the principal types of non-audit engagements approved for 2016 were other assurance services of £2.7 million (of which £1.5 million related to Solvency II reporting and disclosures) and other non-audit services of £0.6 million. Based on the outcome of the effectiveness evaluation and all other considerations, the Committee recommended that KPMG be reappointed as the auditor. A resolution to this effect will be proposed to shareholders at the 2017 Annual General Meeting. The external audit was last put out to competitive re-tender in 1999 when the present auditor, KPMG, was appointed. Since 2005, the Committee has annually considered the need to re-tender the external audit service and it again considered this in May 2016, concluding that there was nothing in the performance of the auditor which required such a tender. The Committee acknowledges the provisions contained in the UK Code in respect of audit tendering, along with European rules on mandatory audit rotation and audit tendering. In conformance with these requirements, the Company will be required to change audit firm no later than for the 2023 financial year end. The Committee also recognises that the industry is in a period of unprecedented change with the IASB expecting to issue a new insurance accounting standard in 2017, for implementation in 2021. The Committee currently believes any change of auditor should be scheduled to limit operational disruption during such a period of change and, as a consequence, is not currently planning to re-tender the audit before the adoption of IFRS 17. This remains subject to the Committee’s normal annual review. The Company has complied throughout the 2016 financial year with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 issued by the Competition and Markets Authority. In line with the Auditing Practices Board Ethical Statements and the Sarbanes-Oxley Act, a new lead audit partner is appointed every five years. A new lead audit partner was appointed in respect of the 2012 financial year who will be replaced following the completion of this 2016 reporting cycle. The replacement lead audit partner has been identified. 99 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceKey matters considered during the year continued Matter considered How the Committee addressed the matter Third line oversight – internal audit Regular reporting The Committee is responsible for approval of the internal audit programme and monitoring the effectiveness of the internal audit function. The independent assurance provided by Group-wide Internal Audit (GwIA) formed a fundamental part of the Committee’s deliberations on the Group’s overall control environment. The Committee received regular updates on audits conducted and management’s progress in addressing audit findings. Each of the Group’s business units has an internal audit team, the heads of which report to the Director of Group-wide Internal Audit. The function also has a Quality Assurance Director, whose primary role is to monitor and evaluate adherence to industry practice guidelines and Group-wide adherence to GwIA’s own standards and methodology. Internal audit resources, plans, budgets and its work, including the function’s annual review of the control environment and risk, and control culture of the organisation, are overseen by both the Committee and the relevant business unit audit committee. The Director of GwIA reports functionally to the Chairman of the Committee and for management purposes to the Group Chief Executive, and also has direct access to the Chairman of the Board. In addition to formal Committee meetings, the Committee meets with the Director of GwIA in private to discuss matters relating to, for example, the effectiveness of the internal audit function, significant audit findings and the risk and control culture of the organisation. Annual plan and focus for 2017 The Committee approved the half year update of the 2016 plan. It also considered and approved the Internal Audit Plan, resource and budget for 2017. At the half year, the Committee considered recommendations to refresh the Internal Audit Plan in response to changes in the business unit operating environments and an update to the Group’s top risks. The 2017 Internal Audit Plan was formulated based on a bottom-up risk assessment of audit needs mapped against various metrics combined with top-down challenge by the GwIA Leadership Team and executive management at business unit and Group level. The plan was then mapped against a series of risk and control parameters, including the top risks identified by the Risk Committee, to verify that it is appropriately balanced between financial, business change, regulatory and operational risk drivers and provides appropriate coverage of key risk areas and audit themes within a risk-based cycle of coverage. Key areas of focus for 2017 include programme assurance, cyber security, outsourcing arrangements, customer outcomes and governance. The Committee assesses the effectiveness through a combination of external effectiveness reviews, required every five years (last conducted in 2012), and an annual internal effectiveness review, performed by the GwIA Quality Assurance Director. In 2016, Deloitte assessed the overall GwIA annual planning approach and the quality of audit work and concluded that the function ‘is a well- developed group function that applies a number of leading practices on a consistent basis across the Prudential Group, including advanced data analytics capabilities and well embedded approaches for conducting audits’. In addition, an internal effectiveness review was conducted in 2016, in accordance with the professional practice standards of the Chartered Institute of Internal Auditors (CIIA). This review concluded that GwIA continues to comply with the requirements of internal audit policies, procedures and practices, and standards in all material respects relating to audit planning and execution, and continued to be aligned with its mandated objectives and maintained general conformance with the CIIA guidance for Effective Internal Audit in the Financial Services Sector. Having considered the findings of Deloitte’s review and the 2016 internal effectiveness review, the Committee concluded that GwIA had continued to operate in compliance with the requirements of GwIA policies, procedures and practice standards in all material respects and had remained aligned to mandated objectives during 2016. Internal audit effectiveness 100 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinuedMatter considered How the Committee addressed the matter Business unit audit committee effectiveness Business unit model terms of reference The Committee is supported by the work carried out by the material subsidiary and other business unit audit committees and annually reviews the effectiveness of these committees in meeting their defined terms of reference. These audit committees provide oversight of the respective business units. During the year, membership of the committees for all material subsidiaries has been changed to comprise solely of independent non-executive directors. The minutes of all business unit audit committees were provided to the Committee and their meetings were attended by the external auditor, as well as senior management from the business unit (including the Business Unit Chief Executive, heads of Finance, Risk, Compliance and GwIA) and from Group Head Office. In addition, the Committee chairman meets in person or telephonically at least quarterly with the chairs of each of the material subsidiary audit committees. The Committee’s assessment of these committees was supported by local teams from GwIA and considered whether each of the committees fulfilled the responsibilities documented in their terms of reference. Attendance rates by audit committee members and evidence of the audit committees’ coverage of key business unit issues, as well as the appropriate escalation of concerns to the Committee, formed part of the criteria used for the evaluation. The Committee approved the Group’s standard terms of reference for the material subsidiary and other business unit audit committees, which were updated to reflect changes in the Committee’s own responsibilities to align them with best practice, as well as the change in membership for the material subsidiaries. These were adopted by the business unit audit committees with minor variations to address local regulations or the particular requirements of the business. Second line oversight – compliance, financial crime prevention, whistleblowing Regular reporting from Compliance Regular updates were provided to the Committee by the Group Regulatory and Government Affairs Director and the Group Compliance Director. The reports kept the Committee apprised of key compliance activities, issues and controls, including progress against the 2016 Compliance Plan, the outcome of compliance monitoring activities across the Group and the effectiveness of business units compliance departments. Compliance Plan and focus for 2017 Financial crime prevention Whistleblowing Internal control Internal control and risk management systems The Committee considered and approved the 2017 Group Compliance Plan. Areas of focus included strengthening the compliance framework, enhancing compliance monitoring arrangements and mitigation of key risks, including conflicts of interest, the fair treatment of customers and anti-money laundering and sanctions. Following the external review of the effectiveness of compliance monitoring, the Plan includes developing a more consistent approach to the planning, execution and reporting of compliance monitoring activity across the Group. The Committee received the Money Laundering Prevention Officer’s report which assessed the operation and effectiveness of the Group’s systems and controls in relation to managing money laundering and sanctions risk. The Committee noted the regulatory developments relating to initiatives by the Financial Action Task Force and the 4th EU Anti-Money Laundering Directive. An external review of the Group’s anti-bribery and corruption programme was undertaken this year and the Committee noted the recommendations being taken forward by management. The Committee noted the launch of an enhanced, Group-wide whistleblowing programme (‘Speak Out’), reflecting UK regulatory changes and the Group’s geographic expansion. The programme captures and comprehensively records matters raised through the Group’s Confidential Reporting process. Throughout the year, the Committee has continued to receive regular updates on such matters and the actions taken to address them. The role of the whistleblowing champion, for the purpose of the Senior Insurance Managers Regime, will be carried out by the chair of the UK business unit risk committee. At Group level, the Chair of the Audit Committee remains responsible for oversight of whistleblowing activities across the whole of the Group. The Committee is responsible for reporting and making recommendations to the Board on the effectiveness of Group-wide internal control and risk management systems. The Committee considered the outcome of the annual review of the systems of internal control and risk management. The report considered all material controls, including financial, operational and compliance controls and reflected changes in the HK Code which became effective for financial years commencing on or after 1 January 2016. Having considered the review, the Committee made recommendations to the Board regarding the ongoing processes and effectiveness of the risk management and internal control systems in place. The Board’s statement regarding effectiveness of these systems can be found on page 91. 101 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceKey matters considered during the year continued Matter considered How the Committee addressed the matter Governance Group Governance Framework The Group Governance Manual sets out the policies and processes by which the Group operates within its framework of internal governance, taking into account relevant statutory and regulatory matters. Used as a platform for mandating specific ways of working across the Group, each business unit attests annually to compliance with: — Mandatory requirements set out in Group-wide policies; — Matters requiring prior approval from those parties with delegated authority; and — Matters which must be reported to the Group Functions. The Committee reviewed the results of the Group Governance Manual annual content review to ensure its continued effectiveness and long-term value to the Group, and the results of the year end certification of compliance with Group Governance Manual requirements for the period ended 31 December 2016. Committee effectiveness A review of the Committee’s activities was conducted against applicable regulation and codes of conduct. The results of this assessment were provided to the Committee alongside the outcome of the part of the annual Board evaluation relating to the Committee. 102 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinuedthe development of the Systemic Risk Mitigation Plan, the Liquidity Risk Mitigation Plan and the Recovery Plan. We also considered the methodology underpinning and validation of our Solvency II internal model, oversaw the delivery of the Group’s major Model Change application to the PRA, and risks arising from the Solvency II regime. We provided oversight of the Group’s planning for, and response to, the results in the Brexit referendum and US presidential election that have driven increased uncertainty in markets and the macroeconomic environment. We reviewed in depth the risk arising from our business, including examining the hedging programme in Jackson, and persistency and policyholder behaviour risks across the Group. Other areas of focus in 2016 included reviewing our cyber defence resilience and defence strategy, and reviewing the effectiveness of the risk management functions across the Group. We commissioned a number of ‘deep dive’ reviews to support these areas, and monitored the implementation of recommendations arising. We also refined our governance processes during the year to enhance the information the Committee receives on the activities of our business unit risk committees and ensure key issues are escalated appropriately. I maintain regular contact with the risk committee chairs of our material subsidiaries and report to the Committee on issues we discuss. Looking forward into 2017, the Committee will remain focused on monitoring the Group’s principal risks and those posed by regulatory developments and macroeconomic conditions. We approved the 2017 plans for the Risk function, and will continue to adapt our plan of work to respond to any changes in the business environment or the Group’s strategy. As Chairman of the Committee, I have responsibility for ensuring the Committee operates effectively. To ensure we do so and provide constructive challenge to management, I encourage open debate and contributions from all Committee members. An annual review of our effectiveness was carried out as part of the Board evaluation, described in more detail on page 87. The Committee was found to be functioning effectively. Risk Committee report Dear Shareholder As Chairman of the Risk Committee, I am pleased to report on the Committee’s activities and focus during 2016. The Committee assists the Board in providing leadership, direction and oversight of the Group’s overall risk appetite and limits, risk strategy and risk culture. We also oversee and advise the Board on current and future risk exposures of the Group, including those which have the potential to impact on the delivery of the Group’s business plan. The Committee reviews and approves the Group Risk Framework and monitors its appropriateness in identifying and managing the risks faced by the Group. The committee met on eight occasions during the year. We work closely with the Audit Committee to ensure both Committees are updated on matters which impact on their responsibilities. Where a matter requires input from both Committees, joint meetings are held with the Audit Committee. In 2016, one joint meeting with the Audit Committee took place to discuss the Solvency II capital position as at 31 December 2015 and associated governance processes. During 2016, we reviewed the Group’s risk policies and updated the Group’s risk appetite limits to reflect changes in the Group’s risk profile and the evolving regulatory and macroeconomic environments. We also reviewed the principal risks facing the Group and received regular updates on these through the course of the year. We receive regular reports from the Chief Risk Officers of our material subsidiaries. Over 2016, we continued to focus on the key risks arising from the products we offer to our customers, the risks inherent in our investment portfolios, and the operational risks that arise from operating our businesses. We regularly reviewed the strength of our capital and liquidity positions, and the significant ongoing changes to the regulatory framework and environment. In addition, we closely monitored risks arising from the macroeconomic environment and regulatory developments such as the risks relating to prolonged low interest rates and the pace of regulatory developments across the globe. During 2016, we oversaw the work required as a result of the Group’s continuing designation as a Global Systemically Important Insurer, including Howard Davies Chairman of the Risk Committee Committee members — Howard Davies (Chairman) — Ann Godbehere — Kai Nargolwala — Lord Turner Regular attendees — Chairman of the Board — Group Chief Executive — Group Chief Risk Officer — Chief Financial Officer — Group Regulatory and Government Relations Director — Group General Counsel and Company Secretary — Director of Group-wide Internal Audit Number of meetings in 2016: eight (in addition, a joint meeting was held with the Audit Committee) 103 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceHow the Committee spent its time during 2016 The table below provides an overview of how the Committee spent its time in 2016. Feb Apr May Jul Sep Oct Nov Markets and Group risk updates Market conditions and impact Group risk update Risk management Group top risk identification Top risk discussions Business unit specific risk matters Risk assessment of business plan Risk function effectiveness Regulatory matters Regulatory matters Risk framework Solvency II internal model development Risk limit updates Risk policy framework refresh Year end E-cap results Governance and reporting Year end risk disclosures Policy compliance Own Risk and Solvency Assessment Compliance report Global Systemically Important Insurer: Liquidity Risk Management Plan, Systemic Risk Management Plan and Recovery Plan Solvency II reporting and governance processes IFRS Phase II Environmental Social Governance (ESG) reporting Committee terms of reference 104 Prudential plc Annual Report 2016 www.prudential.co.ukCommittee reportsContinuedKey matters considered during the year Matter considered How the Committee addressed the matter Risk appetite Risk management Group top risks As part of the Group’s business plan, risk appetite limits were reviewed and updated. The primary driver of the changes was the increased macroeconomic uncertainty and market volatility, while regulatory and business change continued. In order to be confident that the business continued to remain within risk appetite, risk limits were reviewed and several new measures introduced. Annually, business units must assess and certify their compliance with the Group Risk Framework and risk policies as part of the annual Group Governance Manual certification. The annual certification process for risk policies is facilitated by Group Risk and subject to oversight by the Risk Committee. In 2016, the Group Risk Framework and risk policies were subject to their annual review, with changes being approved by the Risk Committee. The Risk Committee approved a number of deep dives to be undertaken during 2016. These focused on risks embedded within the existing portfolio of products in our US, Asia and UK businesses. The Group Cyber Risk Strategy was overseen by the Risk Committee in mid 2016. The Committee reviewed the Cyber Defence Plan, providing further detail around the implementation of the cyber strategy at the end of 2016. The Cyber Strategy and Defence Plan articulate the strategic outcomes and key deliverables relating to our cyber resilience. The Committee also agreed the characteristics of an effective risk function and conducted its first annual review of risk effectiveness in May. The Committee evaluated the Group’s top risks, considering recommendations for promoting additional risks, expanding the scope of existing risks, and removing those risks no longer requiring particular focus from the Committee. The Committee received regular reporting on the top risks and mitigating actions over the course of the year. The Group Chief Risk Officer’s reports also provided the Committee with regulatory updates, particularly regarding Solvency II, the Group’s Internal Model, development of the Group’s global capital standards and the deliverables required as a result of the Group’s designation as a Global Systemically Important Insurer. Solvency II and Pillar 3 reporting The Committee considered the Own Risk and Solvency Assessment report based on the outcomes of the Group’s business plan, the results of the Group’s regular stress and scenario testing, and the current and projected risk and solvency positions prior to its approval by the Board. The approval of the Solvency II Internal Model formalised the Group’s Model change process, which records, evaluates and reports changes to management and the regulator. The Major Model Change application was closely overseen by the Risk Committee throughout 2016 and approved before submission to the regulator. Solvency II results and associated governance processes were considered in a separate meeting held jointly with the Audit Committee. The Financial Stability Board announced on 3 November 2015 that the Group continues to be designated as a Global Systemically Important Insurer. In 2016, the Group was required to update the 2015 Global Systemically Important Insurer deliverables – these include the Systemic Risk Management Plan, Recovery Plan and Liquidity Risk Management Plan. The Committee played a key part in considering and approving a number of these, including the Group’s Liquidity Risk Management Plan, Systemic Risk Management Plan and Recovery Plan. Stress and scenario testing is a key risk measurement and management tool for the Group. The Reverse Stress Test exercise was carried out to confirm the Group’s position as being significantly resilient to certain business failure scenarios. The report related to the Group’s year end 2016 position and was submitted to the PRA. Global Systemically Important Insurer Reverse stress testing Committee effectiveness A review of the Committee’s activities was conducted against applicable regulation and codes of conduct. The results of this assessment were provided to the Committee alongside the outcome of the part of the annual Board evaluation relating to the Committee. Compliance reporting The Committee received reporting on key compliance risks and mitigation activity, including customer risk, conflicts of interest, financial crime and the implementation of the Senior Insurance Managers Regime. The Committee also reviewed and approved a number of regulatory compliance risk-related policies. 105 www.prudential.co.ukAnnualReport2016 Prudential plc 03 Governanceinformation which form part of the Group’s internal governance framework. As part of the framework, the Group has adopted an Inside Information Policy which includes guidance and procedures for the identification and escalation of inside information as well as appropriate controls on the disclosure of such information in line with regulatory requirements. Compliance with corporate governance codes The Board confirms that the Company has complied with all principles and relevant provisions of both the UK and HK Corporate Governance Codes throughout the accounting year. An explanation of how the principles and provisions have been applied is set out in this report and in the Directors’ remuneration report on pages 109 to 157. With respect to Code Provision B.1.2(d) of the HK Code, the responsibilities of the Remuneration Committee do not include making recommendations to the Board on the remuneration of the Non-executive Directors. In line with the principles of the UK Code, fees for the Non-executive Directors are determined by the Board. The UK Code can be viewed on the FRC’s website and the HK Code is available on the website of the HK Stock Exchange. Statutory and regulatory disclosures Financial reporting The Directors have a duty to report to shareholders on the performance and financial position of the Group and are responsible for preparing the financial statements on pages 160 to 318 and the supplementary information on pages 324 to 361. It is the responsibility of the auditor to form independent opinions, based on its audit of the financial 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 319 to 322 and page 362. Company law requires the Directors to prepare financial statements for each financial year that give a true and fair view of the financial affairs of the Company and of the Group. The criteria applied in the preparation of the financial statements are set out in the statement of Directors’ responsibilities on page 318 and page 361. Company law also requires the Board to approve the Strategic report. In addition, the UK Code requires the Directors’ statement to state that they consider the Annual Report and financial statements, taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy. The Directors are further required to confirm that the Strategic report includes a fair review of the development and performance of the business, with a description of the principal risks and uncertainties. Such confirmation is included in the statement of Directors’ responsibilities on page 318 and page 361. The Strategic report provides, on pages 47 and 48, a description of the Group’s capital position, financing and liquidity. The risks facing the Group’s business and how these are managed are discussed in the audited sections of the Group Chief Risk Officer’s report on pages 50 to 60. The Directors who held office at the date of approval of this Directors’ report confirm 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 confirmation is given and should be interpreted in accordance with the provisions of Section 418 of the Companies Act 2006. 106 Going concern In accordance with the requirements of the guidance issued by the Financial Reporting Council in September 2014 ‘Guidance on Risk Management, Internal Control and Related Financial and Business Reporting’, after making sufficient enquiries the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue their operations for a period of at least 12 months from the date that the financial statements are approved. 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 Strategic report on pages 10 to 73. The risks facing the Group’s capital and liquidity positions and their sensitivities are referred to in the Strategic report on pages 50 to 61. The Group’s IFRS financial statements include the details of the Group’s borrowings in Note C6 on page 255, the market risk and liquidity analysis associated with the Group’s assets and liabilities can be found in Note C3.4(a) on pages 224 and 225, policyholder liability maturity profile by business units in Notes C4.1(b), (c) and (d) on pages 232, 234 and 236 respectively, cash flow details in the consolidated statement of cash flows and provisions and contingencies in Notes C11 and D2. The Directors therefore consider it appropriate to continue to adopt the going concern basis of accounting in preparing the financial statements for the year ended 31 December 2016. Powers of the Board The Board may exercise all powers conferred on it by the Company’s Articles 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) and to give a guarantee, security or indemnity in respect of a debt or other obligation of the Company. Securities dealing and inside information Prudential has adopted securities dealing rules relating to transactions by Directors on terms no less exacting than required by Appendix 10 to the HK Listing Rules and by relevant UK regulations (the UK Model Code was replaced by the Market Abuse Regulation with effect from 3 July 2016). The Directors have complied with this code of conduct throughout the period. Relevant controls are applied to the handling and dissemination of inside Prudential plc Annual Report 2016 www.prudential.co.ukAdditional information US regulation and legislation As a result of its listing on the New York Stock Exchange, the Company is required to comply with the relevant provisions of the Sarbanes-Oxley Act 2002 as they apply to foreign private issuers and has adopted procedures to ensure such compliance. In particular, in relation to Section 302 of the Sarbanes-Oxley Act 2002 which covers disclosure controls and procedures, a Disclosure Committee has been established, reporting to the Group Chief Executive, chaired by the Chief Financial Officer and comprising members of head office management. The work of the Disclosure Committee supports the Group Chief Executive and Chief Financial Officer in making the certifications regarding the effectiveness of the Group’s disclosure procedures. 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. Customers The five largest customers of the Group constituted in aggregate less than 30 per cent of its total sales for each of 2016 and 2015. 107 www.prudential.co.ukAnnualReport2016 Prudential plc 03 GovernanceIndex 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) Disclosure of information to auditor Additional disclosures Directors in office during the year Board of Directors Corporate responsibility governance Corporate responsibility review Employment policies and employee involvement Corporate responsibility review Greenhouse gas emissions Corporate responsibility review Political donations and expenditure Corporate responsibility review Remuneration Committee report Directors’ remuneration report Directors’ interests in shares Directors’ remuneration report Agreements for compensation for loss of office or employment on takeover Directors’ remuneration report Details of qualifying third-party indemnity provisions Governance report Internal control and risk management Powers of Directors Governance report Governance report Rules governing appointment of Directors Governance report Significant agreements impacted by a change of control Governance report Future developments of the business of the Company Group Chief Executive’s report 106 77 to 81 62 to 73 69 71 and 72 68 110 to 157 131 and 132 133 and 134 89 90 and 91 106 89 107 4 to 7 Post-balance sheet events Note D3 of the Notes on the Group financial statements 283 Rules governing changes to the Articles of Association Shareholder information Structure of share capital, including changes during the year and restrictions on the transfer of securities, voting rights and significant shareholders Shareholder information and Note C10 of the Notes on the Group financial statements 402 275 10 to 73 Business review Changes in borrowings Dividend details Financial instruments Strategic report Strategic report and Note C6 of the Notes on the Group financial statements. 47, 48 and 255 Strategic report Strategic report 49 50 to 60 and 392 In addition, the risk factors set out on pages 392 to 397 and the additional unaudited financial information set out on pages 364 to 391, are incorporated by reference into the Directors’ report. Signed on behalf of the Board of Directors Alan F Porter Group General Counsel and Company Secretary 13 March 2017 108 Prudential plc Annual Report 2016 www.prudential.co.uk04 Directors’ remuneration report 110 Annual statement from the Chairman of the Remuneration Committee 112 Our Executive Directors’ remuneration at a glance 114 Summary of the current Directors’ remuneration policy 118 Annual report on remuneration 135 New Directors’ remuneration policy 153 Supplementary information This report has been prepared to comply with Schedule 8 of the Large and Medium- sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, as well as the Companies Act 2006 and other related regulations. The following sections were subject to audit: Table of 2016 and 2015 Executive Director total remuneration ‘The Single Figure’ and related notes, salary information table in section entitled Remuneration in respect of performance in 2016, Pension entitlements, Long-term incentives awarded in 2016, Chairman and Non-executive Director remuneration in 2016, Statement of Directors’ shareholdings, Outstanding share options, Recruitment arrangements and Payments to past Directors and payments for loss of office. 04 Directors’ remuneration reportAnnual statement from the Chairman of the Remuneration Committee Dear Shareholder I am pleased to present the Remuneration Committee’s report for the year to 31 December 2016. The Committee’s report is presented in the following sections: — An ‘at a glance’ summary of the Group’s remuneration arrangements on pages 112 and 113; — Our Directors’ remuneration policy on pages 114 to 117 which describes how we pay Directors currently. This policy was approved by shareholders at the 2014 AGM; — Our Annual report on remuneration on pages 118 to 134 and 151 to 152 which describes how the Committee applied the Directors’ remuneration policy in 2016 and the decisions it has made in respect of 2017; — Our new Directors’ remuneration policy on pages 135 to 150 which describes how we propose paying Directors from 18 May 2017. This will be subject to an ordinary resolution of shareholders at the 2017 AGM; and — Supplementary information on pages 153 to 157. By way of preface, I would like to share the context for the key decisions the Committee took during 2016, in particular, the decisions relating to remuneration arrangements in 2017 and how we rewarded the performance achieved in 2016. Reviewing the Directors’ remuneration policy Ahead of the renewal of the Directors’ remuneration policy at the AGM in 2017, the Committee very carefully considered and debated a range of potential remuneration models. The Committee concluded that the current model continues to connect remuneration with the achievement of the Group’s ambitious goals to deliver further profitable growth in the coming years. On this basis, the Committee decided to retain the current remuneration model while making a number of improvements to ensure that it continues to be aligned with the Group’s remuneration principles, business priorities and evolving stakeholder expectations. The proposed new Directors’ remuneration policy set out on pages 135 to 150 has been designed to: Simplify incentive arrangements The Committee is committed to simplifying the remuneration arrangements for the Executive Directors wherever possible. To this end, the number of Annual Incentive Plan financial metrics is being reduced from the seven measures used in 2016 to four measures (cash flow, operating free surplus, IFRS operating profit and NBP EEV profit) for the 2017 financial year. These targets are aligned with the Group’s focus on growth and cash generation. Minimum capital levels must be achieved for future bonuses to be paid, underscoring the importance of disciplined and proactive risk and capital management. In a similar spirit of simplification, the Chief Executive, M&G will receive long-term incentive awards under a single incentive plan (the Prudential Long Term Incentive Plan, PLTIP) from 2017. In the past, the role holder has participated in two long-term incentive arrangements. The face value of the awards will remain unchanged. Reward the delivery of the Group’s longer-term strategy It is proposed that a sustainability scorecard be used to determine vesting of 25 per cent of PLTIP awards made in 2017 and subsequent years. The scorecard rewards the longer-term generation of capital, the development of a more diverse senior leadership team and the achievement of the Group’s conduct expectations. These measures are aligned to the Group’s strategic priorities and corporate values, and achieving them will support the Group’s ability to deliver to its stakeholders during and beyond the three-year performance period. The Committee continues to be mindful of its scope to use discretion to adjust bonus payments and/or PLTIP vesting levels if it is not satisfied that the underlying financial performance of the Company during the relevant performance periods justifies the payments arithmetically suggested by the achievement of the performance conditions. Strengthen the connection between executives and other shareholders The Committee has decided to introduce a two-year holding period for PLTIP awards made in 2017 and subsequent years. This holding period will apply after the end of the three-year performance period, giving a five-year time horizon for these awards. To further strengthen the alignment between executives and shareholders, the value of shares which Executive Directors are asked to own will be increased as follows: — The Group Chief Executive will be asked to own shares worth at least 400 per cent of base salary (350 per cent at present); and — Other Executive Directors will be asked to own shares worth at least 250 per cent of base salary (200 per cent at present). Many of the Executive Directors have shareholdings well in excess of the guidelines that they are asked to meet. For instance, on 31 December 2016, Mike Wells had a beneficial interest in shares with a value of over 700 per cent of his salary. As the Committee considered the new Directors’ remuneration policy, I corresponded with and met shareholders who together own around 43 per cent of the Group’s share capital as well as organisations that represent and advise shareholders. The Committee and I are grateful for the feedback and support that we received. Rewarding 2016 performance Prudential’s executive remuneration arrangements reward the achievement of Group, business and personal targets, provided that this performance is delivered within the Company’s risk framework and appetites, and that the conduct expectations of Prudential, our regulators and other stakeholders are met. 110 Prudential plc Annual Report 2016 www.prudential.co.ukIn rewarding performance, the Committee scrutinises the proposed bonus and LTIP performance targets, which are based on the business plans agreed by the Board, to ensure they are sufficiently challenging, and the Committee sets stretching performance ranges for each of the financial performance measures. The Committee believes that there is a high degree of stretch in both the business plans and the target ranges when factors such as the external economic, political and regulatory environment, across the Group’s businesses and geographies, are taken into account. As set out in the Business review section earlier in this annual report, the Group delivered strong financial performance in 2016, notwithstanding the significant changes which took place in the markets in which it operates. Performance against these key metrics exceeded the stretching targets established by the Board and the results achieved in recent years. The Group achieved these results while maintaining appropriate levels of capital and operating within the Group’s risk framework and appetites. The Committee believes that the bonuses it awarded to Executive Directors for 2016 appropriately reflect this performance. Performance in 2016 built on the strong results achieved in recent years, despite the external challenges faced by the Group during this time. Based on total shareholder return (TSR) and strong cumulative IFRS operating profit performance over the performance period, the Committee determined that between 41.7 and 70.8 per cent of the PLTIP awards made to Executive Directors in 2014 would vest (depending on the business unit). These Strategic priority Group performance £m IFRS operating profit1 Prudential’s primary measure of profitability and a key driver of shareholder value CAGR (excluding Korea): +14% EEV new business profit2 A measure of the future profitability of the new business sold during the year and indicates the profitable growth of the Group CAGR (excluding Korea and UK bulk annuity new business profits): +14% Business unit remittances Cash flows across the Group balance these net remittances (which support dividend payments) with the retention of cash for profitable reinvestment CAGR: +9% 2015-2016 growth 7% 4,007 4,256 2,954 3,186 2,520 2012 2013 2014 2015 2016 2015-2016 growth 24% 3,088 2,617 1,791 1,536 2,115 2012 2013 2014 2015 2016 2015-2016 growth 6% 1,625 1,718 1,482 1,341 1,200 2012 2013 2014 2015 2016 2016 bonus achievement Above stretch level IFRS operating profit accounted for 35 per cent of Group financial bonus targets Above stretch level EEV new business profit accounted for 5 per cent of Group financial bonus targets Above stretch level A cash flow measure was used to determine 10 per cent of the Group financial bonus targets Notes 1 As previously reported and includes the contribution from the Korea Life business for all years prior to 2016. 2 As previously reported and includes the contribution from the Korea Life business and UK bulk annuity new business profits for all years prior to 2016. awards will be released to participants in April 2017. The total 2016 ‘single figure’ for the Group Chief Executive is lower than the total 2015 ‘single figure’, despite continuing strong business performance. This is chiefly a result of a lower level of vesting of the 2014 PLTIP award. Mike Wells’s 2016 ‘single figure’ is 30 per cent less than his 2015 ‘single figure’, notwithstanding his exceptional leadership and personal performance. As you will be aware, there have been three changes to Prudential’s team of Executive Directors during 2016. The remuneration decisions arising from these changes were disclosed in stock exchange and website announcements when they took place. Further information can be found in the Recruitment arrangements and Payments to past Directors sections of this report. I trust that you will find this report a clear account of the way in which the Committee has implemented the Directors’ remuneration policy during 2016 and of the Committee’s proposed new Directors’ remuneration policy. Anthony Nightingale, CMG SBS JP Chairman of the Remuneration Committee 13 March 2017 111 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportOur Executive Directors’ remuneration at a glance Our remuneration strategy and principles During 2016, our remuneration strategy remained unchanged from that previously approved by shareholders: 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 delivery of the business plan can be sustained. Our current remuneration architecture Key elements1,2 Salary and benefits Key features of the policy How we implemented the policy 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 Broadly aligned with pay budget for other employees Salary increases of 1% in 2016 Financial and personal/ functional objectives set with reference to business plans approved by the Board. Cash bonus Deferred bonus Prudential Long Term Incentive Plan (PLTIP) Stretching IFRS profit ranges set with reference to business plans approved by the Board. TSR vesting schedule relative to insurance peers. The maximum opportunity is up to 200% of salary 40% of bonus is deferred into shares for three years Award is subject to malus and clawback provisions The Group Chief Executive has a maximum bonus opportunity of 200% of salary. For other Executive Directors the maximum is 180% of salary or less 2016 bonuses were paid based on performance measures related to profit, cash flow and capital adequacy as well as personal/ functional objectives Maximum award under the Plan is 550% of salary Aligned with long-term business strategy and delivery of shareholder value, with vesting subject to: — Relative TSR; and — Group or business unit IFRS profit. Awards in 2016 were below the Plan limits: — Group Chief Executive: 400% of salary; — CEO, NABU: 460% of salary; — CEO, M&G: 150% of salary; and — Other PLTIP awards were 250% of salary. Measured over the three financial years from year of award Award is subject to malus and clawback provisions For business unit CEOs, awards vest based on TSR and business unit IFRS profit. For other Executive Directors, awards are subject to TSR and Group IFRS profit Share ownership guidelines Significant share ownership guidelines for all Executive Directors as follows: — 350% of salary for the Group Chief Executive; and — 200% of salary for other Executive Directors. Key Fixed pay Short-term variable pay Long-term variable pay Share ownership guidelines Notes 1 2 The Chief Executive, NABU also receives a 10% share of the Jackson bonus pool The Chief Executive, M&G retains separate bonus and long-term incentive arrangements 112 Prudential plc Annual Report 2016 www.prudential.co.ukWhat performance means for Executive Directors’ pay At Prudential, remuneration packages are designed to ensure a strong alignment between pay and performance. As you can see from the charts on page 111, sustained growth across all of our key performance metrics has delivered substantial value to our shareholders. This has been reflected in both the annual bonuses paid and the release of long-term incentive awards, as set out in the Annual report on remuneration. In particular, the long-term incentives awarded to Executive Directors in 2014 had stretching performance conditions attached to vesting and were denominated in shares or ADRs. The value generated for shareholders through share price growth and dividends paid over the last three years is therefore reflected in the value of the LTIP releases. The value of these performance-related elements of remuneration are added to the fixed packages provided to Executive Directors to calculate the 2016 ‘single figure’ of total remuneration. The total 2016 ‘single figure’ for the Group Chief Executive is lower than the total 2015 ‘single figure’, despite continuing strong business performance. This is chiefly a result of a lower level of vesting of the 2014 PLTIP award. Mike Wells’s 2016 ‘single figure’ is 30 per cent less than his 2015 ‘single figure’, notwithstanding his exceptional leadership and personal performance. The values for the current Executive Directors who were Directors during the year are outlined in the table below: Executive Director Role John Foley1 Chief Executive, UK & Europe Group Chief Risk Officer Penny James Nic Nicandrou Chief Financial Officer Anne Richards2 Chief Executive, M&G Barry Stowe Mike Wells Tony Wilkey Chairman & CEO, NABU3 Group Chief Executive Chief Executive, PCA4 Fixed pay Performance related 2016 salary Pension and benefits 2016 bonus LTIP vesting Other payments 2016 single figure 2015 single figure £714,000 £313,000 £1,271,000 £1,781,000 – £4,079,000 – £606,000 £711,000 £228,000 £820,000 £235,000 £347,000 £962,000 £539,000 £1,236,000 £1,518,000 £139,000 £1,368,000 £251,000 £5,229,000 £1,168,000 £1,081,000 £1,143,000 £2,151,000 £2,520,000 £918,000 £845,000 £1,041,000 £1,440,000 – £2,140,000 £3,875,000 – £2,150,000 £958,000 – £4,004,000 £4,278,000 – – £7,468,000 £6,763,000 – £6,895,000 £9,894,000 – £4,244,000 £3,289,000 Notes 1 John Foley was appointed to the Board on 19 January 2016. The remuneration above was paid in respect of his service as an Executive Director, other than the LTIP releases which related to his previous role. 2 Anne Richards was appointed to the Board on 7 June 2016. The remuneration above was paid in respect of her service as an Executive Director. 3 NABU is an abbreviation of North American Business Unit. PCA is an abbreviation of Prudential Corporation Asia. 4 Aligning 2017 pay to performance The Remuneration Committee awarded salary increases to the Executive Directors, other than the Chief Executive, M&G and the Group Chief Risk Officer, for 2017 of 2 per cent, which was below the salary increase budget for the wider workforce. The Chief Executive, M&G, was appointed during the year and therefore no increase in salary was proposed. The Remuneration Committee awarded a salary increase for 2017 of 5 per cent to the Group Chief Risk Officer to reflect her performance and contribution. When Penny was promoted to the Board in 2015 her salary was lower than that of her predecessor. No other changes have been made as we believe remuneration packages remain strongly aligned with performance over both the short and the long term. The resultant remuneration packages for 2017 are set out in detail in the Annual report on remuneration and summarised below: Executive Director Role John Foley Penny James Anne Richards1 Nic Nicandrou Barry Stowe2 Mike Wells Tony Wilkey Chief Executive, UK & Europe Group Chief Risk Officer Chief Executive, M&G Chief Financial Officer Chairman & CEO, NABU Group Chief Executive Chief Executive, PCA AIP 2017 salary Maximum bonus (% salary) Bonus deferred LTI award (% salary) £765,000 £637,000 £400,000 £726,000 US$1,134,000 £1,103,000 HK$9,070,000 180% 160% 600% 175% 160% 200% 180% 40% 40% 40% 40% 40% 40% 40% 250% 250% 450% 250% 460% 400% 250% Notes 1 The bonus opportunity for the Chief Executive, M&G remains the lower of 0.75 per cent of M&G’s IFRS profit or six times salary. The Committee determined that Anne Richards should receive a 2017 PLTIP award with a face value of 450% of base salary, consistent with the combined face value of her previous LTI awards under the PLTIP (150% of salary) and M&G Executive LTIP (300% of salary). All future awards will be made under the PLTIP. The Chairman & CEO, NABU will also continue to have a 10 per cent share of the Jackson bonus pool. 40 per cent of this is deferred in shares. 2 113 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportSummary of the current Directors’ remuneration policy The Company’s Directors’ remuneration policy was approved by shareholders at the 2014 AGM. This policy came into effect following the AGM on 15 May 2014 and will apply until the 2017 AGM, when shareholders will be asked to approve a revised Directors’ remuneration policy. Details of the revised policy can be found on pages 135 to 150. The pages that follow present a summary of the current Directors’ remuneration policy. The complete policy can be found on our website at: www.prudential.co.uk/investors/governance-and-policies/directors-remuneration-policy Remuneration for Executive Directors Fixed pay Element Operation Salary The Committee reviews salaries annually, considering factors such as: — Salary increases for all employees; — The performance and experience of the executive; — Group or business unit financial performance; — Internal relativities; and — Economic factors such as inflation. Market data is also reviewed so that salaries remain in a competitive range relative to each Executive Director’s local market. Benefits Executive Directors are offered benefits which reflect their individual circumstances and are competitive within their local market, including: — Health and wellness benefits; — Protection and security benefits; — Transport benefits; — Family and education benefits; — All employee share plans and savings plans; and — Relocation and expatriate benefits. Current executives have the option to: — Receive payments into a defined contribution scheme; and/or — Take a cash supplement in lieu of contributions. Jackson’s Defined Contribution Retirement Plan has a guaranteed element (6 per cent of pensionable salary) and additional contributions (up to a further 6 per cent of pensionable salary) based on the profitability of Jackson. Provision for an income in retirement Opportunity Annual salary increases for Executive Directors will normally be in line with the increases for other employees across our business units. However, there is no prescribed maximum annual increase. The maximum paid will be the cost to the Company of providing benefits. The cost of benefits may vary from year to year but the Committee is mindful of achieving the best value from providers. Executive Directors are entitled to receive pension contributions or a cash supplement (or combination of the two) up to a total of 25 per cent of base salary. In addition, the Chief Executive, PCA receives statutory contributions into the Mandatory Provident Fund. 114 Prudential plc Annual Report 2016 www.prudential.co.ukVariable pay Element Operation Annual bonus Currently all Executive Directors participate in the Annual Incentive Plan (AIP). AIP awards for all Executive Directors are subject to the achievement of financial and personal objectives. Business unit chief executives either have measures of their business unit’s financial performance in the AIP or they may participate in a business unit specific bonus plan. For example, the Chairman and CEO, NABU currently participates in the Jackson Senior Management Bonus Pool as well as in the AIP. The financial measures used for the annual bonus will typically include profit, cash and capital adequacy. Jackson’s profitability and other key financial measures determine the value of the Jackson Senior Management Bonus Pool. In specific circumstances, the Committee also has the power to recover all (or part of) bonuses for a period after they are awarded to executives. These clawback powers apply to the cash and deferred elements of 2015 and subsequent bonuses made in respect of performance in 2015 and subsequent years. Deferred bonus shares Executive Directors are required to defer a percentage (currently 40 per cent) of their total annual bonus into Prudential shares for three years. The release of awards is not subject to any further performance conditions. The Committee has the authority to apply a malus adjustment to all, or a portion of, an outstanding deferred award in specific circumstances. From 2015 and future awards, the Committee also has the power to recover all, or a portion of, amounts already paid in specific circumstances and within a defined time frame (clawback). Prudential Long Term Incentive Plan Currently all Executive Directors participate in the Prudential Long Term Incentive Plan (PLTIP). The PLTIP has a three-year performance period. Vesting of outstanding awards is dependent on: — Relative total shareholder return (50 per cent of award); and — Group IFRS profit (50 per cent of award); or — Business unit IFRS profit (50 per cent of award). The performance measures attached to each award are dependent on the role of the executive and will be disclosed in the relevant Annual report on remuneration. The Chief Executive, M&G’s PLTIP awards are subject only to the TSR performance condition as the IFRS profit of M&G is a performance condition under the M&G Executive LTIP. The Committee has the authority to apply a malus adjustment to all, or a portion of, an outstanding award in specific circumstances. For 2015 and future awards, the Committee also has the power to recover all, or a portion of, amounts already paid in specific circumstances and within a defined timeframe (clawback). Opportunity The Chief Executive, M&G has a bonus opportunity of the lower of six times salary or 0.75 per cent of M&G’s IFRS profit. For other Executive Directors the maximum AIP opportunity is up to 200 per cent of salary. Annual awards are disclosed in the relevant Annual report on remuneration. In addition to the AIP, the Chairman & CEO, NABU receives a 10 per cent share of the Jackson Senior Management Bonus Pool. The maximum vesting under this arrangement is 100 per cent of the original deferral plus accrued dividend shares. The value of shares awarded under the PLTIP (in any given financial year) may not exceed 550 per cent of the executive’s annual basic salary. Awards made in a particular year are usually significantly below this limit and are disclosed in the relevant Annual report on remuneration. The Committee would consult with major shareholders before increasing award levels during the life of this policy. The maximum vesting under the PLTIP is 100 per cent of the original share award plus accrued dividend shares. M&G Executive LTIP The Chief Executive, M&G currently receives awards under this plan. The incumbent receives an annual award of phantom shares each with a notional starting share price of £1. The phantom share price at vesting is currently determined by M&G’s profitability, with profit and investment performance adjustments, over the three-year performance period. Awards are settled in cash. The Chief Executive, M&G receives an award with an initial value of 300 per cent of salary under this plan. Maximum vesting is 100 per cent of the number of phantom shares originally awarded. The Committee has the authority to apply a malus adjustment to all, or a portion of, an outstanding award in specific circumstances. For 2015 and future awards, the Committee also has the power to recover all, or a portion of, amounts already paid in specific circumstances and within a defined time frame (clawback). 115 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportSummary of the current Directors’ remuneration policy Continued Share ownership guidelines The guidelines for share ownership are as follows: — 350 per cent of salary for the Group Chief Executive; and — 200 per cent of salary for other Executive Directors. Executives have five years from the implementation of these increased guidelines (or from the date of their appointment, if later) to build this level of ownership. The full policy sets out the Committee’s powers in respect of Executive Directors joining or leaving the Board, where a change in performance conditions is appropriate or in the case of corporate transactions (such as a takeover, merger or rights issue). The policy also describes legacy long-term incentive plans under which some Executive Directors continue to hold awards. Remuneration for Non-executive Directors and the Chairman Non-executive Directors Fees Benefits Share ownership guidelines All Non-executive Directors receive a basic fee for their duties as a Board member. Additional fees are paid for added responsibilities such as chairmanship and membership of committees or acting as the Senior Independent Director. Fees are paid to Non-executive Directors in cash. Fees are reviewed annually by the Board with any changes effective from 1 July. If, in a particular year, the number of meetings is materially greater than usual, the Company may determine that the provision of additional fees is fair and reasonable. Chairman The Chairman receives an annual fee for the performance of the role. On appointment, the fee may be fixed for a specified period of time. Fees will otherwise be reviewed annually with any changes effective from 1 July. The Chairman is not eligible to participate in annual bonus plans or long-term incentive plans. Travel and expenses for Non-executive Directors are incurred in the normal course of business, for example, in relation to attendance at Board and Committee meetings. The costs associated with these are all met by the Company. It is expected that Non-executive Directors will 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 are expected to attain this level of share ownership within three years of their appointment. The Chairman has a share ownership guideline of one times his annual fee and is expected to attain this level of share ownership within five years of the date of his appointment. The Chairman may be offered benefits including: — Health and wellness benefits; — Protection and security benefits; — Transport benefits; and — Relocation and expatriate benefits (where appropriate). The Chairman is not eligible to receive a pension allowance or to participate in the Group’s employee pension schemes. 116 Prudential plc Annual Report 2016 www.prudential.co.ukIn setting the Directors’ remuneration policy, the Committee considers a range of factors including: Conditions elsewhere in the Group Across the Group, remuneration is reviewed regularly with the intention that all employees are paid appropriately in the context of their local market and given their individual skills, experience and performance. Each business unit’s salary increase budget is set with reference to local market conditions. The Remuneration Committee considers salary increase budgets in each business unit when determining the salaries of Executive Directors. Prudential does not consult with employees when setting the Directors’ remuneration policy: Prudential is a global organisation with employees, and agents in multiple business units and geographies. As such, there are practical challenges associated with consulting with employees directly on this matter. As many employees are also shareholders, they are able to participate in binding votes on the Directors’ remuneration policy and annual votes on the Annual report on remuneration. Shareholder views The Remuneration Committee and the Company undertake regular consultation with key institutional investors on the remuneration policy and its implementation. This engagement is led by the Remuneration Committee Chairman and is an integral part of the Company’s investor relations programme. The Committee is grateful to shareholders for their feedback and takes this into account when determining executive remuneration. 117 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportAnnual report on remuneration The Board has established Audit, Remuneration, Risk, Nomination and Governance Committees as principal standing committees of the Board. These committees form a key element of the Group governance framework. The operation of the Remuneration Committee Members Anthony Nightingale (the Chairman of the Committee) Kai Nargolwala Philip Remnant Role and responsibility The role and responsibilities of the Committee are set out in its terms of reference, which are reviewed by the Committee and approved by the Board on an annual basis, and which can be found on the Company’s website. The Committee’s role is to assist the Board in meeting its responsibilities regarding the determination, implementation and operation of the overall remuneration policy for the Group, including the remuneration of the Chairman and Executive Directors, as well as overseeing the remuneration arrangements of other staff within its purview. The principal responsibilities of the Committee are: — Determining and recommending to the Board for approval, the framework and policy for the remuneration of the Chairman, Executive Directors and other members of the Group Executive Committee; — Approving the design of performance-related pay schemes operated for the Executive Directors and other members of the Group Executive Committee, and determining the targets and individual payouts under such schemes; — Reviewing the design and development of all share plans requiring approval by the Board and/or the Company’s shareholders; — Approving the share ownership guidelines for the Chairman and Executive Directors and other members of the Group Executive Committee, and monitoring compliance; — Reviewing and approving individual packages for the Executive Directors and other members of the Group Executive Committee, and the fees of the Chairman and the Non-executive Directors of the Group’s material subsidiaries; — Reviewing and approving packages to be offered to newly recruited Executive Directors and other members of the Group Executive Committee; — Reviewing and approving the structure and quantum of any severance package for Executive Directors and other members of the Group Executive Committee; — Ensuring the process for establishing remuneration policy is transparent and consistent with the Group’s risk framework and appetites, encouraging strong risk management and solvency management practices and taking account of remuneration practices across the Group; — Monitoring the remuneration and risk management implications of remuneration of senior executives across the Group, other selected roles and those with an opportunity to earn in excess of £1 million in a particular year; and — Overseeing the implementation of the Group remuneration policy for those roles within scope of the specific arrangements referred to in Article 275 of Solvency II. An annual review of the Committee’s effectiveness was carried out as part of the Board evaluation, as described in more detail on page 87. The Committee was found to be functioning effectively. 118 Prudential plc Annual Report 2016 www.prudential.co.ukIn 2016, the Committee met six times. Key activities at each meeting are shown in the table below: Meeting Key activities February 2016 Approve the 2015 Directors’ remuneration report; consider 2015 bonus awards for Executive Directors; consider vesting of the long-term incentive awards with a performance period ending on 31 December 2015; and approve 2016 long-term incentive awards, performance measures and plan documentation. March 2016 June 2016 Confirm 2015 annual bonuses and the vesting of long-term incentive awards with a performance period ending on 31 December 2015, in light of audited financial results. Consider performance for outstanding long-term incentive awards, based on the half-year results; review the remuneration of senior executives across the Group, employees with a remuneration opportunity over £1 million per annum and employees within the scope of the Solvency II remuneration rules; consider proposals for new Directors’ remuneration architecture and policy; and review progress towards share ownership guidelines by the Chairman, Executive Directors and other Group Executive Committee members. September 2016 Review the dilution levels resulting from the Company’s share plans; review proposed new Directors’ remuneration architecture and policy; review proposed 2017 remuneration arrangements ahead of consultation with shareholders; approve the implementation of the remuneration requirements of Solvency II and approve the Remuneration Policy Statement; and review the Remuneration Committee’s terms of reference. November 2016 Finalise the proposed new Directors’ remuneration architecture and policy and the approach to the shareholder consultation. December 2016 Review the level of participation in the Company’s all-employee share plans; approve Group Executive Committee members’ 2017 salaries and incentive opportunities; consider the annual bonus and long-term incentive measures and targets to be used in 2017; review an initial draft of the 2016 Directors’ remuneration report; approve the Group Remuneration Policy; and approve the Committee’s 2017 work plan. Additionally, a number of resolutions in writing were approved by the Committee between these meetings relating to new Executive Directors’ remuneration arrangements and separation arrangements for an Executive Director who stepped down from the Board. The Chairman and the Group Chief Executive attend meetings by invitation. The Committee also had the benefit of advice from: — Group Chief Risk Officer; — Chief Financial Officer; — Group Human Resources Director; and — Director of Group Reward and Employee Relations. Individuals are never present when their own remuneration is discussed and the Committee is always careful to manage potential conflicts of interest when receiving views from Executive Directors or senior management about executive remuneration proposals. During 2016, Deloitte LLP was the independent adviser to the Committee. Deloitte was appointed by the Committee in 2011 following a competitive tender process. As part of this process, the Committee considered the services that Deloitte provided to Prudential and its competitors as well as other potential conflicts of interest. Deloitte is a member of the Remuneration Consultants’ Group and voluntarily operates under their code of conduct when providing advice on executive remuneration in the UK. Deloitte regularly meets with the Chairman of the Committee without management present. The Committee is comfortable that the Deloitte engagement partner and team providing remuneration advice to the Committee do not have connections with Prudential that may impair their independence and objectivity. The total fees paid to Deloitte for the provision of independent advice to the Committee in 2016 were £48,050 charged on a time and materials basis. During 2016, Deloitte gave Prudential management advice on remuneration, as well as providing guidance on capital optimisation, digital and technology, taxation, internal audit, real estate, global mobility and other financial, risk and regulatory matters. Remuneration advice is provided by an entirely separate team within Deloitte. In addition, management received external advice and data from a number of other providers. This included market data and legal counsel. This advice, and these services, are not considered to be material. During the year, the Company has complied with the appropriate provisions of the UK Corporate Governance Code regarding Directors’ remuneration. 119 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportTable of 2016 Executive Director total remuneration ‘The Single Figure’ £000s John Foley1 Penny James Michael McLintock2 Nic Nicandrou3 Anne Richards4 Barry Stowe5, 8 Mike Wells6 Tony Wilkey 7, 8 2016 salary 714 606 173 711 228 820 1,081 845 2016 taxable benefits* 134 83 70 361 82 46 873 828 2016 total bonus 1,271 962 920 1,236 1,368 5,229 2,151 1,440 Of which: Amount deferred into Prudential shares† 508 385 368 494 547 2,092 860 576 Amount paid in cash 763 577 552 742 821 3,137 1,291 864 2016 LTIP releases‡ Other payments 2016 pension benefits§ Total 2016 remuneration ‘The Single Figure’¶ 1,781 347 1,811 1,518 – 1,168 2,520 918 – – – – 2,140 – – – 179 152 43 178 57 205 270 213 4,079 2,150 3,017 4,004 3,875 7,468 6,895 4,244 Total 5,178 2,477 14,577 8,747 5,830 10,063 2,140 1,297 35,732 * Benefits include (where provided) the cost of providing the use of a car and driver, medical insurance, security arrangements and relocation/expatriate benefits. † The deferred part of the bonus is subject to malus and clawback in accordance with the malus and clawback policies. ‡ In line with the regulations, the estimated value of PLTIP releases in 2016 has been calculated based on the average share/ADR price over the last three months of 2016 (£14.86/$37.02). The actual value of PLTIPs, based on the share price on the date awards are released, will be shown in the 2017 report. Tony Wilkey’s LTIP release includes an award which vested on 23 September 2016 (the share price on that date was £14.08) in addition to the awards which vest in 2017. § 2016 pension benefits include cash supplements for pension purposes and contributions into DC schemes as outlined on page 127. ¶ Each remuneration element is rounded to the nearest £1,000 and totals are the sum of these rounded figures. Total remuneration is calculated using the methodology prescribed by Schedule 8 of the Companies Act. Notes 1 John Foley was appointed to the Board on 19 January 2016. The remuneration above was paid in respect of his service as an Executive Director, other than the LTIP releases which related to his previous role. 2 Michael McLintock stepped down from the Board on 6 June 2016. The remuneration above was paid in respect of his service as an Executive Director. 3 Nic Nicandrou’s benefits relate primarily to relocation support under a legacy relocation clause in his contract, being £156,892 to cover taxes due on stamp duty paid in 2015. 4 Anne Richards was appointed to the Board on 7 June 2016. The remuneration above was paid in respect of her service as an Executive Director. In order to facilitate Anne’s appointment as Chief Executive, M&G , the Company agreed to replace the deferred bonus awards she forfeited on leaving Aberdeen Asset Management. The terms of the replacement award are designed to replicate those of the forfeited awards and further details are set out on page 129. In addition, to support Anne’s appointment as Chief Executive, M&G, the Company pays for accommodation in London and travel from Anne’s home in Edinburgh to London totalling £45,493. 5 Barry Stowe’s bonus figure excludes a contribution of £11,738 from a profit sharing plan which has been made into a 401(k) retirement plan in respect of his role as Chairman & CEO, NABU. This is included under 2016 pension benefits. 6 To facilitate his move to the UK, Mike Wells’s benefits include relocation support including £330,680 to cover taxes due on stamp duty paid in 2015 and £339,624 to cover mortgage interest. In addition, an amount of £497,748 was paid by the Company to meet a payment on account for US tax on these benefits which, as the tax will be payable in the UK, under the UK and US double tax treaty this amount will ultimately be refunded. 7 Tony Wilkey’s benefits include costs of £260,917 for housing and a £413,663 Executive Director Location Allowance. The LTIP releases relate to his previous role, prior to his service as an Executive Director. Barry Stowe and Tony Wilkey are paid in their local currency and exchange rate fluctuations will therefore impact the reported sterling value. 8 120 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedTable of 2015 Executive Director total remuneration ‘The Single Figure’ £000’s Pierre-Olivier Bouée1 Jackie Hunt2 Penny James3 Michael McLintock Nic Nicandrou4 Barry Stowe5, 9 Tidjane Thiam6 Mike Wells7 Tony Wilkey8, 9 Total Of which: 2015 salary 2015 taxable benefits* 270 557 200 394 703 729 455 942 433 38 76 21 71 377 558 44 1,283 402 2015 total bonus 0 1,039 318 2,128 1,224 3,281 704 3,223 748 Amount paid in cash 0 623 191 1,277 734 1,969 422 1,934 449 Amount deferred into Prudential shares† 2015 LTIP releases‡ 2015 pension benefits§ Total 2015 remuneration ‘The Single Figure’¶ 0 416 127 851 490 1,312 282 1,289 299 316 1,688 369 2,676 1,798 2,007 3,382 4,290 1,597 68 139 50 98 176 188 114 156 109 692 3,499 958 5,367 4,278 6,763 4,699 9,894 3,289 4,683 2,870 12,665 7,599 5,066 18,123 1,098 39,439 * Benefits include (where provided) the cost of providing the use of a car and driver, medical insurance, security arrangements and relocation/expatriate benefits. † The deferred part of the bonus is subject to malus and clawback in accordance with the malus and clawback policies. ‡ In line with the regulations, the estimated value of PLTIP releases in 2015 has been recalculated based on the actual share/ADR price on the date awards are released, being £13.25/$38.36. § 2015 pension benefits include cash supplements for pension purposes and contributions into DC schemes. ¶ Each remuneration element is rounded to the nearest £1,000 and totals are the sum of these rounded figures. Total remuneration is calculated using the methodology prescribed by Schedule 8 of the Companies Act. Notes 1 Pierre-Olivier Bouée stepped down from the Board on 31 May 2015. The remuneration above was paid in respect of his service as an Executive Director. 2 3 Penny James was appointed to the Board on 1 September 2015. The remuneration above was paid in respect of her service as an Executive Director, other than the LTIP releases Jackie Hunt stepped down from the Board on 3 November 2015. The remuneration shown above was paid in respect of her service as an Executive Director. which related to her previous role. 4 Nic Nicandrou’s 2015 benefits relate primarily to a legacy relocation clause in his contract agreed on his appointment and disclosed in the 2009 Directors’ remuneration report. The figure includes costs of £243,750 to cover stamp duty. 5 Barry Stowe’s 2015 benefits relate primarily to his expatriate status while he was located in Hong Kong in his previous role as Chief Executive, PCA, including costs of £139,405 for housing, £62,586 home leave and a £152,978 Executive Director Location Allowance. In addition, to facilitate his move back to the US, his benefits include relocation support including costs of £110,101 for relocation, shipping and tax return preparation. His bonus figure excludes a contribution of £10,404 from a profit sharing plan which has been made into a 401(k) retirement plan in respect of his role as Chairman & CEO, NABU. This is included under 2015 pension benefits. 6 Tidjane Thiam stepped down from the Board on 31 May 2015. The remuneration shown above was paid in respect of his service as an Executive Director. 7 To facilitate his move to the UK, Mike Wells’s benefits include relocation support including an allowance of £200,000 for relocation and shipping, £177,890 for temporary accommodation, £513,750 to cover stamp duty and £56,604 to cover mortgage interest. 8 Tony Wilkey was appointed to the Board on 1 June 2015. The remuneration above was paid in respect of his service as an Executive Director, other than the LTIP releases which related to his previous role. Tony Wilkey’s 2015 benefits include costs of £140,134 for housing and a £214,169 Executive Director Location Allowance. 9 Barry Stowe and Tony Wilkey are paid in their local currency and exchange rate fluctuations will therefore impact the reported sterling value. 121 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportRemuneration in respect of performance in 2016 Base salary Executive Directors’ salaries were reviewed in 2015 with changes effective from 1 January 2016. When the Committee took these decisions it considered: — The salary increases awarded to other employees; — The performance and experience of each executive; — The relative size of each Director’s role; and — The performance of the Group. Salary increases for the wider workforce vary across our business units, reflecting local market conditions. To provide context for this review, information was also drawn from the following market reference points: Executive John Foley Penny James Nic Nicandrou Role Benchmark(s) used to assess remuneration Chief Executive, UK and Europe — FTSE 40 — International insurance companies Group Chief Risk Officer — FTSE 40 Chief Financial Officer — FTSE 40 — International insurance companies Michael McLintock Chief Executive, M&G — McLagan UK Investment Management Survey Anne Richards Barry Stowe — International insurance companies Chairman & CEO, NABU — Towers Watson US Financial Services Survey — LOMA US Insurance Survey Mike Wells Group Chief Executive — FTSE 40 — International insurance companies Tony Wilkey Chief Executive, PCA — Towers Watson Asian Insurance Survey As reported last year, after careful consideration by the Committee, all Executive Directors received a salary increase of 1 per cent. The 2016 salary increase budgets for other employees across our business units were between 3 per cent and 6.5 per cent. No changes were made to Executives Directors’ maximum opportunities under either the annual incentive or the long-term incentive plans. Executive Director John Foley1 Penny James2 Michael McLintock3 Nic Nicandrou Anne Richards4 Barry Stowe5 Mike Wells6 Tony Wilkey7 2015 salary 2016 salary – £600,000 £394,000 £703,000 – £750,000 £606,000 £398,000 £711,000 £400,000 US$1,100,000 US$1,111,000 £1,070,000 £1,081,000 HK$8,800,000 HK$8,890,000 Notes 1 2 3 Michael McLintock stepped down from the Board on 6 June 2016. The annualised 2016 salary above was paid in respect of his service as Chief Executive, M&G and was pro-rated for the portion of John Foley was appointed Chief Executive, UK and Europe on 19 January 2016. The annualised 2016 salary above was paid in respect of his service as Chief Executive, UK and Europe. Penny James was appointed Group Chief Risk Officer on 1 September 2015. The annualised 2015 salary above was paid in respect of her service as Group Chief Risk Officer. the year for which he was an Executive Director. 4 Anne Richards was appointed Chief Executive, M&G on 7 June 2016. The annualised 2016 salary above was paid in respect of her service as Chief Executive, M&G. 5 Barry Stowe was appointed Chairman & CEO, NABU on 1 June 2015. The annualised 2015 salary above was paid in respect of his service as Chairman & CEO, NABU. 6 Mike Wells was appointed Group Chief Executive on 1 June 2015. The annualised 2015 salary above was paid in respect of his service as Group Chief Executive. Tony Wilkey was appointed Chief Executive, PCA on 1 June 2015. The annualised 2015 salary above was paid in respect of his service as Chief Executive, PCA. 7 122 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedAnnual bonus 2016 annual bonus opportunities Executive Directors’ bonus opportunities, the weighting of performance measures for 2016 and the proportion of annual bonuses deferred are set out below: Executive Director John Foley1 Penny James Michael McLintock2 Nic Nicandrou Anne Richards3 Barry Stowe4 Mike Wells Tony Wilkey Maximum AIP opportunity (% of salary) Deferral requirement Group financial measures Business unit financial/functional measures Personal objectives Weighting of measures 180% 40% of total bonus 160% 40% of total bonus 600% 40% of total bonus 175% 40% of total bonus 600% 40% of total bonus 160% 40% of total bonus 200% 40% of total bonus 180% 40% of total bonus 20% 50% 20% 80% 20% 80% 80% 20% 60% 30% 60% – 60% – – 60% 20% 20% 20% 20% 20% 20% 20% 20% Notes 1 John Foley was appointed to the Board on 19 January 2016. The maximum bonus opportunity shown represents his annual opportunity as an Executive Director, which was pro-rated for the portion of the year for which he was an Executive Director. 2 Michael McLintock’s annual bonus opportunity in 2016 was the lower of 0.75 per cent of M&G’s IFRS profit and six times annual salary. M&G’s IFRS profit in 2016 was £414 million. Michael stepped down from the Board on 6 June 2016. The maximum bonus opportunity shown represents his annual opportunity as an Executive Director, which was pro-rated for the portion of the year for which he was an Executive Director. 3 Anne Richards’s annual bonus opportunity in 2016 was the lower of 0.75 per cent of M&G’s IFRS profit and six times annual salary. M&G’s IFRS profit in 2016 was £414million. Anne was appointed to the Board on 7 June 2016. The maximum bonus opportunity shown represents her annual opportunity as an Executive Director, which was pro-rated for the portion of the year for which she was an Executive Director. 4 Barry Stowe also receives 10 per cent of the Jackson bonus pool. 2016 AIP performance measures and achievement Target-setting process For the financial metrics of the AIP, the performance ranges are set by the Remuneration Committee prior to, or at the beginning of, the performance period based on the annual business plans approved by the Board. These reflect the ambitions of the Group and business units, in the context of anticipated market conditions. As part of the implementation of Solvency II, a portion of Executive Directors’ 2016 bonuses was determined by the achievement of Solvency II surplus targets, which replaced the IGD capital surplus measure (part of the Solvency I framework). Otherwise no changes were made to the performance measures for the 2016 annual incentive plan. Also as part of the implementation of Solvency II, the weightings of Penny James’s AIP performance targets (with effect from 2016) were changed so that 50 per cent related to financial targets, 30 per cent related to functional targets and 20 per cent related to personal targets. Financial performance The Committee reviewed performance against the performance ranges at its meeting in February 2017; in all of the bonus performance metrics the Group’s 2016 results exceeded the performance required for maximum vesting, other than the Group Solvency II surplus measure, which was between target and maximum. 123 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportThe Committee also considered a report from the Group Chief Risk Officer which confirmed that these results were achieved within the Group’s and business units’ risk framework and appetite. The Group Chief Risk Officer also considered the effectiveness of risk management and internal controls, and specific actions taken to mitigate risks, particularly where these may be at the expense of profits or sales. The Group Chief Risk Officer’s recommendations were taken into account by the Committee when determining AIP outcomes for Executive Directors. The performance measures, their weightings and the achievement compared to the performance range, is illustrated below. The performance range (the levels of performance required for threshold, target and maximum bonuses to be paid) for the 2016 Group financial measures will be disclosed in the 2017 Directors’ remuneration report. Measure Cashflow Operating free surplus Solvency II surplus ECap surplus NBP EEV profit In-force EEV profit IFRS profit Weighting Threshold 0% vesting Midpoint 50% vesting Maximum 100% vesting Above maximum 100% vesting 10% 25% 7.5% 7.5% 5% 10% 35% Group PCA UK and Europe M&G Personal performance As set out in our Directors’ remuneration policy, a proportion of the annual bonus for each Executive Director is based on the achievement of personal and, for the Group Chief Risk Officer, functional objectives. These objectives include: — The executive’s contribution to Group strategy as a member of the Board; — Specific goals related to the business or function for which they are responsible, such as developing product propositions for a new generation of savers and investors; and — Progress on major projects which in 2016 included the initial public offering of our Indian joint venture, ICICI Prudential Life, commencing the divestment of our Korean life business and growing our African business to include Zambia. Performance against these objectives was assessed by the Committee at its meeting in February 2017. 2016 Annual Incentive Plan payments On the basis of the strong performance of the Group and its business units, and the Committee’s assessment of each Executive Director’s personal performance, the Committee determined the following 2016 AIP payments: Executive Director Role John Foley Penny James Michael McLintock2 Nic Nicandrou Anne Richards3 Barry Stowe4 Mike Wells Tony Wilkey Chief Executive, UK and Europe Group Chief Risk Officer Chief Executive, M&G Chief Financial Officer Chief Executive, M&G Chairman & CEO, NABU Group Chief Executive Chief Executive, PCA 2016 salary1 £750,000 £606,000 £398,000 £711,000 £400,000 US$1,111,000 £1,081,000 HK$8,890,000 Maximum 2016 AIP 2016 AIP payment (% of maximum) 180% 160% 600% 175% 600% 160% 200% 180% 94.2% 99.2% 66% 99.3% 100% 99.3% 99.5% 94.6% 2016 AIP payment £1,271,000 £962,000 £920,000 £1,236,000 £1,368,000 US$1,765,000 £2,151,000 HK$15,138,000 Notes 1 At 31 December 2016 or on stepping down from the Board if earlier. 2 Michael McLintock stepped down from the Board on 6 June 2016. The bonus shown above was paid in respect of his service as an Executive Director. 3 Anne Richards was appointed to the Board on 7 June 2016. The bonus shown above was paid in respect of her service as an Executive Director. 4 In addition to the Annual Incentive Plan, Barry Stowe also participates in the Jackson bonus pool (see below). 2016 Jackson bonus pool In 2016, the Jackson bonus pool was determined by Jackson’s profitability, capital adequacy, remittances to Group, in-force experience, ECap solvency ratio and credit rating. Across all these measures Jackson delivered strong performance. As a result of this performance the Committee determined that Barry Stowe’s share of the bonus pool was US$5,318,000. 124 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedDisclosure of targets and achievement for the 2015 Annual Incentive Plan The level of performance required for threshold, target and maximum payment against the Group’s 2015 Annual Incentive Plan financial measures and the results achieved are set out below. Group cash flow £0 £62m £124m Operating free surplus generated £2,471m £2,671m £2,871m £297m £3,050m Group IGD surplus £3,967m £4,717m £5,217m £5,543m Group ECap surplus £12,553m £15,053m £15,643m NBP EEV profit £1,935m £2,160m £2,210m In-force EEV profit £1,548m £1,778m £1,868m Group IFRS profit £2,929m £3,159m £3,319m £2,617m £2,264m £4,007m Achievement from Threshold to target Achievement from Plan to Maximum Achievement above Maximum The Board believes that, due to the commercial sensitivity of the business unit targets, disclosing further details of these targets may damage the competitive position of the Group. Update on performance against targets for awards made in 2015 and 2016 under the Prudential Long Term Incentive Plan As at 31 December 2016, Prudential’s TSR performance during the periods 1 January 2015 to 31 December 2016 and 1 January 2016 to 31 December 2016 was ranked below median. As at 31 December 2016, Prudential’s IFRS operating profit performance during the periods 1 January 2015 to 31 December 2016 and 1 January 2016 to 31 December 2016 was above the stretch targets for Group and all business units other than one which was between plan and the stretch target. Remuneration in respect of performance periods ending in 2016 Long-term incentive plans with performance periods ending on 31 December 2016 Our long-term incentive plans have stretching performance conditions that are aligned to the strategic priorities of the Group. In deciding the portion of the awards to be released, the Committee considered actual financial results against these performance targets. The Committee also reviewed underlying Company performance to ensure vesting levels were appropriate. The Directors’ remuneration policy contains further details of the design of Prudential’s long-term incentive plans. Prudential Long Term Incentive Plan (PLTIP) In 2014, all Executive Directors were granted awards under the PLTIP. The awards were subject to challenging targets. The weightings of these measures are detailed in the table below. Executive Director Michael McLintock Jackie Hunt Barry Stowe Mike Wells All other Executive Directors Notes 1 Group TSR is measured on a ranked basis over three years relative to peers. 2 IFRS profit is measured on a cumulative basis over three years. Weighting of measures Group TSR1 IFRS profit (Group or business unit)2 100% 50% 50% 50% 50% – 50% (business unit target) 50% (business unit target) 50% (business unit target) 50% (Group) Under the Group TSR measure, 25 per cent of the award vests for TSR at the median of the peer group increasing to full vesting for performance within the upper quartile. TSR is measured on a local currency basis since this has the benefit of simplicity and directness of comparison. The peer group for the awards is: Aegon Allianz Legal & General Old Mutual Swiss Re Aflac Aviva Manulife Prudential Financial Zurich Insurance Group AIA AXA MetLife Standard Life AIG Generali Munich Re Sun Life Financial 125 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportPrudential’s TSR performance during the performance period (1 January 2014 to 31 December 2016) was between the median and upper quartile of the peer group (ranked ninth). The portion of the awards related to TSR which therefore vested was 41.7 per cent. Under the IFRS measure, 25 per cent of the award vests for meeting the threshold IFRS profit set at the start of the performance period increasing to full vesting for performance at or above the stretch level. The table below illustrates the cumulative performance achieved over 2014 to 2016 compared to the Group targets set in 2014: Group IFRS operating profit 2014-16 cumulative targets Threshold Plan Maximum 2014-16 cumulative achievement £8,525m £9,472m £10,419m £11,449m Overall vesting 100% The Committee determined that the cumulative IFRS operating profit target established for the PLTIP should be expressed using exchange rates consistent with the reported disclosures. All the individual business units exceeded their stretch performance target and achieved 100% vesting, other than Asia which exceeded plan performance, but not the stretch target, and therefore vested at 95%. Details of business unit IFRS targets have not been disclosed as the Committee considers that these are commercially sensitive and disclosure of targets at such a granular level would put the Company at a disadvantage compared to its competitors. The Committee will keep this disclosure policy under review based on whether, in its view, disclosure would compromise the Company’s competitive position. M&G Executive Long-Term Incentive Plan The phantom share price at vesting for the 2014 M&G Executive Long-Term Incentive award is determined by the increase or decrease in M&G’s profitability over the three-year performance period with adjustments for the investment performance of its funds. M&G performance and the resulting phantom share price for Michael McLintock are shown below: Award 2014 M&G Executive LTIP 3-year profit growth of M&G 3-year investment performance 2016 phantom share price Value of awards vesting 7% Second quartile £1.60 £1,577,398 Prudential Corporation Asia Long-Term Incentive Plan Tony Wilkey received awards under the PCA Long-Term Incentive Plan before he was appointed to the Board, which vested during 2016. The PCA Long-Term Incentive Plan does not have performance conditions. 2016 LTIP vesting The Committee considered a report from the Group Chief Risk Officer which confirmed that the financial results were achieved within the Group’s and business units’ risk framework and appetite. On the basis of this report, and the performance of the Group and its business units described above, the Committee determined the vesting of each executive’s LTIP awards as set out below. Executive Director John Foley Penny James Michael McLintock3 Nic Nicandrou Barry Stowe Mike Wells Tony Wilkey4 Maximum value of award at full vesting1 Percentage of the LTIP award vesting Number of shares/ADRs vesting2 Value of shares vesting1 £2,515,958 £490,380 £707,039 £2,144,163 £1,710,546 £3,559,849 £1,035,757 70.8% 70.8% 41.7% 70.8% 68.3% 70.8% 100%/68.3% 119,872 23,364 15,707 102,158 42,748 92,220 64,254 £1,781,298 £347,189 £233,406 £1,518,068 £1,168,303 £2,520,373 £918,013 Notes 1 The share price used to calculate the value of the LTIP awards with performance periods which ended on 31 December 2016 and vest in 2017 was the average share price/ADR price for the three months up to 31 December 2016, being £14.86/$37.02. The number of shares vesting includes accrued dividend shares. This does not include the vesting of Michael McLintock’s M&G Executive Long-Term Incentive Plan award, and has been pro-rated to reflect Michael’s service during the performance period. Tony Wilkey’s awards include an award that vested on 23 September 2016 (the share price on that date was £14.08) in addition to the awards that vests in 2017. 2 3 4 126 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedPension entitlements Pension provisions in 2016 were: Executive Director 2016 pension arrangement Life assurance provision Barry Stowe Tony Wilkey UK-based executives Pension supplement of 25 per cent of salary, part of which is paid as a contribution to an approved US retirement plan. Pension supplement in lieu of pension of 25 per cent of salary and a HK$18,000 payment to the Hong Kong Mandatory Provident Fund. Pension contribution to defined contribution plan and/or pension supplement in lieu of pension of 25 per cent of salary. Two times salary Four times salary Up to four times salary plus a dependant’s pension Michael McLintock previously participated in a contributory defined benefit scheme that was open at the time he joined the Company. The scheme provided a target pension of two-thirds of final pensionable earnings on retirement for an employee with 30 years or more potential service who remained in service to normal retirement date. Michael is a deferred member of the scheme and his normal retirement date under the scheme is age 60. If Michael claims his deferred pension before this age it will be subject to an actuarial reduction and there are no additional benefits payable should he retire early. At the end of 2016, the transfer value of Michael’s entitlement was £1,505,483. This equates to an annual pension of £59,662 which will increase broadly in line with inflation in the period to Michael’s retirement at the normal retirement date. John Foley previously participated in a non-contributory defined benefit scheme that was open at the time he joined the Company. The scheme provided an accrual of 1/60ths of final pensionable earnings for each year of pensionable service. John is a deferred member of this scheme and, on reaching the normal retirement date (of 60), John has elected to defer payment of his pension. At the end of 2016, the transfer value of John’s entitlement was £555,662. This equates to an annual pension of £19,937, based on current late retirement factors. The pension, once in payment, will be subject to statutory increases in line with the Consumer Prices Index. Performance graph and table The chart below illustrates the TSR performance of Prudential, the FTSE 100 and the peer group of international insurers used to benchmark the Company’s performance for the purposes of the PLTIP. Prudential TSR v FTSE 100 and peer group averages – total return, per cent over eight years to 31 December 2016 £600 £500 £400 £300 £200 £559 £247 £219 £100 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015 Dec 2016 Prudential FTSE 100 Peer group average Note The peer group average represents the average TSR performance of the peer group used for 2016 PLTIP awards (excluding companies not listed at the start of the period). 127 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportThe information in the table below shows the total remuneration for the Group Chief Executive over the same period: £000 2009 2009 2010 2011 2012 2013 2014 2015 2015 2016 Group Chief Executive Salary, pension and benefits Annual bonus payment (As % of maximum) LTIP vesting (As % of maximum) Other payments Group Chief Executive Single Figure of total remuneration M Tucker1 T Thiam T Thiam T Thiam T Thiam T Thiam T Thiam T Thiam2 M Wells M Wells 2,224 2,151 (99.5%) 2,520 (70.8%) – 1,992 1,244 (99.7%) 4,427 (100%) – 1,411 2,056 (99.8%) 5,235 (100%) – 613 704 (77.3%) 3,702 (100%) – 1,458 2,122 (100%) 9,838 (100%) – 1,013 841 (92%) 1,575 (100%) 308 1,373 2,000 (100%) 6,160 (100%) – 1,241 1,570 (97%) 2,528 (100%) – 1,189 1,570 (97%) 2,534 (100%) – 286 354 (90%) – – – 3,737 640 5,293 5,339 9,533 8,702 13,418 5,019 7,663 6,895 Notes 1 Mark Tucker left the Company on 30 September 2009. Tidjane Thiam became Group Chief Executive on 1 October 2009. The figures shown for Tidjane Thiam’s remuneration in 2009 relate only to 2 his service as Group Chief Executive. Tidjane Thiam left the Company on 31 May 2015. Mike Wells became Group Chief Executive on 1 June 2015. The figures shown for Mike Wells’s remuneration in 2015 relate only to his service as Group Chief Executive. Percentage change in remuneration The table below sets out how the change in remuneration for the Group Chief Executive between 2015 and 2016 compared to a wider employee comparator group: Group Chief Executive All UK employees Salary Benefits Bonus +14.8% +3.4% (32%) (6.2%) (33.3%) (2.8%) The employee comparator group used for the purpose of this analysis is all UK employees. This includes employees in the UK insurance operations business, M&G and Group Head Office, and reflects the average change in pay for employees employed in both 2015 and 2016. The salary increase includes uplifts made through the annual salary review as well as any additional changes in the year; for example to reflect promotions or role changes. The UK workforce has been chosen as the most appropriate comparator group as it reflects the economic environment where the Group Chief Executive is employed. The Group Chief Executive’s salary increase reflects his promotion from President & CEO, Jackson to Group Chief Executive during 2015. With effect from 1 January 2016, the Group Chief Executive’s salary increased by 1 per cent. Relative importance of spend on pay The table below sets out the amounts payable in respect of 2015 and 2016 on all employee pay and dividends: All employee pay (£m)1 Dividends (£m) Note 1 All employee pay as taken from note B7 to the financial statements. 2015 1,475 1,253 2016 1,885 1,122 Percentage change 27.80% (10.45%) 128 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedLong-term incentives awarded in 2016 2016 share-based long-term incentive awards The table below shows the awards made to Executive Directors in 2016 under share-based long-term incentive plans and the performance conditions attached to these awards: Executive Director Role Number of shares or ADRs subject to award* Percentage of awards released for achieving threshold targets‡ Face value of award† End of performance period John Foley Chief Executive, UK and 144,340 £1,874,977 Europe Penny James Group Chief Risk Officer 116,628 £1,514,998 Nic Nicandrou Chief Financial Officer 136,836 £1,777,500 Anne Richards1 Chief Executive, M&G 45,906 £600,000 Barry Stowe Chairman & CEO, NABU 137,050 £3,772,770 Tony Wilkey Chief Executive, PCA 153,742 £1,997,109 Mike Wells Group Chief Executive 332,870 £4,323,981 25% 31 December 2018 25% 31 December 2018 25% 31 December 2018 25% 31 December 2018 25% 31 December 2018 25% 31 December 2018 25% 31 December 2018 Weighting of performance conditions IFRS profit Group TSR Group Asia US UK 50% 50% 50% 50% 50% 50% 100% 50% 50% 50% 50% 50% 50% * Awards over shares were awarded to all Executive Directors other than Barry Stowe whose awards were over ADRs. † Awards for Executive Directors are calculated based on the average share price over the three dealing days prior to the grant date. Other than for Anne Richards, awards were granted on 1 April 2016 (based on a share price of £12.99 and an ADR price of US$37.29). ‡ The percentage of awards released for achieving maximum targets is 100 per cent. Note 1 PLTIP awards made to the Chief Executive, M&G are subject only to the TSR performance condition. The IFRS profit of M&G is a performance condition under the M&G Executive LTIP. Anne Richards’s award was granted on 23 June 2016 following her appointment to the Board (based on an average share price of £13.07). Group TSR performance will be measured on a ranked basis. 25 per cent of the award will vest for TSR performance at the median of the peer group increasing to full vesting for performance at the upper quartile. The peer group for 2016 awards is the same as for 2014 awards as detailed on page 125. Performance ranges for IFRS operating profit measured on a cumulative basis over three years are set at the start of the performance period. Due to commercial sensitivities these are not published in advance but Group targets will be disclosed when awards vest. 2016 cash long-term incentive awards In addition to her PLTIP award, in 2016 Anne Richards received a cash-settled award under the M&G Executive LTIP detailed below: Executive Director Role Face value of award (% of salary) Face value of award Percentage of award released for achieving threshold target End of performance period Anne Richards Chief Executive, M&G 300% £1,200,000 See note 31 December 2018 Note The value of the award on vesting will be based on the profitability and investment performance of M&G over the performance period as described in the Directors’ remuneration policy. Buy-out award In order to facilitate Anne Richards’s appointment as Chief Executive, M&G, the Company agreed to replace the deferred bonus awards she forfeited on leaving Aberdeen Asset Management. The terms of the replacement award were designed to replicate those of the forfeited awards and are therefore not subject to performance conditions and will accrue dividend equivalents. These awards entitle Anne to receive a cash amount equal to the market value of the specified notional number of Prudential shares on the date of exercise, less an award price of 5p per share. The award will vest on the dates detailed below. The market value of Prudential plc shares on the date of the award (23 June 2016) was £13.22. Exercise period 1 December 2016 to 1 January 2017 1 December 2017 to 1 January 2018 1 December 2018 to 1 January 2019 1 December 2019 to 1 January 2020 1 December 2020 to 1 January 2021 Number of notional shares 59,086 39,810 25,078 25,078 13,426 In December 2016, Anne exercised the first tranche of this replacement award. The gross value of the award exercised (which included dividend equivalents) was £939,140 and Anne used the net of tax value of £496,162 to buy 31,439 Prudential shares. This buy-out award was made under rule 9.4.2 of the UKLA Listing Rules as the award could not be effected under any of the Company’s existing incentive plans. Anne is the sole participant in this arrangement and no further awards will be made to Anne under the arrangement. 129 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportChairman and Non-executive Director remuneration in 2016 Chairman’s fees The Chairman’s fee was reviewed by the Committee during 2016 and increased by 3 per cent to £720,000 with effect from 1 July 2016 in order to reflect the expansion of the Chairman’s role to include oversight of the chairmen of the Group’s four material subsidiaries and inflation. Non-executive Directors’ fees The Non-executive Directors’ fees were reviewed by the Board during 2016 and the basic fee was increased by 1 per cent to £95,000. Additionally, the fee for chairing the Audit Committee was increased by 7 per cent to £75,000 and the fee for chairing the Risk Committee was increased by 15 per cent to £75,000, to reflect the expanded scope of these roles which now includes more formal oversight of the material subsidiaries’ Audit and Risk Committees. Annual fees Basic fee Additional fees: Audit Committee Chairman Audit Committee member Remuneration Committee Chairman Remuneration Committee member Risk Committee Chairman Risk Committee member Nomination Committee member Senior Independent Director From 1 July 2015 (£) From 1 July 2016 (£) 94,000 95,000 70,000 27,500 60,000 27,500 65,000 27,500 10,000 50,000 75,000 27,500 60,000 27,500 75,000 27,500 10,000 50,000 Note If, in a particular year, the number of meetings is materially greater than usual, the Company may determine that the provision of additional fees is fair and reasonable. The resulting fees paid to the Chairman and Non-executive Directors are: £000s Chairman Paul Manduca Non-executive Directors Howard Davies Ann Godbehere Alistair Johnston1 David Law Kai Nargolwala2 Anthony Nightingale Philip Remnant3 Alice Schroeder Lord Turnbull4 Lord Turner Total 2016 fees 2015 fees 2016 taxable benefits* 2015 taxable benefits* Total 2016 remuneration: ‘The Single Figure’† Total 2015 remuneration: ‘The Single Figure’† 710 202 205 47 122 150 165 210 122 – 122 650 195 200 120 36 146 147 206 120 70 36 121 78 – – – – – – – – – – – – – – – – – – – – 831 202 205 47 122 150 165 210 122 – 122 728 195 200 120 36 146 147 206 120 70 36 2,055 1,926 121 78 2,176 2,004 * Benefits include the cost of providing the use of a car and driver, medical insurance and security arrangements. † Each remuneration element is rounded to the nearest £1,000 and totals are the sum of these rounded figures. Total remuneration is calculated using the methodology prescribed by Schedule 8 of the Companies Act. The Chairman and Non-executive Directors are not entitled to participate in annual bonus plans or long-term incentive plans. Notes 1 Alistair Johnston stepped down from the Board on 19 May 2016. 2 Kai Nargolwala also received an annual fee of £250,000 (payable in HK$) in respect of his non-executive chairmanship of Prudential Corporation Asia Limited with effect from 1 February 2016. 3 4 Philip Remnant also received an annual fee of £250,000 in respect of his non-executive chairmanship of M&G Group Limited with effect from 1 April 2016. Lord Turnbull retired from the Board on 14 May 2015. 130 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedStatement of Directors’ shareholdings The interests of Directors in ordinary shares of the Company are set out below. ‘Beneficial interest’ includes shares owned outright, shares acquired under the Share Incentive Plan and deferred annual incentive awards, detailed in the ‘Supplementary information’ section. It is only these shares that count towards the share ownership guidelines. 1 January 2016 (or on date of appointment) During 2016 31 December 2016 (or on date of retirement) Share ownership guidelines Total beneficial interest (number of shares) Number of shares acquired Number of shares disposed Total beneficial interest* (number of shares) Number of shares subject to performance conditions† Total interest in shares Share ownership guidelines (% of salary/fee)‡ Beneficial interest as a percentage of basic salary/basic fees§ 42,500 – – 42,500 – 42,500 100% 85% 218,644 14,500 210,884 265,219 – 246,656 465,285 189,592 8,730 15,914 10,000 3,327 50,000 30,000 5,816 8,500 2,000 215,696 42,859 122,728 180,757 31,439 255,646 418,559 168,387 319 – – 3,577 20,000 – 1,100 – 3,500 184,375 15,787 134,143 141,838 – 236,424 339,310 237,451 – – – – – – – – – 249,965 41,572 199,469 304,138 31,439 265,878 544,534 120,528 9,049 15,914 10,000 6,904 70,000 30,000 6,916 8,500 5,500 672,445 422,480 212,827 171,255 278,967 79,498 677,466 373,328 77,345 45,906 819,410 553,532 811,178 1,355,712 504,163 383,635 – – – – – – – – – 9,049 15,914 10,000 6,904 70,000 30,000 6,916 8,500 5,500 200% 200% 200% 200% 200% 200% 350% 200% 100% 100% 100% 100% 100% 100% 100% 100% 100% 473% 97% n/a 607% 112% 460% 715% 202% 136% 239% n/a 104% 1,051% 450% 104% 128% 83% Chairman Paul Manduca Executive Directors John Foley1 Penny James Michael McLintock2 Nic Nicandrou Anne Richards3 Barry Stowe4 Mike Wells5 Tony Wilkey Non-executive Directors Howard Davies Ann Godbehere Alistair Johnston6 David Law Kaikhushru Nargolwala Anthony Nightingale Philip Remnant Alice Schroeder7 Lord Turner * There were no changes of Directors’ interests in ordinary shares between 31 December 2016 and 13 March 2017 with the exception of the UK-based Executive Directors due to their participation in the monthly Share Incentive Plan (SIP). John Foley acquired a further 35 shares in the SIP, Nic Nicandrou acquired a further 35 shares in the SIP and Mike Wells acquired a further 35 shares in the SIP during this period. † Further information on share awards subject to performance conditions are detailed in the ‘share-based long-term incentive awards’ section of the Supplementary information. ‡ Holding requirement of the Articles of Association (2,500 ordinary shares) must be obtained within one year of appointment to the Board. The increased guidelines for Executive Directors were introduced with effect from January 2013. Executive Directors have five years from this date (or date of joining or role change, if later) to reach the enhanced guideline. The guideline for Non-executive Directors was introduced on 1 July 2011. Non-executive Directors have three years from their date of joining to reach the guideline. The Chairman has five years from the date of his role change to reach the guideline. Where applicable, all Directors are in compliance with the share ownership guideline. § Based on the average closing share price for the six months to 31 December 2016 (£14.19). The Company and its Directors, Chief Executives and shareholders have been granted a partial exemption from the disclosure requirements under part XV of the Securities and Futures Ordinance (SFO). As a result of this exemption, Directors, Chief Executives and shareholders do not have an obligation under the SFO to notify the Company of shareholding interests, and the Company is not required to maintain a register of Directors’ and Chief Executives’ interests under section 352 of the SFO, nor a register of interests of substantial shareholders under section 336 of the SFO. The Company is, however, required to file with the Hong Kong Stock Exchange any disclosure of interests notified to it in the United Kingdom. Notes 1 John Foley was appointed to the Board on 19 January 2016. 2 Michael McLintock stepped down from the Board on 6 June 2016. 3 Anne Richards was appointed to the Board on 7 June 2016. 4 For the 1 January 2016 figure Barry Stowe’s beneficial interest in shares is made up of 123,328 ADRs (representing 246,656 ordinary shares), (8,513.73 of these ADRs are held within an investment account which secures premium financing for a life assurance policy). For the 31 December 2016 figure the beneficial interest in shares is made up of 132,939 ADRs (representing 265,878 ordinary shares). For the 1 January 2016 figure Mike Wells’s beneficial interest in shares is made up of 232,594 ADRs (representing 465,188 ordinary shares) and 97 ordinary shares. For the 31 December 2016 figure his beneficial interest in shares is made up of 218,576 ADRs (representing 437,152 ordinary shares) and 107,382 ordinary shares. 5 6 Alistair Johnston stepped down from the Board on 19 May 2016. 7 For the 1 January 2016 and 31 December 2016 figure Alice Schroeder’s beneficial interest in shares is made up of 4,250 ADRs (representing 8,500 ordinary shares). 131 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportDisclosure of interests of Directors Outstanding share options The following table sets out the share options held by the Executive Directors in the UK Savings-Related Share Option Scheme (SAYE) as at the end of the period. Anne Richards holds share options under her buy-out arrangement, details of which are set out on page 129. Date of grant Exercise price (pence) Market price at 31 Dec 2016 (pence) Exercise period Number of options Beginning End Beginning of period Granted Exercised Cancelled Forfeited Lapsed End of period 20 Sep 13 John Foley 23 Sep 14 John Foley 21 Sep 16 John Foley 21 Sep 12 Penny James Penny James 22 Sep 15 Michael McLintock 23 Sep 14 16 Sep 11 Nic Nicandrou 23 Sep 14 Nic Nicandrou 21 Sep 16 Nic Nicandrou 21 Sep 16 Anne Richards 22 Sep 15 Mike Wells 901 1,627.5 01 Dec 16 31 May 17 1,155 1,627.5 01 Dec 17 31 May 18 1,104 1,627.5 01 Dec 19 31 May 20 629 1,627.5 01 Dec 15 31 May 16 1,111 1,627.5 01 Dec 18 31 May 19 1,155 1,627.5 01 Dec 19 31 May 20 466 1,627.5 01 Dec 16 31 May 17 1,155 1,627.5 01 Dec 19 31 May 20 1,104 1,627.5 01 Dec 21 31 May 22 1,104 1,627.5 01 Dec 19 31 May 20 1,111 1,627.5 01 Dec 18 31 May 19 998 779 – 858 1,620 2,622 3,268 1,311 – – 815 – – – – – – 1,358 – 1,630 – 1,620 998 – – 858 – – 3,268 – – – – – – – – – – – – – – – – – – – – – – – – – – – – 779 – 815 – – – – 1,620 – 2,622 – – – 1,311 – 1,358 – 1,630 – 1,620 Notes 1 A gain of £49,028.33 was made by Directors in 2016 on the exercise of SAYE options. 2 No price was paid for the award of any option. 3 4 All exercise prices are shown to the nearest penny. 5 Michael McLintock participated in the plan during his time as an Executive Director. The column above marked ‘End of period’ reflects Michael McLintock’s position at his date of retirement. The highest and lowest closing share prices during 2016 were £16.49 and £10.87 respectively. Directors’ terms of employment and external appointments The Directors’ remuneration policy contains further details of the terms included in Executive Director service contracts. Details of the service contracts of each Executive Director are outlined in the table below. Subject to the Group Chief Executive’s or the Chairman’s approval, Executive Directors are able to accept external appointments as non-executive directors of other organisations. Fees payable are retained by the Executive Directors. Service contracts External appointment Date of contract Notice period to the Company Notice period from the Company External appointment during 2016 Fee received in the period the Executive Director was a Group Director 8 December 2010 1 April 2016 26 April 2009 4 July 2016 18 October 2006 21 May 2015 1 June 2015 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months 12 months – Yes – – – – – – £67,000 – – – – – Executive Directors John Foley1 Penny James Nic Nicandrou Anne Richards2 Barry Stowe Mike Wells Tony Wilkey Other Directors served on the boards of educational, charitable and cultural organisations without receiving a fee for these services. Notes 1 John Foley was appointed to the Board on 19 January 2016. 2 Anne Richards was appointed to the Board on 7 June 2016. 132 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedLetters of appointment of the Chairman and Non-executive Directors The Directors’ remuneration policy contains further details on Non-executive Directors’ letters of appointment. Details of their individual appointments are outlined below: Chairman/Non-executive Director Chairman Paul Manduca1 Non-executive Directors Philip Remnant Howard Davies Ann Godbehere2 David Law Kai Nargolwala Anthony Nightingale Alice Schroeder Lord Turner Notes 1 2 Ann Godbehere was reappointed in 2016 for one year. Paul Manduca was appointed as Chairman on 2 July 2012. Appointment by the Board Initial election by shareholders at the AGM Notice period Expiry of the current term of appointment 15 October 2010 AGM 2011 12 months AGM 2018 1 January 2013 15 October 2010 2 August 2007 15 September 2015 1 January 2012 1 June 2013 10 June 2013 15 September 2015 AGM 2013 AGM 2011 AGM 2008 AGM 2016 AGM 2012 AGM 2014 AGM 2014 AGM 2016 6 months 6 months 6 months 6 months 6 months 6 months 6 months 6 months AGM 2019 AGM 2017 AGM 2017 AGM 2019 AGM 2018 AGM 2017 AGM 2017 AGM 2019 Recruitment arrangements In making decisions about the remuneration arrangements for those joining the Board, the Committee worked within the Directors’ remuneration policy approved by shareholders and was mindful of: — The skills, knowledge and experience that each new Executive Director brought to the Board; — The need to support the relocation of executives to enable them to assume their roles; and — Its commitment to honour legacy arrangements. Appointing high-calibre executives to the Board and to different roles on the Board is necessary to ensure the Company is well positioned to develop and implement its strategy and deliver long-term value. As the Company operates in an international marketplace for talent, the best internal and external candidates are sometimes asked to move location to assume their new roles. Where this happens, the Company will offer relocation support. The support offered will depend on the circumstances of each move but may include paying for travel, shipping services, the provision of temporary accommodation and other housing benefits. Executives may receive support with the preparation of tax returns, but no current Executive Director is tax equalised. Anne Richards joined the Board during the year and, as this resulted in Anne relocating to enable her to assume her role, relocation support in line with the approved Directors’ remuneration policy was provided. In addition, on joining the Company, Anne forfeited share awards granted to her by her previous employer and a buy-out award in line with the approved Directors’ remuneration policy was provided. Details of this relocation support and the buy-out award are included in the notes to the 2016 Single Figure table and in the section on long-term incentives awarded in 2016. Payments to past Directors and payments for loss of office The Committee’s approach when exercising its discretion under the policy is to be mindful of the particular circumstance of the departure and the contribution the individual made to the Group. Michael McLintock Michael McLintock stepped down from the Board on 6 June 2016. His remuneration arrangements were in line with the approved Directors’ remuneration policy, and disclosed in stock exchange announcements, and the remuneration he received in respect of his services as an Executive Director is set out in the 2016 Single Figure table. Michael’s employment with the Group ended on 31 July 2016 and between 7 June and 31 July he received £76,024 in respect of salary, benefits and pension in accordance with his contract of employment. In line with market practice, the Group paid the professional legal fees incurred by him in respect of finalising his termination arrangements, which amounted to £7,800. In addition, in consideration of agreeing to a confidentiality clause, Michael received £1,000. Michael did not receive a loss of office payment. Michael’s deferred bonus awards will be released in accordance with the plan rules and remain subject to malus and, for the 2015 award, clawback provisions. Recognising his contribution to the Company’s success, the Committee determined that Michael should be awarded a bonus in respect of the 2016 performance year which was calculated in the usual way and pro-rated for service to 31 July 2016. 60 per cent of this bonus will be paid in 2017 and 40 per cent will be deferred for three years, subject to malus and clawback provisions. The Committee also exercised its discretion in accordance with the approved Directors’ remuneration policy and determined that Michael should be allowed to retain his unvested PLTIP and M&G LTIP awards granted in 2014 and 2015. The 2014 and 2015 awards will vest in accordance with the original timetable, subject to the original performance conditions, remain subject to malus and, for the 2015 award, clawback provisions, and were pro-rated for service. Michael did not receive a 2016 long-term incentive award. 133 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportJackie Hunt As reported in the 2015 Directors’ remuneration report, Jackie Hunt stepped down from the Board on 3 November 2015 and her employment with the Group ended on 30 June 2016. During 2016, Jackie received £441,352 in respect of salary, benefits and pension benefits in accordance with her contract of employment. In addition, in consideration of agreeing to a confidentiality clause, Jackie received £1,000. In line with market practice, the Group paid the professional legal fees incurred by Jackie in respect of finalising her separation arrangements which amounted to £600 in 2016. 2014 PLTIP award vesting Pierre-Olivier Bouée, Tidjane Thiam and Jackie Hunt’s employment with the Group ended on 30 June 2015, 31 May 2015 and 30 June 2016, respectively. The 2015 Directors’ remuneration report provided details of the remuneration arrangements that would apply to Pierre-Olivier, Tidjane and Jackie after they left the Board. As set out in the section ‘Remuneration in respect of performance in 2016’ the performance conditions attached to Pierre-Olivier, Tidjane and Jackie’s 2014 PLTIP awards were partially met and 70.8 per cent of these awards will be released in 2017. These awards were pro-rated for service (15 of 36 months, 14 of 36 months and 27 of 36 months, respectively) and the details of the release are set out below. Former Executive Director Pierre-Olivier Bouée Jackie Hunt Tidjane Thiam Number of shares vesting1 Value of share vesting2 39,319 65,114 98,890 £584,280 £967,594 £1,469,505 Notes 1 2 The number of shares vesting includes accrued dividend shares. The share price used to calculate the value was the average share price for the three months up to 31 December 2016, being £14.86. Other Directors A number of former Directors receive retiree medical benefits for themselves and their partner (where applicable). This is consistent with other senior members of staff employed at the same time. A de minimis threshold of £10,000 has been set by the Committee; any payments or benefits provided to a past Director under this amount will not be reported. Statement of voting at general meeting At the 2014 Annual General Meeting, shareholders were asked to vote on the current Directors’ remuneration policy and at the 2016 Annual General Meeting, shareholders were asked to vote on the 2015 Directors’ remuneration report. Each of these resolutions received a significant vote in favour by shareholders and the Committee is grateful for this support and endorsement by our shareholders. The votes received were: Resolution To approve the Directors’ remuneration policy Votes for % of votes cast Votes against % of votes cast Total votes cast Votes withheld (2014 AGM) 1,745,240,139 91.85% 154,778,305 8.15% 1,900,018,444 46,152,673 To approve the Directors’ remuneration report (2016 AGM) 1,714,488,665 92.80% 132,967,991 7.20% 1,847,456,656 159,010,106 134 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual report on remunerationContinuedNew Directors’ remuneration policy This policy will apply following the AGM on 18 May 2017 (subject to shareholder approval). Total remuneration for our Executive Directors is made up of a number of elements. Fixed pay policy for Executive Directors Component and purpose Operation Base salary Paying salaries at a competitive level enables the Company to recruit and retain key executives. Prudential’s policy is to offer all Executive Directors base salaries that are competitive within their local market. The Remuneration Committee reviews salaries annually with changes normally effective from 1 January. In determining base salary for each executive, the Committee considers factors such as: — Salary increases for other employees across the Group; — The performance and experience of the executive; — The size and scope of the role; — Group and/or business unit financial performance; — Internal relativities; and — External factors such as economic conditions and market data. As the Company has Executive Directors based in multiple geographies, and within insurance and asset management businesses, the Remuneration Committee reviews data from a number of different markets it believes to be the most relevant benchmarks. While salaries are typically paid in the local currency of the country where the executive is based, the Committee may determine that the salary of an executive is set or paid in an alternative currency. Prudential’s policy is for the Committee to have the discretion to offer Executive Directors benefits which reflect their individual circumstances and are competitive within their local market, including: — Health and wellness benefits; — Protection and security benefits; — Transport benefits; — Family and education benefits; — All employee share plans and savings plans; — Relocation and expatriate benefits; and Benefits Provided to executives to assist them in carrying out their duties efficiently. Expatriate and relocation benefits allow Prudential to attract high-calibre executives in the international talent market and to deploy them appropriately within the Group. — Reimbursed business expenses (including any tax liability) incurred when travelling overseas in performance of duties. Provision for an income in retirement Pension benefits provide executives with opportunities to save for an income in retirement. Prudential’s policy is to offer all Executive Directors a pension provision that is competitive and appropriate in the context of pension benefits for senior executives in the relevant local market. The pension provision for Executive Directors will normally be reflective of the arrangements in place for other employees in their business unit when they joined the Group. Executives have the option to: — Receive payments into a defined contribution scheme; and/or — Take a cash supplement in lieu of contributions. In addition, the Chief Executive, PCA receives statutory contributions into the PCA Mandatory Provident Fund. Opportunity Annual salary increases for Executive Directors will normally be in line with the increases for other employees unless there is a change in role or responsibility. The maximum paid will be the cost to the Company of providing these benefits. The cost of these benefits may vary from year to year but the Committee is mindful of achieving the best value from providers. Executive Directors are entitled to receive pension contributions or a cash supplement (or combination of the two) of up to 25 per cent of base salary. Contributions into the PCA Mandatory Provident Fund are in line with statutory limits. 135 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportNew Directors’ remuneration policy Continued Annual bonus policy for Executive Directors Annual bonus Payments under the Annual Incentive Plan (AIP) incentivise the delivery of stretching financial, functional and/or personal objectives which are drawn from the annual business plan. Operation Currently all Executive Directors participate in the AIP. The AIP payments for all Executive Directors are subject to the achievement of either financial and personal objectives or functional and personal objectives. Business unit chief executives either have measures of their business unit’s financial performance in the AIP or they may participate in a business unit specific bonus plan. For example, the Chairman and CEO, NABU currently participates in the Jackson Senior Management Bonus Pool, as well as in the AIP. Form and timing of payment All Executive Directors are required to defer a percentage of their total annual bonus into Prudential shares. Currently all Executive Directors defer 40 per cent of their bonus for three years, with the remaining 60 per cent of their bonus paid in cash following the end of the performance year. The release of deferred bonus awards is not subject to any further performance conditions. Deferred bonus awards carry the right to receive an amount (in shares or cash) to reflect the dividends paid on the released shares, during the deferral period. The Committee has the authority to apply clawback and/or a malus adjustment to all, or a portion of, the cash and deferred award elements of the bonus. More details about clawback and malus are set out below. See the Policy on corporate transactions section for details of the Committee’s powers in the case of corporate transactions. Determining annual bonus payments In assessing financial performance, the Committee determines the annual incentive payment for each Executive Director with reference to the performance achieved against performance ranges. The Jackson Senior Management Bonus Pool is calculated based on Jackson’s performance and distributed to Jackson’s leadership team. In assessing performance, the Committee will take into account the personal performance of the Executive Director and the Group and/or business units’ adherence to the Group’s risk framework and appetite, as well as other relevant factors. To assist them in their assessment the Committee considers a report from the Group Chief Risk Officer on adherence to the Group’s risk framework and appetite and to all relevant conduct standards. The Committee may adjust the formulaic outcome based on the performance targets to reflect the underlying performance of the Company. Opportunity The Chief Executive, M&G has a bonus opportunity which is the lower of 0.75 per cent of M&G’s IFRS profit or six times salary. For other Executive Directors the maximum AIP opportunity is up to 200 per cent of salary. Annual awards are disclosed in the relevant Annual report on remuneration. In addition to the AIP, the Chairman & CEO, NABU receives a 10 per cent share of the Jackson Senior Management Bonus Pool. 136 Prudential plc Annual Report 2016 www.prudential.co.ukAnnual bonus policy for Executive Directors continued Performance measures The Committee has the discretion to determine the specific performance conditions attached to each AIP cycle and to set annual targets for these measures with reference to the business plans approved by the Board. The financial measures used for the AIP will typically include profit and cash flow targets and payments depend on the achievement of minimum capital thresholds. For the measures used in 2016 and 2017, please refer to the Annual report on remuneration. No bonus is payable under the AIP for performance at or below the threshold level, increasing to 100 per cent for achieving or exceeding the maximum level. Jackson’s profitability and other key financial and risk management measures determine the value of the Jackson Senior Management Bonus Pool. The weightings of the performance measures for 2017 for all Executive Directors, other than the Group Chief Risk Officer, are 80 per cent financial measures and 20 per cent personal measures. The Chairman and CEO, NABU also participates in the Jackson Senior Management Bonus pool. For the Group Chief Risk Officer, the performance measures for 2017 are entirely based on a combination of functional and personal measures. The Group Chief Risk Officer is responsible for ensuring that the Company’s risk exposures are within the Board approved risk framework and appetite, and to provide overall leadership to the Risk function. The Committee retains the discretion to adjust and/or set different performance measures if events occur (such as a change in strategy, a material acquisition and/or divestment of a Group business or a change in the share capital of the Company or a change in prevailing market conditions) which cause the Committee to determine that the measures are no longer appropriate and that amendment is required so that they achieve their original purpose. Amendments The Committee may make amendments to the rules of the deferred bonus plan which it considers appropriate (such as amendments which benefit the administration of the plan) but it will not make any amendments which are incompatible with the approved Directors’ remuneration policy. Long-term incentive policy for Executive Directors Prudential Long Term Incentive Plan (PLTIP) The Prudential Long Term Incentive Plan is designed to incentivise the delivery of: — Longer-term business plans; — Sustainable long-term returns for shareholders; and — Group strategic priorities, such as disciplined risk and capital management. Following the end of the performance period, a two-year holding period applies, further aligning the experience of executives and shareholders. Operation Currently all Executive Directors participate in the PLTIP. Granting awards Holding period Prudential’s policy is that Executive Directors may receive long-term incentive awards with full vesting only achieved if the Company meets stretching performance targets. The rules of the PLTIP were approved by shareholders in 2013. Subsequent to this, minor amendments have been made to the rules to incorporate clawback provisions and to provide for a two-year holding period to awards. The PLTIP is a conditional share plan: the shares which are awarded will ordinarily vest after three years to the extent that performance conditions have been met. If performance conditions are not achieved, the unvested portion of any award lapses and performance cannot be retested. The PLTIP has a three-year performance period (although the Committee has the discretion to apply shorter or longer performance periods when the PLTIP is used for buy-out awards on recruitment – see the Approach to recruitment remuneration section). After the end of the three-year performance period, the shares are usually subject to an additional two-year holding period (except for buy out awards made under the PLTIP or in the case of the death of an executive). The Company may sell such number of shares as is required to satisfy any tax liability that arises on vesting. The balance of shares will be subject to the two-year holding period. Determining the release of the award The Committee has the authority to apply clawback and/or a malus adjustment to all, or a portion of, a PLTIP award. More details about clawback and malus are set out below. Awards carry the right to receive an amount (in shares or cash) to reflect the dividends paid on the released shares, during the period between the awards being granted and the award vesting. 137 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration report Long-term incentive policy for Executive Directors continued Opportunity The value of shares awarded under the PLTIP (in any given financial year) may not exceed 550 per cent of the executive’s annual basic salary. Awards made in a particular year are usually significantly below this limit. The levels of award made under the PLTIP in 2017 (as a percentage of base salary) are: Group Chief Executive Chairman & CEO, NABU Chief Executive, M&G 400% 460% 450% All other Executive Directors 250% The Committee does not envisage increasing the current award levels over the life of the policy and would consult with major shareholders before doing so. In addition, these current award levels would be disclosed in the relevant Annual report on remuneration. The maximum vesting under the PLTIP is 100 per cent of the original share award plus accrued dividend shares. Performance measures The performance conditions attached to PLTIP 2017 awards are: All Executive Directors except the Group Chief Risk Officer: — Relative TSR (25 per cent of award); — IFRS profit (50 per cent of award, Group or business unit as appropriate); and — Balanced scorecard of sustainability measures (25 per cent of award). Group Chief Risk Officer: — Relative TSR (50 per cent of award); — Group IFRS profit (20 per cent of award); and — Balanced scorecard of sustainability measures (30 per cent of award). The Committee may decide to attach different performance conditions and/or change the conditions’ weighting for future PLTIP awards. The performance conditions attached to each award are dependent on the role of the executive and will be disclosed in the relevant Annual report on remuneration. Relative TSR is measured over three years. 25 per cent of this portion of each award will vest for achieving the threshold level of median, increasing to full vesting for meeting the stretch level of upper quartile. TSR is measured against a peer group of international insurers similar to Prudential in size, geographic footprint and products. This peer group was reviewed during 2016 to ensure the group remains a relevant comparator group. The peer group for each award is disclosed in the relevant Annual report on remuneration. Three-year cumulative IFRS operating profit is assessed at Group or business unit level. Threshold and maximum achievement levels will be set at the beginning of the performance periods in line with the three-year business plan. 25 per cent of this portion of the award will vest for achieving threshold performance increasing to full vesting for meeting stretch targets. The target for Group IFRS operating profit will be disclosed when the performance period ends. Performance against the measures in the scorecard of sustainability measures is assessed at the end of the three-year performance period. The four measures have an equal weighting. 100 per cent of each measure in this portion of the award will vest for full achievement of that measure and no portion will vest if the measure is not achieved in full. The scorecard measures for each award are disclosed in the relevant Annual report on remuneration for the year of grant. The Committee also considers a report from the Group Chief Risk Officer on whether the results were achieved within the Group’s and business units’ risk framework and appetite. The Group Chief Risk Officer also considers the effectiveness of risk management and internal controls, and specific actions taken to mitigate risks, particularly where these may be at the expense of profits or sales. The Committee may adjust the formulaic outcome based on the performance targets to reflect the underlying performance of the Company. 138 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinued Long-term incentive policy for Executive Directors continued Committee discretions For awards made in 2016 and previous years For awards made in 2017 and subsequent years Amendments For any award made under the PLTIP to vest, the Committee must be satisfied that the quality of the Company’s underlying financial performance justifies the level of reward delivered at the end of the performance period. The Committee receives data about factors such as risk management and the cost of capital to support their decision. The Committee has the discretion to alter or disapply the holding period if it believes that it is appropriate. See the Policy on corporate transactions section for details of the Committee’s powers in the case of corporate transactions. The Committee has the discretion to amend the performance conditions attached to an award if circumstances relevant to the performance conditions have changed, and the Committee is satisfied that the amended measure will be a fairer measure of performance and no more or less demanding than the original condition. The Committee would seek to consult with major shareholders before revising performance conditions on outstanding awards under the PLTIP. The Committee retains the ability to amend the performance conditions attached to an award and/ or set different performance measures (or to revise the weighting of measures) which apply to new or outstanding long-term incentive awards if events occur which cause the Committee to determine that circumstances relevant to the performance conditions have changed such that the measures described in this section are no longer appropriate and that amendment is required so that they achieve their original purpose, provided the Committee is satisfied that the amended measure will be a fairer measure of performance and no more or less demanding than the original condition. Examples of such events could include a change in strategy, a material acquisition and/ or divestment of a Group business, or a change in the share capital of the Company or a change in prevailing market conditions or to meet the requirements of the Company’s regulators. The Committee would seek to consult with major shareholders before revising performance conditions on outstanding awards under the PLTIP. The Committee may make amendments to the rules of the Plan which are minor and benefit the administration of the Plan, which take account of any changes in legislation, and/or which obtain or maintain favourable tax, exchange control or regulatory treatment. Otherwise no amendments may be made to certain key provisions of the PLTIP to the advantage of participants without prior shareholder approval. Share ownership guidelines for Executive Directors Operation The share ownership guidelines for the Executive Directors are: — 400 per cent of salary for the Group Chief Executive; and — 250 per cent of salary for other Executive Directors. Executives have five years from the later of the date of their appointment or promotion, or the date of an increase in these guidelines, to build this level of ownership. Shares earned and deferred under the Annual Incentive Plan are included in calculating the Executive Director’s shareholding for these purposes. Unvested share awards under long-term incentive plans are not included but vested share awards under long-term incentive plans which are subject to the two-year holding period are included. Progress against the share ownership guidelines is detailed in the Statement of Directors’ shareholdings section of the Annual report on remuneration. 139 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportMalus and clawback policy As detailed in the policy table, the Committee may apply clawback and/or a malus adjustment to variable pay in certain circumstances as set out below. The Committee can delay the release of awards pending the completion of an investigation which could lead to the application of malus or clawback. Circumstances when the Committee may exercise its discretion to apply malus or clawback to an award Malus (applies in respect of any annual bonus or long-term incentive award) Where a business decision taken during the performance period by the business unit by which the participant was employed has resulted in a material breach of any law, regulation, code of practice or other instrument that applies to companies or individuals within the business unit. Allows unvested shares awarded under deferred bonus and LTIP plans to be forfeited or reduced in certain circumstances. There is a materially adverse restatement of the accounts for any year during the performance period of (i) the business unit in which the participant worked at any time in that year; and/or (ii) any member of the Group which is attributable to incorrect information about the affairs of that business unit. Any matter arises which the Committee believes affects or may affect the reputation of the Company or any member of the Group. Clawback Allows cash and share awards to be recovered before or after release in certain circumstances. Where at any time before the fifth anniversary of the start of the performance period, either (i) there is a materially adverse restatement of the Company’s published accounts in respect of any financial year which (in whole or part) comprised part of the performance period; or (ii) it becomes apparent that a material breach of a law or regulation took place during the performance period which resulted in significant harm to the Company or its reputation, and the Committee considers it appropriate, taking account of the extent of the participants’ responsibility for the relevant restatement or breach, that clawback be applied to the relevant participant. 140 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinuedNotes to the remuneration policy table for Executive Directors Committee’s judgement The Committee is required to make judgements when assessing Company and individual performance under the Directors’ remuneration policy. In addition, the Committee has discretions under the Company’s share plans, for example, determining if a leaver should retain or lose their unvested awards and whether to apply malus or clawback to an award. Exercise of such discretion during the year will be reported and explained in the next Annual report on remuneration. The Committee may approve payments in excess of, in a different form to, or calculated or delivered other than as described above, where the Committee considers such changes necessary to meet regulatory requirements. If these changes are considered by the Committee to be material, the Company will seek to consult with its major shareholders. Determining the performance measures The Committee selected the performance measures that currently apply to variable pay plans on the following basis: AIP The performance measures are selected to incentivise the delivery of the Group’s business plan, specifically to ensure that financial objectives are delivered while maintaining adequate levels of capital. Executives are also rewarded for the achievement of functional and/or personal objectives. These objectives include the executive’s contribution to Group strategy as a member of the Board, specific goals related to their functional and/or business unit role and achievement of the Group’s strategic priorities. PLTIP Awards made under the PLTIP are currently subject to the achievement of IFRS profit targets, relative TSR and, from 2017, a balanced scorecard of measures: — IFRS profit was selected as a performance measure for the PLTIP (as well as the AIP) because it is central to the management of the business and a key driver of shareholder value; — Relative TSR was selected as a performance measure because it focuses on the value delivered to shareholders – aligning the long-term interests of shareholders with those of executives; and — From 2017, a balanced scorecard of measures was selected to ensure an alignment with the Group’s strategic objectives, which are approved by the Board each year, and reflect Prudential’s cultural values. The Committee may decide to attach different performance conditions and/or change the conditions’ weighting for future PLTIP awards. Setting the performance ranges for financial targets Where variable pay has performance conditions based on business plan measures (for example the financial metrics of the AIP and the IFRS profit element of the PLTIP) the performance ranges are set by the Remuneration Committee prior to, or at the beginning of, the performance period. Performance is based on annual and longer-term plans approved by the Board. These reflect the long-term ambitions of the Group and business units, in the context of anticipated market conditions. For market-based performance conditions (eg relative TSR) the Committee requires that performance is in the upper quartile, relative to Prudential’s peer group, for awards to vest in full. Key differences between Directors’ remuneration and the remuneration of other employees Across the Group, remuneration is reviewed regularly with the intention that all employees are paid appropriately in the context of their local market and given their individual skills, experience and performance. Each business unit’s salary increase budget is set with reference to local market conditions. The Remuneration Committee considers salary increase budgets in each business unit when determining the salaries of Executive Directors. The principles that apply to Executive Directors are cascaded to other employees in their business unit. Senior leaders in the Group participate in annual bonus schemes which have performance conditions that mirror the CEO for their business unit. In addition, they are eligible to receive awards under the long-term incentive plans with performance conditions appropriate for their role. Legacy payments The Committee reserves the right to make any remuneration payments and/or payments for loss of office (including exercising any discretions available to it in connection with such payments) notwithstanding that they are not in line with the policy set out above where the terms of the payment were agreed (i) before 15 May 2014 (the date the Company’s first shareholder-approved Directors’ remuneration policy came into effect); (ii) before this policy came into effect, provided that the terms of the payment were consistent with the shareholder-approved Directors’ remuneration policy in force at the time they were agreed; or (iii) at a time when the relevant individual was not a Director of the Company and, in the opinion of the Committee, the payment was not in consideration for the individual becoming or having been a Director of the Company. For these purposes ‘payments’ includes the Committee satisfying awards of variable remuneration and, in relation to an award over shares, the terms of the payment are ‘agreed’ at the time the award is granted. References to ‘shares’ In this report, references to shares include American Depository Receipts (ADRs). Directors may receive awards denominated in ADRs rather than shares, depending on their location. 141 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportScenarios of total remuneration The chart below provides an illustration of the future total remuneration for each Executive Director in respect of their remuneration opportunity for 2017. Three scenarios of potential outcome are provided based on underlying assumptions shown in the notes to the chart. The Committee is satisfied that the maximum potential remuneration of the Executive Directors is appropriate. Prudential’s policy is to offer Executive Directors remuneration which reflects the performance and experience of the executive, internal relativities and Group and/or business unit financial performance. In order for the maximum total remuneration to be payable: — Financial performance must exceed the Group and/or business unit’s stretching business plan; — Relative TSR must be at or above the upper quartile relative to the peer group; — The sustainability scorecard, aligned to the Group’s strategic priorities, must be fully satisfied; — Functional and personal performance objectives must be fully met; and — Performance must be achieved within the Group’s and business units’ risk framework and appetite. £000 10,000 8,000 6,000 4,000 2,000 0 2,915 39% 1,090 100% 24% 37% i i M n m u m I n l i n e w i t h e x p e c t a t i o n s 4,380 44% 31% 25% i M a x m u m 10,279 37% 6,023 38% 52% 44% 5,617 38% 28% 3,965 32% 8,492 52% 26% 5,596 47% 1,908 100% 20% 48% 20% 1,874 34% 100% 33% 22% 1,082 100% 18% 11% 4,841 37% 50% 2,910 37% 41% 641 100% 22% 13% i i M n m u m i i M n m u m i M a x m u m I n l i n e w i t h e x p e c t a t i o n s i M a x m u m I n l i n e w i t h e x p e c t a t i o n s i i M n m u m i M a x m u m I n l i n e w i t h e x p e c t a t i o n s i i M n m u m i M a x m u m I n l i n e w i t h e x p e c t a t i o n s 4,197 43% 30% 27% i M a x m u m 3,491 46% 29% 25% i M a x m u m 2,825 38% 1,112 100% 23% 39% i i M n m u m I n l i n e w i t h e x p e c t a t i o n s 2,325 40% 22% 38% 879 100% i i M n m u m I n l i n e w i t h e x p e c t a t i o n s John Foley Penny James Nic Nicandrou Anne Richards Barry Stowe Tony Wilkey Mike Wells Fixed Short-term incentives Long-term incentives Notes The scenarios in the chart above have been calculated on the following assumptions: Fixed pay Base salary at 1 January 2017. Minimum In line with expectations Maximum Pension allowance at 1 January 2017. Estimated value of benefits based on amounts paid in 2016. Tony Wilkey and Barry Stowe are paid in HK$ and US$ respectively and figures have been converted to GBP for the purposes of this chart. Annual bonus No bonus paid. Long-term incentives (excludes share price growth and dividends) No PLTIP vesting. 50% of maximum AIP. Jackson bonus pool at the average of the last three years. 100% of maximum AIP. Jackson bonus pool at highest of the last three years. 59.38% (or 58.75% for the Group Chief Risk Officer) of award under PLTIP (midway between threshold and maximum). 100% of award under PLTIP. 142 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinued Approach to recruitment remuneration The table below outlines the approach that Prudential will take when recruiting a new Executive Director. This approach will also apply to internal promotions. The approach to recruiting a Non-executive Director or a Chairman is outlined on page 148. Element Base pay Benefits and pension Variable remuneration opportunity Awards and contractual rights forfeited when leaving previous employer Principles Potential variations The salary for a new Executive Director will be set using the approach set out in the fixed pay policy table on page 135. The benefits for a new Executive Director will be consistent with those outlined in the fixed pay policy table. The variable remuneration opportunities for a new Executive Director would be consistent with the limits and structures outlined in the variable pay policy table. On joining the Board from within the Group, the Committee may allow an executive to retain any outstanding deferred bonus and/or long-term incentive awards and/or other contractual arrangements that they held on their appointment. These awards (which may have been made under plans not listed in this policy) would remain subject to the original rules, performance conditions and vesting schedule applied to them when they were awarded. If a newly-appointed Executive Director forfeits one or more bonuses (including outstanding deferred bonuses) on leaving a previous employer, these payments or awards may be replaced in either cash, Prudential shares or options over Prudential shares with an award of an equivalent value. Replacement awards will normally be released on the same schedule as the foregone bonuses. If a newly-appointed Executive Director forfeits one or more long-term incentive awards on leaving a previous employer, these may be replaced with Prudential awards with an equivalent value. Replacement awards will generally be made under the terms of a long-term incentive plan approved by shareholders, and vest on the same schedule as the foregone awards. Where foregone awards were subject to performance conditions, performance conditions will be applied to awards replacing foregone long-term incentive awards; these will be the same as those applied to the long-term incentive awards made to Prudential executives in the year in which the forfeited award was made. The Committee may consider compensating a newly-appointed executive for other relevant contractual rights forfeited when leaving their previous employer. The use of Listing Rule 9.4.2 to facilitate the recruitment of an Executive Director is now only relevant in ‘unusual circumstances.’ The Committee does not anticipate using this rule on a routine basis but reserves the right to do so in an exceptional circumstance. For example, this rule may be required if, for any reason, like-for- like replacement awards on recruitment could not be made under existing plans. This provision would only be used to compensate for remuneration forfeited on leaving a previous employer. 143 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportPolicy on payment on loss of office Element Principle Potential variations Notice periods The Company’s policy is that Executive Directors’ service contracts will not require the Company to give an executive more than 12 months’ notice without prior shareholder approval. A shorter notice period may be offered where this is in line with market practice in an executive’s location. The Company is required to give to, and to receive from, each of the current Executive Directors 12 months’ notice of termination. An Executive Director whose contract is terminated would be entitled to 12 months’ salary and benefits in respect of their notice period. The payment of the salary and benefits would either be phased over the notice period or, alternatively, a payment in lieu of notice may be made. In agreeing the terms of departure for any Executive Director, other than on death or disablement, the Company will have regard to the need to mitigate the costs for the Company. If an Executive Director is dismissed for cause their contract would be terminated with immediate effect and they would not receive any payments in relation to their notice period. Should an executive die they would not be entitled to receive payments and benefits in respect of their notice period – provisions are made under the Company’s life assurance scheme to provide for this circumstance (see ‘Benefits’ in the policy table). Should an Executive Director step down from the Board but remain employed by the Group, they would not receive any payment in lieu of notice in respect of their service as a Director. Outstanding deferred bonus awards The treatment of outstanding deferred bonuses will be decided by the Committee taking into account the circumstances of the departure including the performance of the Executive Director. Deferred bonus awards are normally retained by participants leaving the Company. Awards will vest on the original timetable and will not normally be released early on termination. Prior to release, awards remain subject to the malus terms originally applied to them. The clawback provisions will continue to apply. Unvested long-term incentive awards The treatment of unvested long-term incentives will be decided by the Committee taking into account the circumstances of the departure including the performance of the Executive Directors. Executive Directors will normally retain their unvested long-term incentive awards. These awards will ordinarily be pro-rated based on time employed, will vest on the original timescale and will remain subject to the original performance conditions assessed over the entire performance period. Prior to release, awards remain subject to the malus terms and holding periods originally applied to them. Any Executive Director dismissed for cause would forfeit all outstanding deferred bonus awards. Should an executive die, outstanding deferred bonus awards will be released as soon as possible after the date of death. Should an Executive Director step down from the Board but remain employed by the Group, they would retain any outstanding deferred bonus awards. These awards would remain subject to the original rules and vesting schedule applied to them when they were awarded. Any Executive Director dismissed for cause would forfeit all unvested long-term incentive awards. On death, disablement and in other exceptional circumstances, the Committee has discretion to release unvested long-term incentive awards earlier than the end of the vesting period. The clawback provisions will continue to apply. Awards made under the M&G Executive LTIP will be released immediately should the Executive Director leave due to disablement or death and would be pro-rated based on time employed. Should an Executive Director step down from the Board but remain employed by the Group, an executive would retain any outstanding long-term incentive awards which they held on their change of role. These awards would remain subject to the original rules, performance conditions and vesting schedule. 144 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinued Policy on payment on loss of office continued Element Principle Potential variations On death, disablement and in other exceptional circumstances, the Committee has discretion to release vested long-term incentive awards earlier than the end of the holding period. The clawback provisions will continue to apply. Should an Executive Director step down from the Board but remain employed by the Group, they would retain any vested long-term incentive awards that remain subject to the holding period. These awards would remain subject to the original rules and release schedule applied to them when they were awarded (ie the holding period will continue to apply). Any Executive Director dismissed for cause would not be eligible for any bonus that has not been paid. Should an Executive Director die whilst serving as an employee a time pro-rated bonus may be awarded. In such circumstances, deferral will not be applied and the payment will be made solely in cash. The Committee may decide to award an executive stepping down from the Board but remaining with the Group a bonus pro-rated to reflect the portion of the financial year which had elapsed on the date of their change of role. This would be calculated with reference to financial and personal or functional and personal performance measures in the usual way. The Committee may determine that a portion of such a bonus must be deferred. Vested long- term incentive awards, subject to the holding period The treatment of vested long-term incentives will be decided by the Committee taking into account the circumstances of the departure. Executive Directors will normally retain their vested long-term incentive awards that remain subject to the holding period. Normally these awards will be released in accordance with the original timescale and will remain subject to the holding period. Prior to release, awards remain subject to the malus terms originally applied to them. Bonus for final year of service The payment of a bonus for the final year of service will be decided by the Committee giving full consideration to the circumstances of the departure including the performance of the Executive Director. The Committee may award a departing executive a bonus which will usually be pro-rated to reflect the portion of the final financial year in which they served which had elapsed on the last day of their employment. Any such bonus would be calculated with reference to financial, functional and/or personal performance measures in the usual way. The normal portion of any such bonus awarded must be deferred. Other payments Consistent with other employees in their business unit, Executive Directors may receive payments to compensate them for the loss of employment rights on termination. Payments may include: — A nominal amount for agreeing to non-solicitation and confidentiality clauses; — Directors and Officers insurance cover for a specified period following the executives’ termination date; — Payment for outplacement services; — Reimbursement of legal fees; and — Repatriation assistance. The Committee reserves the right to make additional exit payments where such payments are made in good faith: — In discharge of an existing legal obligation (or by way of damages for breach of such an obligation); or — By way of settlement or compromise of any claim arising in connection with the termination of a Director’s office or employment. 145 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportPolicy on corporate transactions Treatment Deferred Annual Incentive Plan Awards In the event of a corporate transaction (eg takeover, material merger, winding up etc), the Remuneration Committee will determine whether awards will: — Vest in part or in full; and/or — Continue in accordance with the rules of the plan; and/or — Lapse and, in exchange, the participant will be granted an award under any other share or cash incentive plan which the Remuneration Committee considers to be broadly equivalent to the award; and/or — Be exchanged for replacement awards of equal value. Prudential Long Term Incentive Plan In the case of a corporate transaction (eg takeover, material merger, winding up etc), the Remuneration Committee will determine whether awards will: — Be exchanged for replacement awards (either in cash or shares) of equal value unless the Committee and successor company agree that the original award will continue; or — Be released. Where awards are released the Remuneration Committee will have regard to the performance of the Company, the time elapsed between the date of grant and the relevant event and any other matter that the Remuneration Committee considers relevant or appropriate. Service contracts Executive Directors’ service contracts provide details of the broad types of remuneration to which they are entitled, and about the kinds of plans in which they may be invited to participate. The service contracts offer no certainty as to the value of performance-related reward and confirm that any variable payment will be at the discretion of the Company. Statement of consideration of conditions elsewhere in the Company Across the Group, remuneration is reviewed regularly with the intention that all employees are paid appropriately in the context of their local market and given their individual skills, experience and performance. Each business unit’s salary increase budget is set with reference to local market conditions. The Remuneration Committee considers salary increase budgets in each business unit when determining the salaries of Executive Directors. Prudential does not consult with employees when setting the Directors’ remuneration policy: Prudential is a global organisation with employees, and agents in multiple business units and geographies. As such, there are practical challenges associated with consulting with employees directly on this matter. The Committee will keep this under review. As many employees are also shareholders, they are able to participate in binding votes on the Directors’ remuneration policy and annual votes on the Annual report on remuneration. Statement of consideration of shareholder views The Remuneration Committee and the Company undertake regular consultation with key institutional investors on the Directors’ remuneration policy and implementation. This engagement is led by the Remuneration Committee Chairman and is an integral part of the Company’s investor relations programme. The Committee is grateful to shareholders for the feedback that is provided and takes this into account when determining executive remuneration. 146 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinuedRemuneration policy for Non-executive Directors and the Chairman Fees Benefits Share ownership guidelines Non-executive Directors do not currently receive benefits, a pension allowance or participate in the Group’s employee pension schemes. Travel and business expenses for Non-executive Directors are incurred in the normal course of business, for example, in relation to attendance at Board and Committee meetings. The costs associated with these are all met by the Company, including any tax liabilities arising on these business expenses. It is expected that Non-executive Directors will 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 their date of appointment. Non- executive Directors All Non-executive Directors receive a basic fee for their duties as a Board member. Additional fees are paid for added responsibilities such as chairmanship and membership of committees or acting as the Senior Independent Director. Fees are paid to Non-executive Directors, subject to the appropriate deductions. The basic and additional fees are reviewed annually by the Board with any changes effective from 1 July. In determining the level of fees the Board considers: — The time commitment and other requirements of the role; — Group financial performance; — Salary increases for all employees; and — Market data. If, in a particular year, the number of meetings is materially greater than usual, the Company may determine that the provision of additional fees in respect of that year is fair and reasonable. Should a new committee be formed, or the remit of an existing committee be materially expanded, the new or additional fees paid for the chairmanship or membership of the committee will be commensurate with the new or additional responsibilities and time commitment involved. Non-executive Directors are not eligible to participate in annual bonus plans or long-term incentive plans. 147 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportRemuneration policy for Non-executive Directors and the Chairman continued Fees Benefits Share ownership guidelines Chairman The Chairman receives an annual fee for the performance of their role. This fee is agreed by the Remuneration Committee and is paid to the Chairman in cash, subject to the appropriate deductions. On appointment, the fee may be fixed for a specified period of time. Following the fixed period (if applicable) this fee will be reviewed annually. Changes in the fee are effective from 1 July. In determining the level of the fee for the Chairman the Committee considers: — The time commitment and other requirements of the role; — The performance and experience of the Chairman; — Internal relativities; — Company financial performance; and — Market data. The Chairman is not eligible to participate in annual bonus plans or long-term incentive plans. The Chairman may be offered benefits including: — Health and wellness benefits; — Protection and security benefits; The Chairman has a share ownership guideline of one times his annual fee and is expected to attain this level of share ownership within five years of the date of his appointment. — Transport benefits; — Reimbursement of business expenses (and any associated tax liabilities) incurred when travelling overseas in performance of duties; and — Relocation and expatriate benefits (where appropriate). The maximum paid will be the cost to the Company of providing these benefits. The Chairman is not eligible to receive a pension allowance or to participate in the Group’s employee pension schemes. Recruitment of a new Chairman or Non-executive Director The fees for a new Non-executive Director will be consistent with the current basic fee paid to other Non-executive Directors (as set out in the Annual report on remuneration for that year) and will be reflective of their additional responsibilities as chair and/or members of Board committees. The fee for a new Chairman will be set with reference to the time commitment and other requirements of the role, the experience of the candidate, as well as internal relativities among the other Executive and Non-executive Directors. To provide context for this decision, data would be sought for suitable market reference point(s). Notice periods – Non-executive Directors and Chairman Non-executive Directors are appointed pursuant to letters of appointment with notice periods of six months without liability for compensation. A contractual notice period of 12 months by either party applies for the Chairman. The Chairman would not be entitled to any payments for loss of office. For information on the terms of appointment for the Chairman and Non-executive Directors please see page 133 of the Corporate governance report. 148 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinuedAdditional information: legacy long-term incentive plans for Executive Directors M&G Executive LTIP Operation Granting awards Determining the release of the award The Chief Executive, M&G received annual awards under the M&G Executive LTIP in the period up to and including 2016. Under this plan an annual award of phantom shares was made with a notional starting share price of £1. The phantom share price at vesting is determined by the performance of M&G over the three-year performance period. Awards are settled in cash. The Committee has the authority to apply clawback and/or a malus adjustment to all, or a portion of, an M&G Executive LTIP award. More details about clawback and malus are set out above. Corporate transactions In the event of a change of control, the Committee may determine that the award will vest immediately or continue until the original vest date. See pages 143 to 145 for details of the Committee’s powers in respect of M&G Executive LTIP participants joining or leaving the Group. Opportunity The Chief Executive, M&G received an award with an initial value of 300 per cent of salary under the M&G Executive LTIP. The maximum vesting under the M&G Executive LTIP is 100 per cent of the number of phantom shares originally awarded. Performance measures The phantom share price at vesting is determined by the increase or decrease in M&G’s profitability with profit and investment performance adjustments also applied. 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 bottom quartile will result in awards being forfeited, irrespective of any profit growth. If profits in the third year of the performance period are less than the average annual profit generated over the performance period the award will be reduced, potentially down to zero. Buy-out award for the Chief Executive, M&G (the Prudential plc 2016 Recruitment Plan) In line with the announcement made on 1 February 2016, the Company entered into an agreement with Anne Richards to compensate her for unvested share awards that she forfeited as a consequence of joining Prudential. This arrangement was put in place in accordance with Listing Rule 9.4.2, which allows an individual scheme to be put in place to assist with the recruitment of an Executive Director, and is consistent with the previous Directors’ remuneration policy approved by shareholders in 2014. Anne is the sole participant in this arrangement and no further awards will be made to Anne under the arrangement. Details of this award are set out on page 129 of the Annual report on remuneration. Changes to Directors’ remuneration policy approved at 2014 AGM Component Changes to policy approved at 2014 AGM Reason for changes Benefits Under both the current and proposed new policy, benefits included health and wellness benefits, protection and security benefits, transport benefits, family and education benefits, all employee share plans and savings plans and relocation and expatriate benefits. Reimbursed business expenses, and associated tax liabilities (such as, taxes levied by country revenue services on short-term business travellers eg when overseas-based Directors travel to Board meetings held in the UK) are included as a benefit for the avoidance of doubt. In addition, under the proposed new policy, benefits also include reimbursed business expenses (including any associated tax liability) incurred when travelling overseas in performance of duties. Annual cash bonus The Committee has the power to recover all, or a portion of, deferred bonus awards made since 2015 in specific circumstances and within a defined time frame. As this tax is incurred in performance of the Directors’ duties, and is in addition to the tax paid by the Director in the country in which he or she is resident, the Company pays this tax. The Company does not pay the tax due on salary in the country in which the Director is resident. In line with the requirements of the UK Corporate Governance Code, the Committee has had the power to recover (clawback) awards made since 2015 in specific circumstances and within a defined time frame. For clarity, this power is now reflected in the policy. 149 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportChanges to Directors’ remuneration policy approved at 2014 AGM continued Component Changes to policy approved at 2014 AGM Reason for changes Long-term incentives The Committee has the power to recover all, or a portion of, awards made since 2015 in specific circumstances and within a defined time frame. Executive Directors are required to hold their net of tax vested PLTIP shares, awarded in 2017 and subsequent years, for two years following the end of the three-year performance period, creating a five-year performance and holding period. The M&G Executive LTIP has been replaced with a commensurate PLTIP award for the Chief Executive, M&G. Share ownership guidelines The share ownership guidelines have been updated as follows: — Increased from 350 per cent of base salary to 400 per cent of base salary for the Chief Executive; and — Increased from 200% of base salary to 250% of base salary for other Executive Directors. The policy on replacement awards on recruitment of an Executive Director has been clarified to: — Specifically include options over Prudential shares (in addition to cash and Prudential shares); and — Clarify that performance conditions will be applied where foregone awards were subject to performance conditions. Approach to recruitment remuneration Policy on payment of loss of office In line with the requirements of the UK Corporate Governance Code, the Committee has had the power to recover (clawback) awards made since 2015 in specific circumstances and within a defined time frame. For clarity, this power is now reflected in the policy. The two-year holding period is consistent with investor guidance for shares to have at least a five-year performance and holding period. Shareholders are in favour of simplification, in particular, using a single long-term incentive plan for Executive Directors and the Committee shared this view. Delivering more of the Chief Executive, M&G incentive in Prudential shares strengthens her alignment with the Company’s shareholders and is consistent with the way in which other Executive Directors are rewarded. Shareholding guidelines among large listed companies have continued to increase over recent years and the Committee wanted to recognise this and to maximise the Executive Directors’ community of interest with the Company’s shareholders. The updates to the policy are intended to give the Committee a range of approaches which might be used in replacing awards forfeited by a newly-appointed Director on their departure from their previous employer. This is in line with our overriding principle that replacement awards should, as far as possible, reflect the terms of those forfeited. The policy on payment of loss of office has been clarified to: The updates to the policy are intended to clarify the treatment of leavers in specific circumstances. — Specifically state that should an Executive Director die while serving as a Director, a time pro-rated bonus may be awarded but deferral would not be applied; and — Repatriation assistance may be provided consistent with other employees. Corporate transactions A new section has been added to the policy to cover corporate transactions and the Committee’s discretion in these circumstances to: — Allow full or partial vesting or continuation or lapse and exchange of deferred bonus awards; and This new section has been added in response to a request from shareholders to set out the Committee’s discretion on corporate transactions. These provisions appear in the Rules of the PLTIP which were approved by shareholders in 2013 but are now included in the policy for completeness. — Exchange or release (taking into account performance, time elapsed and other relevant matters) of PLTIP awards. Policy for Non-executive Directors The policy on Non-executive Directors’ fees has been clarified to permit new or additional fees should a new committee be formed or the remit of an existing committee expanded. The updates to the policy are intended to clarify how it would be applied should the number or remit of Committees of the Board change. 150 Prudential plc Annual Report 2016 www.prudential.co.ukNew Directors’ remuneration policyContinuedAnnual report on remuneration Statement of implementation in 2017 Executive Directors Executive Directors’ remuneration packages were reviewed in 2016 with changes effective from 1 January 2017. When the Committee took these decisions, it considered the salary increases awarded to other employees in 2016 and the expected increases in 2017. The external market reference points used to provide context to the Committee were identical to those used for 2016 salaries. All Executive Directors, other than the Chief Executive, M&G and the Group Chief Risk Officer, received a salary increase of 2 per cent. The Chief Executive, M&G received no salary increase and the Group Chief Risk Officer received a salary increase of 5 per cent. The 2017 salary increase budgets for other employees across the Group’s business units were between 2.5 per cent and 6 per cent. No changes have been made to executives’ maximum opportunities under either the annual incentive or the long-term incentive plans. In 2017, the AIP performance measures have been simplified from seven to four measures and Executive Directors’ 2017 bonuses will be determined by the achievement of IFRS operating profit, operating free surplus, NBP EEV profit and cash flow, which are aligned to the Group’s growth and cash generation focus. This reflected the Committee’s objective to simplify the AIP metrics. As part of the continuing implementation of Solvency II, the weightings of Penny James’s AIP performance targets (with effect from 2017) have been changed so that her entire AIP outcome relates to a combination of functional and personal measures. As detailed in the new Directors’ remuneration policy, all long-term incentive awards made to Executive Directors in 2017 will be made under the PLTIP. The vesting of these awards will depend on: — Relative TSR (25 per cent of award); — Group or business unit IFRS profit (50 per cent of award); and — Balanced scorecard of strategic measures (25 per cent of award). As part of the continuing implementation of Solvency II, the weightings of Penny James’s LTIP performance targets (with effect from 2017) will be different to the other Executive Directors and will be: — Relative TSR (50 per cent of award); — Group IFRS profit (20 per cent of award); and — Balanced scorecard of strategic measures (30 per cent of award). Under the Group TSR measure, 25 per cent of the award vests for TSR at the median of the peer group increasing to full vesting for performance within the upper quartile. Following a comprehensive review of the peer group, supported by the Remuneration Committee’s independent adviser and the Group’s Investor Relations team, three companies (Aflac, Munich Re and Swiss Re) have been removed for the 2017 awards because their products and geographic footprints are insufficiently similar to those of the Group. TSR is measured on a local currency basis since this has the benefit of simplicity and directness of comparison. The peer group for the 2017 awards is: Aegon Allianz Legal & General Old Mutual Aviva Manulife Prudential Financial Zurich Insurance Group AIA AXA MetLife Standard Life AIG Generali Sun Life Financial Under the IFRS measure, 25 per cent of the award vests for meeting the threshold IFRS profit set at the start of the performance period increasing to full vesting for performance at or above the stretch level. 151 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportAnnual report on remuneration Continued Under the balanced scorecard, performance is assessed for each of the four measures, at the end of the three year performance period. Each of the measures has equal weighting and these measures are set out below. Capital measure Cumulative three-year ECap Group operating capital generation relative to plan, less cost of capital (based on the capital position at the start of the performance period). Vesting basis: 100 per cent vesting for achieving plan, otherwise 0 per cent vesting. The plan figure for this metric will be published in the Annual Report for the final year of the performance period. Capital measure Cumulative three-year Solvency II Group operating capital generation (as captured in published disclosures) relative to plan. Vesting basis: 100 per cent vesting for achieving plan, otherwise 0 per cent vesting. The plan figure for this metric will be published in the Annual Report for the final year of the performance period. Conduct measure Through appropriate management action, ensure there are no significant conduct/culture/governance issues which result in significant capital add-ons or material fines. Vesting basis: 100 per cent for achieving the Group’s expectations, otherwise 0 per cent vesting. Diversity measure Percentage of the Leadership Team that is female at the end of 2019. The target for this metric will be based on progress towards the goal that the Company set when it signed the Women in Finance Charter, specifically that 30 per cent of our Leadership Team will be female at the end of 2021. For this portion of PLTIP awards made in 2017 to vest, at least 27 per cent of our Leadership Team must be female at the end of 2019. Vesting basis: 100 per cent vesting for achieving the target, otherwise 0 per cent vesting. Chairman and Non-executive Directors Fees for the Chairman and Non-executive Directors were reviewed in 2016 with changes effective from 1 July 2016 as set out on page 130. The next review will be effective 1 July 2017. As referred to in the report of the Nomination and Governance Committee, the appointment of a Chairman of the Board of a material subsidiary (Jackson National Life Insurance Company) has been agreed. The Remuneration Committee has approved a fee of £250,000 per annum, fixed for a period of two years from the date of the appointment. This fee will be payable in US dollars and is the same as the fee agreed for the chairmen of the boards of Prudential Assurance Company Limited, M&G Group Limited and Prudential Corporation Asia Limited. In addition, the Remuneration Committee has approved a basic fee of £70,000 per annum for membership of the boards of these material subsidiaries, a fee for membership of the audit or risk committees of £10,000 per annum and a fee for chairing those committees of £30,000 per annum. Signed on behalf of the Board of Directors Anthony Nightingale, CMG SBS JP Chairman of the Remuneration Committee 13 March 2017 Paul Manduca Chairman 13 March 2017 152 Prudential plc Annual Report 2016 www.prudential.co.ukSupplementary information Directors’ outstanding long-term incentive awards Share-based long-term incentive awards Plan name Year of award Conditional share awards outstanding at 1 Jan 2016 Conditional awards in 2016 Market price at date of award John Foley Penny James PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP Nic Nicandrou PLTIP PLTIP PLTIP PLTIP (Number of shares) (Number of shares) 131,848 125,776 29,556 122,808 144,340 409,988 144,340 25,181 30,279 24,348 116,628 79,808 116,628 122,554 132,375 104,117 136,836 (pence) 1,203 1,317 1,342 1,672 1,279 1,203 1,317 1,672 1,279 1,203 1,317 1,672 1,279 2013 2014 2014 2015 2016 2013 2014 2015 2016 2013 2014 2015 2016 Barry Stowe1 Mike Wells2 Tony Wilkey4 PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PCA LTIP PCA LTIP PLTIP PCA LTIP PCA LTIP PLTIP PCA LTIP PLTIP PLTIP 2013 2014 2015 2015 2016 2013 2014 2015 2015 2016 2013 2013 2013 2014 2014 2014 2015 2015 2015 2016 131,266 114,824 113,940 50,668 274,100 410,698 274,100 273,470 238,954 209,222 30,132 332,870 751,778 332,870 25,244 55,705 47,182 22,935 45,870 68,806 21,091 42,183 29,008 153,742 1,203 1,317 1,672 1,611.5 1,279 1,203 1,317 1,672 1,611.5 1,279 1,203 1,203 1,178 1,317 1,317 1,317 1,672 1,672 1,611.5 1,279 Rights exercised in 2016 Rights lapsed in 2016 Conditional share awards outstanding at 31 Dec 2016 Date of end of performance period Dividend equivalents on vested shares (note 3) (Number of shares released) 14,133 131,848 (Number of shares) – 125,776 29,556 122,808 144,340 31 Dec 15 31 Dec 16 31 Dec 16 31 Dec 17 31 Dec 18 14,133 131,848 – 422,480 2,697 25,181 – 30,279 24,348 116,628 31 Dec 15 31 Dec 16 31 Dec 17 31 Dec 18 2,697 25,181 – 171,255 13,136 122,554 31 Dec 15 31 Dec 16 31 Dec 17 31 Dec 18 – 132,375 104,117 136,836 373,328 45,906 31 Dec 18 45,906 – 114,824 113,940 50,668 274,100 31 Dec 15 31 Dec 16 31 Dec 17 31 Dec 17 31 Dec 18 31 Dec 15 31 Dec 16 31 Dec 17 31 Dec 17 31 Dec 18 31 Dec 15 31 Dec 15 31 Dec 15 31 Dec 16 31 Dec 16 31 Dec 17 31 Dec 17 31 Dec 17 31 Dec 17 31 Dec 18 13,794 127,984 3,282 553,532 29,480 273,470 29,480 273,470 2,636 632 24,612 55,705 47,182 – 238,954 209,222 30,132 332,870 811,178 – – – 22,935 45,870 68,806 21,091 42,183 29,008 153,742 Anne Richards PLTIP 2016 45,906 1,358.5 359,046 136,836 13,136 122,554 45,906 – – – – 13,794 127,984 3,282 358,024 153,742 2,636 127,499 632 383,635 Notes 1 2 The awards for Barry Stowe were made in ADRs (1 ADR = 2 ordinary shares). The figures in the table are represented in terms of ordinary shares. The awards in 2013, 2014 and 2015 for Mike Wells were made in ADRs (1 ADR = 2 ordinary shares). The award in 2016 was made in ordinary shares. The figures in the table are represented in terms of ordinary shares. 3 A dividend equivalent was accumulated on these awards. 4 The PCA LTIP is an arrangement for executives and senior management of PCA. Tony Wilkey was a participant of this plan until his appointment to the Board on 1 June 2015 and has not been eligible to new awards since this date. The column above marked ‘Date of end of performance period’ for the PCA LTIP reflects the end of the vesting period as there are no performance conditions on these awards. 153 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration reportSupplementary information Continued Business-specific cash-based long-term incentive plans Michael McLintock M&G Executive LTIP M&G Executive LTIP M&G Executive LTIP Total payments made in 2016 Anne Richards M&G Executive LTIP Face value of conditional share awards outstanding at 1 January 2016 £000 Year of award Face value of conditional awards outstanding at 31 December 2016 £000 Payments made in 2016 £000 Date of end of performance period 2013 2014 2015 1,112 1,146 1,182 1,991 1,991 31 Dec 2015 1,146 31 Dec 2016 1,182 31 Dec 2017 2016 1,200 1,200 31 Dec 2018 Note Under the M&G Executive LTIP, the value of each unit at award is £1. The value of units changes based on M&G’s profit growth and investment performance over the performance period. For the 2013 award of 1,112,400 units, the unit price at the end of the performance period was £1.79, which resulted in a payment of £1,991,196 to Michael McLintock in 2016. For the 2014 award of 1,146,000 units, the unit price at the end of the performance period was £1.60, which will result in a payment of £1,577,398 to Michael McLintock in 2017. Other share awards The table below sets out Executive Directors’ deferred bonus share awards. Year of grant Conditional share awards outstanding at 1 Jan 2016 (Number of shares) Conditionally awarded in 2016 (Number of shares) Dividends accumulated in 20165 (Number of shares) Conditional share awards outstanding at 31 Dec 2016 (Number of shares) Shares released in 2016 (Number of shares) Date of end of restricted period Date of release Market price at date of award Market price at date of vesting or release (pence) (pence) John Foley Deferred 2012 annual incentive award Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Penny James1 Deferred 2012 Group deferred bonus plan award Deferred 2013 Group deferred bonus plan award Deferred 2014 Group deferred bonus plan award 2013 37,396 37,396 – 31 Dec 15 31 Mar 16 1,055 1,301 2014 32,731 2015 42,062 2016 112,189 63,320 63,320 1,237 1,589 2,393 5,219 33,968 31 Dec 16 43,651 31 Dec 17 65,713 31 Dec 18 1,317 1,672 1,279 37,396 143,332 2013 5,677 5,677 – 31 Dec 15 31 Mar 16 1,083 1,301 2014 4,880 2015 3,943 Deferred 2015 annual incentive award 2016 Nic Nicandrou Deferred 2012 annual incentive award Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award 2013 2014 2015 2016 154 13,290 13,290 14,500 41,821 36,639 28,799 107,259 37,683 37,683 184 148 501 833 1,385 1,088 1,424 5,064 31 Dec 16 1,317 4,091 31 Dec 17 13,791 31 Dec 18 1,672 1,279 5,677 22,946 41,821 – 31 Dec 15 31 Mar 16 1,055 1,301 38,024 31 Dec 16 29,887 31 Dec 17 39,107 31 Dec 18 1,317 1,672 1,279 3,897 41,821 107,018 Prudential plc Annual Report 2016 www.prudential.co.uk Year of grant Conditional share awards outstanding at 1 Jan 2016 (Number of shares) Conditionally awarded in 2016 (Number of shares) Dividends accumulated in 20165 (Number of shares) Conditional share awards outstanding at 31 Dec 2016 (Number of shares) Shares released in 2016 (Number of shares) Date of end of restricted period Date of release Market price at date of award Market price at date of vesting or release (pence) (pence) 40,646 – 31 Dec 15 31 Mar 16 1,055 1,301 1,196 1,054 32,950 31 Dec 16 29,046 31 Dec 17 107,566 4,052 111,618 31 Dec 18 100,392 107,566 6,302 40,646 173,614 86,586 – 31 Dec 15 31 Mar 16 1,055 1,301 3,942 4,382 108,578 31 Dec 16 120,686 31 Dec 17 2016 103,210 3,902 107,112 31 Dec 18 307,526 103,210 12,226 86,586 336,376 1,317 1,672 1,279 1,317 1,672 1,279 40,646 31,754 27,992 2013 2014 2015 2016 2013 86,586 2014 104,636 2015 116,304 Barry Stowe2 Deferred 2012 annual incentive award Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Mike Wells3 Deferred 2012 annual incentive award Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Tony Wilkey4 Deferred 2013 PCA deferred bonus plan award Deferred 2014 PCA deferred bonus plan award Deferred 2015 annual incentive award 2014 70,831 70,831 – 31 Dec 15 31 Mar 16 1,317 1,301 2015 2016 82,290 153,121 34,625 34,625 2,305 1,308 84,595 31 Dec 16 35,933 31 Dec 18 1,672 1,279 3,613 70,831 120,528 Notes 1 The Group deferred bonus plan is an arrangement for executives and senior management. Penny James was a participant of this plan until her appointment to the Board on 1 September 2015 and has not been eligible to new awards from this date. The awards for Barry Stowe were made in ADRs (1 ADR = 2 ordinary shares). The figures in the table are represented in terms of ordinary shares. The awards for Mike Wells in 2013, 2014 and 2015 were made in ADRs (1 ADR = 2 ordinary shares). The award made in 2016 was made in ordinary shares. The figures in the table are represented in terms of ordinary shares. The PCA deferred bonus plan is an arrangement for executives and senior management of PCA. Tony Wilkey was a participant of this plan until his appointment to the Board on 1 June 2015 and has not been eligible for new awards since this date. 2 3 4 5 A dividend equivalent was accumulated on these awards. 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. This scheme allows 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. From 2014 participants could elect to enter into savings contracts of up to £500 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 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. Details of Executive Directors’ rights under the SAYE scheme are set out in the ‘Statement of Directors’ shareholdings’. 155 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration report Supplementary information Continued Share Incentive Plan (SIP) UK-based Executive Directors are also eligible to participate in the Company’s Share Incentive Plan (SIP). From April 2014, all UK-based employees were able to purchase Prudential plc shares up to a value of £150 per month from their gross salary (partnership shares) through the SIP. For every four partnership shares bought, 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. If the employee withdraws from the plan, or leaves the Group, matching shares may be forfeited. The table below provides information about shares purchased under the SIP together with matching shares (awarded on a 1:4 basis) and dividend shares. John Foley Nic Nicandrou Mike Wells Year of initial grant Share Incentive Plan awards held in Trust at 1 Jan 2016 (Number of shares) Partnership shares accumulated in 2016 (Number of shares) Matching shares accumulated in 2016 (Number of shares) Dividend shares accumulated in 2016 (Number of shares) Share Incentive Plan awards held in Trust at 31 Dec 2016 (Number of shares) 2014 2010 2015 255 1,425 97 134 133 134 33 33 34 11 53 5 433 1,644 270 Prudential Corporation Asia All Employee Share Purchase Plan (PruSharePlus) From August 2014, all Asia-based employees were able to purchase Prudential plc shares up to a value of £5,000 per year from their gross salary through the PruSharePlus. For every two shares bought by the employee, one additional matching share is awarded which is purchased by Prudential on the open market. Dividend shares accumulate while the employee participates in the plan. If the employee withdraws from the plan, or leaves the Group, matching shares may be forfeited. The table below provides information about shares purchased under the PruSharePlus together with matching shares (awarded on a 1:2 basis) and dividend shares. Year of initial grant PruSharePlus awards held in Trust at 1 Jan 2016 (Number of shares) Purchased shares accumulated in 2016 (Number of shares) Matching shares accumulated in 2016 (Number of shares) Dividend shares accumulated in 2016 (Number of shares) PruSharePlus awards released from Trust in 2016 (Number of shares) PruSharePlus awards held in Trust at 31 December 2016 (Number of shares) Tony Wilkey* 2014 545 – – 14 559 – * Following his appointment to the Board, Tony Wilkey is no longer eligible to participate in the PruSharePlus with effect from the anniversary of his joining the plan. 156 Prudential plc Annual Report 2016 www.prudential.co.ukCash-settled long-term incentive awards This information has been prepared in line with the reporting requirements of the Hong Kong Stock Exchange and sets out Executive Directors’ outstanding share awards and share options. For details of the cash-settled long-term incentive awards held by some Executive Directors, please see our Annual report on remuneration. Dilution Releases from the Prudential Long Term Incentive Plan are satisfied 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 2016 was 1 per cent of the total share capital at the time. Deferred bonus awards will continue to be satisfied by the purchase of shares in the open market. Five highest paid individuals Of the five individuals with the highest emoluments in 2016, two were Executive Directors whose emoluments are disclosed in this report. The aggregate of the emoluments of the other three individuals for 2016 were as follows: Base salaries, allowances and benefits in kind Pension contributions Performance related pay Total Their emoluments were within the following bands: £6,200,001 – £6,300,000 £6,800,001 – £6,900,000 £9,200,001 – £9,300,000 2016 £000 3,257 123 18,952 22,332 Number of five highest paid employees 2016 1 1 1 157 www.prudential.co.ukAnnualReport2016 Prudential plc 04 Directors’ remuneration report05 Financial statements 160 Index to Group IFRS financial statements 309 Parent company financial statements 311 Notes on the parent company financial statements 318 Statement of Directors’ responsibilities in respect of the Annual Report and the financial statements 319 Independent auditor’s report to the members of Prudential plc 05 Financial statementsIndex to Group IFRS financial statements Primary statements 161 Consolidated income statement 162 Consolidated statement of comprehensive income 163 Consolidated statement of changes in equity: 2016 2015 165 Consolidated statement of financial position 166 Consolidated statement of cash flows Notes to Primary statements C4 C5 C6 C7 229 232 234 236 238 240 246 251 252 255 256 256 257 259 260 265 267 C8 268 268 269 C9 275 C10 276 C11 C12 276 277 279 279 C13 280 C14 Movement and duration of liabilities Products and determining contract liabilities Policyholder liabilities and unallocated surplus of with-profits funds C4.1 C4.1(a) Group overview C4.1(b) Asia insurance operations C4.1(c) US insurance operations C4.1(d) UK insurance operations C4.2 C4.2(a) Asia C4.2(b) US C4.2(c) UK Intangible assets Goodwill C5(a) C5(b) Deferred acquisition costs and other intangible assets Borrowings C6.1 Core structural borrowings of shareholder- financed operations Other borrowings Maturity analysis Group overview Asia insurance operations US insurance operations UK insurance operations Asset management and other operations C6.2 C6.3 Risk and sensitivity analysis C7.1 C7.2 C7.3 C7.4 C7.5 Tax assets and liabilities C8.1 C8.2 Defined benefit pension schemes Share capital, share premium and own shares Provisions Capital C12(a) Group objectives, policies and processes for Deferred tax Current tax managing capital C12(b) Local capital regulations C12(c) Transferability of available capital Property, plant and equipment Investment properties Section D: Other notes 281 D1 282 D2 283 D3 283 D4 283 D5 284 D6 Held for sale Korea life business Contingencies and related obligations Post balance sheet events Related party transactions Commitments Investments in subsidiary undertakings, joint ventures and associates Section E: Further accounting policies 302 Other significant accounting policies E1 Section A: Background and critical accounting policies Basis of preparation and exchange rates 167 A1 Adoption of new accounting pronouncements in 2016 167 A2 Accounting policies A3 A3.1 A3.2 Critical accounting policies, estimates and judgements New accounting pronouncements not yet effective 168 176 Section B: Earnings performance B1 178 179 181 185 188 189 B2 190 B3 190 191 193 193 194 B4 194 B5 199 B6 200 B7 Analysis of performance by segment B1.1 B1.2 Segment results – profit before tax Short-term fluctuations in investment returns on shareholder-backed business Determining operating segments and performance measure of operating segments Segmental income statement Other investment return B1.3 Staff and employment costs Share-based payment Key management remuneration Fees payable to the auditor B1.4 B1.5 Profit before tax – asset management operations Acquisition costs and other expenditure B3.1 B3.2 B3.3 B3.4 Effect of changes and other accounting features on insurance assets and liabilities Tax charge Earnings per share Dividends Section C: Balance sheet notes 201 C1 Asia insurance operations US insurance operations UK insurance operations Analysis of Group statement of financial position by segment Analysis of segment statement of financial position by business type C2.1 C2.2 C2.3 Assets and liabilities – classification and measurement C3.1 C3.2 C3.3 C3.4 C3.4(a) Financial risk C3.4(b) Derivatives and hedging C3.4(c) Derecognition, collateral and offsetting Group assets and liabilities Debt securities Loans portfolio Financial instruments – additional information C2 C3 206 207 208 209 217 223 224 226 227 160 Prudential plc Annual Report 2016 www.prudential.co.uk Consolidated income statement Year ended 31 December Gross premiums earned Outward reinsurance premiums Earned premiums, net of reinsurance Investment return Other income Total revenue, net of reinsurance Benefits and claims Outward reinsurers’ share of benefit and claims Movement in unallocated surplus of with-profits funds Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance Acquisition costs and other expenditure Finance costs: interest on core structural borrowings of shareholder-financed operations Remeasurement of carrying value of Korea life business classified as held for sale Disposal of Japan life business – cumulative exchange loss recycled from other comprehensive income Total charges, net of reinsurance Share of profits from joint ventures and associates, net of related tax Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)* Less tax charge attributable to policyholders’ returns Profit before tax attributable to shareholders Total tax charge attributable to policyholders and shareholders Adjustment to remove tax charge attributable to policyholders’ returns Tax charge attributable to shareholders’ returns Profit for the year attributable to equity holders of the Company Earnings per share (in pence) Based on profit attributable to the equity holders of the Company: Basic Diluted Note 2016 £m 2015 £m B1.4 B1.4 B1.4 B1.4 B3 D1 B1.4 D6 B1.1 B5 B5 B6 38,981 (2,020) 36,961 32,511 2,370 71,842 (60,948) 2,412 (830) (59,366) (8,848) (360) (238) 36,663 (1,157) 35,506 3,304 2,495 41,305 (30,547) 1,389 (498) (29,656) (8,208) (312) – – (46) (68,812) (38,222) 182 3,212 (937) 2,275 (1,291) 937 (354) 1,921 238 3,321 (173) 3,148 (742) 173 (569) 2,579 2016 2015 75.0p 75.0p 101.0p 100.9p * 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 is not representative of pre-tax profits attributable to shareholders. Profit before all taxes 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 by policyholders. 161 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsConsolidated statement of comprehensive income Year ended 31 December Profit for the year Note 2016 £m 2015 £m 1,921 2,579 Other comprehensive income: Items that may be reclassified subsequently to profit or loss Exchange movements on foreign operations and net investment hedges: Exchange movements arising during the year Cumulative exchange loss of sold Japan life business recycled through profit or loss Related tax Net unrealised valuation movements on securities of US insurance operations classified as available-for-sale: Net unrealised holding gains (losses) arising during the year Deduct net gains included in the income statement on disposal and impairment Total Related change in amortisation of deferred acquisition costs Related tax A1 C3.2(c) C5 (b) Total Items that will not be reclassified to profit or loss Shareholders’ share of actuarial gains and losses on defined benefit pension schemes: Gross Related tax 1,148 – 13 1,161 241 (269) (28) 76 (17) 31 1,192 (107) 14 (93) 68 46 4 118 (1,256) (49) (1,305) 337 339 (629) (511) 27 (5) 22 Other comprehensive income (loss) for the year, net of related tax 1,099 (489) Total comprehensive income for the year attributable to the equity holders of the Company 3,020 2,090 162 Prudential plc Annual Report 2016 www.prudential.co.ukConsolidated statement of changes in equity Year ended 31 December 2016 £m Share capital note C10 Share premium note C10 Note Retained earnings Translation reserve Available- for-sale securities reserves Share- holders’ equity Non- controlling interests Total equity – 1,921 – – 1,921 – 1,921 – 1,161 – 1,161 – 1,161 Reserves Profit for the year Other comprehensive income: Exchange movements on foreign operations and net investment hedges, net of related tax Net unrealised valuation movements, net of related change in amortisation of deferred acquisition costs and related tax Shareholders’ share of actuarial gains and losses on defined benefit pension schemes, net of tax Total other comprehensive income (loss) Total comprehensive income for the year Dividends Reserve movements in respect of share-based payments Share capital and share premium New share capital subscribed B7 C10 Treasury shares Movement in own shares in respect of share-based payment plans Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS Net increase in equity At beginning of year At end of year – – – – – – – – 1 – – – – – – – – – 12 – – – – 1,161 1,161 – – – – – (93) (93) 1,828 (1,267) (51) – 2 (6) 31 31 – 31 31 – – – – – (93) 1,099 3,020 (1,267) (51) 13 2 (6) 1 128 129 12 1,915 506 10,436 1,927 10,942 1,161 149 1,310 31 327 358 1,711 12,955 14,666 – – – – – – – – – – 1 1 31 (93) 1,099 3,020 (1,267) (51) 13 2 (6) 1,711 12,956 14,667 163 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements Consolidated statement of changes in equity Continued Year ended 31 December 2015 £m Share capital note C10 Share premium note C10 Note Retained earnings Translation reserve Available- for-sale securities reserves Share- holders’ equity Non- controlling interests Total equity Reserves Profit for the year Other comprehensive income: Exchange movements on foreign operations and net investment hedges, net of related tax Net unrealised valuation movements, net of related change in amortisation of deferred acquisition costs and related tax Shareholders’ share of actuarial gains and losses on defined benefit pension schemes, net of tax Total other comprehensive income (loss) Total comprehensive income for the year Dividends Reserve movements in respect of share-based payments Share capital and share premium New share capital subscribed B7 C10 Treasury shares Movement in own shares in respect of share-based payment plans Movement in Prudential plc shares purchased by unit trusts consolidated under IFRS Net increase in equity At beginning of year At end of year – – – – – – – – – – – – 128 128 – 2,579 – – 2,579 – 2,579 – – – – – – – 7 – – 7 1,908 – – 22 22 2,601 (974) 39 – (38) 20 1,648 8,788 1,915 10,436 118 – 118 – 118 – (629) (629) – 118 118 – (629) (629) – – – – – – – – – – 22 (489) 2,090 (974) 39 7 (38) 20 118 31 149 (629) 956 1,144 11,811 327 12,955 – – – – – – – – – – 1 1 (629) 22 (489) 2,090 (974) 39 7 (38) 20 1,144 11,812 12,956 164 Prudential plc Annual Report 2016 www.prudential.co.ukConsolidated statement of financial position 31 December Note 2016 £m 2015 £m Assets Goodwill Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income Other debtors Investment properties Investment in joint ventures and associates accounted for using the equity method Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Deposits Assets held for sale Cash and cash equivalents Total assets Equity Shareholders’ equity Non-controlling interests Total equity Liabilities Insurance contract liabilities Investment contract liabilities with discretionary participation features Investment contract liabilities without discretionary participation features Unallocated surplus of with-profits funds Core structural borrowings of shareholder-financed operations Operational borrowings attributable to shareholder-financed operations Borrowings attributable to with-profits operations Obligations under funding, securities lending and sale and repurchase agreements Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals, deferred income and other liabilities Provisions Derivative liabilities Liabilities held for sale Total liabilities C5(a) C5(b) C13 C4.1(a)(iv) C8.1 C8.2 C1 C1 C14 D6 C3.3 C3.2 C3.4 D1 C1 C4.1 C4.1 C4.1 C4.1 C6.1 C6.2 C6.2 C8.1 C8.2 C11 C3.4 D1 C1 1,628 10,807 743 10,051 4,315 440 3,153 3,019 14,646 1,273 15,173 198,552 170,458 3,936 5,465 12,185 4,589 10,065 470,498 1,648 8,472 1,197 7,903 2,819 477 2,751 1,955 13,422 1,034 12,958 157,453 147,671 2,958 4,395 12,088 2 7,782 386,985 14,666 1 14,667 12,955 1 12,956 316,436 52,837 19,723 14,317 6,798 2,317 1,349 5,031 8,687 5,370 649 13,825 947 3,252 4,293 455,831 260,753 42,959 18,806 13,096 5,011 1,960 1,332 3,765 7,873 4,010 325 10,416 604 3,119 – 374,029 Total equity and liabilities 470,498 386,985 Included within equity securities and portfolio holdings in unit trusts, debt securities and other investments are £8,545 million (2015: £5,995 million) of lent securities and assets subject to repurchase agreements. The consolidated financial statements on pages 161 to 308 were approved by the Board of Directors on 13 March 2017. They were signed on its behalf: Paul Manduca Chairman Mike Wells Group Chief Executive Nic Nicandrou Chief Financial Officer 165 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsConsolidated statement of cash flows Year ended 31 December Note 2016 £m 2015 £m Cash flows from operating activities Profit before tax (being tax attributable to shareholders’ and policyholders’ returns) note (i) Non-cash movements in operating assets and liabilities reflected in profit before tax: Investments Other non-investment and non-cash assets Policyholder liabilities (including unallocated surplus) Other liabilities (including operational borrowings) Interest income and expense and dividend income included in result before tax Other non-cash items note (ii) Operating cash items: Interest receipts Dividend receipts Tax paid note (v) Net cash flows from operating activities Cash flows from investing activities Purchases of property, plant and equipment Proceeds from disposal of property, plant and equipment Acquisition of subsidiaries and intangibles Sale of businesses Net cash flows from investing activities Cash flows from financing activities Structural borrowings of the Group: Shareholder-financed operations: note (iii) Issue of subordinated debt, net of costs Interest paid With-profits operations: note (iv) Interest paid Equity capital: Issues of ordinary share capital Dividends paid Net cash flows from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Effect of exchange rate changes on cash and cash equivalents Cash and cash equivalents at end of year 3,212 3,321 (37,824) (2,490) 31,135 7,861 (9,749) 834 7,886 2,286 (950) 2,201 (348) 102 (303) – (549) 1,227 (335) (9) 13 (1,267) (371) 1,281 7,782 1,002 10,065 (6,814) (1,063) 6,067 1,761 (8,726) 234 7,316 1,777 (1,340) 2,533 (256) 30 (286) 43 (469) 590 (288) (9) 7 (974) (674) 1,390 6,409 (17) 7,782 C13 C6.1 C6.2 This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders. Notes (i) (ii) Other non-cash items consist of the adjustment of non-cash items to profit before tax. (iii) Structural borrowings of shareholder-financed operations exclude 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. Interest paid on structural borrowings of with-profits operations relate solely to the £100 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. Tax paid includes £226 million (2015: £229 million) paid on profits taxable at policyholder rather than shareholder rates. (iv) (v) 166 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policies A1 Basis of preparation and exchange rates Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international financial services group. Principal operations are 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 primarily include life insurance, pensions and annuities as well as collective investment schemes. Basis of preparation These statements have been prepared in accordance with IFRS Standards as issued by the International Accounting Standards Board (IASB) and as endorsed by the European Union (EU) as required by EU law (IAS Regulation EC1606/2032). EU-endorsed IFRS Standards may differ from IFRS Standards issued by the IASB if, at any point in time, new or amended IFRS Standards have not been endorsed by the EU. At 31 December 2016, there were no unendorsed standards effective for the two years ended 31 December 2016 affecting the consolidated financial information of the Group. There were no differences between IFRS Standards endorsed by the EU and IFRS Standards issued by the IASB in terms of their application to the Group. These statements have been prepared on a going concern basis. The parent company statement of financial position prepared in accordance with the UK Generally Accepted Accounting Practice (including Financial Reporting Standard 101 Reduced Disclosure Framework) is presented on page 309. The Group IFRS accounting policies are the same as those applied for the year ended 31 December 2015 with the exception of the adoption of the new and amended accounting standards as described in note A2. Exchange rates The exchange rates applied for balances and transactions in currency other than the presentational currency of the Group, pounds sterling (GBP) were: Local currency: £ Hong Kong Indonesia Malaysia Singapore China India Vietnam Thailand US Closing rate at 31 Dec 2016 Average rate for 2016 Closing rate at 31 Dec 2015 Average rate for 2015 9.58 16,647.30 5.54 1.79 8.59 83.86 28,136.99 44.25 1.24 10.52 18,026.11 5.61 1.87 8.99 91.02 30,292.79 47.80 1.35 11.42 20,317.71 6.33 2.09 9.57 97.51 33,140.64 53.04 1.47 11.85 20,476.93 5.97 2.1 9.61 98.08 33,509.21 52.38 1.53 Certain notes to the financial statements present 2015 comparative information at Constant Exchange Rates (CER), in addition to the reporting at Actual Exchange Rates (AER) used throughout the consolidated financial statements. AER are actual historical exchange rates for the specific 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. CER results are calculated by translating prior period results using the current period foreign exchange rate ie current period average rates for the income statement and current period closing rates for the balance sheet. The exchange movement arising during 2016 recognised in other comprehensive income is: Asia operations† US operations Unallocated to a segment (central funds)* 2016 £m 2015 £m 785 853 (490) 1,148 (5) 238 (119) 114 * The exchange rate movement unallocated to a segment mainly reflects the translation of currency borrowings that have been designated as a net investment hedge against the currency risk of the investment in Jackson. † 2015 included the cumulative exchange loss of the Japan life business of £46 million. A2 Adoption of new accounting pronouncements in 2016 The Group has adopted the following new accounting pronouncements which were effective in 2016: — Annual improvements to IFRSs 2012 to 2014 cycle; — Clarification of Acceptable Methods of Depreciation and Amortisation (Amendments to IAS 16 and IAS 38); and — Disclosure Initiative (Amendments to IAS 1). The adoption of these pronouncements has had no impact on these financial statements. 167 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsA3 Accounting policies A3.1 Critical accounting policies, estimates and judgements This note presents the critical accounting policies, accounting estimates and judgements applied in preparing the Group’s consolidated financial statements. Other significant accounting policies are presented in note E1. All accounting policies are applied consistently for all years presented and normally are not subject to changes unless new accounting standards, interpretations or amendments are introduced by the IASB. 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 the related disclosure of contingent assets and liabilities. Prudential evaluates its estimates, including those related to long-term business provisioning and the fair value of assets. Below are set out those critical accounting policies the application of which requires the Group to make critical estimates and judgements. Also set out are further critical accounting policies, and other items which require the application of critical estimates and judgements. (a) Critical accounting policies with linked critical estimates and judgements Classification of insurance and investment contracts IFRS 4 requires contracts written by insurers to be classified as either ‘insurance’ contracts or ‘investment’ contracts. The classification of the contract determines its accounting. Judgement is applied in the classification of these contracts. Impacts £410 billion of reported liabilities, requiring classification. Contracts which transfer significant insurance risk to the Group are classified as insurance contracts. Contracts that transfer financial risk to the Group 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 that (a) are likely to be a significant portion of the total contract benefits; (b) have amount or timing contractually at the discretion of the insurer; and (c) are contractually based on asset or fund performance, as discussed in IFRS 4. Insurance contracts and investment contracts with discretionary participation features are accounted for under IFRS 4. Investment contracts without discretionary participation features are accounted for as financial instruments. Business units Insurance contracts and investment contracts with discretionary participation features Investment contracts without discretionary participation features Asia — With-profits contracts — Non-participating term — Minor amounts for a number of small categories of business US UK contracts — Whole life contracts — Unit-linked policies — Accident and health policies — Variable annuity contracts — Fixed annuity contracts — Life insurance contracts — With-profits contracts — Bulk and individual annuity business — Non-participating term contracts — Guaranteed investment contracts (GICs) — Minor amounts of ‘annuity certain’ contracts — Certain unit-linked savings and similar contracts 168 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policiesContinuedMeasurement of policyholder liabilities and unallocated surplus of with-profits Due to their significance to the Group’s business, the measurement of policyholder liabilities and unallocated surplus of with-profits is a critical accounting policy. The measurement basis of policyholder liabilities is dependent upon the classification of the contracts under IFRS 4 described above. Impacts £410 billion of liabilities IFRS 4 permits the continued usage of previously applied Generally Accepted Accounting Practices (GAAP) for insurance contracts and investment contracts with discretionary participating features. A modified statutory basis of reporting was adopted by the Group on first time adoption of IFRS in 2005. This was set out in the Statement of Recommended Practice issued by Association of British Insurers (ABI SORP). An exception was for UK regulated with-profits funds which were measured under FRS 27 as discussed below. FRS 27 and the ABI SORP were withdrawn in the UK for the accounting periods beginning in or after 2015. As used in these consolidated financial statements, the terms ‘FRS 27’ and the ‘ABI SORP’ refer to the requirements of these pronouncements prior to their withdrawal. For investment contracts that do not contain discretionary participating features, IAS 39 is applied and, where the contract includes an investment management element, IAS 18, ‘Revenue’, applies. The policies applied in each business unit are noted below. Additional details are discussed in note C4.2 Measurement of insurance contract liabilities and investment contracts with discretionary participation features liabilities. Asia insurance operations US insurance operations The policyholder liabilities for businesses in Asia are generally determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with the modified statutory basis. Refinements to the local reserving methodology are generally treated as changes in estimates, dependent on their nature. In some operations, including Taiwan, local GAAP is not an appropriate starting point and US GAAP principles are therefore applied. While the basis of valuation of liabilities in this business is in accordance with the requirements of the ABI SORP, it may differ from that determined on the modified statutory basis for UK operations with the same features. The policyholder liabilities for Jackson’s conventional protection-type policies are determined under US GAAP principles with locked in assumptions for mortality, interest, policy lapses and expenses along with provisions for adverse deviations. For other policies, the policyholder liabilities include the policyholder account balance. For those investment contracts in the US with fixed and guaranteed terms, the Group uses the amortised cost model to measure the liability. The US has no investment contracts with discretionary participation features. 169 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued Measurement of policyholder liabilities and unallocated surplus of with-profits continued UK insurance operations The UK regulated with-profits funds’ liabilities are the realistic basis liabilities in accordance with FRS 27. The realistic basis requires the value of liabilities to be calculated as: — A with-profits benefits reserve; plus — Future policy-related liabilities; plus — The realistic current liabilities of the fund. The with-profits benefits reserve 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-profits fund assets attributable to their policies. The future policy-related liabilities 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 shareholders’ share of future costs of bonuses is included within the liabilities for unallocated surplus. Shareholder’s share of profit is recognised in line with the distribution of bonuses to policyholders. For the purposes of local regulations, segregated accounts are established for linked business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year. Mortality rates used in establishing policyholder benefits are based on published mortality tables adjusted to reflect actual experience. Measurement of investment contracts without discretionary participation features liabilities Measured 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. 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 in accordance with IAS 18. Investment contracts without fixed and guaranteed terms are designated as fair value through profit or 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. Further investment contracts are measured at amortised cost. 170 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policiesContinuedMeasurement of policyholder liabilities and unallocated surplus of with-profits continued Measurement of unallocated surplus of with-profits funds Liability adequacy test Represents the excess of assets over policyholder liabilities for the Group’s with-profits funds in the UK, Hong Kong, Malaysia and Singapore that have yet to be appropriated between policyholders and shareholders. The unallocated surplus is recorded wholly as a liability with no allocation to equity. 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. The Group performs adequacy testing on its insurance liabilities to ensure that the carrying amounts (net of related deferred acquisition costs) 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. The practical application for Jackson is in the context of the deferred acquisition cost asset and the liabilities for Jackson’s insurance contracts being determined in accordance with US GAAP. The liabilities include those in respect of the separate accounts (which reflect separate account assets), policyholder account values, and guarantees measured as described in note C4.2. Under US GAAP, most of Jackson’s products are accounted for under Accounting Standard no. 97 of the Financial Accounting Standards Board (FAS 97) whereby deferred acquisition costs are amortised in line with expected gross profits. Recoverability of the deferred acquisition costs in the balance sheet is tested against the projected value of future profits using current estimates and therefore no additional liability adequacy test is required by IFRS 4. The DAC recoverability test is performed in line with US GAAP requirements which in practice is at a grouped level of those contracts managed together. (b) Further critical accounting policies Measurement and presentation of derivatives and debt securities of US insurance operations Jackson holds a number of derivative instruments and debt securities. The selection of the accounting approach for these items significantly affects the volatility of IFRS profit before tax. £7,616 million of US income statement investment return arises from such derivatives and debt securities For derivative instruments of Jackson that are entered into to mitigate economic exposures, 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. The key factors considered in this assessment were the complexity of asset and liability matching in Jackson’s product range and the difficulty and cost of applying the macro hedge provisions under IAS 39 (which are more suited to banking arrangements) to Jackson’s derivative book. The Group has decided that, except for occasional circumstances, applying hedge accounting using IAS 39 to derivative instruments held by Jackson would not improve the relevance or reliability of the financial statements to such an extent that would justify the difficulty and cost of applying these provisions. As a result of this decision, the total income statement results are more volatile as the movements in the fair 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 notes B1.1 and B1.2. 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. 171 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued Presentation of results before tax Profit before tax is a significant IFRS income statement item. The Group has chosen to present a measure of profit before tax attributable to shareholders which distinguishes between tax attributable to policyholders and unallocated surplus and tax borne by shareholders, to support understanding of the performance of the Group. Profit before tax attributable to shareholders is £2,275 million and compares to profit before tax of £3,212 million. The total tax charge for the Group reflects tax that, in addition to relating to shareholders’ profits, is also attributable to policyholders and unallocated surplus of with-profits funds and unit-linked policies. Further detail is provided in note B5. 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. Total segmental operating profit is £4,972 million as shown in note B1.2. The basis of calculation of operating profit is disclosed in note B1.3. For shareholder-backed business, with the exception of debt securities held by Jackson and assets classified as loans and receivables at amortised cost, all financial investments and investment property are designated as assets at fair value through profit or loss. Short-term fluctuations in fair value affect the result for the year and the Group provides additional analysis of results before and after the effects of short-term fluctuations in investment returns, together with other items that are of a short-term, volatile or one-off nature. The effects of short-term fluctuations include asymmetric impacts where the measurement bases of the liabilities and associated derivatives used to manage the Jackson annuity business differ as described in note B1.2. Short-term fluctuations in investment returns on assets held by with-profits funds in the UK, Hong Kong, Malaysia and Singapore, 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. (c) Further critical estimates and judgements Deferred acquisition costs for insurance contracts The Group applies judgement and makes estimates in assessing whether adjustments to the carrying value or amortisation profile of deferred acquisition cost assets are necessary. Except for acquisition costs of with-profits contracts of the UK regulated with-profits funds, which are accounted for under FRS 27, 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. In general, this deferral is shown by an explicit carrying value in the balance sheet. However, in some Asia operations the deferral is implicit through the reserving methodology. The recoverability of the 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. 172 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policiesContinued Deferred acquisition costs for insurance contracts continued 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. £9,178 billion of deferred acquisition costs as per note C5(b). Asia insurance operations US insurance 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 US insurance operations paragraph below are applied to the deferral and amortisation of acquisition costs. For other territories in Asia, the 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. The Group’s US insurance operations apply FAS ASU 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ and capitalises only those incremental costs directly relating to successfully acquiring a contract. For 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 expected gross profits on the relevant contracts. For fixed and fixed index 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. 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, a key assumption is the long-term investment return from the separate accounts, which is determined using a mean reversion methodology. 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 three years, including the current period, the assumed long-term annual return (gross of asset management fees and other charges to policyholders, but net of external fund management fees) is realised on average over the entire eight-year period. Projected returns after the mean reversion period revert back to the long-term investment return. For further details, refer to note C7.3(iv). However, to ensure that the methodology does not over anticipate a reversion to the long-term level of returns following adverse markets, the mean reversion technique has a cap and floor 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 and other charges to policyholders, but net of external fund management fees) in each year. Jackson uses shadow accounting to make adjustments to the deferred acquisition costs which are recognised directly in other comprehensive income. 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 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 deferred acquisition costs 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. 173 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued Deferred acquisition costs for insurance contracts continued UK insurance operations For UK regulated with-profits funds where FRS 27 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 deferral of acquisition costs is negligible. Financial investments – Valuation Financial Investments held at fair value represent £349.8 billion of the Group’s total assets. The Group holds the majority of its financial investments at fair value (either through profit and loss or available for sale). Financial Investments held at amortised cost primarily comprise of Loans and Deposits. The Group applies valuation techniques to determine the balance recognised for financial investments held at fair value. Financial investments held at amortised cost represent £12.2 billion of the Group’s total assets. Determination of fair value 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 as described further in note C3.1. 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. Financial investments measured at fair value are classified into a three level hierarchy as described in note C3.1(b). Determination of impaired value In estimating the present value of future cash flows for determining the impaired value of instruments held at amortised cost, 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. In estimating any required impairment for US residential mortgage-backed and other asset-backed securities held as available for sale, the expected value of future cash flows is determined using a model, the key assumptions of which include how much of the currently delinquent loans will eventually default and assumed loss severity. 174 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policiesContinuedFinancial investments – Determining impairment in relation to financial assets The Group applies estimates and assumptions in determining when an impairment in value has occurred on financial investments classified as ‘available-for-sale’ or ‘at amortised cost’. If a loss event that will have a detrimental effect on cash flows is identified, an impairment loss is recognised in the income statement. The loss recognised is determined as the difference between the book cost and the fair value of the relevant impaired assets. This loss comprises the effect of the expected loss of contractual cash flows and any additional market- price-driven temporary reductions in values. Affects £52.8 billion of assets. Available-for-sale securities 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 note C3.2(c). The majority of the US insurance operation’s debt securities portfolio are accounted for on an available-for-sale basis. The consideration of evidence of impairment requires management’s judgement. In making this determination a range of market and industry indicators are considered including the severity and duration of the decline in fair value and the financial condition and prospects of the issuer. For US residential mortgage-backed and other asset-backed securities, all of which are classified as available-for-sale, impairment is estimated using a model of expected future cash flows. Key assumptions used in the model include assumptions about how much of the currently delinquent loans will eventually default and assumed loss severity. Assets held at amortised cost Assets held at amortised cost are subject to impairment testing where appropriate under IFRS requirements by comparing estimated future cash flows to the carrying value of the asset. 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. In estimating future cash flows, for the purposes of impairment testing for assets held at amortised cost, 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. Reversal of impairment losses 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). Intangible assets – Carrying value of distribution rights The Group applies judgement when considering whether indicators of impairment exist for intangible assets representing distribution rights. Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contractual agreement with the bank partner. Distribution rights impairment testing is conducted when there is an indication of impairment. Affects £1.5 billion of assets. The Group monitors a number of internal and external factors, including indications that the financial performance of the arrangement is likely to be worse than originally expected and changes in relevant legislation and regulatory requirements that could impact the Group’s ability to continue to sell new business through the bancassurance channel, to assess for indications of impairment. 175 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsA3 Accounting policies continued A3.2 New accounting pronouncements not yet effective The following standards, interpretations and amendments have been issued but are not yet effective in 2016, 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 financial statements are discussed. Accounting pronouncements endorsed by the EU but not yet effective IFRS 15, ‘Revenue from Contracts with Customers’ This standard effective for annual periods beginning on or after 1 January 2018, provides a single framework to recognise revenue for contacts with different characteristics and overrides the framework provided for such contracts in other standards. The contracts excluded from the scope of this standard include: — Lease contracts within the scope of IAS 17 ’Leases’; — Insurance contracts within the scope of IFRS 4, ‘Insurance Contracts’; and — Financial instruments within the scope of IAS 39 ‘Financial Instruments’. As a result of the scope exclusion above, this standard is of particular relevance only to the revenue recognition of the Group’s asset management contracts and the measurement of the Group’s investment contracts that do not contain discretionary participating features where the contracts include an investment management element. The Group does not expect the standard to have a significant impact on the Group’s financial statements. IFRS 9, ‘Financial instruments: Classification and measurement’ In July 2014, the IASB published a complete version of IFRS 9 with the exception of macro hedge accounting. The standard becomes mandatorily effective for the annual periods beginning on or after 1 January 2018, with early application permitted and transitional rules apply. This standard replaces the existing IAS 39, ’Financial Instruments – Recognition and Measurement’, and will affect: — The classification and the measurement of financial assets and liabilities. Under IFRS 9, financial assets are classified under one of the following categories: amortised cost, fair value through other comprehensive income (FVOCI) and fair value through profit or loss (FVTPL) based on their contractual cash flow characteristics and/or the business model in which they are held. The existing amortised cost measurement for financial liabilities is largely maintained under IFRS 9 but for financial liabilities designated at FVTPL, changes in fair value due to changes in entity’s own credit risk, required by IFRS 13, are to be recognised in other comprehensive income; — The calculation of the impairment charge relevant for financial assets held at amortised cost or FVOCI. A new impairment model based on an expected credit loss approach replaces the existing IAS 39 incurred loss impairment model; and — The hedge accounting requirements which are more closely aligned with the risk management activities of the company. In September 2016, the IASB published Amendments to IFRS 4, ‘Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts’ to address the temporary consequences of the different effective dates of IFRS 9 and the new insurance contracts standard. The amendments include an optional temporary exemption from applying IFRS 9 that is available to companies whose predominant activity is to issue insurance contracts. Such a deferral will be available until the new Insurance Contracts Standard (IFRS 17) comes into effect (but it cannot be used after 1 January 2021). The Group meets the criteria and intends to take advantage of the temporary exemption afforded by the amendments to IFRS 4 from applying IFRS 9 until IFRS 17 comes into effect, which is expected to be in 2021. The amendments to IFRS 4 are not yet endorsed by the EU. However, the European Financial Reporting Advisory Group (EFRAG) has provided advice to the European Commission recommending endorsement. The Group will be assessing the impact of this IFRS 9 in conjunction with the requirements of the IASB’s proposals for insurance contracts accounting as they are developed to a final standard. The adoption of the requirements of IFRS 9 may result in reclassification of certain of the Group’s financial assets and hence lead to a change in the measurement of these instruments or the performance reporting of value movements. In addition, for any investments classified as FVOCI, as noted above, the impairment provisioning approach is altered from the current IAS 39 approach. The Group does not currently apply hedge accounting for most of its derivative programmes but will reconsider its approach in light of new requirements under the standard on adoption. 176 Prudential plc Annual Report 2016 www.prudential.co.ukA Background and critical accounting policiesContinuedAccounting pronouncements not yet endorsed by the EU IFRS 16, ‘Leases’ In January 2016, the IASB published a new standard, IFRS 16 ‘Leases’ effective for periods beginning on or after 1 January 2019, with earlier adoption permitted if IFRS 15 ‘Revenue from Contracts with Customers’ has also been applied. The new standard brings most leases on-balance sheet for lessees under a single model, eliminating the distinction between operating and finance leases. For lessee accounting, this has the effect of bringing most of the existing operating leases to be accounted for in a similar manner as finance leases under the existing IAS 17, ‘Leases’. Lessor accounting however remains largely unchanged from IAS 17. This new standard is of particular relevance to the operating leases for major assets where Prudential is a lessee, which relate to leases of properties occupied by the Group’s businesses. Under IFRS 16, these leases will be brought on to the statement of financial position with a ‘right to use’ asset being established and a corresponding liability representing the obligation to make lease payments. The current rental accrual charge in the profit and loss account will be replaced with a depreciation charge for the ‘right to use’ asset and the interest expense on the lease liability. The Group is currently assessing the impact of this new standard. Amendments to IAS 12: Income Taxes In January 2016, the IASB issued amendments to IAS 12 Income Taxes clarifying the requirements on recognition of deferred tax assets for unrealised losses on a debt instrument measured at fair value. The amendments are effective from 1 January 2017. The Group has assessed the requirements of these amendments and concluded that they do not require any changes to the Group’s accounting policy for deferred tax. Other new accounting pronouncements In addition to the above, the Group is also assessing the impact of the following new accounting pronouncements but are not expecting them to have a significant impact on the Group’s financial statements: — Amendments to IAS 7 Statement of Cash Flows: Disclosure Initiative, issued in January 2016 and effective from 1 January 2017; — Amendments to IFRS 2: Classification and measurement of share-based payment transactions, issued in June 2016 and effective from 1 January 2018; — Annual Improvements to IFRS Standards 2014-2016 Cycle, issued in December 2016 and effective from 1 January 2017/1 January 2018; — IFRIC Interpretation 22 Foreign Currency Transactions and Advance Consideration, issued in December 2016 and effective from 1 January 2018; and — Amendments to IAS 40, Transfers of Investment Property, issued in December 2016 and effective from 1 January 2018. 177 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB Earnings performance B1 Analysis of performance by segment B1.1 Segment results – profit before tax Asia operations Asia insurance operations* Eastspring Investments Total Asia operations US operations Jackson (US insurance operations) Broker-dealer and asset management Total US operations UK operations UK insurance operations: Long-term business General insurance commission note (i) Total UK insurance operations M&G Prudential Capital Total UK operations Total segment profit Other income and expenditure Investment return and other income Interest payable on core structural borrowings Corporate expenditure note (ii) Total Solvency II implementation costs Restructuring costs note (iii) Interest received from tax settlement Note B4(a) B4(b) 2016 £m 2015* £m % AER note (vi) CER note (vi) 2016 vs 2015 AER note (vi) 2016 vs 2015 CER note (vi) 1,503 141 1,644 2,052 (4) 2,048 799 29 828 425 27 1,280 4,972 1 (360) (334) (693) (28) (38) 43 1,171 115 1,286 1,691 11 1,702 1,167 28 1,195 442 19 1,656 4,644 14 (312) (319) (617) (43) (15) – 3,969 (755) (76) 56 1,303 128 1,431 1,908 13 1,921 1,167 28 1,195 442 19 1,656 5,008 14 (312) (319) (617) (43) (15) – 4,333 (827) (85) 62 28% 23% 28% 15% 10% 15% 21% (136)% 8% (131)% 20% 7% (32)% 4% (31)% (4)% 42% (23)% 7% (93)% (15)% (5)% (12)% 35% (153)% n/a 7% (122)% 0% n/a n/a (28)% 38% (26)% (32)% 4% (31)% (4)% 42% (23)% (1)% (93)% (15)% (5)% (12)% 35% (153)% n/a (2)% (103)% 11% n/a n/a (34)% 43% (32)% Operating profit based on longer-term investment returns Short-term fluctuations in investment returns on shareholder-backed business Amortisation of acquisition accounting adjustments note (iv) (Loss) profit attaching to the held for sale Korea life business Cumulative exchange loss on the sold Japan life business recycled from 4,256 (1,678) (76) (227) B1.2 D1 other comprehensive income note (v) Profit before tax attributable to shareholders Tax charge attributable to shareholders’ returns Profit for the year attributable to shareholders – (46) (46) 2,275 (354) 1,921 3,148 (569) 3,437 (621) 2,579 2,816 Basic earnings per share (in pence) 2016 2015 % B6 AER note (vi) CER note (vi) 2016 vs 2015 AER note (vi) 2016 vs 2015 CER note (vi) Based on operating profit based on longer-term investment returns Based on profit for the year 131.3p 75.0p 124.6p 101.0p 136.0p 110.1p 5% (26)% (3)% (32)% * To facilitate future comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the results attributable to the held for sale Korea life business are included separately within the supplementary analysis of profit above. 178 Prudential plc Annual Report 2016 www.prudential.co.ukNotes (i) The Group’s UK insurance operations transferred its general insurance business to Churchill in 2002. General insurance commission represents the commission receivable net of expenses for Prudential-branded general insurance products as part of this arrangement, which terminated at the end of 2016. Corporate expenditure as shown above is for Group Head Office and Asia Regional Head Office. (ii) (iii) Restructuring costs are incurred in the UK and Asia and represent one-off business development expenses. (iv) Amortisation of acquisition accounting adjustments principally relate to the acquired REALIC business of Jackson. (v) On 5 February 2015, the Group completed the sale of its closed book life insurance business in Japan. (vi) For definitions of AER and CER refer to note A1. B1.2 Short-term fluctuations in investment returns on shareholder-backed business Insurance operations: Asia note (i) US note (ii) UK note (iii) Other operations note (iv) Total 2016 £m 2015*£m (225) (1,455) 198 (196) (1,678) (137) (424) (120) (74) (755) * To facilitate comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the short-term fluctuations in investment returns attributable to the held for sale Korea life business are included separately within the supplementary analysis of profit. Notes (i) Asia insurance operations In Asia, the short-term fluctuations of negative £(225) million (2015: negative £(137) million) principally reflect the impact of changes in interest rates across the region on bonds, and equity market falls in China. (ii) US insurance operations The short-term fluctuations in investment returns for US insurance operations are reported net of related credit for amortisation of deferred acquisition costs, of £565 million as shown in note C5(b) (2015: £93 million) and comprise amounts in respect of the following items: Net equity hedge result note (a) Other than equity-related derivatives note (b) Debt securities note (c) Equity-type investments: actual less longer-term return Other items Total Notes (a) Net equity hedge result 2016 £m 2015 £m (1,587) (126) 201 35 22 (1,455) (504) 29 1 19 31 (424) The purpose of the inclusion of this item in short-term fluctuations in investment returns is to segregate the amount included in pre-tax profit that relates to the accounting effect of market movements on both the measured value of guarantees in Jackson’s variable annuity and fixed index annuity products and on the related derivatives used to manage the exposures inherent in these guarantees. As the Group applies US GAAP for the measured value of the product guarantees this item also includes asymmetric impacts where the measurement bases of the liabilities and associated derivatives used to manage the Jackson annuity business differ as described below. The result comprises the net effect of: 1 The accounting value movements on the variable and fixed index annuity guarantee liabilities. This includes: – The Guaranteed Minimum Death Benefit (GMDB), and the ‘for life’ portion of Guaranteed Minimum Withdrawal Benefit (GMWB) guarantees which are measured under the US GAAP basis applied for IFRS in a way that is substantially insensitive to the effect of current period equity market and interest rate changes; and – The ‘not for life’ portion of GMWB embedded derivative liabilities which are required to be measured under IAS 39 using a basis under which the projected future growth rate of the account balance is based on current swap rates (rather than expected rates of return) with only a portion of the expected future guarantee fees included. Reserve value movements on these liabilities are sensitive to changes to levels of equity markets, implied volatility and interest rates. Fair value movements on free-standing equity derivatives held to manage equity exposures of the variable annuity guarantees and fixed index annuity embedded options. 2 Adjustments in respect of fee assessments and claim payments; 3 4 Related changes to DAC amortisation in accordance with the policy that DAC is amortised in line with emergence of margins. The net equity hedge result therefore includes significant accounting mismatches and other factors that detract from the presentation of an economic result. These other factors include: – The variable annuity guarantees and fixed index annuity embedded options being only partially fair valued under ‘grandfathered’ US GAAP; – The interest rate exposure being managed through the other than equity-related derivative programme explained in note (b) below; and – Jackson’s management of its economic exposures for a number of other factors that are treated differently in the accounting frameworks such as future fees and assumed volatility levels. (b) Other than equity-related derivatives The fluctuations for this item comprise the net effect of: – Fair value movements on free-standing, other than equity-related derivatives; – Accounting effects of the Guaranteed Minimum Income Benefit (GMIB) reinsurance; and – Related amortisation of DAC. The free-standing, other than equity-related derivatives, are held to manage interest rate exposures and durations within the general account and the variable annuity guarantees and fixed index annuity embedded options described in note (a) above. The direct GMIB liability is valued using the US GAAP measurement basis applied for IFRS reporting in a way that substantially does not recognise the effects of market movements. Reinsurance arrangements are in place so as to essentially fully insulate Jackson from the GMIB exposure. Notwithstanding that the liability is essentially fully reinsured, as the reinsurance asset is net settled, it is deemed a derivative under IAS 39 which requires fair valuation. The fluctuations for this item therefore include significant accounting mismatches caused by: – The fair value movements booked in the income statement on the derivative programme being in respect of the management of interest rate exposures of the variable and fixed index annuity business, as well as the fixed annuity business guarantees and durations within the general account; – Fair value movements on Jackson’s debt securities of the general account which are recorded in other comprehensive income rather than the income statement; and – The mixed measurement model that applies for the GMIB and its reinsurance. 179 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B1 Analysis of performance by segment continued B1.2 Short-term fluctuations in investment returns on shareholder-backed business continued (c) Short-term fluctuations related to debt securities Short-term fluctuations relating to debt securities (Charges) credits in the year: Losses on sales of impaired and deteriorating bonds Defaults Bond write-downs Recoveries/reversals Total (charges) credits in the year Less: Risk margin allowance deducted from operating profit based on longer-term investment returnsnote Interest-related realised gains: Arising in the year Less: Amortisation of gains and losses arising in current and prior years to operating profit based on longer-term investment returns Related amortisation of deferred acquisition costs Total short-term fluctuations related to debt securities 2016 £m 2015 £m (94) (4) (35) 15 (118) 89 (29) 376 (135) 241 (11) 201 (54) – (37) 18 (73) 83 10 102 (108) (6) (3) 1 Note The debt securities of Jackson are held in the general account of the business. Realised gains and losses are recorded in the income statement with normalised returns included in operating profit with variations from year to year included in the short-term fluctuations category. The risk margin reserve charge for longer-term credit-related losses included in operating profit based on longer-term investment returns of Jackson for 2016 is based on an average annual risk margin reserve of 21 basis points (2015: 23 basis points) on average book values of US$56.4 billion (2015: US$54.6 billion) as shown below: Moody’s rating category (or equivalent under NAIC ratings of mortgage-backed securities) A3 or higher Baa1, 2 or 3 Ba1, 2 or 3 B1, 2 or 3 Below B3 Total 2016 2015 Average book value US$m 29,051 25,964 1,051 312 40 56,418 RMR Annual expected loss % US$m 0.12 0.24 1.07 2.95 3.81 0.21 (36) (62) (11) (9) (2) (120) £m (27) (46) (8) (7) (1) (89) Average book value US$m 28,185 24,768 1,257 388 35 54,633 RMR Annual expected loss % US$m 0.13 0.25 1.17 3.08 3.70 0.23 (37) (62) (15) (12) (1) (127) £m (24) (40) (10) (8) (1) (83) Related amortisation of deferred acquisition costs (see below) Risk margin reserve charge to operating profit for longer-term credit related losses 23 17 24 16 (97) (72) (103) (67) 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 amortisation of deferred acquisition costs. In addition to the accounting for realised gains and losses described above for Jackson general account debt securities, included within the statement of other comprehensive income is a pre-tax credit for unrealised losses on debt securities classified as available-for-sale net of related change in amortisation of deferred acquisition costs of £48 million (2015: charge for net unrealised losses £(968) million). Temporary market value movements do not reflect defaults or impairments. Additional details of the movement in the value of the Jackson portfolio are included in note C3.2(b). (iii) UK insurance operations The positive short-term fluctuations in investment returns for UK insurance operations of £198 million (2015: negative £(120) million) mainly reflects gains on bonds backing the capital of the shareholder-backed annuity business following the fall in 15-year gilt yields over 2016. (iv) Other The negative short-term fluctuations in investment returns for other operations of £(196) million (2015: negative £(74) million) include unrealised value movements on financial instruments driven by the fall in interest rates. (v) Default losses The Group incurred default losses of £(4) million on its shareholder-backed debt securities for 2016 wholly in respect of Jackson’s portfolio (2015: £nil). 180 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinued B1.3 Determining operating segments and performance measure of operating segments Operating segments The Group’s operating segments, determined in accordance with IFRS 8 ‘Operating Segments’, are as follows: Insurance operations: Asset management operations: — Asia — US (Jackson) — UK — Eastspring Investments — US broker-dealer and asset management — M&G — Prudential Capital The Group’s operating segments are also its reportable segments for the purposes of internal management reporting. Performance measure 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 measurement basis distinguishes operating profit based on long-term investment returns from other constituents of the total profit as follows: — Short-term fluctuations in investment returns on shareholder-backed business. This includes the impact of short-term market effects on the carrying value of Jackson’s guarantee liabilities and related derivatives as explained below. — Amortisation of acquisition accounting adjustments arising on the purchase of business. This comprises principally the charge for the adjustments arising on the purchase of REALIC in 2012; — Loss attaching to the held for sale Korea life business. See note D1 for further details; and — The recycling of the cumulative exchange translation loss on the sold Japan life business from other comprehensive income to the income statement in 2015. 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. Determination of operating profit based on longer-term investment returns for investment and liability movements: (a) General principles (i) UK style with-profits business The operating profit based on longer-term returns reflects the statutory transfer gross of attributable tax. Value movements in the underlying assets of the with-profits funds do not affect directly the determination of operating profit. (ii) Unit-linked business The policyholder unit liabilities are directly reflective of the underlying asset value movements. Accordingly, the operating results based on longer-term investment returns reflect the current period value movements in both the unit liabilities and the backing assets. (iii) US variable annuity and fixed index annuity business This business has guarantee liabilities which are measured on a combination of fair value and other US GAAP derived principles. These liabilities are subject to an extensive derivative programme to manage equity and, with those of the general account, interest rate exposures. The principles for determination of the operating profit and short-term fluctuations are necessarily bespoke, as discussed in section (c) below. (iv) Business where policyholder liabilities are sensitive to market conditions 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 charge for policyholder benefits) the operating result reflects longer-term market returns. Examples of where such bifurcation is necessary are in Hong Kong and for UK shareholder-backed annuity business, as explained in sections b(i) and d(i), respectively. 181 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB1 Analysis of performance by segment continued B1.3 Determining operating segments and performance measure of operating segments continued (v) 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. Except in the case of assets backing liabilities which are directly matched (such as unit-linked business) or closely correlated with value movements (as discussed below) operating profit based on longer-term investment returns for shareholder-financed business is determined on the basis of expected longer-term investment returns. Debt, equity-type securities and loans Longer-term investment returns comprise actual income receivable for the period (interest/dividend income) and for both debt and equity-type securities longer-term capital returns. In principle, for debt securities and loans, the longer-term capital returns comprise two elements: — Risk margin reserve 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 risk margin reserve charge to the operating result is reflected in short-term fluctuations in investment returns; and — 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. At 31 December 2016, the level of unamortised interest-related realised gains and losses related to previously sold bonds for the Group was a net gain of £969 million (2015: £567 million). Equity-type securities For equity-type securities, the longer-term rates of return are estimates of the long-term trend investment returns 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. 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, as discussed below in section (c). (b) Asia insurance operations (i) Business where policyholder liabilities are sensitive to market conditions For certain Asia non-participating business, for example in Hong Kong, 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 (also applied for IFRS basis) was used. For certain other types of non-participating business, longer-term interest rates are used to determine the movement in policyholder liabilities for determining operating results. (ii) Other Asia shareholder-financed business Debt securities For this business, 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 risk margin reserve charge. Equity-type securities For Asia insurance operations, investments in equity securities held for non-linked shareholder-backed operations amounted to £1,405 million as at 31 December 2016 (2015: £840 million). The rates of return applied in 2016 ranged from 3.2 per cent to 13.9 per cent (2015: 3.5 per cent to 13.0 per cent) with the rates applied varying by territory. These rates are broadly stable from period to period but may be different between countries reflecting, for example differing expectations of inflation in each territory. The assumptions are for the returns expected to apply in equilibrium conditions. The assumed rates of return do not reflect any cyclical variability in economic performance and are not set by reference to prevailing asset valuations. The longer-term investment returns for the Asia insurance joint ventures accounted for using the equity method are determined on a similar basis as the other Asia insurance operations described above. 182 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinued(c) US Insurance operations (i) Separate account business 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. (ii) US variable and fixed index annuity business The following value movements for Jackson’s variable and fixed index annuity business are excluded from operating profit based on longer-term investment returns. See note B1.2 note (ii): — Fair value movements for equity-based derivatives; — Fair value movements for embedded derivatives for the ‘not for life’ portion of GMWB and fixed index annuity business, and GMIB reinsurance (see below); — Movements in the accounts carrying value of GMDB and the ‘for life’ portion of GMWB and GMIB 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; — A portion of the fee assessments as well as claim payments, in respect of guarantee liabilities; and — Related amortisation of deferred acquisition costs for each of the above items. Embedded derivatives for variable annuity guarantee minimum income benefit The GMIB liability, which is essentially fully reinsured, subject to a deductible and annual claim limits, is accounted for in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (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, ‘Financial Instruments: Recognition and Measurement’, and the asset is therefore recognised at fair value. As the GMIB 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 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 US shareholder-financed business Debt securities 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 BlackRock Solutions to determine the average annual risk margin reserve 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 risk margin reserve charge. Further details of the risk margin reserve charge, as well as the amortisation of interest-related realised gains and losses, for Jackson are shown in note B1.2. Equity-type securities As at 31 December 2016, the equity-type securities for US insurance non-separate account operations amounted to £1,323 million (2015: £1,004 million). For these operations, the longer-term rates of return for income and capital applied in the years indicated, which reflect the combination of the average risk-free rates over the year and appropriate risk premiums are as follows: Equity-type securities such as common and preferred stock and portfolio holdings in mutual funds Other equity-type securities such as investments in limited partnerships and private equity funds 5.5% to 6.5% 5.7% to 6.4% 7.5% to 8.5% 7.7% to 8.4% 2016 2015 183 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB1 Analysis of performance by segment continued B1.3 Determining operating segments and performance measure of operating segments continued (d) UK Insurance operations (i) Shareholder-backed annuity business For this 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. The operating result based on longer-term investment returns reflects the impact of value movements on policyholder liabilities for annuity business within the non-profit sub-fund of The Prudential Assurance Company (PAC) after adjustments to allocate the following elements of the movement to the category of ‘short-term fluctuations in investment returns’: — The impact on credit risk provisioning of actual upgrades and downgrades during the period; — Credit experience compared with 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. Positive or negative experience compared with assumptions is included within short-term fluctuations in investment returns without further adjustment. 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. (ii) Non-linked shareholder-financed business For debt securities backing non-linked shareholder-financed business of the UK insurance operations (other than the annuity business) 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 risk margin reserve charge. (e) 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 in the operating result with temporary unrealised gains and losses being included in short-term fluctuations. 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. 184 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedB1.4 Segmental income statement Insurance operations Asset management 2016 £m Asia US UK M&G Prudential Capital Eastspring Investments Total segment US Unallo- cated to a segment (central operations) note (iii) Group total Gross premium earned Outward reinsurance 14,006 (648) 14,685 (367) 10,290 (1,005) Earned premiums, net of reinsurance Other income from 13,358 14,318 9,285 – – – – – – – – – – – – 38,981 (2,020) 36,961 – – – 38,981 (2,020) 36,961 external customers note (ii) 77 4 374 972 19 680 176 2,302 68 2,370 Total revenue from external customers Intra-group revenue Interest income note (iv) Other investment returnB1.5 Total revenue, net of reinsurance Benefits and claims and movements in unallocated surplus of with-profits funds, net of reinsurance Interest on core structural borrowings Acquisition costs and other operating expenditureB3 Remeasurement of carrying value of Korea life business classified as held for saleD1 Total charges, net of reinsurance Share of profit from joint ventures and associates, net of related tax Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) note (i) Tax charge attributable to policyholders’ returns Profit (loss) before tax attributable to shareholders 13,435 – 873 2,040 14,322 – 2,149 5,461 9,659 – 4,502 17,577 972 200 15 1 19 37 47 (41) 680 103 2 – 176 211 2 2 39,263 551 7,590 25,040 68 (551) 57 39,331 – 7,647 (176) 24,864 16,348 21,932 31,738 1,188 62 785 391 72,444 (602) 71,842 (11,442) (20,214) (27,710) – (15) – – – – (17) – – – (59,366) – (59,366) – (32) (328) (360) (3,564) (1,174) (2,241) (768) (74) (789) (304) (8,914) 66 (8,848) (238) – – – – – – (238) – (238) (15,244) (21,403) (29,951) (768) (91) (789) (304) (68,550) (262) (68,812) 94 – 21 13 – – 54 182 – 182 1,198 529 1,808 433 (29) (155) – (782) – – (4) – 141 4,076 (864) 3,212 – (937) – (937) 1,043 529 1,026 433 (29) (4) 141 3,139 (864) 2,275 185 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB1 Analysis of performance by segment continued B1.4 Segmental income statement continued Insurance operations Asset management 2016 £m Asia US UK M&G Prudential Capital Eastspring Investments Total segment US Unallo- cated to a segment (central operations) note (iii) Group total Analysis of operating profit Operating profit (loss) based on longer-term investment returns Short-term fluctuations in investment returns on shareholder-backed business Amortisation of acquisition accounting adjustments Loss attaching to the held for sale Korea life businessD1 Profit (loss) before tax attributable to shareholders 1,503 2,052 828 425 27 (4) 141 4,972 (716) 4,256 (225) (1,455) 198 (8) (68) (227) – – – 8 – – (56) – – – – – – – – (1,530) (148) (1,678) (76) (227) – – (76) (227) 1,043 529 1,026 433 (29) (4) 141 3,139 (864) 2,275 186 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedInsurance operations Asset management 2015 £m Asia US UK M&G Prudential Capital Eastspring Investments Total segment US Gross premium earned Outward reinsurance 10,814 (364) 16,887 (320) 8,962 (473) Earned premiums, net of reinsurance 10,450 16,567 8,489 – – – – – – – – – – – 36,663 (1,157) 35,506 Unallo- cated to a segment (central operations) note (iii) – – – Group total 36,663 (1,157) 35,506 Other income from external customers note (ii) Total revenue from external customers note (v) Intra-group revenue Interest income note (iv) Other investment returnB1.5 Total revenue, net of reinsurance Benefits and claims and movements in unallocated surplus of with-profits funds, net of reinsurance Interest on core structural borrowings Acquisition costs and other operating expenditure B3 Disposal of Japan life business: Cumulative exchange loss recycled from other comprehensive income Total charges, net of reinsurance Share of profit from joint ventures and associates, net of related tax Profit (loss) before tax (being tax attributable to shareholders’ and policyholders’ returns) note (i) Tax charge attributable to policyholders’ returns Profit (loss) before tax attributable to shareholders 64 – 374 1,008 19 760 171 2,396 99 2,495 10,514 – 743 (1,042) 16,567 – 1,921 (2,703) 8,863 – 4,240 132 1,008 194 18 17 19 25 107 (97) 760 90 – (7) 171 178 2 1 37,902 487 7,031 (3,699) 99 (487) (13) (15) 38,001 – 7,018 (3,714) 10,215 15,785 13,235 1,237 54 843 352 41,721 (416) 41,305 (6,543) (13,029) (10,084) – (13) – – – – (17) – – – – (29,656) – (29,656) (30) (282) (312) (2,651) (1,544) (2,025) (810) (82) (832) (278) (8,222) 14 (8,208) (46) – – – – – – (46) – (46) (9,240) (14,586) (12,109) (810) (99) (832) (278) (37,954) (268) (38,222) 130 – 53 14 – – 41 238 – 238 1,105 1,199 1,179 441 (45) (69) – (104) – – 11 – 115 4,005 (684) 3,321 – (173) – (173) 1,036 1,199 1,075 441 (45) 11 115 3,832 (684) 3,148 187 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB1 Analysis of performance by segment continued B1.4 Segmental income statement continued Insurance operations Asset management 2015 £m Asia US UK M&G Prudential Capital Eastspring Investments Total segment US Unallo- cated to a segment (central operations) note (iii) Group total Analysis of operating profit Operating profit (loss) based on longer-term investment returns Short-term fluctuations in investment returns on shareholder-backed business Amortisation of acquisition accounting adjustments Profit attaching to the held for sale Korea life business Cumulative exchange loss on the sold Japan life business Profit (loss) before tax attributable to shareholders 1,171 1,691 1,195 442 19 11 115 4,644 (675) 3,969 (137) (424) (120) (1) (64) (8) (68) 56 (46) – – – – – – – – – – – – – – – – – – – (746) (9) (755) (76) 56 (46) – – – (76) 56 (46) 1,036 1,199 1,075 441 (45) 11 115 3,832 (684) 3,148 Notes (i) (ii) Other income from external customers includes £8 million (2015: £19 million) relating to financial instruments that are not held at fair value through profit or loss. These fees This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. (iii) (iv) (v) primarily related to prepayment fees, late fees and syndication fees. In addition to the results of the central operations, unallocated to a segment includes intra-group eliminations. This column includes the elimination of the intra-group reinsurance contract between the UK with-profits and Asia with-profits operations. Interest income includes £3 million (2015: £3 million) accrued in respect of impaired securities. In Asia, revenue from external customers from no individual country exceeds 10 per cent of the Group total except for Hong Kong in 2016 (2015: no individual country exceeded 10 per cent). Total revenue from external customers of Hong Kong is £6,313 million (2015: £3,836 million). (vi) Due to the nature of the business of the Group, there is no reliance on any major customers. B1.5 Other investment return Realised and unrealised gains (losses) and gains (losses) on securities at fair value through profit or loss Realised and unrealised (losses) and gains on derivatives at fair value through profit or loss Realised gains on available-for-sale securities, previously recognised in other comprehensive income* Realised gains (losses) on loans Dividends Other investment income Other investment return * Including impairment. 2016 £m 2015 £m 28,489 (7,050) 270 91 2,283 781 24,864 (4,572) (1,701) 49 (50) 1,791 769 (3,714) Realised gains and losses on the Group’s investments for 2016 recognised in the income statement amounted to a net loss of £1.6 billion (2015: a net gain of £3.0 billion). 188 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedB2 Profit before tax – asset management operations The profit included in the income statement in respect of asset management operations for the year is as follows: Revenue (excluding NPH broker-dealer fees) NPH broker-dealer fees note (i) Gross revenue Charges (excluding NPH broker-dealer fees) NPH broker-dealer fees note (i) Gross charges Share of profit from joint ventures and associates, net of related tax Profit (loss) before tax Comprising: Operating profit based on longer-term investment returns note (ii) Short-term fluctuations in investment returns Profit (loss) before tax 2016 £m Prudential Capital US Eastspring Investments 62 – 62 (91) – (91) – (29) 27 (56) (29) 235 550 785 (239) (550) (789) – (4) (4) – (4) 391 – 391 (304) – (304) 54 141 141 – 141 M&G 1,188 – 1,188 (768) – (768) 13 433 425 8 433 Total 1,876 550 2,426 (1,402) (550) (1,952) 67 541 589 (48) 541 2015 £m Total 1,964 522 2,486 (1,497) (522) (2,019) 55 522 587 (65) 522 Notes (i) The segment revenue of the Group’s asset management operations includes: NPH broker-dealer fees which represent commissions received that are then paid on to the writing brokers on sales of investment products. To reflect their commercial nature the amounts are also wholly reflected as charges within the income statement. After allowing for these charges, there is no effect on profit from this item. The presentation in the table above shows separately the amounts attributable to this item so that the underlying revenue and charges can be seen. (ii) M&G operating profit based on longer-term investment returns: Asset management fee income Other income Staff costs Other costs Underlying profit before performance-related fees Share of associate results Performance-related fees Total M&G operating profit based on longer-term investment returns 2016 £m 2015 £m 900 23 (332) (212) 379 13 33 425 934 5 (293) (240) 406 14 22 442 The revenue for M&G of £956 million (2015: £961 million), comprising the amounts for asset management fee income, other income and performance-related fees shown above, is different to the amount of £1,188 million shown in the main table of this note. This is because the £956 million (2015: £961 million) is after deducting commissions which would have been included as charges in the main table. The difference in the presentation of commission is aligned with how management reviews the business. 189 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B3 Acquisition costs and other expenditure Acquisition costs incurred for insurance policies Acquisition costs deferred less amortisation of acquisition costs Administration costs and other expenditure Movements in amounts attributable to external unit holders of consolidated investment funds Total acquisition costs and other expenditure Total acquisition costs and other expenditure includes: 2016 £m 2015 £m (3,687) 923 (5,522) (562) (8,848) (3,275) 431 (4,746) (618) (8,208) (a) Total depreciation and amortisation expense of £(242) million (2015: £(755) million) relates primarily to amortisation of deferred acquisition costs of insurance contracts and asset management contracts. (b) The charge for non-deferred acquisition costs and the amortisation of those costs that are deferred, was £(2,764) million (2015: £(2,844) million). These amounts comprise £(2,734) million and £(30) million for insurance and investment contracts respectively (2015: £(2,817) million and £(27) million respectively). (c) Movements in amounts attributable to external unit holders are in respect of those OEICs and unit trusts which are required to be consolidated and comprises a charge of £(485) million (2015: £(599) million) for UK insurance operations and a charge of £(77) million (2015: £(19) million) for Asia insurance operations. (d) There were no fee expenses relating to financial liabilities held at amortised cost included in acquisition costs in 2016 and 2015. (e) The segmental analysis of other interest expense and depreciation and amortisation included within total acquisition costs and other expenditure was as follows: Other interest expense Depreciation and amortisation 2016 2015 2016 2015 – (56) (102) – (5) – – (163) (22) (185) – (19) (93) – (22) – – (134) (13) (147) (201) 94 (105) (7) – (3) (2) (224) (18) (242) (175) (453) (93) (8) – (3) (2) (734) (21) (755) 2016 2015 15,439 4,447 6,381 26,267 15,030 4,562 5,920 25,512 Insurance operations Asia US UK Asset management M&G Prudential Capital US Eastspring Investments Total segment Unallocated to a segment (central operations) Group total B3.1 Staff and employment costs The average number of staff employed by the Group during the year was: Business operations: Asia operations US operations UK operations Total 190 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinued The costs of employment were: Business operations: Wages and salaries Social security costs Pension costs: Defined benefit schemes* Defined contribution schemes Total 2016 £m 2015 £m 1,483 110 213 79 1,370 101 (63) 67 1,885 1,475 * The charge (credit) incorporates the effect of actuarial gains and losses. B3.2 Share-based payment (a) Description of the plans The Group operates a number of share award and share option plans that provides Prudential plc shares to participants upon vesting. The plans in operation include Prudential Long-Term Incentive Plan (PLTIP), Annual Incentive Plan (AIP), savings-related share option schemes, share purchase plans and deferred bonus plans. Some of these plans are participated in by executive directors, the details of which are described in the directors’ remuneration report. In addition, the following information is provided. Share scheme Description Prudential Corporation Asia Long- Term Incentive Plan (PCA LTIP) The PCA LTIP provides eligible employees with conditional awards. Awards are discretionary and on a year-by-year basis determined by Prudential’s full year financial results and the employee’s contribution to the business. Awards vest after three years subject to the employee being in employment. Vesting of awards may also be subject to performance conditions. All awards are made in Prudential shares, or ADRs, 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. Savings- related share option schemes Employees and eligible agents in a number of geographies are eligible for plans similar to the HMRC-approved Save As You Earn (SAYE) share option scheme in the UK. Eligible employees participate in the international savings- related share option scheme while eligible agents based in certain regions of Asia can participate in the non- employee savings-related share option scheme. Share purchase plans Eligible employees outside the UK are invited to participate in arrangements similar to the Company’s HMRC- approved UK SIP, which allows the purchase of Prudential plc shares. Staff based in Ireland and Asia are eligible for the Share Participation Plan. Deferred bonus plans Jackson Long-Term Incentive Plan The Company operates a number of deferred bonus schemes including the Group Deferred Bonus Plan, the Prudential Corporation Asia Deferred Bonus Plan (PCA DBP), the Prudential Capital Deferred Bonus Plan (PruCap DBP) and other arrangements. There are no performance conditions attached to deferred share awards made under these arrangements. Eligible Jackson employees were previously granted share awards under a long-term incentive plan that rewarded the achievement of shareholder value targets. These awards were 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 that are tradable on the New York Stock Exchange. The final awards under this arrangement were made in 2012. 191 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B3 Acquisition costs and other expenditure continued B3.2 Share-based payment continued (b) Outstanding options and awards The following table shows movement in outstanding options and awards under the Group’s share-based compensation plans at 31 December 2016 and 2015: Options outstanding under SAYE schemes Awards outstanding under incentive plans including conditional options 2016 2015 2016 2015 Number of options millions Weighted average exercise price £ Number of options millions Weighted average exercise price £ Number of awards millions 8.8 1.4 (2.0) (0.1) (0.8) (0.2) 7.1 0.6 9.44 11.04 7.30 9.95 6.45 9.64 10.74 8.53 8.6 2.2 (1.6) (0.2) (0.2) – 8.8 1.1 8.29 11.11 5.72 8.14 10.15 7.47 9.44 5.71 28.4 13.9 (10.5) (1.5) (0.1) – 30.2 28.8 9.9 (7.9) (2.3) – (0.1) 28.4 Beginning of year: Granted Exercised Forfeited Cancelled Lapsed/Expired End of year Options immediately exercisable, end of year The weighted average share price of Prudential plc for the year ended 31 December 2016 was £13.56 compared to £15.49 for the year ended 31 December 2015. The following table provides a summary of the range of exercise prices for Prudential plc options outstanding at 31 December. Number exercisable (millions) Outstanding Weighted average remaining contractual life (years) Exercisable Weighted average exercise prices £ Number exercisable (millions) Weighted average exercise prices £ 2016 2015 2016 2015 2016 2015 2016 2015 – 0.1 – 0.2 1.1 5.7 7.1 0.2 0.8 – 1.0 2.2 4.6 8.8 – 0.4 – 1.4 1.4 2.9 2.6 0.9 0.9 – 0.9 1.9 3.6 2.6 – 4.66 – 6.29 9.01 11.27 10.74 2.88 4.64 – 6.29 9.01 11.34 9.44 – 0.1 – – 0.5 – 0.6 – 0.4 – 0.7 – – 1.1 2016 – 4.66 – 6.29 9.01 – 8.53 2015 – 4.61 – 6.29 – – 5.71 Between £2 and £3 Between £4 and £5 Between £5 and £6 Between £6 and £7 Between £9 and £10 Between £11 and £12 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 fair value amounts estimated on the date of grant relating to all options and awards, were determined by using the following assumptions: Prudential LTIP (TSR) – 29.36 0.12 – – 12.82 4.41 2016 SAYE options 3.19 25.41 0.15 3.70 11.04 13.94 3.05 Other awards – – – – – – 12.57 Prudential LTIP (TSR) – 21.48 0.88 – – 16.67 7.97 2015 SAYE options 2.35 22.73 1.02 3.79 11.11 13.52 2.95 Other awards – – – – – – 16.28 Dividend yield (%) Expected volatility (%) Risk-free interest rate (%) Expected option life (years) Weighted average exercise price (£) Weighted average share price (£) Weighted average fair value (£) 192 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedThe 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 Prudential LTIP (TSR) for which the Group uses a Monte Carlo model in order to allow for the impact of the LTIP (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 all options and awards, the expected volatility is based on the market implied volatilities as quoted on Bloomberg. The Prudential specific at-the-money implied volatilities are adjusted to allow for the different terms and discounted exercise price on SAYE options by using information on the volatility surface of the FTSE 100. Risk-free interest rates are taken from government bond spot rates with projections for two-year, three-year and five-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 Prudential LTIP (TSR), volatility and correlation between Prudential and a basket of 18 competitor companies is required. For grants in 2016, the average volatility for the basket of competitors was 24.88 per cent. Correlations for the basket are calculated for each pairing from the log of daily TSR returns for the three years prior to the valuation date. 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 relating to share-based compensation is as follows: Share-based compensation expense Amount accounted for as equity-settled Carrying value at 31 December of liabilities arising from share-based payment transactions Intrinsic value of above liabilities for which rights had vested at 31 December 2016 £m 2015 £m 126 127 – – 111 110 6 6 B3.3 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 is analysed in the following table: Salaries and short-term benefits Post-employment benefits Share-based payments 2016 £m 2015 £m 20.7 1.3 18.7 40.7 17.1 1.1 15.5 33.7 The share-based payments charge comprises £12.9 million (2015: £10.4 million), which is determined in accordance with IFRS 2, ‘Share-based Payment’ (see note B3.2) and £5.8 million (2015: £5.1 million) of deferred share awards. Total key management remuneration includes total directors’ remuneration of £37.9 million (2015: £42.7 million) less LTIP releases of £10.1 million (2015: £19.4 million) as shown in the directors’ remuneration table and related footnotes in the directors’ remuneration report. Further information on directors’ remuneration is given in the directors’ remuneration report. B3.4 Fees payable to the auditor Fees payable to the Company’s auditor for the audit of the Company’s annual accounts Fees payable to the Company’s auditor and its associates for other services: Audit of subsidiaries pursuant to legislation Audit-related assurance services Tax compliance services Other assurance services Services relating to corporate finance transactions All other services Total fees paid to the auditor 2016 £m 2015 £m 2.0 7.5 3.9 0.1 2.1 – 0.6 2.0 7.2 3.1 0.7 2.2 0.2 1.2 16.2 16.6 In addition, there were fees incurred by pension schemes of £0.1 million (2015: £0.1 million) for audit services and £0.1 million (2015: £nil) for other assurance services. 193 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B4 Effect of changes and other accounting features on insurance assets and liabilities The following features are of relevance to the determination of the 2016 results: (a) Asia insurance operations In 2016, the IFRS operating profit based on longer-term investment returns for Asia insurance operations included a net credit of £67 million (2015: £62 million) representing a small number of non-recurring items, including a gain resulting from entering into a reinsurance contract in the year. (b) UK insurance operations Annuity business Allowance for credit risk 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. The credit risk allowance comprises an amount for long-term best estimate defaults and additional provisions for credit risk premium, the cost of downgrades and short-term defaults. Prudential Retirement Income Limited (PRIL) was the principal company writing the UK’s shareholder-backed annuity business. In 2016, the business of PRIL was transferred into PAC following a Part VII transfer under the Financial Services and Markets Act 2000. The IFRS credit risk allowance made for the ex-PRIL UK shareholder-backed fixed and linked annuity business equated to 43 basis points at 31 December 2016 (31 December 2015: 43 basis points). The allowance represented 26 per cent of the bond spread over swap rates (31 December 2015: 25 per cent). The reserves for credit risk allowance at 31 December 2016 for the UK shareholder-backed business (both for ex-PRIL and the legacy PAC shareholder annuity business) were £1.7 billion (31 December 2015: £1.6 billion). Other assumption changes For the shareholder-backed business, in addition to the movement in the credit risk allowance discussed above, the net effect of routine changes to assumptions in 2016 was a credit of £16 million (2015: credit of £31 million). Longevity reinsurance and other management actions A number of management actions were taken in 2016 to improve the Solvency II position of the UK insurance operations and further mitigate market risk, which have generated combined profits of £332 million. Similar actions were also taken in 2015. Of this amount £197 million related to profit from additional longevity reinsurance transactions covering £5.4 billion of annuity liabilities on an IFRS basis, with the balance of £135 million reflecting the effect of repositioning the fixed income portfolio and other actions. The contribution to profit from similar longevity reinsurance transactions in 2015 was £231 million, covering £6.4 billion of annuity liabilities (on a Pillar 1 basis). Other asset-related management actions generated a further £169 million in 2015. At 31 December 2016, longevity reinsurance covered £14.4 billion of IFRS annuity liabilities equivalent to 42 per cent of total annuity liabilities. With-profits sub-fund For the with-profits sub-fund, the aggregate effect of assumption changes in 2016 was a net charge to unallocated surplus of £78 million (2015: net charge of £114 million). B5 Tax charge (a) Total tax charge by nature of expense The total tax charge in the income statement is as follows: 2016 £m 2015 £m Current tax Deferred tax (438) (939) (1,377) (326) 412 86 Total (764) (527) (1,291) Total (149) (593) (742) Tax charge UK tax Overseas tax Total tax (charge) credit 194 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedThe total tax charge comprises: Current tax expense: Corporation tax Adjustments in respect of prior years Total current tax Deferred tax arising from: Origination and reversal of temporary differences Impact of changes in local statutory tax rates Credit in respect of a previously unrecognised tax loss, tax credit or temporary difference from a prior period Total deferred tax credit (charge) Total tax charge 2016 £m 2015 £m (1,464) 87 (1,377) 64 6 16 86 (782) 48 (734) (40) 22 10 (8) (1,291) (742) The current tax charge of £1,377 million (2015: £734 million) includes £53 million (2015: £35 million) in respect of the tax charge for the Hong Kong operation. 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. The total tax charge comprises tax attributable to policyholders and unallocated surplus of with-profits funds, unit-linked policies and shareholders as shown below: Tax charge Tax (charge) to policyholders’ returns Tax (charge) credit attributable to shareholders Total tax (charge) credit 2016 £m 2015 £m Current tax Deferred tax (421) (956) (1,377) (516) 602 86 Total (937) (354) (1,291) Total (173) (569) (742) The principal reason for the increase in the tax charge attributable to policyholders’ returns is an increase in realised and unrealised gains on equity and bond investments in the with-profits fund of the main UK insurance business. The principal reason for the decrease in the tax charge attributable to shareholders’ returns is a deferred tax credit on derivative fair value movements in the US insurance operations. The main elements of the deferred tax credit shown in the table below are a charge of £437 million relating to unrealised gains and losses on investments reflecting an increase in unrealised gains on investments in the Group’s insurance operations and a credit of £573 million relating to short-term temporary differences reflecting deferred tax assets on derivative fair value movements in the US insurance operations. The total deferred tax credit (charge) arises as follows: Unrealised gains and losses on investments Balances relating to investment and insurance contracts Short-term temporary differences Capital allowances Unused tax losses Deferred tax credit (charge) 2016 £m 2015 £m (437) (90) 573 4 36 86 272 (55) (200) 1 (26) (8) In 2016, a deferred tax credit of £22 million (2015: credit of £333 million) has been taken through other comprehensive income. (b) Reconciliation of effective tax rate In the reconciliation below, the expected tax rates reflect the corporate income tax rates that are expected to apply to the taxable profit of the relevant business. Where there are profits of more than one jurisdiction the expected tax rates reflect the corporation tax rates weighted by reference to the amount of profit contributing to the aggregate business result. In the column ‘Attributable to policyholders’, the 100 per cent expected tax rate is the result of accounting for policyholder income after the deduction of expenses and movement on unallocated surpluses and on an after tax basis, the effect of which leaves the profit equal to the tax charge. 195 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B5 Tax charge continued (b) Reconciliation of effective tax rate continued Operating profit based on longer-term investment returns Non-operating (loss) profit Profit (loss) before tax Expected tax rate Tax at the expected rate Effects of recurring tax reconciliation items: Income not taxable or taxable at concessionary rates Deductions not allowable for tax purposes Items related to taxation of life insurance businesses Deferred tax adjustments Effect of results of joint ventures and associates Irrecoverable withholding taxes Other Total Effects of non-recurring tax reconciliation items: Adjustments to tax charge in relation to prior years Movements in provisions for open tax matters Impact of changes in local statutory tax rates Write down of Korea life business Total Analysed into: Tax on operating profit based on longer-term investment returns Tax on non-operating profit Actual tax rate: Operating profit based on longer-term investment returns Including non-recurring tax reconciling items Excluding non-recurring tax reconciling items Total profit 196 Total actual tax charge (credit) 239 Asia insurance operations US insurance operations UK insurance operations Other operations Attributable to shareholders Attributable to policyholders 2016 £m 1,503 (460) 1,043 22% 229 2,052 (1,523) 529 35% 185 828 198 1,026 20% 205 (127) (196) (323) 19% (61) 4,256 (1,981) 2,275 25% 558 n/a n/a 937 100% 937 (28) 19 (20) (11) (29) – – (18) 8 (159) – – – – (69) (169) 1 20 – 58 79 (81) – – – (81) (65) (12) 7 (1) 2 – – 1 (3) (7) – (5) – (12) 190 254 (15) 468 (533) 160 30 (9) 26 – (14) (17) 36 (6) 16 5 31 (1) – 35 (10) 12 (22) (67) 60 (180) (23) (46) 36 (5) (225) (82) 51 (6) 58 21 354 894 (540) 17% 16% 23% 23% 27% (12)% 19% 21% 19% (9)% 18% 3% 21% 22% 16% n/a n/a 100% Total n/a n/a 3,212 47% 1,495 (67) 60 (180) (23) (46) 36 (5) (82) 51 (6) 58 21 1,291 n/a n/a n/a n/a 40% – (225) – 937 n/a n/a Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinuedThe 2016 expected and actual tax rates as shown include the impact of the re-measurement loss on the held for sale Korea life business. The 2016 tax rates for Asia insurance and Group, excluding the impact of the held for sale Korea life business, are as follows: Expected tax rate on total profit Actual tax rate: Operating profit based on longer-term investment returns Total profit The more significant reconciling items are explained below: Asia insurance Attributable to shareholders 22% 17% 19% 24% 21% 14% Asia insurance operations The £28 million reconciling item ‘income not taxable or taxable at concessionary rates’ primarily reflects income taxable at rates lower than the expected rates in Malaysia and Singapore. It is lower than the 2015 adjustment of £42 million due to the absence of non-taxable gains on domestic securities in Taiwan. The £20 million reconciling item ‘items related to taxation of life insurance businesses’ reflects where the basis of tax is not the accounting profits, primarily in: — Hong Kong where the taxable profit is based on the net insurance premiums; and — Indonesia and Philippines where investment income is subject to withholding tax at source and no further corporation tax. There is no significant movement in the reconciling items from 2015. The £29 million reconciling item ‘effect of results of the joint ventures and associates’ arises from the accounting requirement for inclusion in the profit before tax of Prudential’s share of the profits after tax from the joint ventures and associates, with no equivalent item included in Prudential’s tax charge. The decrease reflects a lower profit from joint ventures and associates in 2016. The £58 million reconciling item ‘write down of Korea life business’ reflects the non-tax deductible write down of the held for sale Korea life business. US insurance operations The £159 million reconciling item ‘items related to taxation of life insurance businesses’ reflects the impact of the dividend received deduction on the taxation of profits from variable annuity business. The £81 million non-recurring reconciling item ‘adjustments to tax charge in relation to prior years’ arose as a result of the finalisation of the dividend received deduction in the 2015 tax return as compared to the estimate included in the tax charge at 2015. UK insurance operations There are no significant reconciling items or significant movements from 2015. 197 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements B5 Tax charge continued (b) Reconciliation of effective tax rate continued Other operations The £26 million reconciling item ‘deductions not allowable for tax purposes’ primarily relates to non-tax deductible foreign exchange movements on debt instruments. Asia insurance operations US insurance operations UK insurance operations Other operations Attributable to shareholders Attributable to policyholders 2015 £m Operating profit (loss) based on longer-term investment returns Non-operating loss Profit (loss) before tax Expected tax rate Tax at the expected rate Effects of recurring tax reconciliation items: Income not taxable or taxable at concessionary rates Deductions not allowable for tax purposes Items related to taxation of life insurance businesses Deferred tax adjustments Effect of results of joint ventures and associates Irrecoverable withholding taxes Other Total Effects of non-recurring tax reconciliation items: Adjustments to tax charge in relation to prior years Movements in provisions for open tax matters Impact of changes in local statutory tax rates Total 1,171 (135) 1,036 24% 249 (42) 15 (20) 10 (37) – (4) (78) 5 (6) (5) (6) Total actual tax charge (credit) 165 1,691 (492) 1,199 35% 420 (10) 5 (113) – – – (1) (65) – – (65) 236 Analysed into: Tax on operating profit based on longer-term investment returns Tax on non-operating profit Actual tax rate: Operating profit based on longer-term investment returns Including non-recurring tax reconciling items Excluding non-recurring tax reconciling items Total profit 198 170 (5) 408 (172) 15% 15% 16% 24% 28% 20% (119) 11 1,195 (120) 1,075 20% 215 (88) (74) (162) 20% (32) 3,969 (821) 3,148 27% 852 n/a n/a 173 100% 173 (2) 7 – – – – 6 (7) – (16) (23) 203 227 (24) 19% 21% 19% (9) 6 – (11) (13) 28 2 3 – (5) (1) (6) (35) (19) (16) 22% 15% 22% (63) 33 (133) (1) (50) 28 3 (183) (67) (11) (22) (100) 569 786 (217) 20% 22% 18% 173 n/a n/a n/a n/a 100% Total n/a n/a 3,321 31% 1,025 (63) 33 (133) (1) (50) 28 3 (183) (67) (11) (22) (100) 742 n/a n/a n/a n/a 22% Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinued B6 Earnings per share Based on operating profit based on longer-term investment returns Short-term fluctuations in investment returns on shareholder-backed business Loss attaching to held for sale Korea life business Amortisation of acquisition accounting adjustments Based on profit for the year Based on operating profit based on longer-term investment returns Short-term fluctuations in investment returns on shareholder-backed business Profit attaching to held for sale Korea life business Cumulative exchange loss on the sold Japan life business recycled from other comprehensive income Amortisation of acquisition accounting adjustments Based on profit for the year Note B1.2 D1 Note B1.2 D1 Before tax B1.1 £m Tax B5 £m 2016 Net of tax Basic earnings per share Diluted earnings per share £m Pence Pence 4,256 (894) 3,362 131.3p 131.2p (1,678) (227) (76) 2,275 Before tax B1.1 £m 519 (4) 25 (354) Tax B5 £m (1,159) (231) (45.3)p (9.0)p (51) 1,921 (2.0)p 75.0p (45.2)p (9.0)p (2.0)p 75.0p 2015* Net of tax Basic earnings per share Diluted earnings per share £m Pence Pence 3,969 (786) 3,183 124.6p 124.5p (755) 56 (46) (76) 206 (14) – 25 (549) 42 (21.5)p 1.7p (21.5)p 1.7p (46) (51) (1.8)p (1.8)p (2.0)p 101.0p (2.0)p 100.9p 3,148 (569) 2,579 * To facilitate comparisons of operating profit based on longer-term investment returns that reflect the Group’s retained operations, the results attributable to the held for sale Korea life business are included separately within the supplementary analysis of profit above. Earnings per share are calculated based on earnings attributable to ordinary shareholders, after related tax and non-controlling interests. The weighted average number of shares for calculating earnings per share, which excludes those held in employee share trusts and consolidated unit trusts and OEICs, is set out as below: Weighted average number of shares for calculation of: Basic earnings per share Shares under option at end of year Number of shares that would have been issued at fair value on assumed option price Diluted earnings per share 2016 (millions) 2015 (millions) 2,560 7 (5) 2,562 2,553 9 (6) 2,556 199 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsB7 Dividends Dividends relating to reporting year: First interim ordinary dividend Second interim ordinary dividend Special dividend Total Dividends paid in reporting year: Current year first interim ordinary dividend Second interim ordinary dividend/final ordinary dividend for prior year Special dividend Total 2016 Pence per share 12.93p 30.57p – 43.50p 12.93p 26.47p 10.00p 49.40p £m 333 789 – 1,122 332 679 256 1,267 2015 Pence per share 12.31p 26.47p 10.00p 48.78p 12.31p 25.74p – 38.05p £m 315 681 257 1,253 315 659 – 974 Dividend per share For the year ended 31 December 2015 the second interim ordinary dividend of 26.47 pence per ordinary share and the special dividend of 10.00 pence per ordinary share were paid to eligible shareholders on 20 May 2016. The 2016 first interim ordinary dividend of 12.93 pence per ordinary share was paid to eligible shareholders on 29 September 2016. The second interim ordinary dividend for the year ended 31 December 2016 of 30.57 pence per share will be paid on 19 May 2017 in sterling to shareholders on the principal register and the Irish branch register at 6.00pm (BST) on 31 March 2017 (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 26 May 2017. The second interim ordinary dividend will be paid on or about 26 May 2017 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 13 March 2017. The exchange rate at which the dividend payable to the SG Shareholders will be translated into Singapore dollars, will be determined by CDP. Shareholders on the principal register and Irish branch register will be able to participate in a Dividend Reinvestment Plan. 200 Prudential plc Annual Report 2016 www.prudential.co.ukB Earnings performanceContinued Note C5(a) Asia C2.1 245 US C2.2 UK C2.3 Prudential Capital M&G – 153 1,153 Unallo- cated to a segment (central opera- tions) Elimin- ation of intra- group debtors and creditors Eastspring Invest- ments C Balance sheet notes C1 Analysis of Group statement of financial position by segment (a) Position as at 31 December 2016 Insurance operations Asset management 2016 £m By operating segment Assets Goodwill Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income note (i) Other debtors note (i) Investment properties Investment in joint ventures and associates accounted for using the equity method Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Deposits Assets held for sale Cash and cash equivalents note (ii) Total assets C5(b) 2,316 8,323 121 237 107 343 C8.1 C8.2 1,539 98 29 521 2,633 5 7,224 3,861 95 2,590 146 283 549 295 6 1,915 2,447 14,635 D6 C3.3 688 1,303 – 9,735 409 3,572 23,581 120,747 40,745 36,546 834 47 987 – – 1,379 – 3,863 54,037 90,796 2,927 4,449 10,705 726 C3.2 D1 1,995 1,054 4,703 8 5 – 23 25 6 880 – 39 – 140 – – 24 – – 354 76,909 194,692 194,943 2,657 US 16 4 10 – 118 6 79 293 – – – – – – 5 49 – 81 661 – – – – 8 2 20 788 – – 563 – 2,359 124 – – – 1,451 5,315 61 3 3 – 9 – 28 53 – 137 – 18 – – – 46 – 162 520 Group total 1,628 10,807 743 10,051 4,315 440 3,153 3,019 14,646 – 46 24 – 52 – – – – (1,302) – – 35 – 5,620 (9,990) – – – – 29 12 4 – 6 – – – 1,273 15,173 – 198,552 – 170,458 3,936 – 5,465 – 12,185 – 4,589 – 265 – 10,065 6,093 (11,292) 470,498 201 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC1 Analysis of Group statement of financial position by segment continued (a) Position as at 31 December 2016 continued Insurance operations Asset management 2016 £m By operating segment Note Asia C2.1 US C2.2 UK C2.3 Prudential Capital M&G Eastspring Invest- ments US Unallo- cated to a segment (central opera- tions) Elimin- ation of intra- group debtors and creditors Group total Equity and liabilities Total equity Liabilities Insurance contract liabilities Investment contract liabilities with discretionary participation features Investment contract liabilities without discretionary participation features Unallocated surplus of with-profits funds Core structural borrowings of shareholder-financed operations Operational borrowings attributable to shareholder-financed operationsnote (iv) Borrowings attributable to with-profits operations Obligations under funding, securities lending and sale and repurchase agreements Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals, deferred income and other liabilities note (iii) Provisions Derivative liabilities Liabilities held for sale Total liabilities 4,993 5,204 5,999 1,820 22 204 383 (3,958) – 14,667 C4.1 54,417 174,328 88,993 C4.1 347 – 52,490 C4.1 254 3,298 16,171 C4.1 2,667 – 11,650 C6.1 – 202 – C6.2(a) C6.2(b) 19 4 480 167 – 1,345 – 3,534 1,497 – – – – – – – – C8.1 C8.2 C11 C3.4 D1 3,093 935 113 5,887 157 265 3,758 – 2,831 – 4,749 2 64 – 5,594 1,577 447 6,176 442 1,860 535 71,916 189,488 188,944 – 15 64 553 205 – – 837 – – – – 275 – – – – – 7 – – – – – – – – – 1 – 4,396 – 615 – 5,293 5,315 455 1 – – 457 661 – – – – – – – – – – 12 53 72 – – – (1,302) 316,436 – – – 6,321 1,651 – – – 11 6 – 52,837 – – – – – – – – – 19,723 14,317 6,798 2,317 1,349 5,031 8,687 5,370 649 1,546 (9,990) – – – 68 448 – 13,825 947 3,252 4,293 137 10,051 (11,292) 455,831 520 6,093 (11,292) 470,498 Total equity and liabilities 76,909 194,692 194,943 2,657 202 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedUnallo- cated to a segment (central opera- tions) Elimin- ation of intra- group debtors and creditors Eastspring Invest- ments 61 – 47 115 – – – – (1,261) – 33 – (3) 31 – 4,743 (8,881) – – Group total 1,648 8,472 1,197 7,903 2,819 477 2,751 1,955 13,422 (b) Position as at 31 December 2015 Insurance operations Asset management 2015 £m By operating segment Note Asia C2.1 US C2.2 UK C2.3 Prudential Capital M&G Assets Goodwill Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income note (i) Other debtors note (i) Investment properties Investment in joint ventures and associates accounted for using the equity method Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Deposits Assets held for sale Cash and cash equivalents note (ii) Total assets C5 233 – 185 1,153 2,145 6,168 73 192 91 798 C8.1 797 66 34 505 2,212 5 6,211 2,448 307 2,156 132 135 473 22 5 1,622 2,498 13,412 475 1,084 – 7,418 434 3,571 18,532 28,292 57 – 773 – 91,216 34,071 905 810 – – 47,593 83,101 1,930 3,556 11,226 2 16 7 – 30 – 6 672 – 29 – 70 – – 15 – – – – – – 8 1 28 577 – – 885 – 2,204 65 9 – – 2,064 1,405 2,880 430 415 US 16 3 9 – 95 3 66 63 – – – – – – 5 50 – 79 2 3 – 7 – 20 49 – 96 – 15 – – – 39 – 130 422 57,347 151,651 175,322 2,428 4,192 389 – – 27 3 1 – – – 379 – – – – – – – – – 1,034 12,958 157,453 147,671 2,958 4,395 12,088 2 7,782 5,376 (10,142) 386,985 203 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC1 Analysis of Group statement of financial position by segment continued (b) Position as at 31 December 2015 continued Insurance operations Asset management 2015 £m By operating segment Note Asia C2.1 US C2.2 UK C2.3 Prudential Capital M&G Eastspring Invest- ments US Unallo- cated to a segment (central opera- tions) Elimin- ation of intra- group debtors and creditors Group total 3,957 4,154 5,140 1,774 70 182 306 (2,627) – 12,956 Equity and liabilities Total equity Liabilities Insurance contract liabilities Investment contract liabilities with discretionary participation features Investment contract liabilities without discretionary participation features Unallocated surplus of with-profits funds Core structural borrowings of shareholder-financed operations Operational borrowings attributable to shareholder-financed operations Borrowings attributable to with-profits operations Obligations under funding, securities lending and sale and repurchase agreements Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals, deferred income and other liabilities note (iii) Provisions Derivative liabilities Total liabilities 42,084 136,129 83,801 251 – 42,708 181 2,784 15,841 2,553 – 10,543 169 – – – – – – – – – 66 – 179 1,332 10 – – 1,914 1,651 – 200 2,802 734 50 4,476 119 140 22 2,086 3 4,069 6 249 5,049 1,162 203 5,430 158 2,125 53,390 147,497 170,182 – 15 34 404 190 1 654 – – – – 275 – – – – 4 3,361 – 282 4,122 4,192 – – – – – – – – – 2 – 204 1 – 207 389 – – – – – – – – – – 12 51 53 – 116 422 – (1,261) 260,753 – – – 4,567 1,705 – – – 11 19 – – – – – – – – – – 1,302 (8,881) – – 77 322 42,959 18,806 13,096 5,011 1,960 1,332 3,765 7,873 4,010 325 10,416 604 3,119 8,003 (10,142) 374,029 5,376 (10,142) 386,985 Total equity and liabilities 57,347 151,651 175,322 2,428 204 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedNotes (i) Accrued investment income and other debtors Interest receivable Other Total accrued investment income Other debtors comprises: Amounts due from Policyholders Intermediaries Reinsurers Other Total other debtors Total accrued investment income and other debtors Analysed as: Expected to be settled within one year Expected to be settled after one year Total accrued investment income and other debtors (ii) Cash and cash equivalents Cash Cash equivalents Total cash and cash equivalents Analysed as: Held centrally and available for general use by the Group Other funds not available for general use by the Group, including funds held for the benefit of policyholders Total cash and cash equivalents 2016 £m 2015 £m 1,975 1,178 3,153 403 6 90 2,520 3,019 6,172 5,548 624 6,172 1,895 856 2,751 332 14 82 1,527 1,955 4,706 4,273 433 4,706 2016 £m 2015 £m 5,581 4,484 10,065 247 9,818 10,065 5,030 2,752 7,782 365 7,417 7,782 The Group’s cash and cash equivalents are held in the following currencies: pounds sterling 38 per cent, US dollars 25 per cent, Euro 20 per cent and other currencies 17 per cent (2015: pounds sterling 30 per cent, US dollars 36 per cent, Euro 12 per cent and other currencies 22 per cent). (iii) Accruals, deferred income and other liabilities Accruals and deferred income Other creditors Creditors arising from direct insurance and reinsurance operations Interest payable Funds withheld under reinsurance of the REALIC business Other items Total other liabilities (iv) Central operations borrowings, in respect of Prudential Capital’s short-term fixed income security programme Commercial paper Medium Term Notes Total intra-group debt represented by operational borrowings at Group level 2016 £m 2015 £m 1,150 6,788 2,520 90 2,851 426 952 4,876 1,828 70 2,347 343 13,825 10,416 2016 £m 2015 £m 1,052 599 1,651 1,107 598 1,705 205 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C2 Analysis of segment statement of financial position by business type C2.1 Asia insurance operations Assets Goodwill Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income Other debtors Investment properties Investment in joint ventures and associates accounted for using the equity method Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Deposits Assets held for sale Cash and cash equivalents Total assets Total equity Liabilities Insurance contract liabilities Investment contract liabilities with discretionary participation features Investment contract liabilities without discretionary participation features Unallocated surplus of with-profits funds Operational borrowings attributable to shareholder-financed operations Borrowings attributable to with-profits operations Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals, deferred income and other liabilities Provisions Derivative liabilities Liabilities held for sale Total liabilities Total equity and liabilities Note With-profits business 31 Dec 2016 £m Unit-linked assets and liabilities 31 Dec 2015 £m Other business Total Total – 28 89 43 – – 238 1,960 – – 690 10,737 21,861 27 319 – 816 36,808 – – – – – – 2 49 147 – – – 11,439 3,321 – 403 2,877 222 18,460 – 245 2,288 32 1,496 98 27 234 526 5 688 613 1,405 11,364 20 657 986 957 21,641 4,993 245 2,316 121 1,539 98 29 521 2,633 5 688 1,303 23,581 36,546 47 1,379 3,863 1,995 76,909 4,993 233 2,145 73 797 66 34 505 2,212 5 475 1,084 18,532 28,292 57 773 – 2,064 57,347 3,957 28,221 14,035 12,161 54,417 42,084 347 – 2,667 – 4 1,770 639 35 2,837 65 223 – 36,808 36,808 – 254 – 12 – 1,144 25 – 108 – 5 2,877 18,460 18,460 – – – 7 – 179 271 78 2,942 92 37 881 16,648 21,641 347 254 2,667 19 4 3,093 935 113 5,887 157 265 3,758 71,916 76,909 251 181 2,553 – – 2,802 734 50 4,476 119 140 – 53,390 57,347 C3.3 C3.2 D1 C4.1 C4.1 D1 Note The statement of financial position for with-profits business comprises the with-profits assets and liabilities of the Hong Kong, Malaysia and Singapore operations. Assets and liabilities of other participating business are included in the column for ‘Other business’. 206 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC2.2 US insurance operations Assets Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income Other debtors Investment properties Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Cash and cash equivalents Total assets Total equity Liabilities Insurance contract liabilities Investment contract liabilities without discretionary participation features Core structural borrowings of shareholder-financed operations Operational borrowings attributable to shareholder-financed operations Obligations under funding, securities lending and sale and repurchase agreements Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals, deferred income and other liabilities Provisions Derivative liabilities Total liabilities Total equity and liabilities Note C3.3 C3.2 C4.1 31 Dec 2016 £m Variable annuity separate account assets and liabilities Fixed annuity, GIC and other business 31 Dec 2015 £m Total Total – – – – – – – – – 120,411 – – – – 120,411 – 8,323 237 7,224 3,861 95 549 295 6 9,735 336 40,745 834 987 1,054 74,281 5,204 8,323 237 7,224 3,861 95 549 295 6 9,735 120,747 40,745 834 987 1,054 194,692 5,204 6,168 192 6,211 2,448 307 473 22 5 7,418 91,216 34,071 905 810 1,405 151,651 4,154 120,411 53,917 174,328 136,129 – – – – – – – – – – 3,298 202 480 3,534 – 2,831 – 4,749 2 64 3,298 202 480 3,534 – 2,831 – 4,749 2 64 2,784 169 66 1,914 22 2,086 3 4,069 6 249 120,411 120,411 69,077 74,281 189,488 194,692 147,497 151,651 207 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC2 Analysis of segment statement of financial position by business type continued C2.3 UK insurance operations By operating segment Assets Goodwill Deferred acquisition costs and other intangible assets Property, plant and equipment Reinsurers’ share of insurance contract liabilities Deferred tax assets Current tax recoverable Accrued investment income Other debtors Investment properties Investment in joint ventures and associates accounted for using the equity method Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Deposits Assets held for sale note (ii) Cash and cash equivalents Total assets Total equity Liabilities Insurance contract liabilities Investment contract liabilities with discretionary participation features Investment contract liabilities without discretionary participation features Unallocated surplus of with-profits funds Operational borrowings attributable to shareholder- financed operations Borrowings attributable to with-profits operations Obligations under funding, securities lending and sale and repurchase agreements Net asset value attributable to unit holders of consolidated unit trusts and similar funds Deferred tax liabilities Current tax liabilities Accruals deferred income and other liabilities Provisions Derivative liabilities Liabilities held for sale note (ii) Total liabilities Total equity and liabilities 31 Dec 2016 £m Other funds and subsidiaries 31 Dec 2015 £m With- profits sub-funds note (i) Unit- linked assets and liabilities Note Annuity and other long-term business Total Total Total 153 25 325 1,352 82 1 1,227 1,436 12,391 409 1,892 38,803 48,936 2,388 4,443 8,464 726 3,209 – – – 134 – – 101 322 661 – – 15,183 6,277 14 5 1,009 – 694 – 82 18 1,104 64 282 587 689 1,583 – 1,680 51 35,583 525 1 1,232 – 800 – 82 18 1,238 64 282 688 1,011 2,244 – 1,680 15,234 41,860 539 6 2,241 – 1,494 153 107 343 2,590 146 283 1,915 2,447 14,635 409 3,572 54,037 90,796 2,927 4,449 10,705 726 4,703 185 91 798 2,156 132 135 1,622 2,498 13,412 434 3,571 47,593 83,101 1,930 3,556 11,226 2 2,880 126,262 24,400 44,281 68,681 194,943 175,322 – – 5,999 5,999 5,999 5,140 C3.3 C3.2 C4.1 49,001 6,029 33,963 39,992 88,993 83,801 C4.1 52,477 – C4.1 C4.1 18 11,650 16,090 – – 1,345 757 3,513 1,279 90 4,649 95 853 535 4 – – 2,066 – 59 129 – 23 – 13 63 – 163 – 740 15 298 298 1,398 347 984 – 13 52,490 42,708 16,153 – 16,171 11,650 15,841 10,543 167 – 167 1,345 179 1,332 740 1,497 1,651 2,081 298 357 1,527 347 1,007 – 5,594 1,577 447 6,176 442 1,860 535 5,049 1,162 203 5,430 158 2,125 – 126,262 24,400 38,282 62,682 188,944 170,182 126,262 24,400 44,281 68,681 194,943 175,322 Includes the Scottish Amicable Insurance Fund which, at 31 December 2016, have total assets and liabilities of £6,101 million (2015: £6,230 million). The PAC with-profits sub-fund (WPSF) mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). The PAC with-profits fund includes £11.2 billion (2015: £10.8 billion) of non-profits annuities liabilities. The assets and liabilities held for sale for the UK insurance operations at 31 December 2016 comprise the investment properties and consolidated venture investments of the PAC with-profits fund, for which the sales had been agreed but not yet completed at the year end. Notes (i) (ii) 208 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC3 Assets and liabilities C3.1 Group assets and liabilities – measurement (a) 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. 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. The loans and receivables have been shown net of provisions for impairment. The fair value of loans have been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest where applicable. The fair value of investment properties is based on market values as assessed by professionally qualified external valuers or by the Group’s qualified surveyors. The fair value of the subordinated and senior debt issued by the parent company is determined using quoted prices from independent third parties. The fair value of financial liabilities (other than derivative financial instruments) is determined using discounted cash flows of the amounts expected to be paid. (b) Fair value measurement hierarchy of Group assets and liabilities Assets and liabilities carried at fair value on the statement of financial position The table below shows the assets and liabilities carried at fair value analysed by level of the IFRS 13 ‘Fair Value Measurement’ 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. 209 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.1 Group assets and liabilities – measurement continued Financial instruments at fair value Analysis of financial investments, net of derivative liabilities by business type With-profits Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Non-linked shareholder-backed Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Group total analysis, including other financial liabilities held at fair value Group total Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Investment contract liabilities without discretionary participation features held at fair value Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities held at fair value Total financial instruments at fair value Percentage of total 31 Dec 2016 £m Level 1 Level 2 Level 3 Total Quoted prices (unadjusted) in active markets Valuation based on significant observable market inputs Valuation based on significant unobservable market inputs – 45,181 26,227 58 (51) 71,415 56% 146,637 5,136 6 (4) 151,775 97% – 1,966 21,896 – (9) 23,853 25% – 3,669 43,880 3,357 (1,025) 49,881 40% 374 4,462 8 (24) 4,820 3% 276 3 67,915 1,492 (1,623) 68,063 71% 27 690 690 3,443 – 4,850 4% 22 – 5 – 27 0% 2,672 10 252 1,032 (516) 3,450 4% 27 49,540 70,797 6,858 (1,076) 126,146 100% 147,033 9,598 19 (28) 156,622 100% 2,948 1,979 90,063 2,524 (2,148) 95,366 100% – 193,784 53,259 64 (64) 276 4,046 116,257 4,857 (2,672) 247,043 122,764 2,699 722 942 4,480 (516) 8,327 2,975 198,552 170,458 9,401 (3,252) 378,134 – (16,425) – (16,425) (4,217) – 242,826 70% (3,587) (385) 102,367 29% (883) (2,851) 4,593 1% (8,687) (3,236) 349,786 100% All assets and liabilities held at fair value are classified as fair value through profit or loss, except for £40,645 million (2015: £33,984 million) of debt securities classified as available-for-sale. In addition to the financial instruments shown above, the assets and liabilities held for sale on the consolidated statement of financial position at 31 December 2016 in respect of Korea life business included a net financial instruments balance of £3,200 million, primarily for equity securities and debt securities. Of this amount, £2,763 million was classified as level 1 and £437 million as level 2. 210 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedAnalysis of financial investments, net of derivative liabilities by business type With-profits Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Unit-linked and variable annuity separate account Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Non-linked shareholder-backed Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Percentage of total Group total analysis, including other financial liabilities held at fair value Group total Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Investment contract liabilities without discretionary participation features held at fair value Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities held at fair value Total financial instruments at fair value Percentage of total Investment properties at fair value 2016 2015 31 Dec 2015 £m Level 1 Level 2 Level 3 Total Quoted prices (unadjusted) in active markets Valuation based on significant observable market inputs Valuation based on significant unobservable market inputs 35,441 20,312 85 (110) 55,728 54% 116,691 4,350 5 (2) 121,044 96% – 1,150 17,767 – – 18,917 23% 3,200 40,033 1,589 (1,526) 43,296 42% 354 4,940 20 (16) 5,298 4% 255 10 59,491 1,378 (1,112) 60,022 73% – 153,282 42,429 90 (112) 255 3,564 104,464 2,987 (2,654) 195,689 108,616 554 525 3,371 – 4,450 4% 22 – 4 – 26 0% 2,183 31 253 901 (353) 3,015 4% 2,183 607 778 4,276 (353) 7,491 39,195 60,870 5,045 (1,636) 103,474 100% 117,067 9,290 29 (18) 126,368 100% 2,438 1,191 77,511 2,279 (1,465) 81,954 100% 2,438 157,453 147,671 7,353 (3,119) 311,796 – (16,022) – (16,022) (5,782) – 189,907 67% (1,055) (322) 91,217 32% (1,036) (2,347) 4,108 1% (7,873) (2,669) 285,232 100% 31 December £m Level 1 Level 2 Level 3 Total Quoted prices (unadjusted) in active markets Valuation based on significant observable market inputs Valuation based on significant unobservable market inputs – – – – 14,646 13,422 14,646 13,422 211 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.1 Group assets and liabilities – measurement continued Assets and liabilities at amortised cost for which fair value is disclosed The table below shows the assets and liabilities carried at amortised cost on the statement of financial position but for which fair value is disclosed in the financial statements. The assets and liabilities that are carried at amortised cost but where the carrying value approximates the fair value, are excluded from the analysis below. 31 Dec 2016 £m Level 1 Level 2 Level 3 Quoted prices (unadjusted) in active markets Valuation based on significant observable market inputs Valuation based on significant unobservable market inputs Total fair value Total carrying value Assets Loans note (i) Liabilities Investment contract liabilities without discretionary participation features Core structural borrowings of shareholder-financed operations note (ii) Operational borrowings attributable to shareholder-financed operations Borrowings attributable to the with-profits funds Obligations under funding, securities lending and sale and repurchase agreements – – – – – – 4,062 8,846 12,908 12,198 – (3,333) (3,333) (3,298) (7,220) (2,313) (1,220) – (7,220) (6,798) (4) (133) (2,317) (1,353) (2,317) (1,349) (1,926) (3,140) (5,066) (5,031) 31 Dec 2015 £m Level 1 Level 2 Level 3 Quoted prices (unadjusted) in active markets Valuation based on significant observable market inputs Valuation based on significant unobservable market inputs Total fair value Total carrying value Assets Loans note (i) Liabilities Investment contract liabilities without discretionary participation features Core structural borrowings of shareholder-financed operations note (ii) Operational borrowings attributable to shareholder-financed operations Borrowings attributable to the with-profits funds Obligations under funding, securities lending and sale and repurchase agreements – – – – – – 3,423 7,621 11,044 10,520 – (2,820) (2,820) (2,784) (5,419) (1,956) (1,270) – (5,419) (5,011) (4) (74) (1,960) (1,344) (1,960) (1,332) (2,040) (1,735) (3,775) (3,765) Notes (i) (ii) Loans and receivables are reported net of allowance for loan losses of £15 million (2015: £10 million). As at 31 December 2016, £306 million (2015: £481 million) of convertible bonds were included in debt securities and £1,455 million (2015: £1,217 million) were included in borrowings. The fair value of the assets and liabilities in the table above, with the exception of the subordinated and senior debt issued by the parent company, has been estimated from the discounted cash flows expected to be received or paid. Where appropriate, the observable market interest rate has been used and the assets and liabilities are classified within level 2. Otherwise, they are included as level 3 assets or liabilities. The fair value included for the subordinated and senior debt issued by the parent company is determined using quoted prices from independent third parties. 212 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued(c) Valuation approach for level 2 fair valued assets and liabilities 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, stale price reviews and variance 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. 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 below in this note with the objective of arriving at a fair value measurement that 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 determines the input assumptions based on the best available information at the measurement dates. Securities valued in such manner are classified as level 3 where these significant inputs are not based on observable market data. Of the total level 2 debt securities of £116,257 million at 31 December 2016 (2015: £104,464 million), £12,708 million are valued internally (2015: £10,331 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 specified 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. 213 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.1 Group assets and liabilities – measurement continued (d) Fair value measurements for level 3 fair valued assets and liabilities Reconciliation of movements in level 3 assets and liabilities measured at fair value The following table reconciles the value of level 3 fair valued assets and liabilities at 1 January 2016 to that presented at 31 December 2016. Financial instruments at fair value £m Total gains/ losses recorded as other compre- hensive income Purchases Total gains/ losses in income statement Sales Settled Issued Transfers into level 3 Transfers out of level 3 At 31 Dec 2 59 85 427 (20) 11 443 – – 153 185 720 – – (123) 210 (133) (75) (1,002) – (9) (37) – – – – – – – 65 – 73 – – 2,699 – (5) 722 942 (389) – 4,480 (516) 4,276 (353) 359 (163) 7,491 342 861 1,058 (1,210) (169) 210 138 (394) 8,327 (1,036) (2,347) (18) (4) (2) (457) – – 24 – 271 259 (122) (302) – – – – (883) (2,851) At 1 Jan 2,183 607 778 2016 Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities Total financial instruments at fair value 4,108 320 402 1,058 (1,186) 361 (214) 138 (394) 4,593 2015 Loans Equity securities and portfolio holdings in unit trusts Debt securities Other investments (including derivative assets) Derivative liabilities Total financial investments, net of derivative liabilities Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities Total financial instruments at 2,025 2 119 747 790 4,028 (338) 52 (75) 213 (15) 3 1 68 – – 32 243 547 – – (168) 205 (143) (259) (700) – – – – – – – – – – 4 82 120 – – 2,183 (88) (4) 607 778 – – 4,276 (353) 7,252 177 191 822 (1,102) (168) 205 206 (92) 7,491 (1,291) (2,201) (160) (3) (1) (128) (5) – 9 – 412 218 – (233) – – – – (1,036) (2,347) fair value 3,760 14 62 817 (1,093) 462 (28) 206 (92) 4,108 214 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedOf the total net gains and losses in the income statement of £320 million (2015: £14 million), £242 million (2015: £67 million) relates to net unrealised gains of financial instruments still held at the end of the year, which can be analysed as follows: Equity securities Debt securities Other investments Derivative liabilities Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities Total Other assets at fair value – investment properties £m 2016 £m 2015 £m 8 71 182 – (18) (1) 242 94 (12) 160 (15) (160) – 67 Total gains/ losses in income statement 273 537 At 1 Jan 13,422 12,764 Total gains/ losses in other compre- hensive income 97 21 2016 2015 Purchases 1,527 757 Transfers into level 3 Transfers out of level 3 – 5 (41) – Sales (632) (662) At 31 Dec 14,646 13,422 Of the total net gains and losses in the income statement of £273 million (2015: £537 million), £286 million (2015: £505 million) relates to net unrealised gains of investment properties still held at the end of the year. Valuation approach for level 3 fair valued assets and liabilities Financial instruments at fair value 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 flow 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 that 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. In accordance with the Group’s risk management framework, the estimated fair value of derivative financial instruments valued internally using standard market practices are subject to assessment against external counterparties’ valuations. At 31 December 2016, the Group held £4,593 million (2015: £4,108 million) of net financial instruments at fair value within level 3. This represents 1 per cent (2015: 1 per cent) of the total fair valued financial assets net of fair valued financial liabilities. Included within these amounts were loans of £2,672 million at 31 December 2016 (2015: £2,183 million), measured as the loan outstanding balance, attached to REALIC and held to back the liabilities for funds withheld under reinsurance arrangements. The funds withheld liability of £2,851 million at 31 December 2016 (2015: £2,347 million) was also classified within level 3, accounted for on a fair value basis being equivalent to the carrying value of the underlying assets. 215 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.1 Group assets and liabilities – measurement continued Excluding the loans and funds withheld liability under REALIC’s reinsurance arrangements as described above, which amounted to a net liability of £(179) million (2015: £(164) million), the level 3 fair valued financial assets net of financial liabilities were £4,772 million (2015: £4,272 million). Of this amount, a net asset of £72 million (2015: net liability of £(77) million) was internally valued, representing less than 0.1 per cent of the total fair valued financial assets net of financial liabilities (2015: less than 0.1 per cent). Internal valuations are inherently more subjective than external valuations. Included within the internally valued net asset/liability were: (a) Debt securities of £422 million (2015: £381 million), which were either valued on a discounted cash flow method with an internally developed discount rate or on external prices adjusted to reflect the specific known conditions relating to these securities (eg distressed securities or securities which were being restructured). (b) Private equity and venture investments of £956 million (2015: £852 million) which were valued internally based on management information available for these investments. These investments were principally held by consolidated investment funds that are managed on behalf of third parties. (c) Liabilities of £(883) million (2015: £(1,013) million) for the net asset value attributable to external unit holders in respect of the consolidated investment funds, that are non-recourse to the Group. These liabilities are valued by reference to the underlying assets. (d) Derivative liabilities of £(516) million (2015: £(353) million) which are valued internally using standard market practices but are subject to independent assessment against external counterparties’ valuations. (e) Other sundry individual financial investments of £93 million (2015: £56 million). Of the internally valued net asset referred to above of £72 million (2015: net liability of £(77) million): (a) A net asset of £315 million (2015: £29 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. (b) A net liability of £(243) million (2015: £(106) million) was held to support non-linked shareholder-backed business. If the value of all the level 3 instruments held to support non-linked shareholder-backed business valued internally was varied downwards by 10 per cent, the change in valuation would be £24 million (2015: £11 million), which would reduce shareholders’ equity by this amount before tax. Of this amount, a decrease of £24 million (2015: a decrease of £10 million) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and no impact (2015: a decrease of £1 million) would be included as part of other comprehensive income, being unrealised movements on assets classified as available- for-sale. Other assets at fair value – investment properties The investment properties of the Group are principally held by the UK insurance operations that are externally valued by professionally qualified external valuers using the Royal Institution of Chartered Surveyors (RICS) valuation standards. An ‘income capitalisation’ technique is predominantly applied for these properties. This technique calculates the value through the yield and rental value depending on factors such as the lease length, building quality, covenant and location. The variables used are compared to recent transactions with similar features to those of the Group’s investment properties. As the comparisons are not with properties that are virtually identical to the Group’s investment properties, adjustments are made by the valuers where appropriate to the variables used. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of the properties. (e) Transfers into and transfers out of levels The Group’s policy is to recognise transfers into and transfers out of levels as of the end of each half year reporting period except for material transfers which are recognised as of the date of the event or change in circumstances that caused the transfer. During 2016, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to level 2 of £455 million and transfers from level 2 to level 1 of £902 million. 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. In addition, in 2016, the transfers into level 3 were £138 million and the transfers out of level 3 were £394 million. These transfers were between levels 3 and 2 and primarily for equity securities and debt securities. (f) Valuation processes applied by the Group The Group’s valuation policies, procedures and analyses for instruments categorised as level 3 are overseen by business unit committees as part of the Group’s wider financial reporting governance processes. The procedures undertaken include approval of valuation methodologies, verification processes, and resolution of significant or complex valuation issues. In undertaking these activities the Group makes use of the extensive expertise of its asset management functions. 216 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC3.2 Debt securities This note provides analysis of the Group’s debt securities, including asset-backed securities and sovereign debt securities. (a) Credit rating Debt securities are analysed below according to external credit ratings issued, with equivalent ratings issued by different ratings agencies grouped together. Standard and Poor’s ratings have been used where available, if this isn’t the case Moody’s and then Fitch have been used as alternatives. In the table below, AAA is the highest possible rating. Investment grade financial assets are classified within the range of AAA to BBB- ratings. Financial assets which fall outside this range are classified as below BBB-. Debt securities with no external credit rating are classified as ‘Other’. Asia With-profits Unit-linked Non-linked shareholder- backed US Non-linked shareholder- backed UK With-profits Unit-linked Non-linked shareholder- backed Other operations Total debt securities Asia With-profits Unit-linked Non-linked shareholder- backed US Non-linked shareholder- backed UK With-profits Unit-linked Non-linked shareholder- backed Other operations Total debt securities AAA AA+ to AA- A+ to A- BBB+ to BBB- Below BBB- Other Total 2016 £m 3,183 448 8,522 112 3,560 525 2,996 1,321 1,887 494 1,713 421 21,861 3,321 1,082 2,435 2,864 2,388 1,680 915 11,364 445 7,932 10,609 13,950 1,009 6,800 40,745 5,740 461 4,238 830 16,427 9,746 2,660 10,371 1,190 42,968 10,679 1,158 10,558 242 40,195 12,798 1,699 4,515 97 39,764 2015 £m 3,289 212 397 10 6,684 87 5,504 2 48,936 6,277 35,583 2,371 8,978 22,126 170,458 AAA AA+ to AA- A+ to A- BBB+ to BBB- Below BBB- Other Total 2,050 333 700 1,209 5,657 1,101 4,760 1,686 6,212 404 2,626 5,563 8,318 1,842 9,022 119 2,463 420 1,919 2,238 1,050 1,736 1,879 203 1,223 1,493 399 16,335 2,809 944 9,148 8,767 11,623 832 6,077 34,071 9,557 1,164 8,735 285 12,241 1,999 4,994 101 2,673 272 384 14 6,089 103 4,190 2 44,535 6,481 32,085 2,207 17,496 34,106 33,310 35,982 7,480 19,297 147,671 The credit ratings, information or data contained in this report which are attributed and specifically provided by S&P, Moody’s and Fitch Solutions and their respective affiliates and suppliers (‘Content Providers’) is referred to here as the ‘Content’. Reproduction of any Content in any form is prohibited except with the prior written permission of the relevant party. The Content Providers do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. The Content Providers expressly disclaim liability for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold any such investment or security, nor does it address the suitability of an investment or security and should not be relied on as investment advice. 217 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.2 Debt securities continued Securities with credit ratings classified as ‘Other’ can be further analysed as follows: Asia – non-linked shareholder-backed Internally rated Government bonds Corporate bonds – rated as investment grade by local external ratings agencies Other Total Asia non-linked shareholder-backed US Implicit ratings of other US debt securities based on NAIC* valuations (see below) NAIC 1 NAIC 2 NAIC 3-6 Total US Mortgage- backed securities Other securities 2,587 8 12 2,607 2,172 1,901 120 4,193 2016 £m 2015 £m 63 757 95 915 2016 Total 4,759 1,909 132 6,800 162 481 301 944 2015 Total 4,334 1,594 149 6,077 * The Securities Valuation Office of the NAIC classifies 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. UK Internal ratings or unrated AAA to A- BBB to B- Below B- or unrated Total UK 2016 £m 2015 £m 6,939 3,257 2,079 5,570 3,234 1,578 12,275 10,382 In addition to the debt securities shown above, the assets held for sale on the consolidated statement of financial position at 31 December 2016 in respect of Korea life business included a debt securities balance of £652 million. (b) Additional analysis of US insurance operations debt securities Corporate and government security and commercial loans: Government Publicly traded and SEC Rule 144A securities* Non-SEC Rule 144A securities Asset-backed securities (see note (e)) Total US debt securities† 2016 £m 2015 £m 5,856 25,992 4,576 4,321 40,745 4,242 21,776 3,733 4,320 34,071 * A 1990 SEC rule that facilitates the resale of privately placed securities under Rule 144A that are without SEC registration to qualified institutional investors. The rule was designed to develop a more liquid and efficient institutional resale market for unregistered securities. † Debt securities for US operations included in the statement of financial position comprise: Available-for-sale Fair value through profit or loss: Securities held to back liabilities for funds withheld under reinsurance arrangement 2016 £m 2015 £m 40,645 33,984 100 87 40,745 34,071 Realised gains and losses, including impairments, recorded in the income statement are as shown in note B1.2 of this report. 218 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued(c) Movements in unrealised gains and losses on Jackson available-for-sale securities There was a movement in the statement of financial position value for debt securities classified as available-for-sale from a net unrealised gain of £592 million to a net unrealised gain of £676 million as analysed in the table below. 2016 £m 2015 £m Assets fair valued at below book value Book value* Unrealised loss Fair value (as included in statement of financial position) Assets fair valued at or above book value Book value* Unrealised gain Fair value (as included in statement of financial position) Total Book value* Net unrealised gain Fair value (as included in the footnote above in the overview table and the statement of financial position) Foreign exchange translation Changes in unrealised appreciation† Reflected as part of movement in other comprehensive income (118) 116 230 (144) 112 (28) 14,617 (675) 13,942 25,352 1,351 26,703 39,969 676 40,645 The available-for-sale debt securities of Jackson are analysed into US Treasuries and other debt securities as follows: US Treasuries Book value* Net unrealised (loss) gain Fair value Other debt securities Book value* Net unrealised gain Fair value Total debt securities Book value* Net unrealised gain Fair value * Book value represents cost/amortised cost of the debt securities. † Translated at the average rate of US$1.3546: £1.00. 5,486 (412) 5,074 34,483 1,088 35,571 39,969 676 40,645 (30) (436) 142 408 112 (28) 13,163 (673) 12,490 20,229 1,265 21,494 33,392 592 33,984 3,477 54 3,531 29,915 538 30,453 33,392 592 33,984 219 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C3 Assets and liabilities continued C3.2 Debt securities continued (d) US debt securities classified as available-for-sale in an unrealised loss position (i) Fair value of securities as a percentage of book value The following table shows the fair value of the debt securities in a gross unrealised loss position for various percentages of book value: Between 90% and 100% Between 80% and 90% Below 80%: Residential mortgage-backed securities – sub-prime Commercial mortgage-backed securities Other asset-backed securities Government bonds Corporates Total (ii) Unrealised losses by maturity of security 1 year to 5 years 5 years to 10 years More than 10 years Mortgage-backed and other debt securities Total 2016 £m 2015 £m Fair value Unrealised loss Fair value Unrealised loss 12,326 1,598 (405) (259) 11,058 902 – 8 9 – 1 18 – (3) (8) – – (11) 4 – 9 – 517 530 13,942 (675) 12,490 (320) (144) (1) – (7) – (201) (209) (673) 2016 £m 2015 £m (7) (118) (510) (40) (675) (51) (334) (247) (41) (673) (iii) Age analysis of unrealised losses for the periods indicated The following table shows the age analysis of all the unrealised losses in the portfolio by reference to the length of time the securities have been in an unrealised loss position: Less than 6 months 6 months to 1 year 1 year to 2 years 2 years to 3 years More than 3 years Total Non- investment grade 2016 £m Investment grade (3) – (4) (2) (2) (11) (599) (2) (27) (1) (35) (664) Non- investment grade 2015 £m Investment grade (13) (17) (16) (3) (3) (52) (148) (332) (63) (38) (40) (621) Total (602) (2) (31) (3) (37) (675) Total (161) (349) (79) (41) (43) (673) Further, the following table shows the age analysis as at 31 December, of the securities whose fair values were below 80 per cent of the book value: Age analysis Less than 3 months 3 months to 6 months More than 6 months 220 2016 £m 2015 £m Fair value Unrealised loss Fair value Unrealised loss 1 – 17 18 – – (11) (11) 450 64 16 530 (165) (34) (10) (209) Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued (e) Asset-backed securities The Group’s 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 are as follows: Shareholder-backed operations Asia insurance operations note (i) US insurance operations note (ii) UK insurance operations (2016: 25% AAA, 40% AA) note (iii) Asset management operations note (iv) With-profits operations Asia insurance operations note (i) UK insurance operations (2016: 55% AAA, 17% AA) note (iii) Total Notes (i) Asia insurance operations The Asia insurance operations’ exposure to asset-backed securities is primarily held by the with-profits operations. Of the £357 million, 99 per cent (31 December 2015: 84 per cent) are investment grade. (ii) US insurance operations US insurance operations’ exposure to asset-backed securities at 31 December comprises: RMBS RMBS sub-prime (2016: 2% AAA, 12% AA, 4% A) Alt-A (2016: 3% AAA, 6% A) Prime including agency (2016: 72% AA, 3% A) CMBS (2016: 76% AAA, 16% AA, 5% A) CDO funds (2016: 35% AAA, 5% AA, 23% A), including £nil exposure to sub-prime Other ABS (2016: 21% AAA, 18% AA, 52% A), including £129 million exposure to sub-prime Total (iii) UK insurance operations 2016 £m 2015 £m 130 4,321 1,464 771 6,686 357 5,177 5,534 111 4,320 1,531 911 6,873 262 4,600 4,862 12,220 11,735 2016 £m 2015 £m 180 177 675 2,234 50 1,005 4,321 191 191 902 2,403 52 581 4,320 The majority of holdings of the shareholder-backed business are UK securities and relate to PAC’s annuity business. Of the holdings of the with-profits operations, £1,623 million (2015: £1,140 million) relates to exposure to the US markets with the remaining exposure being primarily to the UK market. (iv) Asset management operations Asset management operations’ exposure to asset-backed securities is held by Prudential Capital with no sub-prime exposure. Of the £771 million, 95 per cent (2015: 95 per cent) are graded AAA. (f) Group sovereign debt and bank debt exposure The Group exposures held by the shareholder-backed business and with-profits funds in sovereign debts and bank debt securities at 31 December are analysed as follows: Exposure to sovereign debts Italy Spain France Germany* Other Eurozone Total Eurozone United Kingdom United States† Other, predominantly Asia Total 2016 £m 2015 £m Shareholder- backed business With-profits funds Shareholder- backed business With-profits funds 56 33 22 573 83 767 5,510 6,861 3,979 61 18 – 329 33 441 2,868 9,008 2,079 55 1 19 409 62 546 4,997 3,911 3,368 60 17 – 358 44 479 1,802 6,893 1,737 17,117 14,396 12,822 10,911 * Including bonds guaranteed by the federal government. † The exposure to the United States sovereign debt comprises holdings of the US, UK and Asia insurance operations. 221 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C3 Assets and liabilities continued C3.2 Debt securities continued Exposure to bank debt securities 2016 £m Senior debt Subordinated debt Shareholder-backed business Covered Senior Italy Spain France Germany Netherlands Other Eurozone Total Eurozone United Kingdom United States Other, predominantly Asia Total With-profits funds Italy Spain France Germany Netherlands Other Eurozone Total Eurozone United Kingdom United States Other, including Asia Total – 148 28 46 – – 222 536 – 17 775 – 153 8 96 – – 257 544 – 312 1,113 32 22 53 4 44 19 174 318 2,494 511 3,497 62 60 140 18 189 31 500 400 1,851 1,035 3,786 Total senior debt 32 170 81 50 44 19 396 854 2,494 528 4,272 62 213 148 114 189 31 757 944 1,851 1,347 4,899 Tier 1 Tier 2 Total sub- ordinated debt – – 10 – – – 10 6 6 76 98 – – – – 6 – 6 2 58 220 286 – – 75 74 6 – 155 314 184 414 – – 85 74 6 – 165 320 190 490 1,067 1,165 – – 65 – 7 – 72 450 320 425 – – 65 – 13 – 78 452 378 645 1,267 1,553 2016 Total £m 32 170 166 124 50 19 561 1,174 2,684 1,018 5,437 62 213 213 114 202 31 835 1,396 2,229 1,992 6,452 2015 Total £m 30 154 226 130 31 31 602 957 2,457 718 4,734 57 182 250 111 205 35 840 1,351 1,796 1,656 5,643 The tables above exclude assets held to cover linked liabilities and those of the consolidated unit trusts and similar funds. In addition, the tables above exclude the proportionate share of sovereign debt holdings of the Group’s joint venture operations. (g) Impairment of US available-for-sale debt securities and other financial assets In accordance with the Group’s accounting policy set out in note A3.1, impairment reviews were performed for available-for-sale securities and loans and receivables. During the year ended 31 December 2016, net impairment charges of £(44) million (2015: £(35) million) were recognised for available- for-sale securities and loans and receivables analysed as follows: Available-for-sale debt securities held by Jackson Loans and receivables* Net charge for impairment net of reversals * The impairment charges relate to loans held by the UK with-profits fund and mortgage loans held by Jackson. 2016 £m 2015 £m (20) (24) (44) (19) (16) (35) 222 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedJackson’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 justifiable changes to the base case assumptions would eliminate the need for an impairment loss to be recognised. The impairment loss reflects the difference between the fair value and book value. In 2016, the Group realised gross losses on sales of available-for-sale securities of £152 million (2015: £85 million) with 59 per cent (2015: 57 per cent) of these losses related to the disposal of fixed maturity securities of the top 10 individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £152 million (2015: £ 85 million), £94 million (2015: £54 million) relates to losses on sales of impaired and deteriorating securities. The effect of changes in the key assumptions that underpin the assessment of whether impairment has taken place depends on the factors described in note A3.1. 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 2016, the amount of gross unrealised losses for fixed maturity securities classified as available-for-sale under IFRS in an unrealised loss position was £675 million (2015: £673 million). Note B1.2 provides further details on the impairment charges and unrealised losses of Jackson’s available-for-sale securities. C3.3 Loans portfolio (a) Overview of loans portfolio Loans are accounted for at amortised cost net of impairment except for: — Certain mortgage loans that have been designated at fair value through profit or loss of the UK insurance operations as this loan portfolio is managed and evaluated on a fair value basis; and — Certain policy loans of the US insurance operations that are held to back liabilities for funds withheld under reinsurance arrangements and are also accounted on a fair value basis. The amounts included in the statement of financial position are analysed as follows: Asia With-profits Non-linked shareholder-backed US 2016 £m 2015 £m Mortgage loans* Policy loans† Other loans‡ Total Mortgage loans* Policy loans† Other loans‡ – 179 577 226 113 208 690 613 – 130 452 269 88 145 Total 540 544 Non-linked shareholder-backed 6,055 3,680 – 9,735 4,367 3,051 – 7,418 UK With-profits Non-linked shareholder-backed Asset management operations Total loans securities 668 1,642 – 8,544 6 – – 1,218 38 563 1,892 1,680 563 4,489 2,140 15,173 727 1,508 – 6,732 8 – – 1,324 4 885 2,059 1,512 885 3,780 2,446 12,958 * All mortgage loans are secured by properties. In the US, mortgage loans are all commercial mortgage loans that are secured on the following property types: industrial, multi-family residential, suburban office, retail or hotel. By carrying value, 96 per cent of the £1,642 million (2015: 78 per cent of the £1,508 million) mortgage loans held for UK shareholder-backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 30 per cent (2015: 30 per cent). † In the US, £2,672 million (2015: £2,183 million) policy loans are backing liabilities for funds withheld under reinsurance arrangements and are accounted for at fair value through profit or loss. All other policy loans are accounted for at amortised cost, less any impairment. ‡ Other loans held in UK with-profits funds are commercial loans and comprise mainly syndicated loans. The majority of other loans in shareholder-backed business in Asia are commercial loans held by the Malaysia operation and which are all investment graded by two local rating agencies. 223 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.3 Loans portfolio continued (b) Additional information on US loans 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 £12.4 million (2015: £8.6 million). The portfolio has a current estimated average loan to value of 59 per cent (2015: 59 per cent). At 31 December 2016, Jackson had no mortgage loans where the contractual terms of the agreements had been restructured (2015: none). (c) Loans held by asset management operations These 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: Loans and receivables internal ratings: AA+ to AA- A+ to A- BBB+ to BBB- BB+ to BB- B and other Total 2016 £m 2015 £m 29 100 248 185 1 563 – 157 607 119 2 885 C3.4 Financial instruments – additional information (a) Financial risk (i) Liquidity analysis Contractual maturities of financial liabilities on an undiscounted cash flow basis 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. Total carrying value 1 year or less After 1 year to 5 years After 5 years to 10 years 2016 £m After 10 years to 15 years After 15 years to 20 years Over 20 years No stated maturity Total 6,798 474 778 1,205 1,202 1,011 3,439 3,662 11,771 2,317 1,657 1,349 475 607 748 5,031 5,031 – 13,825 9,873 320 69 32 – 61 – 20 – 80 – 10 – 60 – 2,333 144 1,489 – – – 5,031 103 322 3,272 14,031 8,687 8,687 – – – – – – 8,687 38,007 26,197 2,453 1,367 1,302 1,124 3,821 7,078 43,342 Financial liabilities Core structural borrowings of shareholder-financed operations C6.1 Operational borrowings attributable to shareholder-financed operations C6.2 Borrowings attributable to with-profits funds C6.2 Obligations under funding, securities lending and sale and repurchase agreements Accruals, deferred income and other liabilities Net asset value attributable to unit holders of consolidated unit trusts and similar funds 224 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedFinancial liabilities Core structural borrowings of shareholder-financed operations C6.1 Operational borrowings attributable to shareholder-financed operations C6.2 Borrowings attributable to with-profits funds C6.2 Obligations under funding, securities lending and sale and repurchase agreements Accruals, deferred income and other liabilities Net asset value attributable to unit holders of consolidated unit trusts and similar funds Total carrying value 1 year or less After 1 year to 5 years After 5 years to 10 years 2015 £m After 10 years to 15 years After 15 years to 20 years Over 20 years No stated maturity Total 5,011 197 1,046 1,210 1,197 1,037 3,555 1,900 10,142 1,960 1,301 1,332 256 3,765 3,765 10,416 7,583 616 813 – 99 69 175 – 51 – 53 – 74 – 11 – 100 – 62 – – 1,986 157 1,527 – 3,765 344 2,440 10,691 7,873 7,873 – – – – – – 7,873 30,357 20,975 2,574 1,505 1,324 1,148 3,961 4,497 35,984 Maturity analysis of derivatives The following table shows the gross and net derivative positions together with a maturity profile of the net derivative position: 2016 2015 Carrying value of net derivatives £m Maturity profile of net derivative position £m Derivative assets Derivative liabilities Net derivative position 3,936 2,958 (3,252) (3,119) 684 (161) 1 year or less 1,009 15 After 1 year to 3 years After 3 years to 5 years (14) (10) (7) (7) After 5 years 18 45 Total 1,006 43 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). The Group has no cash flow hedges and in general, contractual maturities are not considered essential for an understanding of the timing of the cash flows for these instruments. The only exception is certain identified 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. Maturity analysis of investment contracts The table below shows the maturity profile for investment contracts on undiscounted cash flow projections of expected benefit payments. 2016 2015 £bn 1 year or less 6 6 After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years 24 21 23 19 16 14 11 10 9 9 Total undis- counted value 89 79 Total carrying value 73 62 Most investment contracts have options to surrender early, often subject to surrender or other penalties. Therefore, most contracts can be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts mean these are unlikely to be exercised in practice and the more useful information is to present information on expected payment. The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of £11 billion (2015: £11 billion) which have no stated maturity but which are repayable on demand. 225 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C3 Assets and liabilities continued C3.4 Financial instruments – additional information continued The vast majority of the Group’s financial assets are held to back the Group’s policyholder liabilities. Although asset/liability matching is an important component of managing policyholder liabilities (both those classified as insurance and those classified 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 are in marketable securities, which can therefore be converted quickly to liquid assets. For the reasons provided above, an analysis of the Group’s assets by contractual maturity is not considered appropriate to evaluate the nature and extent of the Group’s liquidity risk. (ii) Credit risk The Group’s maximum exposure to credit risk of financial 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 comprising 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 C3.4(b) below for derivative assets. The collateral in place in relation to derivatives is described in note C3.4(c) below. Note C3.3 describes the security for these loans held by the Group. Of the total loans and receivables held, £27 million (2015: £27 million) are past their due date but are not impaired. Of the total past due but not impaired, £20 million are less than one year past their due date (2015: £22 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 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 £27 million (2015: £16 million). In addition, during 2016 and 2015, the Group did not take possession of any other collateral held as security. Further details of collateral and pledges are provided in note C3.4(c) below. (iii) Foreign exchange risk As at 31 December 2016, the Group held 23 per cent (2015: 22 per cent) and 12 per cent (2015: 11 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. Of these financial assets, 52 per cent (2015: 53 per cent) are held by the PAC with-profits fund, allowing the fund to obtain exposure to foreign equity markets. Of these financial liabilities, 28 per cent (2015: 40 per cent) are held by the PAC with-profits fund, mainly relating to foreign currency borrowings. The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note 3.4(b) below). The amount of exchange gain recognised in the income statement in 2016, except for those arising on financial instruments measured at fair value through profit or loss, is £1,005 million (2015: £138 million gain). This constitutes £0.4 million gain (2015: £1 million loss) on Medium Term Notes liabilities and £1,005 million of net gain (2015: £139 million net gain), mainly arising on investments of the PAC with-profits fund. The gains/losses on Medium Term Notes liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit or loss. (b) Derivatives and hedging Derivatives The Group enters into a variety of exchange traded and over-the-counter derivative financial 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. Derivatives are used for efficient portfolio management to obtain cost effective and efficient management of 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. The Group also uses interest rate derivatives to reduce exposure to interest rate volatility. In particular: — UK with-profits funds use derivatives for efficient portfolio management or reduction in investment risks. For UK annuity business derivatives are used to assist with asset and liability cash flow matching; — 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 businesses have purchased some swaptions to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets; and — Some products, especially in the US, have guarantee features linked to equity indices. A mismatch between guaranteed product liabilities and the performance of the underlying assets exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to better match asset performance with liabilities under equity-indexed products. 226 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedHedging The Group has formally assessed and documented the effectiveness of the following net investment hedges under IAS 39: At 31 December 2016, the Group has designated perpetual subordinated capital securities totalling US$4.5 billion (2015: US$2.8 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 £3,644 million as at 31 December 2016 (2015: £1,895 million). The foreign exchange loss of £389 million (2015: loss of £104 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. The Group has no cash flow hedges or fair value hedges in place. (c) Derecognition, collateral and offsetting 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. Typically, the value of collateral assets granted to the Group in these transactions is in excess of the value of securities lent, with the excess determined by the quality of the collateral assets granted. Collateral requirements are calculated on a daily basis. The loaned securities are not removed from the Group’s consolidated statement of financial 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 2016, the Group has £8,545 million (2015: £5,995 million) of lent securities and assets subject to repurchase agreements, of which £8,113 million (2015: £4,687 million) related to the PAC with-profits fund. The cash and securities collateral held or pledged under such agreements were £9,086 million (2015: £6,542 million) of which £8,653 million (2015: £5,002 million) was held by the PAC with-profits fund. At 31 December 2016, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities. The fair value of the collateral held in respect of these transactions was £9,319 million (2015: £10,076 million). Collateral and pledges under derivative transactions At 31 December 2016, the Group had pledged £1,853 million (2015: £1,622 million) for liabilities and held collateral of £2,788 million (2015: £1,865 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 agreements. Offsetting assets and liabilities The Group’s derivative instruments, repurchase agreements and securities lending agreements are subject to master netting arrangements and collateral arrangements. A master netting arrangement with a counterparty creates a right of offset for amounts due to and due from that same counterparty that is enforceable in the event of a default or bankruptcy. The Group recognises amounts subject to master netting arrangements on a gross basis within the consolidated balance sheets. The following tables present the gross and net information about the Group’s financial instruments subject to master netting arrangements: Gross amount presented in the consolidated statement of financial position note (i) 31 Dec 2016 £m Related amounts not offset in the consolidated statement of financial position Financial instruments note (ii) Cash collateral Securities collateral note (iii) Net amount Financial assets: Derivative assets Reverse repurchase agreements Total financial assets 3,869 9,132 13,001 (1,053) – (1,053) (1,895) – (1,895) (733) (9,132) (9,865) Financial liabilities: Derivative liabilities Securities lending and repurchase agreements Total financial liabilities (2,874) (1,927) (4,801) 1,053 – 1,053 698 97 795 1,028 1,830 2,858 188 – 188 (95) – (95) 227 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC3 Assets and liabilities continued C3.4 Financial instruments – additional information continued Financial assets: Derivative assets Reverse repurchase agreements Total financial assets Financial liabilities: Derivative liabilities Securities lending and repurchase agreements Total financial liabilities Gross amount presented in the consolidated statement of financial position note (i) 2,835 8,591 11,426 (2,879) (1,979) (4,858) 31 Dec 2015 £m Related amounts not offset in the consolidated statement of financial position Financial instruments note (ii) Cash collateral Securities collateral note (iii) Net amount (1,071) – (1,071) (1,122) – (1,122) (591) (8,591) (9,182) 1,071 – 1,071 764 199 963 809 1,780 2,589 51 – 51 (235) – (235) Notes (i) (ii) (iii) The Group has not offset any of the amounts presented in the consolidated statement of financial position. Represents the amount that could be offset under master netting or similar arrangements where Group does not satisfy the full criteria to offset on the consolidated statement of financial position. Excludes initial margin amounts for exchange-traded derivatives. In the tables above, the amounts of assets or liabilities presented in the consolidated statement of financial position are offset first by financial instruments that have the right of offset under master netting or similar arrangements with any remaining amount reduced by the amount of cash and securities collateral. The actual amount of collateral may be greater than amounts presented in the tables. 228 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4 Policyholder liabilities and unallocated surplus The note provides information of policyholder liabilities and unallocated surplus of with-profits funds held on the Group’s statement of financial position: C4.1 Movement and duration of liabilities C4.1(a) Group overview (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds At 1 January 2015 Comprising: – Policyholder liabilities on the consolidated statement of financial position – Unallocated surplus of with-profits funds on the consolidated statement of financial position – Group’s share of policyholder liabilities of joint ventures and associate‡ Net flows: Premiums Surrenders Maturities/deaths Net flows Shareholders’ transfers post-tax Investment-related items and other movements Foreign exchange translation differences As at 31 December 2015/1 January 2016 Comprising: – Policyholder liabilities on the consolidated statement of financial position – Unallocated surplus of with-profits funds on the consolidated statement of financial position – Group’s share of policyholder liabilities of joint ventures and associate‡ Reclassification of Korea life business as held for sale* Net flows: Premiums Surrenders Maturities/deaths Net flows Shareholders’ transfers post-tax Investment-related items and other movements Foreign exchange translation differences At 31 December 2016 Comprising: – Policyholder liabilities on the consolidated statement of financial position§ – Unallocated surplus of with-profits funds on the consolidated statement of financial position – Group’s share of policyholder liabilities of joint ventures and associate‡ Average policyholder liability balances† 2016 2015 Insurance operations £m Asia note C4.1(b) US note C4.1(c) UK note C4.1(d) Total 45,022 126,746 154,436 326,204 38,705 126,746 144,088 309,539 2,102 4,215 7,784 (2,550) (1,265) 3,969 (43) (364) 194 – – 10,348 – 16,699 (6,759) (1,464) 8,476 – (3,824) 7,515 9,692 (6,363) (6,991) (3,662) (214) 2,319 14 12,450 4,215 34,175 (15,672) (9,720) 8,783 (257) (1,869) 7,723 48,778 138,913 152,893 340,584 41,255 138,913 142,350 322,518 2,553 4,970 (2,812) 9,639 (2,299) (1,558) 5,782 (44) 2,005 9,075 – – – 14,766 (7,872) (1,696) 5,198 – 5,690 27,825 10,543 – – 11,129 (6,821) (6,835) (2,527) (215) 18,626 527 13,096 4,970 (2,812) 35,534 (16,992) (10,089) 8,453 (259) 26,321 37,427 62,784 177,626 169,304 409,714 53,716 177,626 157,654 388,996 2,667 6,401 – – 11,650 – 14,317 6,401 51,765 158,270 150,003 360,038 44,573 132,830 143,219 320,622 *The reclassification of Korea life business as held for sale reflects the value of policyholder liabilities held at 1 January 2016. No other amounts are shown within the 2016 analysis above in respect of Korea. † Averages have been based on opening and closing balances and adjusted for acquisitions, disposals and corporate transactions in the year and exclude unallocated surplus of with-profits funds. ‡ The Group’s investment in joint ventures and associates are accounted for on an equity method basis in the Group’s balance sheet. The Group’s share of the policyholder liabilities as shown above relate to life businesses in China, India and of the Takaful business in Malaysia. § The policyholder liabilities of the Asia insurance operations of £53,716 million (2015: £41,255 million), shown in the table above, is after deducting the intra-group reinsurance liabilities ceded by the UK insurance operations of £1,302 million (2015: £1,261 million) to the Hong Kong with-profits business. Including this amount, total Asia policyholder liabilities are £55,018 million (2015: £42,516 million). 229 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued 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 external 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. Claims represent the policyholder liabilities provision released, rather than the claim amount paid to the policyholder. (ii) Analysis of movements in policyholder liabilities for shareholder-backed business At 1 January 2015 Net flows: Premiums Surrenders Maturities/deaths Net flows note (a) Investment-related items and other movements Foreign exchange translation differences At 31 December 2015/1 January 2016 Comprising: Shareholder-backed business £m Asia US UK Total 26,410 126,746 55,009 208,165 4,793 (2,308) (618) 1,867 (121) (312) 16,699 (6,759) (1,464) 8,476 (3,824) 7,515 3,146 (3,227) (2,613) (2,694) 509 – 24,638 (12,294) (4,695) 7,649 (3,436) 7,203 27,844 138,913 52,824 219,581 – Policyholder liabilities on the consolidated statement of financial position – Group’s share of policyholder liabilities relating to joint ventures 22,874 4,970 138,913 – 52,824 – 214,611 4,970 At 1 January 2016 Reclassification of Korea life business as held for sale* Net flows: Premiums Surrenders Maturities/deaths Net flows note (a) Investment-related items and other movements Foreign exchange translation differences At 31 December 2016 Comprising: 27,844 (2,812) 138,913 – 52,824 – 219,581 (2,812) 4,749 (1,931) (732) 2,086 1,116 4,617 14,766 (7,872) (1,696) 5,198 5,690 27,825 1,842 (2,967) (2,521) (3,646) 6,980 – 21,357 (12,770) (4,949) 3,638 13,786 32,442 32,851 177,626 56,158 266,635 – Policyholder liabilities on the consolidated statement of financial position – Group’s share of policyholder liabilities relating to joint ventures 26,450 6,401 177,626 – 56,158 – 260,234 6,401 * The reclassification of Korea life business as held for sale reflects the value of policyholder liabilities held at 1 January 2016. No other amounts are shown within the 2016 analysis above in respect of Korea. Note (a) Including net flows of the Group’s insurance joint ventures and associate. 230 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued(iii) Movement in insurance contract liabilities and unallocated surplus of with-profits funds Further analysis of the movement in the year of the Group’s insurance contract liabilities, gross and reinsurance share, and unallocated surplus of with-profits funds is provided below: At 1 January 2015 Income and expense included in the income statement and other comprehensive income Foreign exchange translation differences At 31 December 2015/1 January 2016 Income and expense included in the income statement and other comprehensive income Foreign exchange translation differences At 31 December 2016 (iv) Reinsurers’ share of insurance contract liabilities Insurance contract liabilities Gross £m 250,038 3,456 7,259 260,753 20,210 35,472 316,435 Reinsurers’ share £m 6,315 342 335 6,992 752 1,221 8,965 Unallocated surplus of with-profits funds £m 12,450 522 124 13,096 768 453 14,317 Insurance contract liabilities Claims outstanding Asia 1,460 79 1,539 US 6,374 850 7,224 UK 2016 £m 2015 £m 1,131 157 1,288 8,965 1,086 10,051 6,992 911 7,903 The Group cedes certain business to other insurance companies. Although the ceding of insurance does not relieve the Group from its 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. Of the reinsurers’ share of insurance contract liabilities balance of £10,051 million at 31 December 2016 (2015: £7,903 million), 85 per cent (2015: 90 per cent) were ceded by the Group’s UK and US operations, of which 96 per cent (2015: 96 per cent) of the balance were from reinsurers with Standard & Poor’s rating A- and above. The reinsurance asset for Jackson, as shown in the table above, primarily relates to certain fully collateralised former REALIC business retained by Swiss Re through 100 per cent reinsurance agreements. Apart from the reinsurance of REALIC business, 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. Net commissions received on ceded business and claims incurred ceded to external reinsurers totalled £38 million and £500 million respectively during 2016 (2015: £41 million and £442 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2016 or 2015. In each of 2016 and 2015, the Group’s UK insurance business entered into longevity reinsurance transactions on certain aspects of the UK’s annuity liabilities. Further information on these transactions is provided in note B4(b). The gains and losses recognised in profit and loss for the other reinsurance contracts written in the year were immaterial. 231 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued C4.1(b) Asia insurance operations (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits 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: At 1 January 2015 Comprising: – Policyholder liabilities on the consolidated statement of financial position – Unallocated surplus of with-profits funds on the consolidated statement of financial position – Group’s share of policyholder liabilities relating to joint ventures and associate‡ Premiums New business In-force Surrenders note (c) Maturities/deaths Net flows note (b) Shareholders’ transfers post-tax Investment-related items and other movements Foreign exchange translation differences note (a) At 31 December 2015/1 January 2016 Comprising: With-profits business £m Unit-linked liabilities £m 18,612 16,209 Other business £m 10,201 Total £m 45,022 16,510 13,874 8,321 38,705 2,102 – 812 2,179 2,991 (242) (647) 2,102 (43) (243) 506 – 2,335 1,322 1,496 2,818 (2,043) (88) 687 – (536) (394) – 1,880 781 1,194 1,975 (265) (530) 1,180 – 415 82 2,102 4,215 2,915 4,869 7,784 (2,550) (1,265) 3,969 (43) (364) 194 20,934 15,966 11,878 48,778 – Policyholder liabilities on the consolidated statement of financial position – Unallocated surplus of with-profits funds on the consolidated statement 18,381 13,355 9,519 41,255 of financial position 2,553 – – 2,553 – Group’s share of policyholder liabilities relating to joint ventures and associate‡ Reclassification of Korea life business as held for sale* Premiums New business In-force Surrenders note (c) Maturities/deaths Net flows note (b) Shareholders’ transfers post-tax Investment-related items and other movements note (d) Foreign exchange translation differences note (a) At 31 December 2016 note (b) Comprising: – – 1,701 3,189 4,890 (368) (826) 3,696 (44) 889 4,458 2,611 (2,187) 921 1,447 2,368 (1,641) (78) 649 – 621 2,458 2,359 (625) 767 1,614 2,381 (290) (654) 1,437 – 495 2,159 4,970 (2,812) 3,389 6,250 9,639 (2,299) (1,558) 5,782 (44) 2,005 9,075 29,933 17,507 15,344 62,784 – Policyholder liabilities on the consolidated statement of financial position§ – Unallocated surplus of with-profits funds on the consolidated statement 27,266 14,289 12,161 53,716 of financial position 2,667 – – 2,667 – Group’s share of policyholder liabilities relating to joint ventures and associate‡ Average policyholder liability balances† 2016 2015 232 – 3,218 3,183 6,401 22,823 17,446 15,643 16,088 13,299 11,039 51,765 44,573 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued* The reclassification of Korea life business as held for sale reflects the value of policyholder liabilities held at 1 January 2016. No other amounts are shown within the 2016 analysis above in respect of Korea. If Korea life business had been excluded from the 2015 figures, the average policyholder liability balance for 2015 would have been £41,814 million in total allocated £17,446 million, £13,940 million and £10,428 million for its with-profits business, unit-linked business and other business, respectively. † Averages have been based on opening and closing balances and adjusted for acquisitions and disposals in the year and exclude unallocated surplus of with-profits funds. ‡ The Group’s investment in joint ventures and associate are accounted for on an equity method basis and the Group’s share of the policyholder liabilities, as shown above, relate to the life businesses in China, India and of the Takaful business in Malaysia. § The policyholder liabilities of the with-profits business of £27,266 million, shown in the table above, is after deducting the intra-group reinsurance liabilities ceded by the UK insurance operations of £1,302 million to the Hong Kong with-profits business (2015: £1,261 million). Including this amount, the Asia with-profits policyholder liabilities are £28,568 million. Notes (a) Movements in the year have been translated at the average exchange rates for the year. The closing balance has been translated at the closing spot rates as at the end of the year. Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows have increased by £1,860 million to £5,782 million in 2016, after excluding Korea 2015 net inflows of £47 million from the comparative period reflecting increased flows (c) (d) from new business and growth in the in-force books. The rate of surrenders for shareholder-backed business (expressed as a percentage of opening liabilities) was 7.7 per cent in 2016, compared with 7.6 per cent in 2015, excluding Korea (2015: 8.7 per cent including Korea). Investment-related items and other movements for 2016 principally represent realised gains on equity markets and bonds during the year. The gains were mixed across the region with the greatest impact on with-profits and unit-linked business. (ii) Duration of liabilities The table below shows the carrying value of policyholder liabilities and the maturity profile of the cash flows on a discounted basis for 2016 and 2015, taking account of expected future premiums and investment returns: Policyholder liabilities Expected maturity: 0 to 5 years 5 to 10 years 10 to 15 years 15 to 20 years 20 to 25 years Over 25 years 2016 £m 2015 £m 53,716 41,255 % 23 20 16 11 9 21 % 23 20 17 12 9 19 (iii) Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2016, the policyholder liabilities and unallocated surplus for Asia operations of £56.4 billion (2015: £43.8 billion), net of reinsurance of £1,539 million (2015: £798 million), excluding joint ventures, comprised the following: Hong Kong Indonesia Korea* Malaysia Singapore Taiwan Other countries Total Asia operations * The Korea life business was accounted for as held for sale at 31 December 2016 (see note D1). 2016 £m 2015 £m 23,852 3,405 – 4,332 15,324 3,504 4,427 54,844 16,234 2,361 2,810 3,492 12,022 2,724 3,367 43,010 233 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued C4.1(c) US insurance operations (i) Analysis of movements 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 At 1 January 2015 Premiums Surrenders Maturities/deaths Net flows note (b) Transfers from general to separate account Investment-related items and other movements Foreign exchange translation differences note (a) At 31 December 2015/1 January 2016 Premiums Surrenders Maturities/deaths Net flows note (b) Transfers from general to separate account Investment-related items and other movements note (c) Foreign exchange translation differences note (a) At 31 December 2016 Average policyholder liability balances* 2016 2015 * Averages have been based on opening and closing balances. Variable annuity separate account liabilities £m Fixed annuity, GIC and other business £m Total £m 126,746 16,699 (6,759) (1,464) 8,476 – (3,824) 7,515 45,005 3,800 (2,402) (809) 589 (847) 527 2,617 47,891 138,913 4,534 (2,836) (893) 805 (1,164) 444 9,239 14,766 (7,872) (1,696) 5,198 – 5,690 27,825 81,741 12,899 (4,357) (655) 7,887 847 (4,351) 4,898 91,022 10,232 (5,036) (803) 4,393 1,164 5,246 18,586 120,411 57,215 177,626 105,717 52,553 158,270 86,382 46,448 132,830 Notes (a) Movements in the year have been translated at an average rate of US$1.35/£1.00 (2015: US$1.53/£1.00). The closing balances have been translated at a closing rate of US$1.24/£1.00 (2015: US$1.47/£1.00). Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows were £5,198 million in 2016, reflecting continued strong in-flows into the variable annuity business. (c) Positive investment-related items and other movements in variable annuity separate account liabilities of £5,246 million for 2016 primarily reflects the increases in equities and bond values during the year. Fixed annuity, GIC and other business investment and other movements of £444 million primarily reflect the increase in guarantee reserve in the year. 234 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued(ii) Duration of liabilities The table below shows the carrying value of policyholder liabilities and maturity profile of the cash flows on a discounted basis for 2016 and 2015: Fixed annuity and other business (including GICs and similar contracts) £m 2016 Variable annuity separate account liabilities £m Fixed annuity and other business (including GICs and similar contracts) £m Total £m 2015 Variable annuity separate account liabilities £m Total £m Policyholder liabilities 57,215 120,411 177,626 47,891 91,022 138,913 % % % % % % Expected maturity: 0 to 5 years 5 to 10 years 10 to 15 years 15 to 20 years 20 to 25 years Over 25 years 49 26 11 7 3 4 43 29 14 8 4 2 45 28 14 7 3 3 48 26 12 7 4 3 43 28 15 8 4 2 44 28 14 8 4 2 (iii) Aggregate account values The table below shows the distribution of account values for fixed annuities (fixed interest rate and fixed index), the fixed account portion of variable annuities, and interest-sensitive life business within the range of minimum guaranteed interest rates as described above as at 31 December 2016 and 2015: Minimum guaranteed interest rate > 0% – 1.00% > 1.0% – 2.0% > 2.0% – 3.0% > 3.0% – 4.0% > 4.0% – 5.0% > 5.0% – 6.0% Total Fixed annuities and the fixed account portion of variable annuities £m Interest-sensitive life business £m 2016 7,765 8,718 11,249 1,456 1,954 247 31,389 2015 5,563 7,670 9,586 1,263 1,639 212 25,933 2016 – – 243 2,675 2,333 1,839 7,090 2015 – – 204 2,322 2,023 1,574 6,123 235 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued C4.1(d) UK insurance operations (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits 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: At 1 January 2015 Comprising: – Policyholder liabilities – Unallocated surplus of with-profits funds Premiums Surrenders Maturities/deaths Net flows note (a) Shareholders’ transfers post-tax Switches Investment-related items and other movements Foreign exchange translation differences At 31 December 2015/1 January 2016 Comprising: – Policyholder liabilities – Unallocated surplus of with-profits funds Premiums Surrenders Maturities/deaths Net flows note (a) Shareholders’ transfers post-tax Switches Investment-related items and other movements note (b) Foreign exchange translation differences At 31 December 2016 Comprising: – Policyholder liabilities – Unallocated surplus of with-profits funds Average policyholder liability balances* 2016 2015 Shareholder-backed funds and subsidiaries With-profits sub-funds† £m Unit-linked liabilities £m Annuity and other long-term business £m Total £m 99,427 23,300 31,709 154,436 89,079 10,348 6,546 (3,136) (4,378) (968) (214) (189) 1,999 14 23,300 – 1,115 (3,168) (573) (2,626) – 189 579 – 31,709 – 2,031 (59) (2,040) (68) – – (259) – 144,088 10,348 9,692 (6,363) (6,991) (3,662) (214) – 2,319 14 100,069 21,442 31,382 152,893 89,526 10,543 9,287 (3,854) (4,314) 1,119 (215) (152) 11,798 527 21,442 – 1,227 (2,889) (583) (2,245) – 152 2,770 – 31,382 – 615 (78) (1,938) (1,401) – – 4,058 – 142,350 10,543 11,129 (6,821) (6,835) (2,527) (215) – 18,626 527 113,146 22,119 34,039 169,304 101,496 11,650 95,511 89,303 22,119 – 21,781 22,371 34,039 – 157,654 11,650 32,711 150,003 31,545 143,219 * Averages have been based on opening and closing balances and exclude unallocated surplus of with-profits funds. † Includes the Scottish Amicable Insurance Fund. Net outflows improved from £3,662 million in 2015 to £2,527 million in 2016, due primarily to higher premium flows into our with-profits funds following increased sales into with-profits savings and retirement products. This has been offset by lower premiums into our annuity business following our staged withdrawal from this market in the UK. Investment-related items and other movements of £18,626 million mainly reflects investment return earned in the year, attributable to policyholders. Gains on shareholder-backed annuity business reflects a fall in bond yields over 2016. Notes (a) (b) 236 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued(ii) 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. In effect, the maturity term of the other contracts reflects the earlier of death, maturity, or the policy lapsing. In addition, as described in note A3.1, with-profits contract liabilities 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 following tables show the carrying value of the policyholder liabilities and the maturity profile of the cash flows, on a discounted basis for 2016 and 2015: With-profits business 2016 £m Annuity business (insurance contracts) Other Total Insurance contracts Invest- ment contracts Non-profit annuities within WPSF Share- holder- backed annuity Total Total Insurance contracts Invest- ment contracts Total Policyholder liabilities 37,848 52,495 90,343 11,153 33,881 45,034 6,111 16,166 22,277 157,654 Expected maturity: 0 to 5 years 5 to 10 years 10 to 15 years 15 to 20 years 20 to 25 years over 25 years 37 23 15 9 7 9 37 29 16 10 4 4 37 26 16 10 5 6 29 24 18 12 7 10 2016 % 25 22 18 14 9 12 2015 £m 26 23 18 13 9 11 40 23 12 7 4 14 34 23 17 12 7 7 37 23 15 10 6 9 34 25 17 11 6 7 Policyholder liabilities 35,962 42,736 78,698 10,828 30,983 41,811 6,028 15,813 21,841 142,350 Expected maturity: 0 to 5 years 5 to 10 years 10 to 15 years 15 to 20 years 20 to 25 years over 25 years 40 23 14 9 6 8 40 27 17 10 4 2 40 25 16 10 5 4 33 25 18 11 6 7 2015 % 26 22 18 13 9 12 27 23 18 13 9 10 42 26 13 7 4 8 36 23 17 12 6 6 39 24 15 10 5 7 36 24 16 11 6 7 — 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. — Benefit payments do not reflect the pattern of bonuses and shareholder transfers in respect of the with-profits business. — Shareholder-backed annuity business includes the ex-PRIL and the legacy PAC shareholder annuity business. — Investment contracts under ‘Other’ comprise certain unit-linked and similar contracts accounted for under IAS 39 and IAS 18. — 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. 237 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued (iii) Annuitant mortality For annuities in payment, the Continuous Mortality Investigation (CMI) tables used are adjusted to reflect anticipated mortality improvements. The tables and range of percentages used are set out in the table below: CMI model, with calibration to reflect future mortality improvements Non-profit annuities within the WPSF PRIL 2016 CMI 2014 For males: with a long-term improvement rate of 2.25% pa* For females: with a long-term improvement rate of 1.50% pa* 2015 CMI 2014 For males: with a long-term improvement rate of 2.25% pa* For females: with a long-term improvement rate of 1.50% pa* Males 97% – 98% PCMA00 Females 92% – 103% PCFA00 Males 94% – 95% PCMA00 Females 83% – 96% PCFA00 95% – 97% PCMA00 91% – 103% PCFA00 93% PCMA00 83% – 96% PCFA00 * For both males and females, the initial rates of mortality improvement in the CMI Model are uplifted by 0.25% per annum. For annuities in deferment, the tables used by both the non-profit annuities within the WPSF and PRIL were AM92 – four years (males) and AF92 – four years (females) for 2015. C4.2 Products and determining contract liabilities C4.2(a) Asia Contract type Description Material features Determination of liabilities With-profits and participating contracts Provides savings and/or 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 Company. Participating products often offer a guaranteed maturity or surrender value. Declared regular bonus are guaranteed once vested. Future bonus rates and cash dividends are not guaranteed. Market value adjustments and surrender penalties are used for certain products where the law permits such adjustments. Guarantees are predominantly supported by segregated life funds and their estates. With-profits contracts are predominantly sold in Hong Kong, Malaysia and Singapore. The total value of the with-profits funds is driven by the underlying asset valuation with movements reflected principally in the accounting value of policyholder liabilities and unallocated surplus. In Taiwan and India, US GAAP is applied for measuring insurance assets and liabilities. The other Asia operations principally adopt a gross premium valuation method. 238 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4.2(a) Asia continued Contract type Description Material features Determination of liabilities Term, whole life and endowment assurance Non-participating savings and/or protection where the benefits are guaranteed, or determined by a set of defined market-related parameters. These products often offer a guaranteed maturity and surrender value. 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 is reflected within the guaranteed maturity and surrender values. Guarantees are borne by shareholders. Unit-linked Combines savings with protection, the cash value of the policy depends on the value of the underlying unitised funds. The approach to determining the contract liabilities is generally driven by the local solvency basis. A gross premium valuation method is used in those countries where a risk-based capital framework is adopted for local solvency. Under the gross premium valuation method, all cash flows are valued explicitly using best estimate assumptions. In applying this approach, an overlay constraint to the method is applied such that no negative reserves are derived at an individual policyholder level. In Vietnam, the Company uses an estimation basis aligned substantially to that used by the countries applying the gross premium valuation method. For India and Taiwan, US GAAP is applied for measuring insurance assets and liabilities. For these countries, 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 each block of business. The other Asia operations principally adopt a net premium valuation method to determine the future policyholder benefit provisions. The attaching liabilities reflect the unit value obligation driven by the value of the investments of the unit fund. 239 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued C4.2(a) Asia continued Contract type Description Material features Determination of liabilities Health and protection Health and protection features are offered as supplements to the products listed above or sold as stand-alone products. Protection covers mortality or morbidity benefits including health, disability, critical illness and accident coverage. The determination of the liabilities of health and protection contracts are driven by the local solvency basis. A gross premium valuation method is used in those countries where a risk-based capital framework is adopted for local solvency. Under the gross premium valuation method, all cash flows are valued explicitly using best estimate assumptions. In applying this approach, an overlay constraint to the method is applied such that no negative reserves are derived at an individual policyholder level. C4.2(b) US Contract type Description Material features Determination of liabilities Guaranteed minimum interest rate. At 31 December 2016, Jackson had fixed interest rate annuities totalling £14.2 billion (2015: £12.1 billion) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 2.96 per cent average guaranteed rate (2015: 1.0 per cent to 5.5 per cent and a 3.00 per cent average guaranteed rate). As explained in note A3.1 all of Jackson’s insurance liabilities are based on US GAAP. An overview of the deferral and amortisation of acquisition costs for Jackson is provided in note C5(b). With minor exceptions the following is applied to most of Jackson’s contracts. Contracts are accounted for as investment contracts as defined for US GAAP purposes by applying a retrospective deposit method to determine the liability for policyholder benefits. This is then augmented by: — 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). Fixed interest rate annuities Fixed interest rate annuities are primarily deferred annuity products that are used for asset accumulation in retirement planning and for providing income in retirement. At 31 December 2016, fixed interest rate annuities accounted for 8 per cent (2015: 9 per cent) of policy and contract liabilities of Jackson. The policyholder of a fixed interest rate 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 benefit payments at a future date as specified 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. 240 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4.2(b) US continued Contract type Description Material features Determination of liabilities Fixed interest rate annuities continued Approximately 62 per cent (2015: 62 per cent) of the fixed interest rate annuities Jackson wrote in 2016 provide for a (positive or negative) market value adjustment (‘MVA’) on surrender. This formula-based adjustment approximates the change in value that assets supporting the product would realise as interest rates move. 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 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, each of which will be determined based on the best estimate of amounts over the life of the book of contracts without provision for adverse deviation: — Amounts expected to be assessed for mortality less benefit claims in excess of related policyholder balances; — Amounts expected to be assessed for contract administration less costs incurred for contract administration; — Amounts expected to be earned from the investment of policyholder balances less interest credited to policyholder balances; — Amounts expected to be assessed against policyholder balances upon termination of contracts (sometimes referred to as surrender charges); and — Other expected assessments and credits. The interest guarantees are not explicitly valued but are reflected as they are earned in the current account liability value. 241 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued C4.2(b) US continued Contract type Description Material features Determination of liabilities The liability for policyholder benefits that represent the guaranteed minimum return is determined similarly to the liabilities of the fixed interest annuity above. The equity-linked return option within the contract is treated as an embedded liability under IAS 39 and therefore this element of the liability is recognised at fair value. The general principles for fixed annuity and fixed index annuity also apply to variable annuities. The impact of any fixed account interest guarantees is reflected as they are earned in the current account value. Fixed index annuities vary in structure but are generally deferred annuities that enable policyholders to obtain a portion of an equity- linked return (based on participation rates and caps), and provide a guaranteed minimum return. Fixed index annuities accounted for 6 per cent (2015: 6 per cent) of Jackson’s policy and contract liabilities at 31 December 2016. Jackson hedges the equity return risk on fixed index products using offsetting equity exposure in the variable annuity product. The cost of hedging is taken into account in setting the index participation rates or caps. Variable annuities are deferred annuities that have the same tax advantages and payout options as fixed interest rates and fixed index annuities. They are also used for asset accumulation in retirement planning and to provide income in retirement. At 31 December 2016, variable annuities accounted for 74 per cent (2015: 70 per cent) of Jackson’s policy and contract liabilities. The rate of return depends upon the performance of the selected fund portfolio. Policyholders may allocate their investment to either the fixed account 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 2016, 6 per cent (2015: 6 per cent) of variable annuity funds were in fixed accounts. Guaranteed minimum rates are generally set at 1.0 to 3.0 per cent. At 31 December 2016, Jackson had fixed index annuities allocated to indexed funds totalling £7.3 billion (2015: £6.4 billion) in account value with minimum guaranteed rates on index accounts ranging from 1.0 per cent to 3.0 per cent and a 1.77 per cent average guaranteed rate (2015: 1.0 per cent to 3.0 per cent and a 1.79 per cent average guaranteed rate). Jackson also offers fixed interest accounts on some fixed index annuity products. At 31 December 2016, fixed interest accounts of fixed index annuities totalled £2.6 billion (2015: £1.9 billion) in account value. Minimum guaranteed rates on fixed interest accounts range from 1.0 per cent to 3.0 per cent and a 2.55 per cent average guaranteed rate (2015: 1.0 per cent to 3.0 per cent and a 2.52 per cent average guaranteed rate). Jackson had variable annuity funds in fixed accounts totalling £7.3 billion (2015: £5.5 billion) with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 1.64 per cent average guaranteed rate (2015: 1.0 per cent to 3.0 per cent and a 1.70 per cent average guaranteed rate). Jackson offers a choice of guaranteed benefit options within its variable annuity product portfolio, which can be elected for additional fees. These guaranteed benefits might be expressed as the return of either: (a) 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 that contract anniversary. Fixed index annuities Variable annuities 242 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4.2(b) US continued Contract type Description Material features Determination of liabilities Variable annuities continued Jackson hedges these risks using equity options and futures contracts as described in note C7.3. The benefit guarantee types are set out below: Benefits that are payable in the event of death (guaranteed minimum death benefit). Jackson regularly evaluates estimates used and adjusts the benefit guarantee liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised. 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 2016, these liabilities were valued using a series of stochastic investment performance scenarios, a mean investment return of 7.4 per cent (2015: 7.4 per cent) net of external fund management fees, and assumptions for policyholder behaviour, mortality and expense that are similar to those used in amortising the capitalised acquisition costs. Benefits that are payable upon the depletion of funds (guaranteed minimum withdrawal benefit). The liability for the GMWB ‘for life’ portion is determined similarly to GMDB above. GMWB ‘not for life’ features are treated as embedded derivatives under IAS 39. Therefore, provisions for these benefits are recognised at fair value. Non-performance risk is incorporated into the fair value calculation through the use of discount interest rates sourced from an AA corporate credit curve as a proxy for Jackson’s own credit risk. Other risk margins, particularly for policyholder behaviour and long-term volatility, are also incorporated into the model through the use of explicitly conservative assumptions. On a periodic basis, Jackson validates the resulting fair values based on comparisons to other models and market movements. 243 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued C4.2(b) US continued Contract type Description Material features Determination of liabilities Variable annuities continued Benefits that are payable at annuitisation (guaranteed minimum income benefit) This feature is no longer offered and existing coverage is substantially reinsured. Benefits that are payable at the end of a specified period (guaranteed minimum accumulation benefit). This feature is no longer offered. 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 are essentially fully reinsured, subject to a deductible and 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 fluctuations. Volatility and non-performance risk is considered as per GMWB above. GMAB is treated as embedded derivatives under IAS 39. Therefore, provisions for these benefits are recognised at fair value. Volatility and non- performance risk is considered as per GMWB above. 244 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4.2(b) US continued Contract type Description Material features Determination of liabilities Life insurance Institutional products Life products include term life and interest-sensitive life (universal life and variable universal life). Life insurance products accounted for 10 per cent (2015: 11 per cent) of Jackson’s policy and contract liabilities at 31 December 2016. Jackson discontinued new sales of life insurance products in 2012. 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. For certain fixed universal life plans, additional provisions are held to reflect the existence of guarantees offered in the past that are no longer supported by earnings on the existing asset portfolio, or for situations where future mortality charges are not expected to be sufficient to provide for future mortality costs. Institutional products are: guaranteed investment contracts (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 2016 institutional products accounted for 1% of contract liabilities (2015: 3%). Excluding the business that is subject to the retrocession treaties at 31 December 2016, Jackson had interest sensitive life business in force with total account value of £7.1 billion (2015: £6.1 billion), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate (2015: 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate). For traditional life insurance contracts, provisions for future policy benefits are determined under US GAAP using the net level premium method and assumptions as the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviation. For universal life and variable universal life a retrospective deposit method is used to determine the liability for policyholder benefits. This is then augmented by additional liabilities to account for no-lapse guarantees, profits followed by losses, contract features such as persistency bonuses, and cost of interest rate guarantees. Institutional products are classified as investment contracts, and are accounted for as financial liabilities. The currency risk on contracts that represent currency obligations other than US dollars are hedged using cross-currency swaps. GICs feature a lump sum policyholder deposit on which interest is paid at a rate fixed at inception. Market value adjustments are made to the value of any early withdrawals. Funding agreements feature either lump sum or periodic policyholder deposits. Interest is paid at a fixed or index linked rate. Funding agreements have a duration of between one and 30 years. In 2016 and 2015, there were no funding agreements terminable by the policyholder with less than 90 days notice. 245 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued C4.2(c) UK Contract type Description Material features Determination of liabilities With-profits contracts in WPSF Regular bonuses are declared once a year, and once credited, are guaranteed in accordance with the terms of the particular product. Final bonus rates are guaranteed only until the next bonus declaration. With-profits contracts provide returns to policyholders through bonuses that are ‘smoothed’. There are two types of bonuses: ‘regular’ and ‘final’. Regular 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, reduced as appropriate for each type of policy to allow for items such as expenses, charges, tax and shareholders’ transfers. In normal investment conditions, PAC expects changes in regular bonus rates to be gradual over time. However, PAC retains 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. A final bonus which is normally declared annually, 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. 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 in accordance with the requirements of FRS 27. For with-profits business a market consistent valuation is performed. 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. The provisions have been determined on a basis consistent with the detailed methodology included in regulations contained in the PRA’s previously issued rules for the determination of reserves on the PRA’s ‘realistic’ Peak 2 basis. Though no longer in force for regulatory purposes, these rules continue to be applied to determine with-profits contract liabilities in accordance with IFRS 4. 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. The PRA’s Peak 2 calculation under the realistic regime requirement is explained further in note A3.1 under the UK regulated with-profits section. 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. 246 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC4.2(c) UK continued Contract type Description Material features Determination of liabilities 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. The contract liabilities for with-profits business also require assumptions for persistency. These are set based on the results of recent experience analysis. The process of determining policyholder liabilities of SAIF is similar to that for the with-profits policies of the WPSF. With-profits contracts in WPSF continued SAIF with-profits SAIF is a ring-fenced with- profits sub-fund of PAC. No new business is written in SAIF, although regular premiums are still being paid on in-force 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, 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. 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 £571 million was held in SAIF at 31 December 2016 (2015: £412 million) to honour the guarantees. As SAIF is a separate sub-fund solely for the benefit of policyholders of SAIF, this provision has no impact on the financial position of the Group’s shareholders’ equity. 247 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued C4.2(c) UK continued Contract type Description Material features Determination of liabilities Annuities – level, fixed increase and inflation linked annuities Level Provide a fixed annuity payment over the policyholders life. Fixed increase Provide for a regular annuity payment which incorporates automatic increases in annuity payments by fixed amounts over the policyholder’s life. Inflation-linked Provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK RPI. With-profits Written in the WPSF, these 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. As per with-profits products. Annuity liabilities are calculated as the expected future value of future annuity payments discounted by a valuation interest rate. Key assumptions include: Mortality The mortality assumptions are set in light of recent population and internal experience. The assumptions used are percentages of 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. New mortality projection models are released annually by the Continuous Mortality Investigation (CMI). The CMI 2014 model was used to produce the 2016 results calibrated to reflect an appropriate view of future mortality improvements. For annuities in payment, the tables and range of percentages used are set out in C4.1(d)(iii). Expense Maintenance 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. A margin for adverse deviation is added to this amount. Expense inflation assumptions are set consistent with the economic basis and based on the inflation swap spot curve. 248 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued C4.2(c) UK continued Contract type Description Material features Determination of liabilities Annuities – level, fixed increase and inflation linked annuities continued Valuation interest rates 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 internal rate of return of the assets backing the liabilities is used. Properties are valued using the lower of the rental yield and the redemption 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. Credit risk For IFRS reporting, the results for UK shareholder-backed annuity business are particularly sensitive to the allowances made for credit risk on fixed-interest securities. Further details on credit risk allowance are provided in note B4(b). Unit-linked Prudential UK insurance operations also have an extensive book of unit-linked policies. 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. For unit-linked 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 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. To calculate the non-unit reserves for linked business, 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 in the annuities section above. 249 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued Operation of the UK with-profits sub-funds The WPSF mainly contains with-profits business but it also contains some non-profit business (unit-linked, term assurances and annuities). The WPSF’s profits, apportioned 90 per cent to its policyholders and 10 per cent to shareholders as surplus for distribution, are determined via the annual actuarial valuation. Application of significant judgement Determining bonuses using the table described in the material features table above requires the PAC board to apply significant judgement in many respects, including in particular the following: — Determining what constitutes fair treatment of customers; — Smoothing of investment returns; and — Determining at what level to set bonuses to ensure that they are competitive. Key assumptions The overall rate of return on investments and the expectation of future investment returns are the most important influences 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 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 and is also consistent with the requirements of the Principles and Practices of Financial Management (PPFM) that are applied in the management of their with-profits funds. In accordance with industry-wide regulatory requirements, the PAC board has appointed: — A Chief Actuary 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 Principles and Practices of Financial Management and the manner in which any conflicting 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 conflicting rights have been addressed. 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 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-profits fund for each year presented. Net income of the fund: Investment return Claims incurred Movement in policyholder liabilities Add back policyholder bonuses for the year (as shown below) Claims incurred and movement in policyholder liabilities (including charge for provision for asset shares and excluding policyholder bonuses) Earned premiums, net of reinsurance Other income Acquisition costs and other expenditure Share of profits from investment joint ventures Tax charge Net income of the fund before movement in unallocated surplus Movement in unallocated surplus Surplus for distribution Surplus for distribution allocated as follows: – 90% policyholders’ bonus (as shown above) – 10% shareholders’ transfers 250 2016 £m 2015 £m 13,185 (7,410) (11,824) 1,934 (17,300) 9,261 177 (1,288) 22 (739) 3,318 (1,169) 2,149 1,934 215 2,149 3,130 (6,745) (1,307) 1,943 (6,109) 6,507 210 (1,318) 53 (148) 2,325 (168) 2,157 1,943 214 2,157 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued C5 Intangible assets (a) Goodwill Cost At beginning of year Disposal of Japan life business Charge for reclassification as held for sale Additional consideration paid on previously acquired business Exchange differences Net book amount at end of year Goodwill comprises: M&G – attributable to shareholders Other – attributable to shareholders Goodwill – attributable to shareholders Venture fund investments – attributable to with-profits funds Attributable to: Shareholders With-profits 2016 £m 2015 £m 1,463 – (15) 1 26 1,475 185 – (41) 6 3 153 1,648 – (56) 7 29 1,628 1,769 (120) – 2 (3) 1,648 2016 £m 2015 £m 1,153 322 1,475 153 1,628 1,153 310 1,463 185 1,648 Other goodwill represents amounts allocated to entities in Asia and the US operations. These 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 cash-generating units for the purposes of impairment testing. These cash-generating units are based upon how management monitors the business and represent the lowest level to which goodwill can be allocated on a reasonable basis. Assessment of whether goodwill may be impaired Goodwill is tested for impairment by comparing the cash-generating units’ carrying amount, including any goodwill, with its recoverable amount. With the exception of M&G, the goodwill attributable to shareholders 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 current in-force business as determined using the EEV methodology. Any excess of IFRS over EEV carrying value is then compared with EEV basis value of current and projected future new business to determine whether there is any indication that the goodwill in the IFRS statement of financial position may be impaired. The methodology and assumptions underpinning the Group’s EEV basis of reporting are included in the EEV basis supplementary information in this Annual Report. Goodwill for venture fund investments is tested for impairment by comparing the business’s carrying value, including goodwill to its recoverable amount (fair value less costs to sell). M&G The recoverable amount for the M&G cash-generating units 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 ii 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; The assumed growth rate on forecast cash flows beyond the terminal year of the plan. A growth rate of 2.0 per cent (2015: 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; 251 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC5 Intangible assets continued 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 (2015: 12 per cent) has been applied to post-tax cash flows. The pre-tax risk discount rate was 16 per cent (2015: 16 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 4.25 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. (b) Deferred acquisition costs and other intangible assets Deferred acquisition costs and other intangible assets attributable to shareholder Deferred acquisition costs and other intangible assets attributable to with-profits funds Total of deferred acquisition costs and other intangible assets The deferred acquisition costs and other intangible assets attributable to shareholders comprise: Deferred acquisition costs related to insurance contracts as classified under IFRS 4 Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 (PVIF) Distribution rights and other intangibles Total of deferred acquisition costs and other intangible assets 2016 £m 2015 £m 10,755 52 10,807 8,422 50 8,472 2016 £m 2015 £m 9,114 64 9,178 43 1,534 1,577 10,755 6,948 74 7,022 45 1,355 1,400 8,422 Balance at 1 January Additions Amortisation to the income statement:† Operating profit Non-operating profit Disposals and transfers‡ Exchange differences and other movements Amortisation of DAC related to net unrealised valuation movements on the US insurance operation’s available-for-sale securities recognised within other comprehensive income† Balance at 31 December 2016 £m 2015 £m Deferred acquisition costs Asia 781 267 (147) – (147) (251) 138 US 6,148 678 (434) 565 131 – 1,270 Asset management UK PVIF and other intangibles* 81 12 (14) – (14) – – 12 (4) – (4) – – 1,400 222 (87) (8) (95) (17) 67 Total 8,422 1,179 (686) 557 (129) (268) 1,475 Total 7,261 1,190 (762) 93 (669) (8) 311 – 788 76 8,303 – 79 – 8 – 76 1,577 10,755 337 8,422 * PVIF and other intangibles includes amounts in relation to software rights with additions of £38 million, amortisation of £32 million, reclassification to held for sale assets of £14 million, forex gains of £3 million and a balance at 31 December 2016 of £66 million. † Under the Group’s application of IFRS 4, US GAAP is used for measuring the insurance assets and liabilities of its US and certain Asia operations. Under US GAAP, most of the US insurance operation’s products are accounted for under Accounting Standard no. 97 of the Financial Accounting Standards Board (FAS 97) whereby deferred acquisition costs are amortised in line with the emergence of actual and expected gross profits which are determined using an assumption for long-term investment returns for the separate account of 7.4 per cent (2015: 7.4 per cent) (gross of asset management fees and other charges to policyholders, but net of external fund management fees). The amounts included in the income statement and other comprehensive income affect the pattern of profit emergence and thus the DAC amortisation attaching. DAC amortisation is allocated to the operating and non-operating components of the Group’s supplementary analysis of profit and other comprehensive income by reference to the underlying items. ‡ The entire £251 million for the Asia deferred acquisition costs and £14 million out of the £17 million for the PVIF and other intangibles within the ‘Disposals and transfers’ line relate to the reclassification of the Korea life business as held for sale. 252 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedNote PVIF and other intangibles comprise PVIF, distribution rights and other intangibles such as software rights. Distribution rights relate to amounts that have been paid or have become unconditionally due for payment as a result of past events in respect of bancassurance partnership arrangements in Asia. These agreements allow for bank distribution of Prudential’s insurance products for a fixed period of time. US insurance operations The DAC amount in respect of US insurance operations comprises amounts in respect of: Variable annuity business Other business Cumulative shadow DAC (for unrealised gains booked in other comprehensive income)* Total DAC for US operations 2016 £m 2015 £m 7,844 696 (237) 8,303 5,713 703 (268) 6,148 * Consequent upon the negative unrealised valuation movement in 2016 of £28 million (2015: negative unrealised valuation movement of £1,305 million), there is a gain of £76 million (2015: a gain of £337 million) for altered shadow DAC amortisation booked within other comprehensive income. These adjustments reflect movement from period to period, in the changes to the pattern of reported gross profits that would have occurred if the assets reflected in the statement of financial position had been sold, crystallising the unrealised gains and losses, and the proceeds reinvested at the yields currently available in the market. At 31 December 2016, the cumulative shadow DAC balance, as shown in the table above, was negative £237 million (2015: negative £268 million). Sensitivity of amortisation charge The amortisation charge to the income statement is reflected in both operating profit and short-term fluctuations 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 premiums or 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 (which is used for moderating the effect of short-term volatility in investment returns) 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. In 2016, the DAC amortisation charge for operating profit was determined after including a credit for decelerated amortisation of £93 million (2015: charge for accelerated amortisation of £2 million). The 2016 amount primarily reflects the impact of the positive separate account performance, which is higher than the assumed level for the year, and the effect of releasing the 2013 fund returns of 17 per cent from the mean reversion formula. The application of the mean reversion formula, (described in note A3.1) has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. In 2017, it would take approximate movements in separate account values of more than either negative 19 per cent or positive 63 per cent for the mean reversion assumption to move outside the corridor. Deferred acquisition costs and other intangible assets attributable to with-profits funds Other intangible assets in the Group consolidated statement of financial position attributable to with-profits funds consist of: Deferred acquisition costs related to insurance contracts attributable to the PAC with-profits fund Distribution rights attributable to with-profits funds of the Asia insurance operations Computer software and other intangibles attributable to with-profits funds 2016 £m 2015 £m 2 – 50 52 3 27 20 50 253 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC5 Intangible assets continued (i) Deferred acquisition costs related to insurance and investment contracts The movements in deferred acquisition costs relating to insurance and investment contracts are as follows: DAC at 1 January Additions Amortisation Exchange differences Disposals and transfers Change in shadow DAC related to movement in unrealised appreciation of Jackson’s securities classified as available-for-sale DAC at 31 December 2016 £m 2015 £m Insurance contracts Investment management note (i) Insurance contracts Investment management note (i) 6,948 954 (21) 1,408 (251) 76 9,114 74 3 (13) – – – 64 5,840 1,007 (566) 330 – 337 6,948 87 3 (16) – – – 74 Note (i) All of the additions are through internal development. The carrying amount of the balance comprises the following gross and accumulated amortisation amounts: Gross amount Accumulated amortisation Net book amount 2016 £m 2015 £m 145 (81) 64 144 (70) 74 (ii) Present value of acquired in-force (PVIF) and other intangibles attributable to shareholders At 1 January Cost Accumulated amortisation Additions Amortisation charge Disposals and transfers Exchange differences and other movements At 31 December Comprising: Cost Accumulated amortisation 2016 £m Other intangibles PVIF note (i) Distribution rights note (ii) Other intangibles (including software) note (iii) 209 (164) 45 – (8) – 6 43 226 (183) 43 1,387 (129) 1,258 172 (52) (3) 57 1,432 1,628 (196) 1,432 278 (181) 97 50 (35) (14) 4 102 321 (219) 102 Total 1,874 (474) 1,400 222 (95) (17) 67 1,577 2,175 (598) 1,577 2015 £m Other intangibles PVIF note (i) Distribution rights note (ii) Other intangibles (including software) note (iii) 222 (163) 59 – (8) – (6) 45 209 (164) 45 1,269 (82) 1,187 139 (50) (8) (10) 1,258 1,387 (129) 1,258 238 (150) 88 42 (33) – – 97 278 (181) 97 Total 1,729 (395) 1,334 181 (91) (8) (16) 1,400 1,874 (474) 1,400 Notes (i) All of the PVIF balances relate to insurance contracts. The PVIF attaching to investment contracts have been fully amortised. Amortisation is charged over the period of provision of asset management services as those profits emerge. (ii) Distribution rights relate to fees paid in relation to the bancassurance partnership arrangements 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. (iii) 254 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC6 Borrowings C6.1 Core structural borrowings of shareholder-financed operations Holding company operations: note (i) US$1,000m 6.5% Notes (Tier 2) US$250m 6.75% Notes (Tier 1) note (vi) US$300m 6.5% Notes (Tier 1) note (vi) US$700m 5.25% Notes (Tier 2) note (vi) US$550m 7.75% Notes (Tier 1) note (vi) US$1,000m 5.25% Notes (Tier 2) note (iv) US$725m 4.375% Notes (Tier 2) note (v) Perpetual Subordinated Capital Securities ¤20m Medium Term Notes 2023 (Tier 2) note (vii) £435m 6.125% Notes 2031 (Tier 2) £400m 11.375% Notes 2039 (Tier 2) £600m 5% Notes 2055 (Tier 2) £700m 5.7% Notes 2063 (Tier 2) Subordinated Notes Subordinated debt total Senior debt: note (ii) £300m 6.875% Bonds 2023 £250m 5.875% Bonds 2029 Holding company total Prudential Capital bank loan note (iii) Jackson US$250m 8.15% Surplus Notes 2027 note (viii) Total (per consolidated statement of financial position) 2016 £m 2015 £m 809 202 243 565 445 800 580 678 170 203 472 372 – – 3,644 1,895 17 430 395 590 696 2,128 5,772 300 249 6,321 275 202 6,798 15 430 393 590 695 2,123 4,018 300 249 4,567 275 169 5,011 Notes (i) These debt tier classifications (including those noted for the comparative balances) are consistent with the treatment of capital for regulatory purposes under the Solvency II regime. The Group has designated all US$4.5 billion (2015: US$2.8 billion) of its US dollar denominated subordinated debt as a net investment hedge under IAS 39 to hedge the (ii) (iii) (iv) (v) (vi) currency risks related to the net investment in Jackson. The senior debt ranks above subordinated debt in the event of liquidation. The Prudential Capital bank loan of £275 million is drawn at a cost of 12 month GBP LIBOR plus 0.4 per cent and matures on 20 December 2017. In June 2016, the Company issued core structural borrowings of US$1,000 million 5.25 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were £681 million. In September 2016, the Company issued core structural borrowings of US$725 million 4.38 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were £546 million. These 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. (vii) 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 £14 million with interest payable at three-month £LIBOR plus 1.2 per cent. Jackson’s borrowings are unsecured and subordinated to all present and future indebtedness, policy claims and other creditor claims of Jackson. (viii) Prudential plc has debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential plc’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. The financial strength of The Prudential Assurance Company Limited is rated AA by Standard & Poor’s, Aa3 by Moody’s and AA by Fitch. Jackson National Life Insurance Company’s financial strength is rated AA by Standard & Poor’s, A1 by Moody’s, AA by Fitch and A+ by AM Best. Prudential Assurance Co. Singapore (Pte) Ltd.’s (Prudential Singapore) financial strength is rated AA by Standard & Poor’s. All ratings on Prudential and its subsidiaries have been reaffirmed on stable outlook except for PAC, which was placed on negative outlook by Moody’s in June 2016 following the UK referendum on EU membership. 255 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C6 Borrowings continued C6.2 Other borrowings (a) Operational borrowings attributable to shareholder-financed operations Commercial Paper Medium Term Notes 2018 note (i) Borrowings in respect of short-term fixed income securities programmes note (i) Bank loans and overdrafts Obligations under finance leases Other borrowings note (ii) Other borrowings Total note (iii) 2016 £m 2015 £m 1,052 599 1,651 19 5 642 666 1,107 598 1,705 10 4 241 255 2,317 1,960 Notes (i) In January and November 2015, the Company issued £300 million Medium Term Notes that will mature in January 2018 and November 2018 respectively. The proceeds, net of costs, were £299 million for the January 2015 issue and £299 million for the November 2015 issue. (ii) Other borrowings mainly include senior debt issued through the Federal Home Loan Bank of Indianapolis (FHLB), secured by collateral posted with the FHLB by Jackson. In addition, other borrowings include amounts whose repayment to the lender is contingent upon future surplus 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. 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. (iii) (b) Borrowings attributable to with-profits operations Non-recourse borrowings of consolidated investment funds* £100m 8.5% undated subordinated guaranteed bonds of Scottish Amicable Finance plc† Other borrowings (predominantly obligations under finance leases) Total 2016 £m 2015 £m 1,189 100 60 1,349 1,158 100 74 1,332 * In all instances the holders of the debt instruments issued by these subsidiaries and funds do not have recourse beyond the assets of these subsidiaries and funds. † The interests of the holders of the bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund, are subordinated to the entitlements of the policyholders of that fund. C6.3 Maturity analysis The following table sets out the remaining contractual maturity analysis of the Group’s borrowings as recognised in the statement of financial position: Shareholder-financed operations With-profits operations Core structural borrowings Operational borrowings Borrowings 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m 275 – – – – 6,523 6,798 – 275 – – – 4,736 5,011 1,636 599 – 1 1 80 2,317 1,293 – 598 – – 69 1,960 118 48 108 8 146 921 137 226 168 36 32 733 1,349 1,332 Less than 1 year 1 to 2 years 2 to 3 years 3 to 4 years 4 to 5 years Over 5 years Total 256 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC7 Risk and sensitivity analysis C7.1 Group overview The Group’s risk framework and the management of the risk, including those attached to the Group’s financial statements including financial assets, financial liabilities and insurance liabilities, together with the inter-relationship with the management of capital, have been included in the audited sections of the Group Chief Risk Officer’s report on the risks facing our business and how these are managed. The financial and insurance assets and liabilities on the Group’s balance sheet 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. The market and insurance risks, including how they affect Group’s operations and how these are managed are discussed in the Group Chief Risk Officer’s report. The most significant items that the IFRS shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business is sensitive to are shown in the following tables. The distinction between direct and indirect exposure is not intended to indicate the relative size of the sensitivity. Type of business Market and credit risk Insurance and lapse risk Investments/derivatives Liabilities/unallocated surplus Other exposure Asia insurance operations (see also section C7.2) All business Currency risk With-profits business Net neutral direct exposure (indirect exposure only) Unit-linked business Net neutral direct exposure (indirect exposure only) Non-participating business Credit risk Asset/liability mismatch risk Interest rates for those operations where the basis of insurance liabilities is sensitive to current market movements Interest rate and price risk US insurance operations (see also section C7.3) Mortality and morbidity risk Persistency risk Investment performance subject to smoothing through declared bonuses Investment performance through asset management fees All business Variable annuity business Currency risk Persistency risk Net effect of market risk arising from incidence of guarantee features and variability of asset management fees offset by derivative hedging programme Fixed index annuity business Derivative hedge programme to the extent not fully hedged against liability Incidence of equity participation features Fixed index annuities, fixed annuities and GIC business Credit risk Interest rate risk 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 Spread difference between earned rate and rate credited to policyholders Lapse risk, but the effects of extreme events are mitigated by the application of market value adjustments 257 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC7 Risk and sensitivity analysis continued C7.1 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 C7.4) With-profits business Net neutral direct exposure (indirect exposure only) SAIF sub-fund Net neutral direct exposure (indirect exposure only) Unit-linked business Net neutral direct exposure (indirect exposure only) Shareholder-backed annuity business Asset/liability mismatch risk Credit risk for assets covering liabilities and shareholder capital Interest rate risk for assets in excess of liabilities ie assets representing shareholder capital Investment performance subject to smoothing through declared bonuses Asset management fees earned by M&G Investment performance through asset management fees Persistency risk to future shareholder transfers Persistency risk Mortality experience and assumptions for longevity Detailed analyses of sensitivity of IFRS basis profit or loss and shareholders’ equity to key market and other risks by business unit are provided in notes C7.2, C7.3, C7.4 and C7.5. 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. In the equity risk sensitivity analysis shown below, 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 would be expected to occur over a period of time, during which the Group would be able to put mitigating management actions in place. In addition, the equity risk sensitivity analysis provided assumed that all equity indices fall by the same percentage. Impact of diversification on risk exposure The Group benefits from significant diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types. This arises because not all risk scenarios are likely to happen at the same time and across all geographic regions. Relevant correlation factors include: Correlation across geographic regions: — Financial risk factors; and — Non-financial risk factors. Correlation across risk factors: — Longevity risk; — Expenses; — Persistency; and — Other risks. The effect of Group diversification across the Group’s life businesses is to significantly reduce the aggregate stand-alone 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 mortality and longevity risk. 258 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued C7.2 Asia insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The Asia operations sell with-profits and unit-linked policies, and the investment portfolio of the with-profits funds contains a proportion of equities. Non-participating business is largely backed by debt securities or deposits. The Group’s exposure to market risk arising from its Asia operations is therefore at modest levels. This reflects 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 types of 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, or through the availability of premium holiday or partial withdrawal policy features. In summary, for Asia operations, the operating profit based on longer-term investment returns is mainly affected by the impact of market levels on unit-linked 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. i Sensitivity to risks other than foreign exchange risk Interest rate risk Excluding its with-profits and unit-linked businesses, 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 2016, 10-year government bond rates vary from territory to territory and range from 1.2 per cent to 8.1 per cent (2015: 1.0 per cent to 8.9 per cent). For the sensitivity analysis as shown in the table below, the reasonably possible interest rate movement used is 1 per cent for all territories. The estimated sensitivity to the decrease and increase in interest rates at 31 December 2016 and 2015 is as follows: Profit before tax attributable to shareholders Related deferred tax (where applicable) Net effect on profit and shareholders’ equity 2016 £m 2015 £m Decrease of 1% Increase of 1% Decrease of 1% Increase of 1% 213 (41) 172 (509) 62 (447) 185 (34) 151 (339) 59 (280) The pre-tax impacts, if they arose, would mostly be recorded within the category short-term fluctuations in investments returns in the Group’s segmental analysis of profit 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 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. In addition, the degree of sensitivity of the results shown in the table above is dependent on the interest rate level at that point of time. The low interest rates in certain countries have had an adverse impact on the degree of sensitivity to a decrease in interest rates. An additional factor to the direction of the sensitivity of the Asia operations as a whole is movement in the country mix. Equity price risk The non-linked shareholder-backed business has limited exposure to equity and property investment (31 December 2016: £1,410 million). Generally changes in equity and property investment values are not directly offset by movements in non-linked 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 (including those held by the Group’s joint venture and associate businesses), which would be reflected in the short-term fluctuation component of the Group’s segmental analysis of profit before tax, at 31 December 2016 and 2015 would be as follows: Profit before tax attributable to shareholders Related deferred tax (where applicable) Net effect on profit and shareholders’ equity 2016 £m Decrease 2015 £m Decrease of 20% of 10% of 20% of 10% (386) 4 (382) (192) 2 (190) (225) 21 (204) (112) 10 (102) A 10 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. 259 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC7 Risk and sensitivity analysis continued C7.2 Asia insurance operations continued 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 and shareholders’ equity would be decreased by approximately £61 million (2015: £43 million). Mortality and morbidity have a symmetrical effect on the portfolio and any weakening of these assumptions would have a similar equal and opposite impact. ii Sensitivity to foreign exchange 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 2016, the rates for the most significant operations are given in note A1. A 10 per cent increase (strengthening of the pound sterling) or decrease (weakening of the pound sterling) 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: Profit before tax attributable to shareholders Profit for the year Shareholders’ equity, excluding goodwill, attributable to Asia operations A 10% increase in local currency to £ exchange rates A 10% decrease in local currency to £ exchange rates 2016 £m 2015 £m 2016 £m 2015 £m (97) (77) (442) (94) (79) (367) 118 94 540 115 97 449 C7.3 US insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks At the level of operating profit based on longer-term investment returns, Jackson’s results are sensitive to market conditions to the extent of income earned on spread-based products and indirectly in respect of variable annuity asset management fees. Jackson’s main exposures are to market risk through its exposure to interest rate risk and equity risk. Approximately 91 per cent (2015: 92 per cent) of its general account investments support fixed interest rate and fixed index annuities, variable annuity fixed account deposits and guarantees, life business and surplus, and 9 per cent (2015: 8 per cent) support institutional businesses. 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: Risks Equity risk Risk of loss — Related to the incidence of benefits related to guarantees issued in connection with its variable annuity contracts; and — Related to meeting contractual accumulation requirements in fixed index annuity contracts. Interest rate risk — Related to meeting guaranteed rates of accumulation on fixed annuity products following a sharp and sustained fall in interest rates; — Related to increases in the present value of projected benefits related to guarantees issued in connection with its variable annuity contracts following a sharp and sustained fall in interest rates in conjunction with a fall in equity markets; — Related to the surrender value guarantee features attached to the company’s fixed annuity products and 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’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 that are used to manage the liabilities to policyholders and backing investment assets. 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 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 in unrealised appreciation on these securities are included as movement in shareholders’ equity (ie outside the income statement). 260 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedJackson 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 index annuities, certain variable annuity features and reinsured Guaranteed Minimum Income Benefit 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. The principal types of derivatives used by Jackson and their purpose are as follows: Derivative Purpose Interest rate swaps Swaption contracts These 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. These 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 both purchases and writes swaptions in order to hedge against significant movements in interest rates. Treasury futures contracts These derivatives are used to hedge Jackson’s exposure to movements in interest rates. Equity index futures contracts and equity index options Cross-currency swaps Credit default swaps These derivatives (including various call and put options and interest rate contingent options) are used to hedge Jackson’s obligations associated with its issuance of certain VA guarantees. Some of these annuities and guarantees contain embedded options that are fair valued for financial reporting 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. These 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. 261 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C7 Risk and sensitivity analysis continued C7.3 US insurance operations continued i Sensitivity to equity risk At 31 December 2016 and 2015, Jackson had variable annuity contracts with guarantees, for which the net amount at risk (‘NAR’) is defined as the amount of guaranteed benefit in excess of current account value, as follows: 31 December 2016 Return of net deposits plus a minimum return GMDB GMWB – premium only GMWB* GMAB – premium only Highest specified anniversary account value minus withdrawals post-anniversary GMDB GMWB – highest anniversary only GMWB* Combination net deposits plus minimum return, highest specified anniversary account value minus withdrawals post-anniversary GMDB GMIB‡ GMWB* 31 December 2015 Return of net deposits plus a minimum return GMDB GMWB – premium only GMWB* GMAB – premium only Highest specified anniversary account value minus withdrawals post-anniversary GMDB GMWB – highest anniversary only GMWB* Combination net deposits plus minimum return, highest specified anniversary account value minus withdrawals post-anniversary GMDB GMIB‡ GMWB* Minimum return 0-6% 0% 0-5%† 0% Account value £m 93,512 2,217 256 44 8,798 2,479 747 0-6% 0-6% 0-8%† 5,309 1,595 85,402 Minimum return 0-6% 0% 0-5%† 0% Account value £m 70,732 1,916 229 45 7,008 2,025 698 0-6% 0-6% 0-8%† 4,069 1,422 63,924 Weighted average attained age Period until expected annuitisation 65.6 years 66.0 years 68.7 years 0.5 years Weighted average attained age Period until expected annuitisation 65.3 years 65.4 years 68.3 years 0.5 years Net amount at risk £m 2,483 39 22 – 346 125 83 699 595 9,293 Net amount at risk £m 2,614 56 23 – 587 202 101 640 518 7,758 * 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 10-year bonus period. For example 1 + 10 x 0.05 is similar to 1.04 growing at a compound rate of 4 per cent for a further nine years. ‡ The GMIB reinsurance guarantees are essentially fully reinsured. 262 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued Account balances of contracts with guarantees were invested in variable separate accounts as follows: Mutual fund type: Equity Bond Balanced Money market Total 2016 £m 2015 £m 73,430 15,044 17,441 994 106,909 55,488 11,535 13,546 832 81,401 As noted above, Jackson is exposed to equity risk through the options embedded in the fixed index annuity liabilities and guarantees included in certain variable annuity benefits as illustrated above. 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 guaranteed benefit fees. As a result of this hedging programme, if the equity markets were to increase further in the future, the net effect of 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. 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. At 31 December 2016, the estimated sensitivity of Jackson’s profit 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. Pre-tax profit, net of related changes in amortisation of DAC Related deferred tax effects Net sensitivity of profit after tax and shareholders’ equity 2016 £m 2015 £m Decrease Increase Decrease Increase of 20% of 10% of 20% of 10% of 20% of 10% of 20% of 10% 1,061 (371) 488 (171) 370 (129) 59 (21) 738 (258) 259 (91) (86) 30 (128) 45 690 317 241 38 480 168 (56) (83) Note The table above has been prepared to exclude the impact of the instantaneous equity movements on the separate account fees. In addition, the sensitivity movements shown include those relating to the fixed index annuity and the reinsurance of GMIB guarantees. The above table provides sensitivity movements, 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. The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2016 and 2015. 263 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC7 Risk and sensitivity analysis continued C7.3 US insurance operations continued ii Sensitivity to interest rate risk 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’s 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 attached to variable annuity business (other than ‘for life’ components) are accounted for as embedded derivatives which are fair valued and, therefore, 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 the income statement. Fair value movements on debt securities, net of related changes to amortisation of DAC and deferred tax, are recorded within other comprehensive income. The estimated sensitivity of these items and policyholder liabilities to a 1 per cent and 2 per cent decrease and increase in interest rates at 31 December 2016 and 2015 is as follows: Profit and loss: Pre-tax profit effect (net of related changes in amortisation of DAC) Related effect on charge for deferred tax Net profit effect Other comprehensive income: Direct effect on carrying value of debt securities (net of related changes in amortisation of DAC) Related effect on movement in deferred tax 2016 £m 2015 £m Decrease Increase Decrease Increase of 2% of 1% of 1% of 2% of 2% of 1% of 1% of 2% (2,899) 1,015 (1,394) 488 1,065 (373) 2,004 (701) (1,776) 621 (1,884) (906) 692 1,303 (1,155) (847) 296 (551) 628 (220) 408 1,120 (392) 728 3,364 (1,177) 1,883 (659) (1,883) 659 (3,364) 1,177 3,167 (1,108) 1,782 (624) (1,782) 624 (3,167) 1,108 Net effect 2,187 1,224 (1,224) (2,187) 2,059 1,158 (1,158) (2,059) Total net effect on shareholders’ equity 303 318 (532) (884) 904 607 (750) (1,331) 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. Similar to sensitivity to equity risk, the sensitivity movements provided in the table above are at a point in time and reflect the hedging programme in place on the balance sheet date, while the actual impact on financial results would vary contingent upon a number of factors. iii Sensitivity to foreign exchange risk Consistent with the Group’s accounting policies, the profits of the Group’s US operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2016, the average and closing rates were US$1.35 (2015: $1.53) and US$1.24 (2015: US$1.47) to £1.00 sterling, respectively. A 10 per cent increase (weakening of the dollar) or decrease (strengthening of the dollar) in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively, as follows: Profit before tax attributable to shareholders Profit for the year Shareholders’ equity attributable to US insurance operations A 10% increase in US$:£ exchange rates A 10% decrease in US$:£ exchange rates 2016 £m 2015 £m 2016 £m 2015 £m (48) (54) (473) (109) (87) (378) 59 66 578 133 107 462 264 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuediv Other sensitivities The total profit of Jackson is sensitive to market risk on the assets covering liabilities other than variable annuity business segregated in the separate accounts. For 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 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 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. 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 and other types of policyholder behaviour, such as the take-up of its GMWB product features. Jackson’s persistency assumptions reflect a combination of recent past experience for each relevant line of business and expert judgement, especially where a lack of relevant and credible experience data exists. In the absence of hedging, equity and interest rate movements can both cause a loss directly and cause an increased future sensitivity to policyholder behaviour. Jackson has an extensive derivative programme that seeks to manage the exposure to such altered equity markets and interest rates. For variable annuity business, the key assumption is the expected long-term level of separate account returns, which, for 2016, was 7.4 per cent (2015: 7.4 per cent). The impact of using this return is reflected in two principal ways, namely: — Through the projected expected gross profits that 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 A3.1 above; and — The required level of provision for claims for guaranteed minimum death, ‘for life’ withdrawal, and income benefits. C7.4 UK insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The IFRS basis results of the UK insurance operations are most sensitive to asset/liability matching, mortality and default rate experience and longevity assumptions and the difference between the return on corporate bond and risk-free rate for shareholder-backed annuity business of the PAC non-profit sub-fund. Further details are described below. The IFRS operating profit based on longer-term investment returns for UK insurance operations is sensitive to changes in 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 the capital of the shareholder-backed annuity business. With-profits business With-profits sub-fund business The shareholder results of the UK with-profits business (including non-participating annuity business of the with-profits sub-fund) 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-profits contracts, affect the level of unallocated surplus of the fund. Therefore, the level of unallocated surplus is particularly sensitive to the level of investment returns on the portion of the assets that represents surplus. However, as unallocated surplus is accounted for as a liability under IFRS, movements in its value do not affect shareholders’ profit and equity. The shareholder results of the UK with-profits fund correspond to the shareholders’ share of the cost of bonuses declared on the with-profits 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 as it may affect future expected shareholder transfers. Altered persistency trends may affect future expected shareholder transfers. 265 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC7 Risk and sensitivity analysis continued C7.4 UK insurance operations continued Shareholder-backed annuity business 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. In addition, the level of profit is affected by change in the level of reinsurance cover. A decrease in assumed mortality rates of 1 per cent would decrease pre-tax profit by approximately £67 million (2015: £67 million). A decrease in credit default assumptions of five basis points would increase pre-tax profit by £200 million (2015: £176 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase pre-tax profit by £41 million (2015: £35 million). The effect on profit would be approximately symmetrical for changes in assumptions that are directionally opposite to those explained above. The net effect on profit after tax and shareholders’ equity from all the changes in assumptions as described above would be an increase of approximately £144 million (2015: £115 million). 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. The liabilities of the other business 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, 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. Sensitivity 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 annuity business, not generally exposed to interest rate risk. At 31 December 2016, annuity liabilities accounted for 98 per cent (2015: 98 per cent) of UK shareholder-backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure 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 Solvency II reporting requirements and IFRS are not the same with additional assets used for the IFRS annuity liabilities. As a result, IFRS has a different sensitivity to interest rate and credit risk than under Solvency II. 266 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedThe estimated sensitivity of the UK non-linked shareholder-backed business (principally annuities business) to a movement in interest rates is as follows: 2016 £m 2015 £m A decrease of 2% A decrease of 1% An increase of 1% An increase of 2% A decrease of 2% A decrease of 1% An increase of 1% An increase of 2% Carrying value of debt securities and derivatives Policyholder liabilities Related deferred tax effects 12,353 (10,023) (396) 5,508 (4,466) (177) (4,527) 3,636 151 (8,313) 6,635 285 10,862 (8,738) (402) 4,812 (3,909) (172) (3,935) 3,208 138 (7,219) 5,872 257 Net sensitivity of profit after tax and shareholders’ equity 1,934 865 (740) (1,393) 1,722 731 (589) (1,090) In addition, the shareholder-backed portfolio of UK non-linked insurance operations covering liabilities and shareholders’ equity includes equity securities and investment properties. Excluding any second order effects on the measurement of the liabilities for future cash flows to the policyholder, a fall in their value would have given rise to the following effects on pre-tax profit, profit after tax and shareholders’ equity. Pre-tax profit Related deferred tax effects Net sensitivity of profit after tax and shareholders’ equity 2016 £m 2015 £m A decrease of 20% A decrease of 10% A decrease of 20% A decrease of 10% (326) 66 (260) (163) 33 (130) (327) 66 (261) (163) 33 (130) A 10 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 fluctuations in investment returns. C7.5 Asset management and other operations a Asset management i Sensitivities to foreign exchange risk Consistent with the Group’s accounting policies, the profits of Eastspring Investments and US asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. The rates for the functional currencies of most significant operations are shown in note A1. A 10 per cent increase in the relevant exchange rates (strengthening of the pound sterling) would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Eastspring Investments and US asset management operations, by £12 million and £47 million respectively (2015: £11 million and £38 million, respectively). ii Sensitivities to other financial risks for asset management operations The principal sensitivities to other financial risk of asset management operations are credit risk on the bridging loan portfolio of the Prudential Capital operation and the indirect effect of changes to market values of funds under management. Due to the nature of the asset management operations there is limited direct sensitivity to movements in interest rates. Total debt securities held at 31 December 2016 by asset management operations were £2,359 million (2015: £2,204 million), the majority of which are held by the Prudential Capital operation. Debt securities held by Prudential Capital are in general variable rate bonds and so market value is limited in sensitivity to interest rate movements and consequently, any change in interest rates would not have a material impact on profit or shareholders’ equity. The Group’s asset management operations do not hold significant investments in property or equities. b Other operations 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 £150 million. 267 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC8 Tax assets and liabilities C8.1 Deferred tax The statement of financial position contains the following deferred tax assets and liabilities in relation to: Unrealised losses or gains on investments Balances relating to investment and insurance contracts Short-term temporary differences Capital allowances Unused tax losses Total Deferred tax assets Deferred tax liabilities 2016 £m 2015 £m 2016 £m 2015 £m 23 1 4,196 16 79 4,315 21 1 2,752 10 35 2,819 (1,534) (730) (3,071) (35) – (5,370) (1,036) (543) (2,400) (31) – (4,010) Of the short-term temporary differences of £4,196 million, £3,843 million relating to the US insurance operations is expected to be recovered in line with the run-off of the in-force book, and the remaining balances of the £353 million are expected to be recovered within 10 years. The deferred tax asset at 31 December 2016 and 2015 arises in the following parts of the Group: Asia insurance operations US insurance operations UK insurance operations Other operations Total 2016 £m 2015 £m 98 3,861 146 210 4,315 66 2,448 132 173 2,819 Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is 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. 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 deferred tax assets. For the 2016 full year results and financial position at 31 December 2016, the following tax benefits have not been recognised: Capital losses Trading losses 2016 2015 Tax benefit £m Losses £bn Tax benefit £m Losses £bn 89 41 0.4 0.2 98 52 0.5 0.3 Of the unrecognised trading losses, losses of £31 million will expire within the next seven years, £1 million will expire within 20 years and the rest have no expiry date. 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 period. The reduction in the UK corporation tax rate to 17 per cent from 1 April 2020 was substantively enacted on 6 September 2016, and has had the effect of reducing the UK with-profits and shareholder-backed business element of the overall net deferred tax liabilities by £5 million as at 31 December 2016. The effects of these changes are reflected in the financial statements for the year ended 31 December 2016. C8.2 Current tax Of the £440 million (2015: £477 million) current tax recoverable, the majority is expected to be recovered in one year or less. The current tax recoverable includes £112 million in relation to the ongoing litigation relating to the historic tax treatment of dividends received from overseas portfolio investments of life insurance companies. PAC is the test case for this litigation. In April 2016, the UK Court of Appeal found in PAC’s favour on all substantive points in the litigation. HM Revenue & Customs have been granted permission to appeal the Court of Appeal’s judgment to the Supreme Court. The Supreme Court hearing has not yet been scheduled. However, it is expected to be at some time in 2018. The current tax liability increased to £649 million (2015: £325 million) due to positive market movements in the UK insurance operations. 268 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedC9 Defined benefit pension schemes (a) Background and summary economic and IAS 19 financial positions The Group’s businesses operate a number of pension schemes. The specific features of these schemes vary in accordance with the regulations of the country in which the employees are located, although they are, in general, funded by the Group and based either on a cash balance formula or on years of service and salary earned in the last year or years of employment. The largest defined benefit scheme is the principal UK scheme, namely the Prudential Staff Pension Scheme (PSPS). PSPS accounts for 82 per cent (2015: 84 per cent) of the underlying scheme liabilities of the Group’s defined benefit schemes. The Group also operates two smaller UK defined benefit schemes in respect of Scottish Amicable (SASPS) and M&G (M&GGPS). In addition, there are two small defined benefit schemes in Taiwan which have negligible deficits. Under the IAS 19, ‘Employee Benefits’ valuation basis, the Group applies the principles of IFRIC 14, ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’, whereby 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 IFRS financial position recorded, reflects the higher of any underlying IAS 19 deficit and any obligation for committed deficit funding where applicable. The Group asset/liability in respect of defined benefit pension schemes is as follows: Underlying economic surplus (deficit) Less: unrecognised surplus note (i) Economic surplus (deficit) (including investment in Prudential insurance policies) Attributable to: PAC with-profits fund Shareholder-backed operations Consolidation adjustment against policyholder liabilities for investment in Prudential insurance policies note (iii) IAS 19 pension asset (liability) on the Group statement of financial position note (iv) 2016 £m 2015 £m PSPS note (i) SASPS note (ii) M&GGPS Other schemes Total PSPS note (i) SASPS note (ii) M&GGPS Other schemes Total 717 (237) (558) – 159 (237) 111 (95) 48 (142) 84 – 84 – 84 (1) 563 969 (82) – (558) (800) – (1) – (1) 5 16 (11) 169 118 51 (82) (33) (49) 75 – 75 – 75 (1) – (1) – (1) 961 (800) 161 85 76 – – (134) – (134) – – (77) – (77) 159 (237) (50) (1) (129) 169 (82) (2) (1) 84 Notes (i) (ii) (iii) For PSPS, the Group does not have an unconditional right of refund to any surplus of the scheme. The PSPS pension asset represents the present value of the economic benefit (impact) of the Company from the difference between future ongoing contributions to the scheme and estimated accrued cost of service. No deficit or other funding is required for PSPS. Deficit funding, where applicable, is apportioned in the ratio of 70/30 between the PAC with-profits fund and shareholder-backed operations following detailed considerations 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. The deficit of SASPS has been allocated 40 per cent to the PAC with-profits fund and 60 per cent to the shareholders’ fund as at 31 December 2016 and 2015. 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. (iv) At 31 December 2016, the PSPS pension asset of £159 million (2015: £169 million) and the other schemes’ pension liabilities of £288 million (2015: £85 million) are included within ‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position. 269 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC9 Defined benefit pension schemes continued (a) Background and summary economic and IAS 19 financial positions continued Triennial actuarial valuations Defined benefit pension schemes in the UK are generally required to be subject to full actuarial valuations 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 information on the latest completed actuarial valuation for the UK schemes is shown in the table below: Last completed actuarial 5 April 2014 PSPS SASPS 31 March 2014 M&GGPS 31 December 2014 valuation date Valuation actuary, all Fellows of the Institute and Faculty of Actuaries C G Singer Towers Watson Limited Jonathan Seed Xafinity Consulting Paul Belok AON Hewitt Limited Funding level at the last 107 per cent 78 per cent 99 per cent valuation Deficit funding arrangement agreed with the Trustees based on the last valuation No deficit or other funding required. Ongoing contributions for active members are at the minimum level required under the scheme rules (approximately £6 million per annum excluding expenses) Deficit funding of £21 million per annum from 1 January 2015 until 31 March 2024, or earlier if the scheme’s funding level reaches 100 per cent before this date. The deficit funding will be reviewed every three years at subsequent valuations No deficit funding required from 1 January 2016 For PSPS, the market value of the scheme assets as at the 5 April 2014 valuation was £6,165 million. The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the purposes of the 2014 valuation were as follows: Rate of increase in salaries Rate of inflation: Retail Prices Index (RPI) Consumer Prices Index (CPI) Rate of increase of pensions in payment for inflation: Guaranteed (maximum 5%) Guaranteed (maximum 2.5%) Discretionary Expected returns on plan assets Mortality assumptions: The tables used for PSPS pensions in payment at 5 April 2014 were: % Nil 3.5 2.8 2.8 2.5 Nil 3.3 Base post-retirement mortality For current male (female) pensioners 113 per cent (108 per cent) of the mortality rates of the 2000 series mortality tables (PNMA00/ PNFA00), published by the Continuous Mortality Investigation Bureau (CMI). For male (female) non-pensioners 107 per cent (92 per cent) of the 2000 series rates (PNMA00/PNFA00). Allowance for future improvements to post-retirement mortality For males (females) up to 2009 100 per cent (75 per cent) of Medium Cohort subject to a minimum rate of improvement of 2.00 per cent per annum (1.25 per cent per annum) up to age 90, decreasing linearly to zero by age 120. From 2010 onwards, in line with the CMI’s 2009 projection model with a long-term rate of 1.75 per cent per annum (1.50 per cent per annum), and minor scheme-specific calibrations. Risks to which the defined benefit schemes expose the Group Responsibility of making good of any deficit that may arise in the schemes lies with the employers of the schemes, which are subsidiaries of the Group. Accordingly, the pension schemes expose the Group to a number of risks, the most significant of which are interest rate and investment risk, inflation risk and mortality risk. 270 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinuedCorporate governance The Group’s UK pension schemes are regulated by ‘The Pension Regulator’ in accordance with the Pension Act 1995. Trustees have been appointed for each pension scheme and they have the ultimate responsibility to ensure that the scheme is managed in accordance with the Trust Deed & Rules. All of the three Group’s UK defined benefit pension schemes (the PSPS, SASPS and M&GGPS) are final salary schemes, which are closed to new entrants. The Trustee of each scheme 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. The Trustee consults the Principal Employer (eg The Prudential Assurance Company for PSPS), on the investment principles, but the ultimate responsibility for the investment of the assets of the scheme lies with the Trustee. The Trustee of each of the schemes manages the investment strategy of the scheme to achieve an acceptable balance between investing in the assets that most closely match the expected benefit payments and assets that are expected to achieve a greater return, in the hope of reducing the contributions required or providing additional benefits to members. 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. As at 31 December 2016, the nominal value of the interest and inflation-linked swaps amounted to £0.8 billion (2015: £0.7 billion) and £5.0 billion (2015: £3.4 billion) respectively. The SASPS and M&GGPS use very limited or no derivatives to manage their risks. (b) Assumptions The actuarial assumptions used in determining benefit obligations and the net periodic benefit costs for the years ended 31 December were as follows: Discount rate* Rate of increase in salaries Rate of inflation† Retail Prices Index (RPI) Consumer Prices Index (CPI) Rate of increase of pensions in payment for inflation: PSPS: Guaranteed (maximum 5%) Guaranteed (maximum 2.5%) Discretionary Other schemes 2016 % 2015 % 2.6 3.2 3.2 2.2 2.5 2.5 2.5 3.2 3.8 3.0 3.0 2.0 2.5 2.5 2.5 3.0 * 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 inflation reflects the long-term assumption for the UK RPI or CPI depending on the tranche of the schemes. The calculations are based on current mortality estimates with an allowance made for future improvements in mortality. This allowance was updated in 2016 to reflect the CMI’s 2014 mortality improvements model, with scheme-specific calibrations. For immediate annuities in payment, in 2016 and 2015, a long-term mortality improvement rate of 1.75 per cent per annum and 1.25 per cent per annum was applied for males and females, respectively. (c) Estimated pension scheme surpluses and deficits 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 pension 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. The IAS 19 basis excludes the investments in Prudential policies. At 31 December 2016, the investments in Prudential insurance policies comprise £134 million (2015: £77 million) for the M&GGPS and there were no investments in Prudential insurance policies for PSPS and SASPS (2015: £125 million for PSPS). In principle, on consolidation, the investments are eliminated against policyholder liabilities of UK insurance operations, so that the formal IAS 19 position for the scheme in isolation excludes these items. This treatment applies to the M&GGPS investments. However, in 2015, as a substantial portion of the Company’s interest in the underlying surplus of PSPS was not recognised, the adjustment was not necessary for the PSPS investments. 271 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC9 Defined benefit pension schemes continued (c) Estimated pension scheme surpluses and deficits continued 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: All schemes Underlying position (without the effect of IFRIC 14) Surplus Less: amount attributable to PAC with-profits fund Shareholders’ share: Gross of tax surplus (deficit) Related tax Net of shareholders’ tax Application of IFRIC 14 for the derecognition of PSPS surplus Derecognition of surplus Less: amount attributable to PAC with-profits fund Shareholders’ share: Gross of tax Related tax Net of shareholders’ tax With the effect of IFRIC 14 Surplus (deficit) Less: amount attributable to PAC with-profits fund Shareholders’ share: Gross of tax surplus (deficit) Related tax Net of shareholders’ tax 2016 £m Surplus (deficit) in schemes at 1 Jan 2016 (Charge) credit to income statement Actuarial gains and losses in other comprehensive income Contributions paid Surplus (deficit) in schemes at 31 Dec 2016 961 (658) 303 (60) 243 (800) 573 (227) 45 (182) 161 (85) 76 (15) 61 (1) (12) (13) 3 (10) (32) 21 (11) 2 (9) (33) 9 (24) 5 (19) (442) 261 (181) 36 (145) 274 (185) 89 (18) 71 (168) 76 (92) 18 (74) 45 (16) 29 (6) 23 – – – – – 45 (16) 29 (6) 23 563 (425) 138 (27) 111 (558) 409 (149) 29 (120) 5 (16) (11) 2 (9) Underlying investments of the schemes On the ‘economic basis’, after including the underlying assets represented by the investments in Prudential insurance policies as scheme assets, the plans’ assets at 31 December comprise the following investments: Equities UK Overseas Bonds* Government Corporate Asset-backed securities Derivatives Properties Other assets Total value of assets† 2016 Other schemes £m 85 368 550 196 6 (2) 109 67 1,379 Total £m 103 661 5,961 1,365 150 250 180 336 9,006 PSPS £m 18 293 5,411 1,169 144 252 71 269 7,627 2015 Other schemes £m 70 329 427 145 21 (5) 62 42 1,091 Total £m 196 480 5,222 1,115 156 178 132 340 7,819 PSPS £m 126 151 4,795 970 135 183 70 298 6,728 % 1 7 66 15 2 3 2 4 100 % 3 6 67 14 2 2 2 4 100 * 93 per cent of the bonds are investment graded (2015: 93 per cent). † 98 per cent of the total value of the scheme assets are derived from quoted prices in an active market (2015: 98 per cent). None of the scheme assets included shares in Prudential plc or property occupied by the Prudential Group. The IAS 19 basis plan assets at 31 December 2016 of £8,872 million (2015: £7,617 million) is different from the economic basis plan assets of £9,006 million (2015: £7,819 million) as shown above due to the exclusion of investment in Prudential insurance policies, which are eliminated on consolidation of £134 million (2015: £202 million) comprising £134 million for the M&G scheme (2015: £77 million) and nil for PSPS (2015: £125 million). 272 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued The movements in the IAS 19 pension schemes’ surplus and deficit between scheme assets and liabilities as consolidated in the financial statements were: Attributable to policyholders and shareholders Plan assets Present value of benefit obligations note (i) Net surplus (deficit) (without the effect of IFRIC 14) Effect of IFRIC 14 for derecognition of PSPS surplus Economic basis net surplus (deficit) Other adjustments including for investments in Prudential insurance policies note (ii) IAS 19 basis net deficit 2016 £m Net surplus (deficit), beginning of year Current service cost Net interest on net defined benefit liability (asset) Administration expenses Benefit payments Employers’ contributions note (iii) Employees’ contributions Actuarial gains and losses note (iv) Transfer into investment in 7,819 292 (5) (350) 45 2 1,203 (6,858) (34) (254) 350 (2) (1,645) Prudential insurance policies – – Net surplus (deficit), end of year 9,006 (8,443) 2015 £m Net deficit, beginning of year Current service cost Negative past service cost Net interest on net defined benefit liability (asset) Administration expenses Benefit payments Employers’ contributions note (iii) Employees’ contributions Actuarial gains and losses note (iv) Transfer out of investment in Prudential insurance policies 8,067 278 (5) (301) 56 2 (278) – (7,312) (36) 48 (250) 301 (2) 393 – Net surplus (deficit), end of year 7,819 (6,858) 961 (34) 38 (5) – 45 – (442) – 563 755 (36) 48 28 (5) – 56 – 115 – 961 (800) (32) 274 – (558) (710) (26) (64) – (800) 161 (34) 6 (5) – 45 – (168) – 5 45 (36) 48 2 (5) – 56 – 51 – 161 (77) (3) (13) (41) (134) (132) (5) 6 54 (77) 84 (34) 3 (5) – 45 – (181) (41) (129) (87) (36) 48 (3) (5) – 56 – 57 54 84 273 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements C9 Defined benefit pension schemes continued (c) Estimated pension scheme surpluses and deficits continued Notes (i) Maturity profile of the benefit obligations The weighted average duration of the benefit obligations of the schemes is 19.5 years (2015: 18.2 years). The following table provides an expected maturity analysis of the benefit obligations as at 31 December: All schemes £m 1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years 243 240 1,090 1,045 1,585 1,554 1,694 1,688 1,704 1,711 Over 20 years 8,508 8,791 Total 14,824 15,029 2016 2015 (ii) (iii) (iv) The adjustments for investments in Prudential insurance policies are consolidation adjustments for intra-group assets and liabilities with no impact to operating results. Total employer contributions expected to be paid into the Group defined benefit schemes for the year ending 31 December 2017 amount to £45 million (2016: £45 million). The actuarial gains and losses attributable to policyholders and shareholders as shown in the table above are analysed as follows: Actuarial gains and losses Return on the scheme assets less amount included in interest income Losses on changes in demographic assumptions (Losses)/gains on changes in financial assumptions Experience gains on scheme liabilities Effect of derecognition of PSPS surplus Consolidation adjustment for investments in Prudential insurance policies and other adjustments 2016 £m 2015 £m 1,203 (18) (1,733) 106 (442) 274 (13) (181) (278) (3) 371 25 115 (64) 6 57 The losses of £1,733 million in 2016 on change in financial assumptions primarily reflect the effect of the decrease in the discount rate used in determining the scheme liabilities from 3.8 per cent in 2015 to 2.6 per cent in 2016. These losses were partially offset by the increase in the return on the scheme assets, which was greater than the amount included in interest income by £1,203 million. (d) Sensitivity of the pension scheme liabilities to key variables The sensitivity information below is based on the core scheme liabilities and assumptions at the balance sheet date. The sensitivity is calculated based on a change in one assumption with all other assumptions being held constant. As such, interdependencies between the assumptions are excluded. The sensitivity of the underlying pension scheme liabilities as shown above 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 SASPS to the PAC with-profits fund as described above. Assumption applied Impact of sensitivity on scheme liabilities on IAS 19 basis Discount rate 2016 2.6% 2015 Sensitivity change in assumption 2016 2015 3.8% Decrease by 0.2% Increase in scheme liabilities by: Discount rate 2.6% 3.8% Increase by 0.2% Decrease in scheme liabilities by: PSPS Other schemes PSPS Other schemes Decrease in scheme liabilities by: PSPS Other schemes Increase in scheme liabilities by: PSPS Other schemes Rate of inflation 3.2% 2.2% 3.0% RPI: Decrease by 0.2% 2.0% CPI: Decrease by 0.2% with consequent reduction in salary increases Increase life expectancy by 1 year Mortality rate 274 3.5% 5.3% 3.5% 5.0% 0.6% 4.1% 3.5% 3.7% 3.3% 5.0% 3.1% 4.6% 0.5% 4.0% 3.2% 2.8% Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued C10 Share capital, share premium and own shares Number of ordinary shares Issued shares of 5p each fully paid At 1 January Shares issued under share-based schemes 2,572,454,958 8,606,615 At 31 December 2,581,061,573 2016 Share capital £m 128 1 129 Share premium £m Number of ordinary shares 1,915 2,567,779,950 4,675,008 12 1,927 2,572,454,958 2015 Share capital £m 128 – 128 Share premium £m 1,908 7 1,915 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. At 31 December 2016, there were options outstanding under save as you earn schemes to subscribe for shares as follows: 31 December 2016 31 December 2015 Number of shares to subscribe for 7,068,884 8,795,617 Share price range from 466p 288p to Exercisable by year 1,155p 1,155p 2022 2021 Transactions by Prudential plc and its subsidiaries in Prudential plc shares The Group buys and sells Prudential plc shares (‘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. The cost of own shares of £226 million as at 31 December 2016 (2015: £219 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans. At 31 December 2016, 10.7 million (2015: 10.5 million) Prudential plc shares with a market value of £175 million (2015: £161 million) were held in such trusts, all of which are for employee incentive plans. The maximum number of shares held during 2016 was 11.2 million which was in June 2016. The Company purchased the following number of shares in respect of employee incentive plans. The shares purchased each month are as follows: January February March April May June July August September October November December Total Number of shares 67,625 79,077 735,361 84,848 2,272,344 576,386 84,883 73,602 173,166 71,253 69,976 71,626 4,360,147 2016 Share price 2015 Share price Low £ 13.73 11.96 13.09 12.91 13.17 11.28 11.96 14.01 13.69 14.37 13.49 15.76 High £ 14.00 12.01 13.72 13.31 13.31 13.09 12.32 14.25 14.14 14.50 15.40 16.37 Cost £ Number of shares 932,711 947,993 9,686,101 1,115,919 30,238,832 6,604,231 1,040,732 1,040,528 2,372,037 1,026,260 1,044,194 1,134,181 52,474 49,423 4,660,458 52,371 145,542 160,078 55,208 57,653 154,461 58,087 56,948 61,441 57,183,719 5,564,144 Low £ 14.83 16.01 16.44 16.78 16.07 15.65 15.04 15.07 13.57 15.14 15.01 15.00 High £ 15.11 16.14 17.01 17.24 16.61 16.20 15.99 15.17 14.31 15.22 15.61 15.08 Cost £ 786,584 795,683 78,940,633 892,795 2,357,705 2,563,060 868,713 868,091 2,149,244 879,999 866,033 923,600 92,892,140 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 2016 was 6.0 million (2015: 6.1 million) and the cost of acquiring these shares of £61 million (2015: £54 million) is included in the cost of own shares. The market value of these shares as at 31 December 2016 was £97 million (2015: £94 million). During 2016, these funds made net disposals of 77,423 Prudential shares (2015: net disposals of 1,402,697) for a net increase of £7.9 million to book cost (2015: net increase of £13 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 2016 or 2015. 275 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC11 Provisions Provision in respect of defined benefit pension schemes: C9 Other provisions (see below) Total provisions Analysis of other provisions: 2016 £m 2015 £m 288 659 947 85 519 604 Total 507 357 (55) (285) (5) 519 2016 £m 2015 £m Legal provisions Restructuring provisions note (i) Other provisions note (ii) Total Legal provisions Restructuring provisions note (i) Other provisions note (ii) At 1 January Charged to income statement: Additional provisions Unused amounts released Used during the year Exchange differences Total at 31 December 12 5 (4) (7) 1 7 13 494 519 – (5) (1) – 7 376 (44) (214) 33 645 381 (53) (222) 34 659 9 6 (1) (3) 1 12 11 10 (1) (7) – 13 487 341 (53) (275) (6) 494 Notes (i) 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. (ii) Other provisions comprise staff benefits provisions of £415 million (2015: £384 million) that are generally expected to be paid out within the next three years, provisions for onerous contracts of £20 million (2015: £31 million), other provisions of £35 million (2015: £79 million) and a provision for review of past annuity sales of £175 million (2015: £nil). Prudential has agreed with the Financial Conduct Authority (FCA) to review annuities sold without advice after 1 July 2008 to its contract-based defined contribution pension customers. The review will examine whether customers were given sufficient information about their potential eligibility to purchase an enhanced annuity, either from Prudential or another pension provider. The review is expected to commence in 2017 and last a period of three years. A provision of £175 million has been established at 31 December 2016 to cover the costs of undertaking the review and any potential redress. The ultimate amount that will be expended by the Group on the review remains uncertain. Although the Group’s professional indemnity insurance may mitigate the overall financial impact of this review, with potential insurance recoveries of up to £175 million, no such recovery has been factored in the provision, in accordance with the requirements of IAS 37, ‘Provisions, Contingent Liabilities and Contingent Assets’. C12 Capital (a) Group objectives, policies and processes for managing capital (i) Capital measure The Group manages its Group Solvency II own funds as its measure of capital. At 31 December 2016, estimated Group Solvency II Own Funds were £24.8 billion. (ii) External capital requirements From 1 January 2016, Solvency II is the Group’s consolidated capital regime. Solvency II is a risk-based solvency framework required under the European Solvency II Directive as implemented by the Prudential Regulatory Authority in the UK. The Solvency II surplus represents the aggregated capital held by the Group less solvency capital requirements. (iii) Meeting of capital management objectives The Group solvency capital requirement has been met during 2016. As well as holding sufficient capital to meet Solvency II requirements at Group level, the Group also closely manages the cash it holds within its central holding companies so that it can: a) Maintain flexibility, fund new opportunities and absorb shock events b) Fund dividends c) Cover central costs and debt payments More details on holding company cash flows and balances are given in the section II(a) of the additional unaudited financial information. While the Group at a consolidated level is subject to the Solvency II requirements, at a business unit level capital is defined by local capital regulations and local business needs. Each of the Group’s long-term business operations is capitalised to a sufficiently strong level for its individual circumstances. 276 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued The Group manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities in each business. As a result of the diversity of products offered by Prudential and the different regulatory regimes under which it operates, the Group 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, US 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. (b) Local capital regulations The most significant local capital requirements are: (i) Asia insurance operations The estimated capital position for Asia life insurance operations with reconciliation to shareholders equity is shown below: Group IFRS shareholders’ equity Adjustments to regulatory basis Unallocated surplus of with-profits funds Deferred acquisition costs, distribution rights and goodwill of non-participating business not recognised for regulatory reporting Other adjustments Total adjustments Total available capital resources of life assurance businesses on local regulatory bases The capital requirements of material territories are: 2016 £m 2015 £m 4,993 3,956 2,667 2,553 (1,365) 1,627 2,929 7,922 (1,301) (31) 1,221 5,177 Hong Kong The capital requirement varies by underlying risk and duration of liabilities, but is generally determined as 4 per cent of mathematical reserves plus 0.3 per cent of the capital at risk. Mathematical reserves are based on a best estimate basis with prudent margins for adverse deviations, discounted at a valuation interest rate based on a blend between the risk-adjusted portfolio yield and reinvestment rate. Indonesia Solvency capital is determined using a risk-based capital approach. Insurance companies in Indonesia are expected to maintain the level of net assets above 120 per cent of solvency capital. Malaysia A risk-based capital framework applies in Malaysia. 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. Singapore A risk-based capital framework applies in Singapore. A registered insurer incorporated in Singapore is required at all times to maintain a minimum level of paid-up ordinary share capital and to ensure that its financial resources are not less than the greater of (i) the total risk requirement arising from the assets and liabilities of the insurer, calculated in accordance with the Singapore Insurance Act; or (ii) a minimum amount of 5 million Singapore Dollars. The regulator also has the authority to direct that the insurer satisfy additional capital adequacy requirements in addition to those set forth under the Singapore Insurance Act if it considers such additional requirements appropriate. 277 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC12 Capital continued (b) Local capital regulations continued (ii) US insurance operations The estimated capital position for Jackson with reconciliation to shareholders equity is shown below: Group IFRS shareholders’ equity Adjustments to regulatory basis Deferred acquisition costs, distribution rights and goodwill of non-participating business not recognised for regulatory reporting Jackson surplus notes Investment and policyholder liabilities valuation differences between IFRS and regulatory basis for Jackson Other adjustments Total adjustments Total available capital resources of life assurance businesses on local regulatory bases 2016 £m 2015 £m 5,204 4,154 (8,303) 202 6,657 535 (909) 4,295 (6,148) 169 4,927 364 (688) 3,466 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 which includes components calculated by applying factors to various asset, premium and reserve items and a separate model-based component for market risk associated primarily with variable annuity products. At 31 December 2016, 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 is 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 £334 million at 31 December 2016. Under the equivalence provisions of Solvency II, Jackson is incorporated into the Group’s Solvency II position at a level equal to available capital in excess of 250 per cent of the US local risk-based capital requirement. (iii) UK insurance operations From 1 January 2016, UK insurance operations are subject to Solvency II capital requirements on an individual basis. The UK solvency capital requirement has been met during 2016. (iv) Asset management operations – regulatory and other surplus Certain asset management subsidiaries of the Group are subject to regulatory requirements. The movement in the year of the surplus regulatory capital position of those subsidiaries, combined with the movement in the IFRS basis shareholders’ funds for unregulated asset management operations, is as follows: Regulatory and other surplus Beginning of year Gains (losses) during the year Movement in capital requirement Capital injection Distributions made to the parent company Exchange and other movements End of year Asset management operations 2016 £m 2015 £m M&G US Prudential Capital Eastspring Investments Total Total 402 339 (46) – (290) – 405 182 8 – – (18) 33 205 70 (23) – – (45) 20 22 149 122 (8) – (79) 20 204 803 446 (54) – (432) 73 836 534 392 36 4 (262) 99 803 278 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued (c) Transferability of available capital In the UK, the Solvency II regime became effective on 1 January 2016. PAC is required to meet the Solvency II capital requirements as a company as a whole, ie covering both its ring-fenced with-profits funds and non-profit funds. Further, the surplus of the with-profits funds is ring-fenced from the shareholder balance sheet with restrictions as to its distribution. Distributions from the with-profits funds to shareholders continue to reflect the shareholders’ one-ninth share of the cost of declared policyholders’ bonuses. For Jackson, capital retention is maintained at a level consistent with an appropriate rating by Standard & Poor’s. Currently, Jackson is rated AA. Jackson can pay dividends on its capital stock only out of earned surplus unless prior regulatory approval is obtained. Furthermore, dividends which exceed the greater of statutory net gain from operations less net realised investments losses for the prior year or 10 per cent of Jackson’s prior year end statutory surplus, excluding any increase arising from the application of permitted practices, require prior regulatory approval. For Asia 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 businesses in Asia may, in general, remit dividends to the UK, provided the statutory insurance fund meets the local regulatory solvency targets. Available capital of the non-insurance business units is transferable to the life assurance businesses after taking account of an appropriate level of operating capital, based on local regulatory solvency targets, over and above basis liabilities. C13 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: At 1 January Cost Accumulated depreciation Net book amount Year ended 31 December Opening net book amount Exchange differences Depreciation charge Additions Arising on acquisitions of subsidiaries* Disposals and transfers Closing net book amount At 31 December Cost Accumulated depreciation Net book amount Group occupied property 2016 £m Tangible assets 480 (69) 411 411 50 (15) 15 – (110) 351 439 (88) 351 1,387 (601) 786 786 52 (144) 333 – (635) 392 1,077 (685) 392 Group occupied property 2015 £m Tangible assets 390 (58) 332 332 (2) (11) 40 52 – 411 480 (69) 411 1,165 (519) 646 646 (10) (118) 216 84 (32) 786 1,387 (601) 786 Total 1,867 (670) 1,197 1,197 102 (159) 348 – (745) 743 1,516 (773) 743 Total 1,555 (577) 978 978 (12) (129) 256 136 (32) 1,197 1,867 (670) 1,197 * Arising on an acquisition made for venture fund purposes by the PAC with-profits fund. Tangible assets Of the £392 million of tangible assets, £247 million were held by the Group’s with-profits operations, primarily by the consolidated subsidiaries for venture fund and other investment purposes of the PAC with-profits fund. Capital expenditure: property, plant and equipment by segment The capital expenditure of £333 million (2015: £216 million) arose as follows: £244 million in UK, £17 million in US and £61 million in Asia in insurance operations with the remaining balance of £11 million arising from asset management operations and unallocated corporate expenditure (2015: £143 million in UK, £20 million in US and £35 million in Asia in insurance operations with the remaining balance of £18 million arising from asset management operations and unallocated corporate expenditure). 279 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsC14 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: At 1 January Additions: Resulting from property acquisitions Resulting from expenditure capitalised Disposals Net gain from fair value adjustments Net foreign exchange differences Transfers (to) from held for sale assets At 31 December 2016 £m 2015 £m 13,422 12,764 1,338 189 (632) 273 97 (41) 680 77 (662) 537 21 5 14,646 13,422 The 2016 income statement includes rental income from investment properties of £781 million (2015: £769 million) and direct operating expenses including repairs and maintenance arising from these properties of £67 million (2015: £42 million). Investment properties of £6,020 million (2015: £5,468 million) are held under finance leases. The present value of minimum lease payments under these leases is £49 million (2015: £78 million) and 76 per cent (2015: 77 per cent) of lease payments are due in over five years. The Group’s policy is to let 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: Less than 1 year 1 to 5 years Over 5 years Total 2016 £m 2015 £m 314 1,077 2,634 4,025 309 1,091 2,595 3,995 The total minimum future rentals to be received on non-cancellable sub-leases for the Group’s investment properties held under finance leases at 31 December 2016 are £2,238 million (2015: £2,888 million). 280 Prudential plc Annual Report 2016 www.prudential.co.ukC Balance sheet notesContinued D Other notes D1 Held for sale Korea life business On 10 November 2016, the Group announced that it had reached an agreement to sell 100 per cent of its life insurance subsidiary in Korea, PCA Life Insurance Co., Ltd. (‘PCA Life Korea’), to Mirae Asset Life Insurance Co., Ltd. (‘Mirae’), for KRW170 billion (equivalent to £114 million at 31 December 2016 closing exchange rate). The transaction is subject to regulatory approval. The Korea life business has been classified as held for sale in these consolidated financial statements in accordance with IFRS 5, ‘Non-current assets held for sale and discontinued operations’. Consistent with its classification as held for sale, the IFRS carrying value of the Korea life business and its related goodwill has been set to £105 million at 31 December 2016, representing the proceeds, net of £9 million of related expenses. This has resulted in a charge for ‘Remeasurement of Korea Life business classified as held for sale’ of £(238) million in the income statement. To facilitate comparisons of businesses retained by the Group, the supplementary analysis of profit shown in note B1.1 shows separately the results of the Korea life business for both 2016 and 2015. For 2016 the result for the year, including short-term fluctuations in investment returns, together with the adjustment to the carrying value have given rise to an aggregate loss of £(227) million (2015: £56 million profit). This comprises: Remeasurement of carrying value on classification as held for sale Amounts that would otherwise be classified within: Operating profit based on longer-term investment returns Short-term fluctuations in investment returns (Loss) profit attaching to held for sale Korea life business Related tax charge 2016 £m AER 2015 £m CER 2015 £m (238) 20 (9) (227) (4) – 38 18 56 – 42 20 62 (14) (15) The assets and liabilities of the Korea life business classified as held for sale on the statement of financial position as at 31 December 2016 are as follows: Assets Investments including cash and cash equivalents1 Other assets including goodwill2 Adjustment for remeasurement of the carrying value of the business to fair value less costs to sell2 Assets held for sale Liabilities Policyholder liabilities3 Other liabilities Liabilities held for sale Net assets 2016 £m 3,722 379 4,101 (238) 3,863 3,325 433 3,758 105 1 2 3 The investments of the Korea life business comprise primarily Equity securities and portfolio holdings in unit trusts (£2,527 million as at 31 December 2016). The remeasurement adjustment of £238 million comprises the write down of goodwill of £15 million and other non-current assets within the scope of IFRS 5 of £16 million (£14 million of software and £2 million of property, plant and equipment) and an additional remeasurement of £207 million to adjust the carrying value of the business to fair value less costs to sell. The Korea life business has non-linked liabilities and linked liabilities at 31 December 2016 of £749 million and £2,576 million respectively (2015: £625 million and £2,187 million respectively). 281 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD2 Contingencies and related obligations Litigation and regulatory matters In addition to the matters set out in note C11 in relation to the Financial Conduct Authority review of past annuity sales, the Group is involved in various litigation and regulatory issues. These may from time to time include class actions involving Jackson. While 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 financial condition, results of operations, or cash flows. Unclaimed Property Provision Jackson had previously received regulatory enquiries on an industry-wide matter regarding claims settlement practices and compliance with unclaimed property laws. During 2015, Jackson reached agreements to settle issues related to these enquiries. At 31 December 2016, Jackson has accrued £13 million (2015: £16 million) to cover any such liability. Guarantees Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies and are financed by payments assessed on solvent insurance companies based on location, volume and types of business. The estimated reserve for future guarantee fund assessments is not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies. 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. Support for with-profits sub-funds by shareholders’ funds PAC is liable to meet its obligations to with-profits policyholders even if the assets of the with-profits sub-funds are insufficient to do so. The assets, represented by the unallocated surplus of with-profits funds, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (‘the excess assets’) in the with-profits sub-funds could be materially depleted over time by, for example, a significant or sustained equity market downturn, costs of significant fundamental strategic change or a material increase in the pension mis-selling provision. In the unlikely circumstance that the depletion of the excess assets within the long-term fund was such that the Group’s ability to satisfy policyholders’ reasonable expectations was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders’ funds to the with-profits sub-funds to provide financial support. Matters relating to with-profits sub-funds: — Pension mis-selling review – The UK insurance regulator required all UK life insurance companies to review sales of personal pensions policies for potential mis-selling. Offers to all cases were made by 30 June 2002. Costs arising from this review are met by the excess assets of the PAC with-profits sub-fund and hence have not been charged to the asset shares used in the determination of policyholder bonus rates. Prudential has given an assurance that these deductions from excess assets will not impact its bonus or investment policy for policies within the with-profits sub-funds that were in force at 31 December 2003. This assurance does not apply to new business since 1 January 2004. In the unlikely event that such deductions would affect the bonus or investment policy for the relevant policies, Prudential has stated it would make available support to the sub-fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. — Scottish Amicable Insurance sub-fund – Policies within this sub-fund (a with-profits sub-fund closed to new business) contain minimum levels of guaranteed benefit to policyholders. Should the assets of the sub-fund be inadequate to meet the guaranteed benefit obligations of the policyholders of SAIF, the PAC with-profits sub-fund would be liable to cover any such deficiency in the first instance. In addition, certain pensions products within this sub-fund have guaranteed annuity rates at retirement, for which a provision of £571 million was held within the sub-fund (2015: £412 million). — Guaranteed annuities – A provision for guaranteed annuity products of £62 million was held (2015: £47 million) in the PAC with- profits sub-fund. Intra-group capital support arrangements Prudential and PAC have put in place intra-group arrangements to formalise circumstances in which capital support would be made available by Prudential. While Prudential considers it unlikely that such support will be required, the arrangements are intended to provide additional comfort to PAC and its policyholders. In addition, Prudential has put in place intra-group arrangements to formalise undertakings by Prudential to the regulators of the Hong Kong subsidiaries regarding their solvency levels. 282 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedD3 Post balance sheet events Dividends The second interim ordinary dividend for the year ended 31 December 2016, that was approved by the Board of Directors after 31 December 2016 is described in note B7. D4 Related party transactions Transactions between the Company and its subsidiaries are eliminated on consolidation. 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 which are regarded as related parties for the purposes of IAS 24. The balances are included in the Group’s statement of financial position 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. In addition, there are no material transactions between the Group’s joint ventures which are accounted for on an equity method basis and other Group companies. 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 2016 and 2015, other transactions with directors were not deemed to be significant both by virtue of their size and in the context of the directors’ financial positions. 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 B3.3. D5 Commitments Operating leases and capital commitments 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. Future minimum lease payments for non-cancellable operating leases fall due during the following periods: Not later than 1 year Later than 1 year and not later than 5 years Later than 5 years Future minimum sub-lease rentals received for non-cancellable operating leases for land and buildings Minimum lease rental payments included in consolidated income statement 2016 £m 2015 £m 107 209 96 60 115 98 231 116 66 105 In addition, 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 2016 were £458 million (2015: £409 million). At 31 December 2016, Jackson has unfunded commitments of £465 million (2015: £299 million) related to its investments in limited partnerships and £201 million (2015: £64 million) related to commercial mortgage loans and other fixed maturities. These commitments were entered into in the normal course of business and a material adverse impact on the operations is not expected to arise from them. At 31 December 2016, UK insurance operations had unfunded commitments of £2,269 million (2015: £2,034 million) to private equity and infrastructure funds. These commitments were entered into in the normal course of business and no material adverse impact on the operations is expected to arise. 283 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates (a) Dividend restrictions and minimum capital requirements Certain Group subsidiaries and joint ventures are subject to restrictions on the amount of funds they may transfer in the form of cash dividends or otherwise to the parent company. Under UK company law, UK companies can only declare dividends if they have sufficient distributable reserves. Further, UK insurance companies are required to maintain solvency margins in accordance with the rules of the Prudential Regulation Authority. The Group UK asset management company, M&G Investment Management Ltd is also required to maintain capital in accordance with regulatory requirements before making any distribution to the parent company. Jackson is subject to state laws that limit the dividends payable to its parent company based on statutory capital and surplus and prior year earnings. Dividends in excess of these limitations require prior regulatory approval. The Group’s subsidiaries, joint ventures and associates 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. For further details on local capital regulations in Asia please refer to note C12(b). (b) Investments in joint ventures and associates Joint ventures represent arrangements where the controlling parties through contractual or other agreement have the rights to the net assets of the arrangements. The Group has shareholder-backed joint venture insurance and asset management businesses in China with CITIC Group, and until September 2016 in India with ICICI Bank (see below). In addition, there is an asset management joint venture in Hong Kong with Bank of China International Holdings Limited (BOCI) and Takaful general and life insurance joint venture in Malaysia. The Group has various joint ventures relating to property investments held by the PAC with-profits fund. The results of these joint ventures are reflected in the movement in the unallocated surplus of the PAC with-profits funds and therefore do not affect shareholders’ results. For the Group’s joint ventures that are accounted for by using the equity method, the net of tax results of these operations are included in the Group’s profit before tax. The investments in these joint ventures have the same accounting year end as the Group. The Group’s associates, which are also accounted for under the equity method, include PPM South Africa and from September 2016 the Indian insurance entity, see below. In addition, the Group has 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 influence. As allowed under IAS 28, these investments are accounted for on a fair value through profit or loss basis. The aggregate fair value of associates accounted for at fair value through profit or loss, where there are published price quotations, is approximately £3.5 billion at 31 December 2016 (2015: £1.4 billion). During the period, following its listing and consequent amendments to the shareholder agreement, the Group ceased to exercise joint control over the insurance business in India, therefore the investment has been re-classified as an associate, and continues to be accounted for using the equity method. The Group’s share of the profits (including short-term fluctuations in investment returns), net of related tax, and carrying amount of interest in joint ventures and associates, which are equity accounted as shown in the consolidated income statement comprises the following: Shareholder-backed business PAC with-profits fund (prior to offsetting effect in movement in unallocated surplus) Total Joint ventures and associates 2016 £m 2015 £m 161 21 182 185 53 238 Insurance operations Asset management Asia US UK Prudential Capital M&G Eastspring Investments US Total segment Unallocated to a segment (central operations) Group total 2016 Share of profits from joint ventures and associates, net of related tax 2015 Share of profits from joint ventures and associates, net of related tax 94 – 21 13 – – 54 182 – 182 130 – 53 14 – – 41 238 – 238 There is no other comprehensive income in the joint ventures and associates. There has been no unrecognised share of losses of a joint venture or associate that the Group has stopped recognising in the total income. 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 interests in the joint ventures. 284 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinued(c) Related undertakings In accordance with Section 409 of the Companies Act 2006 a list of Prudential Group’s subsidiaries, joint ventures, associates and significant holdings (being holdings of more than 20 per cent) along with the classes of shares held, the registered office address and the country of incorporation, and the effective percentage of equity owned at 31 December 2016 is disclosed below. The definitions of a subsidiary undertaking, joint venture and associate in accordance with the Companies Act 2006 are different from the definition under IFRS. As a result, the related undertakings included within the list below may not be the same as the undertakings consolidated in the Group IFRS financial statements. The Group’s consolidation policy is described in note A3.1(b). Direct subsidiary undertakings of the parent company, Prudential plc (shares held directly or via nominees): Name of entity M&G Group Limited Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential (US Holdco1) Limited Ordinary shares Prudential Capital Holding Company Limited Ordinary shares 100.00% 100.00% Prudential Corporation Asia Limited Ordinary shares 100.00% 13/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong Prudential Financial Services Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Group Holdings Limited Ordinary shares Prudential Property Services Limited Ordinary shares Prudential US Limited (In liquidation) Ordinary shares The Prudential Assurance Company Limited Ordinary shares 100.00% 100.00% 100.00% 100.00% Other subsidiaries, joint ventures, associates and significant holdings of the Group – no shares held directly by the parent company, Prudential plc or its nominees: Name of entity Classes of shares held Proportion held Registered office address and country of incorporation Allied Life Brokerage Agency, Inc Ordinary shares 100.00% 400 East Court Avenue, Des Moines Iowa, 50309, USA BOCHK Aggressive Growth Fund Ordinary shares 54.69% 27th Floor, Bank of China Tower, Central and BOCHK Balanced Growth Fund BOCHK China Equity Fund BOCHK Conservative Growth Fund Ordinary shares Ordinary shares Ordinary shares Western District, Hong Kong 39.05% 12th Floor and 25th Floor, Citicorp Centre, 18 Whitfield Road, Causeway Bay, Wan Chai, Hong Kong 64.15% 43.44% BOCI - Prudential Asset Management Limited Ordinary shares 36.00% 27/F, Bank of China Tower, 1 Garden Road, Hong Kong BOCI - Prudential Trustee Limited Ordinary shares 36.00% 12th Floor and 25th Floor, Citicorp Centre, Brier Capital LLC Limited liability company 18 Whitfield Road, Causeway Bay, Wan Chai, Hong Kong 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA Brooke (Holdco 1) Inc Ordinary shares 100.00% 1105 N Market Street, Suite 1300, Wilmington, DE 19801, USA Brooke Holdings (UK) Ltd (In liquidation) Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Brooke Holdings LLC Ordinary shares 100.00% 1105 N Market Street, Suite 1300, Wilmington, DE 19801, USA Brooke Life Insurance Company Ordinary shares 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA BWAT Retail Nominee (1) Limited BWAT Retail Nominee (2) Limited Calera Capital Partners IV - A AIV I, LP Ordinary shares Ordinary shares Limited partnership interest 50.00% Laurence Pountney Hill, London EC4R 0HH, UK 50.00% 32.87% Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801, USA 285 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Calvin F1 GP Limited Calvin F2 GP Limited Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh Ordinary shares 100.00% EH3 9WJ, UK Canada Property (Trustee) No 1 Limited Ordinary shares 100.00% Lime Grove House, Green Street, St Helier, Jersey JE1 2ST Canada Property Holdings Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Canada Property Jersey No. 2 Trust Canada Property Jersey Trust Units Units 100.00% Lime Grove House, Green Street, St Helier, 100.00% Jersey JE1 2ST Cardinal Distribution Park Management Limited Ordinary shares 66.00% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham B2 5PP, UK Carraway Guildford (Nominee A) Limited Ordinary shares 100.00% 13 Castle Street, St Helier, Jersey JE4 5UT Carraway Guildford (Nominee B) Limited Ordinary shares 100.00% Carraway Guildford General Partner Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Carraway Guildford Investments Unit Trust Units 100.00% 13 Castle Street, St Helier, Jersey JE4 5UT Carraway Guildford Limited Partnership Centaurus Retail LLP Limited partnership interest Limited partnership interest 100.00% Lloyds Chambers, 1 Portsoken Street, London E1 8HZ, UK 50.00% 40 Broadway, London SW1H 0BU, UK Central Square Leeds Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Centre Capital Non-Qualified Investors IV AIV Orion, L.P. Limited partnership interest Centre Capital Non-Qualified Investors IV AIV-ELS, L.P. Limited partnership interest Centre Capital Non-Qualified Investors IV AIV-RA, L.P. Limited partnership interest Centre Capital Non-Qualified Investors IV, L.P. Limited partnership interest Centre Capital Non-Qualified Investors V AIV-ELS LP Limited partnership interest Centre Capital Non-Qualified Investors V L.P. Limited partnership interest CEP IV-A Chicago AIV Limited Partnership CEP IV-A CWV AIV Limited Partnership Limited partnership interest Limited partnership interest 76.75% 2711 Centerville Road, Ste 400, Wilmington, DE 19808, USA 76.53% 71.43% 75.47% 73.16% 67.47% 31.92% 615 S Dupont Hwy, Dover, DE 19901, USA 31.92% 850 New Burton Road, Ste. 201, Dover, DE 19904, USA CEP IV-A Davenport AIV Limited Partnership Limited partnership 31.92% 615 S Dupont Hwy, Dover, DE 19901, USA CEP IV-A Indy AIV Limited Partnership CEP IV-A NMR AIV Limited Partnership CEP IV-A WBCT AIV Limited Partnership interest Limited partnership interest Limited partnership interest Limited partnership interest 31.92% 31.92% 31.91% 286 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity CF Prudential European QIS Fund CF Prudential Japanese QIS Fund Classes of shares held Ordinary shares Ordinary shares Proportion held Registered office address and country of incorporation 97.72% 17 Rochester Row, London SW1P 1QT, UK 97.93% CF Prudential North American QIS Fund Ordinary shares 97.90% 135 Bishopsgate, London EC2M 3UR, UK CF Prudential Pacific Markets Trust Fund Ordinary shares 97.91% Laurence Pountney Hill, London EC4R 0HH, UK CF Prudential UK Growth QIS Fund Ordinary shares 98.60% 17 Rochester Row, London SW1P 1QT, UK CITIC-Prudential Life Insurance Company Limited Ownership interest 50.00% East Tower, World Financial Centre, No.1 East Third Ring Middle Road, Chaoyang District, Beijing, China 100020 CITIC-CP Asset Management Co., Ltd. Ownership interest 26.95% No.128 North Zhangjiabang Road, Pudong District, Shanghai, China CITIC-Prudential Fund Management Company Limited Ownership interest 49.00% Level 9, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong, Shanghai, China Clairvest Equity Partners IV-A Limited Partnership Limited Partnership Interest 31.89% 22 St. Clair Avenue East, Suite 1700, Toronto, ON M4T 2S3 Canada Cribbs Causeway JV Limited Ordinary shares 50.00% 40 Broadway, London SW1H 0BU, UK Cribbs Causeway Merchants Association Ltd Limited by guarantee 100.00% The Mall at Cribbs Causeway, Bristol, BS34 5DG, UK Cribbs Mall Nominee (1) Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Curian Capital, LLC Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA Curian Clearing LLC (Michigan) Membership interest 100.00% Eastspring Al-Wara’ Investments Berhad Ordinary shares 100.00% 16th Floor, Wisma Sime Darby, Jalan Raja Laut, 50350 Kuala Lumpur, Malaysia Eastspring Asset Management Korea Co. Ltd. Ordinary shares Eastspring China Dragon Fund Ordinary shares 100.00% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea 29.13% Eastspring Investments – Cash Reserve Fund Ordinary shares 100.00% Prudential Tower 23rd Floor, Jl. Jendral Sudirman Kav.79, Jakarta Selatan 12910, Indonesia Eastspring Investments – Pan European Fund Ordinary shares 79.06% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 Eastspring Investments – US High Yield Bond Fund Ordinary shares 28.25% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments (Hong Kong) Limited Ordinary shares 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong Eastspring Investments (Luxembourg) S.A. Ordinary shares 100.00% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments (Singapore) Limited Ordinary shares 100.00% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 Eastspring Investments Active Quant Securities Ordinary shares 100.00% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea 287 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Eastspring Investments Asia Pacific Equity Fund Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 100.00% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments Asian Bond Fund Ordinary shares Eastspring Investments Asian Dynamic Fund Ordinary shares Eastspring Investments Asian Equity Fund Ordinary shares Eastspring Investments Asian Equity Income Fund Ordinary shares 46.78% 96.08% 97.31% 82.82% Eastspring Investments Asian High Yield Bond Fund Ordinary shares 48.66% Eastspring Investments Asian Infrastructure Equity Fund Eastspring Investments Asian Low Volatility Equity Fund Eastspring Investments Asian Property Securities Fund Ordinary shares 64.51% Ordinary shares 100.00% Ordinary shares 96.80% Eastspring Investments Berhad Ordinary shares 100.00% 16th Floor, Wisma Sime Darby, Jalan Raja Laut, Eastspring Investments Best Growth Securities Inv Trust 4 Ordinary shares 50350 Kuala Lumpur, Malaysia 97.01% 70, Yeoui-daero, Yeongdeungpo-gu, Seoul, 15/F, Shinhan Investment Tower, Seoul Special City, 07325, Korea Eastspring Investments China Equity Fund Ordinary shares 40.42% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments China Securities Baby Investment Trust Eastspring Investments Commodity Smart Choice Special Assets 1 Ordinary shares 94.78% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea Ordinary shares 100.00% Eastspring Investments Dragon Peacock Fund Ordinary shares 83.12% 26, Boulevard Royal, L-2449 Luxembourg Ordinary shares 100.00% Ordinary shares 98.15% Ownership interest 100.00% 23/F, Saigon Trade Center, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam Ordinary shares 98.30% 26, Boulevard Royal, L-2449 Luxembourg Ordinary shares 93.98% Ordinary shares 100.00% Ordinary shares 95.89% Ordinary shares 100.00% Ordinary shares 90.71% Ordinary shares 99.57% Eastspring Investments Emerging EMEA Dynamic Fund Eastspring Investments European Inv Grade Bond Fund Eastspring Investments Fund Management Limited Liability Company Eastspring Investments Global Bond Navigator Fund Eastspring Investments Global Emerging Markets Bond Fund Eastspring Investments Global Equity Navigator Fund Eastspring Investments Global Market Navigator Fund Eastspring Investments Global Multi Asset Income Plus Growth Fund Eastspring Investments Greater China Equity Fund Eastspring Investments Hong Kong Equity Fund 288 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Classes of shares held Proportion held Registered office address and country of incorporation Eastspring Investments Incorporated Ordinary shares 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA Eastspring Investments India Consumer Equity Open Limited Ordinary shares 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront Port Louis, Mauritius Eastspring Investments India Equity Fund Ordinary shares 80.28% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments India Equity Open Limited Eastspring Investments India Infrastructure Equity Open Limited Eastspring Investments Japan Fundamental Value Fund Ordinary shares 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront Port Louis, Mauritius Ordinary shares 100.00% Ordinary shares 98.53% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments Korea Index Securities Baby Investment Trust Ordinary shares 100.00% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea Eastspring Investments Korea Value Securities Investment Trust Bond Eastspring Investments Latin American Equity Fund Ordinary shares 99.71% Ordinary shares 94.44% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments Limited Ordinary shares 100.00% Marunouchi Park Building, 6-1 Marunouchi 2-chome, Chiyoda-Ku, Tokyo, Japan Eastspring Investments Limited (in liquidation) Ordinary shares 100.00% Level 6, Precinct Building 5, Unit 5, Eastspring Investments North America Value Fund Eastspring Investments Portfolio Management Limited (in liquidation) Ordinary shares 99.76% 26, Boulevard Royal, L-2449 Luxembourg Dubai International Financial Centre, Dubai, United Arab Emirates Ordinary shares 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront Port Louis, Mauritius Eastspring Investments Services Pte. Ltd. Ordinary shares 100.00% 10 Marina Boulevard, #32-01, Eastspring Investments SICAV-FIS - Alternative Investments Fund Eastspring Investments SICAV-FIS - Asia Pacific Loan Fund Eastspring Investments SICAV-FIS Universal USD Bond Fund Eastspring Investments SICAV-FIS Universal USD Bond II Fund Eastspring Investments Standard Plus Securities Investment Trust Eastspring Investments Unit Trusts -Global Technology Fund Ordinary shares 100.00% 2-4 Rue Eugene Ruppert, L-2453 Luxembourg Marina Bay Financial Centre, Singapore 018983 Ordinary shares 100.00% 26, Boulevard Royal, L-2449 Luxembourg Ordinary shares 99.95% Ordinary shares 100.00% Ordinary shares 97.53% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea Ordinary shares 91.69% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 Eastspring Investments US Bond Fund Ordinary shares 65.36% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Investments US Corporate Bond Fund Eastspring Investments US High Inv Grade Bond Fund Eastspring Investments US Investment Grade Bond Fund Ordinary shares 83.44% Ordinary shares 89.13% Ordinary shares 25.03% 289 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Eastspring Investments UT Singapore ASEAN Equity Fund Eastspring Investments UT Singapore Select Bond Fund Eastspring Investments VUL Max Choice Securities Investment Trust 1 Eastspring Investments VUL Max Choice Securities Investment Trust 2 Eastspring Investments VUL NOW Securities Investment Trust 1 Eastspring Investments World Value Equity Fund Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 99.84% 10 Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 Ordinary shares 92.02% Ordinary shares 99.95% 15th Floor, Shinhan Investment Tower, 70 Yoidae-ro, Youngdungpo-gu, Seoul 07325, Korea Ordinary shares 99.95% Ordinary shares 99.96% Ordinary shares 84.92% 26, Boulevard Royal, L-2449 Luxembourg Eastspring Real Assets Partners Ordinary shares 100.00% PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands Eastspring Securities Investment Trust Co., Ltd. Ordinary shares 99.54% 4F, No.1 Songzhi Road, Taipei 110, Taiwan Edger Investments Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Empire Holding S.a.r.l. (In liquidation) Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg Euro Salas Properties Limited Ordinary shares 100.00% 7 West George Street, Glasgow G2 1BA, UK Falan GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh Fashion Square ECO LP EH3 9WJ, UK Limited partnership interest 100.00% The Corporation Trust Company, Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801, USA First Dakota, Inc. Ordinary shares 100.00% 314 East Thayer Avenue, Bismarck, ND 58501, USA Five Hotel Holdings, LLC Membership interest 100.00% CT Corporation System, 208 S. LaSalle St. Suite 814, Chicago IL 60604, Illinois USA Foudry Properties Limited Ordinary shares 50.00% Clearwater Court, Vastern Road, Reading RG1 8DB, UK Furnival Insurance Company PCC Limited Ordinary shares 100.00% PO Box 34, St. Martin’s House, Le Bordage, St. GCI Holdings Corporation Ordinary shares Peter Port, GY1 4AU, Guernsey 75.80% Prentice-Hall Corporation, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, USA 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Limited partnership interest Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh Ordinary shares Ordinary shares 100.00% 100.00% EH3 9WJ, UK Genny GP 1 LLP Genny GP 2 Limited Genny GP Limited GGE GP Limited Global Low Volatility Equity fund D Acc Ordinary shares 94.59% 26, Boulevard Royal, L-2449 Luxembourg Greenpark (Reading) General Partner Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Greenpark (Reading) Nominee No. 1 Limited Ordinary shares Greenpark (Reading) Nominee No. 2 Limited Ordinary shares GS Twenty Two Limited Ordinary shares 100.00% 100.00% 100.00% Hermitage Management LLC Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA 290 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Classes of shares held Proportion held Registered office address and country of incorporation Holborn Bars Nominees Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Holborn Finance Holding Company (In liquidation) Ordinary shares 100.00% Holtwood Limited Ordinary shares 100.00% International House, Castle Hill, Victoria Road, Douglas, IM2 4RB, Isle of Man Hyde Holdco 1 Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK ICICI Prudential Asset Management Company Limited ICICI Prudential Life Insurance Company Limited ICICI Prudential Pension Funds Management Company Limited Ordinary shares 49.00% 12th Floor, Narain Manzil, 23, Barakhamba Road, New Delhi 110001, India Ordinary shares 25.83% ICICI PruLife Towers, 1089 Appasaheb Marathe Marg, Prabhadevi, Mumbai 400025, India Ordinary shares 25.83% ICICI Prudential Trust Limited Ordinary shares 49.00% 12th Floor, Narain Manzil, 23, Barakhamba Road, New Delhi 110001, India IFC Holdings, Inc. Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA Infracapital (AIRI) GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK Infracapital (AIRI) Holdings Limited Ordinary shares Infracapital (AIRI) SLP LP Infracapital (Bio) GP Limited Infracapital (Bio) SLP LP Infracapital (GC) GP Limited Infracapital (GC) SLP LP Partnership interest Ordinary shares Partnership interest Ordinary shares Ordinary shares with partnership interest Infracapital (IT PPP) GP Limited Ordinary shares Infracapital (IT PPP) SLP LP Partnership interest Infracapital (Sense) GP Limited Ordinary shares 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Infracapital (Sense) Holdings Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Infracapital (Sense) SLP LP Partnership interest 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK Infracapital (TLSB) GP Limited Ordinary shares Infracapital (TLSB) SLP LP Infracapital ABP GP Limited Infracapital CI II Limited Infracapital DF II GP LLP Infracapital DF II Limited Infracapital Employee Feeder GP 1 LLP Infracapital Employee Feeder GP 2 LLP Partnership interest Ordinary shares Ordinary shares Limited partnership interest Ordinary shares Limited partnership interest Limited partnership interest 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Infracapital Employee Feeder GP Limited Ordinary shares 100.00% Infracapital F1 GP2 Limited Infracapital F2 GP1 Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK 291 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Classes of shares held Proportion held Registered office address and country of incorporation Infracapital F2 GP2 Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Infracapital GP 1 LLP Infracapital GP 2 LLP Infracapital GP II Limited Infracapital GP Limited Limited partnership interest Limited partnership interest Ordinary shares Ordinary shares Infracapital Greenfield Partners I GP 1 Limited Ordinary shares Infracapital Greenfield Partners I GP 2 Limited Ordinary shares Infracapital Greenfield Partners I GP LLP Ordinary shares Infracapital Greenfield Partners I LP Limited partnership interest 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Infracapital Long Term Income Partners GP 1 Limited Infracapital Long Term Income Partners GP 2 Limited Ordinary shares 100.00% Ordinary shares 100.00% Infracapital Long Term Income Partners GP LLP Limited partnership 100.00% Infracapital Partners II LP Infracapital Partners LP interest Limited partnership interest Limited partnership interest 25.98% 33.04% Infracapital Sisu GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh Infracapital SLP II GP LLP Infracapital SLP Limited Innisfree M&G PPP LLP INVEST Financial Corporation Insurance Agency, Inc. of Delaware INVEST Financial Corporation Insurance Agency, Inc. of Illinois Limited partnership interest 100.00% EH3 9WJ, UK Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Limited partnership interest 35.00% Boundary House, 91-93 Charterhouse Street, London EC1M 6HR, UK Ordinary shares 100.00% 100 West 10th Street Wilmington, DE 19801, USA Ordinary shares 100.00% 208 South LaSalle Street Suite 814 Chicago, IL 60604, USA Investment Centers of America, Inc Ordinary shares 100.00% 314 East Thayer Avenue, Bismarck, ND 58501, USA Jackson Charitable Foundation Non-stock basis 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA Jackson National Asset Management LLC Capital contribution 100.00% Jackson National Life (Bermuda) Limited Ordinary shares 100.00% Cedar House, 41 Cedar Avenue, Hamilton HM 12, Bermuda Jackson National Life Distributors LLC Membership interest 100.00% 1209 Orange St, Wilmington, DE 19801, USA Jackson National Life Insurance Company Ordinary shares 100.00% 1 Corporate Way, Lansing,Michigan 48951, USA Jackson National Life Insurance Company of New York Jefferies Capital Partners V, L.P. Ordinary shares 100.00% 2900 Westchester Av, Suite 305, Purchase, NY 10577, USA Limited partnership interest 21.92% The Corporation Trust Company, Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801, USA JNL Strategic Income Fund LLC Membership interest 100.00% Lion Credit Opportunity Fund Ordinary shares 32.26% 3rd Floor, Kilmore House, Park Lane, Dublin 1, D01 YE64, Ireland 292 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Classes of shares held Proportion held Registered office address and country of incorporation LIPP S.à r.l. (in liquidation) Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg Livicos Limited Ordinary shares 100.00% Montague House, Adelaide Road, Dublin 2, Ireland M&G (Guernsey) Limited Ordinary shares 100.00% Dorey Court, Admiral Park, St. Peter Port, Guernsey GY1 2HT M&G Alternatives Investment Management Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G Asia Property Fund A Class Shares 40.35% 34-38, Avenue de la Liberté, L-1930 Luxembourg M&G Corporate bond Fund Ordinary shares 24.40% Laurence Pountney Hill, London EC4R 0HH, UK M&G Dividend Fund Ordinary shares M&G Emerging Markets Bond Fund Ordinary shares M&G Episode Defensive Fund M&G Episode Macro Fund Ordinary shares Ordinary shares 54.67% 23.85% 94.62% 45.65% M&G European Credit Investment Fund Ordinary shares 100.00% 80, Route d’Esch, L-1470 Luxembourg M&G European High Yield Credit Investment Fund Ordinary shares 100.00% M&G European Property Fund SICAV-FIS Ordinary shares 68.06% 34-38, Avenue de la Liberté, L-1930 Luxembourg M&G European Secured Property Income Fund Units 51.12% M&G European Select Fund Ordinary shares 37.30% Laurence Pountney Hill, London EC4R 0HH, UK M&G European Strategic Value Fund Ordinary shares M&G Feeder of Property Portfolio M&G Financial Services Limited M&G Founders 1 Limited M&G General Partner Inc. Ordinary shares Ordinary shares Ordinary shares 92.47% 28.25% 100.00% 100.00% Ordinary shares 100.00% Walker House, 87 Mary Street, Grand Cayman, KY1 9002, Cayman Islands M&G Gilt & Fixed Interest Income Fund Ordinary shares 41.11% Laurence Pountney Hill, London EC4R 0HH, UK M&G Global Corporate Bond Fund Ordinary shares 63.53% M&G Global Credit Investment Fund Ordinary shares 100.00% 80, Route d’Esch, L-1470 Luxembourg M&G Global Leaders Fund Ordinary shares 24.28% Laurence Pountney Hill, London EC4R 0HH, UK M&G Global Select Fund M&G IMPPP 1 Limited Ordinary shares Ordinary shares M&G International Investments Limited Ordinary shares M&G International Investments Nominees Limited Ordinary shares 23.69% 100.00% 100.00% 100.00% M&G International Investments Switzerland AG Ordinary shares 100.00% Talstrasse 66, 8001 Zurich, Switzerland M&G Investment Management Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G Investments (Hong Kong) Limited Ordinary shares 100.00% 6th Floor, Alexandra House, 18 Chater Road, Central Hong Kong, Hong Kong M&G Investments (Singapore) Pte. Ltd. Ordinary shares 100.00% 10 Marina Boulevard, 39 Marina Bay Financial Centre, Singapore 018983 M&G Investments Japan Co., Ltd. Ordinary shares 100.00% 3-1 Toranomon, 4 Chome, Minato-ko, Tokyo 105-6009, Japan 293 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity M&G Limited Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G Managed Growth Fund Ordinary shares M&G Management Services Limited Ordinary shares M&G Nominees Limited M&G Pan European Dividend Fund M&G Platform Nominees Limited Ordinary shares Ordinary shares Ordinary shares 26.40% 100.00% 100.00% 34.78% 100.00% M&G RE Espana 2016 S.L. Ordinary shares 100.00% Plaza de Colon, Torre II, Planta 14, 28046, Madrid, Spain M&G Real Estate (Luxembourg) S.A. Ordinary shares 100.00% 34-38, Avenue de la Liberté, L-1930 Luxembourg M&G Real Estate Asia Holding Company Pte. ltd Ordinary shares 100.00% 10 Marina Boulevard, #31-03 Marina Bay Financial Centre Tower 2, Singapore 018983 M&G Real Estate Asia PTE. Ltd Ordinary shares 100.00% M&G Real Estate Debt Fund LP Limited partnership interest 29.15% Ground Floor, Dorey Court, Admiral Park, St Peter Port, Guernsey, GY1 2HT M&G Real Estate Funds Management S.a.r.l. Ordinary shares 100.00% 34-38, Avenue de la Liberté, L-1930 Luxembourg M&G Real Estate Japan Co. Ltd Ordinary shares 100.00% Shiroyama Trust Tower, Tokyo, Japan M&G Real Estate Korea Co. Ltd Ordinary shares 100.00% Kyobo Building, Seoul, Korea M&G Real Estate Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G RED Employee Feeder GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK M&G RED GP Limited Ordinary shares 100.00% Dorey Court, Admiral Park, St Peter Port, Guernsey GY1 2HT M&G RED II Employee Feeder GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK M&G RED II GP Limited Ordinary shares 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port Guernsey GY1 1WG M&G RED II SLP GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh M&G RED III Employee Feeder GP Limited Ordinary shares 100.00% EH3 9WJ, UK M&G RED III GP Limited Ordinary shares 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, M&G RED III SLP GP Limited Ordinary shares St Peter Port, Guernsey GY1 1WG 100.00% Burness Paull LLP, 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK M&G RED SLP GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK M&G RPF GP Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G RPF Nominee 1 Limited M&G RPF Nominee 2 Limited M&G Securities Limited Ordinary shares Ordinary shares Ordinary shares 100.00% 100.00% 100.00% M&G SIF Management Company (Ireland) Limited Ordinary shares 100.00% 78 Sir John Rogerson’s Quay, Dublin 2, D02 RK57, Ireland M&G Traditional Credit Fund Ordinary shares 45.41% M&G UK Companies Financing Fund II LP Limited partnership interest 48.32% Laurence Pountney Hill, London EC4R 0HH UK M&G UK Property Fund Class C units 99.79% 34-38, Avenue de la Liberté, L-1930 Luxembourg 294 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Classes of shares held Proportion held Registered office address and country of incorporation M&G UK Property GP Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK M&G UK Property Nominee 1 Limited Ordinary shares M&G UK Property Nominee 2 Limited Ordinary shares 100.00% 100.00% M&G UK Residential Property Fund Class founder units 48.37% 34-38, Avenue de la Liberté, L-1930 Luxembourg M&G UKCF II GP Limited Manchester JV Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Ordinary shares 50.00% 40 Broadway, London SW1H 0BU, UK Manchester Nominee (1) Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK MCF S.r.l. Ordinary shares 45.00% Via Romagnosi 18/a, 00196 Roma, Italy Minster Court Estate Management Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Mission Plans of America, Inc Ordinary shares 100.00% 1999 Bryan Street Suite 900, Dallas, TX 75201, USA MM and S (2375) Limited Ordinary shares 100.00% Mazars Llp, 90 St. Vincent Street, Glasgow G2 5UB, UK Murphy & Partners Fund, LP NAPI REIT, Inc Limited partnership interest Ordinary shares 21.07% Corporation Service Company 2711 Centerville Road, Ste 400, Wilmington, DE 19808, USA 100.00% The Corporation Trust Incorporated, 300 E Lombard Street, Baltimore, MD 21202, USA National Planning Corporation Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA National Planning Holdings, Inc. Ordinary shares 100.00% North Sathorn Holdings Company Limited Ordinary shares 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn Nova Sepadu Sdn. Bhd. Ordinary shares Road, Yannawa Subdistrict, Sathorn District, Bangkok, Thailand 51.00% Suite 1005, 10th Floor Wisma Hamzah-Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia Oaktree Business Park Limited Ordinary shares 12.50% Laurence Pountney Hill, London EC4R 0HH, UK Old Hickory Fund I, LLC Ordinary shares 100.00% Eschenheimer Anlage 1, 60316 Frankfurt am Main, Germany Old Kingsway, LP Limited Partnership Interest 100.00% Corporation Service Company, 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA Optimus Point Management Company Limited Ordinary shares 99.95% Barrat House Cartwright Way, Bardon Hill, Coalville, Leicestershire LE67 1UF, UK Pacus (UK) Limited PCA IP Services Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Ordinary shares 100.00% 13/F, One International Finance Centre, PCA Life Assurance Co. Ltd. PCA Life Insurance Co., Ltd. Ordinary shares Ordinary shares 1 Harbour View Street, Central, Hong Kong 99.79% 8/F, No.1 Songzhi Road, Taipei 11047, Taiwan 100.00% 21/F, PCA Life Tower, 302, Teheran-Ro, Gangnam-gu, Seoul, Korea PCA Reinsurance Co. Ltd. Ordinary shares 100.00% Unit Level 13(A), Main Office Tower, Financial Park Labuan, Jalan Merdeka, 87000 Federal Territory of Labuan, Malaysia PGDS (UK One) Limited PGDS (US One) LLC Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Membership interest 100.00% 1209 Orange St, Wilmington, DE 19801, USA PGF Management Company (Ireland) Limited Ordinary shares 100.00% 25-28 North Wall Quay, Dublin 1, Ireland PPM America Capital Partners II, LLC Membership interest 63.45% 774 Walker Road, Suite C, Dover, DE 19904, USA PPM America Capital Partners III, LLC Membership interest PPM America Capital Partners IV, LLC Membership interest PPM America Capital Partners V, LLC Membership interest 60.50% 34.50% 34.00% 295 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity PPM America Capital Partners VI, LLC Classes of shares held Limited partnership interest Proportion held Registered office address and country of incorporation 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA PPM America Capital Partners, LLC Membership interest 19.38% 774 Walker Road, Suite C, Dover, DE 19904, USA PPM America Private Equity Fund II LP PPM America Private Equity Fund III LP PPM America Private Equity Fund IV LP PPM America Private Equity Fund LP PPM America Private Equity Fund V LP PPM America Private Equity Fund VI LP Limited partnership interest Limited partnership interest Limited partnership interest Limited partnership interest Limited partnership interest Limited partnership interest 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA PPM America, Inc. Ordinary shares 100.00% 774 Walker Road, Suite C, Dover, DE 19904, USA PPM Capital (Holdings) Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK PPM Finance, Inc PPM Holdings, Inc Ordinary shares 100.00% 774 Walker Road, Suite C, Dover, DE 19904, USA Ordinary shares 100.00% PPM Managers GP Limited Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK PPM Ventures (Asia) Limited (in liquidation) Ordinary shares 100.00% Gloucester Tower, 15 Queens Road, Central, Hong Kong PPMC First Nominees Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Property Partners (Two Rivers) Limited Ordinary shares 50.00% Bow Bells House, 1 Bread Street, London EC4M 9HH, UK Pru Life Insurance Corporation of U.K. Ordinary shares 100.00% 9/F, Uptown Place Tower 1, 1 East 11th Drive, Uptown Bonifacio, 1634 Taguig City, Metro Manila, Philippines Prudence Foundation Limited Limited by guarantee 100.00% 13/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong Prudential (Cambodia) Life Assurance Plc. Ordinary shares 100.00% 20F, #445, Monivong Blvd, Boeung Prolit, 7 Makara, Phnom Penh Tower Phnom Penh, Cambodia Prudential (Namibia) Unit Trusts Limited Ordinary shares 100.00% 6 Feld Street, Windhoek, Namibia Prudential (Netherlands One) Limited (In liquidation) Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential / M&G UKCF GP Limited Ordinary shares Prudential Africa Holdings Limited Ordinary shares 100.00% 100.00% Prudential Africa Services Limited Ordinary shares 100.00% 5th Ngong Avenue, Nairobi, Kenya Prudential Annuities Limited Ordinary shares 100.00% Mazars LLP, 45 Church Street, Birmingham B3 2RT, UK Prudential Assurance Company Singapore (Pte) Limited Ordinary shares 100.00% 30 Cecil Street, #30-01 Prudential Tower, Singapore 049712 Prudential Assurance Malaysia Berhad Ordinary shares 51.00% Level 3, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Prudential Assurance Uganda Limited Ordinary shares 100.00% Kampala Road, Kampala, Uganda 296 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Prudential Australia One Limited (in liquidation) Classes of shares held Ordinary shares and 6% Cumulative Preference Shares Proportion held Registered office address and country of incorporation 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential BSN Takaful Berhad Ordinary shares 49.00% Level 8A, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Prudential Capital (Singapore) Pte. Limited Ordinary shares 100.00% 10, Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 Prudential Capital plc Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Corporate Pensions Trustee Limited Ordinary shares 100.00% Prudential Corporation Australasia Holdings Pty Limited Class A and Class B Shares 100.00% Level 7,10-14 Smith Street, Parramatta, Australia, NSW 2124 Prudential Corporation Holdings Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Credit Opportunities 1 S.A.R.L. Ordinary shares 100.00% 1, Rue Hildegard von Bingen, L-1282 Luxembourg Prudential Credit Opportunities GP S.A.R.L. Ordinary Shares Prudential Credit Opportunities SCSp Ordinary shares 100.00% 100.00% Prudential Development Management Limited Ordinary Shares/ 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Redeemable Preference Shares Prudential Distribution Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Dublin Investments Limited Ordinary shares 100.00% IFSC, North Wall Quay, Dublin 1, Ireland Prudential Dynamic 0-30 Portfolio Prudential Dynamic 10-40 Portfolio Prudential Dynamic 20-55 Portfolio Prudential Dynamic 40-80 Portfolio Prudential Dynamic 60-100 Portfolio Ordinary shares Ordinary shares Ordinary shares Ordinary shares Ordinary shares Prudential Dynamic Focused 0-30 Portfolio Ordinary shares Prudential Dynamic Focused 10-40 Portfolio Ordinary shares Prudential Dynamic Focused 20-55 Portfolio Ordinary shares Prudential Dynamic Focused 40-80 Portfolio Ordinary shares Prudential Dynamic Focused 60-100 Portfolio Ordinary shares 29.95% 17 Rochester Row, London SW1P 1QT, UK 31.74% 35.20% 38.61% 40.41% 66.09% 42.44% 50.40% 49.92% 70.93% Prudential Equity Release Mortgages Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Europe Assurance Holdings Limited (in liquidation) Ordinary shares 100.00% Mazars LLP, 90 St. Vincent Street, Glasgow G2 5UB, UK Prudential Financial Planning Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Five Limited Ordinary shares 100.00% Prudential General Insurance Hong Kong Limited Ordinary shares 100.00% 59/F, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong Prudential GP Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Greenfield GP LLP Prudential Greenfield GP1 Limited Prudential Greenfield GP2 Limited Prudential Greenfield LP Prudential Greenfield SLP GP LLP Limited partnership interest Ordinary shares Ordinary shares Limited partnership interest Limited partnership interest 100.00% Laurence Pountney Hill, London EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh EH3 9WJ, UK 297 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Classes of shares held Proportion held Registered office address and country of incorporation Prudential Group Pensions Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Group Secretarial Services Limited Ordinary shares Prudential Holborn Life Limited Ordinary shares 100.00% 100.00% Prudential Holdings Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Hong Kong Limited Ordinary shares 100.00% 59/F, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong Prudential International Assurance plc Ordinary shares 100.00% Montague House, Adelaide Road, Dublin 2, Ireland Prudential International Management Services Limited Ordinary shares 100.00% Prudential International Staff Pensions Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Investment (Luxembourg) 2 S.à r.l. Ordinary shares 100.00% 34-38, Avenue de la Liberté, L-1930 Luxembourg Prudential Investment Managers (South Africa) (Pty) Ltd Ordinary shares 100.00% Protea Place, Cape Town, South Africa Prudential Investments Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential IP Services Limited Ordinary shares 100.00% Prudential Life Assurance (Lao) Company Limited Ordinary shares 100.00% Unit A, 6th Floor, Vientiane Plaza Hotel Office Building, Sailom Road, Hatsady Neua Village, Chanthabouly District, Vientiane Capital, Lao, PDR Prudential Life Assurance (Thailand) Public Company Limited Ordinary shares 99.93% 9/9 Sathorn Building, 20th– 27th Fl., South Sathorn Rd., Yannawa, Sahtorn, Bangkok 10120, Thailand Prudential Life Assurance Kenya Limited Ordinary shares 100.00% 5th Ngong Avenue, Nairobi, Kenya Prudential Life Assurance Limited Ordinary shares 100.00% 226 Finsbury House, Buteko Avenue, Ndola, Zambia Prudential Life Insurance Ghana Limited Ordinary shares 100.00% 35 North Street, Accra, Ghana Prudential Lifetime Mortgages Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Mauritius Holdings Limited Ordinary shares 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront Port Louis, Mauritius Prudential Pensions Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Pensions Management Zambia Ordinary shares 49.00% 226 Finsbury House, Buteko Avenue, Ndola, Zambia Prudential Polska sp. z.o.o Ordinary shares 100.00% 02-670 Warszawa, Pulawska 182, Poland Prudential Portfolio Management Group Limited Prudential Portfolio Managers (Namibia) (Pty) Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Ordinary shares 75.00% 6 Feld Street, Windhoek, Namibia Prudential Portfolio Managers (South Africa) (Pty) Limited Ordinary shares & A Class shares 49.99% PO Box 44813, Claremont 7735, South Africa Prudential Portfolio Managers (South Africa) Life Limited Prudential Portfolio Managers Unit Trusts Limited Prudential Process Management Services India Private Limited Ordinary shares 100.00% Protea Place, Cape Town, South Africa Ordinary shares 100.00% PO Box 44813, Claremont 7735, South Africa Equity shares 100.00% Prudential House, Mumbai, India Prudential Properties Trusty Pty Limited Unclassified shares 100.00% Darling Park Tower 2, Sydney, Australia 298 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Classes of shares held Proportion held Registered office address and country of incorporation Prudential Property Holding Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Property Investment Managers Limited Ordinary shares 100.00% Prudential Property Investments Limited Ordinary shares Prudential Real Estate Investments 1 Limited Ordinary shares Prudential Real Estate Investments 2 Limited Ordinary shares Prudential Real Estate Investments 3 Limited Ordinary shares 100.00% 100.00% 100.00% 100.00% Prudential Retirement Income Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Services Asia Sdn. Bhd. Ordinary shares Class D Preference shares 100.00% 100.00% Suite 1005, 10th Floor, Wisma Hamzah-Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia Prudential Services Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Services Singapore Pte. Ltd. Ordinary shares 100.00% 80 Robinson Road, #21-01/02 Singapore 068898 Prudential Singapore Holdings Pte. Limited Ordinary shares 100.00% 30 Cecil Street, #30-01 Prudential Tower, Singapore 049712 Prudential Staff Pensions Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Trustee Company Limited Ordinary shares Prudential UK Real Estate General Partner Limited Ordinary shares 100.00% 100.00% Prudential UK Real Estate Limited Partnership Limited partnership 100.00% interest Prudential UK Real Estate Nominee 1 Limited Ordinary shares Prudential UK Real Estate Nominee 2 Limited Ordinary shares 100.00% 100.00% Prudential UK Services Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Prudential Unit Trusts Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Prudential Vietnam Assurance Private Limited Ownership interest 100.00% 25/F, Saigon Trade Centre, 37 Ton Duc Thang Street, Prudential Vietnam Finance Company Limited Ownership interest 100.00% District 1, Ho Chi Minh City, Vietnam Prudential/M&G UK Companies Financing Fund LP Limited partnership interest 34.42% Laurence Pountney Hill, London EC4R 0HH, UK Prutec Limited Ordinary shares 100.00% PT. Eastspring Investments Indonesia Ordinary shares 99.95% 23rd Floor, Prudential Tower, JL. Jend. Sudirman Kav.79, Jakarta 12910, Indonesia PT. Prudential Life Assurance Class A ordinary shares 94.62% Prudential Tower, JI. Jend. Sudirman Kav 79, Jakarta 12910, Indonesia PVFC Financial Limited Ordinary shares 100.00% 13/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong PVM Partnerships Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Randolph Street LP Limited partnership interest 100.00% Corporation Service Company, 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA REALIC of Jacksonville Plans, Inc. Ordinary shares 100.00% 9235 Katy Freeway, Houston, TX 77255, USA Reksa Dana Eastspring IDR Fixed Income Fund (NDEIFF) Ordinary shares 100.00% Prudential Tower 23rd Floor, Jl. Jendral Sudirman Kav.79, Jakarta Selatan, 12910, Indonesia Rhodium Investment Fund Ordinary shares 100.00% 10, Marina Boulevard, #32-01, Marina Bay Financial Centre, Singapore 018983 299 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsD6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Rift GP 1 Limited Rift GP 2 Limited ROP, Inc Classes of shares held Proportion held Registered office address and country of incorporation Ordinary shares 100.00% 50 Lothian Road, Festival Square, Edinburgh Ordinary shares 100.00% EH3 9WJ, UK Ordinary shares 100.00% 1209 Orange St, Wilmington, DE 19801, USA ScotAm Pension Trustees Limited Ordinary shares 100.00% Craigforth, Stirling FK9 4UE, UK Scottish Amicable Finance plc Ordinary shares 100.00% Scottish Amicable ISA Managers Limited (in liquidation) Ordinary shares 100.00% Mazars LLP, 90 St Vincent Street, Glasgow G2 5UB, UK Scottish Amicable Life Assurance Society No share capital 100.00% Craigforth, Stirling FK9 4UE UK Scottish Amicable PEP and ISA Nominees Limited (in liquidation) Ordinary shares 100.00% Mazars LLP, 90 St Vincent Street, Glasgow G2 5UB, UK Scotts Spazio Pte. Ltd. Ordinary shares 45.00% 152 Beach Road, #27-01, Gateway East, Sealand (No 1) Limited Sealand (No 2) Limited Sectordate Ltd Singapore 189721 Ordinary shares 100.00% Lime Grove House, Green Street, St Helier, Jersey, Ordinary shares 100.00% JE1 2ST A Ordinary shares 32.60% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham B2 5PP, UK SII Investments, Inc. Ordinary shares 100.00% 2401 South Memorial Drive, Appleton, WI 54915, Silverfleet Capital 2004 LP Silverfleet Capital 2005 LP Silverfleet Capital 2006 LP Silverfleet Capital 2007 LP Silverfleet Capital 2008 LP Silverfleet Capital 2009 LP Silverfleet Capital 2010 LP Silverfleet Capital 2011 LP Smithfield Limited SMLLC Squire Capital I LLC Squire Capital II LLC Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest Limited Partnership Interest USA 100.00% 1 Royal Plaza, St Peters Port, Guernsey, GY1 2HL 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK General Partner 100.00% The Corporation Trust Company, 1209 Orange Street, Wilmington, DE 19801, USA Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA Membership interest 100.00% Squire Reassurance Company II, LLC Capital stock 100.00% 40600 Ann Arbor Road, East Suite 201, Plymouth, MI 48170, USA Squire Reassurance Company LLC Membership interest 100.00% 1 Corporate Way, Lansing, Michigan 48951, USA 300 Prudential plc Annual Report 2016 www.prudential.co.ukD Other notesContinuedName of entity Sri Han Suria Sdn. Bhd. Classes of shares held Ordinary shares Class A and B Preference shares Proportion held Registered office address and country of incorporation 51.00% 100.00% Suite 1005, 10th Floor Wisma Hamzah-Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia St Edward Homes Limited Ordinary shares 50.00% Berkeley House, 19 Portsmouth Road, St Edwards Strand Partnership Limited partnership interest 50.00% Cobham KT11 1JG, UK Stableview Limited Staple Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Ordinary shares 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn Road, Yannawa Subdistrict, Sathorn District, Bangkok, Thailand Staple Nominees Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Thanachart Life Assurance Public Company Limited (in liquidation) Ordinary shares 99.93% 9/9 Sathorn Building, 20th– 27th Floor, South Sathorn Road, Yannawa, Sahtorn, Bangkok 10120, Thailand The Car Auction Unit Trust Ordinary shares 50.00% Dorey Court, Admiral Park, St Peter Port GY1 3BG, Guernsey The First British Fixed Trust Company Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK The Greenpark (Reading) Limited Partnership Limited partnership 100.00% interest The Heights Management Company Limited Ordinary shares The Hub (Witton) Management Company Limited Ordinary shares 50.00% 100.00% The St Edward Homes Partnership Limited partnership interest 49.95% Berkeley House, 19 Portsmouth Road, Cobham, KT11 1JG, UK The Strand Property Unit Trust The Two Rivers Trust THMI, Inc. Units Units Ordinary shares 50.00% Liberte house, 19-23 La Motte Street, St Helier, 50.00% Jersey, Channel Islands, JE2 4SY 75.80% Prentice-Hall Corporation, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, USA Three Snowhill Birmingham Sarl Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg Two Rivers Limited Partnership Ordinary shares 50.00% Bow Bells House, 1 Bread Street, London EC4M 9HH, UK Two Snowhill Birmingham Sarl Ordinary shares 100.00% 5 Rue Guillaume Kroll, L-1882, Luxembourg US Strategic Income Bond Fund D USD Acc Ordinary shares 100.00% 26, Boulevard Royal, L-2449 Luxembourg US Total Return Bond Fund D USD Acc Ordinary shares 100.00% VFL International Life Company SPC, Ltd Ordinary shares 100.00% 171 Elgin Avenue, Grand Cayman, Cayman Islands Warren Farm Office Village Limited Ordinary shares 100.00% Laurence Pountney Hill, London EC4R 0HH, UK Wessex Gate Limited Westwacker Limited Wynnefield Private Equity Partners I, L.P. Wynnefield Private Equity Partners II, L.P. Ordinary shares Ordinary shares Limited partnership interest Limited partnership interest 100.00% 100.00% 99.00% PHS Corporate Services Inc. 1313 N. Market St, Ste 5100, Wilmington, DE 19801, USA 99.00% The Corporation Trust Company Corporation Trust Centre, 1209 Orange St, Wilmington, DE 19801 USA 301 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsE Further accounting policies E1 Other significant accounting policies In addition to the critical accounting policies presented in note A3.1, the following detailed accounting policies are adopted by the Group to prepare the consolidated financial statements. These accounting policies are applied consistently for all years presented and normally are not subject to change unless new accounting standards, interpretations or amendments are introduced by the IASB. (a) Basis of consolidation The Group consolidates those investees it is deemed to control. The Group has control over an investee if all three of the following are met: (1) it has power over an investee; (2) it is exposed to, or has rights to, variable returns from its involvement with the investee; and (3) it has ability to use its power over the investee to affect its own returns. (i) Subsidiaries Subsidiaries are those investees that the Group controls. The majority of the Group’s subsidiaries are corporate entities, but the Group’s insurance operations also invest in a number of limited partnerships. The Group performs a re-assessment of consolidation whenever there is a change in the substance of the relationship between the Group and an investee. Where the Group is deemed to control an entity it is treated as a subsidiary and its results, assets and liabilities are consolidated. Where the Group holds a minority share in an entity, with no control over the entity, the investments are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position. Entities consolidated by the Group include Qualifying Partnerships as defined under the UK Partnerships (Accounts) Regulations 2008 (the ‘Partnerships Act’). Some of these limited partnerships have taken advantage of the exemption under regulation 7 of the Partnerships Act from the financial statements requirements. This is under regulations 4 to 6, on the basis that these limited partnerships are dealt with on a consolidated basis in these financial statements. (ii) Joint ventures and associates Joint ventures are joint arrangements arising from a contractual agreement whereby the Group and other investors have joint control of the net assets of the arrangement. In a number of these arrangements, the Group’s share of the underlying net assets may be less than 50 per cent but the terms of the relevant agreement make it clear that control is jointly exercised between the Group and the third party. Associates are entities over which the Group has significant influence, but it does not control. Generally it is presumed that the Group has significant influence if it holds between 20 per cent and 50 per cent voting rights of the entity. With the exception of those referred to below, the Group accounts for its investments in joint ventures and associates by using the equity method of accounting. The Group’s share of profit or loss of its joint ventures and associates is recognised in the income statement and its share of movements in other comprehensive income is recognised in other comprehensive income. The equity method of accounting does not apply to investments in associates and joint ventures held by the Group’s insurance or investment funds. This includes venture capital business, mutual funds and unit trusts and which, as allowed by IAS 28, ‘Investments in Associates and Joint Ventures’, are carried at fair value through profit or loss. (iii) Structured entities Structured entities are those that have been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity. Voting rights relate to administrative tasks. Relevant activities are directed by means of contractual arrangements. The Group invests in structured entities such as: — Open-Ended Investment Companies (OEICs); — Unit Trusts (UTs); — Limited partnerships; — Variable interest entities; — Investment vehicles within separate accounts offered through variable annuities; — Collateralised debt obligations; — Mortgage-backed securities; and — Similar asset-backed securities. Open-ended investment companies and unit trusts The Group invests in OEICs and UTs, which invest mainly in equities, bonds, cash and cash equivalents, and properties. The Group’s percentage ownership in these entities can fluctuate on a daily basis according to the participation of the Group and other investors in them. — Where the entity is managed by a Group asset manager, and the Group’s ownership holding in the entity exceeds 50 per cent, the Group is judged to have control over the entity. — Where the entity is managed by a Group asset manager, and the Group’s ownership holding in the entity is between 20 per cent and 50 per cent, the facts and circumstances of the Group’s involvement in the entity are considered, including the rights to any fees earned by the asset manager from the entity, in forming a judgement as to whether the Group has control over the entity. — Where the entity is managed by a Group asset manager, and the Group’s ownership holding in the entity is less than 20 per cent, the Group is judged to not have control over the entity. — Where the entity is managed by an asset manager outside the Group, an assessment is made of whether the Group has existing rights that gives it the ability to direct the current activities of the entity and therefore control the entity. In assessing the Group’s ability to direct an entity, the Group considers its ability relative to other investors. The Group has a limited number of OEICs and UTs where it considers it has such ability. 302 Prudential plc Annual Report 2016 www.prudential.co.ukWhere the Group is deemed to control these entities, they are treated as a subsidiary and are consolidated, with the interests of investors other than the Group being classified as liabilities, and appear as net asset value attributable to unit holders of consolidated unit trusts and similar funds. Where the Group does not control these entities (as it is deemed to be acting as an agent) and they do not meet the definition of associates, they are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position. Where the Group’s asset manager sets up OEICs and UTs as part of asset management operations, the Group’s interest is limited to the administration fees charged to manage the assets of such entities. With no participation in these entities, the Group does not retain risks associated with OEICs and UTs. For these open-ended investment companies and unit trusts, the Group is not deemed to control the entities but to be acting as an agent. The Group generates returns and retains the ownership risks in investment vehicles commensurate to its participation and does not have any further exposure to the residual risks of these investment vehicles. Jackson’s separate account assets These are investment vehicles that invest contract holders’ premiums in equity, fixed income, bonds and money market mutual funds. The contract holder retains the underlying returns and the ownership risks related to the underlying investments. The shareholder’s economic interest in separate accounts is limited to the administrative fees charged. The separate accounts are set up as separate regulated entities governed by a Board of Governors or trustees for which the majority of the members are independent of Jackson or any affiliated entity. The independent members are responsible for any decision making that impacts contract holders’ interest and govern the operational activities of the entities’ advisers, including asset managers. Accordingly, the Group does not control these vehicles. These investments are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position. Limited partnerships The Group’s insurance operations invest in a number of limited partnerships, either directly or through unit trusts, through a mix of capital and loans. These limited partnerships are managed by general partners, in which the Group holds equity. Such interest in general partners and limited partnerships provide the Group with voting and similar rights to participate in the governance framework of the relevant activities in which limited partnerships are engaged in. Accounting for the limited partnerships as subsidiaries, joint ventures, associates or other financial investments depends on the terms of each partnership agreement and the shareholdings in the general partners. Other structured entities The Group holds investments in mortgage-backed securities, collateralised debt obligations and similar asset-backed securities that are actively traded in a liquid market. The Group is not the sponsor of the vehicles in which it holds investments and has no administrative rights over the vehicles’ activities. The Group generates returns and retains the ownership risks commensurate to its holding and its exposure to the investments. Accordingly the Group does not have power over the relevant activities of such vehicles and all are carried at fair value through profit or loss within financial investments in the consolidated statement of financial position. The table below provides aggregate carrying amounts of the investments in unconsolidated structured entities reported in the Group’s statement of financial position: Statement of financial position line items Equity securities and portfolio holdings in unit trusts Debt securities Total 2016 £m 2015 £m OEICs/UTs Separate account assets Other structured entities OEICs/UTs Separate account assets Other structured entities 16,489 – 120,411 – – 12,220 16,489 120,411 12,220 12,945 – 12,945 91,022 – 91,022 – 11,735 11,735 The Group generates returns and retains the ownership risks in these investments commensurate to its participation and does not have any further exposure to the residual risks or losses of the investments or the vehicles in which it holds investments. As at 31 December 2016, the Group does not have an agreement, contractual or otherwise, or intention to provide financial support to structured entities that could expose the Group to a loss. 303 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsE1 Other significant accounting policies continued (b) 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. (c) Earned premiums, policy fees and claims paid Premiums 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 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 notified. (d) Investment return Investment return included in the income statement principally comprises interest income, dividends, investment appreciation/ depreciation (realised and unrealised gains and losses) on investments designated as fair value through profit or loss, and realised gains and losses (including impairment losses) on items held at amortised cost and Jackson’s debt securities designated as available-for-sale. Movements in unrealised appreciation/depreciation of Jackson’s debt securities designated as available-for-sale are recorded in other comprehensive income. Interest income is recognised as it accrues, taking into account the effective yield on investments. Dividends on equity securities are recognised on the ex-dividend date and rental income is recognised on an accrual basis. (e) Financial investments other than instruments classified as long-term business contracts (i) Investment classification The Group holds financial investments in accordance with IAS 39, whereby subject to specific criteria, financial instruments are required to be accounted for under one of the following categories: — Financial assets and liabilities at fair value through profit or loss – this comprises assets and liabilities designated by management as fair value through profit or 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; — Financial investments on an available-for-sale basis – this comprises assets that are designated by management as available-for-sale and/or do not fall into any of the other categories. These assets are initially recognised at fair value plus attributable transaction costs. — Available-for-sale assets are subsequently measured at fair value. Interest income is recognised on an effective interest basis in the income statement. 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. Except for foreign exchange gains and losses on debt securities, 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 — Loans and receivables – except for those designated as at fair value through profit or loss or available-for-sale, these instruments comprise non-quoted investments that have fixed or determinable payments. These instruments 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 instruments are carried at amortised cost using the effective interest method. The Group uses the trade date method to account for regular purchases and sales of financial assets. Where assets and liabilities have been valued at fair value or measured on a different basis but fair value is disclosed, the Group has followed the principles under IFRS 13 ‘Fair Value Measurement’. 304 Prudential plc Annual Report 2016 www.prudential.co.ukE Further accounting policiesContinued(ii) 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 Group does not regularly seek to apply fair value or cash flow hedging treatment under IAS 39. The Group has no fair value and cash flows hedges under IAS 39 at 31 December 2016 and 2015. All derivatives that are not designated as hedging instruments are carried at fair value, with movements in fair value being recorded 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 is used for the purposes of efficient portfolio management or reduction in investment risk. 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 their effect on shareholder results. Further details on this aspect of the Group’s financial reporting are described in note B1.2. (iii) Embedded derivatives Embedded derivatives are present in host contracts issued by various Group companies, in particular Jackson. They are embedded within other non-derivative host financial instruments and insurance contracts to create hybrid instruments. Embedded derivatives meeting the definition of an insurance contract are accounted for under IFRS 4. Where economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host instrument, and where the hybrid instrument is not measured at fair value with the changes in fair value recognised in the income statement, the embedded derivative is bifurcated and carried at fair value as a derivative in accordance with IAS 39. For Jackson’s ‘not for life’ Guaranteed Minimum Withdrawal Benefit and Fixed Index Annuity reserves the determination of fair value requires assumptions regarding future mix of Separate Account assets, equity volatility levels, and policyholder behaviour. In addition, the Group applies the option under 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 valuation basis for embedded derivatives attaching to Jackson’s life assurance contracts are provided in note C4.2. (iv) Securities lending and reverse repurchase agreements The Group is party to various securities lending agreements (including repurchase 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. The Group is also party to various reverse repurchase agreements under which securities are purchased from third parties with an obligation to resell the securities. The securities are not recognised as investments in the statement of financial position. (v) Derecognition of financial assets and liabilities The Group’s policy is to derecognise financial 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 specified in the contract is discharged, cancelled or has expired. (vi) Financial liabilities designated at fair value through profit or 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 classification certain financial liabilities at fair value through profit or 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. 305 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsE1 Other significant accounting policies continued (f) 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 identified 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). The products of the insurance operations contain both significant and insignificant levels 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 adviser, 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. Further information on the Group’s operating segments is provided in note B1.3. (g) 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. (h) Investment properties Investments in leasehold and freehold properties not for occupation by the Group, including properties under development for future use as investment properties, are carried at fair value, with changes in fair value included in the income statement. Properties are valued annually either by the Group’s qualified surveyors or by taking into consideration the advice of professional external valuers using the Royal Institution of Chartered Surveyors valuation standards. Each property is externally valued at least once every three years. Leases of investment property where the Group has substantially all the risks and rewards of ownership are classified 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. (i) 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 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 include several insurance contracts that have been issued by the Group. These assets are excluded from plan assets in determining the pension surplus or deficit recognised in the consolidated statement of financial position. The aggregate of the actuarially determined service costs of the currently employed personnel, and the net interest on the net defined benefit liability (asset) at the start of the period, is charged to the income statement. Actuarial and other gains and losses as a result of changes in assumptions or experience variances are recognised as other comprehensive income. Contributions to the Group’s defined contribution schemes are expensed when due. (j) Share-based payments and related movements in own shares 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. 306 Prudential plc Annual Report 2016 www.prudential.co.ukE Further accounting policiesContinued(k) Tax Current tax expense is charged or credited based upon amounts estimated to be payable or recoverable as a result of taxable amounts for the current year and adjustments made in relation to prior years. Prudential is subject to tax in numerous jurisdictions and the calculation of the total tax charge inherently involves a degree of estimation and judgement. The positions taken in tax returns where applicable tax regulation is subject to interpretation are recognised in full in the determination of the tax charge in the financial statements if the Group considers that it is probable that the taxation authority will accept those positions. Otherwise, provisions are established based on management’s estimate and judgement of the likely amount of the liability, or recovery by providing for the single best estimate of the most likely outcome or the weighted average expected value where there are multiple outcomes. The total tax charge includes tax expense attributable to both policyholders and shareholders. The tax expense attributable to policyholders comprises the tax on the income of the consolidated with-profits and unit-linked funds. In certain jurisdictions, such as the UK, life insurance companies are taxed on both their shareholders’ profits and on their policyholders’ insurance and investment returns on certain insurance and investment products. 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 consolidated income statement to provide the most relevant information about tax that the Group pays on its profits. Deferred taxes are provided under the liability method for all relevant temporary differences. IAS 12 ‘Income Taxes’ does not require all temporary differences to be provided for, in particular, the Group does not provide for deferred tax on undistributed earnings of subsidiaries where the Group is able to control the timing of the distribution and the temporary difference created is not expected to reverse in the foreseeable future. Deferred tax assets are only recognised when it is more likely than not that future taxable profits will be available against which these losses can be utilised. 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. (l) Business acquisitions and disposals Business acquisitions are accounted for by applying the purchase method of accounting, which adjusts the net assets of the acquired 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. Income and expenses of entities sold during the period are included in the income statement up to the date of disposal. The gain or loss on disposal is calculated as the difference between sale proceeds net of selling costs, less the net assets of the entity at the date of disposal, adjusted for foreign exchange movements attaching to the sold entity that are required to be recycled to the income statement under IAS 21. (m) 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. (n) Intangible assets Intangible assets acquired on the purchase of a subsidiary or portfolio of contracts are measured at fair value on acquisition. Deferred acquisition costs are accounted for as described in notes A3.1(d) and A3.1(f) above. Other intangible assets, such as distribution rights and software, are valued initially at the price paid to acquire them and are subsequently carried at cost less amortisation and any accumulated impairment losses. Distribution rights relate to fees paid under bancassurance partnership arrangements for bank distribution of products for the term of the contract. Amounts for distribution rights are amortised on a basis to reflect the pattern in which the future economic benefits are expected to be consumed by reference to new business production levels. The same principles apply to determining the amortisation method for other intangible assets unless the pattern cannot be determined reliably, in which case a straight line method is applied. Amortisation of intangible assets is charged to the ‘acquisition costs and other expenditure’ line in the consolidated income statement. (o) 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. (p) 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. 307 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsE1 Other significant accounting policies continued (q) 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. (r) Foreign exchange 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 of foreign subsidiaries are converted at year end exchange rates while 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 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 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. (s) 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 OEICs, which are treated as cancelled. For diluted earnings per share, the weighted average number of shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Group’s only class of potentially dilutive ordinary shares are those share options granted to employees where the exercise price is less than the average market price of the Company’s ordinary shares during the year. No adjustment is made if the impact is anti-dilutive overall. 308 Prudential plc Annual Report 2016 www.prudential.co.ukE Further accounting policiesContinuedStatement of financial position of the parent company 31 December Fixed assets Shares in subsidiary undertakings Current assets Debtors: Amounts owed by subsidiary undertakings Other debtors Tax recoverable Derivative assets Pension asset Cash at bank and in hand Liabilities: amounts falling due within one year Commercial paper Other borrowings Derivative liabilities Amounts owed to subsidiary undertakings Tax payable Deferred tax liability Accruals and deferred income Net current assets Total assets less current liabilities Liabilities: amounts falling due after more than one year Subordinated liabilities Debenture loans Other borrowings Total net assets Capital and reserves Share capital Share premium Profit and loss account Shareholders’ funds Profit for the year Note 2016 £m 2015 £m 5 6 7 8 8 6 9 8 8 8 10 10 11 10,859 12,514 5,798 11 44 4 48 24 5,929 (1,052) – (447) (773) (10) (9) (72) (2,363) 3,566 14,425 (5,772) (549) (599) (6,920) 7,505 129 1,927 5,449 7,505 4,783 3 43 1 51 104 4,985 (1,107) (200) (322) (2,711) (20) (9) (56) (4,425) 560 13,074 (4,018) (549) (598) (5,165) 7,909 128 1,915 5,866 7,909 840 920 The financial statements of the parent company on pages 309 to 317 were approved by the Board of Directors on 13 March 2017 and signed on its behalf. Paul Manduca Chairman Mike Wells Group Chief Executive Nic Nicandrou Chief Financial Officer 309 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsStatement of changes in equity of the parent company Share capital £m 128 Share premium £m Profit and loss account £m 1,908 5,909 Total equity £m 7,945 920 4 924 7 7 (974) (960) – – – 7 – – 7 920 4 924 – 7 (974) (967) 1,915 5,866 7,909 1,915 5,866 7,909 – – – 12 – – 12 840 4 844 – 6 (1,267) (1,261) 5,449 840 4 844 13 6 (1,267) (1,248) 7,505 129 1,927 – – – – – – – 128 128 – – – 1 – – 1 Balance at 1 January 2015 Total comprehensive income for the year Profit for the year Actuarial gains recognised in respect of the defined benefit pension scheme Total comprehensive income for the year Transactions with owners, recorded directly in equity New share capital subscribed Share based payment transactions Dividends Total contributions by and distributions to owners Balance at 31 December 2015 Balance at 1 January 2016 Total comprehensive income for the year Profit for the year Actuarial gains recognised in respect of the defined benefit pension scheme Total comprehensive income for the year Transactions with owners, recorded directly in equity New share capital subscribed Share based payment transactions Dividends Total contributions by and distributions to owners Balance at 31 December 2016 310 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the parent company financial 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 international financial services group with its principal operations in Asia, the US and the UK. In Asia, the Group has operations in Hong Kong, Indonesia, Malaysia, Singapore and other 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 and M&G Investment Management Limited. 2 Basis of preparation The financial statements of the Company, which comprise the statement of financial position, statement of changes in equity and related notes, are prepared in accordance with UK Generally Accepted Accounting Practice, including Financial Reporting Standard 101 Reduced Disclosure Framework (‘FRS 101’) and Part 15 of the Companies Act 2006. In preparing these financial statements, the Company applies the recognition, measurement and disclosure requirements in International Financial Reporting Standards (‘IFRS’) as issued by the International Accounting Standards Board (‘IASB’) and endorsed by the EU, but makes amendments where necessary in order to comply with the Companies Act 2006 and has set out below where advantage of the FRS 101 disclosure exemptions has been taken. The Company has also taken advantage of the exemption under Section 408 of the Companies Act 2006 from presenting its own profit and loss account. In these financial statements, the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: — A cash flow statement and related notes; — Disclosures in respect of transactions with wholly-owned subsidiaries within the Prudential Group; — Disclosure in respect of capital management; and — The effects of new but not yet effective IFRSs. As the consolidated financial statements of the Group include the equivalent disclosure, the Company has also applied the exemptions available under FRS 101 in respect of the following disclosures: — IFRS 2 ‘Share Based Payments’ in respect of Group-settled share-based payments; and — Disclosure required by IFRS 7 ‘Financial Instrument Disclosures’ and IFRS 13 ‘Fair Value Measurement’. The accounting policies set out in note 3 below have, unless otherwise stated, been applied consistently to all periods presented in these financial statements. 3 Significant accounting policies Shares in subsidiary undertakings Shares in subsidiary undertakings are shown at cost less impairment. Amounts owed by subsidiary undertakings Amounts owed by subsidiary undertakings are shown at cost, less provisions. Derivatives Derivative financial instruments are held to manage certain macro-economic exposures. Derivative financial instruments are carried at fair value with changes in fair value included in the profit and loss account. 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 subordinated debt, over the expected life of the instrument. Dividends Interim dividends are recorded in the period in which they are paid. 311 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsNotes on the parent company financial statements Continued 3 Significant accounting policies continued 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. Foreign currency translation Assets and liabilities denominated in foreign currencies, including 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. Tax Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable amounts 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 IAS 12, ’Income Taxes’. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that future taxable profits will be available against which these losses can be utilised. Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, using tax rates enacted or substantively enacted at the reporting date. 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’). The Company applies the requirements of IAS 19 ‘Employee Benefits’ (as revised in 2011) for the accounting of its interest in the PSPS surplus or deficit. Further details are disclosed in note 7. 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 their present value. These calculations are performed by independent actuaries. The aggregate of the actuarially determined service costs of the currently employed personnel and the net income (interest) on the net scheme assets (liabilities) at the start of the period, is recognised in the profit or loss account. Actuarial gains and losses as a result of the changes in assumptions, experience variances or the return on scheme assets excluding amounts included in the net deferred benefit asset (liability) are recorded in other comprehensive income. Share-based payments The Group offers share award and option plans for certain key employees and a Save As You Earn (‘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. Under IFRS 2 ‘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 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. 312 Prudential plc Annual Report 2016 www.prudential.co.uk4 Reconciliation from the FRS 101 parent company results to the IFRS Group results The parent company financial statements are prepared in accordance with FRS 101 and the Group financial statements are prepared in accordance with IFRS as issued by the IASB and endorsed by the EU. At 31 December 2016, there were no differences between FRS 101 and IFRS as issued by the IASB and endorsed by the EU in terms of their application to the parent company. The tables below provide a reconciliation between the FRS 101 parent company results and the IFRS Group results. Profit after tax Profit for the financial year of the Company (including dividends from subsidiaries) in accordance with FRS 101 and IFRS Share in the IFRS result of the Group, net of distributions to the Company* Profit after tax of the Group attributable to shareholders in accordance with IFRS Net equity Shareholders’ equity of the Company in accordance with FRS 101 and IFRS Share in the IFRS net equity of the Group* Shareholders’ equity of the Group in accordance with IFRS 2016 £m 2015 £m 840 1,081 1,921 920 1,659 2,579 2016 £m 2015 £m 7,505 7,161 7,909 5,046 14,666 12,955 * The ‘share in the IFRS result and net equity of the Group’ lines represent the parent company’s equity in the earnings and net assets of its subsidiaries and associates. The profit for the financial year of the Company in accordance with IFRS includes dividends received in the year from subsidiary undertakings of £1,318 million and £985 million for the years ended 31 December 2016 and 2015, respectively. As stated in note 3, under FRS 101, the Company accounts for its investments in subsidiary undertakings at cost less impairment. For the purpose of this reconciliation, no adjustment is made to the Company in respect of any valuation adjustments to shares in subsidiary undertakings that would be eliminated on consolidation. 5 Shares in subsidiary undertakings At 1 January Liquidation of subsidiary undertaking Other movements At 31 December 2016 £m 12,514 (1,600) (55) 10,859 The liquidation related to a central finance subsidiary in order to simplify the Group’s corporate structure. Other movements comprise £6 million in respect of share-based payments, reflecting the value of payments settled by the Company for employees of its subsidiary undertakings, less £61 million relating to cash received from subsidiaries in respect of share awards. Subsidiary undertakings of the Company at 31 December 2016 are listed in note D6 of the Group financial statements. 6 Derivative financial instruments Cross-currency swap Inflation-linked swap Total 2016 £m 2015 £m Fair value assets Fair value liabilities Fair value assets Fair value liabilities 4 – 4 – 447 447 1 – 1 – 322 322 Derivative financial instruments are held to manage certain macro-economic exposures. The change in fair value of the derivative financial instruments of the Company was a loss before tax of £122 million (2015: £7 million). 313 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsNotes on the parent company financial statements Continued 7 Pension scheme financial 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 defined benefit scheme. At 31 December 2005, the allocation of surpluses and deficits attaching to the Scheme between the Company and the unallocated surplus of 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 2016. The IAS 19 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 2014. Further details on the results of this valuation and the total employer contributions to the Scheme for the year are provided in note C9 of the Group financial statements, together with the key assumptions adopted, including mortality assumptions. A description of the regulatory framework in which the Scheme operates, the governance of the Scheme, and the risks to which the Scheme exposes the Company is provided in note C9. The most recent full valuation has been updated to 31 December 2016, applying the principles prescribed by IAS 19. The actuarial assumptions used in determining the IAS 19 benefit obligations and the net periodic costs and sensitivity of IAS 19 benefit obligations to changes in the actuarial assumptions are also provided in note C9. The assets and liabilities of the Scheme were: Scheme assets: Equities UK Overseas Bonds* Government Corporate Asset-backed securities Properties Derivatives Other assets Fair value of Scheme assets Present value of benefit obligations Underlying surplus in the Scheme Effect of the application of IFRIC 14 for de-recognition of surplus Surplus in the Scheme Surplus in the Scheme recognised by the Company† 31 Dec 2016 £m 31 Dec 2015 £m Quoted prices in an active market Other Total Quoted prices in an active market Other Total 7 284 5,411 1,125 142 – 252 269 7,490 11 9 – 44 2 71 – – 137 18 293 5,411 1,169 144 71 252 269 7,627 (6,910) 717 (558) 159 48 118 150 4,795 925 135 – 183 272 6,578 8 – – 45 – 70 – 26 149 126 150 4,795 970 135 70 183 298 6,727 (5,758) 969 (800) 169 51 * 96 per cent (2015: 96 per cent) of the bonds are investment graded. † The surplus in the Scheme recognised in the balance sheet of the Company represents the amount that is recoverable through reduced future contributions and is net of the apportionment to the PAC with-profits fund. 314 Prudential plc Annual Report 2016 www.prudential.co.ukThe changes in the fair value of the underlying Scheme assets and the present value of the underlying benefit obligations are as follows: Balance at 1 January Current service cost Net interest income (cost) Administration expenses Actuarial gains (losses) note (ii) Contributions paid by the employer note (iii) Contributions paid by the employee Benefits paid Balance at 31 December Balance at 1 January Current service cost Negative past service cost Net interest income (cost) Administration expenses Actuarial gains (losses)note (ii) Contributions paid by the employer note (iii) Contributions paid by the employee Benefits paid Balance at 31 December Fair value of Scheme assets Present value of benefit obligations note (i) 6,727 – 250 (4) 949 11 1 (307) 7,627 (5,758) (19) (213) – (1,226) – (1) 307 (6,910) 2016 £m Net surplus without the effect of IFRIC 14 Effect of IFRIC 14 for derecognition of surplus IAS 19 basis net surplus 969 (19) 37 (4) (277) 11 – – 717 (800) – (32) – 274 – – – (558) 169 (19) 5 (4) (3) 11 – – 159 Fair value of Scheme assets Present value of benefit obligations note (i) 2015 £m Net surplus without the effect of IFRIC 14 Effect of IFRIC 14 for derecognition of surplus IAS 19 basis net surplus 6,997 – – 240 (4) (248) 11 1 (270) 6,727 (6,157) (21) 48 (209) – 312 – (1) 270 (5,758) 840 (21) 48 31 (4) 64 11 – – 969 (710) – – (26) – (64) – – – (800) 130 (21) 48 5 (4) – 11 – – 169 Notes (i) The weighted average duration of the benefit obligations of the Scheme is 18 years (2015: 17 years). The following table provides an expected maturity analysis of the benefit obligations as at 31 December: £m 2016 2015 1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years 227 225 1,013 974 1,439 1,422 1,474 1,489 1,407 1,438 5,930 6,303 Total 11,490 11,851 (ii) The actuarial gains attributable to policyholders and shareholders are analysed as follows: Return on Scheme assets excluding interest income* Actuarial gains (losses) Experience gains on Scheme liabilities Actuarial losses – demographic assumptions Actuarial (losses) gains – financial assumptions Total actuarial gains without the effect of IFRIC 14 Actuarial gains attributable to the Company before tax† 2016 £m 2015 £m 949 (248) 87 (32) (1,281) (1,226) (277) 4 28 (3) 287 312 64 4 * The total return on Scheme assets in 2016 was a gain of £1,199 million (2015: loss of £8 million). † Actuarial gains 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 2016, the gains included a credit of £87 million (2015: charge of £15 million) for the adjustment to the unrecognised portion of surplus. The gains after tax of £4 million (2015: £4 million) are recorded in other comprehensive income. (iii) Employer contributions to be paid into the Scheme for the year ending 31 December 2017 are expected to amount to £11 million, comprising ongoing service contributions and expenses. 315 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statements Notes on the parent company financial statements Continued 8 Borrowings Core structural borrowings note (i) Subordinated liabilities note (ii) Debenture loans Other borrowings: note (iii) Commercial paper Floating Rate Notes note (iv) Medium Term Notes 2018 Total borrowings Borrowings are repayable as follows: Within 1 year Between 1 and 5 years After 5 years Core structural borrowings Other borrowings Total 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m 5,772 549 6,321 – – – 4,018 549 4,567 – – – 6,321 4,567 – – 6,321 6,321 – – 4,567 4,567 – – – 1,052 – 599 1,651 1,052 599 – 1,651 – – – 1,107 200 598 1,905 1,307 598 – 1,905 5,772 549 6,321 1,052 – 599 7,972 1,052 599 6,321 7,972 4,018 549 4,567 1,107 200 598 6,472 1,307 598 4,567 6,472 Notes (i) (ii) (iii) (iv) Further details on the core structural borrowings of the Company are provided in note C6.1 of the Group financial statements. The interests of the holders of the subordinated liabilities are subordinate to the entitlements of other creditors of the Company. These borrowings support a short-term fixed income securities programme. The Floating Rate Notes matured in October 2016. 9 Deferred tax liability Deferred tax liability Short-term temporary differences related to pension scheme Total 2016 £m 2015 £m (9) (9) (9) (9) The reduction in the UK corporation tax rate to 17 per cent from 1 April 2020 was substantively enacted on 6 September 2016 and does not have a material impact on the financial statements for the year ended 31 December 2016. 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 2016 is set out in note C10 of the Group financial statements. 11 Retained profit of the Company Retained profit at 31 December 2016 amounted to £5,449 million (2015: £5,866 million). The retained profit includes distributable reserves of £2,962 million and non-distributable reserves of £2,487 million. The non-distributable reserves comprise £2,405 million relating to gains made by intermediate holding companies following the transfer at fair value of certain subsidiaries to other parts of the Group as part of internal restructuring exercises and £82 million of share-based payment reserves. The amount of £2,405 million is not able to be regarded as part of the distributable reserves of the parent company because the gains relate to intragroup transactions. Under English company law, Prudential may pay dividends only if sufficient 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 non-distributable reserves (such as the share premium account) and the payment of the dividend does not reduce the amount of its net assets to less than that aggregate. 316 Prudential plc Annual Report 2016 www.prudential.co.uk12 Other information a b c d e Information on directors’ remuneration is given in the directors’ remuneration report section of this Annual Report and note B3.3 of the Group financial statements. Information on transactions of the directors with the Group is given in note D4 of the Group financial statements. The Company employs no staff. Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2015: £0.1 million) and for other services were £0.1 million (2015: £0.2 million). In certain instances, the Company has guaranteed that its subsidiaries will meet their obligations when they fall due for payment. 13 Post balance sheet events The second interim ordinary dividend for the year ended 31 December 2016, which was approved by the Board of Directors after 31 December 2016, is described in note B7 of the Group financial statements. 317 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsStatement of Directors’ responsibilities in respect of the Annual Report and the financial statements The Directors are responsible for preparing the Annual Report and the Group and parent company financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and parent company financial statements for each financial year. Under that law the Directors are required to prepare the Group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU) and applicable law and have elected to prepare the parent company financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice) including FRS 101 Reduced Disclosure Framework. Under company law the Directors must not approve the financial 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 company financial 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 Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; — For the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and — Prepare the financial 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 the financial position of the parent company and enable them to ensure that its financial 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 strategic report, 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 and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. The Directors of Prudential plc, whose names and positions are set out on pages 77 to 81 confirm that to the best of their knowledge: — The financial 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; — The strategic 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; and — The Annual Report and financial statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy. 318 Prudential plc Annual Report 2016 www.prudential.co.ukIndependent auditor’s report to the members of Prudential plc 1 Our opinion on the financial statements is unmodified We have audited the financial statements of Prudential plc for the year ended 31 December 2016 set out on pages 161 to 317. 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 2016 and of the Group’s profit for the year then ended; — The Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union; — The parent company financial statements have been properly prepared in accordance with UK Accounting Standards including FRS 101 Reduced Disclosure Framework; and — The financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. 2 Our assessment of risks of material misstatement In arriving at our audit opinion on the financial statements, the risks of material misstatement, in decreasing order of audit significance, that had the greatest effect on our audit, which are unchanged from 2015 were as follows: Policyholder liabilities (2016: £388,996 million, 2015: £322,518 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 168 (accounting policy) and pages 229 to 250 (financial disclosures) The risk The Group has significant policyholder liabilities representing 85 per cent of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long term policyholder liabilities. Economic assumptions, including investment return, credit risk and associated discount rates, and operating assumptions including mortality, morbidity, expenses and persistency (including consideration of policyholder behaviour) are the key inputs used to estimate these long term liabilities. Additionally: — In the US, the valuation of the guarantees in the variable annuity business is a complex exercise as it involves exercising significant judgement over the relationship between the investment return attaching to these products and the guarantees contractually provided to policyholders and the likely policyholder behaviour in response to changes in investment performance. — In the UK, the valuation of the policyholder liabilities in relation to the annuity business requires the exercise of significant judgement over the setting of mortality and credit risk assumptions. Our response We used our own actuarial specialists to assist us in performing our procedures in this area. Key procedures included assessing the Group’s methodology for calculating the policyholder liabilities and their analysis of the movements in policyholder liabilities during the year, including consideration of whether the movements are in line with the assumptions adopted by the Group, our understanding of developments in the business and our expectation derived from market experience. Our procedures in the US included: — Considering the appropriateness of the assumptions used in the stochastic models for the valuation of the variable annuity guarantees. — Assessing assumptions for investment mix and projected investment returns by reference to company specific and industry data and for future growth rates by reference to market trends and market volatility. — Assessment of assumptions of policyholder behaviour, including consideration against relevant company and industry historical data. Our procedures in the UK included: — Considering the appropriateness of the mortality assumptions used in the valuation of the annuity liabilities by reference to company and industry data on historical mortality experience and expectations of future mortality improvements, including evaluation of the choice of the Continuous Mortality Investigation (‘CMI’) model and the parameters used in relation to this. — Considering the appropriateness of the credit risk methodology and assumptions by reference to industry practice and our expectation derived from market experience. We utilised the results of KPMG benchmarking of assumptions and actuarial market practice to inform our challenge of management’s assumptions in both areas noted above. Our work on the policyholder liability adequacy test included assessing the reasonableness of the projected cash flows and challenging the assumptions adopted in the context of company and industry experience data and specific product features. We also performed test work to ensure the appropriateness of changes made to the policyholder liability reserving models during the year. We considered whether the Group’s disclosures in relation to the assumptions used in the calculation of policyholder liabilities are compliant with the relevant accounting requirements and appropriately represent the sensitivities of these assumptions to alternative scenarios and inputs. 319 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsIndependent auditor’s report to the members of Prudential plc Continued Valuation of investments (2016: £421,688 million, 2015: £351,979 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 174 (accounting policy) and pages 209 to 228 (financial disclosures) The risk The Group’s investment portfolio represents 90 per cent of the Group’s total assets. The valuation of the portfolio involves judgement in selecting the valuation basis for each investment and further judgement in determining the appropriate valuation for harder to value investments. The areas that involved significant audit effort and judgement in 2016 were the valuation of illiquid positions within the financial investments portfolio representing 2 per cent of the Group’s total assets. These included unlisted equity, unlisted debt securities, certain derivatives and loans such as commercial mortgage loans and bridge loans. For these positions a reliable third party price was not readily available and therefore involved the application of expert judgement in the valuations adopted. Our response We used our own valuation specialists and pricing services to assist us in performing our procedures in this area. Our procedures included: — Assessing the availability of quoted prices in liquid markets; — Assessing whether the valuation process is appropriately designed and captures relevant valuation inputs; — Testing whether associated controls in respect of the valuation process are operating properly; — Performing our own independent price checks from our own pricing services using external quotes for liquid positions and, where available, for illiquid positions; — Assessing pricing model methodologies and assumptions against industry practice and valuation guidelines; — Evaluating the valuation assessment performed by the Group in order to identify any potential impairment in relation to loans; and — Performing our own assessment of loan files to understand the performance of the loans. We examined the existing and prospective investee company cash flows in order to evaluate whether loans can be serviced or refinancing may be required and considered the impact on impairment testing performed. We also assessed whether the Group’s disclosures in relation to the valuation of investments are compliant with the relevant accounting requirements and appropriately presents the sensitivities in the valuations based on alternative outcomes. Deferred acquisition costs (‘DAC’) (2016: £9,178 million, 2015: £7,022 million), the risk compared to the prior year is unchanged. Refer to page 95 (Audit Committee report), page 172 (accounting policy) and pages 252 to 254 (financial disclosures) The risk DAC represents 2 per cent of the Group’s total assets and involves judgements in the identification of the acquisition costs that may be deferred, the appropriateness of the deferral methodology adopted and the assessment of the recoverability of the asset. The DAC associated with the US business, which represents 90 per cent of the total DAC, involves the greatest judgement in terms of measurement and recoverability. The amortisation and recoverability assessment of the US DAC asset is related to the achieved and projected future profit profile. This involves making assumptions about future investment returns and the consequential impact on fee income. Our response We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included — Evaluating the appropriateness of the Group’s deferral policy by comparing it against the requirements of relevant accounting standards; — Evaluating whether costs incurred are deferred in accordance with the Group’s deferral policy; and — Assessing the calculations performed including the appropriateness of the assumptions used in determining the estimated future profit profile and the extent of the associated adjustment necessary to the amortisation of the DAC asset. We compared the estimated future profits to the carrying value of the DAC asset to assess recoverability. Our work included assessing the reasonableness of assumptions such as the projected investment return by comparing against the Group’s investment portfolio mix and market return data. We also considered the adequacy of the Group’s disclosures about the degree of estimation involved in the valuation of DAC. 320 Prudential plc Annual Report 2016 www.prudential.co.uk3 Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £350 million (2015: £350 million) determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 2.4 per cent (2015: 2.7 per cent)). We consider IFRS shareholders’ equity to be the most appropriate benchmark as it represents the residual interest that can be ascribed to shareholders after policyholder assets and corresponding liabilities have been accounted for. We compared our materiality against other relevant benchmarks, such as total assets, total revenue and profit before tax to ensure the materiality selected was appropriate for our audit. We set out below the materiality thresholds that are key to the audit. IFRS shareholders’ equity £14.67bn Materiality Full scope audits for Group reporting purposes in relation to the financial information of: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, and Thailand; and the fund management operations of M&G and Eastspring Singapore (new in scope for 2016). Audits of account balances that correspond to the risks of material misstatement identified above in relation to Prudential Capital and the insurance operations in Korea (full scope audit in 2015), China, Taiwan and Vietnam. The account balances audited are policyholder liabilities, investments, and deferred acquisition costs. For the remaining operations, we performed analysis at an aggregated Group level to re-examine our assessment that there were no significant risks of material misstatement within these operations. These components accounted for the following percentages of the Group’s results: Group revenue 8% 3% £350m £80-£186m £18m Threshold for misstatements reported to the Audit Committee Range of component materialities Materiality for the Group financial statements We report to the Group Audit Committee any corrected or uncorrected identified misstatements exceeding £18 million (2015: £18 million) in addition to other identified misstatements that warrant reporting on qualitative grounds. We subjected the Group’s operations to audits for Group reporting purposes as follows: 89% Audit for Group reporting (2015: 90%) Audit of account balances (2015: 2%) Analysis at Group level (2015: 8%) Group profit before tax 6% 4% 90% Audit for Group reporting (2015: 90%) Audit of account balances (2015: 2%) Analysis at Group level (2015: 8%) Group total assets 10% 3% 87% Audit for Group reporting (2015: 91%) Audit of account balances (2015: 2%) Analysis at Group level (2015: 7%) Group shareholders’ equity 6% 4% 90% Audit for Group reporting (2015: 89%) Audit of account balances (2015: 3%) Analysis at Group level (2015: 8%) The Group audit team in the UK covered the UK Group Head office operations. Component auditors performed the audit work in the remaining locations. The Group audit team held a global planning conference with component auditors to identify audit risks and decide how each component team should address the identified audit risks. The Group audit team instructed component auditors as to the significant areas to be covered, including the relevant risks detailed above and the information to be reported back. The Group audit team approved the component materialities. These were set as £146 million for key reporting components in Asia, other than Eastspring Singapore which was set as £80 million, and £186 million for all other key reporting components (2015: £146 million - £186 million), having regard to the size and risk profile of the Group. The Group audit team visited ten component locations, comprising: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia and Thailand; the fund management operations in M&G and Eastspring Singapore; and 321 www.prudential.co.ukAnnualReport2016 Prudential plc 05 Financial statementsIndependent auditor’s report to the members of Prudential plc Continued We have nothing to report in respect of the above responsibilities. 7 Scope of report and responsibilities As explained more fully in the Directors’ Responsibilities Statement set out on page 318, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/ auditscopeukco2014a which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions. Rees Aronson (Senior Statutory Auditor) For and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants London 13 March 2017 Prudential Capital. Video and telephone conference meetings were also held with these component auditors and certain others that were not physically visited. At these visits and meetings, an assessment was made of audit risk and strategy, the findings reported to the Group audit team were discussed in more detail, key working papers were reviewed and any further work required by the Group audit team was then performed by the component auditor. The Senior Statutory Auditor, in conjunction with other senior staff in the Group team, also regularly attended Business Unit audit committee meetings (at a regional level for Asia) and participated in meetings with local management to obtain additional understanding first hand of the key risks and audit issues at a component level which may affect the Group financial statements. 4 Our opinion on other matters prescribed by the Companies Act 2006 is unmodified In our opinion: — The part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and — The information given in the Strategic Report and the Directors’ Report for the financial year is consistent with the financial statements. Based solely on the work required to be undertaken in the course of the audit of the financial statements and from reading the Strategic Report and the Directors’ Report: — We have not identified material misstatements in those reports; and — In our opinion, those reports have been prepared in accordance with the Companies Act 2006. 5 We have nothing to report on the disclosures of principal risks Based on the knowledge we acquired during our audit, we have nothing material to add or draw attention to in relation to: — The Directors’ viability statement on page 60, concerning the principal risks, their management, and, based on that, the Directors’ assessment and expectations of the Group’s continuing in operation over the three years to 2019; or — The disclosures on page 106 of the Annual Report concerning the use of the going concern basis of accounting. 322 6 We have nothing to report in respect of the matters on which we are required to report by exception Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading. In particular, we are required to report to you if: — We have identified material inconsistencies between the knowledge we acquired during our audit and the Directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy; or — The Audit Committee Report does not appropriately address matters communicated by us to the audit committee. 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’ statements, set out on pages 106 and 60, in relation to going concern and longer-term viability; and — The part of the Corporate Governance Statement on page 106 relating to the company’s compliance with the eleven provisions of the 2014 UK Corporate Governance Code specified for our review. Prudential plc Annual Report 2016 www.prudential.co.uk06 European Embedded Value (EEV) basis results 324 Index to EEV basis results 06 European Embedded Value (EEV) basis resultsIndex to European Embedded Value (EEV) basis results Post-tax operating profit based on longer-term investment returns Post-tax summarised consolidated income statement 325 326 327 Movement in shareholders’ equity 328 Summary statement of financial position Notes on the EEV basis results 1 Basis of preparation 329 2 Effect of Solvency II implementation on EEV basis results 329 on 1 January 2016 329 332 333 335 337 338 338 340 3 Results analysis by business area 4 Analysis of new business contribution 5 Operating profit from business in force 6 Short-term fluctuations in investment returns 7 Effect of changes in economic assumptions 8 Net core structural borrowings of shareholder-financed operations 9 Reconciliation of movement in shareholders’ equity 10 Analysis of movement in net worth and value of in-force for long-term business 342 345 11 Analysis of movement in free surplus 12 Expected transfer of value of in-force business and required capital to free surplus 346 348 354 358 360 13 Sensitivity of results to alternative assumptions 14 Methodology and accounting presentation 15 Assumptions 16 New business premiums and contributions 17 Agreement to sell Korea life business Description of EEV basis reporting In broad terms, IFRS profit for long-term business reflects the aggregate of results on a traditional accounting basis. By contrast, EEV is a way of reporting the value of the life insurance business. The EEV basis results have been prepared in accordance with the amended EEV Principles dated April 2016, prepared by the CFO Forum of major European insurers. The 2016 results for UK insurance operations have been prepared to reflect the Solvency II regime. The 2015 results for UK insurance operations were prepared reflecting the Solvency I basis, being the regime applicable for the year. There is no change to the basis of preparation for Asia and US operations. The EEV Principles provide consistent definitions, a framework for setting actuarial assumptions, and an approach to the underlying methodology and disclosures. Results prepared under the EEV Principles capture the discounted value of future profits expected to arise from the current book of long-term business. The results are prepared by projecting cash flows, by product, using best estimate assumptions for all relevant factors. Furthermore, in determining these expected profits, full allowance is made for the risks attached to their emergence and the associated cost of capital, taking into account recent experience in assessing likely future persistency, mortality, morbidity and expenses. Further details are explained in notes 14 and 15. 324 Prudential plc Annual Report 2016 www.prudential.co.ukEuropean Embedded Value (EEV) basis results Post-tax operating profit based on longer-term investment returns Results analysis by business area Asia operations New business Business in force Long-term business Eastspring Investments Total US operations New business Business in force Long-term business Broker-dealer and asset management Total UK operations note (iv) New business: note (v) Excluding UK bulk annuities UK bulk annuities Business in force Long-term business General insurance commission Total UK insurance operations M&G Prudential Capital Total Other income and expenditure note (i) Solvency II and restructuring costs note (ii) Interest received from tax settlement Operating profit based on longer-term investment returns Analysed as profit (loss) from: New business: note (v) Excluding UK bulk annuities UK bulk annuities Business in force Long-term business Asset management and general insurance commission Other results Note 2016 £m 2015 £m notes (iii),(vi) 4 5 4 5 4 5 4 5 2,030 1,044 3,074 125 3,199 790 1,181 1,971 (3) 1,968 268 – 268 375 643 23 666 341 22 1,482 798 2,280 101 2,381 809 999 1,808 7 1,815 201 117 318 545 863 22 885 358 18 1,029 1,261 (679) (57) 37 (566) (51) – 5,497 4,840 3,088 – 3,088 2,600 5,688 508 (699) 5,497 2,492 117 2,609 2,342 4,951 506 (617) 4,840 Notes (i) (ii) (iii) (iv) (v) (vi) EEV basis other income and expenditure represents the post-tax IFRS basis result less the unwind of expected margins on the internal management of the assets of the covered business (as explained in note 14(a)(vii)). Solvency II and restructuring costs comprise the net-of-tax charge recognised on an IFRS basis and the additional amount recognised on an EEV basis for the shareholders’ share incurred by the PAC with-profits fund. The comparative results have been prepared using previously reported average exchange rates for the year. The EEV basis results have been prepared in accordance with the amended EEV Principles dated April 2016, prepared by the CFO Forum of major European insurers. The 2016 results for UK insurance operations have been prepared to reflect the Solvency II regime. The 2015 results for UK insurance operations were prepared reflecting the Solvency I basis being the regime applicable for the year. There is no change to the basis of preparation for Asia and US operations. Following Prudential’s withdrawal from the UK bulk annuity market, the 2015 comparative results for UK bulk annuities new business have been presented separately. The Group agreed in November 2016 to sell, subject to regulatory approval, its life business in Korea. Accordingly, the presentation of the 2015 comparative EEV basis results and related notes have been adjusted from those previously published for the reclassification of the result attributable to the held for sale Korea life business, as described in note 17. This approach has been adopted consistently throughout this supplementary information. 325 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results Post-tax summarised consolidated income statement Asia operations US operations UK operations† Other income and expenditure Solvency II and restructuring costs Interest received on tax settlement Operating profit based on longer-term investment returns Short-term fluctuations in investment returns Effect of changes in economic assumptions Mark to market value movements on core borrowings Loss attaching to the held for sale Korea life business Total non-operating results Profit for the year attributable to equity holders of the Company Note 2016 £m 2015*£m 3,199 1,968 1,029 (679) (57) 37 5,497 (507) (60) (4) (410) (981) 4,516 2,381 1,815 1,261 (566) (51) – 4,840 (1,215) 66 221 39 (889) 3,951 6 7 17 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. Basic earnings per share Based on post-tax operating profit including longer-term investment returns (in pence)* Based on post-tax profit attributable to equity holders of the Company (in pence) Average number of shares (millions) 2016 214.7p 176.4p 2,560 2015 189.6p 154.8p 2,553 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). 326 Prudential plc Annual Report 2016 www.prudential.co.ukEuropean Embedded Value (EEV) basis resultsContinuedMovement in shareholders’ equity Profit for the year attributable to equity shareholders Items taken directly to equity: Exchange movements on foreign operations and net investment hedges External dividends Mark to market value movements on Jackson assets backing surplus and required capital Other movements Net increase in shareholders’ equity Shareholders’ equity at beginning of year As previously reported Effect of implementation of Solvency II on 1 January 2016* Shareholders’ equity at end of year Comprising: Asia operations US operations UK insurance operations* M&G Prudential Capital Other operations Shareholders’ equity at end of year Representing: Net assets excluding acquired goodwill and holding company net borrowings Acquired goodwill Holding company net borrowings at market value note 8 Long-term business operations Asset management and other operations 18,717 11,805 10,307 – – – 40,829 40,584 245 – 40,829 383 204 25 1,820 22 (4,315) (1,861) 961 1,230 (4,052) (1,861) Total 19,100 12,009 10,332 1,820 22 (4,315) 38,968 41,545 1,475 (4,052) 38,968 Note 2016 £m 2015 £m 4,516 3,951 9 9 9 9 9 9 2 9 4,211 (1,267) (11) (367) 7,082 32,359 (473) 31,886 38,968 Long-term business operations Asset management and other operations 13,876 9,487 9,647 – – – 33,010 306 182 22 1,774 70 (3,005) (651) 244 (974) (76) 53 3,198 29,161 – 29,161 32,359 Total 14,182 9,669 9,669 1,774 70 (3,005) 32,359 32,777 233 866 1,230 33,643 1,463 – (2,747) (2,747) 33,010 (651) 32,359 31 Dec 2016 £m 31 Dec 2015 £m * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. 327 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis resultsSummary statement of financial position Total assets less liabilities, before deduction for insurance funds* Less insurance funds:† Policyholder liabilities (net of reinsurers’ share) and unallocated surplus of with-profits funds Less shareholders’ accrued interest in the long-term business Total net assets Share capital Share premium IFRS basis shareholders’ reserves Total IFRS basis shareholders’ equity Additional EEV basis retained profit‡ Total EEV basis shareholders’ equity (excluding non-controlling interests) Note 31 Dec 2016 £m 31 Dec 2015 £m 407,928 340,666 (393,262) 24,302 (368,960) (327,711) 19,404 (308,307) 38,968 32,359 129 1,927 12,610 14,666 24,302 38,968 128 1,915 10,912 12,955 19,404 32,359 9 9 9 9 9 * Following its classification as held for sale, Korea life business is included in total assets at a carrying value of £105 million (see note 17 for details). † Including liabilities in respect of insurance products classified as investment contracts under IFRS 4. ‡ The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. Net asset value per share Based on EEV basis shareholders’ equity of £38,968 million (2015: £32,359 million) (in pence)† Number of issued shares at year end (millions) Annualised return on embedded value* 31 Dec 2016 31 Dec 2015 1,510p 2,581 1,258p 2,572 17% 17% * Annualised return on embedded value is based on EEV post-tax operating profit, as a percentage of opening EEV basis shareholders’ equity. † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. The supplementary information on pages 325 to 360 was approved by the Board of Directors on 13 March 2017. Paul Manduca Chairman Mike Wells Group Chief Executive Nic Nicandrou Chief Financial Officer 328 Prudential plc Annual Report 2016 www.prudential.co.ukEuropean Embedded Value (EEV) basis resultsContinuedNotes on the EEV basis results 1 Basis of preparation The EEV basis results have been prepared in accordance with the EEV Principles dated April 2016, prepared by the European Insurance CFO Forum. There is no change to the EEV methodology. The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime, as discussed in note 2 below. The 2015 comparative results for UK insurance operations were prepared reflecting the Solvency I basis, being the regime applicable for the year. There is no change to the basis of preparation for Asia and the US operations. Where appropriate, the EEV basis results include the effects of adoption of EU-endorsed IFRS. The directors are responsible for the preparation of the supplementary information in accordance with the EEV Principles. Except for the change in presentation of the results of the operating and non-operating results for Asia operations to show separately the contribution from the held for sale Korea life business (see note 17 for details), the 2015 results have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2015. A detailed description of the EEV methodology and accounting presentation is provided in note 14. 2 Effect of Solvency II implementation on EEV basis results on 1 January 2016 The Solvency II framework is effective from 1 January 2016. For our operations in Asia and the US there is no impact on the EEV results since Solvency II does not act as the local constraint on the ability to distribute profits to the Group. The embedded value for these businesses will continue to be driven by local regulatory and target capital requirements. For the UK insurance operations, Solvency II has an impact on the EEV results as it changes the local regulatory valuation of net worth and capital requirements, affecting the components of the EEV. The impact of Solvency II on EEV shareholders’ equity on 1 January 2016 is shown below: Total EEV basis shareholders’ equity As reported at 31 December 2015 Opening adjustment at 1 January 2016 for long-term business operations Effect of implementation of Solvency II on net worth note (a) Effect of implementation of Solvency II on net value of in-force business (VIF) note (b) Group total shareholders’ equity as at 1 January 2016 note (c) £m 32,359 2,760 (3,233) (473) 31,886 Notes (a) (b) (c) The Solvency II framework requires technical provisions to be valued on a best estimate basis and capital requirements to be risk-based. It also requires the establishment of a risk margin (which for business in force at 31 December 2015 can be broadly offset by transitional measures). As a result of applying this framework the EEV net worth increased by £2,760 million reflecting the release of the prudent regulatory margins previously included under Solvency I, and also from the recognition within net worth of a portion of future shareholder transfers expected from the with-profits fund. The higher net worth incorporated increases in required capital reflecting the higher solvency capital requirements of the new regime. The net value of in-force business (VIF) is correspondingly impacted as follows: – the release of prudent regulatory margins and recognition of a portion of future with-profits business shareholders’ transfers within net worth lead to a corresponding reduction in the VIF; – the run-off of the risk margin, net of transitional measures, is now captured in VIF; and – the cost of capital deducted from the gross VIF increases as a result of the higher Solvency II capital requirements. The overall impact of these changes was to reduce the value of in-force by £(3,233) million. At 1 January 2016 the effect of these changes was a net reduction in EEV shareholders’ equity of £(473) million. The impact of Solvency II in 2016 for UK insurance operations is estimated to have reduced total operating profit from new and in-force business by £(39) million. 3 Results analysis by business area The 2015 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2015 CER comparative results are translated at 2016 average exchange rates. Annual premium equivalents (APE) note 16 Asia operations US operations UK retail operations‡ Group total excluding UK bulk annuities UK bulk annuities‡ Group total 2016 £m 2015* £m % change Note 4 3,599 1,561 1,160 6,320 – 6,320 AER 2,712 1,729 874 5,315 151 5,466 CER 3,020 1,950 874 5,844 151 5,995 AER 33% (10)% 33% 19% (100)% 16% CER 19% (20)% 33% 8% (100)% 5% 329 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results 3 Results analysis by business area continued Post-tax operating profit 2016 £m 2015*£m % change Note AER CER AER CER 4 5 4 5 4 5 4 5 2,030 1,044 3,074 125 3,199 790 1,181 1,971 (3) 1,968 268 – 268 375 643 23 666 341 22 1,482 798 2,280 101 2,381 809 999 1,808 7 1,815 201 117 318 545 863 22 885 358 18 1,660 895 2,555 112 2,667 913 1,127 2,040 8 2,048 201 117 318 545 863 22 885 358 18 1,029 1,261 1,261 (679) (57) 37 (566) (51) – (566) (51) – 37% 31% 35% 24% 34% (2)% 18% 9% (143)% 8% 33% (100)% (16)% (31)% (25)% 5% (25)% (5)% 22% (18)% (20)% (12)% n/a 22% 17% 20% 12% 20% (13)% 5% (3)% (138)% (4)% 33% (100)% (16)% (31)% (25)% 5% (25)% (5)% 22% (18)% (20)% (12)% n/a 5,497 4,840 5,359 14% 3% 3,088 – 3,088 2,600 5,688 508 (699) 2,492 117 2,609 2,342 4,951 506 (617) 2,774 117 2,891 2,567 5,458 518 (617) 24% (100)% 18% 11% 15% 0% (13)% 11% (100)% 7% 1% 4% (2)% (13)% 5,497 4,840 5,359 14% 3% Asia operations New business Business in force Long-term business Eastspring Investments Total US operations New business Business in force Long-term business Broker-dealer and asset management Total UK operations New business‡ UK retail operations UK bulk annuities Business in force Long-term business† General insurance commission Total UK insurance operations† M&G Prudential Capital Total† Other income and expenditure Solvency II and restructuring costs Interest received on tax settlement Operating profit based on longer-term investment returns† Analysed as profit (loss) from: New business‡ Life operations excluding UK bulk annuities UK bulk annuities Business in force Total long-term business† Asset management and general insurance commission Other results Operating profit based on longer-term investment returns† 330 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedPost-tax profit Operating profit based on longer-term investment returns† Short-term fluctuations in investment returns Effect of changes in economic assumptions Mark to market value movements on core borrowings (Loss) profit attaching to the held for sale Korea life business Total non-operating loss Profit for the year attributable to shareholders Basic earnings per share (in pence) 2016 £m 2015*£m % change Note AER CER AER CER 6 7 17 5,497 (507) (60) 4,840 (1,215) 66 5,359 (1,343) 66 14% 58% (191)% 3% 62% (191)% (4) 221 220 (102)% (102)% (410) (981) 4,516 39 (889) 3,951 42 (1,015) 4,344 n/a (10)% 14% n/a 3% 4% 2016 2015 % change AER CER AER CER Based on post-tax operating profit including longer-term investment returns*† Based on post-tax profit† 214.7p 176.4p 189.6p 154.8p 209.9p 170.2p 13% 14% 2% 4% * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. ‡ Following Prudential’s withdrawal from the UK bulk annuity market, the 2015 comparative results for UK bulk annuities new business have been presented separately. 331 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results4 Analysis of new business contribution (i) Group summary Asia operations note (ii) US operations UK insurance operations† Group total Asia operations note (ii) US operations UK retail operations†‡ Total excluding UK bulk annuities UK bulk annuities‡ Group total Annual premium and contribution equivalents (APE) £m note 16 Present value of new business premiums (PVNBP) £m note 16 3,599 1,561 1,160 6,320 19,271 15,608 10,513 45,392 2016 New business contribution £m note 2,030 790 268 3,088 2015* Annual premium and contribution equivalents (APE) £m note 16 Present value of new business premiums (PVNBP) £m note 16 New business contribution £m note 2,712 1,729 874 5,315 151 5,466 14,428 17,286 7,561 39,275 1,508 40,783 1,482 809 201 2,492 117 2,609 New business margin APE % 56 51 23 49 PVNBP % 10.5 5.1 2.5 6.8 New business margin APE % PVNBP % 55 47 23 47 77 48 10.3 4.7 2.7 6.3 7.8 6.4 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. ‡ Following Prudential’s withdrawal from the UK bulk annuity market, the 2015 comparative results for UK bulk annuities new business have been presented separately. Note The increase in new business contribution of £596 million from £2,492 million for 2015 (excluding the contributions from UK bulk annuities) to £3,088 million for 2016 comprises an increase on a CER basis of £314 million and an increase of £282 million for foreign exchange effects. The increase of £314 million on a CER basis comprises a contribution of £226 million for higher retail sales volumes in 2016, a £17 million effect of movement in long-term interest rates, generated by the active basis of setting economic assumptions (analysed as Asia £14 million, US £13 million and UK £(10) million), and a £71 million impact of pricing, product and other actions. (ii) Asia operations – new business contribution by territory China Hong Kong Indonesia Taiwan Other Total Asia operations 2016 £m 2015*£m 63 1,363 175 31 398 2,030 AER 30 835 229 28 360 CER 32 941 260 31 396 1,482 1,660 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). 332 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued 5 Operating profit from business in force (i) Group summary Unwind of discount and other expected returns Effect of changes in operating assumptions Experience variances and other items Total Unwind of discount and other expected returns Effect of changes in operating assumptions Experience variances and other items Total 2016 £m Asia operations note (ii) US operations note (iii) UK insurance operations note (iv) 866 54 124 583 170 428 1,044 1,181 445 25 (95) 375 2015*£m Asia operations* note (ii) US operations note (iii) UK insurance operations† note (iv) 725 12 61 798 472 115 412 999 488 55 2 545 Total note 1,894 249 457 2,600 Total note 1,685 182 475 2,342 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. Note The movement in operating profit from business in force of £258 million from £2,342 million for 2015 to £2,600 million for 2016 comprises: Movement in unwind of discount and other expected returns: Effects of changes in: Growth in opening value Interest rates Foreign exchange Implementation of Solvency II on 1 January 2016 Movement in effect of changes in operating assumptions, experience variances and other items (including foreign exchange of £84 million) Net movement in operating profit from business in force £m 126 (28) 141 (30) 209 49 258 333 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results5 Operating profit from business in force continued (ii) Asia operations Unwind of discount and other expected returns note (a) Effect of changes in operating assumptions: Mortality and morbidity Persistency and withdrawals note (b) Expense Other note (c) Experience variances and other items: Mortality and morbidity note (d) Persistency and withdrawals note (e) Expense note (f) Other Total Asia operations 2016 £m 2015*£m 866 33 (47) 15 53 54 71 52 (23) 24 124 725 63 (46) (1) (4) 12 54 17 (32) 22 61 1,044 798 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). Notes (a) (b) (c) (d) (e) (f) The increase in unwind of discount and other expected returns of £141 million from £725 million for 2015 to £866 million for 2016 comprises a positive £61 million impact for the growth in the opening in-force value, a positive £81 million foreign exchange effect and a net £(1) million effect for movements in long-term interest rates. The 2016 charge of £(47) million (2015: £(46) million) for persistency assumption changes comprises positive and negative contributions from our various operations, with positive persistency updates on health and protection products being more than offset by negative effects for unit-linked business. The 2016 credit of £53 million for other assumption changes reflects a number of offsetting items, including modelling improvements and those arising from asset allocation changes in a number of territories. The positive mortality and morbidity experience variance in 2016 of £71 million (2015: £54 million) mainly reflects better than expected experience in a number of territories. The positive £52 million for persistency and withdrawals experience in 2016 (2015: £17 million) comprises positive and negative contributions from various operations, with positive persistency experience on health and protection products which more than offsets negative experience on unit-linked products. The negative expense experience variance in 2016 of £(23) million (2015: £(32) million) principally arises in operations which are currently sub-scale (China, Malaysia Takaful and Taiwan). (iii) US operations Unwind of discount and other expected returns note (a) Effect of changes in operating assumptions note (b) Experience variances and other items: Spread experience variance note (c) Amortisation of interest-related realised gains and losses note (d) Other note (e) Total US operations 2016 £m 2015 £m 583 170 119 88 221 428 1,181 472 115 149 70 193 412 999 Notes (a) (b) (c) (d) The increase in unwind of discount and other expected returns of £111 million from £472 million for 2015 to £583 million for 2016 comprises a positive £40 million effect for the underlying growth in the in-force book, a positive £60 million foreign exchange effect and an £11 million impact of the 20 basis points increase in the US 10-year treasury yield during the year. The 2016 credit of £170 million comprises assumption updates for mortality, persistency and expense, together with an increase in the assumed level of tax relief reflecting recent experience. The spread assumption for Jackson is determined on a longer-term basis, net of provision for defaults (see note 15(ii)). The spread experience variance in 2016 of £119 million (2015: £149 million) includes the positive effect of transactions previously undertaken to more closely match the overall asset and liability duration. The reduction compared to the prior year reflects the effects of declining yields in the portfolio caused by the prolonged low interest rate environment. 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. (e) Other experience variances of £221 million in 2016 (2015: £193 million) include the effects of positive persistency experience and other variances. 334 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued (iv) UK insurance operations Unwind of discount and other expected returns note (a) Reduction in future UK corporate tax rate note (b) Other note (c) Total UK insurance operations 2016 £m 2015*£m 445 25 (95) 375 488 55 2 545 * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. Notes (a) (b) The decrease in unwind of discount and expected returns of £(43) million from 2015 of £488 million to £445 million for 2016 comprises a positive £25 million effect for the underlying growth in the in-force book, more than offset by a £(38) million effect driven by the 70 basis points decrease in the 15-year gilt yield during the year and a negative £(30) million representing the net effect of adopting the Solvency II regime. The credit of £25 million (2015: £55 million) for the reduction in UK corporate tax rate reflects the beneficial effect of applying a lower corporation tax rate (see note 15) to future life profits from in-force business in the UK. (c) Other items comprise the following: Longevity reinsurance Impact of specific management actions to improve solvency position note (d) Provision for cost of undertaking past non-advised annuity sales review and potential redress note (e) Other items note (f) 2016 £m 2015 £m (90) 110 (145) 30 (95) (134) 75 – 61 2 (d) (e) (f) The 2016 benefit of £110 million (2015: £75 million) arises from the specific management actions to improve solvency, including the effect of repositioning the fixed income asset portfolio. In response to the findings of the FCA’s Thematic Review of Annuities Sales Practices, the UK business will review all internally vesting annuities sold without advice after 1 July 2008. Reflecting this, the UK 2016 result includes a provision of £145 million (post-tax) for the estimated cost of the review and any appropriate customer redress, but excludes any potential for insurance recoveries. The 2016 credit of £30 million (2015: £61 million) comprises assumption updates and experience variances for mortality, expense, persistency and other items. 6 Short-term fluctuations in investment returns Short-term fluctuations in investment returns included in profit for the year arise as follows: (i) Group summary Asia operations note (ii) US operations note (iii) UK insurance operations note (iv) Other operations note (v) Total 2016 £m 2015*£m (100) (1,102) 869 (174) (213) (753) (194) (55) (507) (1,215) * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). (ii) Asia operations The short-term fluctuations in investment returns for Asia operations comprise: Hong Kong Singapore Other Total Asia operations note 2016 £m 2015*£m (105) 52 (47) (100) (144) (104) 35 (213) * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). Note For 2016, the charge of £(100) million mainly reflects the impact of interest rate movements on bonds and other investment returns, with losses due to increased long-term interest rates in Hong Kong, partly offset by gains in Singapore (as shown in note 15(i)). 335 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results6 Short-term fluctuations in investment returns continued (iii) US operations The short-term fluctuations in investment returns for US operations comprise: Investment return related experience on fixed income securities note (a) Investment return related impact due to changed expectation of profits on in-force variable annuity business in future periods based on current year separate account return, net of related hedging activity and other items note (b) Total US operations 2016 £m 2015 £m (85) (17) (1,017) (1,102) (736) (753) Notes (a) (b) The charge relating to fixed income securities comprises the following elements: – the impact on portfolio yields of changes in the asset portfolio in the year; – the excess of actual realised gains and losses over the amortisation of interest-related realised gains and losses recorded in the profit and loss account; and – credit experience (versus the longer-term assumption). This item reflects the net impact of: – changes in projected future fees and future benefit costs arising from the difference between the actual growth in separate account asset values in the current year of 8.9 per cent and that assumed at the start of the year of 6.0 per cent; and – related hedging activity arising from realised and unrealised gains and losses on equity-related hedges and interest rate options, and other items. (iv) UK insurance operations The short-term fluctuations in investment returns for UK insurance operations comprise: Shareholder-backed annuity business note (a) With-profits and other business note (b) Total UK insurance operations 2016 £m 2015*£m 431 438 869 (88) (106) (194) * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. Notes (a) (b) Short-term fluctuations in investment returns for shareholder-backed annuity business comprise: – gains (losses) on surplus assets compared to the expected long-term rate of return reflecting reductions (increases) in corporate bond and gilt yields; – the difference between actual and expected default experience; and – the effect of mismatching for assets and liabilities of different durations. The £438 million fluctuations in 2016 for with-profits and other business represent the impact of achieving a 13.6 per cent pre-tax return on the with-profits fund (including unallocated surplus) compared to the assumed rate of return of 5.0 per cent (2015: total return of 3.1 per cent compared to assumed rate of 5.4 per cent), together with the effect of a partial hedge of future shareholder transfers expected to emerge from the UK’s with-profits sub-fund entered into to protect future shareholder with-profit transfers from movements in the UK equity market. (v) Other operations Short-term fluctuations in investment returns for other operations of negative £(174) million (2015: negative £(55) million) include unrealised value movements on investments held outside of the main life operations. 336 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued 7 Effect of changes in economic assumptions The effects of changes in economic assumptions for in-force business included in the profit for the year arise as follows: (i) Group summary Asia operations note (ii) US operations note (iii) UK insurance operations note (iv) Total 2016 £m 2015*£m 70 45 (175) (60) (139) 109 96 66 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). (ii) Asia operations The effect of changes in economic assumptions for Asia operations comprises: Hong Kong Indonesia Malaysia Singapore Taiwan Other Total Asia operations note 2016 £m 2015*£m 85 46 (20) (60) 12 7 70 100 (15) (30) (50) (97) (47) (139) * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). Note The positive effect for 2016 of £70 million largely arises from the movements in long-term interest rates (see note 15(i)). Non-operating profits arise from higher interest rates and hence fund earned rates in Hong Kong, together with the beneficial impact of valuing future health and protection profits at lower discount rates in Indonesia. Losses arise from a fall in interest rates in Singapore and a higher discount rate in Malaysia. (iii) US operations The effect of changes in economic assumptions for US operations comprises: Variable annuity business Fixed annuity and other general account business Total US operations note 2016 £m 2015 £m 86 (41) 45 104 5 109 Note For 2016, the credit of £45 million mainly reflects the increase in the assumed separate account return and reinvestment rates for variable annuity business, following the 20 basis points increase in the US 10-year treasury yield, resulting in higher projected fee income and a decrease in projected benefit costs. For fixed annuity and other general account business, the impact reflects the effect on the present value of future projected spread income of applying a higher discount rate on the opening value of the in-force book. (iv) UK insurance operations The effect of changes in economic assumptions for UK insurance operations comprises: Shareholder-backed annuity business note (a) With-profits and other business note (b) Total UK insurance operations 2016 £m 2015*£m (113) (62) (175) (56) 152 96 * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. Notes (a) (b) For shareholder-backed annuity business the overall negative effect of £(113) million for 2016 (2015: £(56) million) reflects an increase in the cost of capital, driven by the lower interest rates, partially offset by the change in the present value of projected spread income arising mainly from the adoption of lower risk discount rates as shown in note 15(iii). The charge of £(62) million for 2016 (2015: credit of £152 million) reflects the net effect of changes in expected future fund earned rates and risk discount rates (as shown in note 15(iii)). 337 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results 8 Net core structural borrowings of shareholder-financed operations 31 Dec 2016 £m Mark to market value adjustment IFRS basis EEV basis at market value IFRS basis 31 Dec 2015 £m Mark to market value adjustment EEV basis at market value Holding company (including central finance subsidiaries) cash and short-term investments (2,626) – (2,626) (2,173) Central fundsnote Subordinated debt Senior debt Holding company net borrowings Prudential Capital bank loan Jackson surplus notes Net core structural borrowings of shareholder- financed operations 5,772 549 6,321 3,695 275 202 4,172 182 175 357 357 – 65 422 5,954 724 6,678 4,052 275 267 4,018 549 4,567 2,394 275 169 4,594 2,838 – 211 142 353 353 – 55 408 (2,173) 4,229 691 4,920 2,747 275 224 3,246 Note In June 2016, the Company issued core structural borrowings of US$1,000 million 5.25 per cent Tier 2 perpetual subordinated notes. The proceeds net of costs were £681 million. In September 2016, the Company issued core structural borrowings of US$725 million 4.38 per cent Tier 2 perpetual subordinated notes. The proceeds net of costs were £546 million. The movement in IFRS basis core structural borrowings from 2015 to 2016 also includes foreign exchange effects. 9 Reconciliation of movement in shareholders’ equity 2016 £m Long-term business operations US operations UK insurance operations* Total long-term business operations Asia operations note (i) Asset manage- ment and UK general insurance commission Other operations note (i) Group total Operating profit based on longer-term investment returns: Long-term business: New business note 4 Business in force note 5 Asset management and general insurance commission Other results Post-tax operating profit Loss attaching to the held for sale Korea life business note 17 Other non-operating (loss) profit Profit for the year Other items taken directly to equity: Exchange movements on foreign operations and net investment hedges Intra-group dividends and investment in operations note (ii) External dividends Mark to market value movements on Jackson assets backing surplus and required capital Other movements note (iii) Net increase in shareholders’ equity Shareholders’ equity at beginning of year: As previously reported Effect of implementation of Solvency II note 2 Other opening adjustments note (v) 2,030 1,044 3,074 – – 3,074 (395) (30) 2,649 2,714 (594) – – (6) 790 1,181 1,971 – – 1,971 – (1,057) 268 375 643 – (33) 610 – 694 914 1,304 3,088 2,600 5,688 – (33) 5,655 (395) (393) 4,867 – – 508 – 508 – (38) 470 – – – – (666) (666) (15) (140) 3,088 2,600 5,688 508 (699) 5,497 (410) (571) (821) 4,516 1,878 (388) – (11) (75) – (281) – – (169) 854 4,592 (1,263) 83 (462) – (464) 1,725 (1,267) 4,211 – (1,267) (11) (250) – 9 – (126) (11) (367) 7,935 100 (953) 7,082 4,763 2,318 13,643 – 66 13,709 9,487 – – 9,487 9,647 (473) 279 9,453 32,777 (473) 345 32,649 2,354 – – 2,354 2,454 (2,772) 32,359 (473) – (3,117) 31,886 – (345) (4,070) 38,968 Shareholders’ equity at end of year 18,472 11,805 10,307 40,584 338 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued 2016 £m Long-term business operations US operations UK insurance operations* Total long-term business operations Asia operations note (i) Asset manage- ment and UK general insurance commission Other operations note (i) Group total Representing: Statutory IFRS basis shareholders’ equity: Net assets (liabilities) Goodwill Total IFRS basis shareholders’ equity Additional retained profit (loss) on an EEV basis note (iv) 4,747 – 4,747 13,725 5,204 – 5,204 6,601 5,974 – 5,974 4,333 15,925 – 15,925 24,659 EEV basis shareholders’ equity 18,472 11,805 10,307 40,584 Balance at beginning of year:* Statutory IFRS basis shareholders’ equity: Net assets (liabilities) Goodwill Total IFRS basis shareholders’ equity Additional retained profit (loss) on an EEV basis note (iv) EEV basis shareholders’ equity 3,789 – 3,789 9,920 13,709 4,154 – 4,154 5,333 9,487 5,397 – 5,397 4,056 9,453 13,340 – 13,340 19,309 32,649 1,224 1,230 2,454 – 2,454 1,124 1,230 2,354 – 2,354 (3,958) 13,191 1,475 245 (3,713) 14,666 (357) 24,302 (4,070) 38,968 (2,972) 11,492 1,463 233 (2,739) 12,955 (378) 18,931 (3,117) 31,886 * The balance at the beginning of the year has been presented after the adjustments for the impact of Solvency II for UK insurance operations at 1 January 2016 (see note 2 for details), together with the effect of a classification change (see note (v) below). Notes (i) Other operations of £(4,070) million represents the shareholders’ equity of £(4,315) million for other operations as shown in the movement in shareholders’ equity and includes goodwill of £245 million (2015: £233 million) related to Asia long-term operations. Intra-group dividends represent dividends that have been declared in the year and investments in operations reflect increases in share capital. The amounts included in note 11 for these items are as per the holding company cash flow at transaction rates. The difference primarily relates to intra-group loans, foreign exchange and other non-cash items. (iii) Other movements include reserve movements in respect of the shareholders’ share of actuarial gains and losses on defined benefit pension schemes, share capital subscribed, (ii) (iv) share-based payments and treasury shares. The additional retained loss on an EEV basis for Other operations primarily represents the mark to market value adjustment for holding company net borrowings of a charge of £(357) million (2015: £(353) million), as shown in note 8. (v) Other opening adjustments represents the effect of a classification change of £345 million from Other operations to UK insurance operations of £279 million and to Asia insurance operations of £66 million in order to align with Solvency II segmental reporting, which has no overall effect on the Group’s EEV. 339 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results10 Analysis of movement in net worth and value of in-force for long-term business Group Shareholders’ equity at beginning of year: As previously reported Opening adjustments* New business contribution Existing business – transfer to net worth Expected return on existing business note 5 Changes in operating assumptions and experience variancesnote 5 Solvency II and restructuring costs Post-tax operating profit Loss attaching to held for sale Korea life business note 9 Other non-operating items Profit for the year from long-term business Exchange movements on foreign operations and net investment hedges Intra-group dividends and investment in operations Other movements 2016 £m Required capital Total net worth Value of in-force business note Total long-term business operations 4,704 4,578 9,282 595 (637) 193 (231) – (80) – 505 425 589 – – 10,346 3,105 13,451 (308) 2,423 292 626 (33) 3,000 (86) (427) 2,487 1,222 (1,263) (250) 22,431 (3,233) 19,198 3,396 (2,423) 1,602 80 – 2,655 (309) 34 2,380 3,370 – (11) 32,777 (128) 32,649 3,088 – 1,894 706 (33) 5,655 (395) (393) 4,867 4,592 (1,263) (261) Free surplus note 11 5,642 (1,473) 4,169 (903) 3,060 99 857 (33) 3,080 (86) (932) 2,062 633 (1,263) (250) Shareholders’ equity at end of year* 5,351 10,296 15,647 24,937 40,584 Asia operations New business contribution Existing business – transfer to net worth Expected return on existing business note 5 Changes in operating assumptions and experience variancesnote 5 Post-tax operating profit Loss attaching to held for sale Korea life business note 9 Other non-operating items Profit for the year from long-term business US operations New business contribution Existing business – transfer to net worth Expected return on existing business note 5 Changes in operating assumptions and experience variances note 5 Post-tax operating profit Non-operating items Profit for the year from long-term business (476) 1,157 39 14 734 (86) (91) 557 (298) 1,223 47 596 1,568 (770) 798 139 (92) 54 94 195 – 29 224 324 (213) 53 5 169 (108) 61 (337) 1,065 93 108 929 (86) (62) 781 26 1,010 100 601 1,737 (878) 859 2,367 (1,065) 773 70 2,145 (309) 32 1,868 764 (1,010) 483 (3) 234 (179) 55 2,030 – 866 178 3,074 (395) (30) 2,649 790 – 583 598 1,971 (1,057) 914 340 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedUK insurance operations New business contribution Existing business – transfer to net worth Expected return on existing business note 5 Changes in operating assumptions and experience variances note 5 Solvency II and restructuring costs Post-tax operating profit Non-operating items Profit for the year from long-term business 2016 £m Free surplus note 11 Required capital Total net worth Value of in-force business note Total long-term business operations (129) 680 13 247 (33) 778 (71) 707 132 (332) 86 (330) – (444) 584 140 3 348 99 (83) (33) 334 513 847 265 (348) 346 13 – 276 181 457 268 – 445 (70) (33) 610 694 1,304 * Opening adjustments represent the impact of implementation of Solvency II for UK insurance operations at 1 January 2016 (see note 2 for details), together with the effect of a classification change, as discussed in note 9(v). Note The net value of in-force business comprises the value of future margins from current in-force business less the cost of holding required capital as shown below: Value of in-force business before deduction of cost of capital and time value of guarantees Cost of capital Cost of time value of guarantees Net value of in-force business Total net worth Total embedded value note 9 31 Dec 2016 £m 31 Dec 2015 £m Asia operations US operations UK insurance operations Total long-term business operations Asia operations US operations UK insurance operations* Total long-term business operations 15,371 (477) (87) 14,807 3,665 8,584 (319) (911) 7,354 4,451 3,468 (692) – 2,776 7,531 27,423 (1,488) (998) 24,937 15,647 18,472 11,805 10,307 40,584 11,280 (438) (88) 10,754 2,955 13,709 7,355 (229) (1,012) 6,114 3,373 9,487 3,043 (713) – 2,330 7,123 9,453 21,678 (1,380) (1,100) 19,198 13,451 32,649 * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results in the table above are presented after the adjustments for the impact of Solvency II for UK insurance operations at 1 January 2016, together with the effect of a classification change, as discussed in note 9(v). 341 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results11 Analysis of movement in free surplus For EEV covered business, free surplus is the excess of the regulatory basis net assets for EEV reporting purposes (net worth) over the capital required to support the covered business. Where appropriate, adjustments are made to the net worth so that backing assets are included at fair value rather than cost so as to comply with the EEV Principles. Free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis post-tax earnings and shareholders’ equity, net of goodwill. Free surplus for other operations is taken to be EEV basis post-tax earnings and shareholders’ equity for central operations, net of goodwill, with subordinated debt recorded as free surplus to the extent that it is classified as available capital under Solvency II. Free surplus for insurance and asset management operations and Group total free surplus, including other operations, are shown in the tables below. (i) Underlying free surplus generated – insurance and asset management operations The 2015 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2015 CER comparative results are translated at 2016 average exchange rates. 2016 £m 2015*£m % change AER CER AER CER Asia operations Underlying free surplus generated from in-force life business Investment in new business note (iii)(a) Long-term business Eastspring Investments note (iii)(b) Total US operations Underlying free surplus generated from in-force life business Investment in new business note (iii)(a) Long-term business Broker-dealer and asset management note (iii)(b) Total UK insurance operations Underlying free surplus generated from in-force life business Investment in new business note (iii)(a) Long-term business† General insurance commission note (iii)(b) Total M&G Prudential Capital 1,210 (476) 734 125 859 1,866 (298) 1,568 (3) 1,565 907 (129) 778 23 801 341 22 951 (386) 565 101 666 1,426 (267) 1,159 7 1,166 878 (65) 813 22 835 358 18 1,064 (426) 638 112 750 1,608 (301) 1,307 8 1,315 878 (65) 813 22 835 358 18 Underlying free surplus generated from insurance and asset management operations 3,588 3,043 3,276 Representing: Long-term business: Expected in-force cash flows (including expected return on net assets) 3,159 2,693 2,941 Effects of changes in operating assumptions, experience variances and other items Underlying free surplus generated from in-force life business Investment in new business note (iii)(a) Total long-term business*† Asset management and general insurance commission note (iii)(b) 824 3,983 (903) 3,080 508 3,588 562 3,255 (718) 2,537 506 3,043 609 3,550 (792) 2,758 518 3,276 27% (23)% 30% 24% 29% 31% (12)% 35% (143)% 34% 3% (98)% (4)% 5% (4)% (5)% 22% 18% 17% 47% 22% (26)% 21% 0% 18% 14% (12)% 15% 12% 15% 16% 1% 20% (138)% 19% 3% (98)% (4)% 5% (4)% (5)% 22% 10% 7% 35% 12% (14)% 12% (2)% 10% * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflected the Solvency I basis being the regime applicable for the year. 342 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued(ii) Underlying free surplus generated – total Group 2016 £m 2015*£m % change AER CER AER CER Underlying free surplus generated from insurance and asset management operations note (i) 3,588 3,043 3,276 Other income and expenditure net of restructuring and Solvency II costs note (iii)(b) Interest received on tax settlement Group total underlying free surplus generated, including (703) 37 (588) – (588) – 18% (20)% n/a 10% (20)% n/a other operations 2,922 2,455 2,688 19% 9% * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). (iii) Movement in free surplus – long-term business and asset management operations Underlying free surplus generated Loss attaching to held for sale Korea life business note 10 Other non-operating items note (c) Net cash flows to parent company note (d) External dividends Exchange rate movements, timing differences and other items note (e) Net movement in free surplus Balance at 1 January 2016: Balance at beginning of year Opening adjustments* Balance at end of year Representing: Asia operations US operations UK operations Other operations Balance at 1 January 2016:* Asia operations US operations UK operations Other operations Long-term business note 10 3,080 (86) (932) 2,062 (1,236) 356 1,182 5,642 (1,473) 4,169 5,351 2016 £m Total insurance and asset management operations Asset management and UK general insurance commission note (b) Central and other operations note (b) 508 – (38) 470 (482) 112 100 1,124 – 1,124 1,224 3,588 (86) (970) 2,532 (1,718) – 468 1,282 6,766 (1,473) 5,293 6,575 2,142 2,418 2,015 – 6,575 1,814 1,733 1,746 – 5,293 (666) – (169) (835) 1,718 (1,267) 1,144 760 1,224 (345) 879 1,639 – – – 1,639 1,639 – – – 879 879 Group total 2,922 (86) (1,139) 1,697 – (1,267) 1,612 2,042 7,990 (1,818) 6,172 8,214 2,142 2,418 2,015 1,639 8,214 1,814 1,733 1,746 879 6,172 * Opening adjustments represent the impact of implementation of Solvency II at 1 January 2016 (see note 2 for details), together with the effect of a reclassification between long-term business and other operations, as discussed in note 9(v). Balance at 1 January 2016 has been presented after the opening adjustments. 343 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results11 Analysis of movement in free surplus continued (iii) Movement in free surplus – long-term business and asset management operations continued Underlying free surplus generated Disposal of Japan life business Results of the held for sale Korea life business note 17 Other non-operating items note (c) Net cash flows to parent company note (d) External dividends Exchange rate movements, timing differences and other items note (e) Net movement in free surplus Balance at beginning of year Balance at end of year 2015*£m Total insurance and asset management operations Asset management and UK general insurance commission note (b) Central and other operations note (b) 506 – – (53) 453 (354) – 159 258 866 1,124 3,043 23 15 (468) 2,613 (1,625) – 719 1,707 5,059 6,766 (588) – – 29 (559) 1,625 (974) (307) (215) 1,439 1,224 Long-term business 2,537 23 15 (415) 2,160 (1,271) – 560 1,449 4,193 5,642 Group total 2,455 23 15 (439) 2,054 – (974) 412 1,492 6,498 7,990 * The 2015 comparative results have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). Notes (a) (b) Free surplus invested in new business represents amounts set aside for required capital and acquisition costs. Free surplus for asset management operations and the UK general insurance commission is taken to be IFRS basis post-tax earnings and shareholders’ equity, net of goodwill. Free surplus for other operations is taken to be EEV basis post-tax earnings and shareholders’ equity net of goodwill, with subordinated debt recorded as free surplus to the extent that it is classified as available capital under Solvency II. Non-operating items are principally short-term fluctuations in investment returns and the effect of changes in economic assumptions for long-term business operations. (c) (d) 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. (e) Exchange rate movements, timing differences and other items represent: 2016 £m Exchange rate movements Mark to market value movements on Jackson assets backing surplus and required capital note 9 Other items note (f) Exchange rate movements Mark to market value movements on Jackson assets backing surplus and required capital Other items note (f) Asset management and UK general insurance commission Total insurance and asset management operations 83 – 29 112 716 (11) (237) 468 2015 £m Asset management and UK general insurance commission Total insurance and asset management operations 3 – 156 159 70 (76) 725 719 Long-term business 633 (11) (266) 356 Long-term business 67 (76) 569 560 Central and other operations 48 – 1,096 1,144 Central and other operations 10 – (317) (307) Group total 764 (11) 859 1,612 Group total 80 (76) 408 412 (f) Other items include the movements in subordinated debt for Other operations, together with the effect of intra-group loans and other non-cash items. The 2015 results also included the effect of a classification change of £702 million from Other operations to UK insurance operations in order to align with Solvency II segmental reporting, with no overall effect on the Group’s EEV. 344 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued12 Expected transfer of value of in-force business and required capital to free surplus The discounted value of in-force business and required capital can be reconciled to the 2016 and 2015 totals for the emergence of free surplus as follows: Required capital note 10 Value of in-force business (VIF) note 10 Add back: deduction for cost of time value of guarantees note 10 Expected free surplus generation from the sale of Korea life business note 17 Other items note Total 2016 £m 2015*£m 10,296 24,937 998 (76) (1,430) 34,725 9,282 19,198 1,100 – (1,714) 27,866 * In order to show the cash flows for UK insurance operations on a comparable basis, the 2015 comparative results for UK insurance operations reflect the impact of the implementation of Solvency II at 1 January 2016 (see note 2 for details). Note ‘Other items’ represent amounts incorporated into VIF where there is no definitive time frame for when the payments will be made or receipts received. In particular, other items include the deduction of the shareholders’ interest in the estate, the value of which is derived by increasing final bonus rates so as to exhaust the estate over the lifetime of the in-force with-profits business. This is an assumption to give an appropriate valuation. To be conservative this item is excluded from the expected free surplus generation profile below. Cash flows are projected on a deterministic basis and are discounted at the appropriate risk discount rate. The modelled cash flows use the same methodology underpinning the Group’s EEV reporting and so are 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. Asia operations* US operations UK insurance operations Total Asia operations US operations UK insurance operations† Total† 2016 total as shown above 16,393 10,556 7,776 5,141 5,542 2,890 34,725 13,573 100% 39% 2016 £m Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years 3,331 3,203 1,931 8,465 25% 1,515 372 901 2,788 8% 2,209 1,240 1,119 4,568 13% 2015 £m 3,118 199 899 4,216 12% 1,079 – 36 1,115 3% Expected period of conversion of future post-tax distributable earnings and required capital flows to free surplus 2015 total as shown above 11,858 8,740 7,268 27,866 100% 1-5 years 6-10 years 11-15 years 16-20 years 21-40 years 40+ years 3,916 4,361 2,446 10,723 38% 2,552 2,752 1,812 7,116 26% 1,669 1,129 1,198 3,996 14% 1,115 383 866 2,364 9% 2,055 115 920 3,090 11% 551 – 26 577 2% * Asia operations exclude the cash flows in respect of the held for sale Korea life business. † In order to show the cash flows for UK insurance operations on a comparable basis, the 2015 comparative results for UK insurance operations reflect the impact of the implementation of Solvency II at 1 January 2016 (see note 2 for details). 345 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results13 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 2016 and 31 December 2015 and the new business contribution after the effect of required capital for 2016 and 2015 to: — 1 per cent increase in the discount rates; — 1 per cent increase in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); — 0.5 per cent decrease in interest rates* (1 per cent decrease for 2015), including all consequential changes (assumed investment returns for all asset classes, market values of fixed 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); — The statutory minimum capital level by contrast to EEV basis required capital for (embedded value only); and — 5 basis points increase in UK long-term expected defaults. * To reflect the current level of low interest rates, the sensitivity of new business contribution and embedded value to a 0.5 per cent reduction in interest rates is shown for 2016. In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. New business contribution 2016 £m 2015 £m Asia operations US operations UK insurance operations Total long-term business operations Asia operations* US operations New business contribution note 4 2,030 Discount rates – 1% increase Interest rates – 1% increase Interest rates – 1% decrease Interest rates – 0.5% decrease Equity/property yields – 1% rise Long-term expected defaults – 5 bps increase (375) 51 – (30) 129 – 790 (43) 64 – (49) 91 – (32) 27 – (15) 28 (2) 268 3,088 1,482 (450) 142 – (94) 248 (254) 30 (78) – 71 (2) – – UK insurance operations† Total long-term business operations 318 2,609 (40) 7 (9) – 20 (8) (332) 117 (214) – 186 (8) 809 (38) 80 (127) – 95 * In order to show the Asia long-term business on a comparable basis, the 2015 comparatives for new business contribution have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. Embedded value of long-term business operations 31 Dec 2016 £m 31 Dec 2015 £m Asia operations US operations UK insurance operations Total long-term business operations Asia operations US operations UK insurance operations* Total long-term business operations Shareholders’ equity note 9 18,472 11,805 10,307 40,584 13,643 9,487 9,647 32,777 Discount rates – 1% increase Interest rates – 1% increase Interest rates – 1% decrease Interest rates – 0.5% decrease Equity/property yields – 1% rise Equity/property market values – 10% fall Statutory minimum capital Long-term expected defaults – 5 bps increase (2,078) (701) – 248 771 (361) 150 (379) (241) – 25 653 (11) 223 (809) (638) – 369 314 (399) – (3,266) (1,580) – 642 1,738 (771) 373 (1,448) (380) 132 – 506 (246) 148 (271) (46) (93) – 514 (411) 162 (586) (328) 426 – 271 (373) 4 (2,305) (754) 465 – 1,291 (1,030) 314 – – (138) (138) – – (141) (141) * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. 346 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedThe 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 assumptions shown in the sensitivities were to occur, then the effect shown above would be recorded within two components of the profit analysis for the following year. These are for the effect of economic assumption changes and short-term fluctuations in investment returns. In addition to the sensitivity effects shown above, the other components of the profit 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 changes in interest rates, the effect shown above for Jackson would also be recorded within the fair value movements on assets backing surplus and required capital, which are taken directly to shareholders’ equity. (b) Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2016 and 31 December 2015 and the new business contribution after the effect of required capital for 2016 and 2015 to: — 10 per cent proportionate decrease in maintenance expenses (a 10 per cent sensitivity on a base assumption of £10 per annum would represent an expense assumption of £9 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 2016 £m 2015 £m Asia operations US operations UK insurance operations Total long-term business operations Asia operations* US operations UK insurance operations† Total long-term business operations New business contribution note 4 2,030 790 268 3,088 1,482 809 318 2,609 Maintenance expenses – 10% decrease Lapse rates – 10% decrease Mortality and morbidity – 5% decrease Change representing effect on: Life business UK annuities 33 132 57 57 – 10 26 4 4 – 3 11 (4) – (4) 46 169 57 61 (4) 27 104 49 49 – 8 25 1 1 – 2 9 (13) 1 (14) 37 138 37 51 (14) * In order to show the Asia long-term business on a comparable basis, the 2015 comparatives for new business contribution have been adjusted from those previously published for the reclassification of the results attributable to the held for sale Korea life business (see note 17 for details). † The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. Embedded value of long-term business operations 31 Dec 2016 £m 31 Dec 2015 £m Asia operations US operations UK insurance operations Total long-term business operations Asia operations US operations UK insurance operations* Total long-term business operations Shareholders’ equity note 9 18,472 11,805 10,307 40,584 13,643 9,487 9,647 32,777 Maintenance expenses – 10% decrease Lapse rates – 10% decrease Mortality and morbidity – 5% decrease Change representing effect on: Life business UK annuities 187 659 554 554 – 104 533 192 192 – 91 79 382 1,271 (302) 444 12 (314) 758 (314) 153 508 449 449 – 80 394 172 172 – 68 75 (299) 11 (310) 301 977 322 632 (310) * The 2016 results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. 347 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results 14 Methodology and accounting presentation (a) Methodology 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: — The 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; and – The time value of cost of options and guarantees; — Locked-in required capital; and — The shareholders’ net worth in excess of required capital (free surplus). The value of future new business is excluded from the embedded value. Notwithstanding the basis of presentation of results as explained in note 14(b)(iii), no smoothing of market or account balance values, unrealised gains or investment return is applied in determining the embedded value or profit. Separately, the analysis of profit is delineated between operating profit based on longer-term investment returns and other constituent items, as explained in note 14(b)(i). (i) Covered business The EEV results for the Group are prepared for ‘covered business’, as defined by the EEV Principles. Covered business represents the Group’s long-term insurance business, including the Group’s investments in joint venture and associate insurance operations, for which the value of new and in-force contracts is attributable to shareholders. The post-tax EEV basis results for the Group’s covered business are then combined with the post-tax IFRS basis results of the Group’s asset management and other operations. Under the EEV Principles, the results for covered business incorporate the projected margins of attaching internal asset management, as described in note 14(a)(vii). The definition of long-term business operations 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. Covered business comprises the Group’s long-term business operations, with two exceptions: — The closed Scottish Amicable Insurance Fund (SAIF) which is excluded from covered business. 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. — The presentational treatment of the Group’s principal defined benefit pension scheme, the Prudential Staff Pension Scheme (PSPS). The partial recognition of the surplus for PSPS is recognised in ‘Other’ operations. A small amount of UK group pensions business is also not modelled for EEV reporting purposes. (ii) Valuation of in-force and new business The embedded value results are prepared incorporating best estimate assumptions about all relevant factors including levels of future investment returns, expenses, persistency, mortality and morbidity, as described in note 15. 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. 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 post-tax 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 in 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 is locked in when the assets are purchased at the point of sale of the policy. For other business within the Group, end-of-year economic assumptions are used. New business profitability is a key metric for the Group’s management of the development of the business. In addition, post-tax new business margins are shown by reference to annual premium equivalents (APE) and the present value of new business premiums (PVNBP). These margins are calculated as the percentage of the value of new business profit to APE and PVNBP. APE is calculated as the aggregate of regular premiums and one-tenth of single premiums. PVNBP is calculated as equalling single premiums plus the present value of expected premiums of regular premium new business, allowing for lapses and other assumptions made in determining the EEV new business contribution. 348 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedValuation 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, reflects the market value movements recognised on an IFRS basis. However, in determining the movements on the additional shareholders’ interest, the basis for calculating the EEV result for Jackson acknowledges that, for debt securities backing liabilities, the aggregate EEV results reflect 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 (depreciation) on these securities are accounted for in equity rather than in the income statement, as shown in the movement in shareholders’ equity. (iii) Cost of capital A charge is deducted from the embedded value for the cost of locked-in required capital supporting the Group’s long-term business. 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 post-tax investment earnings 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. (iv) Financial options and guarantees Nature of financial 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 Hong Kong, 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 with floor levels of policyholder benefits that accrue at rates set at inception and do not vary subsequently with market conditions. US operations (Jackson) The principal financial options and guarantees in Jackson are associated with the fixed annuity (FA) 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 both years, depending on the particular product, jurisdiction where issued, and date of issue. For 2016, 87 per cent (2015: 87 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 2.6 per cent (2015: 2.6 per cent). 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 upon depletion of funds (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 policyholders’ value in the event of poor equity market performance. Jackson hedges the GMWB and GMDB guarantees through the use of equity options and futures contracts, and fully reinsures the GMIB guarantees. Jackson also issues fixed index annuities (FIA) that enable policyholders to obtain a portion of an equity-linked return while providing a guaranteed minimum return. The guaranteed minimum returns are of a similar nature to those described above for fixed annuities. 349 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results14 Methodology and accounting presentation continued 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 bonus – 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 PAC with-profits fund also held a provision on the Solvency II basis of £62 million at 31 December 2016 (Pillar I Peak 2 basis at 31 December 2015: £47 million) to honour guarantees on a small number of guaranteed annuity option products. The Group’s main exposure to guaranteed annuity options in the UK is through the non-covered business of SAIF. A provision on the Solvency II basis of £571 million was held in SAIF at 31 December 2016 (Pillar I Peak 2 basis at 31 December 2015: £412 million) to honour the guarantees. As described in note 14(a)(i), 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’ funds. Time value The value of financial options and guarantees comprises two parts: — The first part arises from a deterministic valuation on best estimate assumptions (the intrinsic value); and — The second 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. 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 15(iv), (v) and (vi). 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. 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. (v) Level of required capital In adopting the EEV Principles, Prudential has based required capital on its internal targets subject to it being at least the local statutory minimum requirements. 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. Following the implementation of Solvency II which became effective on 1 January 2016, a portion of future shareholder transfers expected from the with-profits fund is recognised within net worth, together with the associated capital requirements. For shareholder-backed business the following capital requirements apply: — Asia operations: the level of required capital has been set to an amount at least equal to the higher of local statutory requirements and the internal target; — US operations: the level of required capital has been set at 250 per cent of the risk-based capital (RBC) 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 Solvency II Solvency Capital Requirement (SCR) for shareholder- backed business as a whole; for 2015, the capital requirements were set to an amount at least equal to the higher of Solvency I Pillar I and Pillar II requirements for shareholder-backed business as a whole. (vi) 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. 350 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued(vii) Internal asset management The in-force and new business results from long-term business include the projected value of profits or losses from asset management and service companies that support the Group’s covered insurance businesses. The results of the Group’s asset management operations include the current year profits from the management of both internal and external funds. EEV basis shareholders’ other income and expenditure is adjusted to deduct the unwind of the expected internal asset management profit margin for the year. 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 assets for covered business. (viii) Allowance for risk and risk discount rates Overview Under the EEV Principles, discount rates used to determine the present value of future cash flows are set by reference to risk-free rates plus a risk margin. For Asia and US operations, the risk-free rates are based on 10-year local government bond yields. For UK insurance operations, following the implementation of Solvency II on 1 January 2016, the EEV risk-free rate is based on the full term structure of interest rates, ie a yield curve, rather than using a flat 15-year gilt yield (as for 2015). This yield curve is used to determine the embedded value at the end of the reporting period. The risk margin should reflect any non-diversifiable risk associated with the emergence of distributable earnings that is not allowed for elsewhere in the valuation. Prudential has selected a granular approach to better reflect differences in market risk inherent in each product group. The risk discount rate so derived does not reflect an overall Group market beta but instead reflects the expected volatility associated with the cash flows 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 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 flows. 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 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. The projected rates of return for holdings of corporate bonds comprise the risk-free rate plus an assessment of long-term spread over the risk-free rate. 351 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results14 Methodology and accounting presentation continued 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 as shown in note 15(ii). 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 Jackson fixed annuity business are not fixed. 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. The level of the additional allowance is assessed at each reporting period to take account of prevailing credit conditions and as the business inforce alters over time. The additional allowance for variable annuity business has been set at one-fifth of the non-variable annuity business to reflect the proportion of the allocated holdings of general account debt securities. 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, as the assets are generally held to maturity to match liabilities, the future cash flows are discounted using the swap yield curve plus an allowance for liquidity premium based on the Solvency II allowance for credit risk. The Solvency II allowance is set by European Insurance and Occupational Pensions Authority (EIOPA) using a prudent assumption that all future downgrades will be replaced annually, and allowing for the credit spread floor. 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 a best estimate credit risk allowance. The remaining elements of prudence within the Solvency II allowance are incorporated into the risk margin included in the discount rate, shown in note 14(iii). In 2015, the allowance for liquidity premium was 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 asset portfolio subject to credit risk; and an allowance for short-term downgrades and defaults. (2) With-profits fund non-profit annuity business For UK non-profit annuity business including that attributable to the PAC with-profits fund, 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 for this business 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. (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 of the long-term spread over risk-free, 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 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 businesses. For the Group’s Asia operations in China, Indonesia, the Philippines, Taiwan, Thailand and Vietnam, additional allowances are applied for emerging market risk ranging from 100 to 250 basis points. For the Group’s US business and UK business, no additional allowance is necessary. In 2015, for UK shareholder-backed annuity business, a further allowance of 50 basis points was used to reflect the longevity risk, which is covered by the solvency capital requirements following the implementation of Solvency II from 1 January 2016. 352 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued(ix) 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 exchange rates. The principal exchange rates are shown in note A1 of the IFRS financial statements. (x) Taxation In determining the post-tax profit for the year for covered business, the overall tax rate includes the impact of tax effects determined on a local regulatory basis. 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 announced and substantively enacted by the end of the reporting period. (xi) Inter-company arrangements The EEV results for covered business incorporate annuities established in the PAC non-profit sub-fund from vesting pension policies in SAIF (which is not covered business). The EEV results also incorporate the effect of the reinsurance arrangement of non-profit immediate pension annuity liabilities of SAIF to the PAC non-profit sub-fund. (b) Accounting presentation (i) Analysis of post-tax profit To the extent applicable, the presentation of the EEV post-tax profit for the year is consistent in the classification between operating and non-operating results with the basis that the Group applies for the analysis of IFRS basis results. Operating results reflect underlying results including longer-term investment returns (which are determined as described in note 14(b)(ii)) and incorporate the following: — New business contribution, as defined in note 14(a)(ii); — Unwind of discount on the value of in-force business and other expected returns, as described in note 14(b)(iii); — The impact of routine changes of estimates relating to operating assumptions, as described in note 14(b)(iv); and — Operating experience variances, as described in note 14(b)(v). Non-operating results comprise the recurrent items of: — Short-term fluctuations in investment returns; — The mark to market value movements on core borrowings; and — The effect of changes in economic assumptions. In addition, non-operating profit also includes the effect of adjustment to the carrying value of the held for sale Korea life business in 2016 and a reclassification of the result attributable to the held for sale Korea life business in both years (see note 17 for details). Total profit attributable to shareholders and basic earnings per share include these items, together with actual investment returns. The Group believes that operating profit, as adjusted for these items, better reflects underlying performance. (ii) Investment returns included in operating profit 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 14(b)(iii). For the purpose of determining the long-term returns for debt securities of US operations for fixed 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-period 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 business adjusted to reflect end-of-period 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 operating result for the year. 353 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results14 Methodology and accounting presentation continued (iii) 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 at the beginning of the year (adjusted for the effect of current year economic and operating assumption changes); and — Required capital and surplus assets. UK operations In applying this general approach, the unwind of discount included in operating profit is determined by reference to the following: — The unwind is determined by reference to an implied single risk discount rate for 2016. Following the implementation of Solvency II the EEV risk-free rate is based on a yield curve (as set out in note 14a(viii)), which is used to derive a single implied discount rate which, if this rate had been used, would reproduce the same embedded value as that calculated by reference to the yield curve. The difference between the operating profit determined using the single implied discount rate and that derived using the yield curve is included within non-operating profit; and — For with-profits business, the opening value of in-force is adjusted for the effect of short-term investment volatility due to market movements (ie smoothed). In the summary statement of financial position and for total profit reporting, asset values and investment returns are not smoothed. At 31 December 2016, the shareholders’ interest in the smoothed surplus assets used for this purpose only were £77 million lower (31 December 2015: £58 million lower) than the surplus assets carried in the statement of financial position. (iv) Effect of changes in operating assumptions Operating profit includes the effect of changes to non-economic assumptions on the value of in-force at the end of the year. For presentational purposes the effect of changes is delineated to show the effect on the opening value of in-force as operating assumption changes, with the experience variances subsequently being determined by reference to the end-of-period assumptions (see note 14(b) (v)). (v) Operating experience variances Operating profit includes the effect of experience variances on non-economic assumptions, such as persistency, mortality and morbidity, expenses and other factors, which are calculated with reference to the end-of-period assumptions. (vi) Effect of changes in economic assumptions Movements in the value of in-force business at the beginning of the year caused by changes in economic assumptions, net of the related change in the time value of cost of options and guarantees, are recorded in non-operating results. For UK insurance operations, the effect is after allowing for the recalculation of transitional measures on technical provisions. 15 Assumptions 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 risk-free rates of return (defined below for each of the Group’s insurance operations). 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 cash flows, under this methodology the profit emergence is advanced, thus more closely aligning the timing of the recognition of profit with the efforts and risks of current management actions, particularly with regard to business sold during the year. 354 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued(i) Asia operationsnotes (b), (c) The risk-free rates of return for Asia operations are defined as 10-year government bond yields at the end of the year. China Hong Kong notes (b)(d) Indonesia Malaysia note (d) Philippines Singapore note (d) Taiwan Thailand Vietnam Total weighted risk discount rate note (a) Risk discount rate % New business In-force business 10-year government bond yield % Expected long-term inflation % 31 Dec 2016 31 Dec 2015 31 Dec 2016 31 Dec 2015 31 Dec 2016 31 Dec 2015 31 Dec 2016 31 Dec 2015 9.6 3.9 12.0 6.8 11.6 4.2 4.0 9.4 13.0 5.3 9.4 3.7 12.8 6.6 11.3 4.3 4.0 9.3 13.8 5.9 9.6 3.9 12.0 6.9 11.6 5.0 4.0 9.4 13.0 6.1 9.4 3.7 12.8 6.7 11.3 5.1 3.9 9.3 13.8 6.4 3.1 2.5 8.1 4.3 4.8 2.5 1.2 2.7 6.3 2.9 2.3 8.9 4.2 4.6 2.6 1.0 2.5 7.1 2.5 2.3 5.0 2.5 4.0 2.0 1.0 3.0 5.5 2.5 2.3 5.0 2.5 4.0 2.0 1.0 3.0 5.5 Notes (a) (b) (c) (d) 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 post-tax EEV basis new business contribution and the closing value of in-force business. The changes in the risk discount rates for individual Asia territories reflect the movements in 10-year government bond yields, together with the effects of movements in the allowance for market risk and changes in product mix. For Hong Kong the assumptions shown are for US dollar denominated business. For other territories, the assumptions are for local currency denominated business. Equity risk premiums in Asia range from 3.5 per cent to 8.7 per cent (2015: from 3.5 per cent to 8.6 per cent). The mean equity return assumptions for the most significant equity holdings of the Asia operations are: 31 Dec 2016 % 31 Dec 2015 % Hong Kong Malaysia Singapore 6.5 10.2 8.5 6.3 10.2 8.6 (ii) US operations The risk-free rates of return for US operations are defined as 10-year treasury bond yield at the end of the year. Assumed new business spread margins:* Fixed annuity business:† January to June issues July to December issues Fixed index annuity business: January to June issues July to December issues Institutional business Allowance for long-term defaults included in projected spreadnote 14(a)(viii) Risk discount rate: Variable annuity: Risk discount rate Additional allowance for credit risk included in risk discount ratenote 14(a)(viii) Non-variable annuity: Risk discount rate Additional allowance for credit risk included in risk discount ratenote 14(a)(viii) Weighted average total: New business In-force business US 10-year treasury bond yield Pre-tax expected long-term nominal rate of return for US equities Expected long-term rate of inflation Equity risk premium S&P equity return volatilitynote (v) 31 Dec 2016 % 31 Dec 2015 % 1.25 1.25 1.50 1.50 0.50 0.21 6.9 0.2 4.1 1.0 6.8 6.5 2.5 6.5 3.0 4.0 18.0 1.25 1.50 1.50 1.75 0.70 0.24 6.8 0.2 3.9 1.0 6.7 6.2 2.3 6.3 2.8 4.0 18.0 * Including the proportion of variable annuity business invested in the general account and fixed index annuity business, the assumed spread margin grades up linearly by 25 basis points to a long-term assumption over five years. † Including the proportion of variable annuity business invested in the general account. 355 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results15 Assumptions continued (iii) UK insurance operations Effective from 1 January 2016, following the implementation of Solvency II, the EEV risk-free rate is based on the full term structure of interest rates, ie a yield curve, which is used to determine the embedded value at the end of the reporting period. For 2016, these yield curves are used to derive pre-tax expected long-term nominal rates of investment return and risk discount rates. For the purpose of determining the unwind of discount in the analysis of operating profit, these yield curves are used to derive a single implied risk discount rate, as explained in note 14(a)(viii). For 2015, risk-free rates of return and risk discount rates were based on a flat 15-year gilt yield at the end of the year. The key economic assumptions are shown below for both years, for 2016 the single implied risk discount rate is shown, along with the 15-year nominal rate of return based on the yield curve. For 2015 the long-term nominal rates of return are shown. Shareholder-backed annuity business: note (a) Risk discount rate: New business In-force business Pre-tax expected 15-year/long-term nominal rates of investment return: note (b) New business In-force business With-profits and other business: Risk discount rate:* New business In-force business Pre-tax expected 15-year/long-term nominal rates of investment return: note (b) Overseas equities Property 15-year gilt yield Corporate bonds Expected 15-year/long-term rate of inflation Equity risk premium 31 Dec 2016 % 31 Dec 2015 % 3.9 4.5 3.0 2.8 4.7 4.9 5.7 7.4 3.5 3.5 5.6 5.7 6.2 to 9.4 4.5 1.7 3.5 3.6 4.0 6.3 to 9.4 5.2 2.4 4.1 3.1 4.0 * The risk discount rates for with-profits and other business shown above represents a weighted average total of the rates applied to determine the present value of future cash flows, including a portion of future with-profits business shareholders’ transfers recognised in net worth. Notes (a) (b) For shareholder-backed annuity business, the movements in the pre-tax long-term nominal rates of return and risk discount rates for new and in-force businesses reflect the effect of changes in asset yields (based on average yields for new business). The table below shows the pattern of the UK risk-free Solvency II spot yield curve at the end of 31 December 2016: 31 Dec 2016 Year Risk-free rate (%) 1 0.4 5 0.7 10 1.1 15 1.3 20 1.3 Stochastic assumptions Details are given below of the key characteristics of the models used to determine the time value of the financial options and guarantees as referred to in note 14(a)(iv). (iv) Asia operations — The stochastic cost of guarantees is primarily of significance for the Hong Kong, Malaysia, Singapore and Taiwan operations; — The principal asset classes are government and corporate bonds; — The asset return models are similar to the models as described for UK insurance operations below; and — The 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 for both years. (v) US operations (Jackson) — Interest rates and equity returns are projected using a log-normal generator reflecting historical market data; — Corporate bond returns are based on treasury yields plus a spread that reflects current market conditions; and — The volatility of equity returns ranges from 18 per cent to 27 per cent for both years, and the standard deviation of interest rates ranges from 2.3 per cent to 2.6 per cent (2015: from 2.2 per cent to 2.5 per cent). 356 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinued (vi) UK insurance operations — Interest rates are projected using a stochastic interest rate model calibrated to the current market yields; — Equity returns are assumed to follow a log-normal distribution; — The corporate bond return is calculated based on a risk-free return plus a mean-reverting spread; — Property returns are also modelled on a risk-free return plus a risk premium with a stochastic process reflecting total property returns; and — The standard deviation of equities and property ranges from 15 per cent to 20 per cent for both years. Operating assumptions Best estimate assumptions 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. 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. Demographic assumptions Persistency, mortality and morbidity assumptions are based on an analysis of recent experience, but also reflect expected future experience. Where relevant, when calculating the time value of financial options and guarantees, policyholder withdrawal rates vary in line with the emerging investment conditions according to management’s expectations. 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 identified 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), expense overruns are reported where these are expected to be short-lived. For Asia operations, the expenses comprise costs borne directly and recharged costs from the Asia regional head office, 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, which is included in other income and expenditure, comprises: — Expenditure for Group head office, to the extent not allocated to the PAC with-profits 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 office that is not allocated to the covered business or asset management operations which is charged as incurred. These costs are primarily for corporate-related activities and are included within corporate expenditure. Tax rates The assumed long-term effective tax rates for operations reflect the incidence of taxable profits and losses in the projected cash flows as explained in note 14(a)(x). The local standard corporate tax rates applicable for the most significant operations for 2016 and 2015 are as follows: Standard corporate tax rates % Asia operations: Hong Kong Indonesia Malaysia Singapore US operations UK operations* 16.5 per cent on 5 per cent of premium income 25.0 2015: 25.0; from 2016: 24.0 17.0 35.0 2015: 20.0; from 2017: 19.0; from 2020: 17.0 * The Finance Bill included a reduction in the UK corporate tax rate from 18 per cent to 17 per cent effective from 1 April 2020. The impact of this reduction on the UK in-force business is shown in note 5(iv)(b). 357 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results16 New business premiums and contributions note (i) Group insurance operations Asia† US UK‡ Group total excluding UK bulk annuities† UK bulk annuities‡ Group total† Asia insurance operations Cambodia Hong Kong Indonesia Malaysia Philippines Singapore Thailand Vietnam SE Asia operations including Hong Kong China note (ii) Taiwan India note (iii) Total Asia insurance operations† US insurance operations Variable annuities Elite Access (variable annuity) Fixed annuities Fixed index annuities Wholesale Total US insurance operations Single premiums Regular premiums Annual premium and contribution equivalents (APE) note 14(a)(ii) Present value of new business premiums (PVNBP)* note 14(a)(ii) 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m 2,397 15,608 9,836 27,841 – 1,938 17,286 6,955 26,179 1,508 27,841 27,687 – 1,140 236 110 91 523 80 6 2,186 124 36 51 2,397 – 546 230 100 146 454 69 6 1,551 308 45 34 1,938 3,359 – 177 3,536 – 3,536 14 1,798 255 233 61 299 81 115 2,856 187 146 170 3,359 10,653 2,056 555 508 1,836 11,977 3,144 477 458 1,230 15,608 17,286 – – – – – – 2,518 – 179 2,697 – 2,697 8 1,158 303 201 44 264 88 82 2,148 111 127 132 2,518 – – – – – – 3,599 1,561 1,160 6,320 – 6,320 14 1,912 279 244 70 351 89 116 3,075 199 150 175 3,599 1,065 206 55 51 184 2,712 1,729 874 5,315 151 19,271 15,608 10,513 45,392 – 14,428 17,286 7,561 39,275 1,508 5,466 45,392 40,783 8 1,213 326 211 59 309 95 83 2,304 142 131 135 66 10,930 1,048 1,352 278 2,627 404 519 17,224 880 499 668 38 7,007 1,224 1,208 287 2,230 422 343 12,759 739 442 488 2,712 19,271 14,428 1,198 314 48 46 123 10,653 2,056 555 508 1,836 11,977 3,144 477 458 1,230 1,561 1,729 15,608 17,286 358 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedSingle premiums Regular premiums Annual premium and contribution equivalents (APE) note 14(a)(ii) Present value of new business premiums (PVNBP)* note 14(a)(ii) 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m 2016 £m 2015 £m UK and Europe insurance operations Individual annuities Bonds Corporate pensions Individual pensions Income drawdown Other products Total retail Wholesale 546 3,834 110 2,532 1,649 1,165 9,836 – 565 3,327 175 1,185 1,024 679 6,955 1,508 Total UK and Europe insurance operations 9,836 8,463 – – 121 35 – 21 177 – 177 – – 135 32 – 12 179 – 179 55 384 132 289 165 135 1,160 – 57 333 152 150 102 80 874 151 546 3,835 479 2,681 1,649 1,323 10,513 – 565 3,328 600 1,295 1,024 749 7,561 1,508 1,160 1,025 10,513 9,069 Group total† 27,841 27,687 3,536 2,697 6,320 5,466 45,392 40,783 Group total excluding UK bulk annuities† 27,841 26,179 3,536 2,697 6,320 5,315 45,392 39,275 * For 2016, the risk discount rates used to calculate PVNBP for UK insurance operations are on a basis that reflects the Solvency II regime effective on 1 January 2016 (see note 2 for details). The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. † The new business premiums and contributions exclude the results attributable to the held for sale Korea life business (see note 17 for details). The 2015 comparatives have been similarly adjusted. ‡ Following Prudential’s withdrawal from the UK bulk annuity market, the 2015 comparative results for UK bulk annuities new business have been presented separately. 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. A reconciliation of APE and gross earned premiums on an IFRS basis is provided in Note II(i) within the unaudited financial information. (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. 359 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis results17 Agreement to sell Korea life business In November 2016, the Group reached an agreement to sell the life insurance subsidiary in Korea, PCA Life Insurance, to Mirae Asset Life Insurance for KRW 170 billion (£114 million at 31 December 2016 closing exchange rate). Completion of the transaction is subject to regulatory approval. Consistent with the classification of the business as held for sale for IFRS reporting, the EEV carrying value has been set to £105 million at 31 December 2016, representing the estimated proceeds, net of £9 million of related expenses. In order to facilitate comparisons of the Group’s retained businesses, the EEV basis operating profit excludes the contribution from the Korea life business. The 2015 comparative results have been similarly adjusted. For 2016, the post-tax result for the year of £5 million, including short-term fluctuations in investment returns and the effect of changes in economic assumptions, together with the £(415) million adjustment to the carrying value have given rise to an aggregate loss of £(410) million. The 2015 amount of £39 million represents the previously reported profit after tax for this business. The tables below show the results of the held for sale Korea life business which were included in the Group’s results for half year 2016 Half year 2016 £m Full year 2015 £m 3 3 6 (17) (11) (9) 3 (6) 17 11 8 33 41 (2) 39 (27) 34 7 8 15 Single premiums £m Regular premiums £m Annual premium and contribution equivalents (APE) £m Present value of new business premiums (PVNBP) £m 42 182 46 123 50 141 276 780 and full year 2015. EEV post-tax results Operating profit New business contribution Profit from business in force Non-operating loss Total profit after tax Underlying free surplus generated New business contribution Profit from business in force Non-operating profit Total free surplus generated New business premiums and contributions Half year 2016 Full year 2015 360 Prudential plc Annual Report 2016 www.prudential.co.ukNotes on the EEV basis resultsContinuedStatement 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 European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (the EEV Principles) using the methodology and assumptions set out in the Notes on the EEV basis results. 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; — Identified 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 financial statements. 361 www.prudential.co.ukAnnualReport2016 Prudential plc 06 European Embedded Value (EEV) basis resultsIndependent auditor’s report to Prudential plc on the European Embedded Value (EEV) basis supplementary information The purpose of this report and restrictions on its use by persons other than the Company 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. Rees Aronson for and on behalf of KPMG LLP Chartered Accountants London 13 March 2017 Opinions and conclusions arising from our audit Our opinion on the EEV basis supplementary information is unmodified We have audited the EEV basis supplementary information of Prudential plc (the Company) for the year ended 31 December 2016 set out in the EEV basis results and Notes on the EEV basis results pages. The EEV basis supplementary information should be read in conjunction with the Group financial statements. In our opinion, the EEV basis supplementary information of the Company for the year ended 31 December 2016 has been properly prepared, in all material respects, in accordance with the European Embedded Value Principles dated April 2016 by the European Insurance CFO Forum (the EEV Principles) using the methodology and assumptions set out in the Notes on the EEV basis results. 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 361, 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 an audit of financial statements performed in accordance with ISAs (UK and Ireland) A description of the scope of an audit of financial statements is provided on our website at www.kpmg.com/uk/ auditscopeukco2014a. This report is made subject to important explanations regarding our responsibilities, as published on that website, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions. 362 Prudential plc Annual Report 2016 www.prudential.co.uk07 Additional information 364 Index to the additional unaudited financial information 392 Risk factors 402 Shareholder information 405 How to contact us 07 Additional informationIndex to the additional unaudited financial information I. IFRS profit and loss information 365 a 372 373 374 b c d Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver Asia operations – analysis of IFRS operating profit by territory Analysis of asset management operating profit based on longer-term investment returns Contribution to UK Life financial metrics from specific management actions undertaken to position the balance sheet more efficiently under the new Solvency II regime II. Other information 375 376 377 381 a b c d Holding company cash flow Funds under management Solvency II capital position at 31 December 2016 Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus Foreign currency source of key metrics Option schemes Selected historical financial information of Prudential Reconciliation between IFRS and EEV shareholders’ funds Reconciliation of APE new business sales to earned premiums 386 387 389 391 391 e f g h i 364 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial information I IFRS profit and loss information I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver This schedule classifies the Group’s pre-tax operating earnings from long-term insurance operations into the underlying drivers of those profits, using the following categories: — 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 certain policyholder accounts. It excludes the operating investment return on shareholder net assets, which has been separately disclosed as expected return on shareholder assets. — 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. — With-profits business represents the gross of tax shareholders’ transfer from the with-profits fund for the year. — Insurance margin primarily represents profits derived from the insurance risks of mortality and morbidity. — Margin on revenues primarily represents amounts deducted from premiums to cover acquisition costs and administration expenses. — Acquisition costs and administration expenses represent expenses incurred in the year 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 sources of earnings lines (eg investment expenses are netted against investment income as part of spread income or fee income as appropriate). — DAC adjustments comprise DAC amortisation for the year, excluding amounts related to short-term fluctuations in investment returns, net of costs deferred in respect of new business. Analysis of pre-tax IFRS operating profit by source and margin analysis of Group long-term insurance business The following analysis expresses certain of the Group’s sources of operating profit as a margin of policyholder liabilities or other suitable driver. Details on the calculation of the Group’s average policyholder liability balances are given in note (iv) at the end of this section. Spread income Fee income With-profits Insurance margin Margin on revenues Expenses: Acquisition costs note (i) Administration expenses DAC adjustments note (v) Expected return on shareholder assets Longevity reinsurance and other management actions to improve solvency Provision for review of past annuity sales Long-term business operating profit based on longer-term investment returns See notes at the end of this section. Average liability note (iv) 83,054 139,451 118,334 Total bps note (ii) 141 156 27 6,320 229,477 (36)% (85) Asia note (vi) 192 174 48 1,040 1,919 (1,285) (832) 148 99 1,503 US 802 1,942 – 888 – (877) (959) 244 12 2,052 2016 £m UK 177 59 269 63 207 (89) (152) (2) 110 642 332 (175) Total 1,171 2,175 317 1,991 2,126 (2,251) (1,943) 390 221 4,197 332 (175) 1,503 2,052 799 4,354 365 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationI IFRS profit and loss information continued I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued Spread income Fee income With-profits Insurance margin Margin on revenues Expenses: Acquisition costs note (i) Administration expenses DAC adjustments note (v) Expected return on shareholder assets Longevity reinsurance and other management actions to improve solvency Long-term business operating profit based on longer-term investment returns See notes at the end of this section. Spread income Fee income With-profits Insurance margin Margin on revenues Expenses: Acquisition costs note (i) Administration expenses DAC adjustments note (v) Expected return on shareholder assets Longevity reinsurance and other management actions to improve solvency Long-term business operating profit based on longer-term investment returns See notes at the end of this section. Average liability note (iv) 72,900 123,232 106,749 Total bps note(ii) 158 153 29 5,466 203,664 (38)% (81) Average liability note (iv) 78,026 135,717 108,551 Total bps note (ii) 162 156 29 5,995 222,250 (39)% (82) Asia note (vi) 149 154 45 756 1,643 (1,075) (669) 97 71 1,171 US 746 1,672 – 796 – (939) (828) 218 26 1,691 2015 AER £m UK 258 62 269 119 179 (86) (159) (2) 127 767 400 Total 1,153 1,888 314 1,671 1,822 (2,100) (1,656) 313 224 3,629 400 1,171 1,691 1,167 4,029 Asia note (vI) 164 170 50 841 1,821 (1,194) (736) 108 79 1,303 US 845 1,886 – 898 – (1,059) (934) 246 26 1,908 2015 CER £m note (iii) UK 258 62 269 119 179 (86) (159) (2) 127 767 400 Total 1,267 2,118 319 1,858 2,000 (2,339) (1,829) 352 232 3,978 400 1,303 1,908 1,167 4,378 366 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedMargin analysis of long-term insurance business – Asia 2016 Average liability note (iv) £m 13,299 15,643 22,823 Margin note (ii) bps 144 111 21 Profit £m 192 174 48 1,040 1,919 (1,285) 3,599 (832) 28,942 148 (36)% (287) 99 Long-term business Spread income Fee income With-profits Insurance margin Margin on revenues Expenses: Acquisition costs note (i) Administration expenses DAC adjustments note (v) Expected return on shareholder assets Operating profit based on longer-term investment return 1,503 See notes at the end of this section. Analysis of Asia operating profit drivers: Asia note (vi) 2015 AER Average liability note (iv) £m 10,428 13,940 17,446 Margin note (ii) bps 143 110 26 2,712 24,368 (40)% (274) Profit £m 149 154 45 756 1,643 (1,075) (669) 97 71 1,171 2015 CER note (iii) Average liability note (iv) £m 11,466 14,944 19,247 Margin note (ii) bps 143 114 26 3,020 26,410 (40)% (279) Profit £m 164 170 50 841 1,821 (1,194) (736) 108 79 1,303 — Spread income increased on a constant exchange rate basis by 17 per cent to £192 million in 2016 (AER: 29 per cent), predominantly reflecting the growth of the Asia non-linked policyholder liabilities. — Fee income increased by 2 per cent on a constant exchange rate basis to £174 million in 2016 (AER: 13 per cent), broadly in line with the increase in movement in average unit-linked liabilities. — Insurance margin increased on a constant exchange rate basis by 24 per cent to £1,040 million in 2016 (AER: 38 per cent), primarily reflecting the continued growth of the in-force book, which contains a relatively high proportion of risk-based products. Insurance margin includes non-recurring items of £49 million (2015: £17 million on CER basis; £15 million on AER basis). — Margin on revenues increased by £98 million on a constant exchange rate basis from £1,821 million to £1,919 million in 2016, primarily reflecting higher regular premium income recognised in the year. — Acquisition costs increased on a constant exchange rate basis by 8 per cent to £1,285 million in 2016, (AER: 19 per cent) compared to the 19 per cent increase in APE sales (AER: 33 per cent increase), resulting in a decrease in the acquisition costs ratio. The analysis above uses shareholder acquisition costs as a proportion of total APE sales. If with-profits APE sales were excluded from the denominator the acquisition cost ratio would become 70 per cent, which is broadly in line with the 69 per cent on a constant exchange rate basis in 2015. — Administration expenses increased on a constant exchange rate basis by 13 per cent to £832 million in 2016 (AER: 24 per cent) as the business continues to expand. On a constant exchange rate basis, the administration expense ratio has increased from 279 basis points in 2015 to 287 basis points in 2016, the result of changes in country and product mix. 367 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationI IFRS profit and loss information continued I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued Margin analysis of long-term insurance business – US 2016 Average liability note (iv) £m Profit £m 802 37,044 1,942 102,027 888 1,561 (877) (959) 146,043 244 12 US 2015 AER Average liability note (iv) £m 30,927 86,921 Margin note (ii) bps 241 192 Margin note (ii) bps 217 190 Profit £m 746 1,672 796 2015 CER note (iii) Average liability note (iv) £m 35,015 98,402 Margin note (ii) bps 241 192 Profit £m 845 1,886 898 (56)% (66) 1,729 (939) (828) 125,380 218 26 (54)% (66) (1,059) 1,950 (934) 141,924 246 26 (54)% (66) Long-term business Spread income Fee income Insurance margin Expenses Acquisition costs note (i) Administration expenses DAC adjustments Expected return on shareholder assets Operating profit based on longer-term investment returns 2,052 See notes at the end of this section. Analysis of US operating profit drivers: 1,691 1,908 — Spread income declined on a constant exchange rate basis by 5 per cent to £802 million in 2016 (AER increased by 8 per cent). The reported spread margin decreased to 217 basis points from 241 basis points in 2015, primarily due to lower investment yields. Spread income benefited from swap transactions previously entered into to more closely match the asset and liability duration. Excluding this effect, the spread margin would have been 153 basis points (2015 CER: 167 basis points and AER: 166 basis points). — Fee income increased on a constant exchange rate basis by 3 per cent to £1,942 million in 2016 (AER: 16 per cent), primarily due to positive net inflows from variable annuity business and fund appreciation during the second half of the year. Fee income margin has remained broadly in line with the prior year at 190 basis points (2015 CER and AER: 192 basis points). — Insurance margin represents operating profits from insurance risks, including variable annuity guarantees and other sundry items. Insurance margin of £888 million in 2016 was broadly in line with last year on a constant exchange rate basis, with higher income from the variable annuity guarantees offset by a decline in the contribution from the closed books of acquired business. — Acquisition costs, which are commissions and expenses incurred to acquire new business, including those that are not deferrable, have decreased by 17 per cent at a constant exchange rate basis, largely due to lower sales in 2016. — Administration expenses increased to £959 million in 2016 compared to £934 million for 2015 at constant exchange rates (AER £828 million), primarily as a result of higher asset-based commissions . These are paid on policy anniversary dates and are treated as an administration expense in this analysis. Excluding these trail commissions, the resulting administration expense ratio would be 34 basis points (2015 CER and AER: 36 basis points). 368 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedAnalysis of pre-tax operating profit before and after acquisition costs and DAC adjustments 2016 £m Acquisition costs 2015 AER £m Acquisition costs 2015 CER £m note (iii) Acquisition costs Other operating profits Incurred Deferred Total Other operating profits Incurred Deferred Total Other operating profits Incurred Deferred Total Total operating profit before acquisition costs and DAC adjustments Less new business strain Other DAC adjustments – amortisation of previously deferred acquisition costs: Normal (Accelerated)/ Decelerated 2,685 2,685 2,412 2,412 2,721 2,721 (877) 678 (199) (939) 734 (205) (1,059) 828 (231) (527) (527) 93 93 (514) (514) (2) (2) (580) (580) (2) (2) Total 2,685 (877) 244 2,052 2,412 (939) 218 1,691 2,721 (1,059) 246 1,908 Analysis of operating profit based on longer-term investment returns for US operations by product Spread business note (a) Fee business note (b) Life and other business note (c) Total insurance operations US asset management and broker-dealer Total US operations 2016 £m 2015 £m 323 1,523 206 2,052 (4) 2,048 AER 380 1,114 197 1,691 11 1,702 CER 428 1,257 223 1,908 13 1,921 % 2016 vs 2015 AER (15)% 37% 5% 21% n/a 20% 2016 vs 2015 CER (25)% 21% (8)% 8% n/a 7% The analysis of operating profit based on longer-term investment returns for US operations by product represents the net profit generated by each line of business after allocation of costs. Broadly: a) Spread business is the net operating profit for fixed annuity, fixed indexed annuity and guaranteed investment contracts and largely comprises spread income less costs. b) Fee business represents profits from variable annuity products. As well as fee income, revenue for this product line includes spread income from investments directed to the general account and other variable annuity fees included in insurance margin. c) Life and other business includes the profits from the REALIC business and other closed life books. Revenue allocated to this product line includes spread income and premiums and policy charges for life protection, which are included in insurance margin after claim costs. Insurance margin forms the vast majority of revenue. 369 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationI IFRS profit and loss information continued I(a) Analysis of long-term insurance business pre-tax IFRS operating profit based on longer-term investment returns by driver continued Margin analysis of long-term insurance business – UK Long-term business Spread income Fee income With-profits Insurance margin Margin on revenues Acquisition costs note (i) Administration expenses DAC adjustments Expected return on shareholder assets Longevity reinsurance and other management actions to improve solvency Provision for review of past annuity sales Operating profit based on longer-term investment returns See notes at the end of this section. Profit £m 177 59 269 63 207 (89) (152) (2) 110 642 332 (175) 799 UK Margin note (ii) bps 54 27 28 (8)% (28) 2016 Average liability note (iv) £m 32,711 21,781 95,511 1,160 54,492 2015 note (v) Average liability note (iv) £m 31,545 22,371 89,303 Margin note (ii) bps 82 28 30 1,025 53,916 (8)% (29) Profit £m 258 62 269 119 179 (86) (159) (2) 127 767 400 – 1,167 370 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinued Analysis of UK operating profit drivers: — Spread income reduced from £258 million in 2015 to £177 million in 2016, mainly due to lower annuity sales. Spread income has two components: – A contribution from new annuity business which was lower at £41 million in 2016 compared to £123 million in 2015, as we withdrew our participation from this business. IFRS accounting (based on grandfathered GAAP) permits up front recognition of a considerable proportion of the spread to be earned over the entire term of the new contracts. – A contribution from in-force annuity and other business, which was broadly in line with last year at £136 million (2015: £135 million), equivalent to 42 basis points of average reserves (2015: 43 basis points). — Fee income principally represents asset management fees from unit-linked business, including direct investment only business to group pension schemes, where liability flows are driven by a small number of large single mandate transactions and fee income mostly arises within our UK asset management business. Excluding these schemes, the fee margin on the remaining balances was 40 basis points (2015: 43 basis points). — The lower 2016 insurance margin mainly reflects the more positive experience variance seen in 2015 compared to 2016, together with the fall in annual mortality profits following the extension of our longevity reinsurance programme in 2015 and 2016. — Margin on revenues represents premium charges for expenses and other sundry net income received by the UK. — Acquisition costs incurred were broadly consistent with 2015 at £89 million, equivalent to 8 per cent of total APE sales in 2016 (2015: 8 per cent). The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. The year on year comparison of the ratio is therefore impacted by the level of with-profits business (where acquisition costs are funded by the estate) in the year and the contribution from the bulk annuities transactions in the prior year. Acquisition costs expressed as a percentage of shareholder-backed APE sales (excluding the bulk annuity transactions) were 37 per cent (2015: 36 per cent). — The contribution from longevity reinsurance and other management actions to improve solvency during 2016 was £332 million (2015: £400 million). Further explanation and analysis is provided in Additional Unaudited IFRS Financial Information section I(d). — The 2016 provision for the cost of undertaking a review of past non-advised annuity sales and potential redress of £175 million is explained in note C11, ‘Provisions’. The ratio for acquisition costs is calculated as a percentage of APE sales including with-profits sales. Acquisition costs include only those relating to shareholder-backed business. Notes to sources of earnings tables (i) (ii) Margin represents the operating return earned in the year as a proportion of the relevant class of policyholder liabilities excluding unallocated surplus. (iii) The 2015 comparative information has been presented at AER and CER so as to eliminate the impact of exchange translation. CER results are calculated by translating prior year results using the current year foreign exchange rates. All CER profit figures have been translated at current year average rates. For Asia CER average liability calculations, the policyholder liabilities have been translated using current year opening and closing exchange rates. For the US CER average liability calculations, the policyholder liabilities have been translated at the current year month end closing exchange rates. See also Note A1. For UK and Asia, opening and closing policyholder liabilities have been used to derive an average balance for the year, as a proxy for average balances throughout the year. The calculation of average liabilities for Jackson is generally derived from month end balances throughout the year, as opposed to opening and closing balances only. In 2016, given the significant equity market fluctuations in certain months during the year, average liabilities for fee income in Jackson have been calculated using daily balances instead of month end balances in order to provide a more meaningful analysis of the fee income, which is charged on the daily account balance. The 2015 average liabilities for fee income in Jackson have been calculated based on average of month end balances. The alternative use of the daily balances to calculate the average would have resulted in no change to the margin on the CER basis. Average liabilities for spread income are based on the general account liabilities to which spread income attaches. Average liabilities used to calculate the administration expense margin exclude the REALIC liabilities reinsured to third parties prior to the acquisition by Jackson. Average liabilities are adjusted for business acquisitions and disposals in the year. The DAC adjustments contain a credit of £28 million in respect of joint ventures and associate in 2016 (2015: AER credit of £3 million). In order to show the Asia long-term business on a comparable basis, the 2015 comparative results exclude the contribution from the held for sale Korea life business. (iv) (v) (vi) 371 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationI IFRS profit and loss information continued I(b) Asia operations – analysis of IFRS operating profit by territory Operating profit based on longer-term investment returns for Asia operations is analysed as follows: 2016 £m AER 2015 £m CER 2015 £m 2015 AER vs 2016 2015 CER vs 2016 Hong Kong Indonesia Malaysia Philippines Singapore Thailand Vietnam South-east Asia operations including Hong Kong China Taiwan Other Non-recurrent items note (ii) Total insurance operations note (i),(iii) Development expenses Total long-term business operating profit Eastspring Investments Total Asia operations note (iii) 238 428 147 38 235 92 114 1,292 64 35 49 67 1,507 (4) 1,503 141 1,644 150 356 120 32 204 70 86 1,018 32 25 38 62 1,175 (4) 1,171 115 1,286 170 404 128 35 229 76 94 1,136 35 28 42 66 1,307 (4) 1,303 128 1,431 59% 20% 23% 19% 15% 31% 33% 27% 100% 40% 29% 8% 28% 0% 28% 23% 28% 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: New business strain* Business in force Non-recurrent items note (ii) Total 2016 £m 2015 £m (29) 1,469 67 1,507 AER 5 1,108 62 1,175 40% 6% 15% 9% 3% 21% 21% 14% 83% 25% 17% 2% 15% 0% 15% 10% 15% CER 7 1,234 66 1,307 * The IFRS new business strain corresponds to approximately (0.8) per cent of new business APE premiums for 2016 (2015: approximately 0.2 per cent of new business APE). The strain reflects the aggregate of the pre-tax regulatory basis strain to net worth after IFRS adjustments for deferral of acquisition costs and deferred income where appropriate. (ii) Other non-recurrent items of £67 million in 2016 (2015: £62 million) represent a number of items, including a gain from entering into a reinsurance contract in the year. (iii) In order to show the Asia long-term business on a comparable basis, the 2015 comparative results exclude the contribution from the held for sale Korea life business. 372 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinued I(c) Analysis of asset management operating profit based on longer-term investment returns Operating income before performance-related fees Performance-related fees Operating income (net of commission) note (i) Operating expense note (i) Share of associate’s results Group’s share of tax on joint ventures’ operating profit Operating profit based on longer-term investment returns Eastspring Investments note (ii) 2016 £m Prudential Capital 353 7 360 (198) – (21) 141 118 – 118 (91) – – 27 M&G note (ii) 923 33 956 (544) 13 – 425 Average funds under management Margin based on operating income* Cost/income ratio† £250.4bn 37bps 59% £109.0bn 32bps 56% M&G note (ii) Eastspring Investments note (ii) 2015 £m Prudential Capital Operating income before performance-related fees Performance-related fees Operating income (net of commission) note (i) Operating expense note (i) Share of associate’s results Group’s share of tax on joint ventures’ operating profit Operating profit based on longer-term investment returns Average funds under management Margin based on operating income* Cost/income ratio† 939 22 961 (533) 14 – 442 304 3 307 (176) – (16) 115 £252.5bn 37bps 57% £85.1bn 36bps 58% 118 – 118 (99) – – 19 US 235 – 235 (239) – – (4) US 321 – 321 (310) 11 Total 1,629 40 1,669 (1,072) 13 (21) 589 Total 1,682 25 1,707 (1,118) 14 (16) 587 Notes (i) Operating income and expense includes the Group’s share of contribution from joint ventures (but excludes any contribution from associates). In the income statement as shown in note B2 of the IFRS financial statements, these amounts are netted and tax deducted and shown as a single amount. (ii) M&G and Eastspring Investments can be further analysed as follows: 2016 2015 2016 2015 M&G Operating income before performance-related fees Margin of FUM* bps 86 87 Institu- tional‡ £m 419 357 Margin of FUM* bps 22 19 Eastspring Investments Operating income before performance-related fees Margin of FUM* bps 58 61 Institu- tional‡ £m 142 116 Margin of FUM* bps 20 21 Total £m 923 939 Total £m 353 304 Retail £m 504 582 Retail £m 211 188 Margin of FUM* bps 37 37 Margin of FUM* bps 32 36 * Margin represents operating income before performance-related fees as a proportion of the related funds under management (FUM). Monthly closing internal and external funds managed by the respective entity have been used to derive the average. Any funds held by the Group’s insurance operations that 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. ‡ Institutional includes internal funds. 373 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional information I IFRS profit and loss information continued I(d) Contribution to UK Life financial metrics from specific management actions undertaken to position the balance sheet more efficiently under the new Solvency II regime During 2016 management actions were taken to improve the solvency of UK insurance operations and to mitigate market risks. These actions included extending the reinsurance of longevity risk to cover a further £5.4 billion of IFRS annuity liabilities. As at 31 December 2016, the total IFRS annuity liabilities subject to longevity reinsurance were £14.4 billion. Management actions also repositioned the fixed income asset portfolio to improve the trade-off between yield and credit risk and to increase the proportion of the annuity business that benefits from the matching adjustment under Solvency II. During 2015, longevity risk of £6.4 billion on a Pillar 1 basis was reinsured. In addition, a number of other management actions were also taken to reposition the fixed income portfolio and improve matching adjustment efficiency. The effect of these actions on the UK’s long-term IFRS operating profit, underlying free surplus generation and EEV operating profit is shown in the tables below. IFRS operating profit of UK long-term business Shareholder-backed annuity new business: Retail Bulks In-force business: Longevity reinsurance transactions Other management actions to improve solvency Provision for the review of past annuity sales With-profits and other in-force Total Life IFRS operating profit Underlying free surplus generation of UK long-term business* Expected in-force and return on net worth Longevity reinsurance transactions Other management actions to improve solvency Provision for the review of past annuity sales Changes in operating assumptions, experience variances and Solvency II and other restructuring costs Underlying free surplus generated from in-force business New business strain Total underlying free surplus generation EEV post-tax operating profit of UK long-term businesses* Unwind of discount and other expected return Longevity reinsurance transactions Other management actions to improve solvency Provision for the review of past annuity sales Changes in operating assumptions and experience variances Operating profit from in-force business New business profit: Shareholder-backed annuity Other products Total post-tax Life EEV operating profit First half 2016 £m Second half 2016 £m Full year 2016 £m Full year 2015 £m 27 – 27 66 74 – 140 306 473 14 – 14 131 61 (175) 17 295 326 41 – 41 197 135 (175) 157 601 799 34 89 123 231 169 – 400 644 1,167 First half 2016 £m Second half 2016 £m Full year 2016 £m Full year 2015 £m 334 53 137 – 190 31 555 (56) 499 359 73 88 (145) 16 (23) 352 (73) 279 693 126 225 (145) 206 8 907 (129) 778 620 200 75 – 275 (17) 878 (65) 813 First half 2016 £m Second half 2016 £m Full year 2016 £m Full year 2015 £m 205 (10) 41 – 31 23 259 17 108 125 384 240 (80) 69 (145) (156) 32 116 15 128 143 259 445 (90) 110 (145) (125) 55 375 32 236 268 643 488 (134) 75 – (59) 116 545 148 170 318 863 *The 2016 results for the UK insurance operations have been prepared on a basis that reflects the Solvency II regime effective from 1 January 2016. The 2015 comparative results for UK insurance operations reflect the Solvency I basis being the regime applicable for the year. 374 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedII Other information II(a) Holding company cash flow* Net cash remitted by business units: UK life net remittances to the Group With-profits remittance Shareholder-backed business remittance Other UK paid to the Group Total UK net remittances to the Group US remittances to the Group Asia net remittances to the Group Asia paid to the Group: Long-term business Other operations Group invested in Asia: Long-term business Other operations (including funding of regional head office costs) Total Asia net remittances to the Group M&G remittances to the Group PruCap remittances to the Group Net remittances to the Group from business units1 Net interest paid Tax received Corporate activities Total central outflows Operating holding company cash flow before dividend Dividend paid Operating holding company cash flow after dividend* Non-operating net cash flow2 Total holding company cash flow Cash and short-term investments at beginning of year Foreign exchange movements Cash and short-term investments at end of year3 2016 £m 2015 £m 215 85 300 147 447 420 546 81 627 (10) (101) (111) 516 290 45 1,718 (333) 132 (215) (416) 1,302 (1,267) 35 335 370 2,173 83 2,626 201 100 301 30 331 470 494 74 568 (5) (96) (101) 467 302 55 1,625 (290) 145 (209) (354) 1,271 (974) 297 376 673 1,480 20 2,173 *The holding company cash flow differs from the IFRS cash flow statement, which includes all cash flows in the period including those relating to both policyholder and shareholder funds. The holding company cash flow is therefore a more meaningful indication of the Group’s central liquidity. 1 2 3 Net cash remittances comprise dividends and other transfers from business units that are reflective of emerging earnings and capital generation. Non-operating net cash flow principally relates to the issue of subordinated debt less the repayment of debt and payments for distribution rights. Including central finance subsidiaries. 375 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(b) Funds under management (a) Summary Business area: Asia operations US operations UK operations Prudential Group funds under management note (i) External funds note (ii) Total funds under management Notes (i) Prudential Group funds under management comprise: Total investments per the consolidated statement of financial position Less: investments in joint ventures and associates accounted for using the equity method Investment properties which are held for sale or occupied by the Group (included in other IFRS captions) Internally managed funds held in joint ventures Prudential Group funds under management 2016 £bn 2015 £bn 69.6 173.3 185.0 427.9 171.4 599.3 54.0 134.6 168.4 357.0 151.6 508.6 2016 £bn 2015 £bn 421.7 (1.2) 0.4 7.0 427.9 352.0 (1.0) 0.4 5.6 357.0 (ii) External funds shown above as at 31 December 2016 of £171.4 billion (2015: £151.6 billion) comprise £182.5 billion (2015: £162.7 billion) of funds managed by M&G and Eastspring Investments as shown in note (b) below less £11.1 billion (2015: £11.1 billion) that are classified within Prudential Group’s funds. (b) Investment products – external funds under management 1 January Market gross inflows Redemptions Market exchange translation and other movements 31 December 2016 £m 2015 £m Eastspring Investments note 36,287 164,004 (161,766) M&G 126,405 22,841 (30,931) Group total Eastspring Investments note 162,692 186,845 (192,697) 30,133 110,396 (103,360) M&G 137,047 33,626 (40,634) Group total 167,180 144,022 (143,994) 7,231 18,448 25,679 (882) (3,634) (4,516) 45,756 136,763 182,519 36,287 126,405 162,692 Note The £182.5 billion (2015: £162.7 billion) investment products comprise £174.8 billion (2015: £156.7 billion) plus Asia Money Market Funds of £7.7 billion (2015: £6.0 billion). (c) M&G and Eastspring Investments – total funds under management External funds under management Internal funds under management Total funds under management Eastspring Investments M&G 2016 £bn note 2015 £bn note 2016 £bn 2015 £bn 45.7 72.2 117.9 36.3 52.8 89.1 136.8 128.1 264.9 126.4 119.7 246.1 Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2016 of £7.7 billion (2015: £6.0 billion). 376 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedII(c) Solvency II capital position at 31 December 2016 The estimated Group shareholder Solvency II surplus at 31 December 2016 was £12.5 billion, before allowing for payment of the 2016 second interim ordinary dividend and after allowing for recalculation of transitional measures as at 31 December 2016. Estimated Group shareholder Solvency II capital position* Own Funds Solvency Capital Requirement Surplus Solvency ratio 31 Dec 2016 £bn 31 Dec 2015 £bn 24.8 12.3 12.5 201% 20.1 10.4 9.7 193% * The Group shareholder capital position excludes the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced With-Profit Funds and staff pension schemes in surplus. The 31 December 2016 estimated solvency position includes the impact of recalculated transitionals at the valuation date which has reduced the Group shareholder surplus from £12.9 billion to £12.5 billion. In accordance with Solvency II requirements, these results allow for: — Capital in Jackson in excess of 250 per cent of the US local Risk Based Capital requirement. As agreed with the Prudential Regulation Authority, this is incorporated in the result above as follows: – Own funds: represents Jackson’s local US Risk Based available capital less 100 per cent of the US Risk Based Capital requirement (Company Action Level); – Solvency Capital Requirement: represents 150 per cent of Jackson’s local US Risk Based Capital requirement (Company Action Level); and – No diversification benefits are taken into account between Jackson and the rest of the Group. — Matching adjustment for UK annuities and volatility adjustment for US dollar denominated Hong Kong with-profits business, based on approvals from the Prudential Regulation Authority and calibrations published by the European Insurance and Occupational Pensions Authority; and — UK transitional measures, which have been recalculated at the valuation date, reducing the estimated Group shareholder surplus from £12.9 billion to £12.5 billion. The formal Quantitative Reporting Templates (Solvency II regulatory templates) will include transitional measures without this recalculation. The Group shareholder Solvency II capital position excludes: — A portion of Solvency II surplus capital (£1.4 billion at 31 December 2016) relating to the Group’s Asian life operations, including due to ‘contract boundaries’; — The contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds in surplus (representing £3.7 billion of surplus capital from UK with-profits funds at 31 December 2016) and from the shareholders’ share of the estate of with-profits funds; and — The contribution to Own Funds and the Solvency Capital Requirement from pension funds in surplus. It also excludes unrealised gains on certain derivative instruments taken out to protect Jackson against declines in long-term interest rates. At Jackson’s request, the Department of Insurance Financial Services renewed its approval to carry these instruments at book value in the local statutory returns for the period 31 December 2016 to 1 October 2017. At 31 December 2016, this approval had the effect of decreasing local statutory capital and surplus (and by extension Solvency II Own Funds and Solvency II surplus) by £0.3 billion, net of tax. This arrangement reflects an elective long-standing practice first put in place in 2009, which can be unwound at Jackson’s discretion. Korea is included in the Solvency II results above, pending local regulatory approval for the sale, which once complete will increase the shareholder Solvency II ratio by around 1 percentage point. 377 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(c) Solvency II capital position at 31 December 2016 continued Analysis of movement in Group capital position A summary of the estimated movement in Group Solvency II surplus from £9.7 billion at year end 2015 to £12.5 billion at year end 2016 is set out in the table below. The movement from the previously reported economic capital basis solvency surplus at 31 December 2014 to the Solvency II surplus at 31 December 2015 is included for comparison. Analysis of movement in Group shareholder surplus Estimated Solvency II surplus at 1 January 2016/economic capital surplus at 1 January 2015 Underlying operating experience Management actions Operating experience Non-operating experience (including market movements) Other capital movements Subordinated debt issuance Foreign currency translation impacts Dividends paid Methodology and calibration changes Changes to Own Funds (net of transitionals) and SCR calibration strengthening Effect of partial derecognition of Asia Solvency II surplus Estimated Solvency II surplus at end of period The estimated movement in Group Solvency II surplus over 2016 is driven by: Full year 2016 £bn Full year 2015 £bn 9.7 2.3 0.4 2.7 (1.1) 1.2 1.6 (1.3) (0.3) – 12.5 9.7 2.0 0.4 2.4 (0.6) 0.6 0.2 (1.0) (0.2) (1.4) 9.7 — Operating experience of £2.7 billion: generated by in-force business and new business written in 2016 and also the impact of one-off management optimisations implemented in 2016; — Non-operating experience of £(1.1) billion: mainly arising from negative market experience during 2016, allowing for the recalculation of UK transitional measures at the valuation date; — Other capital movements: comprising a gain from foreign currency translation effects and the issuance of debt during 2016 offset by a reduction in surplus from payment of dividends; and — Methodology and calibration changes £(0.3) billion: reflecting model changes during 2016 and true-ups relating to opening balance estimates. Analysis of Group Solvency Capital Requirements The split of the Group’s estimated Solvency Capital Requirement by risk type including the capital requirements in respect of Jackson’s risk exposures based on 150 per cent of US Risk Based Capital requirements (Company Action Level) but with no diversification between Jackson and the rest of the Group, is as follows: 31 Dec 2016 31 Dec 2015 % of undiversified Solvency Capital Requirements % of diversified Solvency Capital Requirements % of undiversified Solvency Capital Requirements % of diversified Solvency Capital Requirements 55% 12% 25% 13% 5% 28% 5% 16% 7% 11% 6% 68% 19% 41% 7% 1% 23% 2% 19% 2% 7% 2% 55% 11% 28% 13% 3% 27% 5% 14% 8% 11% 7% 72% 16% 47% 6% 3% 20% 2% 14% 4% 7% 1% Split of the Group’s estimated Solvency Capital Requirements Market Equity Credit Yields (interest rates) Other Insurance Mortality/morbidity Lapse Longevity Operational/expense FX translation 378 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedReconciliation of IFRS equity to Group Solvency II Shareholder Own Funds Reconciliation of IFRS equity to Group Solvency II Shareholder Own Funds IFRS shareholders’ equity Restate US insurance entities from IFRS onto local US statutory basis Remove DAC, goodwill and intangibles Add subordinated debt Impact of risk margin (net of transitionals) Add value of shareholder transfers Liability valuation differences Increase in value of net deferred tax liabilities (resulting from valuation differences above) Other Estimated Solvency II Shareholder Own Funds 31 Dec 2016 £bn 31 Dec 2015 £bn 14.7 (2.2) (3.8) 6.3 (3.4) 4.0 10.5 (1.3) 0.0 24.8 13.0 (1.5) (3.7) 4.4 (2.5) 3.1 8.6 (0.9) (0.4) 20.1 The key items of the reconciliation as at 31 December 2016 are: — £2.2 billion represents the adjustment required to the Group’s shareholders’ funds in order to convert Jackson’s contribution from an IFRS basis to the local statutory valuation basis. This item also reflects a derecognition of Own Funds of £0.9 billion, equivalent to the value of 100 per cent of Risk Based Capital requirements (Company Action Level), as agreed with the Prudential Regulation Authority; — £3.8 billion due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £6.3 billion due to the addition of subordinated debt which is treated as available capital under Solvency II but as a liability under IFRS; — £3.4 billion due to the inclusion of a risk margin for UK and Asia non-hedgeable risks, net of £2.5 billion transitionals, all of which are not applicable under IFRS; — £4.0 billion due to the inclusion of the value of future shareholder transfers from with-profits business (excluding the shareholders’ share of the with-profits estate, for which no credit is given under Solvency II), which is excluded from the determination of the Group’s IFRS shareholders’ funds; — £10.5 billion due to differences in insurance valuation requirements between Solvency II and IFRS, with Solvency II Own Funds partially capturing the value of in-force business which is excluded from IFRS; and — £1.3 billion due to the impact on the valuation of deferred tax assets and liabilities resulting from the other valuation differences noted above. Sensitivity analysis The estimated sensitivity of the Group shareholder Solvency II capital position to significant changes in market conditions is as follows: Impact of market sensitivities Base position Impact of: 20% instantaneous fall in equity markets 40% fall in equity markets1 50 basis points reduction in interest rates2,3 100 basis points increase in interest rates3 100 basis points increase in credit spreads4 31 Dec 2016 31 Dec 2015 Surplus £bn Ratio Surplus £bn 12.5 201% 0.0 (1.5) (0.6) 1.0 (1.1) 3% (7)% (9)% 13% (3)% 9.7 (1.0) (1.8) (1.1) 1.1 (1.2) Ratio 193% (7)% (14)% (14)% 17% (6)% Notes 1 2 3 4 Where hedges are dynamic, rebalancing is allowed for by assuming an instantaneous 20 per cent fall followed by a further 20 per cent fall over a four-week period. Subject to a floor of zero. Allowing for further transitional recalculation after the interest rate stress. US Risk Based Capital solvency position included using a stress of 10 times expected credit defaults. The Group is positioned to withstand significant deteriorations in market conditions and we continue to use market hedges to manage some of this exposure across the Group, where we believe the benefit of the protection outweighs the cost. The sensitivity analysis above allows for predetermined management actions and those taken to date, but does not reflect all possible management actions which could be taken in the future. 379 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(c) Solvency II capital position at 31 December 2016 continued UK Solvency II capital position1,2 On the same basis as above, the estimated UK shareholder Solvency II surplus at 31 December 2016 was £4.6 billion, after allowing for recalculation of transitional measures as at 31 December 2016. This relates to shareholder-backed business including future with-profits shareholder transfers, but excludes the shareholders’ share of the estate in line with Solvency II requirements. Estimated UK shareholder Solvency II capital position* Own Funds Solvency Capital Requirement Surplus Solvency ratio 31 Dec 2016 £bn 31 Dec 2015 £bn 12.0 7.4 4.6 163% 10.5 7.2 3.3 146% * The UK shareholder capital position excludes the contribution to Own Funds and the Solvency Capital Requirement from ring-fenced with-profits funds and staff pension schemes in surplus. The estimated solvency position at 31 December 2016 includes the impact of recalculated transitionals at the valuation date which has reduced the UK shareholder surplus from £5.0 billion to £4.6 billion. While the surplus position of the UK with-profits funds remains strong on a Solvency II basis, it is ring-fenced from the shareholder balance sheet and is therefore excluded from both the Group and the UK shareholder Solvency II surplus results. The estimated UK with-profits funds Solvency II surplus at 31 December 2016 was £3.7 billion, after allowing for recalculation of transitional measures as at 31 December 2016. Estimated UK with-profits Solvency II capital position Own funds Solvency capital requirement Surplus Solvency ratio 31 Dec 2016 £bn 31 Dec 2015 £bn 8.4 4.7 3.7 179% 7.6 4.4 3.2 175% Reconciliation of UK with-profits IFRS unallocated surplus to Solvency II Own Funds2 A reconciliation between the IFRS unallocated surplus and Solvency II Own Funds for UK with-profits business is as follows: Reconciliation of UK with-profits funds IFRS unallocated surplus of UK with-profits funds Adjustments from IFRS basis to Solvency II Value of shareholder transfers Risk margin (net of transitional) Other valuation differences Estimated Solvency II Own Funds 31 Dec 2016 £bn 31 Dec 2015 £bn 11.7 (2.3) (0.7) (0.3) 8.4 10.5 (2.1) (0.7) (0.1) 7.6 Annual regulatory reporting The Group will publish its Solvency and Financial Condition Report and related quantitative templates no later than 1 July 2017. The templates will require us to combine the Group shareholder solvency position with those of all other ring-fenced funds across the Group. In combining these solvency positions, the contribution to own funds from these ring-fenced funds will be set equal to their aggregate solvency capital requirements, estimated at £6.2 billion (ie the solvency surplus in these ring-fenced funds will not be captured in the templates). There will be no impact on the reported Group Solvency II surplus. Statement of independent review The methodology, assumptions and overall result have been subject to examination by KPMG LLP. Notes 1 2 The UK shareholder capital position represents the consolidated capital position of the shareholder funds of The Prudential Assurance Company Ltd (PAC) and all its subsidiaries. The UK with-profits capital position includes the PAC with-profits sub-fund, the Scottish Amicable Insurance Fund and the Defined Charge Participating Sub-Fund. 380 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinued II(d) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus The tables below show how the value of in-force business (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 3 per cent) of the Group’s embedded value emerges after this date, analysis of cash flows emerging in the years shown in the tables is considered most meaningful. The modelled cash flows use the same methodology underpinning the Group’s embedded value reporting and so are subject to the same assumptions and sensitivities used to prepare our 2016 results. In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in-force business at 31 December 2016, the tables also present the expected future free surplus to be generated from the investment made in new business during 2016 over the same 40-year period. (i) Expected transfer of value of in-force business (VIF) and required capital to free surplus Undiscounted expected generation from all in-force business at 31 December* Undiscounted expected generation from new business written* 2016 £m Expected period of emergence Asia† 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037-2041 2042-2046 2047-2051 2052-2056 1,320 1,247 1,202 1,167 1,142 1,122 1,122 1,098 1,076 1,050 1,001 991 958 940 921 879 859 834 821 805 3,905 3,564 3,257 2,999 US 1,446 1,279 1,273 1,281 1,282 1,152 1,116 1,067 914 865 708 597 547 424 351 321 215 162 153 118 699 – – – UK Total Asia† 675 669 636 622 606 591 576 557 534 508 486 451 434 409 381 490 465 438 413 392 1,542 1,053 554 301 3,441 3,195 3,111 3,070 3,030 2,865 2,814 2,722 2,524 2,423 2,195 2,039 1,939 1,773 1,653 1,690 1,539 1,434 1,387 1,315 6,146 4,617 3,811 3,300 188 157 170 158 170 148 159 154 148 160 137 142 135 132 146 130 130 127 123 130 621 607 593 585 US 270 116 123 136 151 84 79 165 144 159 110 100 82 72 70 53 36 35 31 30 55 – – – UK 27 29 29 31 33 30 29 29 28 27 24 23 22 21 20 18 18 17 16 15 65 66 14 8 Total 485 302 322 325 354 262 267 348 320 346 271 265 239 225 236 201 184 179 170 175 741 673 607 593 Total free surplus expected to emerge in the next 40 years 34,280 15,970 13,783 64,033 5,350 2,101 639 8,090 * The analysis excludes amounts incorporated into VIF at 31 December 2016 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 2056. † Asia operations exclude the cash flows in respect of the held for sale Korea life business. The above amounts can be reconciled to the new business amounts as follows: Undiscounted expected free surplus generation for years 2017 to 2056 Less: discount effect Discounted expected free surplus generation for years 2017 to 2056 Discounted expected free surplus generation for years 2056+ Less: Free surplus investment in new business Other items‡ Post-tax EEV new business profit Asia 5,350 (2,968) 2,382 292 (476) (168) 2,030 2016 £m US 2,101 (746) 1,355 – (298) (267) 790 UK 639 (259) 380 1 (129) 16 268 Total 8,090 (3,973) 4,117 293 (903) (419) 3,088 ‡ 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. 381 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(d) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued The undiscounted expected free surplus generation from all in-force business at 31 December 2016 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2015 as follows: 2016 £m 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m Other £m Total £m 2,621 46 2,667 2,463 55 2,518 2,383 49 2,432 2,378 45 2,423 2,388 43 2,431 2,369 48 2,417 36,173 1,350 50,775 1,636 37,523 52,411 (2,667) – – – – – – (2,667) – – – – – – – (40) (40) (37) (35) (33) (537) (722) – 370 485 11 97 – 355 302 18 128 – 350 322 (16) 69 – 354 326 5 (11) – 346 354 (36) (18) 394 5,023 6,304 394 6,798 8,093 (521) (274) 3,441 3,195 3,111 3,070 3,030 48,186 64,033 2016 £m 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m Other £m Total £m 1,015 962 926 905 871 889 20,640 26,208 (1,015) – – – – – – (1,015) – – – – – – – (40) (40) (37) (35) (33) (537) (722) – 179 188 33 (2) – 172 157 34 (2) – 163 170 8 (7) – 158 158 24 (9) – 157 170 (23) (18) 358 3,737 4,507 358 4,566 5,350 (503) (465) 1,320 1,247 1,202 1,167 1,142 28,202 34,280 2016 £m 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m Other £m Total £m 1,120 991 951 970 1,018 982 6,665 12,697 (1,120) – – – – – 191 270 (5) (1) – 183 116 (5) 34 – 187 123 (15) 8 – 196 136 (15) (54) – 189 151 (7) (33) – 1,286 1,305 (1,120) 2,232 2,101 153 60 – 1,446 1,279 1,273 1,281 1,282 9,409 15,970 Group 2015 expected free surplus generation for years 2016 to 2055: As previously published Effect of Solvency II implementation† Less: Amounts expected to be realised in the current year Less: Contribution from the held for sale Korea life business‡ Add: Expected free surplus to be generated in year 2056* Foreign exchange differences New business Operating movements Non-operating and other movements 2016 expected free surplus generation for years 2017 to 2056 Asia 2015 expected free surplus generation for years 2016 to 2055 Less: Amounts expected to be realised in the current year Less: Contribution from the held for sale Korea life business‡ Add: Expected free surplus to be generated in year 2056* Foreign exchange differences New business Operating movements Non-operating and other movements 2016 expected free surplus generation for years 2017 to 2056 US 2015 expected free surplus generation for years 2016 to 2055: Less: Amounts expected to be realised in the current year Foreign exchange differences New business Operating movements Non-operating and other movements 2016 expected free surplus generation for years 2017 to 2056 382 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedUK 2015 expected free surplus generation for years 2016 to 2055 As previously published Effect of Solvency II implementation† Less: Amounts expected to be realised in the current year Add: Expected free surplus to be generated in year 2056* New business Operating movements Non-operating and other movements 2016 expected free surplus generation for years 2017 to 2056 2016 £m 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m Other £m Total £m 486 46 532 (532) – – – – – 510 55 565 – – 27 (17) 100 506 49 555 – – 29 (11) 96 503 45 548 – – 29 (9) 68 499 43 542 – – 31 (4) 53 498 48 546 – 8,868 1,350 11,870 1,636 10,218 13,506 – (532) – 33 (6) 33 36 490 (169) 36 639 134 675 669 636 622 606 10,575 13,783 * Excluding 2016 new business. † In order to show the cash flows for UK insurance operations on a comparable basis, the 2015 comparative results for UK insurance operations reflect the impact of the implementation of Solvency II at 1 January 2016 (see note 2 for details). ‡ The contribution from the Korea life business has been removed from expected free surplus generation following its reclassification as held for sale. At 31 December 2016, the total free surplus expected to be generated over the next five years (2017 to 2021 inclusive), using the same assumptions and methodology as those underpinning our 2016 embedded value reporting was £15.8 billion, an increase of £3.3 billion from the £12.5 billion expected over an equivalent period from the end of 2015, after allowing for the effect of the implementation of Solvency II on the opening balance sheet. This increase primarily reflects the new business written in 2016, which is expected to generate £1,788 million of free surplus over the next five years. At 31 December 2016, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £64.0 billion, up from the £52.4 billion expected at the end of 2015, after allowing for the effect of the implementation of Solvency II on the opening balance sheet, reflecting the effect of new business written across all three business operations of £8.1 billion and a positive foreign exchange translation effect of £6.8 billion. These positive effects have been offset by the negative impact of £(0.7) billion for the removal of the contribution from the Korea life business following its reclassification as held for sale and a £(0.3) billion net effect reflecting operating, market assumption changes and other items. In Asia, these include the negative impact from movements in long-term interest rates and other regular operating assumption changes. In the US, these mainly reflect the positive effect of higher future separate account growth due to the increase in interest rates and the impact of an increase in equity market returns in 2016, partially offset by the negative effect from the acceleration of free surplus from the contingent financing of specific US statutory reserves. In the UK, these mainly arise from the positive effect of higher than assumed investment returns on with-profits funds, partially offset by the negative effect of longevity reinsurance transactions entered into during the year. The longevity reinsurance transactions executed this year had the effect of accelerating the generation of future free surplus into 2016. The overall growth in the Group’s undiscounted value of free surplus reflects our ability to write both growing and profitable new business. Actual underlying free surplus generated in 2016 from life business in-force at the end of 2016 was £4.0 billion including £0.8 billion of changes in operating assumptions and experience variances. This compares with the expected 2016 realisation at the end of 2015 of £2.7 billion. This can be analysed further as follows: Transfer to free surplus in 2016 Expected return on free assets Changes in operating assumptions and experience variances Underlying free surplus generated from in-force life business in 2016 2016 free surplus expected to be generated at 31 December 2015 Asia £m 1,157 39 14 US £m 1,223 47 596 1,210 1,866 1,015 1,120 UK £m 680 13 214 907 532 Total £m 3,060 99 824 3,983 2,667 383 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(d) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued The equivalent discounted amounts of the undiscounted expected transfers from in-force business and required capital into free surplus shown previously are as follows: Expected period of emergence 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037-2041 2042-2046 2047-2051 2052-2056 Discounted expected generation from all in-force business at 31 December Discounted expected generation from long-term 2015 new business written 2016 £m Asia 1,262 1,113 1,007 916 843 769 724 664 612 562 508 476 436 408 381 346 322 299 282 266 1,154 853 638 473 US UK Total 1,371 1,141 1,069 1,009 952 803 734 658 531 477 365 292 251 185 147 131 80 61 57 43 199 – – – 659 628 572 535 496 458 423 387 349 314 282 245 222 197 173 218 197 178 160 148 515 197 129 58 3,292 2,882 2,648 2,460 2,291 2,030 1,881 1,709 1,492 1,353 1,155 1,013 909 790 701 695 599 538 499 457 1,868 1,050 767 531 Asia 180 137 141 124 127 104 107 99 89 91 73 72 65 60 63 55 52 49 46 47 203 163 131 104 US 261 105 105 108 116 60 52 101 83 90 56 48 36 30 28 19 12 11 9 8 17 – – – UK 26 27 27 28 28 25 23 21 19 17 15 14 12 11 10 9 8 7 6 6 24 12 3 2 Total 467 269 273 260 271 189 182 221 191 198 144 134 113 101 101 83 72 67 61 61 244 175 134 106 Total discounted free surplus expected to emerge in the next 40 years 15,314 10,556 7,740 33,610 2,382 1,355 380 4,117 The above amounts can be reconciled to the Group’s financial statements as follows: Discounted expected generation from all in-force business for years 2017 to 2056 Discounted expected generation from all in-force business for years after 2056 Discounted expected generation from all in-force business at 31 December 2016 Add: Free surplus of life operations held at 31 December 2016 Less: Time value of guarantees Expected free surplus generation from the sale of Korea life business Other non-modelled items Total EEV for life operations 2016 £m 33,610 1,115 34,725 5,351 (998) 76 1,430 40,584 384 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinued(ii) Expected emergence of risk margin release and amortisation of transitional The 31 December 2016 Solvency II own funds included £2.5 billion of transitional relief (recalculated at the valuation date), the majority of which relates to UK annuity business in force on 1 January 2016, established to substantially mitigate the impact of recognising the related risk margin on transition to Solvency II. The following table sets out the expected UK annuity business risk margin release net of the related transitional amortisation over the next 15 years. Expected period of emergence 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 UK free surplus expected to emerge by 2031 Total UK free surplus expected to emerge from 2032 to 2056 Total UK free surplus expected to emerge in the next 40 years (note B(i)) * Including other UK business lines and other cash flows from annuity business. 2016 £m Undiscounted expected generation from all in-force business at 31 December Shareholder-backed annuity business Risk margin release Amortisation of transitional Other* Total UK 163 153 143 141 136 134 132 127 122 117 114 104 102 97 91 (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) (116) 628 632 609 597 586 573 560 546 528 507 488 463 448 428 406 1,876 (1,740) 7,999 675 669 636 622 606 591 576 557 534 508 486 451 434 409 381 8,135 5,648 13,783 The UK annuity risk margin release and related transitional amortisation, together with associated tax reconcile to the amounts shown in the Group Solvency II balance sheet (note II(c) of the IFRS additional unaudited financial information) as follows: Annuity in-force business: – Risk margin release less amortisation of transitional expected to emerge by 2031 – Risk margin release expected to emerge after 2031 and gross up for tax Risk margin release and transitional for other business operations (pre-tax) Total (pre-tax) Risk margin release £bn Amortisation of transitional £bn 1.9 1.1 3.0 2.9 5.9 (1.7) (0.4) (2.1) (0.4) (2.5) 385 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued II(e) Foreign currency source of key metrics The tables below show the Group’s key free surplus, IFRS and EEV metrics analysis by contribution by currency group: Free surplus and IFRS 2016 results US$ linked note (1) Other Asia currencies Total Asia UK£ sterling notes (3),(4) US$ note (4) Total EEV 2016 results US$ linked note (1) Other Asia currencies Total Asia UK£ sterling notes (3),(4) US$ note (4) Total Underlying free surplus generated for total insurance and asset management operations note (2) % Pre-tax operating profit notes (2),(3),(4) % Shareholders’ funds notes (2),(3),(4) % 15 9 24 32 44 21 17 38 14 48 19 17 36 51 13 100 100 100 Post-tax new business profits % 55 10 65 9 26 Post-tax operating profit notes (2),(3),(4) % Shareholders’ funds notes (2),(3),(4) % 46 12 58 6 36 36 13 49 29 22 100 100 100 Notes (1) US$ linked comprising the Hong Kong and Vietnam operations where the currencies are pegged to the US dollar and the Malaysia and Singapore operations where the currencies (2) (3) (4) are managed against a basket of currencies including the US dollar. Includes long-term, asset management business and other businesses. For operating profit and shareholders’ funds, UK sterling includes amounts in respect of central operations as well as UK insurance operations and M&G. For shareholders’ funds, the US$ grouping includes US$ denominated core structural borrowings. Sterling operating profits include all interest payable as sterling denominated, reflecting interest rate currency swaps in place. 386 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinued II(f) Option schemes The Group presently grants share options through four schemes, and exercises of the options are satisfied by the issue of new shares. Executive directors and eligible employees based in the UK may participate in the UK savings-related share option scheme. Executives and eligible employees based in Asia as well as eligible employees based in Europe can participate in the international savings-related share option scheme, while agents based in certain regions of Asia can participate in the international savings-related share option scheme for non-employees. Employees based in Dublin are eligible to participate in the Prudential International Assurance sharesave plan, which currently has no outstanding options in issue. Further details of the schemes and accounting policies are detailed in Note B3.2 of the IFRS basis consolidated financial statements. All options were granted at £nil 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: 16 May 2023; — International savings-related share option scheme: 31 May 2021; — Prudential International Assurance sharesave plan: 3 August 2019; and — 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 2016 was £13.56 (2015: £15.49). Particulars of options granted to directors are included in the Directors’ remuneration report on page 109. The closing price of the shares immediately before the date on which the options were granted during the year was £13.71. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2016. UK savings-related share option scheme Exercise period Number of options Date of grant Exercise price £ 25 Sep 08 27 Apr 09 28 Sep 10 16 Sep 11 21 Sep 12 21 Sep 12 20 Sep 13 20 Sep 13 23 Sep 14 23 Sep 14 22 Sep 15 22 Sep 15 21 Sep 16 21 Sep 16 4.38 2.88 4.61 4.66 6.29 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 11.04 Beginning 01 Dec 15 01 Jun 16 01 Dec 15 01 Dec 16 01 Dec 15 01 Dec 17 01 Dec 16 01 Dec 18 01 Dec 17 01 Dec 19 01 Dec 18 01 Dec 20 01 Dec 19 01 Dec 21 End Beginning of year 31 May 16 3,071 30 Nov 16 154,981 31 May 16 45,959 31 May 17 160,392 31 May 16 215,520 31 May 18 127,520 31 May 17 324,479 31 May 19 70,590 31 May 18 870,308 440,551 31 May 20 31 May 19 1,039,759 234,607 31 May 21 – 31 May 20 – 31 May 22 Granted Exercised Cancelled Forfeited Lapsed End of year – (3,071) – (154,948) – (45,290) – (115,689) – (211,172) – (3,426) – (230,295) – (749) (14,177) – (6,485) – (3,801) – (585) – – 728,729 – 166,084 – – – (653) – – (9,992) – (53,204) (17,566) (74,163) (2,970) (9,582) (1,358) – – – (6,536) (2,862) (3,101) (6,050) (332) (22,430) (7,997) (14,618) (4,590) – (298) – – (33) – (669) – (1,508) 36,006 – (1,486) (1,107) 119,886 73,812 (4,330) 70,258 749 (21,409) 759,088 (17,742) 390,761 (13,936) 933,241 (2,655) 223,807 719,147 164,428 – – 3,687,737 894,813 (789,688) (169,488) (68,814) (64,126) 3,490,434 The total number of securities available for issue under the scheme is 3,490,434 which represents 0.135 per cent of the issued share capital at 31 December 2016. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £14.40. The weighted average fair value of options granted under the plan in the period was £3.02. 387 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued International savings-related share option scheme Exercise period Number of options Date of grant Exercise price £ 16 Sep 11 21 Sep 12 21 Sep 12 20 Sep 13 20 Sep 13 23 Sep 14 23 Sep 14 22 Sep 15 22 Sep 15 21 Sep 16 4.66 6.29 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 Beginning 01 Dec 16 01 Dec 15 01 Dec 17 01 Dec 16 01 Dec 18 01 Dec 17 01 Dec 19 01 Dec 18 01 Dec 20 01 Dec 19 End 31 May 17 31 May 16 31 May 18 31 May 17 31 May 19 31 May 18 31 May 20 31 May 19 31 May 21 31 May 20 Beginning of year 17,617 249,429 14,501 571,967 47,004 8,643 4,464 24,284 3,240 – Granted Exercised Cancelled Forfeited Lapsed End of year – – – (224,996) – – – (395,294) – – – – – – – – – – – 15,516 – – – (32,330) (3,328) (934) – (469) – – – – – (3,907) – – – – – – (16,895) (21,708) – 722 2,725 14,501 (8,756) 131,680 43,676 7,709 4,464 23,556 3,240 15,516 – – – (259) – – 941,149 15,516 (620,290) (37,061) (3,907) (47,618) 247,789 The total number of securities available for issue under the scheme is 247,789 which represents 0.010 per cent of the issued share capital at 31 December 2016. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £14.80. The weighted average fair value of options granted under the plan in the period was £2.96. Prudential International Assurance sharesave plan There are no securities available for issue under the scheme at 31 December 2016. Non-employee savings-related share option scheme Exercise period Number of options Date of grant Exercise price £ 28 Sep 10 16 Sep 11 21 Sep 12 21 Sep 12 20 Sep 13 20 Sep 13 23 Sep 14 23 Sep 14 22 Sep 15 22 Sep 15 21 Sep 16 21 Sep 16 4.61 4.66 6.29 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 11.04 Beginning 01 Dec 15 01 Dec 16 01 Dec 15 01 Dec 17 01 Dec 16 01 Dec 18 01 Dec 17 01 Dec 19 01 Dec 18 01 Dec 20 01 Dec 19 01 Dec 21 End 31 May 16 31 May 17 31 May 16 31 May 18 31 May 17 31 May 19 31 May 18 31 May 20 31 May 19 31 May 21 31 May 20 31 May 22 Beginning of year 341,948 243,641 273,565 82,872 755,540 419,452 615,326 512,917 499,276 422,194 – – Granted Exercised Cancelled Forfeited Lapsed End of year (25,357) (316,591) – (30,064) (183,641) – – (148,635) (124,930) (54,871) – – (2,275) – (397,020) – – – (2,700) (389) – – – – (3,078) – – (779) – – (537) – 334,813 (1,358) – 200,588 – – – – (5,488) – – – – – – – – – – – – 29,936 – 28,001 (4,436) 346,321 (12,602) 406,850 (15,802) 596,435 (10,124) 502,793 (15,373) 480,825 (15,421) 405,994 334,276 199,230 – – 4,166,731 535,401 (601,465) (690,760) (5,488) (73,758) 3,330,661 The total number of securities available for issue under the scheme is 3,330,661 which represents 0.129 per cent of the issued share capital at 31 December 2016. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £15.01. The weighted average fair value of options granted under the plan in the period was £3.09. 388 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedII(g) Selected historical financial information of Prudential The following table sets forth Prudential’s selected consolidated financial data for the periods indicated. Certain data is derived from Prudential’s audited consolidated financial 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 financial statements and the related notes included elsewhere in this document. Income statement data IFRS basis results Gross premium earned Outward reinsurance premiums Earned premiums, net of reinsurance Investment return Other income Total revenue, net of reinsurance Benefits and claims and movement in unallocated surplus of with-profits funds, net of reinsurance Acquisition costs and other expenditure Finance costs: interest on core structural borrowings of shareholder-financed operations Remeasurement of carrying value of Korea life business classified as held for sale Disposal of Japan life business: Cumulative exchange loss recycled from other comprehensive income Remeasurement adjustments Total charges, net of reinsurance Share of profits from joint ventures and associates, net of related tax Profit before tax (being tax attributable to shareholders’ and policyholders’ returns)note 1 Tax charges attributable to policyholders’ returns Profit before tax attributable to shareholders Tax credit (charge) attributable to shareholders’ returns Profit for the year Year ended 31 December 2016 £m 2015 £m 2014 £m 2013 £m 2012 £m 38,981 (2,020) 36,961 32,511 2,370 71,842 36,663 (1,157) 35,506 3,304 2,495 41,305 32,832 (799) 32,033 25,787 2,306 60,126 30,502 (658) 29,844 20,347 2,184 52,375 29,113 (491) 28,622 23,931 1,885 54,438 (59,366) (8,848) (29,656) (8,208) (50,169) (6,752) (43,154) (6,861) (45,144) (6,032) (360) (238) – – (312) (341) (305) (280) – (46) – – – (13) – – (120) – – (68,812) (38,222) (57,275) (50,440) (51,456) 182 238 303 147 135 3,212 (937) 2,275 (354) 1,921 3,321 (173) 3,148 (569) 2,579 3,154 (540) 2,614 (398) 2,216 2,082 (447) 1,635 (289) 1,346 3,117 (370) 2,747 (584) 2,163 2016 2015 2014 2013 2012 Based on profit for the year attributable to the equity holders of the Company: Basic earnings per share (in pence) Diluted earnings per share (in pence) Dividend per share declared and paid in reporting period (in pence) Interim ordinary dividend/final ordinary dividend Special dividend 75.0p 75.0p 49.40p 39.40p 10.00p Supplementary IFRS income statement data 101.0p 100.9p 38.05p 38.05p 86.9p 86.8p 35.03p 35.03p 52.8p 52.7p 30.52p 30.52p 85.1p 85.0p 25.64p 25.64p Operating profit based on longer-term investment returnsnote 2 Non-operating items Profit before tax attributable to shareholders Operating earnings per share (in pence) Year ended 31 December £m 2016 4,256 (1,981) 2,275 131.3p 2015 3,969 (821) 3,148 124.6p 2014 3,154 (540) 2,614 95.7p 2013 2,937 (1,302) 1,635 90.4p 2012 2,504 243 2,747 76.4p 389 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationII Other information continued Supplementary EEV income statement data (post-tax) Operating profit based on longer-term investment returnsnote 2 Non-operating items Profit attributable to shareholders Operating earnings per share (in pence) New business data Annual premium equivalent (APE) sales EEV new business profit (NBP) (post-tax) NBP margin (% APE) Year ended 31 December £m 2016 5,497 (981) 4,516 2015 4,840 (889) 3,951 2014 4,108 235 4,343 2013 4,224 134 4,358 2012 3,161 608 3,769 214.7p 189.6p 161.2p 165.8p 124.4p Year ended 31 December £m 2016 6,320 3,088 49% 2015 5,466 2,609 48% 2014* 4,514 2,104 47% 2013 4,310 2,057 48% 2012 4,100 1,766 43% * Excluding the £23 million APE and £11 million NBP for the sold PruHealth and PruProtect businesses. Statement of financial position data As of and for the year ended 31 December 2016 2015 2014 2013 2012 Total assets Total policyholder liabilities and unallocated surplus of with- profits funds Core structural borrowings of shareholder-financed operations Total liabilities Total equity 470,498 386,985 369,204 325,932 307,644 403,313 6,798 455,831 14,667 335,614 5,011 374,029 12,956 321,989 4,304 357,392 11,812 286,014 4,636 316,281 9,651 268,263 3,554 297,280 10,364 £m Other data As of and for the year ended 31 December Funds under managementnote 3 EEV shareholders’ equity, excluding non-controlling interests Group shareholder Solvency II surplusnote 4 Insurance Groups Directive capital surplus before final dividend 2016 599 39.0 12.5 n/a 2015 509 32.4 9.7 5.5 £bn 2014 496 29.2 n/a 4.7 2013 443 24.9 n/a 5.1 2012 406 22.4 n/a 5.1 This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. 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, gain on dilution of Group’s holdings, the costs arising from the domestication of the Hong Kong business, profit (loss) attaching to the sale of Japan life and profit (loss) attaching to the held for sale Korea life business. Separately on the IFRS basis, operating profit also excludes amortisation of acquisition accounting adjustments. 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. 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. The 2016 surplus is estimated. Notes 1 2 3 4 390 Prudential plc Annual Report 2016 www.prudential.co.ukAdditional unaudited financial informationContinuedII(h) Reconciliation between IFRS and EEV shareholders’ funds The table below shows the reconciliation of EEV shareholders’ funds and IFRS shareholders’ funds at the end of the year: EEV shareholders’ funds Less: Value of in-force business of long-term business note (a) Deferred acquisition costs assigned zero value for EEV purposes Othernotes (b),(c) IFRS shareholders’ funds 31 Dec 2016 £m 31 Dec 2015 £m 38,968 (24,937) 9,170 (8,535) 14,666 32,359 (22,431) 7,010 (3,983) 12,955 Notes (a) The EEV shareholders’ funds comprises the present value of the shareholders’ interest in the value of in-force business, net worth of long-term business operations and IFRS shareholders’ funds of asset management and other operations. The value of in-force business reflects the present value of future shareholder cash flows from long-term in-force business which are not captured as shareholders’ interest on an IFRS basis. Net worth represents the net assets for EEV reporting purposes that reflect the regulatory basis position, sometimes with adjustments to achieve consistency with the IFRS treatment of certain items. (b) Other adjustments represent asset and liability valuation differences between IFRS and the local regulatory reporting basis used to value net worth for long-term insurance operations. It also includes the mark to market of the Group’s core borrowings which are fair valued under EEV but not IFRS. The most significant valuation differences relate to changes in the valuation of insurance liabilities. For example, in Jackson where IFRS liabilities are higher than the local regulatory basis as they are principally based on policyholder account balances (with a deferred acquisition costs recognised as an asset) whereas the local regulatory basis used for EEV is based on future cash flows due to the policyholder on a prudent basis with consideration of an expense allowance as applicable, but with no separate deferred acquisition cost asset. The 2016 EEV results for UK insurance operations have been prepared on a basis that reflects the Solvency II regime, effective from 1 January 2016. The 2015 EEV results for UK insurance operations were prepared on a basis reflecting the Solvency I regime. As noted in (b) above, ‘other adjustments’ represent asset and liability valuation differences between IFRS and the local regulatory basis used to value net worth for long-term insurance operations. At 31 December 2016 for the UK this would be the difference between IFRS and Solvency II, and at 31 December 2015 the difference between IFRS and Solvency I. (c) II(i) Reconciliation of APE new business sales to earned premiums The Group reports annual premium equivalent (APE) new business sales as a measure of the new policies sold in the period. This differs from the IFRS measure of premiums earned as shown below: Annual premium equivalents (APE) as published Adjustment to include 100% of single premiums on new business sold in the period note (a) Contribution from the held for sale Korea life business Premiums from in-force business and other adjustments note (b) Gross premiums earned Outward reinsurance premiums Earned premiums, net of reinsurance as shown in the IFRS financial statements 2016 £m 6,320 25,057 192 7,412 38,981 (2,020) 36,961 2015 £m 5,466 24,918 305 5,974 36,663 (1,157) 35,506 Notes (a) (b) Other adjustments principally include amounts in respect of the following: APE new business sales only include one-tenth of single premiums, recorded on policies sold in the period. Gross premiums earned include 100 per cent of such premiums. – Gross premiums earned includes premiums from existing in-force business as well as new business. The most significant amount is recorded in Asia, where a significant portion of regular premium business is written. Asia in-force premiums form the vast majority of the other adjustment amount; – APE includes new policies written in the period which are classified as investment contracts without discretionary participation features under IFRS 4, arising mainly in Jackson for guaranteed investment contracts and in the UK for certain unit-linked savings and similar contracts. These are excluded from gross premiums earned and recorded as deposits; – APE new business sales are annualised while gross premiums earned are recorded only when revenues are due; and – For the purpose of reporting APE new business sales, we include the Group’s share of amounts sold by the Group’s insurance joint ventures. Under IFRS, joint ventures are equity accounted and so no amounts are included within gross premiums earned. 391 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional information Risk factors A number of risk factors affect Prudential’s operating results and financial 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, and any forward‑looking statements are made subject to the reservations specified below under ‘Forward‑looking statements’. Prudential’s approaches to managing risks are explained in the ‘Group Chief Risk Officer’s report on the risks facing our business and how these are managed’ section of this document. Risks relating to Prudential’s business Prudential’s businesses are inherently subject to market fluctuations and general economic conditions Uncertainty or negative trends in international economic and investment climates could adversely affect Prudential’s business and profitability. Prudential operates against a challenging background of periods of significant volatility in global capital and equity markets and interest rates (which in some jurisdictions have become negative), together with widespread economic uncertainty. For example, government interest rates remain at or near historic lows in the US, the UK and some Asian countries in which Prudential operates. These factors could have a material adverse effect on Prudential’s business and profitability. In the future, the adverse effects of such factors would be felt principally through the following items: — Investment impairments and/or reduced investment returns, which could reduce Prudential’s capital and impair its ability to write significant volumes of new business, increase the potential adverse impact of product guarantees, or have a negative impact on its assets under management and profit; — Higher credit defaults and wider credit and liquidity spreads resulting in realised and unrealised credit losses; — Failure of counterparties who have transactions with Prudential (eg banks and reinsurers) to meet commitments that could give rise to a negative impact on Prudential’s financial position and on the accessibility or recoverability of amounts due or, for derivative transactions, adequate collateral not being in place; — Estimates of the value of financial instruments being difficult because in certain illiquid or closed markets, determining the value at which financial instruments can be realised is highly subjective. Processes to ascertain such values require substantial elements of judgement, assumptions and estimates (which may change over time); and — Increased illiquidity also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline. For example, this could occur where external capital is unavailable at sustainable cost, increased liquid assets are required to be held as collateral under derivative transactions or redemption restrictions are placed on Prudential’s investments in illiquid funds. In addition, significant redemption requests could also be made on Prudential’s issued funds and while this may not have a direct impact on the Group’s liquidity, it could result in reputational damage to Prudential. Global financial markets are subject to uncertainty and volatility created by a variety of factors, including concerns over: the change in accommodative monetary policies in the US, the UK and other jurisdictions with the risk of a disorderly repricing of inflation expectations and global bond yields, sovereign debt, a general slowing in world growth, the increased level of geopolitical risk and policy‑related uncertainty and potentially negative socio‑political events. On 23 June 2016, the UK held a referendum in which a majority of the voting population voted in favour of the UK leaving the European Union (EU). The UK is expected to submit a formal notification of its intention to withdraw from the EU by the end of March 2017. Once this notification has been submitted, the UK will have a period of a maximum two years to negotiate the terms of its withdrawal from the EU. If no formal withdrawal agreement is reached between the UK and the EU, then it is expected the UK’s membership of the EU will automatically terminate two years after the submission of the notification of the UK’s intention to withdraw from the EU. The vote in favour of the UK leaving the EU will have political, legal and economic ramifications for both the UK and the EU, although these are expected to be more pronounced for the UK. The Group has several UK domiciled operations, including Prudential UK and M&G, and these may be impacted by a UK withdrawal from the EU. The potential outcome of the negotiations on UK withdrawal and any subsequent negotiations on trade and access to the country’s major trading markets, including the single EU market is currently unknown. The ongoing uncertainty of when the UK will leave the EU, whether any form of transitional arrangements will be agreed between the UK and the EU, and the possibility of a lengthy period before negotiations are concluded may increase volatility in the markets where the Group operates and create the potential for a general downturn in economic activity and for further or prolonged interest rate reductions in some jurisdictions due to monetary easing and investor sentiment. More generally, upheavals in the financial markets may affect general levels of economic activity, employment and customer behaviour. As a result, 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. In addition, there may be a higher incidence of counterparty failures. 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 its balance sheet and profitability. For example, this could occur if the recoverable value of intangible assets for bancassurance agreements and deferred acquisition costs are reduced. New challenges related to market fluctuations 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 Asian operations, it may not be possible to hold assets which will provide cash flows to match those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets where regulated premium and claim 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 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. Where interest rates in these markets remain lower than those used to calculate premium and claim values over a sustained period, this could have a material adverse effect on Prudential’s reported profit. 392 Prudential plc Annual Report 2016 www.prudential.co.uk In the US, fluctuations in prevailing interest rates can affect results from Jackson which has a significant spread‑based business, with the majority of its assets invested in fixed 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 reflected 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 benefit increases, subject to minimum crediting rates. Declines in spread from these products or other spread businesses that Jackson conducts, and increases in surrender levels arising from interest rate rises, could have a material impact on its businesses or results of operations. Jackson also writes a significant amount of variable annuities that offer capital or income protection guarantees. The value of these guarantees is affected by market factors (such as interest rates, equity values, bond spreads and realised volatility) and policyholder behaviour. There could be market circumstances where the derivatives that Jackson enters into to hedge its market risks may not fully cover its exposures under the guarantees. The cost of the guarantees that remain unhedged will also affect Prudential’s results. Jackson hedges the guarantees on its variable annuity book on an economic basis (with consideration of the local regulatory position) and, thus, accepts variability in its accounting results in the short term in order to achieve the appropriate result on these bases. In particular, for Prudential’s Group IFRS reporting, the measurement of the Jackson variable annuity guarantees is typically less sensitive to market movements than for the corresponding hedging derivatives, which are held at market value. However, depending on the level of hedging conducted regarding a particular risk type, certain market movements can drive volatility in the economic or local regulatory results that may be less significant under IFRS reporting. A significant part of the profit from Prudential’s UK insurance operations is related to bonuses for policyholders declared on with‑profits products, which are broadly based on historical and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns. This profit 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 Investing in sovereign debt 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 cash flow situation, its relations with its central bank, the extent of its foreign currency reserves, the availability of sufficient 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. Moreover, governments may use a variety of techniques, such as intervention by their central banks or imposition of regulatory controls or taxes, to devalue their currencies’ exchange rates, or may adopt monetary and other policies (including to manage their debt burdens) that have a similar effect, all of which could adversely impact the value of an investment in sovereign debt even in the absence of a technical default. 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. In addition, if a sovereign default or other such events described above were to occur, other financial institutions may also suffer losses or experience solvency or other concerns, and Prudential might face additional risks relating to any debt of such financial institutions held in its investment portfolio. There is also risk that public perceptions about the stability and creditworthiness of financial institutions and the financial sector generally might be affected, as might counterparty relationships between financial institutions. If a sovereign were to default on its obligations, or adopt policies that devalue or otherwise alter the currencies in which its obligations are denominated this could have a material adverse effect on Prudential’s financial condition and results of operations. Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses Due to the geographical diversity of Prudential’s businesses, Prudential is subject to the risk of exchange rate fluctuations. Prudential’s operations in the US and Asia, which represent a significant proportion of operating profit based on longer‑term investment returns and shareholders’ funds, generally write policies and invest in assets denominated in local currencies. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon the translation of results into pounds sterling. This exposure is not currently separately managed. The currency exposure relating to the translation of reported earnings could impact on financial reporting ratios such as dividend cover, which is calculated as operating profit after tax on an IFRS basis, divided by the dividends relating to the reporting year. 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 (defined as debt over debt plus shareholders’ funds). The Group’s surplus capital position for regulatory reporting purposes may also be affected by fluctuations in exchange rates with possible consequences for the degree of flexibility the Prudential has in managing its business. Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations and any accounting standards in the markets in which it operates Changes in government policy and legislation (including in relation to tax and 393 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationcapital controls), regulation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, and decisions taken by regulators in connection with their supervision of members of the Group, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, competitiveness, profitability, capital requirements and, consequently, reported results and financing requirements. Also, regulators in jurisdictions in which Prudential operates may impose requirements affecting the allocation of capital and liquidity between different business units in the Group, whether on a geographic, legal entity, product line or other basis. Regulators 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. In addition, there could be changes to the maximum level of non‑ domestic ownership by foreign companies in certain jurisdictions. Furthermore, as a result of interventions by governments in response to recent financial and global economic conditions, it is widely expected that there will continue to be a substantial increase in government regulation and supervision of the financial services industry, including the possibility of higher capital requirements, restrictions on certain types of transactions and enhanced supervisory powers. The European Union’s Solvency II Directive came into effect on 1 January 2016. This measure of regulatory capital is more volatile than under the previous Solvency I regime and regulatory policy may evolve under the new regime. The European Commission has in late 2016 begun a review of some aspects of the Solvency II legislation, which is expected to continue until 2021 and covers, among other things, a review of the Long Term Guarantee measures. Prudential applied for, and has been granted approval by the UK Prudential Regulation Authority to use the following measures when calculating its Solvency II capital requirements: the use of an internal model, the ‘matching adjustment’ for UK annuities, the ‘volatility adjustment’ for selected US Dollar‑ denominated business, and UK transitional measures. Prudential also has permission to use ‘deduction and aggregation’ as the method by which the contribution of the 394 Group’s US insurance entities to the Group’s solvency is calculated, which in effect recognises surplus in US insurance entities in excess of 250 per cent of local US Risk Based Capital requirements. There is a risk that in the future changes are required to be made to the approved internal model and these related applications which could have a material impact on the Group Solvency II capital position. Where internal model changes are subject to regulatory approval, there is a risk that the approval is delayed or not given. In such circumstances, changes in our risk profile would not be able to be appropriately reflected in our internal model, which could have a material impact on the Group’s Solvency II capital position. The UK’s vote to leave the EU could result in significant changes to the regulatory regime under which the Group operates. Currently there are also a number of other global regulatory developments which could impact the way in which Prudential is supervised in its many jurisdictions. These include the Dodd‑Frank Wall Street Reform and Consumer Protection Act (Dodd‑Frank Act) in the US, the work of the Financial Stability Board (FSB) on Global Systemically Important Insurers (G‑SIIs) and the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) being developed by the International Association of Insurance Supervisors (IAIS). In addition, regulators in a number of jurisdictions in which the Group operates are further developing local capital regimes; this includes potential future developments in Solvency II in the UK (as referred to above), National Association of Insurance Commissioners’ reforms in the US, and amendments to certain local statutory regimes in some territories in Asia. These changes and their potential impact on the Group remain uncertain. The Dodd‑Frank Act represents a comprehensive overhaul of the financial services industry within the US 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 remains unclear, as many of its provisions are primarily focused on the banking industry, have a delayed effectiveness and/or require rulemaking or other actions by various US regulators over the coming years. The IAIS has various initiatives which are detailed in this section. On 18 July 2013, it published a methodology for identifying G‑SIIs, and a set of policy measures that will apply to them, which the FSB endorsed. An updated methodology for identifying G‑SIIs was published by the IAIS on 16 June 2016. Groups designated as a G‑SII are subject to additional regulatory requirements, including enhanced group‑wide supervision, effective resolution planning, development of a Systemic Risk Management Plan, a Recovery Plan and a Liquidity Risk Management Plan. Prudential’s designation as a G‑SII was reaffirmed on 21 November 2016. Prudential is monitoring the development and potential impact of the policy measures and is continuing to engage with the PRA on the implications of the policy measures and Prudential’s designation as a G‑SII. The G‑SII regime also introduces two types of capital requirements. The first, a Basic Capital Requirement (BCR), is designed to act as a minimum group capital requirement and the second, a Higher Loss Absorption (HLA) requirement reflects the drivers of the assessment of G‑SII designation. The IAIS intends for these requirements to take effect from January 2019, but G‑SIIs will be expected to privately report to their group‑wide supervisors in the interim. The IAIS is also developing ComFrame which is focused on the supervision of Internationally Active Insurance Groups (IAIGs). ComFrame will establish a set of common principles and standards designed to assist regulators in addressing risks that arise from insurance groups with operations in multiple jurisdictions. As part of this, work is underway to develop a global Insurance Capital Standard (ICS) that is intended to apply to IAIGs. Once the development of the ICS has been concluded, it is intended to replace the BCR as the minimum group capital requirement for G‑SIIs. A consultation on the ICS was concluded in 2016 and the IAIS intends to publish an interim version of the ICS in 2017. Further field testing, consultations and private reporting to group‑wide supervisors on the interim version are expected over the coming years, and the ICS is expected to be adopted as part of ComFrame by the IAIS in late 2019. Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event Prudential plc Annual Report 2016 www.prudential.co.ukRisk factorsContinuedof 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 its first Exposure Draft for its Phase II on insurance accounting, which would introduce significant changes to the statutory reporting of insurance entities that prepare accounts according to IFRS. A revised Exposure Draft was issued in June 2013. The IASB is currently re‑deliberating the Exposure Draft proposals in light of comments by the insurance industry and other respondents and is expecting to issue the final standard (IFRS 17, ‘Insurance Contracts’) in the first half of 2017. The standard is expected to apply from 2021. Any changes or modification of IFRS accounting policies may require a change in the future results or a retrospective adjustment of reported results. The resolution of several issues affecting the financial 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 types 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 pensions 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, lines of business it has closed. Current regulatory actions include the UK business’s undertaking to the Financial Conduct Authority to review annuities sold without advice after 1 July 2008 to its contract‑based defined contribution pension customers and potentially provide redress to certain such customers. Regulators’ interest may also include 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 deficiencies of third‑party distributors. In the US, there has been significant attention on the different regulatory standards applied to investment advice delivered to retail customers by different sectors of the industry. As a result of reports relating to perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms. This includes focus on the suitability of sales of certain products, alternative investments and the widening of the circumstances under which a person or entity providing investment advice with respect to certain employee benefit and pension plans would be considered a fiduciary (subjecting the person or entity to certain regulatory requirements, such as those adopted by the US Department of Labor issued in April 2016 which is likely to cause market disruption in the shorter term). There is a risk that new regulations introduced may have a material adverse effect on the sales of the products by Prudential and increase Prudential’s exposure to legal risks. In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. New requirements could be introduced in these and other regulatory regimes that challenge legal structures, current sales practices, or could retrospectively be applied to sales made prior to their introduction, which could have a negative impact on Prudential’s business or reported results. Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential is, and may be in the future, subject to legal actions, disputes and regulatory investigations in various contexts, including in the ordinary course of its insurance, investment management and other business operations. These legal actions, disputes and investigations may relate to aspects of Prudential’s businesses and operations that are specific to Prudential, or that are common to 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 sufficient. 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 flows. Prudential’s businesses are conducted in highly competitive environments with developing demographic trends and continued profitability depends upon management’s ability to respond to these pressures and trends The markets for financial services in the UK, US and Asia are highly competitive, with several factors affecting Prudential’s ability to sell its products and continued profitability, 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 greater financial resources or a greater market share, offer a broader range of products or have higher bonus rates. 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 financial companies, including global life insurers such as Allianz, AXA, AIA and Manulife, and multinational asset managers such as J.P.Morgan Asset Management, Schroders, HSBC Global Asset Management, and Franklin Templeton. In a number of markets, local companies have a very significant market presence. Within the UK, Prudential’s principal competitors include many of the major retail financial services companies and fund management companies including, in particular, Aviva, Legal & General, Lloyds Banking Group, Standard Life, Schroders, Invesco Perpetual, and Fidelity. Jackson’s competitors in the US include major stock and mutual insurance 395 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationcompanies, mutual fund organisations, banks and other financial services companies such as AIG, AXA Financial Inc., Allianz, Prudential Financial, Lincoln National, MetLife, and Aegon. In addition, changes in methodologies and criteria used by rating agencies could result in downgrades that do not reflect changes in the general economic conditions or Prudential’s financial condition. 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 significantly upon its capacity to anticipate and respond appropriately to these competitive pressures. Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and damage its relationships with creditors or trading counterparties Prudential’s financial strength and credit ratings, which are used by the market to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings, as a result of, for example, decreased profitability, increased costs, increased indebtedness or other concerns, could have an adverse effect on its ability to market products; retain current policyholders; and on the Group’s financial flexibility. In addition, the interest rates Prudential pays on its borrowings are affected by its credit ratings, which are in place to measure the Group’s ability to meet its contractual obligations. Prudential plc’s long‑term senior debt is rated as A2 by Moody’s, A+ by Standard & Poor’s, and A by Fitch. These ratings are all on a stable outlook. Prudential plc’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 financial strength is rated Aa3 (negative outlook) by Moody’s, AA (stable outlook) by Standard & Poor’s, and AA (stable outlook) by Fitch. Jackson’s financial strength is rated AA by Standard & Poor’s and Fitch, A1 by Moody’s, and A+ by AM Best. These ratings have a stable outlook. Prudential Assurance Co. Singapore (Pte) Ltd’s financial strength is rated AA by Standard & Poor’s. This rating is on a stable outlook. 396 Adverse experience in the operational risks inherent in Prudential’s business could disrupt its business functions and have a negative impact on its results of operations Operational risks are present in all of Prudential’s businesses, including the risk (from both Prudential and its outsourcing partners) 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 transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential also employs a large number of models and user‑developed applications in its processes. Further, because of the long‑term nature of much of the Group’s business, accurate records have to be maintained for significant periods. These factors, among others, result in significant reliance on and require significant investment in information technology (IT), compliance and other operational systems, personnel and processes. In addition, Prudential outsources several operations, including a significant part of its UK back office 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 IT, compliance and other operational systems, models and processes incorporate controls designed to manage and mitigate the operational and model risks associated with its activities, there can be no assurance that such controls will always be effective. Due to human error among other reasons, operational and model risk incidents do happen periodically and no system or process can entirely prevent them although there have not been any material events to date. Prudential’s legacy and other IT systems and processes, as with operational systems and processes generally, may be susceptible to failure or breaches. Such events could, among other things, harm Prudential’s ability to perform necessary business functions, result in the loss of confidential or proprietary data (exposing it to potential legal claims and regulatory sanctions) and damage its reputation and relationships with its customers and business partners. Similarly, any weakness in administration systems (such as those relating to policyholder records or meeting regulatory requirements) or actuarial reserving processes could have a material adverse effect on its results of operations during the effective period. Attempts by third parties to disrupt Prudential’s IT systems could result in loss of trust from Prudential’s customers, reputational damage and financial loss Being part of the financial services sector, Prudential and its business partners are increasingly exposed to the risk that third parties may attempt to disrupt the availability, confidentiality and integrity of its IT systems, which could result in disruption to the key operations, make it difficult to recover critical services, damage assets and compromise data (both corporate or customer). This could result in loss of trust from Prudential’s customers, reputational damage and direct or indirect financial loss. The cyber‑security threat continues to evolve globally in sophistication and potential significance. As a result of Prudential’s increasing market profile, the growing interest by customers to interact with their insurance provider and asset manager through the internet and social media, improved brand awareness and the classification of Prudential as a G‑SII, there is an increased likelihood of Prudential being considered a target by cyber criminals. To date, Prudential has not identified a failure or breach which has had a material impact in relation to its legacy and other IT systems and processes. However, it has been, and likely will continue to be, subject to potential damage from computer viruses, attempts at unauthorised access and cyber‑security attacks such as ‘denial of service’ attacks (which, for example, can cause temporary disruption to websites and IT networks), phishing and disruptive software campaigns. Prudential is continually enhancing its IT environment to remain secure against emerging threats, together with increasing its ability to detect system compromise and recover should such an incident occur. However, there can be no assurance that such events will not take place which may have material adverse consequential effects on Prudential’s business and financial position. Prudential plc Annual Report 2016 www.prudential.co.ukRisk factorsContinuedAdverse experience relative to the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations In common with other life insurers, the profitability of the Group’s businesses depends on a mix of factors including mortality and morbidity levels and trends, policy surrenders and take‑up rates on guarantee features of products, investment performance and impairments, unit cost of administration and new business acquisition expenses. Prudential needs to make assumptions about a number of factors in determining the pricing of its products, for setting reserves, and 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, where payments are guaranteed for at least as long as the policyholder is alive. Prudential conducts rigorous research into longevity risk, using industry data as well as its own substantial annuitant experience. 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 informed by models from the Continuous Mortality Investigation (CMI) as published by the Institute and Faculty of Actuaries. Assumptions about future expected levels of mortality are also of relevance to the Guaranteed Minimum Withdrawal Benefit (GMWB) of Jackson’s variable annuity business. If mortality improvement rates significantly exceed the improvement assumed, Prudential’s results of operations could be adversely affected. A further factor is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (known as persistency). This is particularly relevant to its lines of business other than its UK annuity business, especially Jackson’s portfolio of variable annuities. Prudential’s persistency assumptions reflect a combination of recent past experience for each relevant line of business and expert judgement, especially where a lack of relevant and credible experience data exists. Any expected change in future persistency is also reflected in the assumption. If actual levels of future persistency are significantly different than assumed, the Group’s results of operations could be adversely affected. Furthermore, Jackson’s variable annuity products are sensitive to other types of policyholder behaviour, such as the take‑up of its GMWB product features. Another example is the impact of epidemics and other effects that give rise to a large number of deaths or additional sickness claims. Significant influenza epidemics have occurred a number of times over the past 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. 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 Prudential’s subsidiaries are restricted by applicable insurance, foreign exchange and tax laws, rules and regulations that can limit remittances. In some circumstances, this could limit Prudential’s 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, 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 and other similar arrangements. For such Group operations, management control is exercised in conjunction with the other participants. The level of control exercisable by the Group depends on the terms of the contractual agreements, in particular, the allocation of control among, and continued cooperation between, the participants. Prudential may face financial, reputational and other exposure (including regulatory censure) in the event that any of its partners fails to meet its obligations under the arrangements, encounters financial difficulty, or fails to comply with local or international regulation and standards such as those pertaining to the prevention of financial crime. In addition, a significant 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, such as through significant deterioration in the reputation, financial position or other circumstances of the third party or material failure in controls (such as those pertaining to the prevention of financial crime) could adversely affect the results of operations of Prudential. 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 difficult 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. Significant 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 financial condition and results of operations. 397 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationGlossary Actual Exchange Rates (AER) Actual Exchange Rates are actual historical exchange rates for the specific 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 specified 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. AFS securities are measured at fair value on the statement of financial position with unrealised gains and losses being booked in Other Comprehensive Income instead of the income statement. Back book of business The insurance policies sold in past periods that are still in force and hence are still recorded on the insurer’s balance sheet. Bonuses Bonuses refer to the non-guaranteed benefit added to participating life insurance policies and are the way in which policyholders receive their share of the profits of the policies. There are normally two types of bonus: — Regular bonus – expected to be added every year during the term of the policy. It is not guaranteed that a regular bonus will be added each year, but once it is added, it cannot be reversed, also known as annual or reversionary bonus; and — 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, a final bonus may not be paid. Final bonuses may vary and are not guaranteed. Bulk annuity A bulk annuity, sometimes referred to as a bulk purchase annuity, is a contract between a defined benefit pension scheme and an insurance company, whereby an insurance company insures some or all of the liabilities of the pension scheme. 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. Constant Exchange Rates (CER) Constant Exchange Rates – Prudential plc reports its results at both actual exchange rates (AER) to reflect actual results and also constant exchange rates (CER) so as to eliminate the impact from exchange translation. CER results are calculated by translating prior period results using current period foreign currency exchange rates, ie, current period average rates for the income statements and current period closing rate for the balance sheet. Closed-book life insurance business A ‘closed book’ is essentially a group of insurance policies that are no longer sold, but are still featured on the books of a life insurer as a premium-paying policy. The insurance company has ‘closed the books’ on new sales of these products which will remain in run-off until the policies expire and all claims are settled. 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, cash flows, 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 specified age. Discretionary participation features or DPF A contractual right to receive, as a supplement to guaranteed benefits, additional benefits: — That are likely to be a significant portion of the total contractual benefits; — 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. Dividend cover Dividend cover is calculated as operating profit after tax on an IFRS basis, divided by the current period interim dividend plus the proposed second interim dividend. Endowment product An ordinary individual life insurance product that provides the insured party with various guaranteed benefits if it survives specific maturity dates or periods stated in the policy. Upon the death of the insured party within the coverage period, a designated beneficiary receives the face value of the policy. European Embedded Value or EEV Financial results that are prepared on a supplementary basis to the Group’s consolidated IFRS results and which are prepared in accordance with a set of principles issued by the Chief Financial Officers Forum of European Insurance Companies in May 2004 and expanded by the Additional Guidance of EEV Disclosures published in October 2005. The principles are designed to capture the value of the new business sold in the period and of the business in force. 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 offer flexible pay-out options. The contract holder pays the insurer a premium, which is credited to the contract holders’ account. Periodically, 398 Prudential plc Annual Report 2016 www.prudential.co.uk interest is credited to the contract holders’ account and administrative charges are deducted, as appropriate. Fixed indexed annuities These are similar to fixed 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 of financial position and external funds that are managed by Prudential asset management operations. 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 and other reserve movements. Specifically, 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. Guaranteed annuities Policies that pay out a fixed amount of benefit for a defined 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 specified 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 benefit (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 specified number of years. Guaranteed minimum death benefit (GMDB) (US) The basic death benefit offered under variable annuity contracts, which specifies that if the owner dies before annuity income payments begin, the beneficiary will receive a payment equal to the greater of the contract value or purchase payments less withdrawals. Guaranteed minimum income benefit (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 pay-out base equal to premiums credited with some interest rate, or the maximum anniversary value of the account prior to annuitisation. Guaranteed minimum withdrawal benefit (GMWB) (US) A guarantee in a variable annuity that promises that the owner may make annual withdrawals of a defined amount for the life of the owner or until the total guaranteed amount is recovered, regardless of market performance or the actual account balance. Health and protection These comprise health and personal accident insurance products, which provide morbidity or sickness benefits and include health, disability, critical illness and accident coverage. Health and protection products are sold both as standalone policies and as riders that can be attached to life insurance products. Health and protection riders are presented together with ordinary individual life insurance products for purposes of disclosure of financial information. Immediate annuity An annuity in which payments to the annuitant or beneficiary 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 reflected on records that has not expired, matured or otherwise been surrendered or terminated. 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 cash flows 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. Internal vesting Internal vestings are proceeds from a Prudential policy which the policyholder has decided to reinvest in a Prudential annuity product. International Financial Reporting Standards (IFRS) Accounting standards that all publicly listed groups in the European Union are required to apply in preparing consolidated financial statements. 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) or fluctuations 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. Benefits 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. Liquidity coverage ratio Prudential calculates this as assets and resources available to us that are readily convertible to cash to cover corporate obligations in a prescribed stress scenario. We calculate this ratio over a range of time horizons extending to 12 months. 399 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationOpen-ended investment company (OEIC) A collective investment fund structured as a limited company in which investors can buy and sell shares. Operational borrowings Borrowings which arise in the normal course of the business. Participating funds Distinct portfolios where the policyholders have 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. The insurer may either have discretion as to the timing of the allocation of those benefits to participating policyholders or may have discretion as to the timing and the amount of the additional benefits. For Prudential the most significant participating funds are with-profits 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 benefits based on factors such as investment performance, as a supplement to any guaranteed benefits. This is also referred to as with-profits business. Payback period Payback period is the time in which the initial ‘cash’ outflow of investment is expected to be recovered from the ‘cash’ inflows generated by the investment. We measure cash outflow by our investment of free surplus in new business sales. The payback period equals the time taken for this business to generate free surplus to cover this investment. Payback periods are measured on an undiscounted basis. Present value of new business premiums or 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. Prudential Regulation Authority or PRA The PRA is a UK regulatory body responsible for prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. 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 charge is included within operating profit 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 benefit of policyholders of SAIF. Shareholders of Prudential plc have no interest in the profits 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. They 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 key financial parameters which are subject to random variations and are projected into the future. Liquidity premium This comprises the premium that is required to compensate for the lower liquidity of corporate bonds relative to swaps and 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. Market value reduction (MVR) A reduction applied to the payment on with-profits 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 ceded to third-party reinsurers. Net worth Net assets for EEV reporting purposes that reflect the regulatory basis position, sometimes with adjustments to achieve consistency with the IFRS treatment of certain items. 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. New business profit The profits, calculated in accordance with European Embedded Value Principles, from business sold in the financial reporting period under consideration. Non-participating business A life insurance policy where the policyholder is not entitled to a share of the company’s profits and surplus, but receives certain guaranteed benefits. Also known as non-profit in the UK. Examples include pure risk policies (eg fixed annuities, term insurance, critical illness) and unit-linked insurance contracts. 400 Prudential plc Annual Report 2016 www.prudential.co.ukGlossaryContinuedUnit-linked products or unit-linked contracts See ‘investment-linked products or contracts’ above. Universal life An insurance product where the customer pays flexible premiums, subject to specified limits, which are accumulated in an account and are credited with interest (at a rate either set by the insurer or reflecting returns on a pool of matching assets). The customer may vary the death benefit 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 fluctuate, 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. 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-profits funds See ‘participating funds’ on page 400. Yield A measure of the income received from an investment compared to the price paid for the investment. Normally expressed as a percentage. Subordinated debt A fixed 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. Time value of options and guarantees The value of financial 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-profits funds. 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. 401 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationShareholder information Communication with shareholders The Group maintains a corporate website containing a wide range of information relevant for private and institutional investors, including the Group’s financial calendar www.prudential.co.uk In accordance with relevant legislation, shareholders holding 5 per cent or more of the fully paid up issued share capital are able to require the Directors to hold a general meeting. Written shareholder requests should be addressed to the Group Company Secretary at the registered office. Annual General Meeting The 2017 Annual General Meeting (AGM) will be held in the Churchill Auditorium at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on 18 May 2017 at 11.00am. Prudential will continue its practice of calling a poll on all resolutions and the voting results, including all proxies lodged prior to the meeting, will be displayed at the meeting and subsequently published on the Company’s website. Details of the 2016 AGM, including the major items discussed at the meeting and the results of the voting, can be found on the Company’s website. Documents on display 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 AGM. Company constitution Prudential is governed by the Companies Act 2006, other applicable legislation and regulations, and provisions in its Articles. Any change to the Articles must be approved by special resolution of the shareholders. There were no changes to the constitutional documents during 2016. The Memorandum and Articles are available on the Company’s website. Share capital Issued share capital The issued share capital as at 31 December 2016 consisted of 2,581,061,573 (2015: 2,572,454,958) ordinary shares of 5 pence each, all fully paid up and listed on the London Stock Exchange and the Hong Kong Stock Exchange. As at 31 December 2016, there were 48,534 (2015: 56,276) accounts on the register. Further information can be found in note C10 on page 275. Prudential 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) and the Singapore Stock Exchange. Prudential has maintained a sufficiency of public float throughout the reporting period as required by the Hong Kong Listing Rules. Analysis of shareholder accounts as at 31 December 2016 Size of shareholding 1,000,001 upwards 500,001–1,000,000 100,001–500,000 10,001–100,000 5,001–10,000 1,001–5,000 1–1,000 Total Number of shareholder accounts % of total number of shareholder accounts Number of shares 2,278,169,295 108,664,530 107,814,337 41,403,517 11,972,232 24,237,465 8,800,197 0.57 0.31 0.95 2.92 3.55 22.68 69.02 100 2,581,061,573 % of total number of shares 88.27 4.21 4.18 1.60 0.46 0.94 0.34 100 275 151 461 1,418 1,723 11,009 33,497 48,534 Major shareholders The following notifications have been disclosed under the Financial Conduct Authority’s (FCA) Disclosure Guidance and Transparency Rules in respect of notifiable interests exceeding 3 per cent in the voting rights of the issued share capital. As at 31 December 2016 % of total voting rights Capital Group Companies, Inc. BlackRock, Inc Norges Bank 9.87 5.08 4.03 As at 13 March 2017, no notifications have been received since the year end. Rights and obligations The rights and obligations attaching to the Company’s shares are set out in full in the Articles. 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, participants are the beneficial 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 13 March 2017, Trustees held 0.47 per cent of the issued share capital under the various plans in operation. Rights to dividends under the various schemes are set out on pages 110 to 157. 402 Prudential plc Annual Report 2016 www.prudential.co.ukRestrictions 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 any 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 FCA and the Hong Kong Stock Exchange, as well as under the rules of some of the Group’s employee share plans. All Directors are required to hold a minimum number of shares under guidelines approved by the Board, which they would also be expected to retain as described on page 131 of the Directors’ remuneration report. Authority to issue shares The Directors require authority from shareholders in relation to the issue of shares. Whenever shares are issued, these must be offered to existing shareholders pro rata to their holdings unless the Directors have been given authority by shareholders to issue shares without offering them first to existing shareholders. Prudential seeks authority from its shareholders on an annual basis to issue shares up to a maximum amount, of which a defined number may be issued without pre-emption. Disapplication of statutory pre-emption procedures is also sought for rights issues. The 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 AGM. Relevant resolutions to authorise share capital issuances will be put to shareholders at the AGM on 18 May 2017. Details of shares issued during 2015 and 2016 are given in note C10 on page 275. In accordance with the terms of a waiver granted by the Hong Kong Stock Exchange, Prudential confirms 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 the Company’s own shares. Prudential 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. This authority has not been used since it was last granted at the AGM in 2016. This existing authority is due to expire at the end of this year’s AGM and a special resolution to renew the authority will be put to shareholders at the AGM on 18 May 2017. Dividend information 2016 second interim dividend Ex-dividend date Record date Payment date 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. Shareholders registered on the UK register and Hong Kong and Irish branch registers Holders of US American Depository Receipts Shareholders with ordinary shares standing to the credit of their CDP securities accounts 30 March 2017 – 29 March 2017 31 March 2017 31 March 2017 31 March 2017 19 May 2017 On or about 26 May 2017 On or about 26 May 2017 403 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationShareholder information Continued Shareholder enquiries For enquiries about shareholdings, including dividends and lost share certificates, please contact the Company’s registrars: Register By post By telephone Principal UK register Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA. Irish branch register Hong Kong branch register Singapore register ADRs Capita Asset Services, Shareholder solutions (Ireland) Ltd, PO Box 7117, Dublin 2, Ireland. Computershare Hong Kong Investor Services Limited, 17M Floor, Hopewell Centre, 183 Queen’s Road East, Wan Chai, Hong Kong. Shareholders who have shares standing to the credit of their securities accounts with The Central Depository (PTE) Limited (CDP) in Singapore may refer queries to the CDP at 9 North Buona Vista Drive, #01-19/20, The Metropolis, Singapore 138588. Enquiries regarding shares held in Depository Agent Sub-accounts should be directed to your Depository Agent or broker. J.P. Morgan Chase Bank N.A, PO Box 64504, St. Paul, MN 55164-0854, USA. Dividend mandates Shareholders may have their dividends paid directly to their bank or building society account. If you wish to take advantage of this facility, please call Equiniti and request a Cash Dividend Mandate form. Alternatively, shareholders may download the form from www. prudential.co.uk/prudential-plc/ investors/shareholder_services/forms Cash dividend alternative The Company operates a Dividend Re-investment Plan (DRIP). Shareholders who have elected for the DRIP will automatically receive shares for all future dividends in respect of which a DRIP alternative is offered. The election may be cancelled at 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/ investors/shareholder-centre/agm- information/2017 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 benefits. Shareholders who have registered will be sent an email notification 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 certificate or proxy form. The option to receive shareholder documents electronically is not available to shareholders holding shares through CDP. Please contact Equiniti if you require any assistance or further information. Tel 0371 384 2035 Textel 0371 384 2255 (for hard of hearing). Lines are open from 8.30am to 5.30pm (UK), Monday to Friday. International shareholders Tel +44 (0)121 415 7026 Tel +353 1 553 0050 Tel +852 2862 8555 Tel +65 6535 7511 Tel +1 800 990 1135 or from outside the US +1 651 453 2128 or log on to www.adr.com 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 or telephone 0371 384 2248. They also offer a telephone and internet dealing service, Shareview, which provides a simple and convenient way of selling Prudential shares. For telephone sales call 0345 603 7037 between 8.00am and 4.30pm, Monday to Friday, and for internet sales log on to www.shareview.co.uk/dealing ShareGift Shareholders who have only a small number of shares the value of which makes them uneconomic to sell them 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 404 Prudential plc Annual Report 2016 www.prudential.co.ukHow to contact us Prudential plc Laurence Pountney Hill London EC4R 0HH Tel +44 (0)20 7220 7588 www.prudential.co.uk Board Paul Manduca Chairman Mike Wells Group Chief Executive Nic Nicandrou Chief Financial Officer Penny James Group Chief Risk Officer Group Executive Committee Julian Adams Group Regulatory and Government Relations Director Raghu Hariharan Director of Strategy and Capital Market Relations Jonathan Oliver Group Communications Director Alan Porter Group General Counsel and Company Secretary Al-Noor Ramji Group Chief Digital Officer Tim Rolfe Group Human Resources Director Prudential UK and Europe 3 Sheldon Square London W2 6PR Tel +44 (0)800 000 000 www.pru.co.uk John Foley Chief Executive M&G Laurence Pountney Hill London EC4R 0HH Tel +44 (0)20 7626 4588 www.mandg.co.uk Anne Richards 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 Tony Wilkey Chief Executive Jackson National Life Insurance Company 1 Corporate Way Lansing Michigan 48951 USA Tel +1 517 381 5500 www.jackson.com Barry Stowe Chairman and Chief Executive Officer of North American Business Unit Institutional Analyst and Investor Enquiries Tel +44 (0)20 7548 3300 E-mail investor.relations@prudential.co.uk UK Register Private Shareholder Enquiries Tel 0371 384 2035 International shareholders Tel +44 (0)121 415 7026 Irish Branch Register Private Shareholder Enquiries Tel +353 1 553 0050 Hong Kong Branch Register Private Shareholder Enquiries Tel +852 2862 8555 US American Depository Receipts Holder Enquiries Tel +1 651 453 2128 The Central Depository (Pte) Limited Shareholder Enquiries Tel +65 6535 7511 Media Enquiries Tel +44 (0)20 7548 2776 E-mail media.relations@prudential.co.uk 405 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional informationPrudential 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 by the Prudential Regulation Authority and the Financial Conduct Authority 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 financial 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 financial 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, including fluctuations in interest rates and exchange rates, the potential for a sustained low-interest rate environment, and the performance of financial markets generally; the policies and actions of regulatory authorities, including, for example, new government initiatives; the political, legal and economic effects of the UK’s vote to leave the European Union; the impact of continuing designation as a Global Systemically Important Insurer or ‘G-SII’; the impact of competition, economic uncertainty, inflation and deflation; the effect on Prudential’s business and results from, in particular, 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 affiliates operate; and the impact of legal and regulatory actions, investigations 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 benefits. Further discussion of these and other important factors that could cause Prudential's actual future financial 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 the Annual Report and the ‘Risk factors’ heading of Prudential’s most recent annual report on Form 20-F filed with the US Securities and Exchange Commission. Prudential’s most recent annual report and Form 20-F are available on its website at www.prudential.co.uk 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. 406 Prudential plc Annual Report 2016 www.prudential.co.ukFront cover: Phuong Lan Prudential Vietnam Phuong Lan holds PRUmultiple care and PRU-Wealth Assured policies from Prudential Vietnam. These products provide financial protection against critical illness during Phuong Lan’s lifetime, ensure availability of funds to help realise her goals in her later years, and enhance her family’s prosperity. Back cover: Helen Prudential UK and Europe See page 29 for further details. 407 www.prudential.co.ukAnnualReport2016 Prudential plc 07 Additional information408 Prudential plc Annual Report 2016 www.prudential.co.ukHistory Providing financial security since 1848 Successive generations have looked to Prudential to safeguard their financial security – from industrial workers and their families in Victorian Britain, to around 24 million insurance customers worldwide today. Our financial strength, heritage, prudence and focus on our customers’ long‑term needs ensure that people continue to turn to our trusted brands to help them plan for today and tomorrow. 1848 Prudential is established as Prudential Mutual Assurance Investment and Loan Association in Hatton Garden, London, offering loans and life assurance to professional people. 1854 Prudential opens the Industrial Department to sell a new type of insurance, Industrial Insurance, to the working classes, for premiums of a penny and upwards. 1923 Prudential’s first overseas life branch is established in India, with the first policy being sold to a tea planter in Assam. 1949 The ‘Man from the Pru’ advertising campaign is launched. 1986 Prudential acquires Jackson in the United States. 1994 Prudential Corporation Asia is formed in Hong Kong as a regional head office to expand operations beyond an existing presence in Malaysia, Singapore and Hong Kong. 1999 Prudential acquires M&G, pioneer of unit trusts in the UK and a leading provider of investment products. 2000 Prudential and CITIC launch the first Sino‑British life insurance joint venture in China. 2014 Prudential acquires businesses in Ghana and Kenya, marking its entry into the fast‑growing African life insurance industry. www.prudentialhistory.co.uk Fred’s story In June 1949, an article describing the life and work of a long‑serving Prudential agent, Fred Sawyer, appeared in the Weekly Illustrated magazine. One of the pictures was so striking that it prompted Prudential’s publicity department to use it in their next advertising campaign, and the figure of Fred Sawyer came to represent a typical agent. ‘“Service,” says Pru agent Sawyer, “is the secret of success”. He has 1,500 clients and collects in the morning and evening, fitting in clerical work in the afternoon. But he still finds time to be a special constable, a school manager and a district councillor. “I know the people,” says Mr Sawyer, “I wouldn’t change my job for any other.”’ Weekly Illustrated magazine June 1949 P r u d e n t i a l p l c A n n u a l R e p o r t 2 0 1 6 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. Printed on Amadeus 75 Matt, a paper made from 75 per cent recycled post‑consumer waste and 25 per cent fibre sourced from fully sustainable forests; and Amadeus 100 White Offset which is made from 100 per cent recycled post‑consumer waste. All material used in this report has been independently certified according to the rules of the Forest Stewardship Council (FSC). All pulps used are elemental chlorine free, and the inks used are vegetable oil based. The manufacturing mills and the printer are registered to the Environmental Management System ISO 14001 and are FSC chain‑of‑custody certified. Designed by FleishmanHillard Fishburn Printed in the UK by CPI Colour

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