Prudential Bancorp
Annual Report 2017

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 7 Adding more to life Prudential plc Annual Report 2017 H K S t o c k C o d e : 2 3 7 8  The Directors’ Report of Prudential plc for the year ended 31 December 2017 is set out on pages 2 to 8, 82 to 122 and 362 to 407, and includes the sections of the Annual Report referred to in these pages. Contents 01 Group overview Chairman’s statement Group Chief Executive’s report 02 Strategic report At a glance Our business model Our distribution Our performance Our businesses and their performance Chief Financial Officer’s report on the 2017 financial performance Report on the risks facing our business and how these are managed Corporate responsibility review 03 Governance Chairman’s introduction Board of Directors How we operate Further information on Directors Risk management and internal control Committee reports Statutory and regulatory disclosures Additional information Index to principal Directors’ report disclosures 04 Directors’ remuneration report Annual statement from the Chairman of the Remuneration Committee Our Executive Directors’ remuneration at a glance Summary of the current Directors’ remuneration policy Annual report on remuneration Supplementary information 05 Financial statements 06 European Embedded Value (EEV) basis results 07 Additional information Additional unaudited financial information Risk factors Glossary Shareholder information How to contact us Page 02 04 10 12 14 16 18 33 48 64 82 83 88 98 99 101 120 121 122 124 126 128 132 154 159 325 362 391 398 402 406 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. Our year in numbers Summary financials 2017 2016 Change on actual exchange rate basis6 Change on constant exchange rate basis6 IFRS operating profit based on longer‑term investment returns Underlying free surplus generated 1,2 Life new business profit IFRS profit after tax 3 Net cash remittances from business units IFRS shareholders’ funds EEV shareholders’ funds Group Solvency II capital surplus 4,5 £4,699m £4,256m 10% £3,640m £3,566m 2% £3,616m £3,088m 17% £2,390m £1,921m 24% £1,788m £1,718m 4% £14.7bn £16.1bn £44.7bn £39.0bn £13.3bn £12.5bn 15% 10% 6% 6% (1)% 12% 21% – Full‑year ordinary dividend 47 pence (2016: 43.5 pence) +8% Employees volunteered 96,493 hours Notes 1 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 11 of the EEV basis results. 2 The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3 of the IFRS financial statements, as a result Prudential Capital is not included in underlying free surplus generated. 3 IFRS profit after tax reflects the combined effects of operating results determined on the basis of longer‑term investment returns, together with negative short‑term investment variances, which in 2017 largely arose within Jackson, profit (loss) on disposal of businesses, amortisation of acquisition accounting adjustments and the total tax charge for the year. 4 The Group 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 includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 5 Before allowing for second interim ordinary dividend. 6 Further information on actual and constant exchange rates basis is set out in note A1 of the IFRS financial statements. www.prudential.co.uk Annual Report 2017 Prudential plc 01 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationChairman’s statement – Paul Manduca A customer-focused Group delivering long-term sustainable returns I am pleased to present Prudential’s 2017 Annual Report. Prudential has produced another well balanced performance while making a number of important changes to our business. Alongside our 2017 results, the Board announced its intention to demerge M&G Prudential, our UK and European business, from the Group. The Board has always considered it important to create optionality within our corporate structure. After a rigorous review, which considered all options including the status quo, we have concluded that it is in the best interest of the business to operate as two separately listed companies, able to focus on their distinct strategic priorities in their chosen geographies. This will unlock the potential for enhanced value creation in both businesses, as each benefits from strategic focus and capital allocation policies aligned to its market opportunity. On completion of the demerger, shareholders will hold interests in both companies. M&G Prudential is one of the leading retirement and savings businesses in the UK and Europe. As a standalone entity, it will continue to drive its transformation into a more capital‑efficient and customer‑ focused business, targeting growing customer demand for comprehensive financial solutions in these markets. In line with this strategy M&G Prudential agreed in March 2018 to the partial sale of its shareholder annuity portfolio. As with other changes to the business, our priority is to ensure these customers are treated fairly. The international Group will combine the exciting growth potential of our Asia, US and Africa businesses, meeting the growing needs of customers in these markets. These businesses will form a leading international Group focused on the largest insurance markets globally with significant growth prospects. Both independent groups will be headquartered in London, which we regard as the pre‑eminent city from which to operate global financial service businesses, and both are expected to meet the criteria for inclusion in the FTSE100. The Board believes this demerger is in the interests of all our stakeholders. Customers will receive greater focus, employees will be more closely aligned with their businesses and we believe shareholders will benefit from investments in both companies. Our strong full year results demonstrate the positive momentum across all our businesses. Our impact Throughout the demerger process, we will continue to hold ourselves to the highest standards to ensure that both businesses deliver long‑term sustainable returns. As ever, our customers remain our key priority. We help customers make plans for the future by reducing the risks they face. Whether they are saving for the family, protecting their health or managing their retirement, Prudential enables them to manage uncertainty. We also turn their capital into a source of stable investment in companies and countries across the world, driving economic growth and improving infrastructure. Changing the structure of our business will not reduce our commitment to delivering on these promises. Our customer focus means actively engaging with the critical issues facing both our businesses and the wider world. In 2017, the Group published its first environmental, social and governance (ESG) report, demonstrating how we approach all our stakeholders, from our suppliers and employees to the wider communities in which we operate, with the same sense of responsibility and commitment that we apply to our customers, and how we engage with investors and regulators around the risks and impact of issues such as climate change. We will publish our next ESG report in May 2018. Performance and dividend We have delivered another broad‑based operating and financial performance, driven by all of our business units and in particular by our growing Asia businesses. In view of this performance and our confidence about the outlook for the Group, the Board has decided to increase the full‑year ordinary dividend by 8 per cent to 47 pence per share. In line with this, the Directors have approved a second interim ordinary dividend of 32.5 pence per share (2016: 30.57 pence per share). Governance All our stakeholders benefit from the Board taking an active role in the development and execution of our strategy, ensuring it is fit for today and for the future. The Board’s decision to separate M&G Prudential was not taken lightly and we took significant time to consider the benefits for shareholders and customers and the impact on our wider stakeholders. We took an important step towards this decision in August 2017 when we announced our intention to merge our UK asset manager, M&G, and our UK and Europe life insurance business to form M&G Prudential. The combined business now manages £351 billion in assets1 for more than seven million customers and is well placed to thrive as an independent business. The Board now has a vital role to play stewarding the separation process, working with management and ensuring that every part of the Group continues to deliver for customers. This task makes ensuring a strong and diverse Board more important than ever. There were a number of changes to the Board in 2017 in both non‑executive and executive roles, reflecting the strength of our succession planning. 02 Prudential plc Annual Report 2017 www.prudential.co.uk This has enabled us to recruit high‑calibre candidates with a diverse set of skills and expertise and ensured continuity while minimising disruption. I would like to thank Ann Godbehere, Tony Wilkey and Penny James for their significant contribution during their tenures, and to welcome Mark FitzPatrick, Tom Watjen and James Turner to the Board. The global market for talent continues to be highly competitive and our priority remains to ensure that we have the best possible executive and non‑executive team. We have committed to focusing particularly on strengthening gender diversity, alongside diversity of skills, in our succession planning in 2018. Ensuring the effectiveness of the Board also remains a priority for me as Chairman. An external independent evaluation was conducted at the end of 2017 to consider how the Board can improve and work together more effectively. I was pleased that the review concluded that the Board’s strengths included creating a collegiate and constructive environment, effective use of time and materials, and strong risk and control oversight. Our shareholders and other stakeholders A well governed company engages regularly and effectively with its shareholders, responding to their challenges and taking their ideas and concerns seriously. At Prudential, we have open and constructive dialogue with investors via a regular and comprehensive programme of engagement. I have personally found this active engagement hugely valuable and fully commit to continuing this dialogue. Shareholder input is vital to ensuring well informed Board discussions. Policy and regulatory change affects both our short‑term performance and long‑term strategy. Prudential places great importance on having an effective relationship with the regulators and policymakers who supervise us and our markets. We engage regularly and constructively with all our regulators and supervisors, as well as with governments around the world. Throughout the demerger process, the Board will continue to engage with all our stakeholders to ensure that they are kept informed and their input is sought. Our people The success of Prudential is rooted in the commitment, creativity and drive of our teams in each of our markets and businesses. The structural changes we are proposing will only succeed because of the hard work of our people and we will support them through these changes. We are committed to ensuring that Prudential’s people represent the communities we serve and we therefore take a strategic approach to diversity and inclusion at every level of our business. While this is an ongoing journey, we firmly believe diversity both adds strength and ensures a wide range of perspectives. We aim to 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. As part of our commitment to diversity, Prudential has signed the HM Treasury Women in Finance Charter, which aims to increase the number of women working in senior management in financial services companies, and we have set a gender diversity target of 30 per cent females in senior management by the end of 2021. Our communities Prudential provides important benefits to society through our core business activities. In addition to these benefits, Prudential is a responsible business that invests in our local communities, which we strongly believe is in the interests of all our stakeholders. Our community investment work focuses particularly on financial education, disaster preparedness and social inclusion. The Cha‑Ching programme, our financial education platform aimed at primary school‑aged children, is now in its seventh year. It has expanded from its origins in Asia to each of the four continents in which the Group does business, and in all of the markets where it has been launched it has been extremely positively received, with strong feedback from parents, teachers, children and political stakeholders. 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. And in the UK, over the past five years Prudential RideLondon has raised over £50 million for charity and become one of the largest fundraising events in the country. In 2017 alone, more than 800 charities benefited from riders’ fundraising. The direct contribution made by our people to the communities in which they live and participate makes me particularly proud. In 2017, Prudential colleagues volunteered 96,493 hours of their time. I support this activity personally through our flagship international volunteering programme, the Chairman’s Challenge, and I am delighted by the continuing success of the programme, with the number of volunteers increasing year‑on‑ year. From its launch in 2006, when 2,603 employees signed up, volunteer numbers have more than trebled. Last year 8,500 colleagues around the world – over 30 per cent of our workforce – took part, volunteering more than 35,000 hours to support 30 projects. Conclusion Prudential has announced a significant change that we believe will secure the future success of both M&G Prudential and our international business. This decision has been made from a position of strength, with a well balanced 2017 performance driven by every part of our business. The Board has confidence in the creation of two valuable businesses that will continue to deliver for our shareholders, customers and other stakeholders. Paul Manduca Chairman Note 1 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. www.prudential.co.uk Annual Report 2017 Prudential plc 03 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationGroup Chief Executive’s report – Mike Wells Strong performance and continued profitable growth I am pleased to report that over 2017 our clear, consistent strategy, high-quality products and improving capabilities have enabled us to meet the needs of customers around the world better than ever before. Our purpose is to help remove uncertainty from life’s big events. Whether that’s starting a family, saving for a child’s education or planning for retirement, we provide our customers with financial peace of mind, enabling them to face the future with greater confidence. We also invest our customers’ money actively in the real economy, helping not only to improve the lives of individuals and families, but also to build stronger communities and drive the cycle of growth. Our strategy is aligned to structural trends: the savings and protection needs of the fast‑ growing middle class in Asia, the retirement income needs of the approximately 75 million baby boomers in the United States1 and the growing demand for managed savings solutions among the ageing populations of the United Kingdom and Europe. These trends are sustained, and we remain focused on the opportunities they present. We have continued to develop our products and our capabilities in order to improve the way we meet customers’ needs. We are creating new, better and more personalised products, and we have a flexible, collaborative approach to incorporating the best digital technologies into our operations, while also leveraging our global scale to share new insights across our businesses at pace. The result is constant improvement in the way we serve our customers, providing value both to them and to our shareholders. In March 2018 the Group announced its intention to demerge its UK and Europe businesses (‘M&G Prudential’) from Prudential plc, resulting in two separately listed companies, with different investment characteristics and opportunities. Our businesses share common heritage, values and purpose. Looking forward, we believe we will be better able to focus on meeting our customers’ rapidly evolving needs and to deliver long‑term value to investors as two separate businesses. On completion of the demerger, shareholders will hold interests in both Prudential plc and M&G Prudential. In line with its strategy to transition towards a more capital efficient, de‑risked business model, M&G Prudential agreed in March 2018 to the sale of £12.0 billion20 of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion20 of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. The capital benefit of this transaction will be retained within the Group to support the UK demerger process. In preparation for the UK demerger process, and to align the ownership of the Group’s businesses with their operating structures, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019. Our financial performance We have built on our good start to 2017 through disciplined execution of our strategy, again led by our businesses in Asia. We announce today the achievement of our remaining 2017 objectives, which were set in December 2013. During the first half of 2017, we exceeded the Group objective of underlying free surplus generation of at least £10 billion from the beginning of 2014 to the end of 2017. By the end of 2017 we had generated £12.8 billion over this four year period. Our Asia businesses delivered growth in IFRS operating profit based on longer‑term investment returns2 (‘IFRS operating profit’) at a compound average rate of 16 per cent3 over the period 2012 to 2017, and underlying free surplus generation of £1,078 million3 for the full year 2017. This is testament to the strength, scale and diversity of our Asia platform, validates our focus on recurring premium health and protection business and demonstrates the strength of our operational execution. It also marks the third set of objectives that we have successfully achieved within the last 10 years. During 2017 we combined our UK and European life and asset management businesses to form M&G Prudential, which delivered record levels of external asset management net inflows of £17.3 billion in 2017. This contributed to combined assets under management4 of £351 billion at 31 December 2017. 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 currency movement. IFRS operating profit* by business and currency % 2017 25% 35% GBP 11% Other 18% US$ linked 24% US$ 47% 40% Asia US UK and Europe * Segmental earnings of key businesses and excludes other income and expenditure. 04 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Helen, Prudential Hong Kong ‘I’ve always considered good health to be very important to my life. It’s great that Prudential offered me access to myDNA Pro, which has given me key insights into my genetic risk profiles. The first step was to do a DNA test, which showed my body to be sensitive to carbohydrate and fat intake due to my genetic makeup. Based on these findings, the personal health coach I chose as part of the programme helped me set a weight loss goal and plan to maintain a healthier lifestyle, including changing my dietary habits and ensuring I incorporated more cardio workouts into my exercise regime. With these, I have been able to maintain a healthy weight and am now in an overall better shape. I’ve been very impressed by the genetics‑based recommendations and level of personal guidance provided by the programme. Huge thanks to my coach and Prudential for all the support and motivation.’ Group IFRS operating profit was 6 per cent5 higher at £4,699 million (up 10 per cent on an actual exchange rate basis). IFRS operating profit from our Asia life insurance and asset management businesses grew by 15 per cent5, reflecting continued broad‑based business momentum across the region, with double‑digit5 growth in eight out of 12 life insurance markets. In the US, Jackson’s total IFRS operating profit increased by 3 per cent5, due mainly to growth in fee income on higher asset balances, which outweighed the anticipated reduction in spread earnings. In the UK and Europe, M&G Prudential’s total IFRS operating profit was 10 per cent higher than the prior year, reflecting 6 per cent growth in the IFRS operating profit generated from insurance business and 18 per cent growth in that generated from asset management. The Group’s capital generation is underpinned by our large and growing in‑force business portfolio, and focus on profitable, short‑payback business. Overall underlying free surplus generation6 decreased by 1 per cent5 to £3,640 million, with higher contributions in Asia and the UK and Europe, offset by higher restructuring costs and a lower contribution from our US business. 2016 benefited from the impact of a US transaction to enhance local capital efficiency that was not repeated in 2017. Cash remittances to the Group increased to £1,788 million, with Asia the largest contributor7 at £645 million. The Group’s overall performance supported an 8 per cent increase in the 2017 full year ordinary dividend to 47 pence per share. The Group remains robustly capitalised, with a 2017 year‑end Solvency II cover ratio8,9 of 202 per cent. Over the period, IFRS shareholders’ funds increased by 10 per cent to £16.1 billion, reflecting profit after tax of £2,390 million (2016: £1,921 million on an actual exchange rate basis) net of other movements that included dividend payments to shareholders of £1,159 million and adverse foreign exchange movements of £470 million. EEV shareholders’ funds increased by 15 per cent to £44.7 billion, equivalent to 1,728 pence per share10,11. New business profit11 increased by 12 per cent5 to £3,616 million (up 17 per cent on an actual exchange rate basis), driven by improved business mix in Asia, higher UK volumes and the favourable effect of tax reform in the US. In Asia, we continue to develop our capabilities and reach, which build scale and enhance quality. Our strategic emphasis on increasing sales from health and protection business has contributed to a 12 per cent5 increase in new business profit in Asia. Our asset management business, Eastspring Investments, has again seen growth, with its total assets under management up 18 per cent12 to £138.9 billion and IFRS operating profit also up 18 per cent5 to £176 million. In the US we remain focused on meeting the retirement income needs of the growing generation of baby boomer retirees and expanding our operations into the large asset pools of the fee‑based advisory market. Although the evolving regulatory environment continues to cause industry sales disruption, in 2017 Jackson delivered positive separate account net inflows of £3.5 billion, with separate account assets reaching £130.5 billion, an increase of 19 per cent5. In December 2017 the US enacted a major tax reform package, including a reduction in the corporate income tax rate from 35 per cent to 21 per cent effective from 1 January 2018. While this led to a £445 million charge in the income statement from re‑measuring deferred tax balances on the IFRS balance sheet, we expect the tax changes to be positive in the long term. The US effective tax rate is expected to fall from the current rate of circa 28 per cent to circa 18 per cent in the future. www.prudential.co.uk Annual Report 2017 Prudential plc 05 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationGroup Chief Executive’s report – Mike Wells continued In the UK, both our UK life and asset management businesses performed well in 2017. PruFund new business APE sales increased 36 per cent to £1.2 billion, while M&G saw record net inflows of £17.3 billion from external clients. Overall M&G Prudential assets under management4 reached £351 billion, up from £311 billion at 31 December 2016. Our financial KPIs continue to reflect the outcome of the Group’s strategy. Our Asia life businesses are driven by growth in our recurring premium base and focus on health and protection business, and elsewhere we are benefiting from our prioritisation of fee‑generating products across our Asia asset management, US variable annuity and UK and European asset management activities. A successful strategy Our performance is based on our clear, consistent and successful strategy, which is focused on long‑term opportunities arising from structural trends in our markets around the world. In Asia, the growth of the middle class is creating significant and long‑term demand for the products we offer. The working‑age population in the region is growing by a million people a month, and by 2030 is expected to reach 2.5 billion13, while 65 per cent of Asian private financial wealth is held in cash14 and at the same time, that wealth is growing by US$4 trillion a year14. The growing and increasingly wealthy middle classes of the region are under‑ protected. In Asia, out‑of‑pocket healthcare spend makes up 42 per cent of total health expenditure15, compared with just 12 per cent in the US and 9 per cent in the UK. While in a more developed market such as the UK insurance penetration is equivalent to 7.5 per cent16 of GDP, in Asia that figure is just 2.4 per cent16, giving an idea of the scale of the growth opportunity that remains in our Asian markets. The gap between the insurance cover of people in the region and what they need in order to maintain the living standards of their families has been estimated at circa £35 trillion17. We help to bridge that gap with a broad range of solutions across 14 markets in the region. We are in the top three in nine of our markets in Asia18, and we have 15 million life customers, with access to total markets of more than 3.3 billion people. The United States is the world’s largest retirement market, with approximately 40 million Americans reaching retirement age over the next decade alone, and these consumers have a need for investment options through which they can grow their savings while at the same time protecting their income. This is creating demand for our variable annuity products, which are designed to help this cohort of Americans avoid running out of money and provide them with a reliable cushion against volatile markets. In the US, over US$15 trillion is invested in adviser‑distributed financial assets net of existing annuities, while penetration of variable annuity sales into the retirement market remains low, demonstrating the scale of the opportunity for us. In the UK and Europe there is growing demand among customers for managed solutions, savings products that provide better long‑term returns than cash, while smoothing out the ups and downs of the market. We meet that need through our PruFund propositions and our comprehensive range of actively managed funds. M&G Prudential is well positioned to target this growing customer demand for comprehensive financial solutions and the demerger will enable this business to play an even greater role in these markets. Doing more for our customers We deliver on our clear strategy and our long‑term opportunities by paying close attention to the needs of our customers, by responding to those needs with products that fit their changing requirements, and by improving our capabilities continually in order to deliver the best products in the most effective way. In Asia, our broad‑based portfolio of businesses continues to drive the growth of the Group. We are constantly improving the range and quality of the products we offer in the region, developing our multi‑channel distribution platform to ensure that those products reach as many customers as possible and improving our capabilities throughout our operations, not least by accessing new innovations in digital technology. We develop products that meet the needs of our customers, whether that is for more personalised features or products aimed at new areas of the market and in 2017 we launched a number of new health and protection products in Indonesia, Vietnam, Singapore, Malaysia and Hong Kong. Prudential’s Group Executive Committee Mike Wells is advised and assisted by the Group Executive Committee, which comprises our Executive Directors and a team of functional specialists. The members of the Group Executive Committee and their roles are set out on page 406. Back, left to right: Tim Rolfe, Julian Adams, Al‑Noor Ramji, Anne Richards, Jonathan Oliver, Alan Porter. Front, left to right: Nic Nicandrou, John Foley, Mike Wells, Mark FitzPatrick, Barry Stowe. James Turner was appointed as an Executive Director and as Group Chief Risk Officer in March 2018. 06 Prudential plc Annual Report 2017 www.prudential.co.uk Prudential won the insurance category of Management Today’s ‘Britain’s Most Admired Companies’ awards in December 2017. We were also named Britain’s most admired company overall for quality of management and inspirational leadership and fourth for our ability to attract and retain top talent. The highly regarded awards are based on a review by peers. We are also continuing to improve both our agency platform and our bancassurance partnerships in Asia to ensure that we reach as many customers as possible. Nowhere is this clearer than in China, where, through our joint venture CITIC‑ Prudential, we now have a presence in 77 cities, with access to 940 million people, or about 70 per cent of the population of the world’s most populous country. We have over 44,000 agents in China and access to more than 4,000 bank branches. Across the region during 2017 we increased our total agents to over 600,000 and we ended the year with over 15 million life insurance customers. Recent announcements of new agreements in the Philippines, Thailand, Indonesia and Vietnam have also increased the reach of our bancassurance partnerships. Continuous improvement of our capabilities is also a key part of our approach, and in Asia we introduced a number of digital initiatives that will benefit both our customers and our shareholders, including apps and chatbots, that, among other services, can provide rapid claims payment, constant customer support, answer queries, help schedule appointments and transfer feedback from customers to our businesses. Building on its success in Hong Kong, our myDNA service, which provides diet and exercise advice based on genetic profiles, has been launched in Vietnam, Malaysia and Singapore. In Singapore we also launched PRU Fintegrate, a new initiative enabling us to collaborate with fintech startups to co‑develop digital solutions for customers. Eastspring is well placed for the anticipated growth in Asia’s retail mutual fund market. To prepare further, we have strengthened our in‑house investment teams, entered into new strategic partnerships and made significant progress in systems and operating model upgrades. In addition, Eastspring recognises that environmental, social and governance (ESG) factors can be material to investment returns, particularly in the long term, and has become a signatory to the United Nations‑supported Principles for Responsible Investment (PRI), joining M&G Prudential asset management. In the United States, we are continuing to develop our business to ensure we capture the opportunity presented by the millions of Americans moving into retirement now and over the coming years. Regulatory and industry changes are creating new areas of growth potential and we are adapting our offering to meet those opportunities. During 2017, in response to evolving conditions in the hybrid adviser segment of the market, Jackson launched Perspective Advisory II, an advisory version of our flagship product, Perspective II. We also announced the formation in November of our Private Wealth & Trust group, a specialised team focused on complex planning, investment management and tax mitigation strategies for high‑net‑worth clients. At the same time, we are improving communication for customers, and our initiatives in this area last year included the launch of a new website, the Financial Freedom Studio, where consumers can learn about financial planning for retirement, aimed at simplifying the language and focusing on planning for lifetime income. In the UK and Europe, the combination of our life and asset management businesses into M&G Prudential has enabled us to meet the needs of our customers better than ever before. The business manages £351 billion of assets4 for more than seven million customers, both in the UK and internationally, and we are leveraging our scale, financial strength and complementary product and distribution capabilities to enhance the development of capital‑efficient, customer‑focused solutions. Bringing these businesses together has given us the opportunity to deliver better collaboration across business segments and more innovative and differentiated propositions. It also provides better access to customers and channels, merger cost synergies and transformation benefits, including the chance to invest to create a digital, data‑led business with low marginal cost of growth. M&G Prudential is in the top five in UK retail funds19, with an active management offering, and provides a range of consumer‑focused retirement and savings wrappers. The performance of its products continues to make them very popular among customers. The flagship PruFund Growth Life Fund, for example, has grown by 36 per cent since the start of 2013, compared with benchmark growth of 30 per cent, and this performance has driven growth in PruFund assets under management from £7.5 billion in 2012 to £35.9 billion at the end of 2017. To improve the offering to customers, in 2017 the business rolled out myM&G, its direct‑to‑ consumer platform. We took another step forward in our Africa business in 2017 when we entered Nigeria, Africa’s largest economy and our fifth market in the region. Following the launch of our businesses in Ghana, Kenya, Uganda and Zambia, this further demonstrates our commitment to Africa and our determination to bring the benefits of our products to customers across the region. We continue to invest in our capabilities and our people across the organisation. In July we welcomed Mark FitzPatrick to our executive team as Chief Financial Officer, succeeding Nic Nicandrou, who took over from Tony Wilkey as Chief Executive of Prudential Corporation Asia. Mark brings with him significant experience and knowledge of the sector, and I am confident that Nic will lead our Asian business to further success. In March 2018 James Turner was appointed Group Chief Risk Officer, bringing fresh perspective and additional leadership capacity to our executive team. www.prudential.co.uk Annual Report 2017 Prudential plc 07 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationGroup Chief Executive’s report – Mike Wells continued A positive outlook With our clear strategy focused on long‑term trends around the world and continued improvements in our execution capabilities, we are delivering value to our customers, our shareholders and the communities in which we operate. This is supported by our ongoing focus on risk management and the strength of our balance sheet. We believe the demerger of M&G Prudential from the international group will leave both businesses better able to focus on meeting our customers’ rapidly evolving needs and to deliver long‑term value to investors as two separate companies. I have no doubt that the strength of our underlying opportunities and our proven ability to innovate and improve the way we do things, will ensure that both businesses are well positioned to continue to serve our customers well and grow profitably into the future. Mike Wells Group Chief Executive Notes 1 Source: US Census Bureau, Population Division, 2017 2 estimate of population. 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 The current year and all comparative amounts for the Asia objectives exclude contributions from the Korea life business which was sold in 2017. The 2017 Asia IFRS operating profit objective was adjusted accordingly. 2012 comparative amounts include the one‑off gain on sale of the stake in China Life of Taiwan of £51 million. 4 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. 5 Year‑on‑year percentage increases are stated on a constant exchange rate basis unless otherwise stated. 6 Underlying free surplus generated comprises underlying free surplus generated from the Group’s long‑term business (net of investment in new business) and that generated from asset management operations. Further information is set out in note 11 of the EEV basis results. 7 Based on the 2017 operating segments. 8 The Group 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 includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 9 Estimated before allowing for second interim dividend. 10 Closing EEV shareholders’ funds divided by issued shares, as set out in note II(n) of the Additional unaudited financial information. 11 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 II(k) of the Additional unaudited financial information. 12 Growth rate on an actual exchange rate basis. 13 Working age population 15 ‑ 64 years. Source: United Nations, Department of Economic and Social Affairs, Population Division (2015). World Population Prospects: The 2015 Revision, DVD Edition. 14 Source: BCG Global Wealth 2016. Navigating the New Client Landscape. 15 Source: World health Organisation ‑ Global Health Observatory data repository (2013). Out of pocket as percentage of total health expenditure. 16 Source: Swiss Re Sigma 2015. Insurance penetration calculated as premiums as percentage of GDP. Asia penetration calculated on a weighted population basis. 17 Source: Swiss Re, Mortality Protection Gap: Asia‑Pacific, 2015. 18 Source: Based on formal (Competitors’ results release, local regulators and insurance associations) and informal (industry exchange) market share data. Ranking based on new business (APE or weighted FYP depending on the availability of data). 19 Source: The Investment Association, September 2017. 20 Relates to £12.0 billion of IFRS shareholder annuity liabilities, valued as at 31 December 2017. 08 Prudential plc Annual Report 2017 www.prudential.co.uk Strategic report Page At a glance Our business model Our distribution Our performance Our businesses and their performance 10 12 14 16 18 18 24 28 Chief Financial Officer’s report on the 2017 financial performance 33 Report on the risks facing our business and how these are managed 48 64 Corporate responsibility review Asia US UK and Europe www.prudential.co.uk Annual Report 2017 Prudential plc 09 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information02At a glance Group at a glance We meet the long-term savings and protection needs of a growing middle class and ageing population. We focus on three markets – Asia, the US and UK and Europe – where the need for our products is strong and growing and we use our capabilities, footprint and scale to meet that need. In recent years, we have expanded into Africa, taking advantage of the emerging demand for our products in the region. Our strategy Asia Savin s, h e a lth & prote cti o g n Asia Significant protection gap and investment needs of the middle class US Transition of ‘baby-boomers’ into retirement UK and Europe ‘Savings gap’ and ageing population in need of returns/ income Savin g s Savin 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 and continental European population. 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. Africa 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. Leading pan-regional franchise 94% of APE sales are regular premium £139bn Eastspring Investments funds under management £3.1bn Eastspring Investments external net inflows1 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 help our customers to live longer and healthier lives, and save to improve future choices for them and their families. 1 Excluding money market funds. 10 Prudential plc Annual Report 2017 www.prudential.co.uk £669bn total funds under management +26m customers worldwide US UK and Europe 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 has helped us forge a solid reputation for meeting the needs of customers. Jackson’s variable annuities offer a distinct retirement solution designed to provide a variety of investment choices to help customers pursue their financial goals. M&G Prudential In August we announced the formation of M&G Prudential, a leading savings and investments business, ideally positioned to target growing customer demand for financial solutions in the UK and Europe. Our vision is a business built for the customer: simple, efficient, digitally enabled, capital light, fast‑growing and above all focused on delivery. The combined business benefits from two strong complementary brands, a world‑class investment capability, international distribution and a robust capital position. Premier retirement income player premium growth since 1995 6.8x 19% market share of US variable annuities1 £3.5bn separate account net inflows Well recognised brands with a strong track record of a long-term conviction-led investment approach £17.3bn asset management external net inflows M&G Prudential funds under management1 £351bn +7.2m customers 1 ©2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) 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 Company 3Q YTD 2017. 1 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. www.prudential.co.uk Annual Report 2017 Prudential plc 11 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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 — 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 US — Retiring ‘baby boomer’ generation — Large and growing retirement asset pools — Growing demand for guaranteed income Our businesses and their performance page 24 UK and Europe — Ageing population — Large and growing retirement asset pools — Growing demand for savings and income Our businesses and their performance page 28 Customers 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 the retirement phase of life. We are expanding our digital infrastructure to enhance our customer experience. 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, including adding digital tools, 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. We invest in digital capabilities to empower our distributors and improve customer service. 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. Report on the risks facing our business page 48 12 Prudential plc Annual Report 2017 www.prudential.co.uk Creating value… …for our stakeholders Growth £4,699m IFRS operating profit +6%1 on 2016 £3,616m New business profit +12%1 on 2016 £6,598m EEV operating profit +15%1 on 2016 Cash £3,640m Free surplus generation ‑1%1 on 2016 £1,788m Remittances +4%2 on 2016 Capital £13.3bn Solvency II surplus +6%2 on 2016 202% Cover ratio +1pp on 2016 The Group has a number of key performance indicators internally to measure financial performance. Read more on page 16 1 Growth rates on constant exchange rate basis. 2 Growth rates on an actual exchange rate basis. 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. Investors Growing dividends and share price performance enhance shareholder value. Read more on pages 68 to 70 Read more on pages 16 to 80 Employees Providing an environment with equal opportunities, career potential and rewards enabling us to attract and retain high‑quality individuals to deliver our strategy. Communities Supporting communities where we operate, through investment in business and infrastructure, tax revenues and community support activities. Read more on pages 74 to 77 Read more on pages 70 to 74 www.prudential.co.uk Annual Report 2017 Prudential plc 13 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Our 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. Jackson Prudential Africa Strength and flexibility of our distribution network gives us a distinctive advantage Largest VA wholesale distribution force in the US1 Most productive VA wholesale distribution force in the US1 627 broker‑dealers’ selling agreements covering +226,545 (73%) of total US advisers2 #1 selling variable annuity contract3 in the independent channel since 2003 Establishing network with market-leading initiatives +2,200 agents 4 exclusive bank partners Access to +600 bank branches 2 mobile bank partners Approximately 700,000 customers 14 Prudential plc Annual Report 2017 www.prudential.co.uk M&G Prudential Prudential Corporation Asia Diversified distribution model underpinned by strong brand Pan-regional multi-channel network £351 billion total assets under management4 Products registered in 24 jurisdictions around the world +7.2 million customers +300 Prudential Financial Planning partners +600,000 agents Multiple established bank partnerships Active in +10,000 bank branches Eastspring Investments are present in 10 major Asian markets and distribution offices in US and Europe Independent research and Market Metrics, a Strategic Insight Business. Notes 1 2 The Cerulli Report Adviser Metrics 2017 and Jackson research. 3 ©2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) 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 Company & by Contract 3Q YTD 2017. Jackson ranks #1 out of 735 VA contracts with reported sales in the Independent Channel in 3Q YTD 2017. 4 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. www.prudential.co.uk Annual Report 2017 Prudential plc 15 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur performance Measuring our performance To create sustainable economic value for our shareholders we focus on delivering growth and cash while maintaining appropriate capital. Profit, cash and capital1 Prudential takes a balanced approach to performance management across IFRS, EEV and cash. We aim to demonstrate how we generate profit under different accounting bases, reflecting the returns we generate on capital invested and the cash generation of our business. IFRS operating profit based on longer-term investment returns2 £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, eg the effects of corporate transactions are excluded. Group IFRS operating profit in 2017 is 6 per cent higher on a constant exchange rate basis (10 per cent on an actual exchange rate basis), compared with 2016, reflecting resilient performance in our life businesses, with Asia up 15 per cent (20 per cent on an actual exchange rate basis), the US up 3 per cent (8 per cent on an actual exchange rate basis) and UK and Europe up 8 per cent. Our asset management businesses have performed well with M&G Prudential asset management up 18 per cent and Eastspring also up 18 per cent (25 per cent on an actual exchange rate basis). CAGR +12% 3,969 4,699 4,256 2,937 3,154 2013 2014 2015 2016 2017 EEV new business profit3 £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 new business profit in 2017 increased by 12 per cent on a constant exchange rate basis (17 per cent on an actual exchange rate basis) compared with 2016, driven by strong performance in each of our businesses with Asia up 12 per cent (17 per cent on an actual exchange rate basis), the US up 9 per cent (15 per cent on an actual exchange rate basis), and the UK up 28 per cent. CAGR +15% 2,492 3,616 3,088 2,077 2,021 2013 2014 2015 2016 2017 EEV operating profit3 £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 the 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 EEV operating profit in 2017 increased by 15 per cent on a constant exchange rate basis (20 per cent on an actual exchange rate basis), compared with 2016, driven by higher new business profit and higher contributions from the in‑force business. Group free surplus generation4,5 £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. Overall underlying free surplus generation decreased by 1 per cent on a constant exchange rate basis (increased 2 per cent on an actual exchange rate basis), reflecting a one‑off benefit in the prior year in our US business and higher restructuring costs within the Group, offsetting higher contributions in Asia and the UK and Europe. CAGR +12% 4,840 6,598 5,497 4,225 4,108 2013 2014 2015 2016 2017 CAGR +11% 3,025 3,566 3,640 2,417 2,553 2013 2014 2015 2016 2017 16 Prudential plc Annual Report 2017 www.prudential.co.uk Business unit remittances6 £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. Total remittances to the Group increased by 4 per cent in 2017, compared with 2016, with significant contributions from each of our major businesses. This increase was driven by remittances from Asia, up 25 per cent (on an actual exchange rate basis) compared with 2016. CAGR +7% 1,625 1,718 1,788 1,482 1,341 2013 2014 2015 2016 2017 Group Solvency II capital surplus7,8 £bn 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. 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 £13.3 billion at 31 December 2017. 13.3 12.5 9.7 2015 2016 2017 2017 objectives We are pleased to report that the Group has successfully achieved the financial objectives announced in December 2013. This demonstrates the successful execution of our strategy and is testament to the strength, scale and diversity of our Asia platform. Asia objectives9 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 ‑ 2017. Asia underlying free surplus, £m Asia underlying free surplus generation4 of £0.9 billion to £1.1 billion in 2017. Group objective10 Group cumulative underlying free surplus, £bn Cumulative Group underlying free surplus generation of at least £10 billion over the four‑year period from 2014 to end‑2017. CAGR +16% 1,885* 2017 objective >£1,826m 1,029* 2017 objective £0.9-1.1bn 12.8 2014-2017 objective >£10bn 884* 909 2012 Comparative stated at reported currency basis *Expressed at Dec 2013 FX rates 1,975 2017 454* 468 2012 Comparative stated at reported currency basis *Expressed at Dec 2013 FX rates 1,078 2017 2017 Notes 1 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 2017 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. 2 3 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. 4 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 11 of the EEV basis results. 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. 5 The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3 of the IFRS financial statements. On re‑presentation, Prudential Capital is excluded from underlying free surplus generated. 6 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. 7 The Group 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 includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 8 Estimated before allowing for second interim ordinary dividend. 9 The current year and all comparative amounts for the Asia objectives exclude contributions from the Korea life business which was sold in 2017. The 2017 Asia IFRS operating profit objective was adjusted accordingly. 2012 comparative amounts include the one‑off gain on sale of the stake in China Life of Taiwan of £51 million. 10 For the purpose of the Group objective, cumulative underlying free surplus generation includes the free surplus relating to Prudential Capital. www.prudential.co.uk Annual Report 2017 Prudential plc 17 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance Asia There are compelling structural trends that underpin the long term opportunities for savings and protection across the region, and Prudential is positioned for further growth in these markets. 2017 performance highlights — Continued performance in key metrics: new business profit up 12 per cent1, IFRS operating profit up 15 per cent1 and underlying free surplus generation up 19 per cent1 — 2017 financial objectives achieved — Eastspring total funds under management of £138.9 billion up 18 per cent2 — Operating in 77 cities in China with APE sales up 43 per cent1 — Eastspring named ‘Best Asset Management House’ by Asia Asset Management for 2018 Awards In Asia the insurance and savings industries are still in their infancy with average insurance penetration rates at just 2.4 per cent6, well below those seen in the UK. 65 per cent of personal wealth in Asia is held in cash or deposits relative to 14 per cent in the US. There are significant growth opportunities that arise from simply addressing these existing concerns. However, there are key structural trends that will further increase this strong demand for savings and protection for decades ahead. The first is the growing working population which is predicted to increase at over 1 million people per month. This means that between 2015 and 2030 some 178 million people will reach working age, roughly the equivalent to the combined populations of the UK, France and Italy. The second trend relates to the significant economic growth potential of the region with, GDP in Asia predicted to increase significantly. The implications on wealth creation are profound, with private financial wealth increasing by some US$4 trillion per annum from 2016 to reach US$78 trillion by 2021. The third trend covers the expanding mortality and morbidity protection gaps; as families’ wealth increases so does the amount of money they need to sustain their lifestyles in the event of a life‑changing event such as the death of a breadwinner or the diagnosis of a critical illness. Research concluded that in Prudential’s life markets the mortality gap is US$45 trillion8 and out of pocket healthcare expenditure is roughly four times the rates seen in the US and UK. While these opportunities are attractive, there are a number of challenges associated with executing them. The industry is highly regulated as governments are rightly very concerned about ensuring individuals do not take undue risks with their savings and receive fair outcomes. The products are intangible, with the benefits potentially not crystallising for many years; customers need to have a high level of confidence in the company that they are entrusting their financial well‑being to. The products can be complex and unfamiliar, so customers typically need advice and guidance on how to address their individual needs. Building, training and managing teams of financial advisers that can do this takes considerable time and expertise. Within this context, Prudential is differentiated by its long history in Asia, the breadth and depth of its operations, and its discipline and quality of execution. Prudential Corporation Asia has all the key attributes for continuing success, starting with a footprint of life insurance and asset management business spanning 14 countries and giving us access to 3.3 billion people. We also have unrivalled expertise in the region, having been in Malaysia since 1924, and entering markets early such as India, China, Vietnam and most recently Cambodia and Laos. We also pioneered industry developments in the region, such as unit‑linked products and bancassurance. Our sheer scale is a key competitive advantage with over 600,000 agents, access to more than 10,000 bank branches, 15 million life customers, 24 million life policies currently in force and £139 billion of assets under management. From this position of strength, we are now leveraging our expertise further to deliver greater value from our agency and bank channels, broaden our product offering and drive efficiencies in our operational platforms. We are also being increasingly innovative in the ways we add value for our customers, often harnessing digital technology. Distribution Prudential Corporation Asia has one of the strongest distribution platforms in the region, with a well diversified mix of tied agents and bank partners that enables us to reach a broad range of customers. Our experience is that customers’ fundamental preference for face‑to‑face advice and service from a trusted financial adviser is undiminished, and so tied agency and in‑branch bank sales staff will remain our primary distribution channels. However, we are making significant investments in upgrading our capabilities to ensure we not only meet but exceed our customers’ expectations, including digital innovations and efficiencies, when they interact with our distributors. For example, in Singapore our agents are now equipped 18 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Nasrun, Prudential Indonesia ‘As a PRUcustomer Friend20, one of my first direct interactions with a Prudential customer was meeting a gentleman who was thinking of surrendering his policy. I encouraged him to maintain an active policy by citing the benefits, and thankfully he did just that. Not long after our meeting, I received the sad news that he had passed away. His daughter, who was the beneficiary of his life insurance policy, visited and thanked me for persuading her father not to surrender the policy. She said, “thanks to you, we were able to cover the hospital bills and other expenses after my father passed away”. It’s moments like these that I’m grateful for my role at Prudential, which gives me the opportunity to make a difference in people’s lives.’ with our fourth generation of an electronic point of sales (‘ePos’) portal that uses the latest developments in biometric authentication and produces a detailed quote within three minutes. In China our mobile policy application process has reduced customer on‑boarding time from five days to 30 minutes, and includes auto underwriting and verification so policies can be issued within seconds. These initiatives not only give our customers a better experience, but also help our agents become more productive; in China the number of active agents increased 24 per cent last year and their average case sizes increased 21 per cent. Our agency management capabilities in terms of recruiting and training are well proven, but we are continuing to upgrade these. For example in Indonesia, where we recruited an average of over 4,500 agents per month during 2017, our PRUforce agency workbench has enabled us to reduce significantly on‑boarding times. ‘Million Dollar Round Table’ membership is an industry‑recognised indicator of agency quality, and in Hong Kong we lead the market with over 4,000 qualifiers up by 53 per cent9. We are also adapting technology to improve the service we provide to our agents, such as askPRU in Singapore, the industry’s first chatbot policy enquiry system. Since its launch, calls to the service centre have reduced by 30 per cent. We believe bancassurance is an effective way to increase insurance penetration and Prudential has an excellent track record in growing high quality business through this channel with a number of different partners. For example, we have had an enduring regional relationship with Standard Chartered Bank since 1998 and the ongoing effectiveness of this relationship is evidenced by a 12 per cent growth in APE last year. We have also had great success in securing and then activating newer relationships, for example Thanachart Bank in Thailand grew APE by 17 per cent last year following collaboration on a new regular premium product. In addition we are actively increasing our engagement with other banks. We have recently announced new agreements with Robinsons Bank in the Philippines, Siam Commercial Bank in Thailand for the provision of unit linked products to their high worth customers and Shinhan Bank in Indonesia and Vietnam. Products Prudential has a full suite of products that are tailored to meet individual market requirements and customer needs. Our overarching priority is to ensure firstly that customers have appropriate levels of protection and then support them with their long‑term savings objectives. Consequently a relatively high proportion of our average premiums are directed to protection products; equal to 27 per cent of total APE in 2017, and regular premiums comprised 94 per cent of the total APE. This mix is also beneficial to shareholders, as regular premiums provide a reliable stream of compounding revenues and protection business has higher profit margins as shareholders are providing capital to support risks. Understanding our markets Working age population3,4 +1 million a month 2.5bn 2.5bn 2030 2030 2.3bn 2015 Health gap: out-of-pocket healthcare spend5 42% Asia 12% US 9% UK Insurance penetration6 7.5% UK 2.4% Asia Private financial wealth7 +US$4 trillion a year US$78tr 2021 US$53tr 2016 www.prudential.co.uk Annual Report 2017 Prudential plc 19 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance continued A leading pan-Asia franchise The combination of Prudential Corporation Asia’s broad capability set, wide business footprint, and the significant opportunity across the market underpins our business in Asia. Accelerate Asia Compounding revenues and profits Prudential Corporation Asia is a business with compounding revenues underpinned by high quality recurring income that is uncorrelated to investment markets. The current scale and profitability has been achieved by increasing our customer base and penetration across the continent. Growth is driven by our ability to meet customer needs through the breadth of markets we operate in, the scale and innovation of our operations, the capabilities of Eastspring Investments, our pan‑Asia asset manager, and our diverse and talented workforce. Life Life weighted premium income10,11 £bn CER Asset management Funds under management12 £bn 139 118 11.5 9.5 8.0 6.9 5.9 4.9 4.3 3.6 2.6 1.2 3.1 1.1 1.4 1.5 1.8 2.0 2.4 3.8 3.6 3.7 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 In‑force New business +1.2x 2016 2017 20 Prudential plc Annual Report 2017 www.prudential.co.uk Diversification 11 1 10 9 8 7 6 5 £1,975m +15% 3 4 Hong Kong Philippines Life insurance Market ranking12 Population Penetration13 2 Eastspring Funds under management14 India15 Life insurance Market ranking12 Population Penetration13 2nd 7m 16.2% £3.4bn 1st 1.3bn 2.7% Life insurance Market ranking12 Population Penetration13 Singapore18 Life insurance Market ranking12 Population Penetration13 3rd 102m 1.2% 2nd 6m 5.5% Eastspring Funds under management14 £74.8bn IFRS operating profit by region Full year 2017 % 1 Indonesia 2 Singapore 3 Hong Kong 4 Malaysia 5 Vietnam 6 Thailand 7 China 8 Philippines 9 Taiwan 10 Eastspring 11 Others 23% +2% 14% +10% 17% +38% 9% +15% 7% +15% 5% +7% 5% +38% 2% +11% 7% +10% 9% +18% 2% +14% Eastspring Funds under management14 £17.2bn Taiwan Indonesia Life insurance Market ranking12 Population Penetration13 Life insurance Market ranking12 Population Penetration13 Eastspring Funds under management14 1st 261m 1.6% Eastspring Funds under management14 £4.0bn Thailand 12th 24m 16.6% £5.4bn 10th 68m 3.7% 2nd 94m 1.0% Life insurance Market ranking12 Population Penetration13 Vietnam Life insurance Market ranking12 Population Penetration13 Eastspring Funds under management14 £2.0bn Growth rate vs 2016 constant exchange rates Japan Eastspring Funds under management14 £7.2bn Korea Eastspring Funds under management14 £8.7bn Cambodia19 Life insurance Market ranking12 Population Penetration13 China15 Life insurance Market ranking12 Population Penetration13 Laos Life insurance Market ranking12 Population Penetration13 1st 16m 0.1% Malaysia17 4th 1.4bn 2.3% Life insurance Market ranking12 Population Penetration13 3rd 7m 0.0% 1st 31m 3.1% Eastspring Funds under management14 £6.3bn Eastspring Funds under management14 £7.4bn www.prudential.co.uk Annual Report 2017 Prudential plc 21 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance continued Investing for growth Given the compelling opportunities we see in the region we will continue investing for growth. We will continue to enhance our core operations, expanding our traditional distribution reach with more, higher quality agents; we will add new bank distribution partners and explore adding some non‑ traditional ones too. We will accelerate the work in digitising and automating our processes and ensure we have enhanced abilities to connect with the broader cloud‑based ecosystem. We are already one of the leaders in the health space, but we will investigate opportunities to participate more broadly in this area with more comprehensive and flexible coverages and a wider range of value added services. We will position Eastspring to play a greater role in managing Asia’s rising wealth and we will also expand our presence in China. Underpinning our ability to build on our existing strengths and build out our capabilities is our priority to continue investing in our people. It is vital that we further enhance our diverse and highly talented workforce. Nic Nicandrou Chief Executive Prudential Corporation Asia While we are already one of the leaders in the protection space, continued innovation is essential for our ongoing success. In Hong Kong we recently launched a very popular upgrade to our critical illness product, PRUhealth critical illness multi‑care, which provides lifetime multi‑claim, lump‑sum cover for 113 disease conditions, including three claims for cancer up to a total of 300 per cent of the sum assured. We are also successfully evolving our product ranges within markets to cater for a more differentiated range of customer needs. For example, in Indonesia we have introduced Hebat, a lower premium investment linked product, at one end of the spectrum for emerging customers and an ‘as charged’ medical product at the other end for higher net worth customers. In Indonesia and Malaysia we have been successfully developing Takaful products to provide for the specific needs of Muslim customers. Work is also underway to ensure we have active dialogues with our customers so their products keep up with their changing needs. Technology is also helping here; during 2017 we piloted ‘next best offer’ with our agents in Hong Kong. This is an AI‑driven app that automatically recommends additional coverage to existing customers. Customers Excellent customer service is a prerequisite for sustained success in the industry and we are continuously driving improvements. For example, in China we have introduced WeChat e‑claims that have reduced the processing time for a seven day hospitalisation claim from around 18 days to two days. The usage rate of e‑claims is 99 per cent. In Hong Kong we have simplified the verification processes for Mainland China customers using iPads and GPS so they no longer need to visit our customer service centre. In Indonesia we have developed PRUcheers, an analytics‑driven business engine that performs a pre‑assessment of claims so that low risk ones can now be turned around in minutes, and the turnaround time for medical claims has been reduced by 15 per cent. However, in addition to improved processes, customers are increasingly looking for value added services that go beyond the basic product proposition and so provide opportunities for us to increase our connections with them. In Hong Kong we found that myDNA, a service that provides customised diet and exercise advice supported by an app and based on an individual’s genetic profile, is very popular and so this has already been rolled out to Vietnam, Malaysia and Singapore. In Malaysia we have partnered with BP Global for their Doctor2U app. This gives our customers preferential rates on services that include online video medical consultations and the option to have a call‑out 24/7. In Indonesia we have the PRUmedical network covering 45 hospitals in 24 cities. Our customers receive priority admission and discharge to reduce waiting times, and are also guaranteed rooms. More broadly, we are also engaging with customers in areas that concern them. Our Relationship Index gives insights on one of the most important areas of customers’ lives, their relationships with their loved ones. Customers are also increasingly concerned that companies they are associated with are ‘good’. Our Prudence Foundation has well recognised community initiatives around children’s education, including the Cha‑Ching financial literacy programme and our disaster preparedness initiatives including the Safe Steps campaigns on natural disasters, road safety and first aid. Our YouTube channels that hold videos related to these and other initiatives have had over 100 million views. Eastspring Investments Eastspring has a number of advantages and is well placed for the anticipated growth in Asia’s retail mutual fund market. It has one of the largest footprints in Asia, being operational in 10 major markets. It has a well diversified customer base comprising Prudential’s internal life funds, and a number of institutional clients, including sovereign wealth funds and retail customers. Assets managed are also well diversified between fixed income and equities and also include infrastructure funds. Recent developments include a broadening and strengthening of our in house investment teams with some key hires, winning the ‘Best Asset Management House’ award21, new strategic partnerships (BlackRock, Sustainable Growth Advisers and Korea Advanced Institute of Science and Technology), significant progress with our systems and operating model upgrades and enhancing our institutional coverage by adding consultants in Asia and the US. We have also recently received approval of our business licence as an investment management wholly‑foreign owned enterprise in China. 22 Prudential plc Annual Report 2017 www.prudential.co.uk 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. Creating value and benefiting our stakeholders 15 million life customers Products We listen to our customers to help us understand their changing needs and tailor our design of product solutions and services. For example: PRUhealth cancer multi‑care was launched to address the impact of multiple cancer diagnoses in Hong Kong and the region. 94% of APE sales in regular premium Brand awareness of 85% (average 94% 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 customer interaction that delivers high‑quality, needs‑based advice. +600,000 agents Access to over 10,000 bank branches Investment for growth Building on our strong track record, we are building for future growth by investing in new opportunities and capabilities. Now in 77 cities in China Indonesia distribution expansion – circa 400 offices Eastspring Investments total funds under management £139 billion Notes 1 Growth rate on a constant exchange rate basis. 2 Growth rate on an actual exchange rate basis. 3 United Nations, Department of Economic and Social Affairs, Population Division (2015). World Population Prospects: The 2015 Revision, DVD Edition 15. 4 Working age population: 15 to 64 years. 5 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. 6 Source: Swiss Re Sigma 2015. Insurance penetration calculated as premiums as percentage of GDP. Asia penetration calculated on a weighted population basis. 7 Source: BCG Global Wealth 2017: Winning the growth game. 8 Source: Swiss Re Mortality Protection Gap Report – Asia Pacific 2015. 9 Annual growth to 1 July 2017. Source: The Premier 13 Market penetration: Swiss Re (Sigma) – based on Association of Financial Professionals. 10 Weighted premium income comprises gross earned premiums at 100 per cent of renewal premiums, 100 per cent of first year premiums and 10 per cent of single premiums. 11 Comparatives have been stated on an constant exchange rate basis. Historic have been restated to exclude sales from Korea Life, classified as held for sale. 2014 excludes intra‑group reinsurance contracts between the UK and Asia with‑profits businesses. 12 Based on FY17 or the latest information available. Source include 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). insurance premiums as a percentage of GDP in 2016 (estimated). 14 FUM reported based on the country where the funds are managed. 15 Ranking among foreign JVs. 16 Ranking among private players. 17 Includes Takaful sales at 100 per cent. 18 Singapore includes onshore only, excluding Eldershield and DPS. 19 First year premiums. 20 PRUcustomer Friends are employed by Prudential Indonesia to provide customer service and support, and enhance customer relationships. 21 2018 Asia Asset Management ‘Best of the Best Regional Awards’ – Best Asset Management House. www.prudential.co.uk Annual Report 2017 Prudential plc 23 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance United States Providing an ageing American population with financial strategies for stable retirements. 2017 performance highlights — Cash remittance of £475 million — Total IFRS operating profit of £2.2 billion – up 3 per cent1 — Variable annuity total net inflows of £4.7 billion — Strong separate account asset growth – up 19 per cent1 at US$176.6 billion (£130.5 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 11th consecutive year of recognition for customer service performance in both categories The US is the world’s largest retirement savings market with approximately 40 million Americans reaching 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 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 needed. To overcome these challenges, Americans need and demand 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. Jackson continues to respond to this demand with product innovation and distribution strategies that meet the needs of a growing retirement population, while generating shareholder value. Customers and products Through its distribution partners, Jackson provides products, including variable, fixed and fixed index annuities, which offer Americans the retirement strategies they need. These products offer a range of features: — Variable annuity A Jackson variable annuity, with investment freedom, represents an attractive option for retirees, providing both access to equity market appreciation and guaranteed lifetime income as an add on benefit. — Fixed index annuity A Jackson fixed index annuity is a guaranteed product with limited market exposure but no actual equity ownership. It is designed to build wealth through a combination of a base crediting rate that is generally lower than a traditional fixed annuity crediting rate, but with the potential for additional upside based upon the performance of the linked index. — Fixed annuity A Jackson fixed annuity is a guaranteed product designed to build wealth without market exposure, through a crediting rate that is likely to be superior to interest rates offered from banks or money market funds. These products also offer tax deferral, which allows interest and earnings to grow tax‑free until withdrawals are made. Jackson has a proven track record in this market with its market‑leading flagship product6, Perspective II. Jackson’s success has been built on its quick‑to‑market product innovation, as demonstrated by the development and launch of Elite Access in 2012, our investment‑only variable annuity. Further demonstrating Jackson’s flexibility and manufacturing capabilities, Jackson has launched Perspective Advisory II and Elite Access Advisory to serve advisers and distributors with a preference for advisory products. In November, Jackson launched Private Wealth Shield (PWS), a variable annuity developed specifically for trusts and private banks. To support this new product, Jackson also announced the formation of its Private Wealth & Trust group, a specialised team focused on complex planning, investment management and tax mitigation strategies for high‑net‑worth and ultra‑high net‑worth clients. Distribution Jackson distributes products in all 50 states of the US and in the District of Columbia. Operations in the state of New York are conducted through a New York subsidiary. Jackson markets its retail products primarily through advice based distribution channels, including independent agents, independent broker‑dealer firms, regional 24 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Saundra, Jackson ‘My retirement story is about how I want to spend the winter of my life. It’s about having fun, enjoying my family, travelling and having the freedom to do the things I want to do, like spending time with my grandson. My relationship with my financial adviser is a wonderful one. He is like a family member and confidant; easy to work with and establish goals. I’m very pleased I chose a Jackson annuity. It gives me the confidence I need for my retirement. And to just live my life the way I want to live my life.’ Understanding our markets Retirement wave Baby boomer population by age2 4.5m Age 55 in 2016 4.0m Age 60 in 2016 3.5m Age 65 in 2016 Under-saved Median net worth3 US$000 187.3 55-64 124.2 45-54 Increased longevity Life expectancy at 654 19.4 years 2015 14.3 years 1960 Regulatory landscape 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), which seeks to eliminate conflicts of interest in investment advice, in order to protect and encourage savings and investment for working Americans. The DoL implemented a partial applicability date of 9 June 2017 where fiduciary advisers have an obligation to give advice that adheres to ‘impartial conduct standards’. These impartial conduct standards require advisers to adhere to a best interest standard when making investment recommendations, charge no more than reasonable compensation for their services, and refrain from making misleading statements. In late November, the DoL announced an 18‑month extension on the full applicability date from 1 January 2018 to 1 July 2019. The DoL intends to complete its review under the Presidential Memorandum, instructing the DoL to re‑examine its fiduciary rule and decide whether to propose further changes, leaving the final form of the Rules unclear. broker‑dealers, wirehouses, and banks. For variable annuity sales, Jackson is the leader in the independent broker‑dealer, bank and wirehouse channels9 and second in regional firms9. Jackson’s distribution strength also sets us apart from our competitors. Our wholesaling force is the largest7 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 is the most productive variable annuity wholesale distribution force in the US7. In August 2017, National Planning Holdings (NPH), an affiliate of Jackson, announced the sale of the business of the four firms in its independent broker‑dealer network to LPL Financial LLC (LPL). With the US financial services industry experiencing a time of significant regulatory change and consolidation in the independent broker‑dealer (IBD) sector, Jackson has determined its overall strategy did not include being a consolidator in the retail IBD space. Rather, our primary strategy is to focus on expanding Jackson’s success as the leading manufacturer of retirement income products in the country. www.prudential.co.uk Annual Report 2017 Prudential plc 25 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance continued 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. Barry Stowe Chairman and Chief Executive North American Business Unit As a result of the DoL regulatory initiative and the uncertainties regarding the application and implementation of the Rules, the annuity industry saw continued pressure on sales in 2017. Sales in the variable annuity industry as of the third quarter of 2017 at US$70.9 billion10 were down 11 per cent compared with the same period last year. Even with competitors recently offering fixed index annuities with benefits that resemble those of variable annuities, sales of fixed index annuities (US$42.9 billion)10 along with fixed annuity products (US$38.9 billion)10 were lower as of the third quarter of 2017 at 9 per cent and 13 per cent respectively, compared with the same period last year. Total annuity industry sales were down approximately 11 per cent10 as of the third quarter of 2017. 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. Because of its strong distribution, leadership in the annuities market, best‑in‑class service and low‑cost efficient operation, Jackson is extremely well positioned to take advantage of this opportunity. The US National Association of Insurance Commissioners (NAIC) is currently conducting an industry consultation with the aim of reducing the non‑economic volatility in the variable annuity statutory balance sheet and enhancing risk management. Following an industry quantitative impact study (QIS), changes have been proposed to the current framework. These changes were presented to the December NAIC national meeting, and were exposed for comment by industry and interested parties until early March 2018. Jackson will continue to engage with the industry and the NAIC during the comment period. On 22 December, 2017, President Trump signed into law the Tax Cuts and Jobs Act making significant changes to America’s tax code. In 2017, the lowering of the corporate tax rate resulted in a charge for the reduction of Jackson’s deferred tax assets. In the future, the lower rate and the effect of other changes to the calculation of taxable income are expected to lead to higher after‑tax earnings, return on equity and capital generation, all else being equal. Investment for growth With trillions of dollars of adviser‑ distributed assets across distribution platforms that have not historically been a focus, such as the dually 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 has implemented changes necessary to meet the requirements of the sections of the fiduciary rules which are effective. Jackson has made and continues to consider changes to its product offerings, entered into new selling agreements with advisory providers, and is working with its distributors to support implementation of the Best Interest Contract Exemption or product changes to the extent those become necessary before July 2019. Evolution of capabilities to succeed in the advisory market Near‑term Mid‑term Long‑term Product launches + Changing the narrative + New selling agreements + Technology integration 26 Prudential plc Annual Report 2017 www.prudential.co.uk Driving our business Customers Products Distribution Investment for growth 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 Americans currently transitioning to and through retirement. 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. Jackson’s distribution teams set us apart from our competitors. Jackson’s wholesaling force is the largest and most productive in the industry, supporting thousands of advisers across multiple channels and distribution outlets. Creating value and benefiting our stakeholders Average of 10,000 Americans retire per day5 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 Largest VA wholesale distribution force in the US7 Most productive VA wholesale distribution force in the US7 Jackson continues to invest in technology and innovative products to efficiently and effectively adapt to what our customers and regulatory environment require. Jackson has recently launched an advisory version of our flagship product Perspective II and our innovative Elite Access product to allow for penetration into untapped distribution channels. Corporate Insight Annuity Monitor Awards for excellence in the online and offline experience offered to prospects, clients and advisers Approximately 35% of Jackson’s advisory variable annuity sales from new advisers8 Notes 1 Growth rate on a constant exchange rate basis. 2 US Census Bureau Population division 2014 estimate of population. 3 2016 Federal Reserve Board’s Triennial Survey of Consumer Finances. 4 US Department of Health and Human Services, ‘Health, United States 2016’. 5 Social Security Administration, Annual Performance Plan for FY 2012, and Revised Final Performance Plan for FY 2011. 6 ©2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) 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 2017. Jackson’s Perspective II for base states ranks #1 and Elite Access for base states ranks #8 for Total VA Sales out of 991 VA contracts with reported sales to Morningstar’s quarterly sales survey as of 3Q YTD 2017. Independent research and Market Metrics, a Strategic Insight Business. 7 8 New advisers defined as producers who have not sold Jackson product since 2014. 9 ©2018 Morningstar Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) 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 company and channel 3Q YTD 2017. Jackson ranks #1 out of 25 companies in the Independent NASD channel, #1 out of 19 companies in the Bank channel, #1 out of 14 companies in the Wirehouse channel, and #2 out of 19 companies in the Regional Firms channel. 10 LIMRA/Secure Retirement Institute, US Individual Annuity Participants Report 3Q YTD 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 27 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance United Kingdom and Europe Creating a simple, modern savings and investments business. 2017 performance highlights — Announcement of merger of M&G and Prudential’s UK and European business — Start of major investment programme to improve customer service, accelerate product development and widen customer choice — Total M&G Prudential assets under management1 of £351 billion, up 13 per cent — Net investment inflows to mutual funds and institutional investment strategies of £17.3 billion — PruFund range reaches £36 billion in customer assets under management, up 46 per cent — 45 per cent growth in funds under advice from our in house direct advice service, Prudential Financial Planning, to £5.5 billion Understanding our markets In August 2017, we combined M&G, our international investment management business, with Prudential’s UK and European life insurance business to form M&G Prudential. We also announced a major investment programme in the new combined business’s infrastructure to improve customer service, accelerate product development and widen customer choice. M&G Prudential serves two of the world’s largest savings and investments markets with asset pools in the UK and Europe of £7 trillion and ¤14 trillion respectively. Across the region, people increasingly need help to meet their long‑term financing goals as responsibility for retirement savings passes from state and employer to the individual. They want easy access to savings and investment solutions, as well as guidance and advice from trusted providers. In addition, persistently low rates of return on bank cash deposits are fuelling demand for investment solutions, whether people are saving for retirement, building a lump sum or protecting their wealth from inflation. Managing £351 billion of assets1 for over seven million customers in the UK and internationally, M&G Prudential has investment expertise, scale and financial strength and two well‑respected brands – M&G Investments and Prudential UK. With the substantial investment we will be making over the next five years in transforming the business’s operations, including building our digital distribution capability, M&G Prudential is well placed to meet the growing and evolving saving and investment needs of customers across intermediated, institutional and retail direct channels. Customers Whether we’re helping an individual saver plan for their future with more confidence, or helping a big pension fund to meet its future commitments to pensioners, serving the long‑term interests of our customers is key to the long‑term performance of our business. Assets under management 31 Dec 2017 Customers UK customers Investment funds £36bn 186k direct customers PruFund Traditional products European customers Institutions £36bn 400k customers £151bn 6.6m customers £44bn Leading cross‑border fund sales £84bn 794 clients £351bn1,2 +7.2m customers 28 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Maureen, M&G Prudential ‘I was in my early 20s when I started investing with M&G through a monthly savings plan. I found the idea of investing with other people in different companies fascinating. I still do, in fact. I wasn’t saving up for anything specific, but I wanted to put my money to work for the future – either for a big purchase, like a home, or just for more financial security. At the end of the day, money can give you choices. You never know what opportunities or challenges might be around the corner. And not just for yourself – it’s great to be able to help your family. Having grown over the years, my investments with M&G have given me more options in life. Decades on from the first £10 I put in to one of their funds, I really value still being an investor.’ We offer a range of investment and saving propositions to different customer groups. In the UK, we manage the savings of direct and intermediated customers through a range of mutual funds. We are also a leading provider of savings and retirement solutions to direct and advised UK customers with a 19 per cent market share in life and pensions retail investments as at end September 2017, including the popular and successful PruFund proposition in a number of different wrappers. We also have a large book of UK customers who own traditional insurance‑based savings products. In continental Europe, where we have a leading position in cross‑border fund distribution with £44 billion2 in assets under management, customers in 17 countries are able to access our investment strategies. Finally, we manage the pension and other long‑term savings of millions of people through our relationships with 794 institutional clients, including 70 per cent of the UK’s 50 largest pension schemes. We see significant opportunities for continued revenue growth in four of these customer segments, including from the synergies available from the combination of our investment management and savings and retirement solutions businesses. We also see an opportunity to offer customers in our existing book of traditional savings products a new set of propositions as their needs evolve. The expertise of the business in delivering investment outcomes for all of our customers is demonstrated by the scale of our operations. In total, M&G Prudential fund managers invest over £187 billion of assets on behalf of Prudential policyholders, in addition to the £164 billion of assets for customers invested in M&G mutual funds and institutional strategies. This combined investment footprint bolsters our investment solution capabilities allowing us to build the business around our customers and use our experience and insights to meet their needs. Our products Our aim is to provide our customers with savings and investment solutions which meet their long‑term financial needs and goals, in the structure which best suits them. Behind these solutions is a powerful investment engine: a highly skilled team of over 120 fund managers who put our customers’ money to work by sourcing investment opportunities globally across a wide spectrum of asset classes, including equities, bonds, credit, real estate and cash across both private and public markets. Of the total of £351 billion in assets under management1 across our entire product range, approximately 60 per cent is now invested in multi‑asset solutions and strategies, including the market leading £36 billion PruFund range and the strongly performing £12 billion Episode Allocation range. This expertise in asset allocation is a key part of our investment capability and has again driven substantial inflows over the last year, as customers across the UK and Europe have continued to seek the diversification and flexibility of a multi‑asset solution. www.prudential.co.uk Annual Report 2017 Prudential plc 29 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance continued PruFund investment performance3 100% 75% 50% 25% 0% -25% Mutual fund investment performance, net of fees, weighted by: assets under management4 % +80% +53% 25% 45% 17% 13% 39% 35% 14% 12% 71% 13% 4% 12% 42% 18% 25% 15% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 PruFund Growth ABI sector comparator One year – Dec 2017 Three years – Dec 2017 Five years – Dec 2017 Since fund manager tenure Dec 2017 (Average = 6.1 years) First quartile Second quartile Third quartile Fourth quartile Other products include a range of unit‑linked and collective investments, and within our corporate pension portfolio we continue to facilitate a range of auto‑enrolment services. For our savings and retirement customers we offer the PruFund range, which invests in our with‑profits fund, the largest in the UK. The with‑profits fund aims to smooth some of the extreme ups and downs of short‑term investment performance to provide a more stable return. It has performed well over the past five years: for example, customers in the PruFund Growth Fund have seen growth of 36 per cent since the start of 2013 against benchmark growth of 30 per cent. For direct investors in the UK and intermediated customers in the UK and internationally, we offer a range of 75 open‑ ended funds. The range offers a broad choice of asset types, geographies and investment strategies to help achieve a diversified portfolio. Our funds generally aim to deliver a rising income stream, long‑term capital growth or a mixture of both, and the vast majority are available in ISA or JISA wrappers to UK direct customers. Almost all of our funds are managed actively for the long term. Our open‑ended flexible global bond fund, the M&G Optimal Income Fund, performed strongly in 2017. Having achieved an average annualised return of over 7 per cent since its launch in 2006, Optimal Income has been one of the top performing bond funds across all sectors over the last decade. This return for its customers has been rewarded with net inflows of over £5 billion during 2017, bringing its assets under management to £23 billion. This year we added our first open‑ended infrastructure fund to our range, which aims to provide individual investors with both a growing income stream and long‑term capital appreciation through exposure to the equity of global listed infrastructure companies. We also launched the M&G ESG Global High Yield Fund, a sister fund to our £1 billion Global High Yield Bond Fund. The new fund is aimed at meeting the needs of individual investors seeking higher yield. During 2017, we also launched a further six M&G funds on our new Luxembourg‑ domiciled SICAV platform. As one of the most popular investment vehicles within Europe, the ability to offer SICAV funds will enable us to expand and deepen our highly successful international business further over the coming years. The new platform will also ensure we can continue to serve our European‑based customers regardless of the outcome of Brexit negotiations between the UK and the EU. To that end, in September we announced our plans to migrate assets in four UK‑domiciled funds held by European customers to the SICAV platform during 2018. For our own life funds as well as for our third‑party institutional clients, we continue to deliver innovative and competitive investment strategies to meet their specific needs. We are leading investors in ‘alternative’ assets such as commercial real estate debt, infrastructure debt and equity, and direct lending. These private assets are increasingly attractive options for investors looking for a yield to match their long‑term pension liabilities, and of course also provide a valuable source of competitively‑priced funding for new housing and infrastructure projects. Reflecting growing demand from institutional clients for investments which make a positive societal and environmental impact, in 2017 we seeded our first Impact Financing Fund with investment from the Prudential life business and two third‑party investors. Through private and illiquid debt transactions, the fund is already financing projects including a regeneration scheme, green energy and social housing construction. Distribution In M&G and Prudential, we have two well‑respected and complementary brands: Prudential is closely associated with retirement in the UK, while M&G is recognised as a leading investment brand, both in the UK and across international markets. 30 Prudential plc Annual Report 2017 www.prudential.co.uk Driving our business Creating value and benefiting our stakeholders Customers Meeting the growing and fast‑evolving saving and investment needs of customers across retail, institutional and direct channels. +7.2 million customers £351 billion total assets under management1 across a broad range of strategies and asset classes Products Market leading propositions, including PruFund and the M&G Optimal Income Fund, available in a number of saving and investment wrappers; and a range of strategies to help institutional customers meet their long‑term commitments. £36 billion PruFund assets under management Launch of new M&G Global Listed Infrastructure Fund Distribution Multi‑channel distribution, based on strong relationships with institutional investors, advisors and intermediaries, and substantial direct‑to‑customer franchises, including Prudential Financial Planning. Investment for growth Investing circa £250 million of shareholders’ funds into our infrastructure to improve customer service and business efficiency and drive long‑term growth. +5,400 adviser firms dealing with M&G Prudential MyPru and MyM&G digital services for direct customers Extension of SICAV fund platform for European growth Roll out of new scalable, simplified investment platform through Aladdin implementation Strategic partnership with Tata Consultancy Services leveraging digital capabilities to enhance customers’ experience www.prudential.co.uk Annual Report 2017 Prudential plc 31 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur businesses and their performance continued While our two brands occupy different market segments, both share a common philosophy of aiming to deliver excellent long‑term customer outcomes, and both offer solutions powered by a world‑class investment capability. Working together as M&G Prudential gives us new opportunities for growth by building on these shared values and strengths. In the UK, where both M&G and Prudential products are distributed, we will be building on the great success of the PruFund range by broadening the existing proposition, making full use of M&G and Prudential’s combined distribution network and making our customers’ experiences – whether direct or advised – as good as possible throughout the lifetime of their products. Our digital transformation programme is essential to this, providing the infrastructure necessary to offer good value, state of the art solutions. With over 15 years of experience in international distribution, offices in 18 countries and a new Luxembourg investment platform, we are well placed to continue to take advantage of the attractive growth opportunities in Europe and beyond. This includes retail distribution in Europe, and in international institutional markets, where our strong track record in private asset origination is a real competitive advantage. Investment for growth In a world of low interest rates and increasing life expectancy, more people than ever need long‑term savings and investment solutions. We also know that our customers have far higher expectations of service and value for money, thanks to new technology and digital disruption. Over the last 169 years we have had a proud track record of innovating to deliver good outcomes to our customers, but we need to invest in our business to continue to do so. Over the next five years, we will be investing circa £250 million of shareholders’ funds in our business, including a new digital infrastructure which will improve customer service, accelerate product development and increase customer choice. Strategic partnerships, such as the recently announced Tata Consultancy Services partnership to enhance service for our UK savings and retirement customers, are an important part of these plans to improve customer outcomes. With a simpler, more efficient, digitally enabled business, we will respond quicker and better to our customers’ needs, offer better value and compete at scale in our markets even more effectively. John Foley Chief Executive M&G Prudential Notes 1 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. 2 Europe includes AUM in Asia and South Africa. 3 ABI Mixed Investment 20 per cent – 60 per cent Shares (performance is net of charge). PruFund returns are also net of charge (0.65 per cent). 4 Quartile ranking based on ranking of the funds representative share class, net of fees, within their respective Investment Association (IA) or Morningstar sectors. Closed funds excluded. M&G total wholesale AUM was £79.7bn as at 31 December 2017, representing 23 per cent of the total M&G Prudential AUM. One year figures represent £78.1bn AUM, three year figures represent £76.1bn AUM, 5 year figures represent £71.2bn AUM, fund manager tenure figures represent £78.2bn AUM. Performance figures in GBP, bid to bid, net income reinvested. Average fund manager tenure December 2017 = 6.1 years. Source: M&G Prudential, December 2017. IA and Morningstar Inc. combined UK and Pan‑European peer groups as at end December 2017. 32 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick Broad-based performance and strong growth in high quality business I am pleased to report that Prudential’s financial performance in 2017 has resulted in all of our 2017 financial objectives being met. Our progress across our KPIs reflects the benefits of our focus on driving growth in high-quality, recurring health and protection and fee business across our geographies, products and distribution channels. Performance was broad‑based across our business units led by our Asia businesses which delivered double digit growth in new business profit (up 12 per cent1), IFRS operating profit based on longer‑term investment returns (‘IFRS operating profit’) (up 15 per cent1) and underlying free surplus generation3 (up 19 per cent1). Asia achieved its 2017 financial objectives, demonstrating successful execution of its strategy, focusing on diversified recurring premium business, at scale. In the US, we saw good growth in fee income, driven by positive net inflows and favourable equity market conditions, which outweighed the expected reduction in the contribution from spread income. During 2017 we combined M&G and our UK and Europe life business to form M&G Prudential. I am pleased to report that M&G Prudential asset management delivered record external net inflows of £17.3 billion, with overall assets under management4 at a new high of £351 billion at the end of 2017. We are making good progress in delivering our merger and transformation programme, and remain on track to deliver our previously announced savings by the end of 2022. Sterling continued to strengthen against most of the currencies in our major international markets over 2017. However, on an average basis, sterling exchange rates remain lower than 2016, contributing to a positive effect on the translation of results from our non‑sterling operations in 2017. If sterling exchange rates remain at or above end 2017 levels over the remainder of 2018, this will act to depress our results on translation of our non‑sterling operations in 2018 compared with 2017. To aid comparison of underlying progress, we continue to express and comment on the performance trends in our Asia and US operations on a constant currency basis. Our performance in 2017 was also supported by favourable equity markets, which lifted average investment balances on which we earn fees. During the year the S&P 500 index increased 19 per cent, the FTSE 100 index 8 per cent and the MSCI Asia excluding Japan index 39 per cent. Long‑term yields showed little movement in 2017 and therefore have had no material impact on 2017 performance versus 2016. The key financial highlights in 2017 were as follows: — New business profit was 12 per cent higher at £3,616 million (17 per cent on an actual exchange rate basis), underpinned by higher volumes with APE sales up 6 per cent (10 per cent on an actual exchange rate basis). In Asia, new business profit increased 12 per cent primarily as a result of prioritisation of health and protection products and positive pricing actions. Jackson’s new business profit increased by 9 per cent, including the benefit of US tax reform. UK life new business profit grew by 28 per cent, driven by a 29 per cent increase in APE sales, supported by consumer demand for products offering access to our PruFund investment option. — Asset management net inflows reached record levels, with M&G Prudential asset management reporting external net inflows of £17.3 billion (2016: net outflows of £8.1 billion) reflecting growth across its wholesale/direct and institutional businesses, and Eastspring delivering external net inflows of £3.1 billion (excluding money market funds) (2016: £1.8 billion on an actual exchange rate basis). — IFRS operating profit based on longer-term investment returns was 6 per cent higher at £4,699 million (10 per cent higher on an actual exchange rate basis). IFRS operating profit from our Asia business grew by 15 per cent to £1,975 million, reflecting continued business momentum. In the US, IFRS operating profit increased by 3 per cent, reflecting mainly growth in fee income on higher asset balances, which outweighed the anticipated reduction in spread earnings. In the UK, M&G Prudential’s total IFRS operating profit was 10 per cent higher than the prior year reflecting 6 per cent growth in the insurance business, with core5 life operating profit stable at £597 million, and record asset management profit of £500 million resulting from the positive impact on earnings of net fund inflows, supportive markets and higher performance fees. — Total IFRS post tax profit was up 21 per cent at £2,390 million (24 per cent on an actual exchange rate basis) and total EEV after‑tax profit was 87 per cent higher at £8,751 million (94 per cent on an actual exchange rate basis). Total profit includes the impact of short‑term fluctuations in financial assets held to back the commitments that we have made to our customers, and the related liabilities, and are reported outside the operating result which is based on longer‑term investment return assumptions. In 2017 these principally arose within Jackson as discussed later in my report. Total profit after‑tax includes the impact of the US tax reform, which generated an IFRS charge of £445 million from the re‑measurement of US net deferred tax balances following the reduction in the corporate income tax rate and an EEV gain of £390 million which additionally includes the benefit of future profits being taxed at a lower rate. Reflecting this post tax profit, Group IFRS shareholders’ equity was 10 per cent higher at £16.1 billion. Similarly, EEV basis shareholders’ equity was up 15 per cent at £44.7 billion. www.prudential.co.uk Annual Report 2017 Prudential plc 33 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information — Underlying free surplus generation2,3, our preferred measure of cash generation, from our life and asset management businesses, decreased by 1 per cent to £3,640 million (up 2 per cent on an actual exchange rate basis), after financing new business growth. Increased contributions from our Asia and UK businesses were balanced by a lower contribution from our US business primarily as a result of non‑recurrence of a transaction undertaken in 2016 to enhance local capital efficiency. We continue to focus on high‑return new business with fast payback periods. £12.5 billion, 201 per cent). The improvement in the period reflects the continuing strength of the Group’s operating capital generation in excess of growing dividend payments to shareholders. — Group shareholders’ Solvency II capital surplus6 was estimated at £13.3 billion at 31 December 2017, equivalent to a cover ratio of 202 per cent7 (1 January 2017: — Full year ordinary dividend increased by 8 per cent to 47 pence per share, reflecting our 2017 performance and our confidence in the future prospects of our Group. IFRS profit2 Operating profit before tax based on longer-term investment returns Asia Long‑term business Asset management Total US Long‑term business Asset management Total UK and Europe Long‑term business General insurance commission Total insurance operations Asset management Total Other income and expenditure8 Total operating profit based on longer‑term investment returns before tax, restructuring costs and interest received from tax settlement Restructuring costs Interest received from tax settlement Total operating profit based on longer-term investment returns before tax Non‑operating items: Short‑term fluctuations in investment returns on shareholder‑backed business Amortisation of acquisition accounting adjustments Profit (loss) attaching to disposal of businesses Profit before tax Tax charge attributable to shareholders' returns Profit for the year IFRS earnings per share Actual exchange rate Constant exchange rate 2017 £m 2016 £m Change % 2016 £m Change % 1,799 176 1,975 2,214 10 2,224 861 17 878 500 1,378 (775) 4,802 (103) – 1,503 141 1,644 2,052 (4) 2,048 799 29 828 425 1,253 (694) 4,251 (38) 43 20 25 20 8 350 9 8 (41) 6 18 10 (12) 13 (171) n/a 1,571 149 1,720 2,156 (4) 2,152 799 29 828 425 1,253 (700) 4,425 (39) 43 15 18 15 3 350 3 8 (41) 6 18 10 (11) 9 (164) n/a 4,699 4,256 10 4,429 6 (1,563) (63) 223 3,296 (906) 2,390 (1,678) (76) (227) 2,275 (354) 1,921 7 17 n/a 45 (156) 24 (1,764) (79) (244) 2,342 (360) 1,982 11 20 n/a 41 (152) 21 Basic earnings per share based on operating profit after tax Basic earnings per share based on total profit after tax 145.2 93.1 131.3 75.0 11 24 136.8 77.4 6 20 Actual exchange rate Constant exchange rate 2017 pence 2016 pence Change % 2016 pence Change % 34 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedIFRS operating profit based on longer-term investment returns 2017 total IFRS operating profit increased by 6 per cent (10 per cent on an actual exchange rate basis) to £4,699 million, with increased contributions from all of our core business units. Asia total operating profit of £1,975 million was 15 per cent higher than the previous year (20 per cent on an actual exchange rate basis). IFRS operating profit from life insurance operations increased 15 per cent to £1,799 million (20 per cent on an actual exchange rate basis), reflecting the continued growth of our in‑force book of recurring premium business, with renewal insurance premiums9 reaching £11.6 billion (2016: £9.5 billion on a constant exchange rate basis). Insurance margin was up 21 per cent, reflecting our continued focus on health and protection business. At a country level, we have seen improvement in all of our markets, with double‑digit growth in IFRS operating profit in eight out of 12, led by Hong Kong and China (both increasing 38 per cent). Including money market funds and the assets managed for internal life operations, Eastspring’s total assets under management increased to £138.9 billion (2016: £117.9 billion on an actual exchange rate basis), while the cost‑income ratio was stable at 56 per cent (2016: 56 per cent), driving an 18 per cent increase in IFRS operating profit to £176 million (2016: £149 million). US total operating profit at £2,224 million increased by 3 per cent (9 per cent increase on an actual exchange rate basis), reflecting increased profit from our variable annuity business. US equity markets have continued to rise in 2017, which together with separate account net asset inflows of £3.5 billion, has led to separate account balances that were on average 17 per cent higher than the prior period. As a result, fee income increased 15 per cent to £2,343 million. Spread‑ based income decreased 10 per cent, as anticipated, reflecting the impact of lower yields on our fixed annuity portfolio and a reduced contribution from asset duration swaps. We expect these effects to continue to compress spread margins, although continued upwards movements in US yields may help to reduce the speed of the decline. UK and Europe total operating profit was 10 per cent2 higher at £1,378 million. Life insurance IFRS operating profit increased by 8 per cent to £861 million (2016: £799 million). Within this total, the contribution from our core5 with‑profits and in‑force annuity business was £597 million (2016: £601 million), including an increased transfer to shareholders from the with‑profits funds of £288 million (2016: £269 million) of which 15 per cent was from PruFund business (2016: 10 per cent). The balance of the life insurance result reflects the contribution from other activities which are not expected to recur to the same extent going forward. This includes, as anticipated, lower IFRS operating profit from the sale of annuities of £9 million (2016: £41 million) and a number of other items discussed below. Asset management IFRS operating profit increased 18 per cent to £500 million, driven by higher average assets under management and improved performance fees, together with a lower cost‑income ratio of 58 per cent (2016: 59 per cent). We took a number of actions during the year to optimise our asset portfolios and capital position, which generated profit of £276 million (2016: £332 million). Of this amount £31 million related to profit from longevity risk transactions (2016: £197 million) and £245 million from the effect of repositioning the fixed income asset portfolio (2016: £135 million). Favourable longevity assumption changes, reflecting updated actuarial mortality tables, contributed a further £204 million. This was offset partly by an increase of £225 million (2016: £175 million) in the provision related to the potential costs and related potential redress of reviewing internally vesting annuities sold without advice after 1 July 2008. The provision does not include potential insurance recoveries of up to £175 million. Life insurance profit drivers The increase in our IFRS operating profit levels reflects the growth in the scale of our operations, driven primarily by positive business flows. 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 IFRS operating profit by business2 £m (% vs 2016) 42% (18%) 29% 47% £4,699m +6% (+10% AER) Asia £1,975m, +15% (+20% AER) US £2,224m, +3% (+9% AER) UK and Europe £1,378m, +10% Others8 £(878)m, ‑26% 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. Focusing on business supported by shareholder capital, which generates the majority of the life profit, in 2017 net flows into our businesses were overall positive at £2.7 billion driven by our US and Asian operations, as we continue to focus on both retaining our existing customers and attracting new business to drive long‑term value creation. In the UK our shareholder liabilities includes the run‑off of the in‑force annuity portfolio following our effective withdrawal from selling new annuity business. This has been more than offset by inflows into the with‑profits funds of £3.5 billion. Positive investment markets, offset partly by currency effects as sterling has strengthened over the period, increased liabilities by £5.1 billion. In total, business flows and market movements have increased shareholder‑backed policyholder liabilities from £266.6 billion to £274.5 billion. www.prudential.co.uk Annual Report 2017 Prudential plc 35 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationShareholder-backed policyholder liabilities and net liability flows10 £m Net liability flows11 £3,638m 2,086 5,198 (3,646) 46,228 266,635 32,851 177,626 Net liability flows11 £2,717m 2,301 3,137 (2,721) 5,141 274,493 37,402 180,724 Reclassification of Korea life business held for sale Asia life US life UK and Europe life Market and other movements 56,158 56,367 216,769 (2,812) 27,844 138,913 52,824 1 Jan 2016 Asia life US life UK and Europe life Market and other movements 31 Dec 2016 Asia life US life UK and Europe life Market and other movements 31 Dec 2017 Policyholder liabilities and net liability flows in with-profits business10,12 2017 £m Actual exchange rate 2016 £m Actual exchange rate Asia UK and Europe Total Group At 1 January Net liability flows11 29,933 113,146 143,079 4,574 3,457 8,031 Market and other movements 1,930 8,096 10,026 At 31 December 36,437 124,699 161,136 At 1 January Net liability flows11 20,934 100,069 121,003 3,696 1,119 4,815 Market and other movements 5,303 11,958 17,261 At 31 December 29,933 113,146 143,079 Policyholder liabilities in our with‑profits business have increased by 13 per cent to £161.1 billion reflecting the growing popularity of our participating funds in Asia and PruFund in the UK, as consumers seek protection from some of the short‑term ups and downs of direct stock market investments by using an established smoothing process. Across our Asia and UK operations, net liability flows increased to £8.0 billion. 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. Analysis of long-term insurance business IFRS operating profit by driver £m (% vs 2016) UK one‑off items Other income Spread income Insurance margin Fee income Life expenses (net of DAC adjustments and margin on revenues) Growth vs 2016 on a constant exchange rate basis £4,354m £4,525m £4,874m 157 538 1,171 1,991 157 546 1,215 2,083 2,175 2,280 255 576 1,108 2,271 2,603 (1,678) (1,756) (1,939) 2016 AER 2016 CER 2017 +5% -9% +9% +14% -10% 36 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedAsset management external net flows and external funds under management13,14 £m Net flows £20,478m 15,248 17,337 3,141 1,495 Asia Money Market Funds (MMF) Asia asset management15 UK and Europe asset management Market and other movements 219,740 9,317 46,568 163,855 Net flows £(6,255)m (8,090) 1,835 403 25,679 182,519 7,714 38,042 136,763 162,692 6,006 30,281 126,405 1 Jan 2016 UK and Europe asset management Asia asset management MMF Market and other movements 31 Dec 2016 UK and Europe asset management Asia asset management MMF Market and other movements 31 Dec 2017 We continue to maintain our preference for high‑quality sources of income such as insurance margin from life and health and protection business, and fee income. We favour insurance margin because it is relatively insensitive to the equity and interest rate cycle and prefer fee 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 9 per cent (up 14 per cent on an actual exchange rate basis) and fee income by 14 per cent (up 20 per cent on an actual exchange rate basis), while spread income decreased by 9 per cent (down 5 per cent on an actual exchange rate basis). Administration expenses increased to £2,297 million (2016: £2,025 million) as the business continues to expand. The expense margin has grown from 85 basis points to 88 basis points reflecting the continued increase in US producers selecting asset‑based commissions which are treated as an administrative expense in this analysis. Asset management profit drivers Movements in asset management operating profit are also influenced primarily 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 2017, average assets under management in our asset management businesses in the UK and Asia benefited from positive net inflows of assets and favourable markets, driving higher fee revenues. Reflecting this, IFRS operating profit derived from asset management activities in M&G Prudential increased by 18 per cent to £500 million and in Eastspring by 18 per cent (up 25 per cent on an actual exchange rate basis) to £176 million. M&G Prudential’s external assets under management have benefited from a record level of net inflows, reflecting improvement in investment performance and supportive markets. External asset management net inflows totalled £17.3 billion (2016: net outflows of £8.1 billion), with significant contributions from European investors in the Optimal Income Fund, Global Floating Rate High Yield Fund and multi‑asset range, and from institutional clients, notably within our public debt, illiquid credit strategies and infrastructure equity funds. External assets under management increased 20 per cent to £163.9 billion during the year. Internal assets benefiting from PruFund sales and favourable markets increased 7 per cent, taking total M&G Prudential assets under management to £350.7 billion (2016: £310.8 billion). Eastspring also attracted good levels of external net inflows during the year across its equity, fixed income and balanced fund range, totalling £3.1 billion, excluding money market funds (2016: £1.8 billion on an actual exchange rate basis). Overall external assets under management increased by 22 per cent to £46.6 billion, combined with higher internal assets under management and money market funds lifted Eastspring’s total assets under management to £138.9 billion. Other income and expenditure and restructuring costs8 Higher interest costs following the debt issued in 2016 and 2017, and restructuring costs of £103 million, as the business invests for the future, including UK and Europe infrastructure, contributed to an increase in net central expenditure of £139 million to £878 million (2016: £732 million on an actual exchange rate basis). IFRS non-operating items8 IFRS non‑operating items consist of short‑term fluctuations in investment returns on shareholder‑backed business of negative £1,563 million (2016: negative £1,764 million), the results attaching to disposal of businesses of £223 million (2016: negative £244 million), and the amortisation of acquisition accounting adjustments of negative £63 million (2016: negative £79 million) arising mainly from the REALIC business acquired by Jackson in 2012. The profit attributable to disposal of businesses relates to amounts in respect of the Korea life business sold in 2017 and the disposal of the US broker‑dealer network in August 2017. Short‑term fluctuations in investment returns on shareholder‑backed business represent the most significant component of non‑operating items and are discussed further below. www.prudential.co.uk Annual Report 2017 Prudential plc 37 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIFRS short-term fluctuations in investment returns on shareholder- backed business 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 2017, the total short‑term fluctuations in investment returns on shareholder‑backed business were negative £1,563 million and comprised negative £1 million for Asia, negative £1,568 million in the US, negative £14 million in the UK and positive £20 million in other operations. In the US, Jackson provides certain guarantees on its annuity products, the value of which would rise typically when equity markets fall and long‑term interest rates decline. Jackson includes the expected cost of hedging when pricing its products and charges fees for these guarantees which are used, as necessary, 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 declines 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 capital and economics of the business from large movements in investment markets and accepts the variability in accounting results. The negative short‑term fluctuations in investment returns on shareholder‑backed business of £1,568 million in the year are attributable mainly to the net value movement in the period of the hedge instruments held to manage market exposures and reflect the positive equity market performance in the US during the period. IFRS effective tax rates In 2017, the effective tax rate on IFRS operating profit based on longer‑term investment returns was 21 per cent, which is unchanged from 2016 (21 per cent). The 2017 effective tax rate on the total IFRS profit was 27 per cent (2016: 16 per cent), reflecting the inclusion of a £445 million one‑off charge on the re‑measurement of US deferred tax balances using a rate of 21 per cent (previously 35 per cent) following the enactment in December 2017 of a comprehensive US tax reform package. Excluding this one‑off charge, the 2017 effective tax rate would have been 14 per cent. In addition to the impact on the IFRS profit, the re‑measurement of US deferred tax balances also resulted in a separate benefit of £134 million recognised in other comprehensive income, in relation to changes to deferred tax on cumulative unrealised gains (net of DAC) on bonds which are taken directly through other comprehensive income. The main driver of the Group’s effective tax rate is the relative mix of the profits between jurisdictions with higher tax rates (such as Indonesia and Malaysia), New business performance Life EEV new business profit and APE new business sales (APE sales) jurisdictions with lower tax rates (such as Hong Kong and Singapore), and jurisdictions with rates in between (such as the UK, and now from 2018, the US). Once the US tax changes are fully reflected, we would expect a favourable impact on the Group’s effective tax rate. The US operating profit effective tax rate is expected to be circa 18 per cent (previously 28 per cent), and the overall Group operating profit effective tax rate is likely to settle in the range of 16 per cent to 18 per cent. Total tax contribution The Group continues to make significant tax contributions in the jurisdictions in which it operates, with £2,903 million remitted to tax authorities in 2017. This was similar to the equivalent amount of £2,887 million in 2016. Tax strategy In May 2017 the Group published its tax strategy, which in addition to complying with the mandatory UK (Finance Act 2016) requirements, also included a number of additional disclosures, including a breakdown of revenues, profits and taxes for all jurisdictions where more than £5 million tax was paid. This disclosure was included as a way of demonstrating that our tax footprint (ie where we pay taxes) is consistent with our business footprint. An updated version of the tax strategy, including 2017 data, will be available on the Group’s website before 31 May 2018. Actual exchange rate Constant exchange rate 2017 £m 2016 £m Change % 2016 £m Change % APE sales New business profit APE sales New business profit APE sales New business profit APE sales New business profit APE sales New business profit 3,805 1,662 1,491 6,958 2,368 906 342 3,616 3,599 1,561 1,160 6,320 2,030 790 268 3,088 6 6 29 10 17 15 28 17 3,773 1,641 1,160 6,574 2,123 830 268 3,221 1 1 29 6 12 9 28 12 Asia US UK and Europe Total Group 38 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedNew business performance £m (% vs 2016) 55% 9% 66% 21% 25% 24% Split of APE new business sales £6,958m, +6% (+10% AER) Asia £3,805m, +1% (+6% AER) US £1,662m, +1% (+6% AER) UK and Europe £1,491m, +29% Split of new business profit £3,616m, +12% (+17% AER) Asia £2,368m, +12% (+17% AER) US £906m, +9% (+15% AER) UK and Europe £342m, +28% Life insurance new business profit was up 12 per cent (17 per cent on an actual exchange rate basis) to £3,616 million, and Life insurance new business APE sales increased by 6 per cent (10 per cent on an actual exchange rate basis) to £6,958 million. In Asia, new business profit was 12 per cent higher at £2,368 million (17 per cent on an actual exchange rate basis), primarily reflecting the beneficial impact of our strategic emphasis on increasing sales from health and protection business and pricing actions. Our focus on quality is undiminished with regular premium contracts accounting for 94 per cent of APE sales and supporting a 26 per cent increase in health and protection 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. In Hong Kong new business profit has increased by 8 per cent as we continue to focus on driving growth in health and protection business. This targeted shift to higher margin, but lower case size protection business, aligned with the de‑emphasis of broker sales and the expected moderation in the level of sales from Mainland China has, as we reported previously, resulted in a 14 per cent reduction in Hong Kong APE sales. Outside Hong Kong, new business profit increased by 20 per cent, in line with APE sales which were up 17 per cent. Our performance remains broad‑based, with double digit growth in new business profit across both agency and bancassurance channels. In China, new business profit more than doubled, driven by higher sales and a significant uplift in regular premium health and protection business from our increased scale and productivity in the agency channel, together with a positive contribution from our bancassurance partners. In Singapore, new business profit increased by 22 per cent supported by APE sales growth of 21 per cent, reflecting growth across both agency and bancassurance channels. Indonesia’s APE sales grew 2 per cent while new business profit declined 5 per cent due to product mix. In the US, new business profit increased by 9 per cent to £906 million (up 15 per cent on an actual exchange rate basis) reflecting a modest increase in APE sales, up 1 per cent (6 per cent on an actual exchange rate basis) and the positive impact on future profit from a reduction in corporate income tax rates. Uncertainty regarding the application and implementation of the US Department of Labor Fiduciary Duty Rule has led to continued pressure on industry sales in 2017 which were down 11 per cent over the first nine months of the year. Despite this, Jackson’s variable annuity sales increased by 1 per cent, with the economics on new business in variable annuities remaining extremely attractive, with high internal rates of return and short payback periods. Net inflows into Jackson’s separate account asset balances, which drive fee‑based earnings on variable annuity business, remained positive at £3.5 billion. More favourable market conditions relating to the institutional product market also provided Jackson with the opportunity to write APE sales of £232 million (2016: £193 million). 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 new business profit, which increased to £342 million, up 28 per cent. APE sales increased 29 per cent to £1,491 million. We have seen notable success with the build out of PruFund, which has contributed significantly towards an APE sales increase in individual pensions (up 110 per cent), income drawdown (up 35 per cent) and ISAs (up 7 per cent). Reflecting this performance, total PruFund assets under management of £35.9 billion as at 31 December 2017 were 46 per cent higher than at the start of the year. www.prudential.co.uk Annual Report 2017 Prudential plc 39 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationFree surplus generation2,3 Free surplus generation Asia US UK and Europe Underlying free surplus generated from in‑force life business and asset management before restructuring costs Restructuring costs Underlying free surplus generated from in‑force life business and asset management Investment in new business Underlying free surplus generated Market related movements, timing differences and other non‑operating movements Profit (loss) attaching to disposal of businesses Net cash remitted by business units Total movement in free surplus Free surplus at end of year Actual exchange rate Constant exchange rate 2017 £m 2016 £m Change % 2016 £m Change % 17 (15) 15 3 (381) 2 (1) 2 1,405 1,957 1,287 4,649 (16) 4,633 (942) 3,691 11 (19) 15 – (381) (2) 3 (1) 1,562 1,582 1,486 4,630 (77) 4,553 (913) 3,640 (1,012) 172 (1,788) 1,012 7,578 1,335 1,863 1,287 4,485 (16) 4,469 (903) 3,566 (432) (86) (1,718) 1,330 6,566 Free surplus generation is the financial metric we use to measure the internal cash generation of our business operations and is based on the capital regimes which apply locally in the various jurisdictions in which our life businesses operate. 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 operating profit for the period. We drive free surplus generation by targeting markets and products that have low capital 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. In 2017, underlying free surplus generation from our life insurance and asset management business decreased by 1 per cent to £3,640 million (increased 2 per cent on an actual exchange rate basis), reflecting increased contributions from our Asia and UK businesses, a non‑recurrence of a one‑off prior year gain from our US business, and higher restructuring costs. In Asia, growth in the in‑force life portfolio, combined with post‑tax asset management profit from Eastspring, contributed to free surplus generation of £1,562 million, up 11 per cent. In the US, in‑force free surplus generation decreased by 19 per cent reflecting the non‑recurrence of a £247 million benefit from contingent financing actions taken in 2016, together with lower favourable experience variances. In the UK, in‑force free surplus generation increased by 15 per cent to £1,486 million, attributable to growth in asset management earnings, the adoption of the CMI 2015 assumption basis and portfolio and capital management actions including longevity reinsurance to improve the solvency position of our UK life business of £400 million (2016: £351 million). The result includes an increase in the provision for the costs of the UK review of past non‑advised annuity sales practices and related potential redress, which has a post‑tax impact of £187 million in 2017 (2016: £145 million). Although new business profit increased by 12 per cent, the amount of free surplus invested in writing new life business in the period was lower at £913 million (2016: £942 million) reflecting a greater proportion of sales in Asia and the UK where strain is lower, and a higher proportion of variable annuity premium being allocated to the separate account in the US. After funding cash remittances from the business units to the Group, recognition of the profit attaching to the disposal of businesses, and other movements, which includes adverse currency effects and the impact of US tax reform, the closing value of free surplus in our life and asset management operations was £7.6 billion at 31 December 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. 40 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedActual exchange rate 2017 £m 2016 £m 645 475 643 25 1,788 2,264 516 420 590 192 1,718 2,626 Business unit remittance2,16 Net cash remitted by business units: Asia US UK and Europe Other UK (including Prudential Capital) Net cash remitted by business units Holding company cash at 31 December Movement in central cash2,16 £m 1,788 (1,159) 645 475 Asia US UK and 643 Europe Other UK 25 2,626 (470) (521) 2,264 1 Jan 2017 Cash remitted to Group Dividends paid Central costs Corporate activities/other 31 Dec 2017 2016 second interim dividend and 2017 first interim dividend Cash remitted to the corporate centre in 2017 amounted to £1,788 million, driven by higher remittances from Asia. For the first time, our Asia business unit is the largest contributor17 to cash in the Group, demonstrating the quality and scale of its growth. Jackson made sizeable remittances of £475 million. The remittance from M&G Prudential of £643 million was 9 per cent higher than the combined remittance in 2016. Prudential Capital contributed a further £25 million. Cash remitted to the Group in 2017 was used to meet central costs of £470 million (2016: £416 million) and pay the 2016 second interim and 2017 first interim dividends respectively. These movements and other corporate cash flows, including a net reduction in core structural borrowings and the impact of currency movements, led to holding company cash decreasing from £2,626 million to £2,264 million over 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 41 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationPost-tax profit – EEV2 Post-tax operating profit based on longer-term investment returns Asia operations Long‑term business Asset management Total US operations Long‑term business Asset management Total UK and Europe operations Long‑term business General insurance commission Total insurance operations Asset management Total Other income and expenditure18 Post‑tax operating profit based on longer‑term investment returns before restructuring costs and interest received from tax settlement Restructuring costs18 Interest received from tax settlement Post-tax operating profit based on longer-term investment returns Non‑operating items: Short‑term fluctuations on investment returns Effect of changes in economic assumptions Mark to market value movements on core structural borrowings Impact of US tax reform Profit (loss) attaching to disposal of businesses Post-tax profit for the year Earnings per share Actual exchange rate Constant exchange rate 2017 £m 2016 £m Change % 2016 £m Change % 3,705 155 3,860 2,143 7 2,150 1,015 13 1,028 403 1,431 (746) 6,695 (97) – 6,598 2,111 (102) (326) 390 80 8,751 3,074 125 3,199 1,971 (3) 1,968 643 23 666 341 1,007 (682) 5,492 (32) 37 5,497 (507) (60) (4) – (410) 21 24 21 9 333 9 58 (43) 54 18 42 (9) 22 (203) n/a 20 516 (70) (8,050) n/a n/a 3,220 132 3,352 2,071 (4) 2,067 643 23 666 341 1,007 (688) 5,738 (32) 37 5,743 (567) (54) (4) – (445) 4,516 94 4,673 15 17 15 3 275 4 58 (43) 54 18 42 (8) 17 (203) n/a 15 472 (89) (8,050) n/a n/a 87 Basic earnings per share based on post‑tax operating profit Basic earnings per share based on post‑tax total profit 257.0 340.9 214.7 176.4 20 93 224.3 182.5 15 87 Actual exchange rate Constant exchange rate 2017 pence 2016 pence Change % 2016 pence Change % EEV operating profit On an EEV basis, Group post‑tax operating profit based on longer‑term investment return increased by 15 per cent (up 20 per cent on an actual exchange rate basis) to £6,598 million in 2017. EEV operating profit includes new business profit from the Group’s life business, which increased by 12 per cent (up 17 per cent on an actual exchange rate basis) to £3,616 million. It also includes in‑force life business profit of £3,247 million, which was 20 per cent higher than prior year (up 25 per cent on an actual exchange rate basis), primarily reflecting the growth in our in‑force business. This is most evident in the profit from the unwind of the in‑force business, which was 10 per cent higher at £2,166 million (2016: £1,962 million). Experience and assumption changes were positive at £1,081 million (2016: £751 million), reflecting our ongoing focus on managing the in‑force book for value. In Asia, EEV life operating profit was up 15 per cent to £3,705 million, reflecting growth in new business profit of 12 per cent at £2,368 million. In‑force profit was 22 per cent higher at £1,337 million reflecting the increased value of in‑force business and positive assumption changes and experience as the business continues to grow with discipline. Jackson’s EEV life operating profit was up 3 per cent to £2,143 million, reflecting a 9 per cent increase in new business profit to £906 million and a stable contribution from in‑force profit of £1,237 million, which included favourable operating assumption changes and experience variances of £543 million (2016: £628 million), related largely to persistency and mortality effects. The increase in our US EEV new business profit reflects the positive impact on future profits from lower tax rates. 42 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedEEV operating profit by business2 £m (% vs 2016) 56% (13%) 9% 15% Capital position, financing and liquidity Capital position Analysis of movement in Group shareholder Solvency II surplus20 Solvency II surplus at 1 January Operating experience Non‑operating experience (including market movements)* Other capital movements Subordinated debt (redemption)/issuance Foreign currency translation impacts Dividends paid Model changes Estimated Solvency II surplus at 31 December * 2017 includes a £(0.6) billion reduction in deferred tax assets following US tax reform. 2017 £bn 2016 £bn 12.5 3.6 (0.6) (0.2) (0.7) (1.2) (0.1) 13.3 9.7 2.7 (1.1) 1.2 1.6 (1.3) (0.3) 12.5 32% £6,598m +15% (+20% AER) Asia life £3,705m, +15% (+21% AER) US life £2,143m, +3% (+9% AER) UK and Europe life £1,015m, +58% Asset management and general insurance £578m, +17% (+19% AER) Other18 £(843)m, ‑23% (‑25% AER) In the UK and Europe, EEV life operating profit increased by 58 per cent to £1,015 million (2016: £643 million). The increase was driven by a 28 per cent increase in new business profit, and higher in‑force profit including a £195 million benefit from revisions to longevity assumptions following adoption of updated actuarial mortality projections under CMI 201519. Profits arising from actions undertaken to improve solvency were more than offset by an increase in the provision related to the potential costs and related potential redress of reviewing internally vesting annuities sold without advice after 1 July 2008. The high quality and recurring nature of our operating capital generation and our disciplined approach to managing balance sheet risk has resulted in an increase in the Group’s shareholders’ Solvency II capital surplus which is estimated at £13.3 billion6,7, at 31 December 2017 (equivalent to a solvency ratio of 202 per cent), compared with £12.5 billion (201 per cent) at 31 December 2016. In 2017 we generated £3.6 billion of operating capital. This was offset by dividends to shareholders, net repayment of subordinated debt, adverse foreign currency effects and the £0.6 billion reduction in statutory deferred tax assets following US tax reform. Prudential has been designated as a Global Systemically Important Insurer (G‑SII) and is monitoring and engaging with the PRA on the development and potential impact of the policy measures associated with such a designation. Solvency II surplus20 £bn 12.5 13.3 201% 202% 31 Dec 2016 31 Dec 2017 6 Solvency II capital ratio Local statutory capital All of our subsidiaries continue to hold appropriate capital levels on a local regulatory basis. In the UK, at 31 December 2017 The Prudential Assurance Company Limited and its subsidiaries21 had an estimated Solvency II shareholder surplus22 of £6.1 billion (equivalent to a cover ratio of 178 per cent) and a with‑profits surplus23 of £4.8 billion (equivalent to a cover ratio of 201 per cent). In the US, following the enactment in December 2017 of a comprehensive reform package, a £628 million reduction in the level of the statutory net admitted deferred tax asset more than offset operational capital formation, resulting in a risk based capital ratio of 409 per cent (2016: 485 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 and 98 per cent of our UK portfolio and 97 per cent of our US portfolio are investment grade29. During 2017, default losses were minimal and reported impairments across the UK and US portfolios were £2 million (2016: £35 million). www.prudential.co.uk Annual Report 2017 Prudential plc 43 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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 2022. Apart from small drawdowns to test the process, these facilities have never been drawn, and there were no amounts outstanding at 31 December 2017. The medium‑term note programme, the US shelf programme (platform for issuance of SEC registered public bonds in the US market), 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 flexible funding capacity. Net core structural borrowings £m (EEV basis) 4,594 422 4,172 22% 2016 4,759 743 4,016 20% 2017 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, as set out in note II(d) of the Additional unaudited financial information. Financing and liquidity The Group had central cash resources of £2.3 billion at 31 December 2017 (31 December 2016: £2.6 billion). Total core structural borrowings reduced by £0.5 billion, from £6.8 billion to £6.3 billion, with the issue of US$750 million (£547 million at 31 December 2017) 4.875 per cent tier 2 perpetual subordinated debt in October 2017 being more than offset by the redemption of US$1 billion (£741 million at 31 December 2017) 6.5 per cent tier 2 perpetual subordinated debt in December 2017. In addition to its net core structural borrowings of shareholder‑financed operations 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 2017, we had issued commercial paper under this programme totalling US$650 million, to finance non‑core borrowings. Shareholders’ funds Profit after tax for the year24 Exchange movements, net of related tax Cumulative exchange gain of Korea life business recycled to profit and loss account Unrealised gains and losses on Jackson fixed income securities classified as available for sale25 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 Shareholders’ value per share26 Return on shareholders’ funds27 IFRS EEV 2017 £m 2016 £m 2017 £m 2016 £m 2,389 (409) (61) 1,921 1,161 – 8,750 (2,045) – 4,516 4,211 – 486 (1,159) 31 (1,267) – (1,159) – (1,267) – 175 1,421 14,666 16,087 622p 25% – (135) 1,711 12,955 14,666 568p 26% 40 144 5,730 38,968 44,698 (11) (367) 7,082 31,886 38,968 1,728p 1,510p 17% 17% 44 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedBased on asset and liability values as at 31 December 2017, the transaction is estimated to give rise to a pre‑tax IFRS loss of around £500 million in the first half of 2018, alongside the de‑risking being achieved. Prudential plc’s Hong Kong subsidiaries which are subject to legal transfer from The Prudential Assurance Company Limited to Prudential Corporation Asia Limited comprise its life business, Prudential Hong Kong Limited, and its general insurance business, Prudential General Insurance Hong Kong Limited. Hong Kong will continue to be included in the segmental reporting of Asia’s IFRS and embedded value results. The transfers will be subject to regulatory approval. The sale of the UK annuity portfolio and the transfer of Prudential plc’s Hong Kong subsidiaries to Asia are expected to complete by the end of 2019. Assuming that these actions had both been completed as at 31 December 2017, the Group’s embedded value of £44.7 billion is estimated to reduce by approximately £300 million, reflecting the loss of future profits on the portion of annuity liabilities being sold. The estimated pro forma impact on the Group shareholder Solvency II capital position, assuming that these actions had both been completed as at 31 December 2017, is an increase in surplus of £0.3 billion and an increase in the shareholder solvency ratio of 6 percentage points. The Group’s EEV basis shareholders’ funds also increased by 15 per cent to £44.7 billion (31 December 2016: £39.0 billion on an actual exchange rate basis), On a per share basis the Group’s embedded value at 31 December 2017 equated to 1,728 pence, up from 1,510 pence at 31 December 2016. Corporate transactions Intention to demerge the Group’s UK businesses and sale of £12.0 billion30 UK annuity portfolio In March 2018, the Group announced its intention to demerge its UK and Europe businesses (‘M&G Prudential’) from Prudential plc, resulting in two separately listed companies. On completion of the demerger, shareholders will hold interests in both Prudential plc and M&G Prudential. In preparation for the UK demerger process, and to align the ownership of the Group’s businesses with their operating structures, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019. M&G Prudential agreed in March 2018 to the sale of £12.0 billion30 of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion30 of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. The capital benefit of this transaction will be retained within the Group to support the demerger process. The IFRS liabilities relating to M&G Prudential’s total UK shareholder annuity portfolio as at 31 December 2017 were £32.6 billion. The UK annuity business being sold contributed around £140 million towards UK life insurance core5 IFRS operating profit before tax of £597 million in 2017. Total M&G Prudential IFRS operating profit before tax was £1,378 million in 2017. IFRS shareholders’ funds £bn +10% 14.7 16.1 31 Dec 2016 31 Dec 2017 EEV shareholders’ funds £bn +15% 39.0 44.7 1,510p 1,728p 31 Dec 2016 31 Dec 2017 EEV value per share Group IFRS shareholders’ funds at 31 December 2017 increased by 10 per cent to £16.1 billion (31 December 2016: £14.7 billion on an actual exchange rate basis), driven by the strength of the operating result, offset by dividend payments of £1,159 million. During the period, UK sterling has strengthened relative to the US dollar and various Asian currencies. With approximately 50 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 negative exchange rate movement on the net assets in the period. In addition, the moderate decline in US long‑term interest rates between the start and the end of the reporting period produced unrealised gains on fixed income securities held by Jackson accounted through other comprehensive income. www.prudential.co.uk Annual Report 2017 Prudential plc 45 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationPro forma estimated Group shareholder Solvency II capital position 31 December 2016 as reported 31 December 2017 as reported 31 December 2017 pro forma estimate* Solvency capital requirement £bn Own funds £bn 24.8 26.4 26.2 12.3 13.1 12.6 Surplus £bn 12.5 13.3 13.6 Ratio % 201 202 208 * The pro forma estimate assumes that the partial sale of the UK annuity portfolio and the transfer of Prudential plc’s Hong Kong subsidiaries to Asia had both been completed as at 31 December 2017. On the same basis, the estimated pro forma impact on the shareholder Solvency II capital position of the UK regulated insurance entity, The Prudential Assurance Company Limited, is provided in the table below. This pro forma solvency position reflects the reduced risk exposures in the UK insurance entity after the partial annuity sale and Hong Kong transfer. Pro forma estimated The Prudential Assurance Company Limited shareholder Solvency II capital position 31 December 2016 as reported 31 December 2017 as reported 31 December 2017 pro forma estimate* Solvency capital requirement £bn Own funds £bn 12.0 14.0 8.5 7.4 7.9 5.7 Surplus £bn 4.6 6.1 2.8 Ratio % 163 178 150 * The pro forma estimate assumes that the partial sale of the UK annuity portfolio and the transfer of Prudential plc’s Hong Kong subsidiaries to Asia had both been completed as at 31 December 2017. In relation to the sale of the UK annuity portfolio, this estimate includes a £1.3 billion reduction in the Solvency Capital Requirement (SCR) and a £0.2 billion decrease in Own Funds, resulting in an increase in capital surplus of £1.1 billion, of which £0.6 billion is expected to be recognised in the UK capital position as at 30 June 2018 under the reinsurance agreement. In relation to the Hong Kong transfer, the impact on the SCR allows for the release of the Hong Kong business standalone SCR of £2.0 billion, partially offset by the removal of diversification benefits between UK and Hong Kong of £1.1 billion. Dividend The Board has decided to increase the full‑year ordinary dividend by 8 per cent to 47 pence per share, reflecting our 2017 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 32.5 pence per share (2016: 30.57 pence per share). The Group’s dividend policy remains unchanged. The Board will maintain 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 an assessment of opportunities to generate attractive returns by investing in specific areas of the business28. Entrance into Nigeria In July 2017 the Group acquired a majority stake in Zenith Life of Nigeria and formed exclusive bancassurance partnerships with Zenith Bank in Nigeria and Ghana. The acquisition and bancassurance partnerships will see Prudential enter the market in Nigeria, Africa’s largest economy, with a population of over 180 million. This expands Prudential’s regional platform in Africa following the launch of businesses in Ghana and Kenya in 2014, in Uganda in 2015 and Zambia in 2016. Disposal of Korea life In May 2017, the Group completed the sale of the Group’s life insurance subsidiary in Korea, PCA Life Insurance Co. Ltd to Mirae Asset Life Insurance Co. Ltd. for KRW170 billion (equivalent to £117 million at 17 May 2017 closing rate). Disposal of broker-dealer network in the US In August 2017, the Group, through its subsidiary National Planning Holdings, Inc. (‘NPH’) sold its US independent broker‑ dealer network to LPL Financial LLC for an initial purchase price of US$325 million (equivalent to £252 million at 15 August 2017). Mark FitzPatrick Chief Financial Officer 46 Prudential plc Annual Report 2017 www.prudential.co.uk Chief Financial Officer’s report on the 2017 financial performance – Mark FitzPatrick continuedNotes Increase stated on a constant exchange rate basis. 1 2 The 2016 comparative results have been re‑presented from those published previously, following reassessment of the Group’s operating segments as described in note B1.3 of the IFRS financial statements. 3 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 11 of the EEV basis results. Free surplus represents ‘underlying free surplus’ based on operating movements and excludes market movements, foreign exchange, capital movements, shareholders’ other income and expenditure and restructuring and Solvency II implementation costs arising centrally. 4 Represents M&G Prudential asset management external funds under management and internal funds included on the M&G Prudential long‑term insurance business balance sheet. 5 Core refers to the underlying profit of the UK and Europe insurance business excluding the effect of, for example, management actions to improve solvency and material assumption changes. Details of these are set out in note I(d) of the Additional unaudited financial information. 6 The Group 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 includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 7 Before allowing for second interim ordinary dividend. 8 Refer to note B1.1 in IFRS financial statements for the breakdown of other income and expenditure and other non‑operating items. 9 Gross earned premiums for contracts in second and subsequent years, comprising Asia segment IFRS gross earned premium of £15.7 billion less gross earned premiums relating to new regular and single premiums of £5.7 billion, plus renewal premiums from joint ventures of £1.6 billion, and excluding any amounts relating to the sold Korea life business. 10 Includes Group’s proportionate share of the liabilities and associated flows of the insurance joint ventures and associates in Asia. 11 Defined as movements in shareholder‑backed policyholder liabilities arising from premiums (net of charges), surrenders/withdrawals, maturities and deaths. 12 Includes Unallocated surplus of with‑profits business. 13 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 unaudited financial information. Company Limited are Prudential General Insurance Hong Kong Limited, Prudential Hong Kong Limited, Prudential International Assurance plc and Prudential Pensions Limited. 22 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 includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 23 The estimated solvency position includes management’s calculation of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 24 Excluding profit for the year attributable to non‑ controlling interests. 15 Net inflows exclude Asia Money Market Fund (MMF) 25 Net of related charges to deferred acquisition costs inflows of £1,495 million (2016: net inflows £403 million). External funds under management exclude Asia MMF balances of £9,317 million (2016: £7,714 million). 16 Net cash remitted by business units are included in the Holding company cash flow, which is disclosed in detail in note II(a) of the Additional unaudited financial information. 17 Based on the 2017 operating segments. 18 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 further detail on other income and restructuring costs. 19 Continuous Mortality Investigation 2015 mortality improvements model. 20 The methodology and assumptions used in calculating the Solvency II capital results are set out in note II(f) of the Additional unaudited financial information. and tax. 26 Closing IFRS shareholders’ funds divided by issued shares, as set out in note II(e) of the Additional unaudited financial information. Closing EEV shareholders’ funds divided by issued shares, as set out in note II(n) of the Additional unaudited financial information. 27 Operating profit after tax and non‑controlling interests as percentage of opening shareholders’ funds, as set out in notes II(c) and II(m) of the Additional unaudited financial information. 28 Refer to note 11 on the parent company financial statements for further detail on the distributable profits of Prudential plc. 29 Based on hierarchy of Standard & Poor’s, Moody’s and Fitch, where available and if unavailable, internal ratings have been used. 30 Relates to £12.0 billion of IFRS shareholder annuity 21 The insurance subsidiaries of The Prudential Assurance liabilities, valued as at 31 December 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 47 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed Generating value through selective exposure to risk 2017 was, in many respects, a year of global geopolitical transition. Popular discontent was one of the driving factors, shifting the political landscape in many countries, in particular in the US and across Western Europe. The nature of technology risks evolved during the year, with high profile and untargeted attacks affecting companies around the world. Despite all this, financial markets appeared largely unperturbed during 2017 with low volatility and steady and broad global economic growth, and the first steps were taken toward monetary policy tightening in key economies. As in previous years, we continue to maintain a sustained focus on managing prevailing market conditions and macroeconomic uncertainty arising from the global environment. Looking internally, in August 2017 we announced our intention to combine M&G and our UK life business to form M&G Prudential, allowing us better to leverage our scale and capabilities. Change inherently carries risk, but we will manage and minimise this appropriately in order to provide better outcomes for our customers. Our results show that, even in times of unpredictability, we can generate value for our shareholders by taking selective exposure to risks that are rewarded commensurately and that can be quantified appropriately 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 the exposure appropriately. Our Group Risk Framework and risk appetite have allowed us to control our risk exposure successfully throughout the year. Our 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. This section explains the main risks inherent in our business and how we manage those 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 implementing our strategies and objectives successfully, which are outlined on page 10. This includes all internal or external events, acts or omissions that have the potential to threaten the success and survival of the Group. Accordingly, material risks will be retained selectively when 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, risk culture and risk management process. Risk governance Our risk governance comprises the Board, organisational structures, reporting relationships, delegation of authority, roles and responsibilities, and risk policies that the Group Head Office and our business units establish to make decisions and control their activities on risk‑related matters. This encompasses individuals, Group‑wide functions and committees involved in overseeing and managing risk. Risk committees and governance structure Our risk governance structure is led by the Group Risk Committee, supported by independent non‑executives on risk committees of major subsidiaries. These committees monitor the development of the Group Risk Framework, which includes risk appetite, limits, and policies, as well as risk culture. In addition to our risk committees, 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, an advisory committee to the Group Chief Risk Officer which is supported by a number of sub‑committees, including security and information security where specialist skills and knowledge are required. Risk governance Risk management cycle Identified major risk categories r d s a o B a n d committee s Risk culture R n R is is d ards k policies an d s g ers k appetite, limit s a n d t ri g Risk management f r a m e w o r k a t Risk identific a ti o n Risk m and as e a s s e s u r e s m m e e n n t t Risk management cycle M o n i t o r a n d report a n M a ol g e and contr ss operatio n s e in s u b r u o m o r f s k s i R e n vir o n m e n B u si n e s s t O p e r f r o m o u r i n v e s t m e n t s g i c Str a t e Market R i s k s C r e d i t Group risk profile a tio nal Insura n c e Risks fro m o u r business pr o d u c t Liquidity s 48 Prudential plc Annual Report 2017 www.prudential.co.uk Group Risk Framework The Group Risk Framework has been developed to monitor and manage the risks to our business and is owned by the Board. The aggregate Group exposure to our key risk drivers is monitored and managed by the Group Risk function which is responsible for reviewing, assessing and reporting on the Group’s risk exposure and solvency position from the Group economic, regulatory and ratings perspectives. The Framework requires all our businesses and functions to establish processes for identifying, evaluating, managing and reporting of the key risks faced by the Group – the ‘Risk Management Cycle’ (see below) 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 most material risks. These risks range from those 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 operations. This is used to inform risk reporting to the risk committees and the Board for the year. The Group Risk Committee reviews the Group Risk Framework and recommends changes to our Board to ensure that it remains effective in identifying and managing the risks faced by the Group. A number of core risk policies and standards support the Framework to ensure that risks to the Group are identified, assessed, managed and reported. During 2017 we made a number of enhancements to our policies and processes. These included changes to our processes around new product approvals, management of our critical outsourcing arrangements and increased oversight of model risk across the Group. A new framework was developed to support the monitoring and reporting of risks associated with material transformation programmes, and work continued over the year on the Group’s risk culture. Risk appetite, limits and triggers The extent to which we are willing to take risk in the pursuit of our business strategy and objective to create shareholder value is defined by a number of qualitative and quantitative expressions of risk appetite, operationalised through measures such as limits, triggers, thresholds and indicators. The Group Risk function is responsible for reviewing the scope and operation of these risk appetite measures at least annually to determine that they remain relevant. The Board approves all changes made to the Group’s aggregate risk appetite, and has delegated authority to the Group Risk Committee to approve changes to the system of limits, triggers and indicators. Group risk appetite is set with reference to economic and regulatory capital, liquidity and earnings volatility, as well as for our major risks, and is aimed at ensuring that we take an appropriate level of aggregate risk. It covers risks to shareholders, including those from participating and third‑party business. We have some appetite to take market and credit risk where it arises from profit‑generating insurance activities, to the extent that it remains part of a balanced portfolio of sources of income for shareholders and is compatible with a robust solvency position. We also have some appetite for retaining insurance risks in areas where we believe we have expertise and operational controls, and where we judge it to create more value to retain rather than transfer the risk. The extent of insurance risk that we are willing to hold is conditional on a balanced portfolio of income to shareholders and compatibility with a robust solvency position. We have no appetite for material losses (direct or indirect) suffered as a result of failing to develop, implement or monitor appropriate controls to manage operational risks. Similarly, we have no appetite for liquidity risk, ie for any business to have insufficient resources to cover its outgoing cash flows, or for the Group as a whole to not meet cash flow requirements from its debt obligations under any plausible scenario. Group limits operate within these expressions of risk appetite to constrain material risks, while triggers and indicators provide further constraint and ensure escalation. The Group Chief Risk Officer determines the action to be taken upon all breaches of Group limits which may include escalation to the Group Risk Committee or Board. Any decision on action taken by the Group Chief Risk Officer is reviewed at the subsequent Group Risk Committee meeting. 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. 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 against 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 (ECap) 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. www.prudential.co.uk Annual Report 2017 Prudential plc 49 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued 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 on an annual basis that they have implemented the necessary controls to evidence compliance with the Group Governance Manual. 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 forms part of the Group Risk 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 discuss risk openly as part of the way they perform their role; and — Employees invite open discussion on the approach to the management of risk. During 2017 a risk culture assessment was performed across the Group. The assessment allowed us to compare the Group’s risk culture against best practice behaviours, identify any areas which need improvement and provide high‑level industry benchmarking and peer comparison. The Group Risk Committee also has a key role in providing advice to the Remuneration Committee on risk management considerations to be applied in respect of executive remuneration. Our Code of Conduct and our Group Governance Manual include a series of guiding principles that govern the day‑to‑day conduct of all our people and any organisations acting on our behalf. This is supported by specific risk policies which require that we act in a responsible manner. This includes, but is not limited to, policies on anti‑money laundering, financial crime and anti‑bribery and corruption. Our Group outsourcing and third‑party supply policy ensures that human rights and modern slavery considerations are embedded within all of our supplier and supply chain arrangements. We also have embedded procedures to allow individuals to speak out safely and anonymously against unethical behaviour and conduct. The risks associated with our environmental, social and governance (ESG) activities and the policies we maintain in relation to them, are detailed in the Corporate responsibility review on page 64. 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 perform a robust assessment of the principal risks facing the Company through the Group‑wide risk identification process, Group ORSA report, and the risk assessments done as part of the business planning review, including how they are managed and mitigated. Reverse stress testing, which requires us to ascertain the point of business model failure, is another tool that helps us to identify the key risks and scenarios that may have a material impact on 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. In 2017 we enhanced our Emerging Risk Framework to bring it closer to the Group’s risk management activity. This included a redefinition of the relationship between emerging and emerged risks, enabling a consistent framework for evaluating and escalating sufficiently developed emerging risks for risk management activity. 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. 50 Prudential plc Annual Report 2017 www.prudential.co.uk 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 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. Risk management and control The control procedures and systems established within the Group are designed to manage the risk of failing to meet business objectives reasonably and are detailed in the Group risk policies. This can 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. Risk identific a ti o n Risk m and as e a s s e s u r e s m m e e n n t t Risk management cycle M o n i t o r a n d report a n M a ol g e and contr Risks are assessed in terms of materiality. Material risks which are modelled are included in capital models, including ECap. 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 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 the Further risk information section 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. www.prudential.co.uk Annual Report 2017 Prudential plc 51 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Report on the risks facing our business and how these are managed continued Summary risks The components of our business model, outlined on page 12, give rise to risks of varying nature across the Group which can broadly be categorised as those which arise as a result of our business operations; those risks arising from our investments; those which arise from the nature of our products; and those broad risks which apply to us because of the global environment in which we operate. These risks, where they materialise, may have a financial impact on the Group, and could also impact on the performance of our products or the services we provide our customers and distributors, which gives rise to potential risks to our brand, reputation and have conduct risk implications. These risks are summarised below. We have indicated whether these risks are considered material at the level of the Group or our business units. Our disclosures covering risk factors can be found at the end of this document. ‘Macro’ risks Risks from our investments Risks from our products Risks from our business operations 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 (guarantees) we have made to our customers. Our fund investment performance may also be impacted, which is a fundamental part of our business in providing appropriate returns for our customers and shareholders. Changes in economic conditions can also have an indirect impact on us; 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. We consider this to be a risk which is material at the level of the Group. Geopolitical risk The geopolitical environment has produced varying levels of volatility in recent years as seen by political developments in the UK, the US and the Eurozone. Uncertainty in these regions, combined with conflict in the Middle East and elevated tensions in east Asia and the Korean peninsula underline that geopolitical risks are truly global and their potential impacts are wide‑ranging; for example through increased regulatory and operational risks. 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 advanced 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. We consider digital disruption from both an external and internal view. The external view considers the rise of new technologies and how this may impact on our industry and our competitiveness within it, while the internal view considers the risks associated with our own internal developments in meeting digital change challenges and opportunities. While we are embracing such opportunities, we are also closely monitoring any risks which arise. Credit risk Insurance risks Operational risks Is the potential for reduced value of our The nature of the products offered by the The complexity of our Group and activities investments due to the uncertainty Group exposes it to insurance risks, around investment returns arising from which we consider to form a significant means we face a challenging operating environment. This results from the high the potential for defaults of our part of our overall Group risk profile. volume of transactions we process; product investment counterparties. Invested credit risk arises from our asset portfolio. We increase sector focus where necessary. The insurance risks that we are exposed to by virtue of our products include longevity risk (policyholders living and investment portfolios; our people, processes and IT systems; and the extensive regulations under which we operate. The assets backing the M&G Prudential (policyholders with life protection dying); business transformation; introducing new and Jackson annuity businesses means morbidity risk (policyholders with products; new technologies; engaging in third credit risk is considered a material risk for health protection becoming ill) and party relationships; and entering into new these business units in particular. persistency risk (customers lapsing markets and geographies. Implementing our longer than expected); mortality risk We also face operational risks through 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. Certain market risks are considered more material for specific business units. In our Asia business, our main market risks arise from the value of fees from our fee‑earning products. 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. In the UK, exposure arises from 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 Prudential 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 assets to meet our obligations as they fall due, and incorporates the risk arising from funds composed of illiquid assets. It results from a mismatch between the liquidity profile of assets and liabilities. We consider this a risk which is material at the level of the Group. their policies, and a type of policyholder business strategy requires interconnected behaviour risk). From our health protection products, increases in the costs of claims (including change initiatives across the Group. The pace of change further adds to the complexity of our operational risk profile. the level of medical expenses) increasing Without an effective operational risk over and above price inflation (claim framework, such risks could cause significant 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 disruption our systems and operations, resulting in financial loss and/or reputational damage. We consider operational risk to be material at the level of the Group. Information security risk is a significant assumptions. Where experience deviates consideration within operational risk, from these assumptions our profitability including both the continuously evolving risk may be impacted. Across our business units, some insurance risks are more material than others. Persistency and morbidity risks are 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 digitalisation and the increasing number of high profile cyber security incidents across among the most material insurance risks industries means that this risk will continue to for our Asia business given our focus on be an area of high focus and is one considered health protection products in the region. to be material to the Group. For M&G Prudential the most material insurance risk is longevity risk driven by legacy annuity business. At Jackson, the most material insurance risk is policyholder behaviour risk, profitability of the variable annuity business and influenced by market performance and the value of policy guarantees. Regulatory risk We also operate under the ever‑evolving requirements set out by diverse regulatory and legal and tax regimes, as well as utilising a significant number of third parties to distribute products and to support business operations; all of which adds to the complexity of our operations. The number of regulatory changes underway across Asia, in particular those focusing on consumer protection means that regulatory change in the region is considered a key risk. Both Jackson and M&G Prudential operate in highly regulated markets. Regulatory reforms can have a material impact on our businesses, and regulatory focus continues to be high. Is the risk of not having sufficient liquid including persistency. This impacts the 52 Prudential plc Annual Report 2017 www.prudential.co.uk ‘Macro’ risks Risks from our investments Risks from our products Risks from our business operations 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 (guarantees) we have made to our customers. Our fund investment performance may also be impacted, which is a fundamental part of our business in providing appropriate returns for our customers and shareholders. Changes in economic conditions can also have an indirect impact on us; 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. We consider this to be a risk which is material at the level of the Group. Geopolitical risk The geopolitical environment has produced varying levels of volatility in recent years as seen by political developments in the UK, the US and the Eurozone. Uncertainty in these regions, combined with conflict in the Middle East and elevated tensions in east Asia and the Korean peninsula underline that geopolitical risks are truly global and their potential impacts are wide‑ranging; for example through increased regulatory and operational risks. 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 advanced 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. We consider digital disruption from both an external and internal view. The external view considers the rise of new technologies and how this may impact on our industry and our competitiveness within it, while the internal view considers the risks associated with our own internal developments in meeting digital change challenges and opportunities. While we are embracing such opportunities, we are also closely monitoring any risks which arise. 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 M&G Prudential and Jackson annuity businesses means credit risk is considered a material risk for these business units in particular. 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. Certain market risks are considered more material for specific business units. In our Asia business, our main market risks arise from the value of fees from our fee‑earning products. 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. In the UK, exposure arises from 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 Prudential 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 due, and incorporates the risk arising from funds composed of illiquid assets. It results from a mismatch between the liquidity profile of assets and liabilities. We consider this a risk which is material at the level of the Group. Insurance risks The nature of the products offered by the Group exposes it to insurance risks, which we consider to form a significant part of our overall Group 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, and a type of policyholder behaviour risk). 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, some insurance risks are more material than others. Persistency and morbidity risks are among the most material insurance risks for our Asia business given our focus on health protection products in the region. For M&G Prudential the most material insurance risk is longevity risk driven by legacy annuity business. At Jackson, the most material insurance risk is policyholder behaviour risk, including persistency. This impacts the profitability of the variable annuity business and influenced by market performance and the value of policy guarantees. Operational risks The complexity of our Group and activities means we face a challenging operating environment. This results from the high volume of transactions we process; product and investment portfolios; our people, processes and IT systems; and the extensive regulations under which we operate. We also face operational risks through business transformation; introducing new products; new technologies; engaging in third party relationships; and entering into new markets and geographies. Implementing our business strategy requires interconnected change initiatives across the Group. The pace of change further adds to the complexity of our operational risk profile. Without an effective operational risk framework, such risks could cause significant disruption our systems and operations, resulting in financial loss and/or reputational damage. We consider operational risk to be material at the level of the Group. Information security risk is a significant consideration within operational risk, including both the continuously evolving 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 digitalisation and the increasing number of high profile cyber security incidents across industries means that this risk will continue to be an area of high focus and is one considered to be material to the Group. Regulatory risk We also operate under the ever‑evolving requirements set out by diverse regulatory and legal and tax regimes, as well as utilising a significant number of third parties to distribute products and to support business operations; all of which adds to the complexity of our operations. The number of regulatory changes underway across Asia, in particular those focusing on consumer protection means that regulatory change in the region is considered a key risk. Both Jackson and M&G Prudential operate in highly regulated markets. Regulatory reforms can have a material impact on our businesses, and regulatory focus continues to be high. www.prudential.co.uk Annual Report 2017 Prudential plc 53 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued Further 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 have assets and liabilities 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 M&G Prudential 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 business by our need to match the duration of 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 funds’ declared bonuses and policyholder net investment gains is shared with shareholders and so our investment exposure relates to the future performance of that proportion (future transfers). This investment risk is driven mainly by equities in the funds, although there is some risk associated with other investments such as property and bonds. Some hedging to protect against a reduction in the value of these future transfers against falls in equity prices is performed outside the funds using derivatives. The with‑profits funds’ large Solvency II own funds – estimated at £9.6 billion as at 31 December 2017 (31 December 2016: £8.4 billion) – helps to protect against market fluctuations and helps the funds to maintain appropriate solvency levels. The with‑profits funds’ Solvency II own funds are protected partially 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 based broadly on historical and current rates of return from our investment portfolios which include equities. 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 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 increased broadly since mid‑2016 and indications are for further gradual tightening of monetary policy and the start of balance sheet normalisation by central banks, 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 M&G Prudential’s insurance 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 54 Prudential plc Annual Report 2017 www.prudential.co.uk margin. The UK business assesses on a continual basis 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 borne largely 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 managed appropriately, 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 to us may increase when interest rates fall. We monitor the level of sales of variable annuity products with guaranteed living benefits actively, 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 includes hybrid derivatives to provide some protection 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 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 favourable economically to do so. Generally, we do not have appetite for significant direct shareholder exposure to foreign exchange risks in currencies outside of the countries in which we operate, but we do have some 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. 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, and counterparties; — Collateral arrangements we have in place for derivative, secured lending reverse repo and reinsurance transactions; — The Group Credit Risk Committee’s oversight of credit and counterparty credit risk and sector and/or name‑ specific reviews. In 2017 it has conducted sector reviews in the Asia sovereign sector, the UK banking sector, the US retail property sector, and continues to review the developments around central clearing; — 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 exposed mainly to credit risk on fixed income assets in the shareholder‑backed portfolio. At 31 December 2017, this portfolio contained fixed income assets worth £35.3 billion. Credit risk arising from a further £57.4 billion of fixed income assets is borne largely by the with‑profits fund, to which the shareholder is not exposed directly although under extreme circumstances shareholder support may be required if the fund is unable to meet payments as they fall due. Credit risk also arises from the debt portfolio in our Asia business, the value of which was £41.0 billion at 31 December 2017. The majority (68 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 32 per cent of the debt portfolio is held to back the shareholder business. Credit risk also arises in the general account of the Jackson business, where £35.4 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 other operations was £2.3 billion as at 31 December 2017. Further details of the composition and quality of our debt portfolio, and exposure to loans, can be found in the IFRS financial statements. www.prudential.co.uk Annual Report 2017 Prudential plc 55 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued Group sovereign debt (Audited) We also invest in bonds issued by national governments. This sovereign debt represented 19 per cent or £16.5 billion of the shareholder debt portfolio as at 31 December 2017 (31 December 2016: 19 per cent or £17.1 billion). 5 per cent of this was rated AAA and 90 per cent was considered investment grade (31 December 2016: 92 per cent investment grade). 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 2017 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 considered a material risk for the Group with an appropriate level of management information provided to the Group’s risk committees and the Board. The exposures held by the shareholder‑ backed business and with‑profits funds in bank debt securities at 31 December 2017 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 31 December 2017, shareholder exposures by rating1 and sector are shown below: — 95 per cent of the shareholder portfolio is investment grade rated. In particular, 69 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). Shareholder exposure by rating 5 1 2 3 4 10% 1 AAA 27% 2 AA 32% 3 A 4 BBB 26% 5 BB or below or non‑rated assets 5% Shareholder exposure by sector 1 12 11 10 9 8 7 6 5 4 3 1 Financial 2 Government 3 Real estate 4 Utilities 5 Consumer, non‑cyclical 6 Mortgage securities 7 8 Energy 9 Communications 10 Consumer, cyclical 11 Asset‑backed securities 12 Other Industrial 2 22.43% 26.23% 9.80% 7.66% 7.87% 3.02% 3.78% 4.01% 3.10% 2.46% 3.25% 6.39% 56 Prudential plc Annual Report 2017 www.prudential.co.uk 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 impact on market conditions and valuation of assets in a more uncertain way than for other risks like interest rate or credit risk. It 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 external 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 2022. We have access to further liquidity by way of the debt capital markets, and also have in place an extensive 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 monitored regularly and are assessed to be sufficient. Our risk management and mitigation of liquidity risk include: — 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 have 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 policyholder behaviour (variability in how customers interact with their policies, including utilisation of withdrawals, take‑up of options and guarantees and persistency, ie lapsing of policies), and increases in the costs of claims, including the level of medical expenses increases over and above price inflation (claim inflation). The principal drivers of the Group’s insurance risks are persistency and morbidity risk in the Asia business; longevity risk in the UK legacy business of M&G Prudential; and policyholder behaviour risks in Jackson. 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; — Using reinsurance to mitigate longevity and morbidity risks; — Ensuring appropriate medical underwriting when policies are issued and appropriate claims management practices when claims are received in order to mitigate morbidity risk; — Maintaining the quality of our sales processes and using initiatives to increase customer retention in order to mitigate persistency risk; — Using product re‑pricing and other claims management initiatives in order to mitigate medical expense inflation risk; 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 reduced the demand for retail annuities greatly and further liberalisation is anticipated. Although we have withdrawn from selling new annuity business, 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. www.prudential.co.uk Annual Report 2017 Prudential plc 57 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued The business environment we operate in has become increasingly complex over the years. The political, environmental, societal, legal and economic landscape is highly dynamic and uncertain. Changes and developments on the horizon may result in emerging risks to us which are monitored under our Emerging Risk Framework. The Group maintains active engagement with our shareholders, governments, policymakers and regulators in our key markets, as well as with international institutions. This introduces expectations for the Group to act and respond to environmental, social and governance (ESG) matters in a certain manner. The perception that our key stakeholders have of us and our businesses is crucial in forming and maintaining a robust brand and reputation. As such, the Group’s operational risk framework explicitly incorporates ESG as a component of our social and environmental responsibility, brand management and external communications within our framework. This is further strengthened by factoring considerations for reputational impacts when the materiality of operational risks are assessed. The climate risk landscape continues to evolve and is moving up the agenda of many regulators, governments, non‑ governmental organisations and investors. Examples of this include the US Department of Labor’s decision to change its guidance to pension fund fiduciaries to allow them to factor ESG issues into investment decisions; Hong Kong Stock Exchange listing rules requiring listed companies to provide a high‑level discussion of ESG approaches and activities in external disclosures, and the Financial Stability Board’s (FSB) Task Force for Climate‑related Financial Disclosures. Our persistency assumptions reflect similarly 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 observed historically) 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 depends mostly on the value of the product features and market conditions. Risks from our business operations Non-financial risks In the course of doing business, the Group is exposed to non‑financial risks arising from our operations, the business environment and our strategy. Our main risks across these areas are detailed below. We define operational risk as the risk of loss (or unintended gain or profit) arising from inadequate or failed internal processes, personnel or systems, or from external events. This includes employee error, model error, system failures, fraud or some other event which disrupts business processes. Processes are established for activities across the scope of our business, including operational activity, regulatory compliance, and those supporting environmental, social and governance (ESG) activities among others, any of which can expose us to operational risks. We process a large volume of complex transactions across a number of diverse products, and are subject to a high number of varying legal, regulatory and tax regimes. We also have a number of important third‑party relationships that provide the distribution and processing of our products, both as market counterparties and as outsourcing partners. M&G Prudential outsources several operations, including a significant part of its back office, customer‑facing functions and a number of IT functions. These third‑party arrangements help us to provide a high level and cost‑effective service to our customers, but they also make us reliant on the operational performance of our outsourcing partners. The performance of our core business activities places reliance on the IT infrastructure that supports day‑to‑day transaction processing. Our IT environment must also be secure and we 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 for us, particularly the risk that legacy infrastructure supporting core activities/ processes affects business continuity or impacts on business growth. Operational challenges also exist in keeping pace with regulatory changes. This requires implementing processes to ensure we are, and remain, compliant on an ongoing basis, including regular monitoring and reporting. 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, interpret correctly, implement and/or monitor regulatory compliance. See Global regulatory and political risk section below. 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 those related to sales practice and anti‑money laundering, bribery and corruption. We have a particular focus on regulations related to the latter in newer/ emerging markets. 58 Prudential plc Annual Report 2017 www.prudential.co.uk  — An internal incident capture process, which identifies, quantifies and monitors remediation conducted through application of action plans for risk events that have occurred across the business; — A scenario analysis process for the quantification of extreme, yet plausible manifestations of key operational risks across the business on a forward looking basis. This is carried out at least annually and supports external and internal capital requirements as well as informing risk activity across the business; and — An operational risk appetite framework that articulates the level of operational risk exposure the business is willing to tolerate and sets out escalation processes for breaches of appetite. Outputs from these processes and activities performed by individual business units are monitored by the Group Risk function, who provide an aggregated view of risk profile across the business to the Group Risk Committee and Board. These core framework components are embedded across the Group via the Group Operational Risk Policy and Standards documents, which sets out the key principles and minimum standards for the management of operational risk across the Group. The Group operational risk policy, standards and operational risk appetite framework sit alongside other risk policies and standards that individually engage with key operational risks, including outsourcing and third‑party supply, business continuity, technology and data, and operations processes. The increased regulatory focus on environmental issues not only reflects existing commitments, for example in the UK under the 2008 Climate Change Act, but also a heightened societal awareness of climate change as a pressing global concern. Regulatory and stakeholder interest in environmental matters is expected to increase as climate change moves higher up governmental agendas. This increase in focus creates a number of potential near term risks. These include: — Investment risk in the form of ‘transition risk’. This is the risk that an abrupt, unexpected tightening of carbon emission policies lead to a disorderly re‑pricing of carbon‑intensive assets; — Liability risk, if the Group is unable to demonstrate sufficiently that we have acted to mitigate our exposure to climate change risk; and — Reputational risks, where the Group’s actions could affect external perceptions of our brand and corporate citizenship. The Group has established a Group‑wide Responsible Investment Advisory Committee with designated responsibility to oversee Prudential’s responsible investment activities as both asset owners and asset managers. Physical impacts of climate change could also arise, driven by specific climate‑related events such as natural disasters. These impacts are mitigated through our crisis management and disaster recovery plans. Further information on the climate risks facing our business and how we are managing and responding to these can be found in the Corporate responsibility review on page 77. Strategic risk requires a forward‑looking approach to risk management. A key part of our approach are the risk assessments performed as part of the Group’s annual strategic planning process, which supports the identification of potential future threats and the initiatives needed to address them, as well as competitive opportunities. We also assess the impact on the Group’s businesses and our risk profile to ensure that strategic initiatives are within the Group’s overall risk appetite. Implementation of the Group’s strategy and the need to comply with emerging regulation has resulted in a significant portfolio of transformation and change initiatives, which may further increase in the future. In particular the intention to demerge the UK and Europe business from the rest of the Group will result in a substantial change programme which will need to be managed at the same time that other material transformation programmes are being delivered. The scale and the complexity of the transformation programmes could impact business operations and customers, and has the potential for reputational damage if these programmes fail to deliver their objectives. Implementing further strategic initiatives may amplify these risks. Other significant change initiatives are occurring across the Group. The volume, scale and complexity of these programmes increases the likelihood and potential impact of risks associated with: — Dependencies between multiple projects; — The organisational ability to absorb change being exceeded; — Unrealised business objectives/ benefits; and — Failures in project design and execution. The risks detailed above form key elements of the Group’s operational risk profile. In order to effectively identify, assess, manage, control and report on all operational risks across the business, a Group‑wide operational risk framework is in place. The key components of the framework are: — Application of a risk and control assessment (RCA) process, where operational risk exposures are identified and assessed as part of a periodical cycle. The RCA process takes into account a range of internal and external factors, including an assessment of the control environment, to determine the business’s most significant risk exposures on a prospective basis; www.prudential.co.uk Annual Report 2017 Prudential plc 59 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued These policies and standards include subject matter expert‑led processes that are designed to identify, assess, manage and control operational risks, including the application of: — A transformation risk framework that assesses, manages and reports on the end‑to‑end transformation lifecycle, project prioritisation and the risks, interdependencies and possible conflicts arising from a large portfolio of transformation activities; — Internal and external review of cyber security capability; — Regular updating and testing of elements of disaster‑recovery plans and the Critical Incident Procedure process; — Group and business unit‑level compliance oversight and testing in respect of adherence with in‑force regulations; — Regulatory change teams in place assist the business in proactively adapting and complying with regulatory developments; — A framework in place for emerging risk identification and analysis in order to capture, monitor and allow us to prepare for operational risks that may crystallise beyond the short‑term horizon; — Corporate insurance programmes to limit the financial impact of operational risks; and — Reviews of key operational risks and challenges within Group and business unit business plans. These activities are fundamental in maintaining an effective system of internal control, and as such outputs from these also inform core RCA, incident capture and scenario analysis processes and reporting on operational risk. Furthermore, they also ensure that operational risk considerations are embedded in key business decision‑ making, including material business approvals and in setting and challenging the Group’s strategy. Global regulatory and political risk Our risk management and mitigation of regulatory and political risk includes the following: — Risk Assessment of the Business Plan which includes consideration of current strategies; — Close monitoring and assessment of our business environment and strategic risks; — The consideration of risk themes in strategic decisions; and — Ongoing engagement with national regulators, government policy teams and international standard setters. Recent shifts in the focus of some governments toward more protectionist or restrictive economic and trade policies could impact on the degree and nature of regulatory changes and Prudential’s competitive position in some geographic markets. This could take effect, for example, through increased friction in cross‑border trade, capital controls or measures favouring local enterprises such as changes to the maximum level of non‑domestic ownership by foreign companies. We continue to monitor these developments at a national and global level and these considerations form part of our ongoing engagement with government policy teams and regulators. On 29 March 2017 the UK submitted formal notification of its intention to withdraw from the EU. In December 2017, agreement was reached between the UK and EU to progress negotiations onto transitional arrangements and the future trading relationship. The outcome of negotiations remains highly uncertain. If no formal withdrawal agreement is reached then it is expected the UK’s membership of the EU will terminate automatically two years after the submission of the notification. The ongoing uncertainty during the remainder of the negotiation period and the potential for a disorderly exit from the EU by the UK without a negotiated agreement may increase volatility in the markets where we operate, creating the potential for a general downturn in economic activity and for falls in interest rates in some jurisdictions due to easing of monetary policy and investor sentiment. As a Group, our diversification by geography, currency, product and distribution should reduce some of the potential impact. We have UK‑domiciled operations including M&G Prudential, and due to the geographical location of both its businesses and its customers, its insurance and the fund management operations have most potential to be affected by the UK’s exit. The extent of the impact will depend in part on the nature of the arrangements that are put in place between the UK and the EU. Contingency plans were developed ahead of the referendum by business units and operations that may be impacted immediately by a vote to withdraw the UK from the EU, and these plans have been enacted since the referendum result. We have since also undertaken significant work to ensure that our business, and in particular our customer base, is not unduly affected by the decision of the UK to exit from the EU. 60 Prudential plc Annual Report 2017 www.prudential.co.uk The UK’s decision to leave the EU has introduced uncertainty to the extent of future applicability of the Solvency II regime in the UK. In October 2017, the Treasury Committee published its report on the Solvency II Directive and the UK Insurance Industry, which highlighted the need for a strategy, post‑UK exit, to foster innovation, competition and competitiveness for the benefit of UK consumers. In late 2016 the European Commission began a review of some aspects of the Solvency II legislation, with a particular focus on the Solvency Capital Requirement calculated using the standard formula, which is expected to run until 2021. 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, the work of the Financial Stability Board (FSB) on Global Systemically Important Insurers (G‑SIIs) and the Insurance Capital Standard being developed by the International Association of Insurance Supervisors (IAIS). There are also 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 IAIS. Decisions taken by regulators, including those related to solvency requirements, corporate or governance structures, capital allocation and risk management may have an impact on our business. The IAIS’s G‑SII regime forms additional compliance considerations for us. Groups designated as 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. The FSB did not publish a new list of G‑SIIs in 2017, however the policy measures set out in the FSB’s 2016 communication on G‑SIIs continue to apply to the Group. Prudential is monitoring the development and potential impact of the policy measures and is continuing to engage with the PRA on the implications of such measures and Prudential’s designation as a G‑SII. The IAIS has launched a public interim consultation on an activities‑based approach to systemic risk. Following the feedback from this, a second consultation with proposals for policy measures is due to be launched in 2018. Any changes to the designation methodology are expected to be implemented in 2019. We continue to engage with the IAIS on developments in capital requirements for groups with G‑SII designation. The regime introduces capital requirements in the form of a Higher Loss Absorption (HLA) requirement. This requirement was initially intended to come into force in 2019 but has been postponed until 2022. The HLA is also now intended to be based on the Insurance Capital Standard, which is being developed by the IAIS as the capital requirements under its Common Framework (ComFrame). This framework is focused on the supervision of Internationally Active Insurance Groups (IAIGs) and 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 Internationally Active Insurance Groups. The IAIS has announced that the implementation of ICS will be conducted in two phases – a five‑year monitoring phase followed by an implementation phase. During the monitoring phase, IAIGs will be required to report on ICS to the group‑ wide supervisor on a confidential basis, although these results will not be used as a basis to trigger supervisory action. 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, some parts of the Department of Labor (DoL) rule introducing fiduciary obligations for distributors of investment products, which may reshape dramatically the distribution of retirement products, became effective on 9 June 2017. This included those provisions on impartial conduct standards, although other provisions of the rule have now been delayed until 1 July 2019. Jackson has introduced fee‑based variable annuity products in response to the introduction of the rule, and we anticipate that the business’s strong relationships with distributors, history of product innovation and efficient operations should further mitigate any impacts. The US National Association of Insurance Commissioners (NAIC) is continuing its industry consultation with the aim of reducing the non‑economic volatility in the variable annuity statutory balance sheet and risk management. Following two industry quantitative impact studies, proposed changes to the current framework have been released by the NAIC for comment from industry and other interested parties. Jackson continues to be engaged in the consultation and testing process. The proposed changes are expected to be effective from 2019 at the earliest. In December 2017, the Tax Cuts and Jobs Act was signed into law in the US. Some uncertainty exists on the implications of the tax reforms on the NAIC’s proposals. A degree of uncertainty as to the timing, status and final scope of these key US reforms exists. Our preparations to manage the impact of these reforms will continue while we await further clarification. In May 2017, the International Accounting Standards Board (IASB) published IFRS 17 which will introduce fundamental changes to the statutory reporting of insurance entities that prepare accounts according to IFRS from 2021. The Group is reviewing the complex requirements of the standard and is considering its potential impact. This is expected to, among other things, include altering the timing of IFRS profit recognition, and the implementation of the standard is likely to require changes to the Group’s IT, actuarial and finance systems. www.prudential.co.uk Annual Report 2017 Prudential plc 61 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationReport on the risks facing our business and how these are managed continued In Asia, regulatory regimes are developing at different speeds, driven by a combination of global factors and local considerations. New local capital rules and requirements could be introduced in these and other regulatory regimes that challenge legal or ownership structures, current sales practices, or could be applied to sales made prior to their introduction retrospectively, which could have a negative impact on Prudential’s business or reported results. Cyber risk Cyber risk remains an area of heightened focus 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. Disruption to the availability, confidentiality and integrity of our IT systems could make it difficult to recover critical services, result in damage to assets and compromise the integrity and security of data. This could result in significant impacts to business continuity, our customer relationship and our brand reputation. Developments in data protection worldwide (such as the EU General Data Protection Regulation that comes into force in May 2018) may increase the financial and reputational implications for Prudential of a breach of its (or third‑party suppliers’) IT systems. Given this, cyber security is seen as a key risk for the Group and is an area of increased scrutiny by global regulators. The threat landscape is continuously evolving, and our assessment is that the systemic risk from untargeted but sophisticated and automated attacks has increased. Cyber risks are also increasingly stemming from geopolitical tensions. The core objectives of our Cyber Risk Management Strategy are: 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. Our 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. We have made progress in all of these across 2017. 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. The Board receives periodic updates on cyber risk management throughout the year, which includes assessments against the core objectives under our Group‑wide Cyber Risk Management Strategy and progress updates on the associated Group‑wide Coordinated Cyber Defence Plan. 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 prepared in accordance with the provision C.2.2 of the UK code The Group’s longer-term prospects The Group’s strategy is based around meeting the long‑term savings and protection needs of its customers and hence creating value for both customers and shareholders over a time frame that can be many years. As described on pages 12 to 13, the Group’s business model supports this strategy by constantly evolving our products to meet changing customers’ needs, building out and diversifying distribution capabilities and relationships to reach new customers and investing in technology to better empower and serve the salesforce and customers. Examples of the actions undertaken during 2017 are set out on pages 18 to 32. This focus, together with our risk management framework, supports the sustainability of our business over the longer term. The Directors regularly consider strategic matters that may affect the longer‑term prospects of the Group. In performing this viability assessment, the Directors considered the potential impact on the viability of the Company and the Group of the announced intention to demerge the Group’s UK operations. 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. Further details on the current capital strength of the Group are provided on pages 48 to 63. Period of viability assessment The Directors have assessed the viability of the Company and the Group for a period longer than the 12 months required by the going concern statement. 62 Prudential plc Annual Report 2017 www.prudential.co.uk The Directors also considered the risks that would arise from the proposed intention to demerge M&G Prudential that could impact their assessment of the Group’s viability over the three years ended December 2020. The assessment did not change the Board’s conclusion. 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 2020. The Directors performed the assessment by reference to the three‑year period to December 2020. 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 Directors 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. This projection involves setting a number of economic and other assumptions that are inherently volatile over a much longer reporting 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 or changes in regulation. Assessment of risks over the period The Group’s business plan implements the Group’s strategic objectives through the business model and activities discussed on pages 10 to 13. As noted above, underpinning the projections in the business plan are a number of economic and other assumptions. Assessment of the risks to achieving the projected performance therefore remains an integral part of the planning process. The Group’s approach to risk management and a summary of the key risks facing the Group are set out on pages 48 to 63. For the purposes of assessing the Group’s viability, the Directors 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 53, 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. The scenarios tested showed that the Group would be able to maintain viability, over the three‑year period under assessment, after taking account of the actions available to management to mitigate the impacts on capital and liquidity in such scenarios. The 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. While unexpected changes cannot be fully anticipated and hence modelled, 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. Note 1 Based on hierarchy of Standard & Poor’s, Moody’s and Fitch, where available and if unavailable, internal ratings have been used. www.prudential.co.uk Annual Report 2017 Prudential plc 63 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review Building stronger communities We build stronger communities by delivering products that enable our customers to move ahead in their lives with confidence, and by investing in the real economy to drive the cycle of growth. 2017 performance highlights — £25 million total community investment — £500,000 raised through Prudential RideLondon from charity partners and employees — 96,493 hours volunteered by employees across the Prudential Group — £412,375 donated by employees through payroll giving across the Group Alongside the benefits we provide through our core business activities, we also play a wider role in fostering sustainable development through our corporate responsibility programmes around the world. This corporate responsibility review provides an overview of our community investment, environmental, diversity and inclusion, talent development and performance management activities and progress in 2017, which have helped to improve the lives of customers and strengthened communities throughout the markets in which we operate. More detailed information is available online at www. prudential.co.uk/corporate‑responsibility and in our 2017 Environmental, social and governance report. Environmental, social and governance (ESG) – a changing landscape The ESG landscape is evolving rapidly. We recognise these changes and position ourselves to adapt to them proactively, to ensure that we remain a sustainable business and demonstrate that sustainability as transparently as possible. We will report in detail on our material, non‑financial ESG issues in our 2017 ESG Report. We have chosen to include a summary of our material ESG issues and how we manage these for the first time here in our Annual Report and commit to continuing to develop these disclosures for our investors in future Annual Reports. This reflects our belief in the importance of ESG considerations to our long‑term success. Our approach to ESG Our relationships with our customers are long term, so it is vital that our strategy and its execution ensure that we are a sustainable business. Our success in delivering for our customers and shareholders depends on effective engagement with our stakeholders. Our business model is set out on pages 12 to 13. Managing a sustainable business means managing a wide range of ESG issues. Every one of these areas is integral to our performance and sustainability and we approach them accordingly. We recognise that the ESG landscape is changing and position ourselves to adapt to this proactively. Managing our material ESG issues In 2016, we undertook a Group‑wide review to identify the ESG issues that are most material for Prudential. We determined the relevance and significance of each ESG issue, based on the risks and opportunities to Prudential and our stakeholders, and prioritised these issues according to the greatest impact to the sustainability of our business. Our material ESG issues fall into the following areas: business integrity, customers, environment, responsible investment, suppliers, technology, people and communities. These remain the most material issues for Prudential. 64 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Prudential Scholarship programme, Zambia Prudential’s scholarship programme in Zambia is run in partnership with the international charity, Camfed, and was endorsed by the Ministry of Education. The programme focuses on educating young girls and people with disabilities in rural Zambia. Sara is the sixth born in a family of eight children. Having completed primary school and achieved impressive results in her primary leaving examination, she was awarded a place at secondary school, but her parents did not have the money to pay the fees and it looked as if she would have to turn down her place. Fortunately, Sara was awarded a scholarship. Prudential’s support is enabling Sara to take her final school leaving examination, giving her the potential to go on and pursue her dream of becoming a medical professional. She says: ‘I encourage Camfed donors to continue supporting other vulnerable children in the same way they have done for me. When I complete my Grade 12, I wish to work in the health sector as a medical personnel by studying for Medicine at the University of Zambia, if possible becoming a surgeon.’ Business integrity At Prudential, responsible and ethical behaviour is a business imperative and is integrated throughout our operations and locations. We believe that the way in which we conduct ourselves on a daily basis is key to building trust, maintaining our reputation and positive relationships with our stakeholders and ultimately in achieving long‑term business success. We have embedded a robust framework throughout our operations to ensure that we are able to effectively manage existing and emerging risks in this area, including maintaining our financial strength, fighting financial crime, undertaking responsible tax practices and upholding the highest standards for professional conduct. Customers Serving our customers well is core to our strategy and to creating long‑term sustainable value. We provide fair and transparent products that meet our customers’ needs, often providing solutions to the biggest financial challenges of their lives. Prudential serves a global customer base with a broad range of needs. The financial challenges facing our customers continue to change and we want to serve our customers for the long term, which involves proactively listening to their needs and developing our products and solutions to improve financial access and deliver consistent, long‑term sustained performance. Environment Managing the climate‑related risks facing our business is crucial to creating long‑term value for our customers, shareholders and the communities of which we are a part. As an occupier of approximately 400 properties worldwide, we recognise the importance of our own internal environmental targets and decarbonisation goals in reducing our direct footprint. As a life insurer, asset owner and manager, we also recognise the positive role we can play in financing the transition to a low‑carbon economy and in managing associated risks. Responsible investment Responsible investment for us is the integration of ESG considerations into our investment processes and our stewardship activities. Our general approach is one of ‘inclusion’ through engagement with investee companies and active ownership practices rather than ‘exclusion’ (the restriction of investment opportunities). However, we maintain the ability to exclude entities from our internal insurance mandates, where their practices, policies or procedures conflict with our Group values, or where we see a need to explicitly recognise international consensus. To date, owing to the decentralised nature of our Group, our asset management and ownership businesses have managed ESG risks in our investment portfolios, distinctly. In recognition of the importance of ESG in delivering long‑term sustainable returns across our investment portfolio, we created our Group Responsible Investment Framework during 2017. The framework sets minimum requirements and provides guidance that enables our Business Units to explain, in a manner that is consistent with our Group Values and Code of Conduct, how they incorporate ESG considerations into their investment processes and stewardship commitments as asset owners. Further information on our Group Responsible Investment Framework will be found in our 2017 ESG Report. www.prudential.co.uk Annual Report 2017 Prudential plc 65 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued Suppliers As a global financial services organisation, we source goods and services from thousands of outsourced and third‑party suppliers across the world. We recognise the need to source these goods and services in a way that maximises value and minimises our supply risk, and we do this in an ethically and socially responsible manner. Given the number of our outsourced and third‑party supply relationships, we also have a responsibility to make it as simple as possible for our suppliers to do business with us. We manage this through our responsible procurement practices. We believe in respecting human rights and acting responsibly and with integrity. We have always believed this commitment extends beyond our organisation and into our supply chain. For information around modern slavery and how we are identifying and managing our risks in relation to slavery, human trafficking, child and forced labour, please read our forthcoming 2017 Modern Slavery Statement. Technology Emerging technologies enable us to provide financial protection to previously unreachable communities and deliver better, more efficient outcomes for our customers. They also bring new concerns, in particular cyber risks, which pose threats to our business operations and the customer data that we hold and protect. Cyber risk remains a prominent concern and focus area for regulators and corporates globally, and could have a significant impact on business continuity, our customer relationships and our brand reputation. We closely monitor and respond to developments in this area, to ensure that we can maximise the benefits of new emerging technology while minimising the risks. People At Prudential we encourage an inclusive working environment where we continually develop our talent, reward great performance and value our differences in order to deliver outstanding service and products for our customers, shareholders and communities. This is achieved through our continued focus on diversity and inclusion, talent development, performance and reward and health and safety. Further information on the diversity of our Board, our policy in respect of this, how this is implemented and the associated results in 2017 can be found in our Governance statement on page 101. Communities We recognise that we have a role to play in the broader sustainable development agenda, for example in building financial literacy and improving financial inclusion. Our community investment strategy is closely aligned with our business objectives and with our stakeholders’ concerns and interests, and is aimed at protecting and encouraging more sustainable and resilient communities. To achieve this, our programme is focused around four principal areas: social inclusion, financial education and life skills, disaster preparedness, and employee engagement. Further information on our material ESG issues, including 2017 progress and performance can be found in our forthcoming 2017 ESG Report. For more information on the principal risks facing our business and general risk governance and risk management policies and procedures and how these are managed, refer to the report on the Risks facing our business and how these are managed on pages 48 to 63. ESG policy framework – Group Governance Manual Group‑wide ESG standards are established through the Group Governance Manual. The Manual sets out the policies and procedures by which the Group operates within our framework of internal governance, taking into account relevant statutory and regulatory matters. Group‑wide policies relating to the Group’s material ESG issues include: Material ESG issues Business integrity Our Group-wide policies* — Code of Business Conduct Policy, setting out the standards that are required across the Group, by all employees and any individuals and organisations acting on our behalf. This includes our core values – prudence, security, integrity and initiative – and that we pursue opportunities to grow our business in line with these values, and our commitments to our customers, investors and economies, our people and communities. — Anti Bribery and Corruption Policy, outlining the value we place on our reputation for ethical behaviour and for financial probity and reliability, our prohibition of corruption and the payment or receipt of bribes for any purpose and how we limit our exposure to this. — Anti Money Laundering and Counter Terrorist Financing Policy, setting out our prohibition of money laundering and terrorist financing, and how we combat and limit our exposure to this. — Sanctions Policy, outlining our commitment to complying with sanctions laws and regulation and how we comply with this through screening, prohibited business activity, restricting business activities and investigation. — Security Policy, outlining how we ensure a level of security commensurate with our regulatory and legal obligations, while meeting the demands of our competitive, commercial organisation. This includes our principles to enhance commercial opportunity, while minimising corporate risks utilising financial crime and fraud investigations and ‘Speak out’ whistleblowing processes. — Tax Risk Policy, covering our processes to identify, measure, control and report on tax‑related risks, including technical judgement, operational, regulatory and reputational tax risk. 66 Prudential plc Annual Report 2017 www.prudential.co.uk Material ESG issues Our Group-wide policies* Customers — Customer Commitments Policy, covering our five key commitments to our customers and how we assess, manage and report on these: 1 Treat customers fairly, openly and honestly; 2 Provide and promote a range of products and services that meet customer needs, are easy to understand and that deliver real value; 3 Maintain the confidentiality of our customer information (except where the law requires disclosure); 4 Provide and promote high standards of customer service and monitor these standards rigorously; and 5 Ensure that our complaints processes provide an effective and fair means of arbitration between the Group’s businesses and customers. Environment — Environment Policy, covering how we manage the impact of our businesses on the environment, including our environmental commitments and how we measure, monitor, review and report on our environmental performance. Responsible investment Suppliers — Owing to the distinct investment risks faced by our asset management and ownership businesses, with each investing in different markets and asset classes, each business manages ESG‑related matters through the pursuit of business‑specific responsible investment policies. This is overlain by our Group‑wide Responsible Investment Framework, aligned to our Group‑wide Code of Conduct and underpinned by our Group Responsible Investment Standards. Further information on our Group Responsible Investment Framework will be found in our 2017 ESG Report. — Outsourcing and Third Party Supply Policy, outlining our commitment to ensuring we have a robust, well managed outsourcing and third‑party supplier network. It covers how we manage and oversee these arrangements, through: due diligence/selection criteria, contractual requirements, the ongoing monitoring of such relationships and reporting and escalation. Additionally, our policy considers the requirements of the UK Modern Slavery Act, and the principles of the UN’s Universal Declaration of Human Rights. Technology — Risk Security Policy – we are in the process of updating our data protection policies to prepare for the implementation of the General Data Protection Regulation (GDPR). This policy ensures the protection of information, information systems and technical infrastructure from unauthorised access, use, disclosure, disruption, modification, or destruction, in order to provide confidentiality, integrity, and availability of information. People — Diversity and Inclusion Policy, setting out how we foster an inclusive workforce and ensure all our employees are treated fairly and feel valued, and together have the diversity in skill sets and backgrounds that enriches the organisation. Our policy considers a range of diversity aspects of our employees, including gender, age, ethnicity, disability, sexual orientation and background. Further information on the diversity of our Board, our policy in respect of this, how this is implemented and the associated results in 2017 can be found in our Governance statement on page 101. — Employee Relations Policy, outlining the way we engage our employees and motivate them to achieve success for the Group: promoting positive relationships with employees, representative organisations and trade unions, and maintaining a positive reputation for the treatment of employees. — Performance and Learning Policy, setting out the importance of our people and framing how we invest in their development to deliver against our strategy and the future success of the organisation. This includes our Performance Management Framework. — Remuneration Policy, outlining our effective approach to appropriately rewarding our employees in a way which: aligns incentives to business objectives and enables the recruitment, retention and incentivisation of high‑calibre employees in line with our risk appetite and Group Reward Principles. — Talent Policy, demonstrating how we attract and select the best people for roles that will ensure high performance in the short term and improve the longer‑term succession and talent pipeline. It sets out our fair and effective approach to pursuing this. — Health and Safety Policy, covering our employees, business partners, customers and others that may be affected by our operations. This details our health and safety core principles, our commitments and the measuring and reporting on our health and safety performance. Communities — Community Investment Policy, outlining our commitment and approach to being an active and supporting member of the community. The policy includes the development of our community investment strategy and sets out investments that are not permitted, relevant records and reporting. * In addition to our Group‑wide policies, our business units have underlying business‑specific policy frameworks, reflective of their individual risks and operating environments. For the purposes of this report, we focus primarily on the Group policy framework. www.prudential.co.uk Annual Report 2017 Prudential plc 67 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Corporate responsibility review continued The Group Governance Manual is used as a platform for mandating specific ways of working across the Group. Each Business Unit chief executive attests annually to compliance with applicable requirements set out in the Group‑wide ESG policies, including matters that must be reported to the Group. Specific procedures are followed for the reporting of non‑compliance. Business units present such instances in their annual certification, which in turn is reported to the Group Audit Committee. Due diligence on ESG-related policies A key component of the Group Governance Manual is the Group Risk Framework, which requires all Business Units to establish processes for identifying, evaluating and managing risks, including those relating to ESG issues. This includes conducting due diligence on related policy requirements. Compliance guidance is also provided by the policy owners to clarify Business Unit scope and minimum evidencing standards required to demonstrate compliance. The Group Audit Committee reviewed the results of the year‑end certificate of compliance with Group Governance Manual requirements. While a number of improvements to ensure the policies are fully embedded were discussed, no significant areas of non‑compliance in relation to the policies relevant to ESG issues were noted. For further information on our Group business standards and policies pursued in relation to our material ESG issues, refer to the ‘Business standards’ pages of our website at: www.prudential.co.uk/ responsibility/standards Serving our customers Improving the lives of customers is at the heart of what we do. Across our markets in Asia, the US, the UK and Europe and Africa, the needs of customers are often very different and this is reflected in the products we offer, but wherever we operate we aim to remove uncertainty from life’s big events and help customers build their lives with confidence. Whether that means starting a family, saving for a child’s education or planning for old age, our products are shaped around that core purpose. Asia In Asia, the demand for savings and protection products continues to grow as people seek greater financial security and peace of mind. Lack of insurance protection is one of the primary reasons why a middle‑income family falls below the poverty line following a significant life event, and through some of our products that situation can be averted. We continue to broaden our offering to help meet the distinct needs of our customers. The value of insurance in helping customers move away from poverty is being increasingly recognised. The China Insurance Regulatory Commission, for example, has set a penetration target for insurance of 5 per cent by 2020, from a current rate of only 2 per cent. We are working with the Chinese authorities to help them reach that target and deliver all the benefits to both customers and communities that our industry’s products bring. Our 15 million life insurance customers in Asia give us access to fast, comprehensive feedback on what they want, how their needs are evolving and how we can best adapt our products and capabilities to improve our service and operational efficiency. Customers are increasingly looking for product features that reflect changes in their own lives. One of these is a more personalised approach, and one example of how we are addressing this demand is ‘myDNA’, a DNA‑based, personalised precision health programme, which we are making accessible to more customers across the region. Following its successful launch in Hong Kong in 2016, ‘myDNA’ can now be accessed by customers in Singapore, Malaysia and Vietnam, with its launch in these markets last year. Last year, Prudential Hong Kong also introduced ‘myDNA Pro’, which offers users a simple DNA test and lifestyle assessment to evaluate the overall risk of developing three common and potentially life‑threatening conditions – type 2 diabetes, hypertension and high cholesterol. It includes a dedicated mobile app which offers guidance from a personal health coach, plus a 16‑week programme to help customers establish good diet, nutrition and exercise regimes, and reduce their risks of developing these three debilitating conditions. Through both ‘myDNA’ and ‘myDNA Pro’, we are enabling our customers to make better lifestyle decisions and ultimately lead healthier lives, bringing benefits to families and communities. Customers are also increasingly expecting an on‑demand digital experience in all areas of their lives, and we are meeting that need in a number of ways. In Singapore, Vietnam and Hong Kong, we have launched artificial intelligence‑driven chatbots. Prudential Vietnam’s ‘PruBot’, available on its corporate website and Facebook page, provides customers with 24/7 support by answering queries related to its products and services, as well as helping them schedule appointments with financial consultants. ‘AskPRU’ allows Prudential Singapore’s financial consultants to instantly retrieve information specific to their customers’ life insurance plans. Prudential Vietnam has also launched ‘Matchbook’, a mobile app allowing customers to choose their financial consultants based on several criteria, including preferred personality traits and type of consultation services they require, and to make appointments. Prudential Malaysia has launched ‘PRUDream Planner’, a first‑of‑its kind needs‑based mobile app that allows its financial consultants to provide tailored solutions to customers, enabling them to collect pertinent information on customers’ financial profiles, assess their needs and financial priorities in relation to their life goals, and navigate our wide selection of insurance solutions to provide tailored recommendations. Prudential Singapore’s ground‑breaking ‘PRU Fintegrate Partnership’ identifies fintech startups from around the world to co‑develop digital solutions for customers. The scope of these solutions covers the entire value chain – from helping customers understand how to bridge their protection gaps and to plan for their financial future, to simplifying purchase and claims processes and improving service levels. Another example of how we develop our products in response to the needs of customers in different markets is Prudential Indonesia’s launch last year of ‘PRUprime healthcare’, a hospitalisation product that is comprehensive, offers growing benefits and is available to customers in both conventional and sharia versions. The plan provides an additional 10 per cent of the annual benefit limit if no claims are made within a year, up to a maximum of 50 per cent of the initial annual limit. It also offers cashless admission, where a letter of guarantee is issued by Prudential Indonesia to the hospital so the customer does not have to pay upfront, at a wide network of partner hospitals in Indonesia, Singapore and Malaysia. 68 Prudential plc Annual Report 2017 www.prudential.co.uk The proven investment capability and risk‑managed solution offered by our PruFund range of investment fund options also continues to meet customer needs, especially for those investors who are moving towards the latter stages of saving before needing to secure an income for their retirement. In offering unparalleled diversification, financial strength and smoothed investment returns across ISA, bond, pension income and drawdown products, the assets under management in PruFund reached £36 billion in 2017. The service we provide to customers and financial advisers goes hand‑in‑hand with the retirement solutions we offer. An important part of this service is the ongoing support for intermediary advisers provided by our regional sales units, business development team and technical helpline, which handled 17,000 adviser enquiries in 2017. A number of technology improvements were delivered in 2017, each designed to help reduce the time advisers spend on administration. These included the introduction of paperless offshore bond claims and an electronic signature facility for the Prudential Retirement Account. A further customer milestone was reached in 2017 when our digital customer engagement strategy reached one million customer log‑ins through the MyPru service, a customer portal giving access to update contact details, view annual statements and check valuations and payment information online. External recognition at the 2017 Financial Adviser Service Awards saw us retain the coveted Five Star ratings in the Life and Pensions and Investments categories for the seventh consecutive year. We once again achieved success at one of the most sought‑after awards in our industry, receiving top awards at the Investment Life & Pensions MoneyFacts Awards in 2017 for Best Investment Bond Provider and Best Income Drawdown Provider. US Jackson provides retirement income strategies aimed at the approximately 75 million baby boomers in the US. Our pursuit of excellence in product innovation and our distinctive distribution capabilities have helped us forge a solid reputation for meeting the needs of customers, through a diverse range of variable, fixed and fixed‑index annuity products. As part of a carefully designed plan, our variable annuities help retirees avoid running out of money and provide a reliable cushion against volatile markets. We support our industry‑leading product development and distribution teams with award‑winning customer service. In 2017, Jackson launched two new fee‑based variable annuity products: Perspective Advisory II (PAII), the next evolution of Perspective Advisory, and Private Wealth Shield (PWS), designed to serve clients within the trust market. As with previous fee‑based launches, PAII and PWS are intended to meet increased market demand for products compatible with fee‑based accounts and platforms as a result of the US Department of Labor (DOL) fiduciary rules, released in April 2016. We believe commissions and fees can co‑exist in the annuity space, and our growing suite of products is a step towards making this a reality for our distribution partners. PAII has more than 130 investment options, providing access to world‑class money managers and the flexibility to build a portfolio that meets consumers’ investing needs. Furthermore, this product has no surrender charges and a low‑cost sub‑account structure. A robust suite of optional living and death benefits is also available for an additional charge, designed to provide the opportunity to grow retirement assets and obtain guaranteed income for life. PWS will be sold through companies in the trust space, following a distribution process that differs from Jackson’s other products. The company has developed a Trust Team to form relationships with professionals in the private wealth and trust industry who are interested in using annuities in trusts to manage taxes and control income for multiple generations. In 2017, we also introduced ‘Retire on Purpose’, a new platform with a focus on thoughtful life planning as a crucial first step towards creating a comprehensive financial plan. The presentation and its accompanying materials are designed to help advisers build richer relationships with their clients and integrate a more holistic approach to financial and life planning in their practices. Jackson has been simplifying the language used around financial products to make them clearer and more transparent for consumers, and change the conversation to focus on planning for the lifetime income consumers need to live well throughout their lives. To promote this simple language approach, Jackson has launched a new website, The Financial Freedom Studio (www.jackson.com/financialfreedomstudio/), which now serves as the company’s central content ‘hub.’ The site is an evolution and expansion of the financial education resource for consumers, the Center for Financial Insight. UK and Europe Growing customer demand for comprehensive financial solutions was at the heart of our announcement in August 2017 that we were combining our asset manager, M&G, and Prudential UK & Europe to form M&G Prudential, a leading savings and investments business. The combined business manages £351 billion of assets for more than six million customers, both in the UK and internationally, and will leverage its scale, financial strength and complementary product and distribution capabilities to enhance the development of capital‑light, customer‑focused solutions. The new entity combines M&G’s active investment expertise with Prudential UK & Europe’s capabilities in volatility‑adjusted savings and liability‑driven investment to provide more choice for customers across both brands through retail, institutional and direct channels. The unified business is also better positioned to develop and fund joint product propositions and to build new digital service and distribution to meet fast‑changing customer needs. With core strengths in with‑profits and retirement solutions, M&G Prudential is well positioned to continue to meet the growing needs of customers taking on the responsibility for managing their own savings, following reform of the UK’s pension and retirement income system in 2015. The Prudential Retirement Account, which allows customers to save flexibly for their retirement and access their retirement income, has proven extremely popular since launching at the end of 2016, accumulating assets under management of £7.2 billion in its first year. www.prudential.co.uk Annual Report 2017 Prudential plc 69 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued In investment management, M&G Prudential is a long‑term investor that takes seriously its responsibilities as a steward of clients’ assets. Our fund managers believe that if a company is run well it is more likely to be successful in the long run. Regular meetings with company directors allow us to identify whether a company’s strategy is aligned with our interests as long‑term shareholders and the interest of our customers. Active voting is an integral part of our investment approach, both adding value and protecting our interests as shareholders and those of our customers. We provide transparency on our voting record by publishing it quarterly on our website at www.mandg.com/about‑us/responsible‑ investment/equities/voting‑history/ In 2017, we launched myM&G, a new online investing service. Over 90 per cent of our direct customers will benefit from lower fund charges if they move their old paper‑based account to the online service, which is free to join and carries no platform or service fee. A customer with £100,000 invested across M&G equity funds which offer R class shares, for example, should save at least £5,000 in fees over 10 years by switching their account to myM&G. At M&G, we actively involve our customers in the development of services such as myM&G, as well as new products and investor communications. This is achieved through engagement with end investors, including our Client Council, our own panel of around 400 direct customers. During 2017, our principal research focus has been to engage with private investors, including those in our Client Council, to understand the role that socially responsible investing plays in driving their investment decisions and how they would like to receive more information about responsible investment. In Africa, we are continually looking for new ways to meet our customers’ needs, and in 2017 we rolled out a new ‘never lapse’ feature in Ghana. This addresses one of the main concerns our customers in Ghana have about insurance – that unforeseen circumstances might lead them to miss premium payments on their insurance policies and result in them losing their benefits. This new feature ensures that, beyond the first policy year, the policy will never lapse or become inactive. The feature is due to be rolled out in Kenya, Uganda and Zambia in 2018. Investing for positive change As an asset manager and asset owner, we have the ability to affect positive change, indirectly through the direction of our capital and our customers’ capital. We allocate our customers’ capital into projects that fuel economic growth and improve the quality of people’s lives, including through investments in affordable homes, transport programmes that cut commuting times, broadband networks that connect people and power stations using clean energy. These investments translate into strong, reliable returns for our customers and tangible benefits for the communities we serve. The long‑term nature of the promises we make to our customers and clients makes long‑term investments in infrastructure an ideal way of ensuring we can afford to meet those promises in full. In 2017, Eastspring Investments announced a significant step forward in our infrastructure investment capabilities. IFC, part of the World Bank, chose Eastspring as its first Asian partner in a programme that mobilises funds from institutional investors into projects in emerging markets. This US$500 million partnership will help us scale up our skills in the region. Worldwide, 1.2 billion people still have no access to electricity and 660 million lack a clean source of drinking water. This programme will help at least some of those people get these basic amenities, while at the same time helping our customers meet their own vital savings needs. Our investment teams in Asia, Europe and the US are all working hard to invest with a positive purpose. Developed economies may not face the same basic threats to survival that are found in emerging markets, but traffic congestion, electricity ‘brown‑outs’ and rural broadband black spots can constrain economic growth and make daily life frustrating. M&G Prudential is innovating in this important field. Our new Greenfield Fund will enable our clients to participate in infrastructure projects at an earlier stage than was previously possible, which will translate into stronger returns and more essential projects receiving the funding they need. The UK government in 2017 recognised our skills in this area by appointing M&G Prudential to manage a portion of its £400 million Digital Infrastructure Investment Fund, aimed at kick‑starting better broadband connections across the country. In the US too we are investing in important infrastructure. PPMA, our American asset manager, is helping states such as California and Texas meet their ambitious green energy targets and reduce the risk of future power shortfalls, with investments in wind and solar generation. We have also made a recent investment in new storage batteries, which enable consistent power delivery from renewable sources. The value we provide through investments in the real economy and through our products 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. Supporting local communities 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. In addition, we believe it is important to make a contribution to delivering the United Nation’s Sustainable Development Goals and we are supportive of those priorities. Education and life skills Cha-Ching – the first global financial education programme Developed by Prudential, Cha‑Ching is the world’s only global financial education platform aimed at primary school‑aged children. Now in its seventh year, the programme has expanded from its origins in Asia to each of the four continents where the Group does business. In all of the markets where it has been launched it has been very well received, with positive feedback from parents, teachers, children and political stakeholders. In Asia, the programme reaches over 34 million households a day through a multi‑distribution platform including Cartoon Network, and through a school contact programme that has reached more than 300,000 children since inception. The standardised Cha‑Ching curriculum developed in partnership with Junior Achievement has been well received and 70 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Jackson National Life Insurance with Junior Achievement, US Jackson volunteers worked with Junior Achievement Middle Tennessee (JA) to teach work‑readiness, entrepreneurship and financial literacy skills through hands‑on programmes in schools, and led a programme at the Nashville Rescue Mission, a shelter for families experiencing homelessness. Through this partnership, JA was able to reach students outside the traditional classroom and provide experiences to help young people break the cycles of financial and personal hardship. Jackson volunteers joined nearly 700 students at a STEM (science, technology, engineering and mathematics) Summit, which combined hands‑on activities in the fields of science, technology, engineering and mathematics with a career panel from employees in many fields of the local economy. Colleagues also provided support at the JA Finance Park, an experiential budgeting simulation facility to help students build a foundation for smart financial decisions. rolled out to more than 90,000 students in Indonesia, the Philippines and Malaysia. In addition, Cha‑Ching increased its presence during the year on digital platforms, including a new smartphone app called the ‘Cha‑Ching Challenge’, which helps further engagement with children. In the US, the Jackson Charitable Foundation has introduced Cha‑Ching nationally in a partnership with Discovery Education and Junior Achievement USA. The Jackson Charitable Foundation has integrated Cha‑Ching videos and lessons into Junior Achievement’s third grade classroom programme, which is funded by the Foundation for six years and is expected to reach approximately 2.7 million students over that time, in 15,000 classrooms annually throughout the country. The partnership with Discovery Education is aimed toward supporting educators and includes free classroom activities and teacher guides to use Cha‑Ching in their classrooms and will reach more than 1 million students across the country. In the UK, working with Young Enterprise, we have developed an online educational resource for primary school students in England and Wales that has enabled the Cha‑Ching programme to be brought into the classroom. The Quality Marked teaching resource is linked to the Personal Finance Education Group’s Financial Education Framework and has guidance for teachers on how most effectively to integrate activities into their teaching as well as activities for home‑learning. Since launch in late 2016, the resource has been downloaded over 20,000 times in more than 650 schools across the UK. In other markets, the online educational resource has also been utilised to support the roll‑out of the Cha‑Ching programme across our African markets as part of a financial literacy campaign delivered jointly by Junior Achievement Africa and Prudential Africa employees. Cha‑Ching was launched in Poland in 2015 and the first 10 films were translated into Polish and aired on several children’s television channels. A website with materials for children and teachers was created to share in local schools. First Read – developing children’s skills 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 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 and count together. It also helps parents understand the importance of healthy and nutritious food for children’s development. Since First Read’s inception, over 270,000 children and adults have benefited directly and over 540,000 community members indirectly. In 2018, the partnership will continue, with Save the Children focusing on quality implementation and building a strong evidence base to demonstrate First Read’s impact. Fostering careers in IT and coding Through four programmes, Jackson’s IT employees are devoting considerable personal time and skills toward increasing IT exposure to diverse youth in Middle Tennessee. In 2014, Nashville IT associates adopted a small coding club at Woodland Middle School in Williamson County. The programme has gained momentum through Jackson and other local businesses’ volunteers. So much so, that after seeing the impact of volunteer efforts alone, the school system invested in paid training for teachers to further support and professionalise the efforts. www.prudential.co.uk Annual Report 2017 Prudential plc 71 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued Female colleagues encourage careers in finance Since 2014, Jackson has supported Rock the Street, Wall Street (RTSWS), a charity that increases financial literacy and interest in finance careers for high‑school girls. What began in 2014 with a field trip to the Jackson Sales Desk has grown over time, with Jackson now sponsoring two RTSWS classes at Ravenwood and Centennial High Schools. Sponsorship of a class is much more than the financial contribution, also entailing five female sales professionals teaching a six‑week curriculum, hosting students for a field trip, pairing students with female finance professional mentors and creating job shadow experiences with their mentors. Supporting young people with employability and financial skills M&G Prudential is a partner member of the KickStart Money primary financial education programme. The programme aims to reach 20,000 primary school children and focuses on saving, budgeting, careers, borrowing and consumer and public finance. Through three secondary school partnerships in Paddington, Reading and Stirling, Prudential UK has also been directly involved in building the knowledge and skills of young people. These partnerships have supported over 3,700 young people since 2013, with 360 employees giving their time and sharing their knowledge and skills. The M&G business is a supporter of The Lord Mayor of London’s Appeal Charity, which aims to work towards a City that is healthy, skilled, inclusive and fair. Prudential’s partnership with MyBnk, which delivers financial literacy programmes in secondary schools in London, helped develop money skills for 5,000 young people in secondary schools in deprived areas of the capital. Secondary school scholarships across Africa In our new markets in Africa we have committed to provide support for academically able but financially disadvantaged high school students, and to help build capacity for training in actuarial sciences at local universities. Prudential has worked with a number of charities operating in Ghana, Kenya, Uganda and Zambia by funding educational programmes and projects since 2014. Education and gender equality are key priorities and we have already provided scholarships to 700 young people on the continent and expect to reach over 1,000 more in the near future. These programmes have focused on allowing vulnerable children in these countries to access quality education through the provision of scholarship awards, as well as ensuring that those marginalised by society receive education, skills and support. Disaster readiness and relief Helping to make Asia more prepared and safer As a life insurance and asset management company, our core business is to help protect and reduce the vulnerability of individuals and their families in the face of unfortunate events. Asia Pacific is the world’s most disaster‑prone region so Prudence Foundation is working with humanitarian and private sector organisations and governments to help communities better prepare for disasters and also, when required, provide immediate emergency response and longer‑term recovery support. Aligned with aiming to protect communities and make them less vulnerable in emergency situations, Prudence Foundation launched its third Safe Steps programme in September 2017. Safe Steps First Aid is in partnership with the International Federation of Red Cross and Red Crescent Societies (IFRC) and National Geographic. It builds on the success of its previous two Safe Steps programmes, which focus on natural disasters and road safety. Safe Steps First Aid provides essential, easy‑to‑understand first aid information to millions of people throughout Asia. Safe Steps is a first‑of‑its‑kind, in terms of reach and breadth of partnerships, pan‑Asian public service initiative to enhance awareness through the dissemination of educational survival tips for natural disasters, road safety and first aid. It is a multi‑platform programme including on‑air video messages and informative website and educational collateral that can be shared among communities. Core to the programme is a series of 60‑second educational videos that advise individuals and households on what to do should a natural disaster strike, how to be safe on the roads and what to do if they encounter a first aid emergency. The programme has been well received and partnerships continue to be formed across Asia, helping to spread the messages, including free‑to‑air channels, radio stations and cinema. Through these partnerships, Safe Steps currently reaches more than 200 million people a day in Asia. Safe Schools programme Prudence Foundation supports 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 supports the organisation of disaster simulations and evacuation drills for students and their communities. Since 2013, more than 82,000 students and 33,000 teachers have participated. Volunteering to build disaster-resilient homes Prudence Foundation continues to provide support to major emergency relief efforts across Asia. During 2017, Prudence Foundation completed its long‑term commitment to support the Typhoon Haiyan/Yolanda disaster recovery efforts in the Philippines. In March, around 70 volunteers spent one week helping to complete the building of 126 homes with partner Habitat for Humanity and the local government. In total, almost 400 regional volunteers have donated their time and skills to help Bantayan Island since 2014. 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 2017 the emergency fund was used 81 times and reached over a million people in 40 countries caught up in emergencies. This included help for casualties of heavy monsoon rains in India, Bangladesh and Nepal, a mudslide in Sierra Leone, an earthquake in Mexico and hurricanes in the US. Social inclusion Commitment to social inclusion in the UK through Prudential RideLondon In the past five years Prudential RideLondon has raised over £50 million for charity and become one of the UK’s largest fundraising events. In 2017, more than 846 72 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: PruGoals programme, UK Prudential’s PruGoals programme provides inspiration and support for disadvantaged young people, helping them build confidence and employability and encouraging personal motivation. The programme provides aspirational challenges and workshops leading up to the Prudential RideLondon‑Surrey 46 mile cycle ride, and participants are provided with bikes, training and equipment, as well as coaching and mentoring. Around 260 students completed the PruGoals programme in 2017 as part of Prudential’s partnership with Teach First and Greenhouse Sports, and 82 per cent said that taking part in PruGoals had changed their mindset in a positive way. Jessica, aged 16, said: ‘I have developed motivation skills and learnt that I can complete anything if I put my mind to it’, and Fatima added: ‘I’ve realised as part of this programme that a strong mindset is important. If I want to accomplish something, I can.’ charities benefited from riders’ fundraising, up from 740 in 2016. Prudential has sponsored the event since inception in 2013 and, as part of our renewal of the sponsorship in 2016, we decided to refocus support to concentrate on charity and community engagement. The PruGoals programme helps young people to achieve their goals regardless of social or economic background by providing aspirational challenges culminating in taking on the Prudential RideLondon‑Surrey 46. In 2017 this programme supported 300 disadvantaged young people to take part in the Prudential RideLondon‑Surrey 46. Following the success of the 2016 ‘Fixing Dad’ documentary, in 2017 Prudential supported the ‘Fixing Challenge’. The new challenge followed four people hoping to improve their type‑2 diabetes, weight issues or weight‑related health concerns. As with Fixing Dad, the culmination of the Fixing Challenge shows the four individuals taking on the challenge of Prudential RideLondon‑Surrey 100 and having their journey filmed as part of a new documentary. 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 strengthen families and increase economic opportunities through bi‑annual grants in communities where Jackson’s 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. Enhancing later life Building on previous Age UK programmes, Prudential is funding the Later Life Links programme with the charity, providing long‑term companionship, advice and practical help to older people. Launched in six UK communities in February 2017, the programme has supported over 9,000 older people in its first year. Last year also saw the launch of a new partnership with Royal Voluntary Service (RVS). First Time for Everything events run in 11 RVS centres, providing around 1,200 elderly people in 2017 with a chance to try something for the first time for free, such as tai chi, yoga and drawing, aiming to tackle loneliness and social isolation with the support of RVS volunteers. Apprenticeships in the UK Youth unemployment is a huge social challenge and M&G Prudential is helping to shape future job prospects for young people. Over the past five years Prudential UK has recruited over 200 young people to our apprenticeship programme. Based at our London, Reading or Stirling offices, apprentices gain important paid work and life skills as well as achieving recognised vocational and professional qualifications. In 2017, 40 apprentices completed a 13‑month apprenticeship. 93 per cent secured ongoing employment with Prudential, while others choose to work elsewhere or move on to higher education. In 2017, the UK business was recognised as a ‘Top 100 Employer for 2017‑2018’ by RateMyApprenticeship. The clear benefits to both the young people and to the business mean Prudential is committed to continuing the apprenticeship programme but with an increased focus on social inclusion. Twenty two apprentices joined Prudential in 2017 on the apprenticeship programme, which targets GCSE and A‑level school leavers, and in 2018 12 trainees will join the traineeship programme, which is aimed at recruiting young people aged 16 to 24 not in employment, education or training. M&G has run its Apprentice programme for the last six years and, as part of Investment20/20, offers the scheme to encourage school leavers to establish a career in the financial services industry. The programme is designed to help people without degrees start their careers, straight after sixth form or college, providing an opportunity to receive on‑the‑job training and earn a competitive salary. A total of 65 apprentices have been hired by the business since 2012 across all Business Units, including fund management teams. One of the benefits of this programme is that the positions are permanent and training and development is undertaken from the outset. www.prudential.co.uk Annual Report 2017 Prudential plc 73 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued Support for disadvantaged communities M&G supports disadvantaged communities near its offices and during 2017 more than 190 charities received support either by donation or as a result of employee volunteering. Grants typically focused on education, medical research, social and welfare programmes and children and youth projects. In 2017, M&G continued its support of the City Giving initiative led by the Lord Mayor of London’s Appeal, and an onsite event showcased the services provided by charities that had received support from M&G. 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. M&G continues to sponsor the RHS Chelsea Flower Show and is refocusing the sponsorship to increase charitable activity through support of RHS campaigns such as Greening Grey Britain, which aims to transform urban grey spaces into community green spaces. Employee 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 227 per cent. Last year 8,500 colleagues around the world took part, volunteering over 35,000 hours to support 30 projects. 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. 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 2017, the Group spent £25 million supporting community activities. The direct cash donations to charitable organisations amounted to £19.2 million, of which approximately £4.9 million came from our UK and EU operations. The remaining £14.3 million was contributed to charitable organisations by Jackson National Life Insurance Company and Prudential Corporation Asia. The cash contribution to charitable organisations from our UK and EU operations is broken down as follows: education £2,971,000; social, welfare and environment £1,861,000 and cultural £62,000. The balance includes in‑kind donations as set out on the Group website at www.prudential.co.uk/responsibility/ performance/community‑investment and prepared in accordance with LBG guidelines. This included 9,460 employees who dedicated 96,493 hours of volunteer service in their communities. Furthermore, £412,375 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 2017. Valuing our people We strive to foster an environment in which employees can derive meaning and empowerment from their work and feel that they are making an active contribution to the organisation. In addition to the core principle of providing interesting work and challenging opportunities to engage our people we drive employee engagement through an array of initiatives across our businesses. These include colleague appreciation programmes, wellbeing programmes, employee engagement surveys, networking opportunities with peers and senior leaders across functions, employee focus groups, and volunteering activities. The success of our engagement efforts has again been recognised externally by winning prestigious awards. For example, in 2017 M&G Investments was ranked number one Asset Manager in both the HITC Best Places to Work and the RateMyPlacement Top 100 employers surveys. Our businesses, including Group Head Office, have processes, and where appropriate a policy, in place for engaging with employees. In addition, our businesses in the UK have a longstanding relationship with the union Unite. We encourage volunteering through which our employees can support our communities and acquire new skills. See page 76 for further detail. Diversity and inclusion Prudential believes that diversity of experience and background is vital to success, both today and in the future. The Board has made D&I one of the strategic objectives for Prudential. Tim Rolfe, Group HR Director, is the executive responsible for sponsoring D&I activities across the Group, with Nic Nicandrou, Chief Executive of Prudential Corporation Asia, acting as the Board member accountable for D&I work. 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, sexual orientation or professional and educational background. 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. 74 Prudential plc Annual Report 2017 www.prudential.co.uk Adding more to life: Prudential Charity Trustee programme, UK Colleagues have been taking part in the Prudential Charity Trustee programme to develop valuable skills to become trustees on charity boards. A series of training workshops outlined what was involved in becoming a trustee and the skills and time required. Working with our charity partner, Getting on Board, colleagues were then given help to find the right role. Melissa Kantor, from Prudential plc’s Group Talent team, is now a trustee for SEED Madagascar, which is working to alleviate poverty and maintain the island nation’s unique environment. ‘Since joining SEED’s board in May, I have learned much about functions outside my main areas of expertise and I hope to continue to be challenged outside my comfort zone’, said Melissa. ‘I am thrilled to be able to assist SEED by leveraging my corporate experience, largely around HR, relationships and governance.’ Tony Jones, Chair of Trustees at SEED Madagascar, said: ‘We have been fortunate recently in appointing two enthusiastic trustees with very relevant skills for us. Coming from major institutions which encourage staff to get involved in the third sector, we have enhanced our capacity to manage change more effectively and also to ensure our own staff and volunteers are properly motivated and rewarded.’ Photo © SEED Madagascar. We aim to foster a working environment where individuals are empowered and differences recognised. We aspire that over time our senior management, including our Board, better represents the experiences and backgrounds of our customers and stakeholders. We recognise that diversity contributes to effectiveness and is essential for successfully delivering the strategy of an international Group. We are committed to recruiting and developing the best available talent and appointing the most appropriate candidate for each role while at the same time ensuring appropriate diversity of experience, skillsets and professional background. Further information on the diversity of our Board, our policy in respect of this, how this is implemented and the associated results in 2017 can be found in our Governance statement on page 101. We have a strategic, long‑term approach to D&I and the Board monitors progress regularly. We invest in targeted activity across 10 priority areas, ranging from unconscious bias training to mentoring and support for various affinity groups. In addition our commitment to D&I is supported, across our businesses, by initiatives such as reviews of pay, performance management consistency, providing training to staff, engaging with recruitment firms and awareness campaigns to diversify the pool of potential candidates. For example, 268 senior managers and executives from our businesses in Asia, the US and the UK participated in unconscious bias workshops in 2017. We sponsored Dive In, the D&I festival in insurance and the financial sector, which took place in 17 countries in the Americas, Asia, Africa, the Middle East and Europe, and we published the first Group‑wide D&I newsletter for all employees. We are committed to developing a robust and diverse talent pipeline and increasing representation of women in senior positions in the Group and on the Board. We were among the first cohort of companies to sign the HM Treasury Women in Finance Charter in 2016. In 2017, we monitored progress against our target of 30 per cent of women in senior management by the end of 2021. We will continue to focus effort toward achieving our aim to have 27 per cent women in senior management by the end of 2019. Please see Basis of Reporting at www.prudential.co.uk/~/media/Files/ P/Prudential‑v2/content‑pdf/basis‑of‑ reporting‑2017 for the definition of senior managers. Gender diversity: senior management We are committed to supporting women who aim to return to work after an extended career break. As an example of this commitment, in 2017 Eastspring Malaysia launched the ‘Career Comeback for Women’ programme. In the US, Jackson sponsored a 10‑stop national speaking tour focusing on women’s empowerment. As part of our diversity agenda more broadly, at M&G Prudential, 57 employees qualified as mental health first aiders this year and M&G Real Estate was awarded the National Equality Standard. In Africa the Prudential Actuarial Support System supports the top 10 graduates in Ghana and the top three in Kenya, helping them with exam fees. Group Head Office (GHO) also rolled out the ‘PruThrive’ programme for colleagues, covering physical health, mental wellness and inclusivity. In addition to the established Prudential Women’s Network and M&G Pride (for LGBT employees and allies), several new affinity group networks launched, focusing on mental health, disability and cultural awareness. Across all businesses and at GHO, more than 20 initiatives supported schools and students, often from underprivileged backgrounds. 75% 83% Male Female 2017 2017 25% 2012 2012 17% www.prudential.co.uk Annual Report 2017 Prudential plc 75 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued Prudential headcount as at 31 December 2017 – total population Headcount Total Male Female Undisclosed2 Unspecified3 Chairman & Independent Non‑executive Directors Executive Directors Group Executive Committee (GEC) Includes Executive Directors Senior managers Excludes the Chairman, all directors and GEC members Whole company1 full time equivalent 9 6 11 92 = = = = 8 5 10 69 1 1 1 23 Includes the Chairman, all directors, GEC members and senior managers 24,711 = 11,777 12,864 23 47 Notes 1 Excludes Prudential Corporation Asia joint ventures 2 3 No specification or information is captured on gender for an immaterial number of our employees. These employees are recorded as ‘unspecified’. In many of our businesses, we provide our employees with the option to not disclose their gender. For these employees, gender is recorded as ‘undisclosed’. 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. Our Business Units implement policies and practices at a local level that aim to ensure compliance with statutory and regulatory requirements in the local labour market and the prevention of slavery, human trafficking, child and forced labour. As a global business, focused on our customers, it is important that our employment models reflect the markets in which we operate. In certain markets, this means hiring local agents to sell our products, or partnering with joint ventures to offer the breadth of products and services that meet our customers’ needs. We are clear – slavery, human trafficking, child labour or any other abuse of human rights has no place in our organisation or supply chain. This supply chain includes our joint ventures and the agents we use to distribute our products. For further information around how we manage slavery, human trafficking, child and forced labour risks, refer to our forthcoming Modern Slavery Statement. 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 a relevant 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 2017, 120 senior high‑potential individuals participated in our established and well respected Group‑wide leadership development programmes ‘Impact’ and ‘Agility’ and the ‘Next Generation’ emerging talent programme. These programmes were developed in partnership with world‑ leading academic institutions and co‑delivered with business school thought leaders. Within our businesses there are many examples of our continuing commitment to talent development. In 2015 we launched a Group‑wide Long‑Term Workforce Planning Initiative, which has progressed in 2016 and 2017. For example, in 2017 Prudential Corporation Asia deployed strategic workforce planning to predict the capabilities required to ensure our continued success utilising a succession‑ driven talent strategy to build the next generation of leaders with the capabilities we require. In the US, Jackson offers customised on‑premises programmes, as well as access to an online university, to meet the personal and professional development needs of employees with all levels of experience. M&G Prudential supports talent development through a range of development programmes to increase personal and organisational capability alongside bespoke development support for key individuals. GHO provides innovative programmes designed in partnership with top academic institutions and industry experts ‑ focused on early career development, leadership development, and opportunities to develop a strategic and innovation mindset through varied career experiences and projects. Employee engagement We want to foster an environment in which employees can derive meaning and empowerment from their work and feel that they are making an active contribution to the organisation. We drive employee engagement through an array of initiatives, including colleague appreciation programmes, wellbeing programmes, networking opportunities with peers and senior leaders across functions, employee focus groups, and volunteering activities with charitable causes such as Prudential UK’s partnerships with numerous schools. Each of our businesses manage their own activities including employee engagement surveys, regular employee open‑forums with senior management, and away days to discuss business performance and internal management. The success of our engagement efforts has again been recognised externally by winning prestigious awards. For example, in 2017 M&G Investments was ranked number one Asset Manager in both the HITC Best Places to work and the RateMyPlacement Top 100 employers surveys. 76 Prudential plc Annual Report 2017 www.prudential.co.uk Our businesses, including GHO, have processes, and where appropriate a policy, in place for engaging with employees. Reporting to Group HR is required on jurisdiction specific or sector specific trends and developments in certain areas. For any significant issues that are likely to impact either positively or negatively on our reputation as an employer – at both business and Group level – immediate reporting to Group HR is required. In addition, our businesses in the UK have a longstanding relationship with the union Unite. We encourage volunteering through which our employees can support our communities and acquire new skills. See page 74 for further detail. Performance and reward Our reward arrangements are designed to attract, motivate and retain high‑calibre people. Each individual contributes to the success of the Group and is rewarded accordingly. We recognise and reward high performance and are committed to a fair and transparent system of reward. We have recently reported our 2017 UK gender pay gap figures/data along with information about how we are working to increase the number of women in leadership, investment management and senior operational roles. Remuneration 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 have done so. There are recognition initiatives running across our businesses, such as the Jackson High Five Recognition Program, which allows individuals to recognise when their colleagues go above and beyond, and for Prudential Stars awards at GHO, in which individuals can nominate their colleagues to recognise examples of exceptional contributions, specifically in the areas of delivering synergy, adding value, fostering innovation, demonstrating stakeholder focus and maintaining risk awareness. We also believe in the importance of giving employees the opportunity to benefit from the Group’s success through share ownership, and operate 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. Of all eligible employees, 59 per cent participate in the Group’s UK Sharesave and 25 per cent in the share incentive plans. Protecting the environment and managing the risks from climate change We take a long‑term and holistic approach to managing the risks and opportunities posed by climate change and our impact on the environment and strive to play our part in reducing both our direct and indirect impacts where possible. Our long‑term approach includes investing in the low‑carbon economy, measuring and improving the environmental performance of our global operations and reducing the impact of our investments on the environment. Managing our climate-related risks and opportunities As a life insurer, asset owner and manager, we are long‑term stewards of our customers’ assets and we recognise the challenge that climate change presents. We also recognise our responsibility to customers, society and the environment to effectively integrate associated considerations into investment decisions and fiduciary and stewardship duties and help finance the transition to a more sustainable economy. Active consideration of ESG factors is integral to our stewardship responsibilities. For example, in 2017 M&G Prudential joined Climate Action 100+, an initiative bringing together more than 250 global institutional investors to engage with the world’s largest corporate greenhouse gas emitters to improve climate‑related financial disclosure and curb emissions, and in October M&G Prudential launched the ESG Global High Yield Bond Fund, which fully integrates ESG factors into its investment process. In February 2018 Eastspring became the third Prudential signatory to the United Nations Principles for Responsible Investment, joining PPMSA and M&G. Further information on the indirect environmental impact of our asset management activities is available in our forthcoming ESG Report. In 2017 the Financial Stability Board (FSB) published the recommendations of its Task Force on Climate‑Related Financial Disclosures (TCFD). We welcomed the release of these recommendations, which provide additional guidance in this area. Currently, our oversight in this area is provided at Group Executive Committee level by the Group’s ESG sponsor, Jonathan Oliver, Group Director of Communications, who has responsibility for our corporate responsibility strategy and activities more broadly. The Board approves the Group’s annual ESG Report, which is also reviewed by the Group Audit Committee and Group Disclosure Committee. We are in the process of refreshing our enterprise‑wide assessment of climate‑related risks, while also establishing the internal capabilities needed to make enhanced climate‑related financial disclosures in future reporting periods, considering the geographical and asset class breadth of our investment activities. Managing our direct environmental impact Managing the climate‑related risks facing our business is crucial to creating long‑term value for our customers, shareholders and the communities of which we are part. As an occupier of approximately 400 properties worldwide, we recognise the importance of our own internal environmental targets and decarbonisation goals in reducing our direct footprint. In 2017, we decreased our absolute greenhouse gas (GHG) emissions (scope 1 and 2) from our occupied estate and company‑owned vehicles by 5 per cent to 70,723 tCO2e (2016: 74,315 tCO2e). This was driven by consolidation of our property portfolio and continued investment in energy efficiency initiatives through our mechanical and electrical life cycle replacement programmes to ensure that we occupy efficient buildings. When normalised against net lettable floor area, our GHG emissions efficiency metric improved by 2 per cent to 148 kgCO2e/m2 in 2017 (2016: 151 kgCO2e/m2). Prudential Group Scope 1 and 2 GHG Emissions tCO2e 37,536 71,104 14,893 74,315 15,035 70,723 2015 2016 2017 Investment Estate Occupied Estate www.prudential.co.uk Annual Report 2017 Prudential plc 77 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCorporate responsibility review continued Adding more to life: Jackson, a star performer In 2017, Jackson were awarded a U.S. Environmental Protection Agency (EPA) Energy Star for a second building on our Lansing campus, demonstrating superior energy efficiency. Commercial buildings that earn EPA’s Energy Star certification use an average of 35 per cent less energy than typical buildings. Our new building, 8 Corporate Way, received an Energy Star score of 93 placing it in the top 10 per cent of all similar facilities nationwide. To earn the Energy Star certification, Jackson created a five‑year energy plan that included the installation of new mechanical and electrical building controls to enhance monitoring and control of all systems, improving comfort and efficiency along with the advanced lighting controls to with occupancy sensors and daylight harvesting to maximise the use of natural light. Jackson received honourable mention for best commercial project in Michigan State at the 2017 Governor’s Energy Excellence Awards. As one of the largest companies in the Greater Lansing area, Jackson’s commitment to energy efficiency and environmental conservation sets a positive example for other local companies and organisations and helps bring awareness to this important topic. We improved our CDP Climate Change disclosure and were awarded a ‘Leadership’ ranking of A‑ (2016: B) and in ClimateWise, the insurance sector climate initiative managed by the Cambridge Institute for Sustainability Leadership, we improved our score, achieving 71 per cent (2016: 60 per cent). Our performance in ClimateWise against six core principles is independently audited by PwC. We continue to develop our energy and environmental management strategies, 14 per cent of our global electricity consumption is now renewably sourced. In the UK, we successfully transitioned our environmental management system to ISO 14001:2015 and renewed our focus on waste and recycling by collecting our waste coffee grounds for energy recovery by conversion into biofuel. We are also rolling out advanced energy analytics software across our largest UK properties following a successful trial. In the US, we continue to demonstrate superior energy efficiency with an Energy Star score of 93 for our new corporate office in Lansing, placing it in the top 10 per cent of all similar facilities nationwide. In Asia we have developed an environmental management framework to review current site performance and identify opportunities for energy and water efficiency improvements for our most significant buildings. M&G Real Estate, part of M&G Prudential, has an approach to responsible property investment that enables it to manage and respond to the growing range of environmental and social issues that can impact property values. It continues to decarbonise its property estate through continued LED lighting rollout and its first UK solar photovoltaic installation, covering an area of 3,800 m2, equivalent to 15 tennis courts. It is anticipated the system will generate enough electricity annually to power the equivalent of 68 average UK households and save 165 tonnes of carbon dioxide. 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/ Further detail on our environmental performance throughout 2017 is available online and will be published in our 2017 ESG Report later in 2018, including performance against our global environmental targets framework. Prudential plc – greenhouse gas emissions statement We have compiled our global GHG emissions in accordance with the Companies Act 2006 (Strategic and Directors’ Reports) Regulations 2013. GHG emissions are broken down into three scopes; we have included full reporting for Scope 1 and 2, and select Scope 3 reporting as best practice. Scope 1 emissions are our direct emissions from the combustion of fuel, fugitive emissions and company owned vehicles. Scope 2 emissions cover our indirect emissions from the purchase of electricity, heating and cooling. We have reported our Scope 2 emissions using both the location and market‑based methods in line with the GHG Protocol Scope 2 Guidance. Our Scope 3 footprint includes UK booked business travel, global water consumption and waste generated from our investment properties with operational control, UK and US occupied properties. We continue to work with our Business Units to review the extent of our Scope 3 reporting and increase coverage where practicable. Please refer to our Basis of Reporting and supplementary reporting online for further detail on our methodology, reported consumption and drivers of variation. 78 Prudential plc Annual Report 2017 www.prudential.co.uk Emissions source (tCO2e) Scope 1 Scope 2 – Location‑based Occupied Investments Occupied Investments Scope 2 – Market‑based (supplier and residual mix) Occupied Scope 3 Scope 1 and Scope 2* Total Scope 1 and 2* Total Scope 1, 2 and 3* Carbon intensity* Investments Group Occupied Investments Group Group kg CO2e per m2 – Scope 1 and 2 only kg CO2e per employee – Scope 1 and 2 only kg CO2e per m2 – Scope 1, 2 and 3 Group Group Group * Note that when reporting Group totals, the market‑based emission are used. 2016 % Change 2017 10,498 7,703 59,227 18,751 60,225 7,332 15,313 70,723 15,035 85,758 10,2331 7,8141 62,413 21,3981 64,0822 7,0792 11,5801 74,315 14,893 89,208 101,071 100,788 3% ‑1% ‑5% ‑12% ‑6% 4% 32% ‑5% 1% -4% 0% 2017 2016 % Change 31 3.4 36 34 3.8 38 -9% -12% -5% Data notes Reporting Period: Baseline year: Independent Assurance: 1 October 2016 to 30 September 2017 1 October 2015 to 30 September 2016 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. Consolidation (boundary) approach: Operational Control Consistency with financial statements: The reporting period does not correspond with the Directors’ Report period (01 January 2017 to 31 December 2017) as it was brought forward by three months to improve the availability of invoice data and reduce 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: Scope 1 and 3 reporting uses the UK DEFRA 2017 GHG Conversion Factors. Scope 2 calculations use the IEA GHG 2017 Conversion Factors for location‑ based reporting. Market‑based reporting uses supplier emission factors for our UK REGO‑backed supply (Investment) and RE‑DISS factors where available. The Greenhouse Gas Protocol Corporate Accounting and Reporting Standard Five per cent Accounting methodology: Materiality threshold: Notes 1 2016 figure restated as accurate data became available from suppliers. 2 This figure has not been assured as not reported in 2016. www.prudential.co.uk Annual Report 2017 Prudential plc 79 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Corporate responsibility review continued 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 Prudential and Jackson 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. The boards of each of our Material Subsidiaries consider updates on corporate responsibility activities and spend in their communities on an annual basis. Code of Business Conduct Consideration of environmental, social and community matters is integrated in our Code of Business Conduct. Our code is reviewed by the Board on an annual basis. Refer to page 76 for more information. Risk assessment For more information on the risks facing our business see our Report on the risks facing our business and how these are managed on page 48. Further information on how we manage our material ESG issues and associated risks are provided in the ‘Managing our material ESG issues’ section of the Corporate responsibility review on page 64. 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, aligned with the methods and practices of the Chartered Institute of Purchasing and Supply, an industry‑recognised body. Further information on our supply chain management and performance will be provided in our forthcoming 2017 ESG Report. Strategic report approval by the Board of Directors The strategic report set out on pages 9 to 80 is approved by the Board of Directors. Signed on behalf of the Board of Directors Mike Wells Group Chief Executive 14 March 2018 80 Prudential plc Annual Report 2017 www.prudential.co.uk 03 Governance Chairman’s introduction Board of Directors How we operate Further information on Directors Risk management and internal control Committee reports Statutory and regulatory disclosures Additional information Index to principal Directors’ report disclosures Page 82 83 88 98 99 101 120 121 122 www.prudential.co.uk Annual Report 2017 Prudential plc 81 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationChairman’s introduction Robust and transparent governance supporting the delivery of our strategy Dear Shareholder This report provides an explanation of the Group’s governance arrangements and our activities in this area during 2017. Good governance encourages decisions to be made in the best interests of the business, taking account of the views of stakeholders. We aim to achieve this through a responsive governance framework that supports and challenges our executives’ decision making. Effective leadership As Chairman, one of my priorities is how we as a Board can improve and work together even more effectively. The Board undertakes an annual review of its performance, both collectively and as individuals and uses the outcomes of these reviews to drive improvements over the coming year. The actions taken by the Board in 2017 to address the recommendations of the 2016 review are set out on pages 93 and 94. An external independent evaluation was conducted at the end of 2017 in order to provide shareholders with further comfort that the Board continues to operate effectively. Details of the 2017 review can be found on page 94 and I was pleased that the review concluded that the Board’s strengths included “strong leadership in a collegiate and constructive environment”, “effective use of time and materials”, and “strong risk and control oversight”. 2017 has seen a refresh of the Board in both Non‑executive and Executive roles. The changes to the Board have highlighted the strength of our succession planning activities which have allowed us to successfully navigate a number of changes without disruption. This planning has enabled us to recruit very high calibre candidates to the Board, with diverse skills and expertise. Succession planning has therefore been a particular area of focus during the year and we continue to keep this under active review. The activities of the Nomination & Governance Committee in this respect are set out on pages 101 to 104 and all changes to the Board are set out on page 83 of this report. I would like to express my thanks once again for the contributions made by Ann Godbehere, Penny James and Tony Wilkey during their tenures and to welcome Mark FitzPatrick, James Turner and Tom Watjen to the Board. Risk and internal controls Fundamental to demonstrating good governance and stewardship is having in place processes to allow the Board to make a robust assessment of the risks facing our business and those internal controls used to mitigate them. Details of our approach to internal controls and risk management are set out on pages 99 to 100. The Audit Committee report on pages 105 to 114 describes how the Committee monitors the effectiveness of the internal control and risk management systems and the Risk Committee report on pages 115 to 119 sets out how that Committee has considered the Group’s risk appetite. Culture I continue to believe that tone is set from the top and the Board and senior management must therefore exhibit the behaviours expected throughout the Group. Individual businesses are also shaping culture locally, contributing to our shared values. Under my stewardship, our international volunteering programme, Chairman’s Challenge, has grown significantly and over 8,000 colleagues offered their time and skills to supporting the community in 2017. The Board has set itself an objective for the Group to develop a framework for a measurable, definable culture. As part of this, a risk culture survey was developed by the Risk Committee covering all businesses. The Board will continue to build on this in 2018, bringing together the many strands of initiatives around the Group. In December, the Board approved an updated Group Code of Conduct which introduced standards of business conduct. This clarifies expectations over employee behaviour and seeks to ensure employees understand the individual obligations that the Group imposes on them through our policies, including financial crime prevention, conflicts of interest, information security and securities dealing, public communications and social media, people related policies and confidential reporting. Strategic projects In 2017, the Board considered a number of strategic projects. Most notably, we announced in August 2017 our intention to merge our UK asset manager, M&G, and our UK life insurance business to form M&G Prudential. The combined business manages over £330 billion in assets for more than six million customers. Further details of the merger are set out in the Strategic report on pages 10 to 80. From a governance perspective, the Board and Audit Committee spent significant time considering the benefits of the transaction for shareholders and customers and the impact on our wider stakeholders. During the year we also announced the sale of our broker‑dealer network in the US, which was owned by our subsidiary National Planning Holdings Inc. and consisted of INVEST Financial Corporation, Investment Centres of America, Inc, National Planning Corporation and SII Investments, Inc., to LPL Financial LLC. This allows us to focus on our primary strategy in North America of being the leading manufacturer of retirement products. Looking after our stakeholders The Board continues to be aware of the impact of its decisions on all of our stakeholders. Feedback we receive from engaging with stakeholders helps us to devise and manage policies and processes. In 2017, the Group published its first environmental, social and governance (ESG) report which gave a detailed account of our approach to ESG matters. That report explains that while serving our customers is at the centre of our business, we approach other stakeholders with the same sense of responsibility and commitment, from our suppliers and employees to the wider communities in which we operate. We expect to publish our next ESG report in May 2018. Looking forward On the governance front, of key interest will be the changes proposed to the UK Corporate Governance Code, which are set to include a range of new requirements for both behaviour and reporting. Once in place, the Board and its Committees will consider how any changes will affect the way we work. On a regulatory level, the impact of International Financial Reporting Standard 17 (IFRS 17) on the Group will be further assessed following work already undertaken by the Board and Audit Committee. I hope that this report and the reports of my fellow Committee Chairs will demonstrate to you the work we have undertaken over the course of the year as well as the tangible and positive impact this has had on our business. Paul Manduca Chairman 82 Prudential plc Annual Report 2017 www.prudential.co.uk Board of Directors Chairman NG Paul Manduca Chairman Appointment: October 2010 Age: 66 Chief Executive Michael Wells Group Chief Executive Appointment: January 2011 Age: 57 Key to Committee membership Chair Au Audit Re Remuneration Ri Risk NG Nomination & Governance 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. During 2017, Paul stepped down as chairman and a member of the board of Henderson Diversified Income Limited with effect from 26 April and was appointed to the board of RateSetter (Retail Money Market Limited) with effect from 1 June and as chairman from 17 July. Paul initially joined the Board in October 2010 as the Senior Independent Director and member of the Audit and Remuneration Committees, roles he held until his appointment as Chairman in July 2012. On becoming Chairman, Paul was also appointed Chair of the Nomination & Governance Committee, having been a member of the Committee since January 2011. Other appointments — Securities Institute — RateSetter (Retail Money Market Limited) (chairman) — Templeton Emerging Markets Investment Trust (TEMIT) (chairman) — TheCityUK advisory council Relevant skills and experience Mike has more than three decades’ experience in insurance and retirement services, having started his career at the US brokerage house Dean Witter, before going on to become a managing director at Smith Barney Shearson. During his leadership of Jackson, Mike was responsible for the development of Jackson’s market‑leading range of retirement solutions. He was also part of the Jackson teams that purchased and successfully integrated a savings institute and two life companies. Mike joined the Prudential Group 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. Mike joined the Board in 2011 and was appointed Group Chief Executive in June 2015. Board changes Non-executive Directors Ann Godbehere retired from the Board at the conclusion of the Annual General Meeting held on 18 May 2017. David Law succeeded Ms Godbehere as Chair of the Audit Committee and became a member of the Risk Committee and the Nomination & Governance Committee with effect from 19 May 2017. Lord Turner was appointed a member of the Audit Committee with effect from 19 May 2017. Post year end, Alice Schroeder was appointed a member of the Risk Committee with effect from 1 March 2018. Executive Directors Tony Wilkey stepped down as a member of the Board and as Chief Executive of Prudential Corporation Asia and Nic Nicandrou succeeded him in this position. Mark FitzPatrick was appointed to the Board to succeed Mr Nicandrou as Chief Financial Officer. The effective date for these changes was 17 July 2017. Tom Watjen was appointed to the Board and as a member of the Remuneration Committee with effect from 11 July 2017. In August 2017, the Company announced its intention to merge its asset manager, M&G, and Prudential UK & Europe to form M&G Prudential. John Foley became Chief Executive of M&G Prudential and Anne Richards became Deputy Chief Executive of M&G Prudential (retaining her role as Chief Executive of M&G). Penny James stepped down from the Board and as Chief Risk Officer with effect from 30 September 2017. James Turner was appointed as an Executive Director and as Group Chief Risk Officer with effect from 1 March 2018. Pat Casey held the role of Group Chief Risk Officer on an interim basis until 1 March 2018. www.prudential.co.uk Annual Report 2017 Prudential plc 83 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationBoard of Directors continued Executive Directors Mark FitzPatrick ca Chief Financial Officer Appointment: July 2017 Age: 49 Relevant skills and experience Mark previously worked at Deloitte for 26 years, building his industry focus on insurance and investment management globally. During this time, Mark was Managing Partner for Clients and Markets, a member of the executive committee and a member of the board of Deloitte UK. He was a vice chairman of Deloitte for four years, leading the CFO Programme and developing the CFO Transition labs. Mark previously led the Insurance & Investment Management audit practice and the insurance industry practice. Mark joined the Board as an Executive Director and Chief Financial Officer in July 2017. 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. Before joining Prudential, John spent three years as general manager, global capital markets at National Australia Bank. John 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 Chief Executive of Prudential UK & Europe. John first joined the Board in 2011 as Group Chief Risk Officer and was reappointed in January 2016, having stepped down during his time as Group Investment Director. In 2017, John’s role was expanded from Chief Executive of Prudential UK & Europe to Chief Executive of M&G Prudential, the Group’s combined UK asset management and savings and retirement solutions business. John Foley Chief Executive of M&G Prudential Appointment: January 2016 Age: 61 Other appointments — European Insurance CFO Forum (chairman) — CITIC‑Prudential Life Insurance Company Limited (a Prudential plc joint venture) Relevant skills and experience Nic started his career at PricewaterhouseCoopers (PwC). 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. In July 2017, Nic became Chief Executive of Prudential Corporation Asia having originally joined the Board in October 2009 as an Executive Director and Chief Financial Officer. Nicolaos Nicandrou aca Chief Executive of Prudential Corporation Asia Appointment: October 2009 Age: 52 84 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Committee membership Chair Au Audit Re Remuneration Ri Risk NG Nomination & Governance 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. Anne joined the Board in 2016 as an Executive Director and Chief Executive of M&G. She became Deputy Chief Executive of M&G Prudential in 2017 whilst remaining Chief Executive of M&G. Other appointments — Financial Services advisory board — CFA UK Advisory — Financial Conduct Authority practitioner panel (chair) — Standing Council on Europe — IBDE advisory board Anne Richards Deputy Chief Executive of M&G Prudential and Chief Executive of M&G Appointment: June 2016 Age: 53 Other appointments — International Insurance Society — American Council of Life Insurers Relevant skills and experience 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. Barry joined the Board in 2006 as an Executive Director and the Chief Executive of Prudential Corporation Asia, leading Prudential’s Asian business through a period of major growth and development. Barry fulfilled this role until June 2015 when he became Chairman and Chief Executive of the North American Business Unit. Barry Stowe Chairman and Chief Executive Officer of the North American Business Unit Appointment: November 2006 Age: 60 Executive Director appointment post year end Relevant skills and experience James led internal audit teams in UBS in both the UK and Switzerland. Prior to joining Prudential, James was the deputy head of compliance for Barclays plc. He also held a number of senior internal audit roles across the Barclays group, leading teams that covered the UK, the US, Western Europe, Africa and Asia retail and commercial banking activities. James joined Prudential in November 2010 as the Director of Group‑wide Internal Audit and was appointed Director of Group Finance in September 2015, with responsibility for delivery of the Group’s internal and external financial reporting, business planning, performance monitoring and capital and liquidity planning. He also led the development of the Group’s Solvency II internal model. James joined the Board as an Executive Director and Group Chief Risk Officer in March 2018. Other appointments — West Bromwich Building Society James Turner fca Group Chief Risk Officer Appointment: March 2018 Age: 48 www.prudential.co.uk Annual Report 2017 Prudential plc 85 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationBoard of Directors continued Non-executive Directors NG Au Re The Hon. Philip Remnant cbe fca Senior Independent Director Appointment: January 2013 Age: 63 NG Au Ri Sir Howard Davies Appointment: October 2010 Age: 67 NG Au Ri David Law aca Appointment: September 2015 Age: 57 Ri Re Kaikhushru Nargolwala fca Appointment: January 2012 Age: 67 Relevant skills and experience Philip was a senior advisor at Credit Suisse and 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. Philip joined the Board in January 2013 as a Non‑executive Director, as Senior Independent Director and as a member of each of the Audit Committee, the Remuneration Committee and the Nomination & Governance Committee. Relevant skills and experience Sir Howard has a wealth of experience in the financial services industry, across the 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. Sir Howard joined the Board in October 2010 as a Non‑executive Director and Chair of the Risk Committee. He joined the Audit Committee in November 2010 and the Nomination & Governance Committee in July 2012. Relevant skills and experience David was the Global Leader of PricewaterhouseCoopers (PwC) 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. David joined the Board in September 2015 as a Non‑executive Director and member of the Audit Committee. David was appointed Chair of the Audit Committee and a member of the Risk Committee and of the Nomination & Governance Committee in May 2017. 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 and now serves as director and chairman of their remuneration committee. Other appointments — City of London Investment Trust (chairman) — M&G Group Limited (Prudential plc subsidiary) (chairman) — Severn Trent plc — Takeover Panel — UK Financial Investments Limited Other appointments — China Banking Regulatory Commission international advisory board — China Securities Regulatory Commission international advisory board (chairman) — Institut d’Études Politiques (Sciences Po) — Millennium LLC regulatory advisory board — Royal Bank of Scotland (chairman) Other appointments — L&F Holdings Limited (CEO) and its subsidiaries (the professional indemnity captive insurance group that serves the PwC network and its member firms) Kai has served on a number of other boards, including Singapore Telecommunications and Tate and Lyle plc. Kai joined the Board in January 2012 as a Non‑executive Director and member of the Remuneration and Risk Committees. Other appointments — Clifford Capital Pte. Ltd (chair) — Credit Suisse Group AG — Duke‑NUS Medical School (chairman) — Prudential Corporation Asia Limited (Prudential plc subsidiary) (chairman) — PSA International Pte Ltd 86 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Committee membership Chair Au Audit Re Remuneration Ri Risk NG Nomination & Governance Other appointments — Jardine Matheson Holdings (and other Jardine Matheson group companies) — Schindler Holding Limited — Shui On Land Limited — The Hong Kong‑APEC trade policy study group (chairman) — UK‑ASEAN Business Council — Vitasoy International Holdings Limited Re NG Anthony Nightingale cmg sbs jp Appointment: June 2013 Age: 70 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. Anthony joined the Board in June 2013 as a Non‑executive Director and member of the Remuneration Committee. He became Chair of the Remuneration Committee and a member of the Nomination & Governance Committee in May 2015. Ri Au 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. Alice joined the Board in June 2013 as a Non‑executive Director and member of the Audit Committee. She became a member of the Risk Committee in March 2018. Other appointments — Bank of America Merrill Lynch International — Showfer Media LLC (formerly WebTuner Corp) (chair) Alice Schroeder Appointment: June 2013 Age: 61 Au Ri Relevant skills and experience Lord Turner began his career with McKinsey & Co, advising companies across a range of industries. Lord Turner joined the Board in September 2015 as a Non‑executive Director and member of the Risk Committee. He became a member of the Audit Committee in May 2017. He 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, a member of the international Financial Stability Board and a non‑executive director of the Bank of England. Other appointments — Chubb Europe (chairman) — Energy Transition Commission (chairman) — House of Lords crossbench member (from 2005) — Institute for New Economic Thinking (chairman) — London School of Economics and Cass Business School (visiting professor) — OakNorth Bank (advisor) Lord Turner frs Appointment: September 2015 Age: 62 Re Relevant skills and experience Tom started his career at Aetna Life and Casualty before joining Conning & Company, an investment and asset management provider, where he became partner in the capital markets and venture capital division. A key architect of Provident’s merger with Unum in 1999, Tom was appointed president and chief executive officer of the renamed Unum Group in 2003, a role he held for 12 years before becoming non‑executive chairman until his retirement in May 2017. He joined Morgan Stanley in 1987 as a managing director in its insurance practice and in 1994, was appointed executive vice president and chief financial officer of Provident Companies Inc. Tom joined the Board in July 2017 as a Non‑executive Director and member of the Remuneration Committee. Other appointments — SunTrust Banks, Inc Thomas Watjen Appointment: July 2017 Age: 63 www.prudential.co.uk Annual Report 2017 Prudential plc 87 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationHow we operate Corporate governance codes – statement of compliance The Company has dual primary listings in London (premium listing) and Hong Kong and has therefore adopted a governance structure based on the UK and Hong Kong Corporate Governance Codes. The Board confirms that, for the year under review, the Company has complied with all the principles and provisions of those Codes other than the provision of the Hong Kong Corporate Governance Code set out below. A narrative description of how the Company has complied is set out in the following pages and in the Directors’ remuneration report. The Company does not comply with provision B.1.2(d) of the Hong Kong Corporate Governance Code which requires companies, on a comply or explain basis, to have a remuneration committee which makes recommendations to a main board on the remuneration of non‑ executive directors. This provision is not compatible with supporting provision D.2.3 of the UK Corporate Governance Code which recommends that the board determines the remuneration of non‑ executive directors. Prudential has chosen to adopt a practice in line with the recommendations of the UK Corporate Governance Code. The Executive Directors are the senior management population for the purposes of the Hong Kong Listing Rules. The UK Corporate Governance Code is available from: www.frc.org.uk The HK Corporate Governance Code is available from: www.hkex.com.hk How the Board leads the Group The Group is headed by a Board which the Chairman is responsible for leading. The Board is currently made up of 16 Directors, of which a majority, excluding the Chairman, are independent Non‑ executive Directors. Biographical details of each of the Directors can be found on pages 83 to 87 and further details of the roles of the Chairman, Group Chief Executive, Senior Independent Director, Committee Chairs and the Non‑executive Directors can be found on pages 89 and 90. The Board is collectively responsible to shareholders for the success of the business through: — The delivery of sustainable value to shareholders; The content of the Manual is reviewed regularly with significant changes reported to the relevant Board Committee, reflecting the developing nature of both the Group and the markets in which it operates. — Setting the Group’s strategy and overall risk appetite; — Providing leadership within a Material Subsidiary governance Material Subsidiaries framework of effective controls; and Jackson National Life Insurance Company — Monitoring management’s performance against strategic goals and ensuring sufficient resources are in place to achieve these goals. Specific matters are reserved for decision by the Board, including: — Determination of dividends; — Approval of strategic projects; — Approval of the three‑year business and financial plan; — Approval of key financial reporting including the Group’s full and half yearly Report and Accounts; and — Responsibility for the system of internal control and risk management. In making decisions, the Board has regard to the balance of interests between all relevant stakeholders, including shareholders, employees, customers, regulators and the community. Our governance framework The Group has established a governance framework for the business which is designed to promote appropriate behaviours across the Group. The governance framework outlines the key mechanisms through which the Group sets strategy, plans its objectives, monitors performance, considers risk management, holds business units to account for delivering on business plans and arranges governance. The Group Governance Manual (the Manual) sets out the policies and procedures by which the Group operates within this framework, taking into account relevant statutory, regulatory and governance matters. Business units manage and report compliance with Group‑wide mandatory requirements set out in the Manual through their Governance, Risk Management and Internal Control – Annual Statement of Compliance attestations. This includes compliance with our risk management framework, details of which are set out on pages 99 and 100 of this report. M&G Group Limited Prudential Corporation Asia Limited The Prudential Assurance Company Limited Prudential has appointed independent non‑executive directors to the boards of its four Material Subsidiary entities within the Group. Each Material Subsidiary has a board of directors led by an independent chair and an audit committee and risk committee, composed entirely of independent non‑executives. Dialogue between the Group Chair, Group Risk Committee Chair and Group Audit Committee Chair and their counterparts in the Material Subsidiaries provides an effective information flow. An externally facilitated evaluation of each Material Subsidiary board and their audit and risk committees was carried out by Lintstock Limited, a corporate advisory firm, which concluded that each of those boards and committees operated effectively during the year. The Nomination & Governance Committee is responsible for oversight of governance arrangements for the Material Subsidiaries. The activities of the Nomination & Governance Committee during 2017 is set out on pages 101 to 104. Regulatory environment The Group’s business means it is subject to regulatory requirements and oversight. The Group’s primary regulator is the Prudential Regulatory Authority (PRA). We are also regulated by the Financial Conduct Authority in the UK and by other regulators worldwide. Interactions with our regulators shape our governance framework and the Chairman and Group Chief Executive play a leading role in representing the Group to regulators and ensuring our dialogue with them is constructive. 88 Prudential plc Annual Report 2017 www.prudential.co.uk Independent scrutiny of corporate social responsibility actions As part of the Group’s focus on corporate responsibility, the Chairman has instructed the boards of our Material Subsidiaries to consider updates on corporate responsibility activities and spend in their communities on an annual basis. This initiative has added a layer of independent scrutiny and helped to ensure that those boards are close to the community and charitable activities of their business units. Board roles and governance Chairman – Paul Manduca The Chairman is responsible for the leadership and governance of the Board, ensuring its smooth and effective running in discharging its responsibilities to the Group’s stakeholders and managing Board business. Managing Board business — Responsible for setting the Board agenda, ensuring the right issues are brought to the Board’s attention through collaboration with the Group Chief Executive and the Group General Counsel and Company Secretary — Facilitating open, honest and constructive debate among Directors. When chairing meetings, ensuring there is sufficient time to consider all topics, all views are heard and all Board members, and in particular Non‑executive Directors, have an opportunity to constructively challenge management — Meeting with Non‑executive Directors throughout the year. In 2017, the Chairman met with Non‑executive Directors without Executive Directors being present on three occasions — Ensuring information brought to the Board is accurate, clear, timely and contains sufficient analysis appropriate to the scale and nature of the decisions to be made — Promoting effective reporting of Board Committee business at Board meetings through regular Committee Chair updates Membership and composition of the Board — Leading the Nomination & Governance Committee in succession planning and the identification of potential candidates, having regard to the skills and experience the Board needs to fulfil its strategy, and making recommendations to the Board — Considering the development needs of the Directors so that Directors continually update their skills and knowledge required to fulfil their duties, including the provision of a comprehensive induction for new Directors — Maintaining an effective dialogue with the Non‑executive Directors to encourage engagement and maximise their contributions Governance — Leading the Board’s determination of appropriate corporate governance and business values, including ethos, values and culture at Board level and throughout the Group — Working with the Group General Counsel and Company Secretary to ensure continued good governance — Acting as key contact for independent chairs of Material Subsidiaries — Meeting with the independent chairs of the Group’s Material Subsidiaries on a regular basis and reporting to the Board on the outcome of those meetings Relationship with the Group Chief Executive — Discussing broad strategic plans with the Group Chief Executive prior to submission to the Board — Ensuring the Board is aware of the necessary resources to achieve the strategic plan — Providing support and advice to the Group Chief Executive Representing the Group externally to shareholders and other stakeholders — Representing the Board externally at business, political and community level. Presenting the Group’s views and positions as determined by the Board — Playing a major role in the Group’s engagement with regulators — Balancing the interests of different categories of stakeholders, preserving an independent view and ensuring effective communication — Engaging in a programme of meetings with key shareholders throughout the year and reporting to the Board on the issues raised at those meetings www.prudential.co.uk Annual Report 2017 Prudential plc 89 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationHow we operate continued Group Chief Executive – Mike Wells Senior Independent Director – Philip Remnant The Group Chief Executive leads the Executive Directors and senior executives and is responsible for the operational management of the Group on behalf of the Board on a day‑to‑day basis: The Senior Independent Director acts as an alternative conduit to the Board for shareholder concerns and leads the evaluation of the Chairman: — Keeps in close contact with the Chairman and acts as — Responsible for the implementation of Board decisions sounding board for him — Establishes processes to ensure operations are compliant — Leads the Non‑executive Directors in conducting the with regulatory requirements Chairman’s annual evaluation — Sets policies, provides day‑to‑day leadership and makes — Holds meetings with Non‑executive Directors without management being present, typically at least once a year to evaluate the performance of the Chairman — Offers meetings to major shareholders to provide them with an additional communication point on request and is generally available to any shareholder to address concerns not resolved through normal channels decisions on matters affecting the operation, performance and strategy of the Group, seeking Board approval for matters reserved to the Board — Supported by the Group Executive Committee (GEC) which he chairs and 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 — Chairs the Chief Executive’s Committee (CEC) meetings which are held weekly to review matters requiring approval under the Group’s framework of delegated authorities — Keeps in regular contact with the Chairman and briefs him on key issues — Meets with key regulators worldwide Committee Chairs Non-executive Directors Each of the Committee Chairs is responsible for the effective operation of their respective Committees: — Responsible for the leadership and governance of their Committee All of the Non‑executive Directors are deemed to be independent and together have a wide range of experience used to attain the strategic aims of the Group through: — Constructive and effective challenge — Sets the agenda for Committee meetings — Scrutinising the performance of management in meeting — Reports to the Board on the activities of each Committee meeting and the business considered, including, where appropriate, seeking Board approval for actions in accordance with the Committees’ terms of reference — Works with the Group General Counsel and Company Secretary to ensure the continued good governance of each Committee during the year — The Chairs of the Audit and Risk Committees act as key contact points for the independent chairs of the audit and risk committees of the Material Subsidiaries agreed goals and objectives — Serving on at least one of the Board’s principal Committees — Engaging with Executive Directors and management at Board and Committee meetings as well as at site visits, training sessions and on an informal basis — Taking part in one‑to‑one meetings with the Group Strategy team and participation in the annual Strategy Away Day 90 Prudential plc Annual Report 2017 www.prudential.co.uk The Board has established four principal Committees whose functions are summarised below. Board Nomination & Governance Committee Audit Committee Risk Committee Remuneration Committee Chair Paul Manduca — Responsible for reviewing, maintaining and enhancing the balance of skills and experience on the Board in support of the Group’s strategic objectives — Maintains an effective framework for senior succession planning including at Board level — Recommends appointments to the Board and its principal Committees and appointments of non‑executive chairs to the boards of the Material Subsidiaries — Oversees the governance of Material Subsidiaries and the Group’s overall governance framework See Nomination & Governance Committee report on pages 101 to 104 Chair David Law — Responsible for the integrity of the Group’s financial reporting, including scrutinising accounting policies — Monitors the 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 Chair 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 — Provides advice to the Remuneration Committee on risk management considerations to inform remuneration decisions Chair Anthony Nightingale — Recommends the Directors’ Remuneration Policy for approval by shareholders — Approves 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 and approves and assesses performance targets where applicable See Audit Committee report on pages 105 to 114 See Risk Committee report on pages 115 to 119 See Remuneration Committee report on pages 124 to 157 Terms of reference for the principal Committees can be accessed at www.prudential.co.uk/investors/governance‑and‑policies/board‑committees‑terms‑of‑reference www.prudential.co.uk Annual Report 2017 Prudential plc 91 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationHow we operate continued Key areas of focus – how the Board spent its time The Board held 10 meetings during 2017. In addition to those meetings set out in the table below, the Board held a separate three‑day strategy event in June. In addition to meetings, the Board receives monthly update reports from management. Feb Mar1 May Jun Jul Aug Sep Nov Dec Strategy and implementation Approval and review of strategic priorities Strategic priorities monitoring Approval of three year operating plan Strategic projects2 Tax strategy reporting Group Chief Executive’s report Report from Committee Chairs Audit Nomination & Governance Remuneration Risk Financial reporting and dividends Chief Financial Officer’s performance report Full year Half year Group Solvency II reporting Business unit Chief Executive updates Prudential Corporation Asia North American business unit M&G Prudential3 Risk, regulatory and compliance Regulatory and compliance updates Chief Risk Officer’s report Government relations PRA relations Governance and stakeholders Governance updates Board evaluation and actions tracking Succession planning Corporate responsibility reporting and ESG Diversity and inclusion Talent review Non‑executive Directors’ fees Feedback on investor meetings Notes 1 The Board held two meetings in March 2017. 2 Strategic projects during the year included the merger of our business units M&G and Prudential UK & Europe, and the sale of our broker‑dealer network in the USA. 3 Prior to their merger in August 2017, M&G and Prudential UK & Europe reported to the Board separately. 92 Prudential plc Annual Report 2017 www.prudential.co.uk Board and Committee meeting attendance throughout 2017 Individual Directors’ attendance at meetings throughout the year is set out in the table below. Board Audit Committee Nomination & Governance Committee Remuneration Committee Risk Committee Joint Audit and Risk Committee General Meeting Number of meetings held Chairman Paul Manduca Executive Directors Mike Wells Mark FitzPatrick1 John Foley Nic Nicandrou Anne Richards Barry Stowe Executive Directors who stepped down during the year Tony Wilkey2 Penny James3 Non-executive Directors Philip Remnant Howard Davies David Law Kai Nargolwala Anthony Nightingale Alice Schroeder Lord Turner Tom Watjen4 Non-executive Director who 10 10 10 5/5 10 10 10 10 4/5 8/8 10 10 10 10 10 10 10 5/5 9 – – – – – – – – – 9 9 9 – – 9 5/5 – 4 4 – – – – – – – – 4 4 2/2 – 4 – – – stepped down during the year Ann Godbehere5 4/ 4 4/ 4 2/ 2 Notes 1 Mark FitzPatrick joined the Board with effect from 17 July 2017. 2 Tony Wilkey stepped down from the Board with effect from 17 July 2017. 3 Penny James stepped down from the Board with effect from 30 September 2017. 4 Tom Watjen joined the Board with effect from 11 July 2017. 5 Ann Godbehere retired from the Board with effect from 18 May 2017. 6 – – – – – – – – – 6 – – 6 6 – – 2/2 – 6 – – – – – – – – – – 6 3/3 6 – – 6 – 3/3 1 – – – – – – – – – 1 1 1 1 – 1 1 – 1 1 1 1 – 1 1 1 1 1 1 1 1 1 1 1 1 1 – 1 Full details of changes to the Board during the year can be found on page 83. 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 2017 During the year, the action points that had been identified in the 2016 evaluation were addressed and the Board received an update on progress against those actions in September 2017 and February 2018. Subsidiary governance – the 2016 review identified that ensuring good subsidiary governance was maintained was a continuing priority from 2015. — Group Secretariat continued to monitor and support the regular interactions between the Chairman, Audit Committee Chair and Risk Committee Chair with their Material Subsidiary counterparts; and to the Audit and Risk Committees as regular agenda items; — Subsidiary independent non‑executive directors and chairs, along with all Prudential Non‑executive Directors, were invited to a meeting at which the Executive team gave presentations on each business unit with a question and answer session. The sessions also provided the opportunity for the Prudential Board and subsidiary boards to spend time together in an informal setting; and — Group Secretariat continued its established quarterly ‘round table’ sessions with subsidiary counterparts to share governance best practices. — Reports of all material issues at subsidiary level were given to the Board Board agenda – the 2016 review noted that time spent at meetings should flex to reflect strategic priorities, with an increased focus on products and customers. — Agendas continued to be reviewed by the Chairman, Group Chief Executive and the Group General Counsel and Company Secretary, as well as other senior executives where appropriate; — The Board specifically debated at its July 2017 meeting, as part of a wider discussion on good governance, whether sufficient time was allowed for discussion and debate and concluded positively; and — The aspiration to create an information pack on products and markets for Board background information was developed into an app, which was trialled to the GEC in the first quarter of 2018. www.prudential.co.uk Annual Report 2017 Prudential plc 93 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationHow we operate continued Senior employee focus – the 2016 review noted the focus on rebuilding strength in senior management teams around the Group, following a number of successful internal promotions. — The Board met all members of the Prudential Corporation Asia executive committee as well as a number of senior Prudential Corporation Asia executives at its Jakarta sessions in April 2017. All members of the Prudential Indonesia executive committee also presented to the Board on this occasion; — The Board held a two‑day session in Craigforth in September 2017 at which the M&G Prudential executive committee and senior executives gave business and strategy updates, including on the merger of the M&G and Prudential UK & Europe businesses; — The Board received reports from all business units at its meetings on key joiners and leavers; and — A number of senior executives below GEC level presented to each of the Audit Committee and Risk Committee on a regular basis during the year. Remuneration – the 2016 review noted the growing complexity of remuneration across all UK‑listed companies and, over the course of 2017, the Board noted the increased governance focus in this area. — A training session on remuneration was established for those Non‑executive Directors who do not serve on the Remuneration Committee, to discuss the Directors’ Remuneration Policy and broader market practice information. This took place in May 2017 and further sessions will be delivered on an as‑required basis; and — A specific and detailed induction was arranged for Mr Watjen on his appointment, given his role as a member of the Remuneration Committee. 2017 review and actions for 2018 The Board undertook an external evaluation of its performance and that of its Committees in 2017. The review was facilitated by Boardroom Review Limited, a consultancy which undertakes no other business for the Company. The external nature of the review met the provision of the UK Corporate Governance Code which requires external evaluations on no less than three‑yearly intervals. The evaluation included interviews with all Board members and the Group General Counsel and Company Secretary, and attendance and observation by Dr Tracy Long at a number of Board and Committee meetings. Supporting materials to enhance the assessment team’s understanding of how the Board and its Committees operate were provided. The findings were presented to the Board in December 2017 and a collective Board discussion to exchange ideas and agree priorities arising from the report took place. The report identified a number of strengths of the Board, including strong leadership from the Chairman and Group Chief Executive; a collegiate and constructive environment; effective use of time; high quality information flow; robust risk and control oversight; appropriate tone through the Remuneration Committee; attention to leadership development and effective shareholder communication. Through the evaluation and subsequent discussion at the Board meeting in February 2018, the Board identified areas of particular focus and related actions: Theme Summary of actions Creating the right environment for critical decision making Highlighting culture on the agenda Increasing the Board’s resilience Spend additional time on site visits. Continue to hold Non‑executive Director only sessions on an as‑required basis Provide further reports to the Board on culture in 2018 and mature the Group’s strategic objective to ‘develop a framework for a measurable, definable culture’ Continue to focus on gender and other diversity in all new Board appointments. Introduce a skills map to monitor experience and expertise more formally Director evaluation The performance during 2017 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 outcome of these evaluations is reported to the Nomination & Governance Committee in February each year in order to inform the Committee’s recommendation that each Board member be put forward for re‑election by shareholders. Executive Director performance is also reviewed by the Remuneration Committee as part of its deliberations on bonus payments. 94 Prudential plc Annual Report 2017 www.prudential.co.uk Building Directors’ knowledge Induction – new Directors On appointment, each new Director is provided with a comprehensive induction, tailored to reflect the experience of the individual and his or her position as a Non‑executive or Executive Director. Our two new Directors, Mr Watjen and Mr FitzPatrick each received a full induction to the business. A summary of the general topics covered, as well as the role specific topics on which they each received comprehensive briefings, are set out in the table below. General induction programme relevant to all new Directors Role-specific induction programme for new Directors Understanding our governance Understanding our business — Tailored briefings with each business unit to gain a comprehensive understanding of each of their business models, product suites, pricing arrangements and governance structures — Introductory meetings with all Group functions — Comprehensive briefings on the regulatory environment in which the Group operates — Briefings on top risks and internal controls — Meetings with the Chairman and Group Chief Executive separately — Explanation of the Group’s strategy and business plan — Explanation of Prudential’s corporate structure, Board and Executive Committee structure — Briefings on Group governance framework and key policies — Training as needed on the rules and governance requirements of the London and Hong Kong Stock Exchanges and on fulfilling the statutory duties of a Director Mark FitzPatrick Tom Watjen — Tailored meetings with members of the Group Finance function — Company financial reporting overview on key Group issues including US GAAP differences, IFRS Insurance Performance Management, IFRS contracts and tax — Walkthrough of financial reporting disclosures — Additional tailored support in his first role as Chief Financial Officer of a global financial services operation — Human Resources‑specific induction provided by the Director of Human Resources, including an overview of Group Reward, current UK remuneration hot topics, and the role of the Remuneration Committee and business unit remuneration committees — Meeting with the Chair of the Remuneration Committee to discuss the annual cycle of Committee work, its current focus and focus for 2018 and beyond Lord Turner received a detailed briefing from the Director of Group Finance on appointment to the Audit Committee. A full description of all Board and role changes during 2017 are set out on page 83. Induction – role changes Since Mr Nicandrou was appointed Chief Executive of Prudential Corporation Asia he has continued to deepen his knowledge of the Asia business with a tour of operations across each of the 14 markets in which Prudential Corporation Asia operates. As part of his visits, Mr Nicandrou spent time with senior management, staff and agents of both Prudential Corporation Asia’s Life and Eastspring operations. He held a regional conference to provide insights on the strategic direction of the business and to discuss opportunities to broaden distribution, simplify products and services, and the role of digital technology in upgrading the way the business engages and services its customers. He has also engaged extensively with regulators, government officials, existing and prospective partners and hosted a regional investor conference. Mr Law had been a member of the Audit Committee for almost two years at the time of his appointment as Chair, which provided him with detailed knowledge of its operations and he worked closely with the outgoing Chair to ensure a smooth transition. In addition Mr Law met with the Chief Financial Officer and other members of Group Finance, the Group‑wide Internal Audit Director, the Group Regulatory and Government Relations Director and the Director of Group Compliance in preparation for his role as Chair. Mr Law attended one of each of the Material Subsidiary audit committee meetings to gain a better understanding of their operations. He also met with the Group Chief Risk Officer and other members of Group Risk to prepare him for his role as a member of the Risk Committee. www.prudential.co.uk Annual Report 2017 Prudential plc 95 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationHow we operate continued Board site visits Jakarta, Indonesia All Board members made a site visit to the Group’s operations in Jakarta, Indonesia in March 2017. The visit included presentations from the Prudential Corporation Asia executive team on regional financial performance and an overview of the asset management and life businesses across Asia. This was followed by detailed presentations by the local Indonesian executive team focusing on agency, Sharia strategy, products, operations, compliance and risk management, brand and corporate social responsibility. The Board also attended an agency ‘Greater Together’ recognition event at the Kasablanca Hall with more than 4,000 agents and visited an agency training centre and two agency offices in Menara 88 (PruVictory and PruFavor) which gave an opportunity to see the Group’s distribution in action. Craigforth, Scotland All Board and GEC members visited the Group’s operations in Craigforth, Scotland in September 2017. The visit included presentations from the M&G Prudential executive team, which gave opportunity to demonstrate to the Board the activity that had taken place in merging the M&G and Prudential life businesses. In addition, focus sessions were held to provide an in‑depth understanding of Prudential Savings & Retirement Solutions and M&G. These included sessions on the annuities business, the customer vision and strategy, distribution, investment management, transformation and culture. As well as formal presentations, the Board visited different parts of the Craigforth site for demonstrations from employees on typical processing systems and technology innovation. Continuing development of knowledge and skills During 2017, the Board and its Committees received a number of technical and business updates as part of their scheduled meetings, providing information on external developments relevant to the Group and on particular products or operations. Below is an overview of how Directors are kept up to date: — The Board holds an annual strategy session, which allows for detailed updates on each of the business units and deep dives on strategic direction and objectives for the Group; — The Board receives updates on brand and corporate responsibility activities, usually once a year; — The Board receives updates at each of its full Board meetings on corporate governance, political and regulatory developments, and the dynamics of equity and currency markets. In 2017, this included updates on the political environment, such as Brexit and tax reform in the USA. The Board also considered MiFID II, the General Data Protection Regulation, the Modern Slavery Act, and the review of the FRC’s UK Corporate Governance Code; — In December 2017, the Group ran a focused cyber training session for members of the Risk and Audit Committees, which was open to all Directors; — The Board reviews each business unit at least once a year and conducts periodic site visits as part of this. In 2017, the Board met in Jakarta, Indonesia and Craigforth, Scotland. Details of the activities undertaken on these visits are set out above; — The Board and the Risk Committee receive regular updates on market developments and key risks, including updates on Solvency II and cyber risk. The Risk Committee reviews top risks on an annual basis and deep dives into specific topics in response to the identification of key risks. This review covers the financial, operational and strategic risks, whilst also identifying and addressing business environment and insurance risks within the Group. The identification of such risks inform the risk reporting provided to the Committee and the Board; — The Audit Committee receives updates on developments affecting financial reporting and the role of audit committees generally. In 2017, this included updates on MiFID II, audit matters for consideration, and financial reporting disclosures as well as forward looking consideration for IFRS 17; and — The Remuneration Committee receives updates on regulatory and governance developments affecting the Group’s remuneration arrangements. In 2017, these included the PRA’s guidance on Solvency II remuneration requirements, the Investment Association Principles of Remuneration, BEIS Corporate Governance reform concerning remuneration and gender pay gap reporting. Further information on the activities of the Board and its Committees can be found in the tables explaining how the Board and its Committees spent their time on pages 92, 102, 107, 117 and 133. All Directors have the opportunity to discuss their individual 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. All Directors have the right to obtain professional advice at Prudential’s expense. 96 Prudential plc Annual Report 2017 www.prudential.co.uk Shareholder engagement As a major institutional investor, the Board recognises the importance of maintaining an appropriate level of two‑way communication with shareholders. Shareholder feedback and key issues from these meetings is communicated to the Board. Details of when feedback was discussed by the Board in 2017 can be found on page 92. 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 2017 Annual General Meeting. Details of the 2018 Annual General Meeting are available on www.prudential.co.uk/investors 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 Investor Relations team. A conference for investors and analysts is held on a regular basis, including in‑depth business presentations and opportunities for attendees to meet with members of the Board and senior executives and an opportunity for the executive team to communicate progress and strategy outside of the financial reporting cycle. The most recent event was held in November 2017 and feedback was provided to the Board in December 2017. 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 2017, as part of the investor relations programme, over 320 meetings were held with approximately 700 individual institutional investors in London, continental Europe, the USA and Asia. 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. Engagement with institutional investors on the Directors’ remuneration policy and implementation is led by the Remuneration Committee Chair. Other Non‑executive Directors are available to meet with major shareholders on request. 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. This is reflected in our Group Diversity and Inclusion Policy which aims to provide equal opportunities to all who apply for and who perform work for our organisation – including our Directors – irrespective of sex, race, age, ethnic origin, educational, social and cultural background, marital status, pregnancy and maternity, civil partnership status, any gender reassignment, religion or belief, sexual orientation, disability, or part‑time/ fixed‑term work, and to ensure appropriate diversity of experience, skill sets and professional backgrounds. 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 an appropriate diversity on the Board. The Nomination & Governance Committee takes into account the Group Diversity and Inclusion Policy when considering succession planning. Prudential has a preference for using suppliers recognised for their commitment to diversity. The Board considers that its diversity of experience, skill set and professional background has been increased as a result of Board level succession in 2017. The Board continues to commit to developing a robust and diverse talent pipeline and to 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 an aim to achieve at least 30 per cent of women in senior management by the end of 2021 and in 2017, all Executive Directors volunteered to mentor members from our senior management team of various ages, gender, educational and professional backgrounds. The Group also engaged in a number of targeted activities in support of our Diversity and Inclusion Policy, including awareness training of unconscious bias. www.prudential.co.uk Annual Report 2017 Prudential plc 97 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationFurther 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 Director tenure is shown on page 150. — Non‑executive Directors are appointed for an initial term of three years, commencing with their election by shareholders. — Subject to review by the Nomination & 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. — The Directors’ remuneration report sets out the terms of the Non‑executive Directors’ letters of appointment on page 130 and the terms of Executive Directors’ service contracts on page 150. Time commitment — At present, the average time commitment expected of a Non‑executive Director is 32.5 days per annum. In addition, all Non‑executive Directors currently serve on at least one of the Board’s principal Committees, which requires an additional commitment of time dependent on the Committee and role. — On appointment, all Non‑executive Directors confirm they are able to devote sufficient time to the Group’s affairs to meet the demands of the role. — All Non‑executive Directors are required to discuss any additional commitments which might impact the time which he or she is able to devote to their role with the Chairman prior to accepting. Independence — The independence of the Non‑executive Directors is determined by reference to the UK Code and HK Listing Rules as follows: – 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; and – all the Non‑executive Directors were considered independent for the purposes of the HK Listing Rules, and each Non‑executive Director provides an annual confirmation of his or her independence as required under the HK Listing Rules. — In accordance with US regulatory requirements, Prudential affirms annually that all members of the Audit Committee are independent within the meaning of the Sarbanes‑Oxley legislation. — 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. Audit Committee experience — In relation to the provisions of the UK Corporate Governance Code and HK Listing Rules, the Board is satisfied that Mr Law has recent and relevant financial experience and that the Committee as a whole has competence relevant to the sectors in which the business operates. Full biographies of the Committee members including experience and professional qualifications, are set out on pages 86 and 87. — The Board has determined that Mr Law qualifies as the Audit Committee financial expert under the requirements of Form 20‑F. Indemnities — 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 2017 and remain so. 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. 98 Prudential plc Annual Report 2017 www.prudential.co.uk 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 Risk Committee is constituted by the Board for the purpose of assisting the Board in providing leadership, direction and oversight of the Group’s overall risk appetite, risk tolerance and strategy, and for monitoring the effectiveness of the risk management framework and adherence to the various risk policies. The Risk Committee also has authority to review and approve changes made to the Group risk framework and risk policies, approve changes to risk limits within the overall Board approved risk appetite, approve the Group’s top risks, and oversee, and advise the Board, on the current and potential future risk exposures of the Group. Regular activities are detailed in the report on pages 115 to 119. 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 approval requirements, among other requirements. Second 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, where appropriate challenging the actions being taken to manage and control risks and approving 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. 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. 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 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 105 to 114. www.prudential.co.uk Annual Report 2017 Prudential plc 99 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationRisk management and internal control continued Board Nomination & Governance Committee Group Chief Executive 1st line of defence Executives Chief Executive Committee Remuneration Committee Risk Committee Audit Committee 2nd line of defence 3rd line of defence Group Executive Committee Chief Financial Officer Group Regulatory Director Group Chief Risk Officer Balance Sheet & Capital Management Committee Management Group Executive Risk Committee Technical Actuarial Committee Group Security Committee Group Credit Risk Committee Emerging Risk Assessment Committee Solvency II Technical Oversight Committee Group Information Security Committee 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 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. 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 2017. 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. 100 Prudential plc Annual Report 2017 www.prudential.co.uk Committee reports The principal Board Committees are the Nomination & Governance, Audit, Risk and Remuneration Committees. These Committees form a key element of the Group governance framework, providing effective independent oversight of the Group’s activities by the Non-executive Directors. Each Committee Chair provides an update to the Board of each Committee meeting, supported by a short written summary of the Committee business considered. Nomination & Governance Committee report Dear Shareholder The Board changes in 2017 have again demonstrated the effectiveness of our preparations for Board level succession. Full details of all Board changes during the year can be found on page 83. The smooth transition of David Law as our new Audit Committee Chair, who also joined this Committee in May, and the appointment and induction of Tom Watjen has helped to refresh the Non‑executive roles on the Board. The move by Nic Nicandrou to become Chief Executive of Prudential Corporation Asia and the appointment of Mark FitzPatrick as Chief Financial Officer demonstrates both the effectiveness of our succession planning preparations and the ability of the Committee to recruit high calibre candidates with the appropriate skills and knowledge for our business. Having the right individuals in place in leadership roles is fundamental to the successful delivery of our strategy. The Board requires a diverse skill set which can be deployed across our Committees and businesses for the benefit of the Group and its stakeholders. Careful ongoing review and planning ensures that our Board continues to attract the high calibre individuals it requires and that there are no gaps in leadership. In 2017, the Committee formalised its approach in this area by creating a skills map to support succession planning, which identifies sector‑specific and general operational competencies as well as geographic and business experience. The retirement of Ann Godbehere, in May 2017, at the end of nine years of service as a Non‑executive Director, and Penny James stepping down as an Executive Director and Group Chief Risk Officer in September 2017, have impacted the Board’s gender diversity. The Committee has therefore committed to focus particularly on strengthening gender diversity, alongside diversity of skills, in its succession planning in 2018. The role of the Committee has grown since 2016 when we took on responsibility for overseeing the governance arrangements in the Group. This includes the governance of our Material Subsidiaries, in order to ensure that those boards operate effectively and that their independent non‑executive directors can constructively challenge and monitor performance in those businesses. We have spent time as a Committee considering the composition and effectiveness of those boards, the processes around their risk and audit committees, and the tenure and succession of their non‑executives. Part of my role as Chair is to oversee the governance arrangements for this Committee. The Committee considered its terms of reference in November 2017, and in the preparation of this report I have considered the time commitment, number of meetings and skills and experiences required for Committee members. As the Committee Chair, I also have the responsibility for ensuring the Committee runs effectively and makes the most of its meeting time. I encourage open debate and contributions from all Committee members. As part of the Board’s effectiveness review, described in more detail on pages 93 and 94, the Committee was found to be operating effectively and given action points around developing its skills map and considering Committee membership, both of which are ongoing tasks. Paul Manduca Chair of the Nomination & Governance Committee Committee members — Paul Manduca (Chair) — Howard Davies — David Law (from May 2017) — Anthony Nightingale — Philip Remnant — Ann Godbehere (until May 2017) Regular attendees — Group Chief Executive — Group Human Resources Director — Group General Counsel and Company Secretary Number of meetings in 2017: Four www.prudential.co.uk Annual Report 2017 Prudential plc 101 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationFeb May Jun Nov Committee reports continued How the Committee spent its time during 2017 Year end matters, re-election and tenure Review external positions, conflicts of interests and independence, time commitment, tenure and terms of appointment Review performance of Chairman and Non‑executive Directors Review relevant disclosures in the Annual Report and Accounts Recommend election of Directors by shareholders Succession planning, skills mapping and appointments Chairman Non‑executive Directors Group Chief Executive Executive Directors GEC composition Governance Membership review of principal Board Committees Committee terms of reference Material Subsidiary governance Subsidiary board composition, non‑executive succession planning and appointments Material Subsidiary committee attendance Terms of reference for Material Subsidiary boards, chairs and committees Material Subsidiary governance manual Material Subsidiary board, chair and director evaluations Key matters considered during the year Matter considered How the Committee addressed the matter Succession planning Throughout the year, the Committee kept succession plans for all Executive and Non‑executive Board roles under review. Succession plans are supported by the year end Board evaluation and individual performance evaluations. The Committee takes account of the size, structure and composition of the Board and its Committees, including existing knowledge, experience and diversity. In doing so, the Committee considers the Group’s strategic needs and anticipates future needs, skills and experience. The Committee is responsible for developing and periodically reviewing objectives established for the implementation of diversity on the Board and monitoring progress toward the achievements of those objectives. A description of the Group Diversity and Inclusion Policy is included on page 97. Following the departure of Ann Godbehere and Penny James in 2017, the Committee is focusing on gender diversity, alongside diversity of skills, in its succession planning in 2018. The Committee works with the Group Chief Executive and Group Human Resources Director to ensure that when a vacancy or a gap in the Board’s skills is identified, a role specification is prepared, taking into account feedback from the Committee and the Group’s Diversity and Inclusion Policy. Once the specification is agreed, specialist talent agencies are typically engaged to create a shortlist of candidates for review by the Committee and other stakeholders. Interviews with individuals then take place and feedback is provided to the Committee members. In this manner, a preferred candidate is selected and the Committee then recommends the individual to the Board for appointment (subject to regulatory approval where required). Contemporaneously with this process, thorough due diligence checks are undertaken on the candidate and we liaise with the FCA and PRA as to the suitability of the individual from a regulatory perspective, as needed. 102 Prudential plc Annual Report 2017 www.prudential.co.uk Key matters considered during the year continued Matter considered How the Committee addressed the matter Non‑executive Directors During the year, the Committee finalised the terms of appointment of Mr Watjen as a Non‑executive Director. The work of the Committee was supported by Russell Reynolds as search consultant. See page 104. In 2017, the Committee debated and approved a skills map for use in Non‑executive succession planning discussions. The skills map identifies key skills and experiences, including sector, geographic and operational skills, which are desirable for the Board as a whole, taking account of the Group’s strategic direction. As part of its focus on searching for an additional Non‑executive Director, in November 2017 The Miles Partnership was instructed to begin a market mapping exercise with particular focus on potential female candidates to ensure that the Board’s gender diversity was addressed in a positive manner. Executive Directors and senior executives The Committee carried out its annual review of the succession plans in place for the Group Chief Executive, other Executive Directors and Group Executive Committee roles. The development and renewal of these plans was led by the Group HR Director, supported by Egon Zehnder in the case of the Group Chief Executive plan and by Talent Intelligence for the other Executive Director roles and GEC members. In 2017, Talent Intelligence prepared long‑lists and short‑lists with a focus on gender and ethnic diversity requirements. The Committee has oversight of senior executive level succession planning and the talent pipeline. The Committee discussed these plans closely with the Group Chief Executive to identify business requirements and plan for future succession needs and gave feedback on the planning process. The Company continues to commit to developing a robust and diverse talent pipeline, increasing representation of women in senior positions. During 2017: — Mr FitzPatrick was appointed as Chief Financial Officer in July 2017, following completion of a comprehensive search; — Following the departure of Penny James in September 2017, Prudential appointed Pat Casey as Interim Group Chief Risk Officer while the search for a permanent successor continued. Following a recommendation from the Committee, the Board appointed James Turner as an Executive Director and as Group Chief Risk Officer with effect from 1 March 2018; and — Mr Nicandrou took on the role of Chief Executive of Prudential Corporation Asia, following Mr Wilkey’s departure. In each case, the Committee was well prepared and responsive, considering candidate profiles and skills and conducting interviews. Neither Russell Reynolds nor The Miles Partnership have any additional connection with Prudential. In addition to acting as search consultant for certain executive hires, Egon Zehnder also provides support for senior development assessments. Talent Intelligence also provides additional succession planning support to the Group below GEC level. Use of search consultancies Review of principal Committee membership The Committee regularly reviews the membership of all principal Committees and makes recommendations to the Board as appropriate. In February 2017, the Committee made recommendations to the Board to appoint Lord Turner to the Audit Committee and to appoint Mr Law to the Risk Committee and as Audit Committee Chair, which changes became effective in May 2017. The Committee recommended the appointment of Mr Watjen to the Remuneration Committee on his appointment as a Non‑executive Director in July 2017. In February 2018, the Committee also recommended the appointment of Ms Schroeder as a member of the Risk Committee, which was effective from 1 March 2018. Full details of changes to the membership of the principal Committees are set out on page 83. www.prudential.co.uk Annual Report 2017 Prudential plc 103 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year continued Matter considered How the Committee addressed the matter Election of Directors As part of its ongoing work on Board succession planning, the Committee considered the terms of appointment for the Chairman, Committee Chairs and Non‑executive Directors taking into account time commitment and the general balance of skills, diversity, experience and knowledge on the Board, assessing length of service in their roles. Particular attention has been paid to the recommendation to re‑elect Mr Nargolwala and Sir Howard Davies at the Annual General Meeting to be held in 2018 due to their length of service. Having reviewed the performance of the Non‑executive Directors in office at the time, and having received feedback from the Group Chief Executive on the performance of the Executive Directors, the Committee concluded that each Director continued to perform effectively and was able to devote sufficient time to fulfil their duties, taking account of the number and nature of their external appointments. The Committee recommended to the Board that all Directors should stand for election at the Company’s Annual General Meeting. Independence and conflicts of interest Independence criteria The Committee considered the independence of the Non‑executive Directors against relevant requirements as outlined on page 98. Conflicts of interest The Board has delegated authority to the Committee to consider, and authorise where necessary, any actual or potential conflicts of interest. Prior to proposing Directors for re‑election, 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. In addition, the Committee considered the external positions of those Directors appointed during the year, noted changes in the external positions of existing Directors and considered whether these gave rise to any conflicts. The Board considers that the procedures set out above for dealing with conflicts of interest, operate effectively. During the year under review, the Committee carried out various duties related to the Material Subsidiaries including succession planning arrangements for non‑executive directors, evaluating the performance of the Material Subsidiary boards, chairs and directors, reviewing Material Subsidiary governance arrangements, including principles for attendance at committee meetings, and the terms of reference for the Material Subsidiary boards and chairs. Governance Group subsidiaries Appointment of Tom Watjen The Committee undertook a thorough and international search for potential candidates, supported by Russell Reynolds who were engaged for this purpose. The objective of the search was to enhance the Board’s US expertise and insurance executive experience. Mr Watjen was identified as a preferred candidate following interviews with the Chairman, the Senior Independent Director and Group Chief Executive. The Committee reviewed Mr Watjen’s skills and experiences against the needs of the business, noting in particular his knowledge of the insurance sector, his many years in senior executive roles and his understanding of US regulatory matters. His appointment was then recommended to the Board for consideration and subsequently approved in July 2017. 104 Prudential plc Annual Report 2017 www.prudential.co.uk Audit Committee report Dear Shareholder It has been a great pleasure to take over responsibility as Chair of the Committee from Ann Godbehere who retired from the Board in May 2017. I would like to thank her for the significant contribution she made to the Committee during her nine years of service. In May 2017 we welcomed Lord Turner as an additional Committee member. Lord Turner’s biography is included on page 87. A key part of the Committee’s role is to provide the Board with assurance as to the integrity of the business through our activities in monitoring financial reporting and the second and third lines of defence as part of our internal control environment. The Committee continued to focus on the integrity of the Group’s financial reporting and ensuring appropriate financial accounting policies are adopted and implemented. We reviewed management’s annual process for setting assumptions which underpin the Group’s IFRS insurance liabilities and European Embedded Value (EEV) results and requested additional information and clarification where needed. Building on work undertaken in prior years, in 2017 we further accelerated our year end process and carried out a substantive review of key judgements, such as UK mortality and expenses, policyholder behaviour assumptions in Jackson and, for EEV reporting in particular, persistency in Asia, before the year end. As in previous years, the Committee reviewed the Group’s Annual Report and Accounts and advised the Board that they were considered to be fair, balanced and understandable. The Committee also reviewed the Group’s Solvency II reporting disclosures forming part of our 2016 full year and 2017 half and full year reports. Following a transfer of duties from the Risk Committee during the year, the Committee is now responsible for reviewing the Solvency and Financial Condition Report (SFCR) and the Regulatory Supervisory Report (RSR), which is a private regulatory filing. An important part of the Committee’s duties is to monitor the relationship with the Group’s external and internal auditors. The Committee reviewed the activities of KPMG as external auditor and made a recommendation to the Board concerning their continuing appointment (subject to shareholder approval) which took into account a number of factors including independence and objectivity, the level of remuneration, effectiveness, and tenure. The Committee also approved non audit work that was considered appropriate and in line with the Group’s policy. During the year, KPMG scored highly in our effectiveness review which included feedback from senior finance personnel across all our business units. It remains the Committee’s current view that, without exceptional circumstances, change to auditors should not occur prior to the adoption of the new accounting standards on insurance contracts (IFRS 17). A plan to identify their successors to ensure a smooth transition has been developed. During the year the Committee continued to receive regular briefings from the Group‑wide Internal Audit (GwIA) function. Delivery of the internal audit plan represents a key component of the Committee’s oversight of the Group’s internal controls procedures. GwIA undertook a programme of risk‑based audits covering matters across the business units in addition to assurance work on significant change programmes such as preparations for the implementation of the General Data Protection Regulations (GDPR) and MiFID II. We also approved the 2018 audit plan which focuses on matters such as financial, business change, regulatory and operational risks as well as consideration of controls to deliver appropriate customer outcomes. The plan was mapped to the key risks identified by the Group Risk Committee and is kept under review throughout the year as necessary to ensure the programme remains in line with business needs. The Committee regularly reviews the performance of GwIA and monitors the adequacy of the resourcing available to the function. In addition, in 2017 an independent External Quality Assessment (EQA) of GwIA was undertaken by Deloitte in line with the Chartered Institute of Internal Auditors Standards (the Standards). The EQA concluded that GwIA met the Standards and code of ethics, and assisted both the Committee and the executive management in identifying and mitigating risk. During the year I was involved in recruiting a successor to the role of Director of GwIA. After an extensive internal and external search, we appointed an individual with extensive knowledge of the Group, having previously been the Chief Operating Officer of Group Risk, and before that the Group Compliance Director. David Law Chair of the Audit Committee Committee members — David Law (Chair) (from May 2017) — Ann Godbehere (until May 2017) — Howard Davies — Philip Remnant — Alice Schroeder — Lord Turner (from May 2017) 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 2017: Nine. In addition, a joint meeting was held with the Risk Committee www.prudential.co.uk Annual Report 2017 Prudential plc 105 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued As part of my transition, as well as the regular meetings with the Material Subsidiary audit committee chairs to facilitate escalation of important matters and reporting of material issues to the Committee, I attended one of each of the Material Subsidiary audit committee meetings to gain a better understanding of how they operate. I found this helpful and will look to repeat this in the coming years. Part of my role as Chair is to consider the governance arrangements for the Committee. The Committee considers its terms of reference at least annually and proposed changes to its terms of reference in December 2017. The only significant change related to the review of Solvency II disclosures which now rests with the Committee. As Chair 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. Committee members are encouraged to meet with management or the internal and external audit team where this assists them in their preparations. I report to the full Board after each meeting on the main matters discussed. An annual review of our effectiveness was carried out as part of the Board evaluation, described in more detail on page 94. The Committee was found to be functioning effectively. The Committee received updates against the annual Compliance Plan (the Plan). In 2017 the Plan focused on a number of areas to help strengthen the compliance framework, which is intended to aid the Group in meeting regulatory obligations. The Plan also included the management and review of Group Compliance top risks, including anti‑money laundering and anti‑bribery and corruption. We also refreshed the Group’s whistleblowing protocols and spent time with the Group Resilience Director to gain comfort that he was appropriately supported. The Committee sponsored a special review to ensure there was no evidence of abuse of power in the workplace. During 2017 the Committee reviewed our first published tax strategy and environmental, social and governance (ESG) report, both released in May. Another key piece of work was our review of the disclosures about the merger of M&G and Prudential UK & Europe into one business and an additional meeting was held to discuss these. Members of the Committee also received additional updates on the impact of MiFID II, and reviewed the financial disclosures relating to the partial sale of the UK annuity portfolio. The Committee looks to identify matters likely to impact the Group going forward. In addition to its usual activities, in 2018 the Committee expects to consider further the impact of IFRS 17, as well as monitoring regulatory changes and the impact of major projects such as the creation of M&G Prudential on the Group’s internal controls functions. The Committee also works closely with the Risk Committee to make sure both Committees are updated and aligned on matters of common interest. Where responsibilities are perceived to overlap between the two Committees, I work with Sir Howard to agree the most appropriate Committee to consider the matter. In December we held a joint informational session on cyber security, to which all Directors were invited. 106 Prudential plc Annual Report 2017 www.prudential.co.uk Feb Mar1 May Jul Aug1 Nov Dec How the Committee spent its time during 2017 Financial reporting and external auditor Periodic financial reporting including: — Key accounting judgements and disclosures — Solvency II results and governance processes — Associated audit reports Review of announcement of the merger of M&G and Prudential UK & Europe Developments in tax disclosures Audit planning, fees, independence, effectiveness and re appointment Internal control framework Internal control framework effectiveness Internal auditors Status updates and effectiveness Internal audit plan Compliance Status updates Compliance plan MiFID II updates Financial crime and whistleblowing Update on whistleblowing issues raised Financial crime prevention including anti‑money laundering, prevention of tax evasion and anti‑bribery and corruption programmes Governance and reporting Material Subsidiaries updates Internal framework effectiveness/refresh Environmental, social and governance reporting Business unit audit committee effectiveness, status updates and terms of reference Committee terms of reference Note 1 Two meetings were held in each of March and August 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 107 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year Matter considered How the Committee addressed the matter Financial reporting and tax Overview 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 2017 that had a material effect on the Group’s 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 and reviewing the up‑date of these disclosures for revised reporting requirements. In May 2017 the Group published externally, for the first time, a Group tax strategy document and a Group environmental, social and governance report. Both documents were reviewed by the Committee, which was updated on the approach and progress as the documents were developed. Key assumptions and judgements 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 (including mortality) 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. Mortality assumptions were a particular focus for the Committee following a detailed review of granular historic experience data by the UK business and the release of new industry mortality improvement tables. Further information is contained in the consolidated financial statements on pages 267 to 269. The Committee was satisfied that the assumptions adopted by management were appropriate. The Committee also received information on the nature of goodwill and intangible asset values and 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 2017. The Committee reviewed and challenged updates to the Group’s independent price valuation policy for investments and endorsed the proposed enhancements to Group Finance oversight of this policy. It also received information on the carrying value of investments in the Group’s balance sheet including data on the approach used in that valuation (for example, the level of asset valued on a mark to market basis). The Committee satisfied itself that overall investments were valued appropriately. The Committee regularly reviews the Group’s provisions, including the level of provisioning for regulatory and litigation matters and provisions for certain open tax items including tax matters in litigation. The Committee was satisfied that the level of provisioning adopted by management was appropriate. 108 Prudential plc Annual Report 2017 www.prudential.co.uk Key matters considered during the year continued Matter considered How the Committee addressed the matter Other financial reporting matters and tax reporting 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. 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. Following the announcement of the merger of M&G and the UK life business, the Committee re‑evaluated the Group’s segmental disclosure, resulting in a revision to reflect the revised business unit structure. Prior to the announcement of the merger, the Committee also reviewed the basis of preparation of the costs and synergies disclosed. This work was supported by external independent review of management’s proposed disclosures. The potential impact of proposed US tax reforms was considered in advance of their implementation in December 2017 and the impact of the final rule changes were discussed in detail post year end. The Committee reviewed and approved the Group’s tax strategy which was subsequently published in May 2017 and was also updated on the 2016 country by country tax disclosures required to be filed with HM Revenue & Customs by the end of 2017. The Committee reviewed the parent company profit and loss account and balance sheet, which included recognition of a pension surplus asset. 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 new accounting standards due to be implemented over the period 2018‑2021. In particular it received an overview of the requirements of IFRS 17 on insurance contracts, following publication of the final standard in the first half of 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 109 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year continued Matter considered How the Committee addressed the matter External audit Review of effectiveness, non-audit services and auditor reappointment External audit effectiveness The Group’s external auditor is KPMG LLP (KPMG) and oversight of the relationship with them is one of the Committee’s key responsibilities. This included challenging and querying KPMG’s approach to risk and other issues regularly throughout the year. Auditor independence and objectivity 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. 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 were given the opportunity to respond to the findings in the report. KPMG also provided commentary on the findings of the FRC’s Annual Audit Quality Review of KPMG and the firm‑wide actions being taken to address observations made. 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. 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: — 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 rules and regulations of the US Securities and Exchange Commission (SEC) and the standards of the Public Company Accounting Oversight Board (PCAOB). In 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. This ensured that the schedule of prohibited non‑audit services was in line with EU reforms referenced above. In 2017 the Committee reconsidered the Policy and concluded that it remained appropriate. 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. 110 Prudential plc Annual Report 2017 www.prudential.co.uk Key matters considered during the year continued Matter considered How the Committee addressed the matter Fees paid to the auditor Reappointment Audit tender The fees paid to KPMG for the year ended 31 December 2017 amounted to £17.3 million (2016: £16.2 million) of which £2.6 million (2016: £2.8 million) was payable in respect of non‑audit services. Non‑audit services accounted for 15 per cent of total fees payable (2016: 17 per cent). A breakdown of the fees paid to KPMG can be found in Note B2.4 to the financial statements on page 194. Of the £2.6 million of non‑audit services, the principal types of non‑audit engagements approved for 2017 were other assurance services of £1.5 million (of which £0.8 million related to Solvency II reporting and disclosures) and other non‑audit services of £0.7 million. In accordance with the Policy, all non‑audit services were pre‑approved by the Committee. It was considered appropriate for KPMG to undertake work relating to the Group’s Solvency II reporting and disclosure requirements because the terms of the engagement were in compliance with the Policy and KPMG’s knowledge of the Group’s processes facilitated the efficient execution of the work. Based on the outcome of the effectiveness evaluation and all other considerations, the Committee concluded that there was nothing in the performance of the auditor which would require a change. The Committee therefore recommended that KPMG be reappointed as the auditor. A resolution to this effect will be proposed to shareholders at the 2018 Annual General Meeting. 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 external audit was last put out to competitive retender in 1999 when the present auditor, KPMG, was appointed. Since 2005, the Committee has annually considered the need to retender the external audit service. The Committee recognises that the industry is in a period of unprecedented change with the IASB issuing its 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 change auditors before the adoption of IFRS 17. This remains subject to the Committee’s normal annual review of auditor performance and recommendation to shareholders as described above. The Committee considered its strategy on audit tendering in November 2017, concluding that the existing timeline for appointing a new auditor by the 2022 year end, did not need to be amended. In conducting this review, the Committee concluded that it would be appropriate to commence a competitive tender for the 2022 audit in 2019. The Company has complied throughout the 2017 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. A plan to identify successor firms to ensure that there is sufficient time for an orderly transition and to safeguard independence was considered and agreed by the Committee. In line with the FRC Ethical Standard, the rules and regulations of the SEC and the standards of the PCAOB, a new lead audit partner, Philip Smart, has been appointed in respect of the 2017 financial year. Mr Smart is expected to be in place until the completion of the 2021 reporting cycle. Prior to taking up this role, Mr Smart shadowed the outgoing lead audit partner. During the 2016 year end audit, he met with members of the Committee and management team, including management teams of our business units, and attended Committee meetings and met with members of the Committee. www.prudential.co.uk Annual Report 2017 Prudential plc 111 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year continued Matter considered How the Committee addressed the matter Third line oversight Internal audit Regular reporting The quality of the internal control systems is assessed by the Group’s Internal Audit function using independent audit procedures. Each of the Group’s business units has an Internal Audit team, the heads of which report to the Director of GwIA. The Committee received regular updates from GwIA on audits conducted and management’s progress in addressing audit findings within agreed timelines. Any delays in implementing remediation action are escalated to the Committee and given particular scrutiny. The independent assurance provided by GwIA formed a key part of the Committee’s deliberations on the Group’s overall control environment. 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 2018 The Committee approved the half year update of the 2017 plan. It also considered and approved the Internal Audit Plan, resource and budget for 2018. Internal audit effectiveness 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 2018 Internal Audit Plan was formulated based on a bottom‑up risk assessment of audit needs mapped against various metrics combined with top‑down challenge. 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 2018 include strategic change initiatives, customer outcomes, cyber security and digitalisation. The Committee is responsible for approval of the GwIA charter, audit plan, resources, and for monitoring the effectiveness of the function. The Committee assesses the effectiveness of GwIA through a combination of EQA reviews, required every five years, and an annual internal effectiveness review, performed by the GwIA Quality Assurance Director. In 2017, Deloitte performed an EQA of GwIA, which assessed that GwIA generally conforms with the Institute of Internal Audit (IIA) Standards and Code of Ethics (the highest rating under the IIA’s framework), and displays an overall level of adherence to the principles set out in the UK Chartered IIA Code. The assessment also considered GwIA’s purpose, position, processes and reporting in the context of Group’s wider systems of governance. In addition, to ensure GwIA skill sets and resourcing levels align to the approved audit plan, a skills and resource gap analysis was undertaken to highlight any resource shortfall or required change in available skill sets to support the delivery of the plan. The analysis concluded that resources were sufficient to execute the plan. Having considered the findings of the EQA, and the 2017 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 2017. 112 Prudential plc Annual Report 2017 www.prudential.co.uk Key matters considered during the year continued Matter considered How the Committee addressed the matter Business unit audit committees Business unit model terms of reference The Committee is supported by the work carried out by the audit committees at the level of individual business units, in particular those established by our Material Subsidiaries, which provide oversight of the respective business units. The Committee annually reviews the effectiveness of these committees in meeting their defined terms of reference. Membership of the committees for all Material Subsidiaries comprises solely of independent non‑executive directors of those subsidiaries. Minutes of 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 Chair meets in person or telephonically with the chairs of each of the Material Subsidiary audit committees, usually on a quarterly basis. The Chair has also attended one of each of the Material Subsidiary audit committee meetings since his appointment to enhance his understanding of how they operate. An assessment of the business unit audit committees was completed and the outcomes reported to the Committee and to the business unit audit committees in February 2018. The assessment was supported by local teams from GwIA and considered whether each of the committees fulfilled the responsibilities documented in their terms of reference. The evaluation also considered 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. The evaluation concluded that the audit committees operated in accordance with their terms of reference. 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. These were adopted by the business unit audit committees, with minor variations to address local regulations or the particular requirements of the business where necessary. The Committee also reviewed the membership of the Material Subsidiary audit committees. Second line oversight Compliance, financial crime prevention, whistleblowing Regular reporting from the Compliance function 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 2017 Compliance Plan, the outcome of compliance monitoring activities across the Group and the effectiveness of business units’ compliance activities. Compliance Plan and focus for 2018 Financial crime prevention The Committee considered and approved the 2018 Group Compliance Plan. The strategic focus of the Plan in 2018 will be on enhancing the assurance framework, building on work undertaken in 2017. Group Compliance will also continue to drive forward capabilities within the team and wider compliance community, carrying out activities to maintain oversight of the top risks identified. The Committee received the Money Laundering Reporting Officer’s report which assessed the operation and effectiveness of the Group’s systems and controls in relation to managing financial crime risks. As part of its responsibility for the oversight of financial crime prevention, the Committee received updates on Anti‑bribery and Corruption and Anti‑money Laundering, Sanctions and Fraud procedures. The Risk Committee was updated on risk assessments of anti‑bribery and corruption and fraud prevention, during the year, which informed the update provided to the Committee in early 2018. www.prudential.co.uk Annual Report 2017 Prudential plc 113 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year continued Matter considered How the Committee addressed the matter Whistleblowing Internal control Internal control and risk management systems Governance Group Governance Framework In 2016 Prudential launched a Group‑wide whistleblowing programme (‘Speak Out’). The programme captures and comprehensively records matters raised through the Group’s confidential reporting process. Throughout the year the Committee received regular updates on matters raised through the programme and on actions taken to address them. The Committee also reviewed the arrangements for the monitoring and reporting of whistleblowing activities to ensure they continue to comply with regulatory requirements and governance best practice. The procedures were refreshed during the year and the Chair communicated the enhanced protocols to the chairs of each of the Material Subsidiary audit committees. The Committee and the Chair also spent time privately with the Group Resilience Director to ensure cases were being appropriately followed up. The role of the whistleblowing champion, for the purpose of the Senior Insurance Managers Regime, is carried out by the chair of the audit committee of Prudential Assurance Company (PAC), who is an independent non‑executive director of PAC and is supported by the PAC audit committee. The terms of reference for each Material Subsidiary audit committee provides for them to ensure Speak Out arrangements are in place for those business units. The Committee was also updated on arrangements for promoting awareness of the Speak Out policy, including computer based training tailored for each business unit, and the distribution of communications across the Group. At Group level, the Chair of the Audit Committee is 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, 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. Having considered the review, the Committee made recommendations to the Board regarding the ongoing process for identifying, evaluating and managing the significant risks faced by the Group, noting that it had been in place throughout the period and confirming that the systems remain effective. The Board’s statement regarding effectiveness of these systems can be found on page 100. The Group Governance Manual sets out the policies and procedures 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, including matters which must be reported to the Group functions; and — Matters requiring prior approval from those parties with delegated authority. The Committee reviewed the results of the Group Governance Manual annual content review and the results of the year end certification of compliance with Group Governance Manual requirements for the year ended 31 December 2017. 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. 114 Prudential plc Annual Report 2017 www.prudential.co.uk In respect of our principal risks, we continued to focus on those arising from the products we offer our customers, those inherent in our investment portfolios and the risks that arise from the operation of 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 the pace of regulatory developments across the globe. The Committee reviewed in depth the risks arising from our business. This included a further review into the Jackson hedging programme and providing oversight of implementation of recommended actions. Reviews were also performed on asset liability management for our UK with‑profit business, our China joint ventures and other aspects relating to our Asia business. During the year we continued to oversee the work required as a result of the Group’s continuing designation as a Global Systemically Important Insurer (G‑SII), which included the approval of the 2017 Systemic Risk Management Plan, Liquidity Risk Management Plan and Recovery Plan. The Committee reviewed the methodology and annual calibration of the Solvency II internal model, and we also oversaw the successful submission of the Group’s Major Model Change application in November 2017 in respect of the model. Cyber security remains an area of focus which saw attention from the Committee in 2017. During the year we reviewed progress achieved on the implementation of our Cyber Defence Plan. The Committee considered the Group‑wide approach, and changes in governance and processes required, for compliance with the EU’s General Data Protection Regulations which are due to come into force in May 2018. The Group also prepared its first environmental, social and governance report in 2017 with the Committee reviewing the risk elements included in that report. Risk Committee report Dear Shareholder As Chairman of the Risk Committee, I am pleased to report on the Committee’s activities and focus during 2017. 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 the Group Risk Framework and recommends changes to it for approval by the Board, to ensure that it remains effective in identifying and managing the risks faced by the Group. We work closely with the Audit Committee to ensure both Committees are updated and aligned on matters of common interest. Where responsibilities are perceived to overlap between the two Committees, I work with Mr Law to agree the most appropriate Committee to consider the matter. During the year we transferred responsibility for the review of Solvency II disclosures to the Audit Committee. The Committee received regular reports from the Group Chief Risk Officer (CRO), who is advised by the Group Executive Risk Committee (GERC). I provided feedback on the performance of the CRO to the Group Chief Executive Officer as part of the annual evaluation of the Board and its members. The Committee also received regular reports from the Group‑wide Internal Audit and Compliance functions and updates from other areas of the business as needed. During 2017, we reviewed the Group’s risk policies and the aggregate limits accompanying the Group risk appetite statements. In addition, the Group’s risk appetite limits were reviewed and updated where necessary 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 major subsidiaries. A fuller explanation of key risks facing the Group and the way in which the Group manages these is set out in the Report on the risks facing our business on pages 48 to 63. Howard Davies Chair of the Risk Committee Committee members — Howard Davies (Chair) — Ann Godbehere (until May 2017) — David Law (from May 2017) — Kai Nargolwala — Alice Schroeder (from March 2018) — 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 2017: Six. In addition, a joint meeting was held with the Audit Committee www.prudential.co.uk Annual Report 2017 Prudential plc 115 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued As Chair 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 94. The Committee was found to be functioning effectively. During 2017 the Committee considered the results of a Group‑wide risk culture assessment which built on the previous work of the Committee in this area. The assessment was intended to compare the Group’s risk culture against best practice behaviours, identify any areas which need improvement and provide high‑level industry benchmarking and peer comparison. In August we announced the merger of two of our business units to form M&G Prudential. The Committee considered the approach for managing risks associated with the merger, and will monitor and assess these risks through 2018. The Committee will remain focused on monitoring the Group’s principal risks, including those posed by regulatory developments and macroeconomic conditions, in the context of the Group’s operations as a whole and the environment in which we operate. I meet the Material Subsidiary risk committee chairs to facilitate escalation of important matters and reporting of material issues to the Committee. Since the year end, we welcomed Alice Schroeder as a member of the Committee with effect from 1 March 2018. Her biography is set out on page 87. Part of my role as Chair is to consider the governance arrangements for the Committee. The Committee considers its terms of reference at least annually and in October 2017 considered proposed changes to its terms of reference. We formalised the Committee’s role in considering how changes in the financial environment impact the Group’s risk profile. We also refreshed our terms of reference to reflect the Committee’s role in providing advice to the Remuneration Committee on risk management considerations to be applied in respect of executive remuneration. 116 Prudential plc Annual Report 2017 www.prudential.co.uk How the Committee spent its time during 2017 Feb1 May Jul Oct Dec Markets and Group risk updates 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 Risk culture survey Risk oversight of remuneration Regulatory matters Regulatory matters Risk framework Solvency II internal model development Solvency II Major Model Change Group risk appetite review Risk limit updates Risk policy framework refresh Year‑end E‑cap results Group operation risk appetite statement Responsible investing framework Governance and reporting Material Subsidiaries updates Year‑end risk disclosures Policy compliance Own Risk and Solvency Assessment Governance, Risk and Compliance report Global Systemically Important Insurer Liquidity Risk Management Plan, Systemic Risk Management Plan and Recovery Plan Pillar 3 reporting Solvency II reporting and governance processes Environmental, social and governance (ESG) reporting Committee terms of reference Note 1 Two meetings were held in February 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 117 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationCommittee reports continued Key matters considered during the year Matter considered How the Committee addressed the matter Business Plan As part of the Committee’s role in overseeing and advising the Board on future risk exposures and strategic risks, the Committee reviewed Group Risk’s assessment of the Group’s Business Plan, which covered a range of both financial and non‑financial considerations. As part of the Group Risk’s review of the annual Group Business Plan, Group Approved Limits were reviewed, updated and approved by the Committee. Risk appetite The Risk Committee is responsible for recommending the Group’s overall risk appetite and tolerance to the Board. Risk management Group top risks The Committee approved the Group Risk Appetite Statement, which sets aggregate risk limits in respect of capital requirements, earnings volatility and liquidity as well as maintaining the existing tolerance levels associated with each of these limits. 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 2017, the Group Risk Framework and risk policies were subject to their annual review, with changes being approved by the Risk Committee. In October 2017, the Committee considered the results of a Group‑wide survey on Risk Culture which provided high‑level industry and peer benchmarking. The Risk Committee considered the results of a number of ‘deep dive’ reviews undertaken during 2017. These focused on risks embedded within the existing portfolio of products in our US, Asia and UK businesses. The Cyber Strategy and Cyber Defence Plan articulates the strategic outcomes and key deliverables relating to our cyber resilience. The Group Cyber Risk Strategy was reviewed by the Risk Committee in mid‑2017. The Committee also reviewed the Cyber Defence Plan and were provided further detail around the implementation of the Cyber Strategy at the end of 2017. The Committee considered the Group‑wide approach for compliance with GDPR regulations and received updates through the year on progress on implementation activity. The Committee also agreed the characteristics of an effective risk function and conducted its second 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 and the Group’s Internal Model; the implications of the developing global capital standards; and developments and the deliverables required as a result of the Group’s designation as a Global Systemically Important Insurer (see further, opposite). 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 and the FY16 risk and solvency positions prior to its approval by the Board. The report was also considered in light of the results of the Group’s regular stress testing. The Committee reviewed the methodology and annual calibration of the Solvency II internal model. The 2017 Major Model Change application was closely overseen by the Committee throughout the year and we approved the model changes as part of the submission of the application to the regulator. Solvency II results and associated governance processes were considered in a separate meeting held jointly with the Audit Committee. 118 Prudential plc Annual Report 2017 www.prudential.co.uk Key matters considered during the year continued Matter considered How the Committee addressed the matter Global Systemically Important Insurer Reverse Stress Testing The Financial Stability Board (FSB) announced on 21 November 2016 that the Group continues to be designated as a Global Systemically Important Insurer. In 2017, the Group was required to consider and approve updated deliverables associated with the designation. These included the Systemic Risk Management Plan, Recovery Plan and Liquidity Risk Management 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 2017 position and was submitted to the PRA. Remuneration The role of the Committee with respect to the provision of advice to the Remuneration Committee on risk management considerations in respect of remuneration was formalised during the year. The Committee considered a plan enabling it to meet its Remuneration responsibilities and received updates on Remuneration‑related matters. 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 regular reporting on key compliance risks and mitigation activity, including assessments and reporting on anti‑bribery and corruption customer commitments. The Committee also reviewed and approved a number of regulatory compliance risk‑related policies. www.prudential.co.uk Annual Report 2017 Prudential plc 119 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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 314 and the supplementary information on pages 326 to 359. 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 315 to 323 and page 360. 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 pages 314 and 360. 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 pages 314 and 360. The Strategic report provides, on pages 43 and 44, 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 Report on the risks facing our business on pages 48 to 63. 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 Directors have complied with these rules throughout the period. The Group has adopted an Inside Information Policy which includes guidance and procedures for the identification, dissemination and escalation of inside information as well as appropriate controls on the disclosure of such information in line with regulatory requirements. All staff are made aware of the policy and receive communications reminding them of their obligations when they work on any confidential matters in the business or are notified when the Company enters or exits a closed period. Requirements of Listing Rule 9.8.4 Information to be included in the annual report and accounts under Listing Rule 9.8.4 may be found as follows: Listing Rule Description Page 9.8.4 (4) Details of long‑term 146 incentive schemes required by Listing Rule 9.4.3 9.8.4 (10) Contracts of Significance 98 involving a Director 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. 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 80. The risks facing the Group’s capital and liquidity positions and their sensitivities are referred to in the Strategic report on pages 48 to 63 and note II(c) ‘Solvency Capital Position at 31 December 2017’ within Additional Unaudited Financial Information. The Group’s IFRS financial statements include the details of the Group’s borrowings in Note C6 on page 257, the market risk and liquidity analysis associated with the Group’s assets and liabilities can be found in Note C3.4(a) on pages 225 to 227, policyholder liability maturity profile by business units in Notes C4.1(b), (c) and (d) on pages 233, 235 to 237 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 2017. 120 Prudential plc Annual Report 2017 www.prudential.co.uk Additional 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 revenue from sales for each of 2017 and 2016. www.prudential.co.uk Annual Report 2017 Prudential plc 121 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIndex to principal Directors’ report disclosures Information required to be disclosed in the Directors’ report may be found in the following sections: Information Section in Annual Report Page number(s) Disclosure of information to auditor Statutory and regulatory disclosures Directors in office during the year Board of Directors Corporate responsibility governance Corporate responsibility review Employment practices Greenhouse gas emissions Charitable donations Corporate responsibility review Corporate responsibility review Corporate responsibility review Political donations and expenditure Corporate responsibility review Remuneration Committee report Directors’ remuneration report Directors’ interests in shares Agreements for compensation for loss of office or employment on takeover Directors’ remuneration report 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 Post‑balance sheet events Note D3 of the Notes on the Group financial statements Rules governing changes to the Articles of Association Shareholder information 120 83 to 87 64 to 80 74 to 77 78 and 79 74 74 124 to 157 148 151 and 152 98 99 and 100 120 98 121 4 to 8 284 402 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 and 277 Business review Changes in borrowings Dividend details Financial instruments Strategic report Strategic report and Note C6 of the Notes on the Group financial statements Strategic report Strategic report 10 to 80 44 and 257 2 and 34 48 and 63 In addition, the risk factors set out on pages 391 to 397 and the additional unaudited financial information set out on pages 362 to 390, 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 14 March 2018 122 Prudential plc Annual Report 2017 www.prudential.co.uk 04 Directors’ remuneration report Annual statement from the Chairman of the Remuneration Committee Our Executive Directors’ remuneration at a glance Summary of the current Directors’ remuneration policy Annual report on remuneration Supplementary information Page 124 126 128 132 154 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 2017 and 2016 Executive Director total remuneration (the ’single figure’) and related notes, salary information table in section entitled Remuneration in respect of performance in 2017, Pension entitlements, Long-term incentives awarded in 2017, Chairman and Non-executive Director remuneration in 2017, Statement of Directors’ shareholdings, Outstanding share options, Recruitment arrangements and Payments to past Directors and payments for loss of office. www.prudential.co.uk Annual Report 2017 Prudential plc 123 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationAnnual 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 2017. The Committee’s report is presented in the following sections: 1 2 3 An ‘at a glance’ summary of the Group’s remuneration arrangements on pages 126 and 127; A summary of our Directors’ remuneration policy on pages 128 to 131 which describes how we pay Directors. This policy was approved by shareholders at the 2017 AGM; Our Annual report on remuneration on pages 132 to 153 which describes how the Committee applied the Directors’ remuneration policy in 2017 and the decisions it has made in respect of 2018; and 4 Supplementary information on pages 154 to 157. By way of preface, I would like to share the context for the key decisions the Committee took during 2017, in particular, how we rewarded the performance achieved in 2017 and the decisions relating to remuneration arrangements in 2018. I am also delighted to welcome Thomas Watjen, who joined the Committee in July 2017. Implementing the Directors’ remuneration policy During 2017, the Committee operated all elements of remuneration in line with the Directors’ remuneration policy, which received the support of 90.7 per cent of shareholders at the AGM in May 2017. As you may recall, the new policy simplified pay arrangements by reducing the number of annual bonus measures and by offering the Chief Executive of M&G awards under a single long‑term incentive plan rather than two. The policy also introduced a two‑year holding period on long‑term incentive awards and increased share ownership guidelines. During late 2017 and early 2018, I corresponded with and met the majority of our major shareholders, as well as organisations that represent and advise shareholders. On behalf of the Committee, I would like to thank shareholders for their engagement. Rewarding 2017 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. As set out in the Business review section earlier in this Annual Report, the Group delivered sustained growth in profit and cash in 2017. Performance against business unit remittances and IFRS operating profit exceeded, or were closely aligned to, the stretching targets established by the Board. EEV new business profit delivered double digit growth, a strong result in the light of the challenges outlined in the business performance review and delivered a result approaching the Board approved targets. 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 2017 (between 89 per cent and 100 per cent of executives’ maximum opportunities) appropriately reflect this performance. Performance in 2017 built on the momentum achieved in recent years. The Group delivered total IFRS operating profits of £12,924 million in 2015, 2016 and 2017 financial years. I am pleased to say that the continued impressive financial performance has translated into significant returns to the Company’s shareholders, with £100 invested on 1 January 2015 being worth £139 on 31 December 2017. Based on this level of total shareholder return (TSR) and strong cumulative IFRS operating profit performance over the performance period 2015 to 2017, the Committee determined that between 89.3 and 95.8 per cent of the Prudential Long Term Incentive Plan (PLTIP) awards made to Executive Directors in 2015 would vest (depending on the business unit). The Committee continues to ensure that payments and releases reflect the performance of the business, and remains mindful of its scope to use discretion if it is not satisfied that underlying financial performance justifies the payments arithmetically suggested by the achievement of the performance conditions. The Group Chief Executive’s total remuneration The total 2017 remuneration or ‘single figure’ for the Group Chief Executive, Mike Wells, is 18 per cent higher than the total 2016 ‘single figure’. This chiefly reflects that a greater proportion of 2015 PLTIP awards vested than of 2014 awards, based on the Company’s sustained performance and share price growth achieved over the period 1 January 2015 to 31 December 2017. 2015 was also the first year in which Mike received a PLTIP award in his capacity as Group Chief Executive. This remuneration outcome reflects Mike’s exceptional leadership and personal performance. Changes to the executive team As you will be aware, there have been three changes to Prudential’s team of Executive Directors during 2017; Nic Nicandrou was appointed Chief Executive of Prudential Corporation Asia in July 2017 after Tony Wilkey stepped down from the Board; Mark FitzPatrick replaced Nic Nicandrou as Chief Financial Officer in July 2017 and Penny James stepped down from the Board as Group Chief Risk Officer on 30 September 2017. The Committee applied the Directors’ recruitment policy and loss of office policy when determining joining and separation remuneration arrangements for these executives. 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. Implementation in 2018 The Committee intends to continue to operate within the current Directors’ remuneration policy during 2018. In determining remuneration packages for 2018, the Remuneration Committee was mindful of the need for restraint in base salary increases. All Executive Directors received a salary increase of 2 per cent. The 2018 salary increase budgets for other employees across the Group’s business units were between 2.5 per cent and 10 per cent. No changes have been made to executives’ maximum opportunities under either the annual incentive or the long‑term incentive plans, as we believe remuneration packages provide an appropriate balance between performance over the short and the long term. 124 Prudential plc Annual Report 2017 www.prudential.co.uk The Committee has enhanced the Annual Incentive Plan (AIP) reporting this year, a development that I trust you find welcome. The details of the targets, ranges and results achieved for the Group financial performance measures for the 2016 and 2017 AIP bonuses are included in this Directors’ remuneration report, thereby removing the one‑year reporting lag previously adopted. In response to shareholder feedback, the Committee has decided that the sustainability scorecard element of the PLTIP awards from 2018 onwards will be assessed on a sliding scale rather than on a meet or fail basis. UK gender pay gap The UK business entities have recently reported their 2017 UK gender pay gap data and details can be found on www.prudential.co.uk. We have a policy and carry out procedures to ensure that, where men and women perform similar roles, they are paid equally. However, the gender pay gaps demonstrate the demographic profile of the business (and the financial services sector more widely): there is a greater proportion of males in more senior and front‑office roles and a greater proportion of females in more junior, support and back‑office non‑finance roles. All the Group’s businesses are working on initiatives to increase the proportion of women in senior management and operating roles as part of the Group’s strategic focus on diversity and inclusion as described in the Diversity and Inclusion Statement on our website. This important priority is reflected in the Group’s reward structure as a result of the diversity measure attached to PLTIP awards granted from 2017 onwards. 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 2017. Anthony Nightingale, CMG SBS JP Chairman of the Remuneration Committee 14 March 2018 Strategic priority IFRS operating profit1 Prudential’s primary measure of profitability and a key driver of shareholder value CAGR4 (excluding Korea): +12% Group performance £m 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 CAGR4 (excluding Korea and UK bulk annuity new business profits): +15% Business unit remittances Cash flows across the Group balance these net remittances (which support dividend payments) with the retention of cash for profitable reinvestment CAGR4: +7% 2016-2017 growth3 10% 2016-2017 growth3 17% 2016-2017 growth3 4% 4,256 3,969 4,699 2,937 3,154 2,077 2,021 2,492 3,616 3,088 1,482 1,625 1,341 1,718 1,788 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2017 bonus achievement Above target, approaching stretch target level IFRS operating profit accounted for 35 per cent of Group financial bonus targets Approaching target level EEV new business profit accounted for 15 per cent of Group financial bonus targets Above stretch target level A cash flow measure was used to determine 20 per cent of the Group financial bonus targets Notes 1 As previously reported and excluding the contribution from the Korea life business for all years. 2 As previously reported and excluding the contribution from the Korea life business and UK bulk annuity new business profits for all years. 3 As reported. 4 2013‑2017 CAGR www.prudential.co.uk Annual Report 2017 Prudential plc 125 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationOur Executive Directors’ remuneration at a glance Our current remuneration architecture Key elements1,2 Salary and benefits 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 1 2 0 2 2 2 0 2 Key features of the policy How we implemented the policy Broadly aligned with pay budget for other employees Salary increase of 2% in 2017 Financial/functional and personal objectives set with reference to business plans approved by the Board Cash bonus Deferred bonus 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 2017 bonuses were paid based on financial performance or functional measures as well as personal 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; — Group or business unit IFRS operating profit; and — Balanced scorecard measures. Measured over three financial years from year of award with a two-year post-performance holding period Award is subject to malus and clawback provisions Awards in 2017 were below the plan limits: — Group Chief Executive: 400% of salary — CEO, NABU: 460% of salary — CEO, M&G: 450% of salary — Other PLTIP awards were 250% of salary For business unit CEOs, awards vest based on TSR, business unit IFRS operating profit and balanced scorecard measures For other Executive Directors, awards vest based on TSR, Group IFRS operating profit and balanced scorecard measures Significant share ownership guidelines for all Executive Directors as follows: — 400% of salary for the Group Chief Executive — 250% of salary for other Executive Directors Stretching IFRS profit ranges set with reference to business plans approved by the Board TSR vesting relative to international insurance peers Balanced scorecard of capital, conduct and diversity measures Prudential Long Term Incentive Plan (PLTIP) Share ownership guidelines Key Fixed pay Short‑term variable pay Long‑term variable pay Share ownership guidelines Notes 1 The Chief Executive, NABU also receives a 10% share of the Jackson bonus pool. 2 The Chief Executive, M&G retains separate bonus arrangements. 126 Prudential plc Annual Report 2017 www.prudential.co.uk What 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 125, 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 2015 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 reflected in the value of the LTIP releases. The value of these performance‑related elements of remuneration is added to the fixed packages provided to Executive Directors to calculate the 2017 ‘single figure’ of total remuneration. The total 2017 ‘single figure’ for the Group Chief Executive is higher than the total 2016 ‘single figure’, which is chiefly a result of the higher value of the 2015 PLTIP release. The values for the current Executive Directors who were Directors during the year are outlined in the table below: Executive Director Role Mark FitzPatrick1 John Foley Chief Financial Officer Chief Executive, Fixed pay Performance related 2017 salary Pension and benefits 2017 bonus LTIP vesting 2017 single figure 2016 single figure £335,000 £102,000 £1,197,000 – £1,634,000 N/A Nic Nicandrou2 Anne Richards Barry Stowe Mike Wells M&G Prudential Chief Executive, PCA3 Chief Executive, M&G Chairman & CEO, NABU4 Group Chief Executive £765,000 £869,000 £400,000 £880,000 £1,103,000 £306,000 £521,000 £253,000 £279,000 £769,000 £1,283,000 £1,414,000 £2,400,000 £5,354,000 £2,072,000 £2,378,000 £2,016,000 – £3,109,000 £4,758,000 £4,732,000 £4,820,000 £3,053,000 £9,622,000 £8,702,000 £4,291,000 £4,184,000 £3,875,000 £7,679,000 £7,370,000 Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017 as Chief Financial Officer. The remuneration above was paid in respect of his service as an Executive Director. 2 Nic Nicandrou was appointed Chief Executive, Prudential Corporation Asia on 17 July 2017. The remuneration above was paid in respect of his service as Chief Financial Officer and Chief Executive, Prudential Corporation Asia. 3 PCA is an abbreviation of Prudential Corporation Asia. 4 NABU is an abbreviation of North American Business Unit which includes Jackson National Life and PPM America. Aligning 2018 pay to performance The Remuneration Committee awarded salary increases to the Executive Directors for 2018 of 2 per cent, which was below the salary increase budget for the wider workforce. 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 2018 are set out in detail in the Annual report on remuneration and summarised below: Executive Director Role Mark FitzPatrick John Foley Nic Nicandrou Anne Richards1 Barry Stowe2 Mike Wells Chief Financial Officer Chief Executive, M&G Prudential Chief Executive, PCA Chief Executive, M&G Chairman & CEO, NABU Group Chief Executive AIP 2018 salary Maximum bonus (% salary) Bonus deferred PLTIP award (% salary)3 £745,000 £781,000 HK$10,710,000 £408,000 US$1,157,000 £1,126,000 175% 180% 180% 600% 160% 200% 40% 40% 40% 40% 40% 40% 250% 250% 250% 450% 460% 400% Notes 1 The bonus opportunity for the Chief Executive, M&G remains the lower of 0.75 per cent of M&G’s IFRS operating profit or six times salary. 2 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. 3 The PLTIP award is subject to a three‑year performance period and a further two‑year holding period. www.prudential.co.uk Annual Report 2017 Prudential plc 127 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationSummary of the current Directors’ remuneration policy The Company’s Directors’ remuneration policy was approved by shareholders at the 2017 AGM. This policy came into effect following the AGM on 18 May 2017 and is expected to apply until the 2020 AGM, when shareholders will be asked to approve a revised Directors’ remuneration policy. 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 Salary Operation The Committee reviews salaries annually, considering 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. 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; — Relocation and expatriate benefits; and 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. — Reimbursed business expenses (including any tax liability) incurred when travelling overseas in performance of duties. Provision for an income in retirement Current Executive Directors 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. 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, Prudential Corporation Asia receives statutory contributions into the Mandatory Provident Fund. 128 Prudential plc Annual Report 2017 www.prudential.co.uk Variable pay Element Operation Annual bonus Currently all Executive Directors participate in the Annual Incentive Plan (AIP). AIP awards for all Executive Directors, other than the Group Chief Risk Officer, are subject to the achievement of financial and personal objectives. The Group Chief Risk Officer’s performance measures are entirely based on a combination of functional and personal measures. 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 and cash flow targets and payments depend on the achievement of minimum capital thresholds. 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 bonuses made in respect of performance in 2015 and subsequent years. 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 and CEO, NABU receives a 10 per cent share of the Jackson Senior Management Bonus Pool. 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 maximum vesting under this arrangement is 100 per cent of the original deferral plus accrued dividend shares. 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, 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). 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; and — Group IFRS operating profit; or — Business unit IFRS operating profit; and — Balanced scorecard of sustainability measures. 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 Committee has the authority to apply a malus adjustment to all, or a portion of, an outstanding award in specific circumstances. For 2015 and subsequent years, 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). From 2017, PLTIP awards are usually subject to an additional two‑year holding period following the end of the three‑year performance period. Share ownership guidelines The guidelines for share ownership are as follows: — 400 per cent of salary for the Group Chief Executive; and — 250 per cent of salary for other Executive Directors. 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. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 129 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationSummary of the current Directors’ remuneration policy continued 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. Scenarios 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 2018. 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 appetites. £000 12,000 10,000 8,000 6,000 4,000 2,000 0 1,091 100% i i M n m u m 4,450 44% 32% 24% i M a x m u m 3,014 41% 23% 36% I n l i n e w i t h e x p e c t a t i o n s 1,046 100% i i M n m u m 4,213 44% 31% 25% i M a x m u m 2,862 41% 23% 36% I n l i n e w i t h e x p e c t a t i o n s 4,947 37% 50% 13% i M a x m u m 3,035 38% 40% 22% I n l i n e w i t h e x p e c t a t i o n s 663 100% i i M n m u m 10,960 38% 51% 8,605 30% 56% 1,182 100% 14% 11% 1,788 100% 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 6,389 42% 30% 28% i M a x m u m 4,423 38% 22% 40% I n l i n e w i t h e x p e c t a t i o n s 8,657 52% 26% 22% i M a x m u m 5,842 48% 19% 33% I n l i n e w i t h e x p e c t a t i o n s 1,901 100% i i M n m u m John Foley Mark FitzPatrick Anne Richards Barry Stowe Nic Nicandrou Mike Wells Fixed Short‑term incentives Long‑term incentives Note The scenarios in the chart above have been calculated on the following assumptions: Fixed pay Base salary at 1 January 2018. Minimum In line with expectations Maximum Pension allowance at 1 January 2018. Estimated value of benefits based on amounts paid in 2017. Nic Nicandrou 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. 100% of maximum AIP. Jackson bonus pool at the average of the last three years. Jackson bonus pool at highest of the last three years. Vesting of 62.5% of award under PLTIP (midway between threshold and maximum). 100% of award under PLTIP. 130 Prudential plc Annual Report 2017 www.prudential.co.uk 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. Non‑executive Directors are not eligible to participate in annual bonus plans or long‑term incentive plans. 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 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 Chairman is not eligible to receive a pension allowance or to participate in the Group’s employee pension schemes. In 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 Chair 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. www.prudential.co.uk Annual Report 2017 Prudential plc 131 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationAnnual report on remuneration The Board has established Audit, Remuneration, Risk and Nomination & 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 Chair of the Committee) Kai Nargolwala Philip Remnant Thomas Watjen (member since 11 July 2017) 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 94. The Committee was found to be functioning effectively. 132 Prudential plc Annual Report 2017 www.prudential.co.uk In 2017, the Committee met six times. Key activities at each meeting are shown in the table below: Meeting Key activities February 2017 Approve the 2016 Directors’ remuneration report; consider 2016 bonus awards for Executive Directors; consider vesting of the long‑term incentive awards with a performance period ending on 31 December 2016; approve 2017 long‑term incentive awards, performance measures and plan documentation; and note an update on regulation affecting remuneration. March 2017 May 2017 June 2017 Confirm 2016 annual bonuses and the vesting of long‑term incentive awards with a performance period ending on 31 December 2016, in light of audited financial results. Approve remuneration arrangements for a new Executive Director and an Executive Director whose role changed and separation arrangements for an Executive Director who stepped down from the Board. 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; review progress towards share ownership guidelines by the Chairman, Executive Directors and other Group Executive Committee members; approve the Chairman’s fees; and note an update on regulation affecting remuneration. September 2017 Review proposed 2018 remuneration arrangements ahead of consultation with shareholders; approve the Solvency II Remuneration Policy Statement; and review the Remuneration Committee’s terms of reference. December 2017 Review level of participation in the Company’s all‑employee share plans and dilution levels resulting from the Company’s share plans; approve Group Executive Committee members’ 2018 salaries and incentive opportunities in light of initial shareholder feedback; consider the annual bonus and long‑term incentive measures and targets to be used in 2018; review an initial draft of the 2017 Directors’ remuneration report; approve the Committee’s 2018 work plan; approve the fees for independent non‑executive directors of the material subsidiaries; and note an update on regulation affecting remuneration. 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 2017, 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 meet with the Chair 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 2017 were £56,000 charged on a time and materials basis. During 2017, 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. www.prudential.co.uk Annual Report 2017 Prudential plc 133 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationTable of 2017 Executive Director total remuneration (the ‘single figure’) £000’s Mark FitzPatrick1 John Foley Penny James2 Nic Nicandrou3, 8 Anne Richards4 Barry Stowe5,8 Mike Wells6 Tony Wilkey7 Total 2017 taxable benefits* 18 115 81 303 153 59 493 456 2017 total bonus 1,197 1,283 – 1,414 2,400 5,354 2,072 787 Of which: Amount deferred into Prudential shares† Amount paid in cash 2017 LTIP releases‡ 2017 pension benefits§ Total 2017 remuneration the ‘single figure’¶ 718 770 – 848 1,440 3,212 1,243 472 479 513 – 566 960 2,141 829 315 – 2,378 – 2,016 – 3,109 4,758 2,952 84 191 119 218 100 220 276 123 1,634 4,732 678 4,820 3,053 9,622 8,702 4,808 1,678 14,507 8,703 5,803 15,213 1,331 38,049 2017 salary 335 765 478 869 400 880 1,103 490 5,320 * 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 but no further conditions. ‡ In line with the regulations, the estimated value of PLTIP releases in 2017 has been calculated based on the average share/ADR price over the last three months of 2017 (£18.52/$49.12). The actual value of PLTIPs, based on the share price on the date awards are released, will be shown in the 2018 report. § 2017 pension benefits include cash supplements for pension purposes and contributions into DC schemes as outlined on page 142. ¶ 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 Statutory Instrument 2013 No. 1981 ‑ The Large and Medium‑sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013. Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017. 2 Penny James stepped down from the Board on 30 September 2017. The remuneration above was paid in respect of her service as an Executive Director. 3 To facilitate Nic Nicandrou’s relocation to Hong Kong to take up his new role as Chief Executive, Prudential Corporation Asia, Nic’s benefits include relocation support being temporary accommodation of £126,000 and tax and immigration advice of £33,000. 4 To facilitate her appointment as Chief Executive, M&G, in 2016 Anne Richards’s benefits include travel costs from Anne’s home in Edinburgh to London of £15,000. 5 Barry Stowe’s bonus figure excludes a contribution of £16,200 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 2017 pension benefits. 6 To facilitate his appointment as Group Chief Executive and move to the UK in 2015, Mike Wells’s benefits include £340,000 to cover mortgage interest and £37,000 to cover home leave flights. 7 Tony Wilkey stepped down from the Board on 17 July 2017. The remuneration above was paid in respect of his service as an Executive Director. His benefits include £148,000 for housing, £24,000 for home leave flights and a £235,000 Executive Director Location Allowance. Two of the LTIP releases relate to his previous role, prior to his service as an Executive Director. 8 Barry Stowe, Tony Wilkey and, following his appointment as Chief Executive, Prudential Corporation Asia, Nic Nicandrou are paid in their local currency and exchange rate fluctuations will therefore impact the reported sterling value. 134 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedTable of 2016 Executive Director total remuneration (the ‘single figure’) 2016 salary 714 606 173 711 228 820 1,081 845 2016 taxable benefits* 134 83 70 361 82 46 893 828 2016 total bonus 1,271 962 920 1,236 1,368 5,229 2,151 1,440 Of which: Amount deferred into Prudential shares† Amount paid in cash 2016 LTIP releases‡ 2016 Other payments 2016 pension benefits§ Total 2016 remuneration the ‘single figure’¶ 763 577 552 742 821 3,137 1,291 864 508 385 368 494 547 2,092 860 576 1,993 388 2,252 1,698 – 1,379 2,975 1,707 – – – – 2,140 – – – 179 152 43 178 57 205 270 213 4,291 2,191 3,458 4,184 3,875 7,679 7,370 5,033 £000’s John Foley1 Penny James Michael McLintock2 Nic Nicandrou3 Anne Richards4 Barry Stowe5,8 Mike Wells6 Tony Wilkey7,8 Total 5,178 2,497 14,577 8,747 5,830 12,392 2,140 1,297 38,081 * 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 but no further conditions. ‡ In line with the regulations, the estimated value of PLTIP releases in 2016 has been recalculated based on the actual share/ADR price on the date awards are released, being £16.63/$41.58. § 2016 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 Statutory Instrument 2013 No. 1981 ‑ The Large and Medium‑sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013. 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 the value is set out in the ‘Other payments’ column. 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 and the value is included in the ‘taxable benefits’ column. 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. Mike’s benefits figure has been amended to include an additional £20,000 of home leave flights taken in 2016. 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. 8 Barry Stowe and Tony Wilkey are paid in their local currency and exchange rate fluctuations will therefore impact the reported sterling value. www.prudential.co.uk Annual Report 2017 Prudential plc 135 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationRemuneration in respect of performance in 2017 Base salary Executive Directors’ salaries 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, which vary across our business units, reflecting local market conditions; — The performance and experience of each Executive Director; — The relative size of each Executive Director’s role; and — The performance of the Group. As reported last year, after careful consideration by the Committee, all Executive Directors, other than the Group Chief Risk Officer, received a salary increase of 2 per cent. The Group Chief Risk Officer received a salary increase of 5 per cent. The 2017 salary increase budgets for other employees across our business units were between 2.5 per cent and 6 per cent. No changes were made to Executive Directors’ maximum opportunities under either the annual incentive or the long‑term incentive plans. To provide context for the market review, information was also drawn from the following market reference points: Executive John Foley Penny James Nic Nicandrou Mark FitzPatrick Anne Richards Role Benchmark(s) used to assess remuneration Chief Executive, M&G Prudential — FTSE 40 — International insurance companies Group Chief Risk Officer — FTSE 40 Chief Financial Officer — FTSE 40 — International insurance companies Chief Executive, M&G — McLagan UK Investment Management Survey — International insurance companies Barry Stowe Chairman & CEO, NABU — Towers Watson US Financial Services Survey — LOMA US Insurance Survey Mike Wells Group Chief Executive — FTSE 40 Tony Wilkey Nic Nicandrou Executive Director Mark FitzPatrick1 John Foley2 Penny James3 Nic Nicandrou4 Anne Richards5 Barry Stowe Mike Wells Tony Wilkey6 Chief Executive, Prudential Corporation Asia — International Insurance Companies — Towers Watson Asian Insurance Survey 2016 salary 2017 salary N/A £750,000 £606,000 £711,000 £400,000 £730,000 £765,000 £637,000 HK$10,500,000 £400,000 US$1,111,000 US$1,134,000 £1,081,000 £1,103,000 HK$8,890,000 HK$9,070,000 Notes 1 Mark FitzPatrick was appointed Chief Financial Officer on 17 July 2017. The annualised 2017 salary above was paid in respect of his service as Chief Financial Officer. 2 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. 3 Penny James stepped down from the Board on 30 September 2017. 4 Nic Nicandrou was appointed Chief Executive, Prudential Corporation Asia on 17 July 2017. The annualised 2017 salary above was paid in respect of his service as Chief Executive, Prudential Corporation Asia. 5 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. 6 Tony Wilkey stepped down from the Board on 17 July 2017. 136 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedAnnual bonus 2017 annual bonus opportunities Executive Directors’ bonus opportunities, the weighting of performance measures for 2017 and the proportion of annual bonuses deferred are set out below: Executive Director Mark FitzPatrick1 John Foley Penny James2 Nic Nicandrou3 Anne Richards Barry Stowe4 Mike Wells Tony Wilkey5 Maximum AIP opportunity (% of salary) Deferral requirement Group financial measures Weighting of measures Business unit financial/ functional measures Personal objectives 175% 40% of total bonus 180% 40% of total bonus 160% 40% of total bonus 180% 40% of total bonus 600% 40% of total bonus 160% 40% of total bonus 200% 40% of total bonus 180% 40% of total bonus 80% 20% – 20% 20% 80% 80% 20% 20% – 20% 60% 100% (functional/personal) 20% 60% 20% 60% 20% – 20% – 20% 60% Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017. The maximum bonus opportunity shown represents his annual opportunity as an Executive Director. This was not pro‑rated for the portion of the year for which he was an Executive Director, as Mark did not receive a 2017 bonus from his previous employer. 2 Penny James stepped down from the Board on 30 September 2017. The maximum bonus opportunity shown represents her annual opportunity as an Executive Director but no bonus was paid. 3 Nic Nicandrou was Chief Financial Officer until his appointment as Chief Executive, Prudential Corporation Asia on 17 July 2017. The maximum bonus opportunity and performance measures shown represents his annual opportunity in his current role – this was pro‑rated for the portion of the year he was in this role and he also received a pro‑rated AIP for the portion of the year he was Chief Financial Officer. 4 Barry Stowe also receives 10 per cent of the Jackson bonus pool. 5 Tony Wilkey stepped down from the Board on 17 July 2017. The maximum bonus opportunity shown represents his annual opportunity as an Executive Director. This was pro‑rated for the portion of the year for which he was an Executive Director. 2017 AIP performance measures and achievement Target-setting process For the financial AIP metrics, 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. The Committee seeks advice from the Group Risk Committee on risk management considerations to be applied to remuneration architecture and performance measures to ensure risk management culture and conduct is appropriately reflected in the design and operation of Executive Directors’ remuneration. In 2017, the AIP performance measures were simplified from seven to four measures and Executive Directors’ 2017 bonuses were 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 the Group Chief Risk Officer’s AIP performance targets (with effect from 2017) were changed so that the entire AIP outcome relates to a combination of functional and personal measures. Financial performance The Committee reviewed performance against the performance ranges at its meeting in March 2018. Of the bonus performance metrics, the maximum targets were all exceeded other than Group IFRS operating profit, Savings & Retirement Solutions cash flow and IFRS operating profit, and Prudential Corporation Asia operating free surplus generated and IFRS operating profit which were between plan and maximum and Group NBP EEV profit and Prudential Corporation Asia NBP EEV profit which were between threshold and plan. www.prudential.co.uk Annual Report 2017 Prudential plc 137 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationThe Group Remuneration Committee considered a report from the interim Group Chief Risk Officer which had been approved by the Group Risk Committee. This report confirmed that the 2017 results were achieved within the Group’s and business units’ risk framework and appetite. The interim 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 interim Group Chief Risk Officer’s recommendations were taken into account by the Committee when determining AIP outcomes for Executive Directors. The level of performance required for threshold, plan and maximum payment against the Group’s 2017 Annual Incentive Plan financial measures and the results achieved are set out below. 2017 AIP measure Group IFRS operating profit Operating free surplus generated Group Cash flow NBP EEV profit Weighting Threshold (£m) 35% 30% 20% 15% 3,967 3,090 (284) 3,339 Plan (£m) 4,464 3,398 16 3,697 Maximum (£m) Achievement (£m) 4,785 3,628 136 3,836 4,699 3,640 159 3,616 The Board believe 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. 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 objectives including: — The executive meeting their individual conduct and customer measures; — The executive’s contribution to Group strategy as a member of the Board; and — Specific goals related to the business or function for which they are responsible and progress on major projects. At its meeting in March 2018, the Committee concluded that there had been a high level of performance against these 2017 objectives, as summarised below: Business Overview of objectives 2017 highlights Group Head Office Prudential Corporation Asia and Africa Objectives included developing relationships with stakeholders, enhancing external publications, continued development of executive bench strength and leveraging digital opportunities Objectives included leveraging digital opportunities, developing distribution channels, continued development of executive bench strength, developing Eastspring and growing the Group’s Africa footprint — Highly commended in the 2017 Building Public Trust in Corporate Reporting Awards in the category for tax reporting; — Developed executive bench strength and succession and emerging talent to leverage high potential talent across the Group as demonstrated by the appointment of the former Group Chief Financial Officer as Chief Executive, Prudential Corporation Asia; and — Won the Insurance category of Managements Today’s Britain’s Most Admired Companies’ award. — Delivered various customer experience enhancements including askPRU, an insurance chatbot with real time information, and roll‑out of myDNA, our DNA‑based health and nutrition programme that enables customers to take a more personalised approach to their wellbeing; — Launched PRU Fintegrate, an initiative that enables us to collaborate with fintech start‑ups; — Eastspring was chosen by IFC, part of the World Bank, as its first Asian partner in a programme that mobilises funds from institutional investors into projects in emerging markets; and — Entered Nigeria, our fifth African market, by acquiring a majority stake in Zenith Life and formed exclusive bancassurance partnerships with Zenith Bank plc. 138 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedBusiness Overview of objectives 2017 highlights North American Business Unit Objectives included leveraging digital opportunities, developing our product range and focusing on core business areas — Launched Jackson’s The Financial Freedom Studio which aims to make retirement and investment choices easier to understand; — Introduced ‘Retire on Purpose’, a new platform with a focus on thoughtful life planning as a crucial first step towards creating a comprehensive financial plan; M&G Prudential Objectives included the merger and successful integration of the Prudential UK and M&G businesses, leveraging digital opportunities, developing our range of products and investment offerings, and continued development of executive bench strength — Launched Perspective Advisory II and Elite Access Advisory to serve advisers and distributors with a preference for advisory products, and launched Private Wealth Shield, entering the Private Wealth and Trust Market; and — Through our subsidiary National Planning Holdings, sold our US independent broker‑dealer network in order to focus on our core business. — Announced the merger of M&G and Prudential UK to offer customers and distributors wider and better choice and achieve cost savings; — Entered a 10‑year partnership with Tata Consultancy Services, a global leader in IT, business process and digital services, to enhance service for our UK savings and retirement customers; — Introduced myM&G, a new online direct‑to‑consumer investing platform, with lower fund charges; and — Launched our first open‑ended infrastructure fund of global listed infrastructure companies, the M&G ESG Global High Yield Fund and six further M&G funds on the new SICAV platform. 2017 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 2017 AIP payments: Executive Director Role Mark FitzPatrick2 John Foley Penny James3 Nic Nicandrou4 Anne Richards Barry Stowe4 Mike Wells Tony Wilkey5 Chief Financial Officer Chief Executive, M&G Prudential Group Chief Risk Officer Chief Financial Officer/ Chief Executive, PCA Chief Executive, M&G Chairman & CEO, NABU Group Chief Executive Chief Executive, PCA 2017 salary1 £730,000 £765,000 £637,000 £726,000/ HK$10,500,000 £400,000 US$1,134,000 £1,103,000 HK$9,070,000 Maximum 2017 AIP 2017 AIP payment (% of maximum) 2017 AIP payment 175% 180% 160% 175%/ 180% 600% 160% 200% 180% 94% 93% 0% 90% 100% 94% 94% 89% £1,197,000 £1,283,000 £nil £1,414,000 £2,400,000 £5,354,000 £2,072,000 £787,000 Notes 1 At 31 December 2017 or on stepping down from the Board if earlier. 2 As Mark FitzPatrick did not receive a bonus from his previous employer for 2017, his bonus was not pro‑rated. 3 Penny James stepped down from the Board on 30 September 2017 and no bonus was paid. 4 5 Tony Wilkey stepped down from the Board on 17 July 2017. The AIP shown above was paid in respect of his service as an Executive Director. In addition to the Annual Incentive Plan, Barry Stowe also participates in the Jackson bonus pool (see below). 2017 Jackson bonus pool In 2017, the Jackson bonus pool was determined by Jackson National Life Insurance’s profitability, capital adequacy, remittances to Group, in‑force experience, ECap solvency ratio and credit rating. Across all these measures Jackson delivered strong performance, and more detail on that performance is set out on pages 24 to 27. As a result of this performance the Committee determined that Barry Stowe’s share of the bonus pool was US$5,199,580. www.prudential.co.uk Annual Report 2017 Prudential plc 139 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationDisclosure of targets and achievement for the 2016 Annual Incentive Plan The level of performance required for threshold, plan and maximum payment against the Group’s 2016 Annual Incentive Plan financial measures and the results achieved are set out below. 2016 AIP measure Group cash flow Operating free surplus generated Group Solvency II surplus Group ECap surplus NBP EEV profit In‑force EEV profit Group IFRS operating profit Weighting Threshold (£m) Plan (£m) Maximum (£m) Achievement (£m) 10% 25% 7.5% 7.5% 5% 10% 35% (357) 2,719 9,400 15,551 2,674 1,682 3,483 (224) 3,244 11,900 18,551 2,949 1,912 3,733 (195) 3,394 12,900 20,051 3,009 2,002 3,908 35 3,566 12,483 22,470 3,088 2,409 4,256 The Board believe 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 2016 and 2017 under the Prudential Long Term Incentive Plan As at 31 December 2017, Prudential’s TSR performance during the period 1 January 2016 and 31 December 2017 was ranked between median and upper quartile and during the period 1 January 2017 to 31 December 2017 was ranked in the upper quartile. Prudential’s Group IFRS operating profit performance between 1 January 2016 to 31 December 2017 was 5 per cent above the stretch target established for 2016 PLTIP awards. The Group’s IFRS achievement between 1 January 2017 and 31 December 2017 was 2 per cent above the stretch target adopted for 2017 PLTIP award. Between 1 January 2017 and 31 December 2017, the Group also made good progress towards meeting the measures which form part of the sustainability scorecard used for 2017 to 2019 PLTIP awards: — Capital measure As at 31 December 2017, the Group’s Solvency II operating capital generation was above the plan level. — Conduct measure During 2017, there were no significant conduct/culture/governance issues that resulted in significant capital add‑ons or material fines. — Diversity measure As at 31 December 2017, 25 per cent of our Leadership Team was female. This represented good progress towards the target that 27 per cent of the Leadership Team be female by the end of 2019. Remuneration in respect of performance periods ending in 2017 Long-term incentive plans with performance periods ending on 31 December 2017 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, including an assessment of whether results were achieved within the Group and business units’ risk framework and appetite. The Directors’ remuneration policy contains further details of the design of Prudential’s long‑term incentive plans. Prudential Long Term Incentive Plan (PLTIP) In 2015, 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 John Foley Barry Stowe Mike Wells Tony Wilkey All other Executive Directors Weighting of measures Group TSR1 IFRS operating profit (Group or business unit)2 50% 50% 50% 50% 50% 50% (business unit target) 50% (business unit target) 50% (business unit and Group target) 50% (business unit target) 50% (Group target) Notes 1 Group TSR is measured on a ranked basis over three years relative to peers. 2 IFRS operating profit is measured on a cumulative basis over three years. 3 Mike Wells, Barry Stowe and Tony Wilkey received additional awards following their change in role in 2015 and these awards had performance measures reflective of their new roles. 140 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continued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 2015 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 Following the merger of Standard Life and Aberdeen Asset Management during the year, the Remuneration Committee determined that Standard Life would be retained in the peer group for the pre‑merger period and the combined entity would be included in the peer group from the date of the merger for all outstanding PLTIP awards. Prudential’s TSR performance during the performance period (1 January 2015 to 31 December 2017) was between the median and upper quartile of the peer group (ranked 6th). The portion of the awards related to TSR that therefore vested was 91.67 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 2015 to 2017 compared to the Group targets set in 2015: Group IFRS operating profit 2015-17 cumulative targets Threshold Plan Maximum 2015-17 cumulative achievement £9,872m £10,969m £12,066m £12,962m 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 per cent vesting, other than Asia which exceeded plan performance, but not the stretch target, and therefore vested at 87 per cent. 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. Prudential Corporation Asia Long Term Incentive Plan (PCA LTIP) Tony Wilkey holds PCA LTIP awards granted in 2014 and 2015. These PCA LTIP awards were granted before Tony was appointed to the Board. One of these awards, granted in 2014, had performance conditions and one of these awards, granted in 2015, had no performance conditions. Details of the performance conditions attached to the 2014 award and performance achieved are set out below: Performance measure Prudential Corporation Asia IFRS operating profit Prudential Corporation Asia operating free surplus generated Performance target (to be achieved by 31 December 2017) Performance achieved by 31 December 2017 Weighting 50% 50% £1,826m £900m £1,855m £1,029m www.prudential.co.uk Annual Report 2017 Prudential plc 141 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationLTIP vesting The Committee considered a report from the interim Group Chief Risk Officer which had been approved by the Group Risk Committee. This report 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 Director’s LTIP awards as set out below. Executive Director John Foley Nic Nicandrou Barry Stowe Mike Wells Tony Wilkey Maximum value of award at full vesting1 Percentage of the LTIP award vesting Number of shares/ADRs vesting2 Value of shares vesting1 £2,481,758 £2,104,050 £3,405,243 £4,967,070 £3,058,597 95.8% 95.8% 95.8% and 89.3% 95.8% 100% and 89.3% 128,376 108,838 81,591 124,861 159,373 £2,377,524 £2,015,680 £3,109,433 £4,758,453 £2,951,588 Notes 1 The share price used to calculate the value of the LTIP awards with performance periods which ended on 31 December 2017 and vest in 2018 was the average share price/ADR price for the three months up to 31 December 2017, being £18.52/$49.12. 2 The number of shares vesting includes accrued dividend shares. 3 Mike Wells, Barry Stowe and Tony Wilkey received additional awards following their change of role in 2015, and these awards had performance measures reflective of their new roles. Pension entitlements Pension provisions in 2017 were: Executive Director 2017 pension arrangement Life assurance provision Barry Stowe Tony Wilkey/Nic Nicandrou 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 Eight times salary Up to four times salary plus a dependants’ pension 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. The normal retirement date is 60 years of age and during 2017 John elected to commence payment of his pension. John took a tax free cash sum of £103,551.06 and from March 2017 received pension payments equivalent to £15,533 per annum, which increased to £15,636 per annum from 1 April 2017, in line with the Consumer Prices Index. The pension will continue to be subject to statutory increases in line with the Consumer Prices Index. 142 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continued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 vs. FTSE 100 and peer group average – total return per cent over nine years to December 2017 £800 £700 £600 £500 £400 £300 £200 £100 £713 £292 £246 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Prudential FTSE 100 Peer group average Note The peer group average represents the average TSR performance of the peer group used for 2017 PLTIP awards (excluding companies not listed at the start of the period). The 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 2017 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 M Wells 1,872 2,072 (94%) 4,758 (95.8%) – 613 704 (77.3%) 3,702 (100%) – 2,244 2,151 (99.5%) 2,975 (70.8%) – 1,992 1,244 (99.7%) 4,290 (100%) – 1,411 2,056 (99.8%) 5,235 (100%) – 1,458 2,122 (100%) 9,838 (100%) – 1,373 2,000 (100%) 6,160 (100%) – 1,189 1,570 (97%) 2,534 (100%) – 1,241 1,570 (97%) 2,528 (100%) – 1,013 841 (92%) 1,575 (100%) 308 286 354 (90%) – – – 3,737 640 5,293 5,339 9,533 8,702 13,418 5,019 7,526 7,370 8,702 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 his service as Group Chief Executive. 2 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. www.prudential.co.uk Annual Report 2017 Prudential plc 143 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationPercentage change in remuneration The table below sets out how the change in remuneration for the Group Chief Executive between 2016 and 2017 compared to a wider employee comparator group: Group Chief Executive All UK employees Salary Benefits 2% 3% (44.8)% 3.3% Bonus (3.7)% 6.3% 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 2016 and 2017. 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. Relative importance of spend on pay The table below sets out the amounts payable in respect of 2016 and 2017 on all employee pay and dividends: All employee pay (£m)1 Dividends (£m) Note 1 All employee pay as taken from note B2.1 to the financial statements. 2016 1,885 1,122 2017 1,985 1,216 Percentage change 5% 8.4% Long-term incentives awarded in 2017 2017 share-based long-term incentive awards As detailed in the Directors’ remuneration policy, approved by shareholders at the 2017 AGM, all long‑term incentive awards made to Executive Directors in 2017 were granted under the PLTIP. The vesting of these awards will depend on: — Relative TSR (25 per cent of award); — Group or business unit IFRS operating 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 the Group Chief Risk Officer’s LTIP performance targets (with effect from 2017) were different to the other Executive Directors and were: — Relative TSR (50 per cent of award); — Group IFRS operating 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) were 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 Aviva Manulife Standard Life Aberdeen AIA AXA MetLife Sun Life Financial AIG Generali Old Mutual Zurich Insurance Group Allianz Legal & General Prudential Financial 144 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedUnder the IFRS measure, 25 per cent of the award vests for meeting the threshold IFRS operating profit, set at the start of the performance period increasing to full vesting for performance at or above the stretch level. 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 the 2017 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 that 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 by 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 by the end of 2019. Vesting basis: 100 per cent vesting for achieving the target, otherwise 0 per cent vesting. The table below shows the awards made to Executive Directors in 2017 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† Weighting of performance conditions IFRS operating profit End of performance period Group TSR Balanced scorecard Group Asia US UK M&G Mark FitzPatrick Chief Financial 101,360 £1,824,987 Officer John Foley Chief Executive, 114,177 £1,912,465 Penny James Group Chief Risk 95,073 £1,592,473 M&G Prudential Nic Nicandrou Chief Financial 108,357 £1,814,980 Officer Officer/ Chief Executive, PCA Anne Richards Chief Executive, 107,461 £1,799,972 Barry Stowe Chairman & CEO, 123,845 $5,216,351 M&G Mike Wells Tony Wilkey NABU Group Chief Executive Chief Executive, PCA 263,401 £4,411,967 139,340 £2,333,945 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 31 December 2019 25% 25% 50% 25% 25% 25% 25% 25% 25% 50% 25% 30% 20% 25% 50% 50% 25% 25% 50% 50% 25% 50% 25% 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, being £16.75 and an ADR price of $42.12 for all Executive Directors other than Mark FitzPatrick and £18.005 for Mark FitzPatrick. ‡ The 2017 balanced scorecard is assessed on a binary basis. The percentage of awards released for achieving maximum targets is 100 per cent. www.prudential.co.uk Annual Report 2017 Prudential plc 145 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationBuy-out award As reported in the 2016 Annual report on remuneration, 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 outstanding awards and the exercise periods are detailed below. Exercise period 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 25,078 25,078 13,426 In December 2017, Anne exercised the second tranche of this replacement award. The gross value of the award exercised (which included dividend equivalents) was £747,671 and Anne used the net of tax value of £395,174 to buy 21,408 Prudential shares. Anne has committed to use the net of tax value of all her outstanding awards to buy 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. 146 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedChairman and Non-executive Director remuneration in 2017 Chairman’s fees The Chairman’s fee was reviewed by the Committee during 2017 and increased by 2 per cent to £734,000 with effect from 1 July 2017 in order to reflect inflation. Non-executive Directors’ fees The Non‑executive Directors’ fees were reviewed by the Board during 2017 and the basic fee was increased by 2 per cent to £97,000. None of the fees for additional duties were increased: Annual fees Basic fee Additional fees: Audit Committee Chair Audit Committee member Remuneration Committee Chair Remuneration Committee member Risk Committee Chair Risk Committee member Nomination Committee member Senior Independent Director From 1 July 2016 (£) From 1 July 2017 (£) 95,000 97,000 75,000 27,500 60,000 27,500 75,000 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 Turner Thomas Watjen4 Total 2017 fees 2016 fees 2017 taxable benefits* 2016 taxable benefits* Total 2017 remuneration: the ‘single figure’† Total 2016 remuneration: the ‘single figure’† 727 209 79 – 176 151 166 211 124 140 59 710 202 205 47 122 150 165 210 122 122 – 122 121 – – – – – – – – – – – – – – – – – – – – 849 209 79 – 176 151 166 211 124 140 59 831 202 205 47 122 150 165 210 122 122 – 2,042 2,055 122 121 2,164 2,176 * 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 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. 4 Thomas Watjen joined the Board on 11 July 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 147 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationStatement 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 (SIP) 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 2017 (or on date of appointment) During 2017 31 December 2017 (or on date of retirement) Share ownership guidelines Total beneficial interest (number of shares) Number of shares acquired Number of shares disposed Number of shares subject to performance conditions† Total beneficial interest* (number of shares) Total interest in shares Share ownership guidelines‡ (% of salary/fee) Beneficial interest as a percentage of basic salary/ basic fees§ Chairman Paul Manduca Executive Directors Mark FitzPatrick1 John Foley Penny James2 Nic Nicandrou Anne Richards Barry Stowe3 Mike Wells4 Tony Wilkey5 Non-executive Directors Howard Davies Ann Godbehere6 David Law Kaikhushru Nargolwala Anthony Nightingale Philip Remnant Alice Schroeder7 Lord Turner Tom Watjen8 42,500 – – 42,500 – 42,500 – 249,965 41,572 304,138 31,439 265,878 544,534 120,528 9,049 15,914 6,904 70,000 30,000 6,916 8,500 5,500 – 81 154,770 47,365 134,338 54,922 227,178 243,195 101,428 229 – 2,162 – 20,000 – – 1,052 5,500 – 154,619 13,376 146,167 – 210,710 125,106 147,537 – – – – – – – – – 81 250,116 75,561 292,309 86,361 282,346 662,623 74,419 9,278 15,914 9,066 70,000 50,000 6,916 8,500 6,552 5,500 101,360 381,325 236,049 349,310 153,367 686,398 835,625 454,170 101,441 631,441 311,610 641,619 239,728 968,744 1,498,248 528,589 – – – – – – – – – 9,278 15,914 9,066 70,000 50,000 6,916 8,500 6,552 5,500 100% 250% 250% N/A 250% 250% 250% 400% N/A 100% N/A 100% 100% 100% 100% 100% 100% 100% 108% 0% 596% N/A 510% 394% 585% 1095% N/A 178% N/A 174% 1343% 959% 133% 163% 126% 106% * There were no changes of Directors’ interests in ordinary shares between 31 December 2017 and 13 March 2018, with the exception of the UK‑based Executive Directors due to their participation in the monthly SIP. Mark FitzPatrick acquired a further 31 shares in the SIP, John Foley acquired a further 30 shares in the SIP and Mike Wells acquired a further 30 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 and increased again in 2017. 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. Where applicable, all Directors are in compliance with the share ownership guideline. § Based on the average closing price for the six months to 31 December 2017 (£18.23). 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 Stock Exchange of Hong Kong Limited any disclosure of interests notified to it in the United Kingdom. Notes 1 Mark FitzPatrick was appointed to the Board on 17 July 2017. Total interest in shares is shown from this date. 2 Penny James stepped down from the Board on 30 September 2017. Total interest in shares is shown as at this date. 3 For the 1 January 2017 figure, Barry Stowe’s beneficial interest in shares is made up of 132,939 ADRs (representing 265,878 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 2017 figure the beneficial interest in shares is made up of 141,173 ADRs (representing 282,346 ordinary shares). 4 For the 1 January 2017 figure, Mike Wells’ beneficial interest in shares is made up of 218,576 ADRs (representing 437,152 ordinary shares) and 107,382 ordinary shares. For the 31 December 2017 figure his beneficial interest in shares is made up of 249,811 ADRs (representing 499,622 ordinary shares) and 163,001 ordinary shares. 5 Tony Wilkey stepped down from the Board on 17 July 2017. Total interest in shares is shown as at this date. 6 Ann Godbehere stepped down from the Board on 18 May 2017. Total interest in shares is shown as at this date. 7 For the 1 January 2017 and 31 December 2017 figure, Alice Schroeder’s beneficial interest in shares is made up of 4,250 ADRs (representing 8,500 ordinary shares). 8 Tom Watjen was appointed to the Board on 11 July 2017. Total interest in shares is shown from this date. For the 31 December 2017 figure, Tom Watjen’s beneficial interest in shares is made up of 2,750 ADRs (representing 5,500 ordinary shares). 9 James Turner, who joined the Board as Group Chief Risk Officer on 1 March 2018, has a total beneficial interest in 9,701 shares, awards over 82,976 shares subject to performance conditions and an option over 1,237 shares in the UK Prudential Savings‑Related Share Option Scheme. There was no change in his share interests between 1 and 13 March 2018. 148 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continued The bar chart below illustrates the Executive Directors’ shareholding as a percentage of base salary versus the share ownership guideline. % 1,200 1,000 800 600 400 200 0 1,095 596 585 394 400 510 250 250 250 250 250 John Foley Mark FitzPatrick Anne Richards Barry Stowe Mike Wells Nic Nicandrou 0 Share ownership guideline as % of salary Beneficial interest as % of salary 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 options under her buy‑out arrangement, details of which were set out on page 146. Date of grant Exercise price (pence) Market price at 31 Dec 2017 (pence) Exercise period Number of options Beginning Beginning of period Granted Exercised Cancelled Forfeited End Lapsed End of period Mark FitzPatrick John Foley John Foley John Foley Penny James Nic Nicandrou Nic Nicandrou Anne Richards Mike Wells 21 Sep 17 23 Sep 14 21 Sep 16 21 Sep 17 22 Sep 15 23 Sep 14 21 Sep 16 21 Sep 16 22 Sep 15 1,455 1,905.5 01 Dec 22 31 May 23 1,155 1,905.5 01 Dec 17 31 May 18 1,104 1,905.5 01 Dec 19 31 May 20 1,455 1,905.5 01 Dec 20 31 May 21 1,111 1,905.5 01 Dec 18 31 May 19 1,155 1,905.5 01 Dec 19 31 May 20 1,104 1,905.5 01 Dec 21 31 May 22 1,104 1,905.5 01 Dec 19 31 May 20 1,111 1,905.5 01 Dec 18 31 May 19 – 779 815 – 1,620 1,311 1,358 1,630 1,620 2,061 – – 618 – – – – – – 779 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 2,061 – 815 618 1,620 1,311 1,358 1,630 1,620 Notes 1 A gain of £5,139.84 was made by Directors in 2017 on the exercise of SAYE options. 2 No price was paid for the award of any option. 3 The highest and lowest closing share prices during 2017 were £19.15 and £15.32 respectively. 4 All exercise prices are shown to the nearest pence. 5 Penny James participated in the plan during her time as an Executive Director. The column above marked ‘End of period’ reflects Penny James’s position as at 30 September 2017, the date at which she stepped down from the Board. 6 Following Nic Nicandrou’s appointment as Chief Executive of Prudential Corporation Asia on 17 July 2017, he was able to continue saving under his SAYE option contracts at that date but is no longer eligible to participate in future SAYE grants. www.prudential.co.uk Annual Report 2017 Prudential plc 149 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationDirectors’ terms of employment and external appointments Details of the service contracts of each Executive Director are outlined in the table below. The Directors’ remuneration policy contains further details of the terms included in Executive Director service contracts. 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 2017 Fee received in the period the Executive Director was a Group Director 17 May 2017 8 December 2010 27 April 2009 4 July 2016 18 October 2006 21 May 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 – – – – – – – – – – – – Executive Directors Mark FitzPatrick John Foley Nic Nicandrou Anne Richards Barry Stowe Mike Wells Directors served on the boards of educational, charitable and cultural organisations without receiving a fee for these services. Details of changes to the Board of Directors during the year are set out in the Corporate governance report. Letters of appointment of the Chairman and Non-executive Directors Details of Non‑executive Directors’ individual appointments are outlined below. The Directors’ remuneration policy contains further details on their letters of appointment. 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 Thomas Watjen3 Notes 1 Paul Manduca was appointed as Chairman on 2 July 2012. 2 Ann Godbehere retired from the Board at the 2017 AGM. 3 Thomas Watjen joined the Board on 11 July 2017. 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 11 July 2017 AGM 2013 AGM 2011 AGM 2008 AGM 2016 AGM 2012 AGM 2014 AGM 2014 AGM 2016 AGM 2018 6 months 6 months 6 months 6 months 6 months 6 months 6 months 6 months 6 months AGM 2019 AGM 2018 N/A AGM 2019 AGM 2018 AGM 2020 AGM 2020 AGM 2019 AGM 2018 150 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continued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 market place 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. Mark FitzPatrick joined the Board during the year. As Mark did not need to relocate to enable him to assume his role and he had no awards from his previous employer to replace, there were no specific arrangements required for his recruitment. Nic Nicandrou changed Board role during the year. As this change resulted in Nic relocating to enable him to assume his new role, relocation support in line with the approved Directors’ remuneration policy was provided. Details of this support are included in the notes to the 2017 ‘single figure’ table. 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. Penny James Penny James stepped down from the Board, and her employment ended, on 30 September 2017. Her remuneration arrangements were in line with the approved Directors’ remuneration policy, and disclosed in stock exchange announcements, and the remuneration she received in respect of her services as an Executive Director is set out in the 2017 ‘single figure’ table. Penny did not receive a loss of office payment. Penny’s deferred bonus awards will be released in accordance with the plan rules and remain subject to malus and clawback provisions. The Committee determined that Penny should not receive a bonus in respect of the 2017 performance year. The Committee also exercised its discretion in accordance with the approved Directors’ remuneration policy and determined that Penny should forfeit her unvested PLTIP awards granted in 2015, 2016 and 2017. Tony Wilkey Tony Wilkey stepped down from the Board on 17 July 2017. 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 2017 ‘single figure’ table. Tony’s employment with the Group will end on 17 July 2018 and between 18 July 2017 and 31 December 2017 he received £1,345,308 in respect of salary, benefits and pension in accordance with his contract of employment. Tony did not receive a loss of office payment. Tony’s deferred bonus awards will be released in accordance with the plan rules and remain subject to malus and clawback provisions. Recognising his contribution to the Company’s success, the Committee determined that Tony should be awarded a bonus in respect of the 2017 performance year which was calculated in the usual way and pro‑rated for service to 17 July 2017. 60 per cent of this bonus will be paid in 2018 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 Tony should be allowed to retain his unvested PCA LTIP and PLTIP awards granted in 2014, 2015, 2016 and 2017. These awards will vest in accordance with the original timetable, subject to the original performance conditions, remain subject to malus and clawback provisions, and will be pro‑rated for service. As referred to above, Tony holds PCA LTIP and PLTIP awards granted in 2014 and 2015. The two PCA LTIP awards were granted before Tony was appointed to the Board: one of these awards, granted in 2014, had performance measures and one of these awards, granted in 2015, had no performance conditions. www.prudential.co.uk Annual Report 2017 Prudential plc 151 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationAs set out in the section ‘Remuneration in respect of performance in 2017’ the performance conditions attached to Tony’s 2015 PLTIP awards were partially met and 89.3 per cent of these awards will be released in 2018 and the performance conditions attached to Tony’s 2014 PCA Performance LTIP awards were met in full and 100 per cent of these awards will be released in 2018. The details of all Tony’s LTIP releases are set out below. Award PCA LTIP PCA LTIP with performance conditions Prudential LTIP Number of shares vesting1 Value of shares vesting2 42,183 68,806 48,384 £781,229 £1,274,287 £896,071 Notes 1 The number of shares vesting include accrued dividend shares. 2 The share price used to calculate the value was the average share price for the three months up to 31 December 2017, being £18.52. Michael McLintock Michael McLintock’s employment with the Group ended on 31 July 2016. The 2016 Directors’ remuneration report provided details of the remuneration arrangements that would apply to Michael after he left the Board. During the year, tax was paid by the Company in 2017 on certain non‑payroll benefits received by Michael in 2016 (and reported in the Annual report on remuneration for 2016), which amounted to £7,496. Michael holds a PLTIP award granted in 2015 and as set out in the section ‘Remuneration in respect of performance in 2017’ the performance condition attached to Michael’s 2015 PLTIP awards was partially met and 91.67 per cent of these awards will be released in 2018. These awards were pro‑rated for service (16 of 36 months) and the details of the release are set out below. Award Prudential LTIP Number of shares vesting1 Value of shares vesting2 15,557 £288,116 Notes 1 The number of shares vesting includes accrued dividend shares. 2 The share price used to calculate the value was the average share price for the three months up to 31 December 2017, being £18.52. Additionally, Michael holds phantom share awards granted under the 2015 M&G Executive Long‑Term Incentive. The share price of those awards 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. These awards were pro‑rated for service (578 of 1,096 days) and M&G’s performance and the resulting phantom share price are shown below: Award 2015 M&G Executive LTIP Three-year profit growth of M&G Three-year investment performance 2016 phantom share price Value of awards vesting 12% 2nd quartile £2.05 £1,277,875 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. 152 Prudential plc Annual Report 2017 www.prudential.co.uk Annual report on remuneration continuedStatement of voting at general meeting At the 2017 Annual General Meeting, shareholders were asked to vote on the new Directors’ remuneration policy and the 2016 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 (2017 AGM) 1,773,691,171 90.71 181,582,497 9.29 1,955,273,668 45,820,585 To approve the Directors’ remuneration report (2017 AGM) 1,754,440,188 88.86 219,921,823 11.14 1,974,362,011 26,736,043 Statement of implementation in 2018 Executive Directors Executive Directors’ remuneration packages were reviewed in 2017 with changes effective from 1 January 2018. When the Committee took these decisions, it considered the salary increases awarded to other employees in 2017 and the expected increases in 2018. The external market reference points used to provide context to the Committee were identical to those used for 2017 salaries. All Executive Directors received a salary increase of 2 per cent. The 2018 salary increase budgets for other employees across the Group’s business units were between 2.5 per cent and 10 per cent. No changes have been made to executives’ maximum opportunities under either the annual incentive or the long‑term incentive plans. The Executive Directors’ bonus opportunity, performance measures and weightings will remain the same as in 2017. The Executive Directors’ long‑term incentive awards will be made under the PLTIP and the opportunity, performance measures and weightings will remain the same as 2017 other than: — Following the merger of Standard Life and Aberdeen Asset Management, the combined entity of Standard Life Aberdeen will be included in the relative TSR peer group; and — Performance against the balanced scorecard measures in the scorecard used for the 2018 PLTIP awards will be assessed on a vesting scale of threshold, target and maximum performance over a three‑year period rather than using the binary, meet/fail, approach used for the 2017 PLTIP awards. On 1 March 2018, the Company announced that James Turner had joined the Board as Group Chief Risk Officer. James’s basic salary will be £625,000 per annum. He will have a maximum bonus opportunity of 160 per cent of base salary under the Annual Incentive Plan. In accordance with the Solvency II remuneration requirements, James’s bonus will be assessed solely on functional and personal objectives. Forty per cent of any bonus will be deferred into the Company’s shares for three years. Long‑term incentive awards, granted under the Prudential LTIP, will have a face value on grant of 250 per cent of base salary. In accordance with the Solvency II remuneration requirements, the vesting of James’s PLTIP awards will depend on TSR (50 per cent of award), Group IFRS operating profit (20 per cent of award) and the sustainability scorecard (30 per cent of award). James’s service contract contains a notice provision under which either party may terminate upon 12 months’ notice. Chairman and Non-executive Directors Fees for the Chairman and Non‑executive Directors were reviewed in 2017 with changes effective from 1 July 2017, as set out on page 147. The next review will be effective 1 July 2018. Signed on behalf of the Board of Directors Anthony Nightingale, CMG SBS JP Chair of the Remuneration Committee 14 March 2018 Paul Manduca Chairman 14 March 2018 www.prudential.co.uk Annual Report 2017 Prudential plc 153 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Supplementary 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 2017 Conditional awards in 2017 Market price at date of award Mark FitzPatrick PLTIP 2017 John Foley Nic Nicandrou Anne Richards Barry Stowe1 Mike Wells2 PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP PLTIP 2014 2014 2015 2016 2017 2014 2015 2016 2017 2016 2017 2014 2015 2015 2016 2017 2014 2015 2015 2016 2017 (number of shares) (number of shares) 101,360 – 101,360 125,776 29,556 122,808 144,340 114,177 422,480 114,177 132,375 104,117 136,836 108,357 (pence) 1,828 1,317 1,342 1,672 1,279 1,672 1,317 1,672 1,279 1,672 Dividend equivalents on vested shares3 (number of shares released) Rights exercised in 2017 Rights lapsed in 2017 Conditional share awards outstanding at 31 Dec 2017 Date of end of performance period (number of shares) 101,360 31 Dec 19 – – – 101,360 7,972 1,872 89,093 36,683 20,935 8,621 – 31 Dec 16 – 31 Dec 16 122,808 31 Dec 17 144,340 31 Dec 18 114,177 31 Dec 19 9,844 110,028 45,304 381,325 8,390 93,768 38,607 – 31 Dec 16 104,117 31 Dec 17 136,836 31 Dec 18 108,357 31 Dec 19 373,328 108,357 8,390 93,768 38,607 349,310 45,906 107,461 1,358.5 1,672 45,906 31 Dec 18 107,461 31 Dec 19 45,906 107,461 – – – 153,367 114,824 113,940 50,668 274,100 247,690 553,532 247,690 238,954 209,222 30,132 332,870 263,401 1,317 1,672 1,611.5 1,279 1,672 1,317 1,672 1,611.5 1,279 1,672 7,034 78,462 36,362 – 31 Dec 16 113,940 31 Dec 17 50,668 31 Dec 17 274,100 31 Dec 18 247,690 31 Dec 19 7,034 78,462 36,362 686,398 15,178 169,262 69,692 – 31 Dec 16 209,222 31 Dec 17 30,132 31 Dec 17 332,870 31 Dec 18 263,401 31 Dec 19 811,178 263,401 15,178 169,262 69,692 835,625 Notes 1 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. 2 The awards in 2014 and 2015 for Mike Wells were made in ADRs (1 ADR = 2 ordinary shares). The awards in 2016 and 2017 were 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. Business-specific cash-based long-term incentive plans Anne Richards M&G Executive LTIP Face value of conditional share awards outstanding at 1 January 2017 £000 Payments made in 2017 £000 Face value of conditional share awards outstanding at 31 December 2017 £000 Date of end of performance period Year of award 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. 154 Prudential plc Annual Report 2017 www.prudential.co.uk Other share awards The table below sets out Executive Directors’ deferred bonus share awards. Year of grant Conditional share awards outstanding at 1 Jan 2017 (number of shares) Conditionally awarded in 2017 (number of shares) Dividends accumulated in 2017 (number of shares) (note 3) Conditional share awards outstanding at 31 Dec 2017 (number of shares) Shares released in 2017 (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 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Deferred 2016 annual incentive award Nic Nicandrou Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Deferred 2016 annual incentive award 2014 2015 2016 2017 2014 2015 2016 2017 Anne Richards Deferred 2016 annual incentive award 2017 33,968 43,651 65,713 143,332 38,024 29,887 39,107 107,018 30,352 30,352 29,504 29,504 32,668 32,668 Barry Stowe (note 1) Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Deferred 2016 annual incentive award Mike Wells (note 2) Deferred 2013 annual incentive award Deferred 2014 annual incentive award Deferred 2015 annual incentive award Deferred 2016 annual incentive award 2014 2015 32,950 29,046 2016 111,618 2017 173,614 134,534 134,534 2014 108,578 2015 120,686 2016 107,112 2017 336,376 51,371 51,371 33,968 – 31 Dec 16 03 Apr 17 1,317 1,653 1,132 1,705 787 44,783 31 Dec 17 67,418 31 Dec 18 31,139 31 Dec 19 1,672 1,279 1,672 3,624 33,968 143,340 38,024 – 31 Dec 16 03 Apr 17 1,317 1,653 775 1,014 765 30,662 31 Dec 17 40,121 31 Dec 18 30,269 31 Dec 19 1,672 1,279 1,672 2,554 38,024 101,052 846 846 754 2,900 3,494 7,148 3,136 2,778 1,332 33,514 31 Dec 19 1,672 33,514 32,950 – 31 Dec 16 03 Apr 17 1,317 1,653 29,800 31 Dec 17 114,518 31 Dec 18 138,028 31 Dec 19 1,672 1,279 1,672 32,950 282,346 108,578 – 31 Dec 16 03 Apr 17 1,317 1,653 123,822 31 Dec 17 109,890 31 Dec 18 52,703 31 Dec 19 1,672 1,279 1,672 7,246 108,578 286,415 Notes 1 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. 2 The awards for Mike Wells in 2014 and 2015 were made in ADRs (1 ADR = 2 ordinary shares). The awards made in 2016 and 2017 were 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. www.prudential.co.uk Annual Report 2017 Prudential plc 155 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationSupplementary information continued 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. Since 2014 participants have been able to 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 ‘Outstanding share options’ table. Share Incentive Plan (SIP) UK‑based Executive Directors are also eligible to participate in the Company’s Share Incentive Plan (SIP). Since April 2014, all UK‑based employees have been 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. Mark FitzPatrick John Foley Nic Nicandrou1 Mike Wells Year of initial grant Share Incentive Plan awards held in Trust at 1 Jan 2017 (Number of shares) Partnership shares accumulated in 2017 (Number of shares) Matching shares accumulated in 2017 (Number of shares) Dividend shares accumulated in 2017 (Number of shares) Share Incentive Plan awards held in Trust at 31 Dec 2017 (Number of shares) 2017 2014 2010 2015 – 433 1,644 270 65 104 63 104 16 26 16 26 – 13 43 8 81 576 1,766 408 Note 1 Following Nic Nicandrou’s appointment as Chief Executive of Prudential Corporation Asia on 17 July 2017, he is no longer eligible to participate in the SIP. However, while his shares remain in the SIP Trust he will receive any dividends payable on these shares. 156 Prudential plc Annual Report 2017 www.prudential.co.uk Cash-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 and the Prudential Agency 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 2017 was 1.09 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 2017, two were Executive Directors whose emoluments are disclosed in this report. The aggregate of the emoluments of the other three individuals for 2017 were as follows: Base salaries, allowances and benefits in kind Pension contributions Performance related pay Total Their emoluments were within the following bands: £7,800,001‑£7,900,000 £8,100,001‑£8,200,000 £11,700,001‑£11,800,000 2017 £000 3,381 129 24,236 27,746 Number of five highest paid employees 2017 1 1 1 www.prudential.co.uk Annual Report 2017 Prudential plc 157 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information 158 Prudential plc Annual Report 2017 www.prudential.co.uk 05 Financial statements Index to Group IFRS financial statements Parent company financial statements Notes on the parent company financial statements Statement of Directors’ responsibilities Independent auditor’s report to Prudential plc Page 160 305 307 314 315 www.prudential.co.uk Annual Report 2017 Prudential plc 159 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIndex to Group IFRS financial statements Primary statements Consolidated income statement Consolidated statement of comprehensive income Consolidated statement of changes in equity: 2017 2016 Consolidated statement of financial position Consolidated statement of cash flows Section Notes to the Primary statements A A1 A2 A3 Background and critical accounting policies Basis of preparation and exchange rates New accounting pronouncements in 2017 Accounting policies Critical accounting policies, estimates and judgements New accounting pronouncements not yet effective A3.1 A3.2 B1.1 B1.2 B1.3 B1.4 B1.5 B1.6 B2.1 B2.2 B2.3 B2.4 C2.1 C2.2 C2.3 B B1 B2 B3 B4 B5 B6 C C1 C2 C3 B1.6(a) Asia B1.6(b) US B1.6(c) UK and Europe Earnings performance Analysis of performance by segment 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 Additional analysis of performance by segment components Acquisition costs and other expenditure Staff and employment costs Share‑based payment Key management remuneration Fees payable to the auditor Effect of changes and other accounting matters on insurance assets and liabilities Tax charge Earnings per share Dividends Balance sheet notes Analysis of Group statement of financial position by segment Analysis of segment statement of financial position by business type Asia US UK and Europe Assets and liabilities – classification and measurement Group assets and liabilities Debt securities Loans portfolio Financial instruments – additional information 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 Page 161 162 163 164 165 166 Page Section C4 Policyholder liabilities and unallocated Movement and duration of liabilities C4.1 C4.1(a) Group overview C4.1(b) Asia insurance operations C4.1(c) US insurance operations C4.1(d) UK and Europe insurance operations C4.2 C4.2(a) Asia C4.2(b) US C4.2(c) UK and Europe Products and determining contract liabilities C5 C6 C7 C8 C9 C10 C11 C12 C13 C14 D D1 D2 D3 D4 D5 D6 E E1 Intangible assets Goodwill C5(a) C5(b) Deferred acquisition costs and other intangible C6.1 C6.2 C6.3 C7.1 C7.2 C7.3 C7.4 C7.5 C8.1 C8.2 assets Borrowings Core structural borrowings of shareholder‑ financed operations Other borrowings Maturity analysis Risk and sensitivity analysis Group overview Asia insurance operations US insurance operations UK and Europe insurance operations Asset management and other operations Tax assets and liabilities Deferred tax Current tax Defined benefit pension schemes Share capital, share premium and own shares Provisions Capital C12(a) Group objectives, policies and processes for managing capital Local capital regulations Transferability of available capital Property, plant and equipment Investment properties C12(b) C12(c) Other notes Disposal of businesses Contingencies and related obligations Post balance sheet events Related party transactions Commitments Investments in subsidiary undertakings, joint ventures and associates Further accounting policies Other significant accounting policies 167 167 168 176 179 180 182 186 188 188 189 191 191 192 194 194 195 196 201 202 203 206 207 208 209 217 223 225 227 228 Page 230 233 235 237 239 242 248 253 254 257 258 258 259 261 262 267 269 270 271 271 277 278 278 279 281 281 282 283 283 284 285 285 285 298 160 Prudential plc Annual Report 2017 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 Disposal of Korea life business: Cumulative exchange gain recycled from other comprehensive income Remeasurement adjustments Gain on disposal of other businesses Total charges, net of reinsurance and gain (loss) on disposal of businesses 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 Non‑controlling interests Profit for the year Earnings per share (in pence) Note 2017 £m 2016 £m B1.4 B1.4 B1.4 B1.4 B1.4 B2 D1 D1 B1.4 D6 B1.1 B4 B4 44,005 (2,062) 41,943 42,189 2,430 86,562 (71,854) 2,193 (2,871) (72,532) (10,165) (425) 61 5 162 38,981 (2,020) 36,961 32,511 2,370 71,842 (60,948) 2,412 (830) (59,366) (8,848) (360) – (238) – (82,894) (68,812) 302 3,970 (674) 3,296 (1,580) 674 (906) 2,390 2,389 1 2,390 182 3,212 (937) 2,275 (1,291) 937 (354) 1,921 1,921 – 1,921 2017 2016 93.1p 93.0p 75.0p 75.0p Based on profit attributable to the equity holders of the Company: B5 Basic Diluted * 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. www.prudential.co.uk Annual Report 2017 Prudential plc 161 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationConsolidated statement of comprehensive income Year ended 31 December Profit for the year Note 2017 £m 2016 £m 2,390 1,921 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 gain of sold Korea 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 arising during the year Net gains (losses) 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) C8 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 (404) (61) (5) (470) 591 26 617 (76) (55) 486 16 104 (15) 89 1,148 – 13 1,161 241 (269) (28) 76 (17) 31 1,192 (107) 14 (93) Other comprehensive income for the year, net of related tax 105 1,099 Total comprehensive income for the year Attributable to: Equity holders of the Company Non‑controlling interests Total comprehensive income for the year 2,495 3,020 2,494 1 2,495 3,020 – 3,020 162 Prudential plc Annual Report 2017 www.prudential.co.uk Consolidated statement of changes in equity Year ended 31 December 2017 £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 – 2,389 – – 2,389 1 2,390 (470) – (470) – (470) 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 related tax Total other comprehensive income (loss) Total comprehensive income for the year Dividends Reserve movements in respect of share‑based payments Change in non‑controlling interests* Share capital and share premium New share capital subscribed B6 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 (decrease) in equity At beginning of year At end of year – – – – – – – – – – – – – – – – – – – 89 89 2,478 (1,159) 89 21 – – (15) (9) – – (470) (470) – – – – 486 486 – 486 486 – – – – – 89 105 2,494 (1,159) 89 – 21 (15) (9) – – – 1 – – 5 – – – 6 1 7 486 89 105 2,495 (1,159) 89 5 21 (15) (9) 1,427 14,667 16,094 – 129 129 21 1,927 1,384 10,942 1,948 12,326 (470) 1,310 840 486 358 844 1,421 14,666 16,087 * Arising from the acquisition of the majority stake in Zenith Life of Nigeria in 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 163 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationConsolidated statement of changes in equity continued 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 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 related 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 B6 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 – 1,921 – – 1,921 – 1,921 – 1,161 – 1,161 – 1,161 – – – – – – – – 1 – – – – – – – – – 12 – – – (93) (93) 1,828 (1,267) (51) – 2 (6) – – 1,161 1,161 – – – – – 31 31 – 31 31 – – – – – (93) 1,099 3,020 (1,267) (51) 13 2 (6) – – – – – – – – – – 1 1 31 (93) 1,099 3,020 (1,267) (51) 13 2 (6) 1,711 12,956 14,667 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 14,666 164 Prudential plc Annual Report 2017 www.prudential.co.uk Consolidated statement of financial position 31 December Note 2017 £m 2016 £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 Total equity and liabilities C5(a) C5(b) C13 C4.1(a)(iv) C8.1 C8.2 C1 C1 C14 D6 C3.3 C3.2 C3.4 C1 C4.1 C4.1 C4.1 C4.1 C6.1 C6.2 C6.2 C8.1 C8.2 C11 C3.4 C1 1,482 11,011 789 9,673 2,627 613 2,676 2,963 16,497 1,416 17,042 223,391 171,374 4,801 5,622 11,236 38 10,690 493,941 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 16,087 7 16,094 14,666 1 14,667 328,172 62,677 20,394 16,951 6,280 1,791 3,716 5,662 8,889 4,715 537 14,185 1,123 2,755 – 477,847 493,941 316,436 52,837 19,723 14,317 6,798 2,317 1,349 5,031 8,687 5,370 649 13,825 947 3,252 4,293 455,831 470,498 Included within equity securities and portfolio holdings in unit trusts, debt securities and other investments are £8,232 million (2016: £8,545 million) of lent securities and assets subject to repurchase agreements. The consolidated financial statements on pages 161 to 304 were approved by the Board of Directors on 14 March 2018. They were signed on its behalf. Paul Manduca Chairman Mike Wells Group Chief Executive Mark FitzPatrick Chief Financial Officer www.prudential.co.uk Annual Report 2017 Prudential plc 165 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationConsolidated statement of cash flows Year ended 31 December Note 2017 £m 2016 £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 Operating cash items: Interest receipts Dividend receipts Tax paidnote (iv) 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 intangiblesnote (v) Sale of businessesnote (v) Net cash flows from investing activities Cash flows from financing activities Structural borrowings of the Group: Shareholder‑financed operations:note (ii) Issue of subordinated debt, net of costs Redemption of subordinated debt Interest paid With‑profits operations:note (iii) 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 3,970 3,212 (49,771) (968) 44,877 3,360 (8,994) 549 6,900 2,612 (915) 1,620 (134) – (351) 1,301 816 565 (751) (369) (9) 21 (1,159) (1,702) 734 10,065 (109) 10,690 (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 C13 C6.1 C6.2 Notes (i) (ii) This measure is the formal profit before tax measure under IFRS but it is not the result attributable to shareholders. 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. The changes in the carrying value of the structural borrowings of shareholder‑financed operations during 2017 are analysed as follows: Cash movements £m Non-cash movements £m Balance at 1 Jan 2017 Issue of debt Redemption of debt Foreign exchange movement Other movements Balance at 31 Dec 2017 Structural borrowings of shareholder‑financed operations 6,798 565 (751) (341) 9 6,280 (iii) 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. There is no change in respect of the carrying value of the £100 million structural borrowings of the with‑profits operations during 2017. 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 £298 million (2016: £226 million) paid on profits taxable at policyholder rather than shareholder rates. (iv) (v) Net cash flows for corporate transactions are for distribution rights and acquisition and disposal of businesses (including private equity and other subsidiaries acquired by with‑profits funds for investment purposes). 166 Prudential plc Annual Report 2017 www.prudential.co.uk A 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. The Group has operations in Asia, the US, UK and Europe and Africa. 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 2017, there were no unendorsed standards effective for the two years ended 31 December 2017 which impact 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 305. The Group IFRS accounting policies are the same as those applied for the year ended 31 December 2016 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 2017 Average rate for 2017 Closing rate at 31 Dec 2016 Average rate for 2016 10.57 18,353.44 5.47 1.81 8.81 86.34 30,719.60 44.09 1.35 10.04 17,249.38 5.54 1.78 8.71 83.90 29,279.71 43.71 1.29 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 Certain notes to the financial statements present 2016 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 2017 recognised in other comprehensive income is: Asia operations* US operations Unallocated to a segment (other funds)† 2017 £m 2016 £m (295) (477) 307 (465) 785 853 (490) 1,148 * 2017 included the recycling of the cumulative exchange gain of the sold Korea life business of £61 million to the income statement. † The exchange rate movement unallocated to a segment mainly reflects the translation of currency borrowings, issued by group holding companies, that have been designated as a net investment hedge against the currency risk of the Group’s investment in Jackson. A2 New accounting pronouncements in 2017 The IASB has issued the following new accounting pronouncements to be effective for 1 January 2017: — Disclosure Initiative (Amendments to IAS 7, ‘Statement of Cash Flows’); — Recognition of deferred tax assets for unrealised losses (Amendments to IAS 12, ‘Income Taxes’); and — Annual improvements to IFRSs 2014 – 2016 cycle. Other than the additional disclosure of the changes in structural borrowings during the year in the statement of cash flows, these pronouncements have no effect on these financial statements. www.prudential.co.uk Annual Report 2017 Prudential plc 167 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 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 affecting the presentation of the Group’s results and other items that 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 considering whether the material features of a contract gives rise to the transfer of significant insurance risk. Impacts £436 billion of reported liabilities, requiring classification. Contracts that transfer significant insurance risk to the Group are classified as insurance contracts. This judgement is made at the point of contract inception and is not revisited. For the majority of the Group’s contracts classification is based on a readily identifiable scenario that demonstrates a significant difference in cash flows if the covered event occurs (as opposed to does not occur) reducing the level of judgement involved. Contracts that transfer financial risk to the Group but not significant insurance risk are classified as 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 such discretionary participation features are accounted for as financial instruments under IAS 39. Insurance business units Insurance contracts and investment contracts with discretionary participation features Investment contracts without discretionary participation features Asia US — With‑profits contracts — Non‑participating term — Minor amounts for a number of small categories of business contracts — Whole life contracts — Unit‑linked policies — Accident and health policies — Variable annuity contracts — Fixed annuity contracts — Life insurance contracts — Guaranteed investment contracts (GICs) — Minor amounts of ‘annuity UK and Europe — With‑profits contracts — Bulk and individual annuity business — Non‑participating term contracts certain’ contracts — Certain unit‑linked savings and similar contracts 168 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedMeasurement 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 £436 billion of liabilities. Measurement of insurance contract liabilities and investment contracts liabilities with discretionary participation features. Asia insurance operations US insurance operations 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. When measuring policyholder contract liabilities a number of assumptions are applied to estimate future amounts due to or from the policyholder. The nature of assumption varies by product and among the most significant are assumed rates of policyholders’ mortality, particularly in respect of annuities sold in the UK, and policyholder behaviour, particularly in the US. Additional details of valuation methodologies and assumptions applied for material product types are discussed in note C4.2. 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, Taiwan and India, US GAAP principles are 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 and Europe insurance 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. The sensitivity of US insurance operations to variations in key estimates and assumptions, including policyholder behaviour, is discussed in note C7.3. www.prudential.co.uk Annual Report 2017 Prudential plc 169 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued Measurement of policyholder liabilities and unallocated surplus of with-profits continued UK and Europe 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 charges and expenses. 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. Shareholders’ 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. The sensitivity of UK and Europe insurance operations to variations in key estimates and assumptions, including annuitant mortality, is discussed in note C7.4. Measurement of investment contracts without discretionary participation features liabilities. Investment contracts without discretionary participation features are 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. Measurement of unallocated surplus of with‑profits funds. 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 classified as financial instruments and 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. Other investment contracts are measured at amortised cost. Represents the excess of assets over policyholder liabilities that are determined in accordance with the Group’s accounting policies and are based on local GAAP for the Group’s with‑profits funds in the UK, Hong Kong and Malaysia 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. 170 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedMeasurement of policyholder liabilities and unallocated surplus of with-profits continued Liability adequacy test. 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. Jackson’s liabilities for insurance contracts, which include those for separate accounts (reflecting separate account assets), policyholder account values and guarantees measured as described in note C4.2 and the associated deferred acquisition cost asset are measured under US GAAP and liability adequacy testing is performed in this context. Under US GAAP, most of Jackson’s products are accounted for under Accounting Standards Codification Topic 944, Financial Services – Insurance of the Financial Accounting Standards Board (ASC 944) 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 enters into derivative instruments 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. 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 B4. 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. 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. £18,533 million of US income statement investment return arises from such derivatives and debt securities. 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 £3,296 million and compares to profit before tax of £3,970 million. www.prudential.co.uk Annual Report 2017 Prudential plc 171 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued 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 £5,577 million and is 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 policyholder liabilities (including the unallocated surplus). (c) Further critical estimates or judgements Deferred acquisition costs for insurance contracts The Group applies judgement in determining qualifying costs that should be capitalised (ie those costs of acquiring new insurance business that meet the criteria under the Group’s accounting policy for deferred acquisition costs). It makes estimates in projecting future profits/ margins to assess 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 is deemed impaired if the projected margins (which are estimated based on a number of assumptions similar to those underlying policyholder liabilities) 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. £9.2 billion of deferred acquisition costs as per note C5(b). Asia insurance operations For those business units 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. 172 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedDeferred acquisition costs for insurance contracts continued US insurance operations The most material estimates and assumptions applied in the measurement and amortisation of deferred acquisition cost balances relate to the US insurance operations. The Group’s US insurance operations apply FAS ASU 2010‑26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ and capitalise 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 experience, 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 on current balances, assumptions and sensitivity, refer to note C5 (b) and C7.3(iv). To ensure that the methodology in extreme market movements produces future expected returns that are realistic, 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 makes certain adjustments to the deferred acquisition costs which are recognised directly in other comprehensive income (‘shadow accounting’). If the 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 consistent with the gains or losses on the securities. More precisely, shadow deferred acquisition costs 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. For UK regulated with‑profits funds where ‘grandfathered’ FRS 27 is applied, 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. UK and Europe insurance operations www.prudential.co.uk Annual Report 2017 Prudential plc 173 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 Accounting policies continued A3.1 Critical accounting policies, estimates and judgements continued Financial investments – Valuation Financial investments held at fair value represent £407.3 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 loans and deposits. The Group applies valuation techniques, including the use of estimates, 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 having quoted prices. Actively traded investments without quoted prices are valued using prices provided by third parties as described further in note C3.1. Financial investments measured at fair value are classified into a three‑level hierarchy as described in note C3.1(b). 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. Details of the financial investments classified as ‘level 3’ to which valuation techniques are applied, and the sensitivity of profit before tax to a change in these items’ valuation, are presented in note C3.1(d). 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. Further details of the assumptions and estimates applied in assessing impairment of US available‑ for‑sale securities is given in note C3.2(g). 174 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedFinancial investments – Determining impairment in relation to financial assets The Group applies judgement as to whether evidence of an impairment in value exists for financial investments classified as ‘available‑for‑sale’ or ‘at amortised cost’. If evidence for impairment exists, valuation techniques, including estimates, are then applied in determining the impaired value. Affects £47.5 billion of assets. For 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 impairment assets. The loss comprises the effect of the expected loss of contractual cash flows and any additional market‑price driven temporary reductions in values. 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 methodology and estimates used to determine impairments of the available‑for‑sale securities of Jackson are described in note C3.2(g). The majority of the US insurance operation’s debt securities portfolio is 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. 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. Affects £1.5 billion of assets. 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. To ensure any required impairment is recognised in the current period 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, and then applies judgement to assess whether these factors indicate impairment has occurred. If an impairment has occurred, an impairment charge is recognised for the difference between the carrying value and recoverable amount of the asset. The recoverable amount is the greater of fair value less costs to sell and value in use. Value in use is calculated as the present value of future expected cash flows from the asset or the cash generating unit to which it is allocated. www.prudential.co.uk Annual Report 2017 Prudential plc 175 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 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 2017, 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 contracts 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, IFRS 15 in the context of Prudential’s business, applies to 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 provision for investment management services. The IFRS 15 impact assessment performed included the review of the recognition of asset management and performance fees of these contracts. The adoption of this standard in 2018 is not expected to result in a restatement of the Group’s profit for the year or shareholders’ equity. 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. In October 2017, the IASB issued two amendments to IFRS 9, to permit the measurement of debt instruments with prepayment compensation features to be measured at amortised cost or fair value through other comprehensive income if certain conditions are met, and to clarify that IFRS 9 applies to long‑term interests in joint ventures and associates. Both of these amendments that were issued in October 2017 are effective for the annual periods beginning on or after 1 January 2019, but are not yet endorsed by the EU. 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 IFRS 17, ‘Insurance Contracts’. The amendments include an optional temporary exemption from applying IFRS 9 and the associated amendments until IFRS 17 comes into effect in 2021. This temporary exemption is available to companies whose predominant activity is to issue insurance contracts based on meeting the eligibility criteria as at 31 December 2015 as set out in the amendments. The Group met the eligibility criteria and will defer the adoption of IFRS 9 to 1 January 2021. When adopted IFRS 9 replaces the existing IAS 39, ’Financial Instruments – Recognition and Measurement’, and will affect the following three areas: — The classification and the measurement of financial assets and liabilities Under IFRS 9, the classification of financial assets is redefined. Based on the business model in which the assets are held and their contractual cash flow characteristics (whether the cash flows represent ‘solely payments of principal and interest’), financial assets are classified into one of the following categories: amortised cost, fair value through other comprehensive income (FVOCI) and fair value through profit or loss (FVTPL). An option is also available at initial recognition to irrevocably designate a financial asset as at FVTPL if doing so eliminates or significantly reduces accounting mismatches. At present a significant proportion (82 per cent) of the Group’s investments are valued at FVTPL and the Group’s current expectation is that a significant proportion will continue to be designated as such under IFRS 9. The existing IAS 39 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, resulting in earlier recognition of credit losses compared to IAS 39. The impairment charge recognition under the new model is in three stages: – Stage 1 – at initial recognition, and for each subsequent reporting period when there has been no significant increase in credit risk since initial recognition, recognise 12 month expected credit losses; – Stage 2 – recognise lifetime expected credit losses if there has been a significant increase in credit risk since initial recognition; or – Stage 3 – recognise incurred losses for credit‑impaired assets, similar to IAS 39. This aspect is the most complex area of IFRS 9 to implement and will involve significant judgements and estimate processes. — The hedge accounting requirements which are more closely aligned with the risk management activities of the Company. No significant change to the Group’s hedge accounting is currently anticipated, but this remains under review. 176 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedThe Group is assessing the impact of IFRS 9 and implementing this standard in conjunction with the IFRS 17. Further details on IFRS 17 are provided below. Adoption of IFRS 9 may result in reclassifying certain of the Group’s financial assets and hence lead to a change in the measurement of those instruments or the reporting of their value. In addition, for any investments classified as amortised cost or FVOCI, as noted above, the impairment provisioning approach is altered from the current IAS 39 approach. The Group is currently assessing the scope of assets to which these requirements will apply. The Group does not currently apply hedge accounting for most of its derivate programmes but will reconsider its approach in light of new requirements under the standard on adoption. IFRS 16, ‘Leases’ In January 2016, the IASB published 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 requiring most of the existing operating leases to be accounted for in a similar manner as finance leases under the existing IAS 17, ‘Leases’. The only optional exemptions are for short‑term leases and leases of low‑value assets. Lessor accounting however remains largely unchanged from IAS 17. IFRS 16 applies primarily to operating leases of major properties occupied by the Group’s businesses where Prudential is a lessee. Under IFRS 16, these leases will be brought onto the Group’s 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 income statement will be replaced with a depreciation charge for the ‘right to use’ asset and an interest expense on the lease liability leading to a more front‑loaded operating lease cost profile compared to IAS 17. The Group is currently sourcing the required information to implement this new standard. IFRS 16 permits transition to the new standard through a modified retrospective approach or a full retrospective approach. Under the modified retrospective approach, as well as affording a number of simplifications the Group’s comparative information is not restated, but there is an adjustment to retained earnings at the date of initial application (ie 1 January 2019). The Group is currently assessing the impact of the modified retrospective approach before confirming the approach it intends to adopt. The ultimate impact of IFRS 16 on the Group’s financial statements will be dependent on the leases that are in place and the related discount rate on the date of initial application. Accounting pronouncements not yet endorsed by the EU IFRS 17, ‘Insurance Contracts’ In May 2017, the IASB issued IFRS 17 ‘Insurance Contracts’ to replace the existing IFRS 4 ‘Insurance Contracts’. The standard, which is subject to endorsement in the EU and other territories, applies to annual periods beginning on or after 1 January 2021. Early application is permitted; provided the entity also applies IFRS 9 and IFRS 15 on or before the date it first applies IFRS 17. The Group intends to adopt the new standard on its mandatory effective date in 2021, alongside the adoption of IFRS 9 (see above). IFRS 4 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. IFRS 17 replaces this with a new liability and revenue measurement model for all insurance contracts. The new measurement model requires liabilities for insurance contracts to be recognised as the present value of future cash flows, incorporating an explicit risk adjustment, and a contractual service margin (CSM) that is equal and opposite to any day‑one gain arising. Losses are recognised directly into the income statement. The present value of future cash flows and the risk adjustment are updated at each reporting date in order to reflect current conditions. The CSM is released to the income statement as profit over the coverage period of the insurance contract, reflecting the delivery of services to the policyholder. Subsequent changes in non‑economic assumptions applied to the valuation of insurance liabilities are recognised as an adjustment to the CSM, prospectively affecting the amounts released to the statement of comprehensive income. For the purpose of the measurement insurance contracts are grouped together with contracts of similar risk, profitability profile and issue year, with the measurement model applied at this group level. IFRS 17 provides an adaptation of the measurement model designed to account for certain contracts with participating features, such as UK style with‑profits contracts and unit‑linked or similar contracts, in which the policyholder will be paid a substantial share of the fair value returns of a specified group of items and the return to the insurer effectively reflects a variable management fee. This adaptation – the Variable Fee Approach (VFA) – allows the CSM to be adjusted for changes in economic experience and assumptions which reflect a change in the overall future fee the insurer expects to receive as a result of managing the participating pool of assets. IFRS 17 introduces a new measure of insurance revenue, based on the delivery of services to policyholders and excluding any premiums related to the investment elements of policies, which will be significantly different from existing premium revenue measures, currently reported in the income statement. Retrospective application of the standard is required for determining the CSM for the opening balance sheet. However, if full retrospective application for a group of insurance contracts is impracticable, then the entity is required to choose either a modified retrospective approach or a fair value approach. Choosing the appropriate approach and hence determining the opening balance sheet is one of the most critical activities in implementing the new standard, as the approach adopted will have a significant impact on the entity’s results both on the initial impact on shareholders’ funds at IFRS 17 adoption and on the future profits to be earned on the in‑force business at the date of transition. www.prudential.co.uk Annual Report 2017 Prudential plc 177 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationA3 Accounting policies continued A3.2 New accounting pronouncements not yet effective continued IFRS 17 Implementation Programme The Group has commenced a Group‑wide programme to implement IFRS 17 and IFRS 9 (as discussed above). The requirements of IFRS 17 are complex and will have the effect of introducing fundamental changes to the existing IFRS 4 insurance accounting and require the application of significant judgement and new estimation techniques. As previously highlighted IFRS 9 could require reclassification of investments and the introduction of new and complex impairment models. The effect of changes required to the Group’s accounting policies as a result of implementing these standards are currently uncertain, but these changes can be expected to, among other things, alter the timing of IFRS profit recognition. The implementation of this standard is also likely to involve significant enhancements to IT, actuarial and finance systems of the Group, and so will have an impact on the Group’s expenses. A Group‑wide Steering Committee, chaired by the Group Chief Financial Officer and with participation from group’s and business units’ senior finance managers, provides oversight and strategic direction to the implementation programme. A number of sub‑ committees are also in place to provide governance over the technical interpretation and accounting policies selected, programme management and design and delivery of the project. The key responsibilities of the programme include setting a framework for Group‑wide accounting policies, determining additional data requirements, assessing the level of IT and finance system changes as well as establishing an appropriate work plan for determining the opening balance sheet. The work is at an early stage. Other new accounting pronouncements In addition to the above, the following new accounting pronouncements have also been issued and are not yet effective but the Group is not expecting them to have a significant impact on the Group’s financial statements: — Amendments to IFRS 2: Classification and measurement of share‑based payment transactions, issued in June 2016 and effective from 1 January 2018; — IFRIC Interpretation 22 Foreign Currency Transactions and Advance Consideration, issued in December 2016 and effective from 1 January 2018; — Amendments to IAS 40, Transfers of Investment Property, issued in December 2016 and effective from 1 January 2018; — IFRIC Interpretation 23 Uncertainty over Income Taxes, issued June 2017 and effective from 1 January 2019; — Annual Improvements to IFRSs 2015‑2017 cycle; and — Amendments to IAS 19: Plan Amendment, Curtailment or Settlement, issued on 7 February 2018 and effective from 1 January 2019. 178 Prudential plc Annual Report 2017 www.prudential.co.uk A Background and critical accounting policies continuedB Earnings performance B1 Analysis of performance by segment B1.1 Segment results – profit before tax Asia Insurance operations Asset management Total Asia US Jackson (US insurance operations) Asset management Total US UK and Europe UK and Europe insurance operations: Long‑term business General insurance commissionnote (i) Total UK and Europe insurance operations UK and Europe asset managementnote (vi) Total UK and Europe Total segment profit Restructuring costs note (iii) Other income and expenditure: Investment return and other income Interest payable on core structural borrowings Corporate expenditurenote (ii) Solvency II implementation costs Total other income and expenditure Interest received from tax settlement Operating profit based on longer-term investment returns Short‑term fluctuations in investment returns on shareholder‑backed business Amortisation of acquisition accounting adjustmentsnote (iv) Profit (loss) attaching to disposal of businesses Cumulative exchange gain on the sold Korea life business recycled from other comprehensive income Profit before tax Tax charge attributable to shareholders' returns Profit for the year Attributable to: Equity holders of the Company Non‑controlling interests Basic earnings per share (in pence) 2017 £m 2016* £m % AER note (v) CER note (v) 2017 vs 2016 AER note (v) 2017 vs 2016 CER note (v) 1,799 176 1,975 2,214 10 2,224 861 17 878 500 1,378 5,577 1,503 141 1,644 1,571 149 1,720 2,052 (4) 2,156 (4) 2,048 2,152 20% 25% 20% 8% 350% 9% 15% 18% 15% 3% 350% 3% 799 29 828 425 799 29 828 425 1,253 4,945 1,253 5,125 8% (41)% 8% (41)% 6% 18% 10% 13% 6% 18% 10% 9% (103) (38) (39) (171)% (164)% 11 (425) (361) – (775) 28 (360) (334) (28) (694) 28 (360) (340) (28) (700) – 43 43 4,699 4,256 4,429 (1,563) (63) 162 (1,678) (76) (227) (1,764) (79) (244) 61 – – 3,296 2,275 2,342 (61)% (18)% (8)% n/a (12)% n/a 10% 7% 17% n/a n/a 45% (61)% (18)% (6)% n/a (11)% n/a 6% 11% 20% n/a n/a 41% (906) (354) (360) (156)% (152)% 2,390 1,921 1,982 24% 21% 2,389 1 1,921 – 1,982 – 24% N/A 21% N/A 2017 2016 % AER note (v) CER note (v) 2017 vs 2016 AER note (v) 2017 vs 2016 CER note (v) Note B3(a) B3(b) B3(c) B1.2 D1 D1 B4 B5 Based on operating profit based on longer‑term investment returnsnote (vii) Based on profit for the year 145.2p 93.1p 131.3p 75.0p 136.8p 77.4p 11% 24% 6% 20% * The 2016 comparative results have been re‑presented from those previously published following the reassessment of the Group’s operating segments as described in note B1.3. www.prudential.co.uk Annual Report 2017 Prudential plc 179 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB Earnings performance continued B1 Analysis of performance by segment continued B1.1 Segment results – profit before tax continued Notes (i) General insurance commission represents the commission receivable net of expenses for Prudential‑branded general insurance products in connection with the arrangement to transfer the UK general insurance business to Churchill in 2002. Corporate expenditure as shown above is primarily for Group Head Office and Asia Regional Head Office. (ii) (iii) Restructuring costs are incurred primarily in UK and Europe and Asia and represent business transformation and integration costs. (iv) Amortisation of acquisition accounting adjustments principally relate to the REALIC business of Jackson which was acquired in 2012. (v) For definitions of AER and CER refer to note A1. The difference between ‘Profit for the year attributable to shareholders’ in the prior year on an AER basis and a CER basis is £61 million, arising from the retranslation of the prior year results of the Group’s foreign subsidiaries into GBP using the exchange rates applied to the equivalent current year results. (vi) UK and Europe asset management 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 UK and Europe asset management operating profit based on longer‑term investment returns 2017 £m 2016 £m 1,027 7 (400) (202) 432 15 53 500 900 23 (332) (212) 379 13 33 425 (vii) Tax charges have been reflected as operating and non‑operating in the same way as for pre‑tax items. In 2017 a significant US tax reform package was enacted, and the effects of which in the income statement have been treated as non‑operating. Further details are provided in note B4. B1.2 Short-term fluctuations in investment returns on shareholder-backed business Asia US note (i) UK and Europe note (ii) Other operations note (iii) Total 2017 £m 2016 £m (1) (1,568) (14) 20 (1,563) (225) (1,455) 206 (204) (1,678) Notes (i) US 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 £462 million as shown in note C5(b) (2016: £565 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 2017 £m 2016 £m (1,490) (36) (73) 12 19 (1,568) (1,587) (126) 201 35 22 (1,455) 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 in note B1.3(c) below. 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 as described in note B1.3 (c); – 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. The net equity hedge result (net of related DAC) can be summarised as follows: Fair value movements on equity hedge instruments1 Accounting value movements on the variable and fixed index annuity guarantee liabilities2 Fee assessments net of claim payments Total 2017 £m 2016 £m (1,871) (99) 480 (1,490) (1,786) (188) 387 (1,587) 1 2 Held to manage equity exposures of the variable annuity guarantees and fixed index annuity options. The accounting value movements on the variable and fixed index annuity guarantee liabilities reflect the impact of market movements and changes in economic and actuarial assumptions. These actuarial assumptions changes include, amongst other items, a charge (net of related DAC) of £359 million for strengthening policyholder utilisation and persistency rates offset by a benefit (net of related DAC) of £382 million from modelling refinements in the period, principally enhancements to how Jackson’s own credit risk is incorporated in the fair valuation of these long‑term liabilities. 180 Prudential plc Annual Report 2017 www.prudential.co.uk (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; – Fair value movements on the Guaranteed Minimum Income Benefit (GMIB) reinsurance asset that are not matched by movements in the underlying GMIB liability, which is not fair valued as explained in note B1.3; 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. Accounting mismatches arise because of differences between the measurement basis and presentation of the derivatives, which are fair valued with movements recorded in the income statement, and the exposures they are intended to manage. (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 credits (charges) in the year Less: Risk margin allowance deducted from operating profit based on longer‑term investment returnsnote Interest‑related realised (losses) gains: (Losses) 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 2017 £m 2016 £m (3) – (2) 10 5 86 91 (43) (140) (183) 19 (73) (94) (4) (35) 15 (118) 89 (29) 376 (135) 241 (11) 201 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 2017 is based on an average annual risk margin reserve of 21 basis points (2016: 21 basis points) on average book values of US$55.3 billion (2016: US$56.4 billion) as shown below: Moody’s rating category (or equivalent under NAIC ratings of mortgage-backed securities) A3 or higher Baa1, 2 or 3 Ba1, 2 or 3 B1, 2 or 3 Below B3 Total Average book value US$m 27,277 26,626 1,046 318 23 55,290 2017 2016 RMR Annual expected loss Average book value RMR Annual expected loss % US$m £m US$m % US$m 0.12 0.22 1.03 2.70 3.78 0.21 (33) (58) (11) (9) (1) (25) (45) (8) (7) (1) 29,051 25,964 1,051 312 40 (112) (86) 56,418 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) Related amortisation of deferred acquisition costs (see below) Risk margin reserve charge to operating profit for longer‑term credit‑related losses 21 15 (91) (71) 23 17 (97) (72) 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 of £541 million for net unrealised gains on debt securities classified as available‑for‑sale net of related amortisation of deferred acquisition costs (2016: credit of £48 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). (ii) UK and Europe operations The negative short‑term fluctuations in investment returns for UK and Europe operations of £(14) million (2016: positive £206 million) include net unrealised movements on fixed income assets supporting the capital of the shareholder‑backed annuity business. (iii) Other operations The positive short‑term fluctuations in investment returns for other operations of £20 million (2016: negative £(204) million) include unrealised value movements on financial instruments. www.prudential.co.uk Annual Report 2017 Prudential plc 181 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information B Earnings performance continued B1 Analysis of performance by segment continued B1.3 Determining operating segments and performance measure of operating segments Operating segments The Group’s operating segments for financial reporting are defined and presented in accordance with IFRS 8, ‘Operating Segments’ on the basis of the management reporting structure and its financial management information. Following the combination during the year of the Group’s UK insurance business and M&G to form M&G Prudential, the Group has reassessed its operating segments. Under the Group’s management and reporting structure its chief operating decision‑maker is the Group Executive Committee (GEC). In the revised management structure, responsibility is delegated to the Chief Executive Officers of Prudential Corporation Asia, the North American Business Unit and M&G Prudential for the day‑to‑day management of their business units (within the framework set out in the Group Governance Manual). Financial management information used by the GEC has been revised to align with these three business segments. These operating segments derive revenue from both long‑term insurance and asset management activities. In the prior year, the operating segments of the Group were each of the insurance operations in Asia, US and UK, and the asset management operations of Asia, US, M&G and Prudential Capital. Operations which do not form part of any business unit are reported as ‘Unallocated to a segment’. These include Group Head Office and Asia Regional Head Office costs. Following the formation of M&G Prudential certain minor operations which were previously reported as ‘Unallocated to a segment’ are now included in the UK and Europe segment, reflecting the revised structure. Prudential Capital and Africa operations do not form part of any operating segment under the revised structure, and their assets and liabilities and loss before tax are not material to the overall financial position of the Group. Prudential Capital and Africa operations are therefore reported as ‘Unallocated to a segment’. Comparative segmental information for prior periods has been presented on a basis consistent with the current year. 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; and — Profit/loss attaching to businesses that have been sold in the year including, where relevant, the recycling of the cumulative translation gain or loss in respect of sold businesses. 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 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, movements in liabilities for some types of business 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. For other types of Asia’s non‑participating business, expected longer‑term investment returns are used to determine the movement in policyholder liabilities for determining operating results. 182 Prudential plc Annual Report 2017 www.prudential.co.uk (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. 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. Debt securities and loans 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 2017, the level of unamortised interest‑related realised gains and losses related to previously sold bonds for the Group was a net gain of £855 million (2016: £969 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 separate accounts are principally relevant 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 derivatives 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, expected longer‑term investment returns 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 £1,759 million as at 31 December 2017 (2016: £1,405 million). The rates of return applied in 2017 ranged from 4.3 per cent to 17.2 per cent (2016: 3.2 per cent to 13.9 per cent) with the rates applied varying by business unit. These rates are broadly stable from period to period but may be different between countries reflecting, for example, differing expectations of inflation in each business unit. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 183 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB1 Analysis of performance by segment continued B1.3 Determining operating segments and performance measure of operating segments continued (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 (i): — Fair value movements for equity‑based derivatives; — Fair value movements for embedded derivatives for the ‘not for life’ portion of Guaranteed Minimum Withdrawal Benefit (GMWB) and fixed index annuity business, and Guaranteed Minimum Income Benefit (GMIB) reinsurance (see below); — Movements in the accounts carrying value of Guaranteed Minimum Death Benefit (GMDB), GMIB and the ‘for life’ portion of GMWB liabilities (see below), 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 (ie they are relatively insensitive to the effect of current period equity market and interest rate changes); — 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 the ‘not for life’ portion of GMWB and fixed index annuity business The ‘not for life’ portion of GMWB embedded derivative liabilities is measured under the US GAAP basis applied for IFRS in a manner consistent with IAS 39 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. Embedded derivatives for variable annuity guarantee minimum income benefit The GMIB liability, which is substantially 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. This accounting basis substantially does not recognise the effects of market movements. 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 other 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. 184 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continued(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 2017, the equity‑type securities for US insurance non‑separate account operations amounted to £946 million (2016: £1,323 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 6.1% to 6.5% 5.5% to 6.5% 8.1% to 8.5% 7.5% to 8.5% 2017 2016 (d) UK and Europe 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 shareholder‑backed annuity business within The Prudential Assurance Company Limited (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 and Europe 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. www.prudential.co.uk Annual Report 2017 Prudential plc 185 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB1 Analysis of performance by segment continued B1.4 Segmental income statement 2017 £m Asia US UK and Europe Total segment 15,688 (656) 15,164 (352) 13,126 (1,050) 43,978 (2,058) 15,032 307 15,339 40 932 8,063 24,374 14,812 669 15,481 64 2,085 16,448 34,078 12,076 1,406 13,482 5 3,413 11,171 28,071 41,920 2,382 44,302 109 6,430 35,682 86,523 Unallo- cated to a segment (other operations) note (iii) 27 (4) 23 48 71 (109) 67 10 39 Group total 44,005 (2,062) 41,943 2,430 44,373 – 6,497 35,692 86,562 (18,291) (31,205) (23,025) (72,521) (11) (72,532) (4,052) – (2,257) (16) (3,379) – (9,688) (16) (477) (409) (10,165) (425) 61 5 – – – 162 – – – 61 5 162 – – – 61 5 162 Gross premium earned Outward reinsurance Earned premiums, net of reinsurance 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 Acquisition costs and other operating expenditureB2 Interest on core structural borrowings Disposal of Korea life businessD1 Cumulative exchange gain on the sold Korea life business recycled from other comprehensive incomeD1 Remeasurement adjustments Gain on disposal of other businessesD1 Total charges, net of reinsurance and gain (loss) on disposal of businesses (22,277) (33,316) (26,404) (81,997) (897) (82,894) 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 181 2,278 (250) 2,028 – 762 – 762 121 302 – 302 1,788 (424) 1,364 4,828 (674) 4,154 (858) – (858) 3,970 (674) 3,296 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 disposal of businesses Cumulative exchange gain on the sold Korea life business recycled from other comprehensive incomeD1 Profit (loss) before tax 1,975 2,224 1,378 5,577 (878) 4,699 (1) (7) – 61 2,028 (1,568) (14) (1,583) 20 (1,563) (56) 162 – 762 – – – 1,364 (63) 162 61 4,154 – – – (63) 162 61 (858) 3,296 186 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continued2016* £m Asia US UK and Europe Total segment 14,006 (648) 13,358 253 13,611 27 875 2,042 16,555 14,685 (367) 14,318 684 15,002 53 2,151 5,461 22,667 10,290 (1,005) 9,285 1,346 10,631 4 4,517 17,578 32,730 38,981 (2,020) 36,961 2,283 39,244 84 7,543 25,081 71,952 Unallo- cated to a segment (other operations) note (iii) – – – 87 87 (84) 104 (217) (110) Group total 38,981 (2,020) 36,961 2,370 39,331 – 7,647 24,864 71,842 (11,442) (20,214) (27,710) (59,366) – (59,366) (3,684) – (238) (1,913) (15) (2,813) – (8,410) (15) (438) (345) (8,848) (360) – – (238) – (238) Gross premium earned Outward reinsurance Earned premiums, net of reinsurance 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 Acquisition costs and other operating expenditureB2 Interest on core structural borrowings Remeasurement of carrying value of Korea life business classified as held for saleD1 Total charges, net of reinsurance and gain (loss) on disposal of business (15,364) (22,142) (30,523) (68,029) (783) (68,812) 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 148 1,339 (155) 1,184 – 525 – 525 34 182 – 182 2,241 (782) 4,105 (937) (893) – 3,212 (937) 1,459 3,168 (893) 2,275 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 1,644 2,048 1,253 4,945 (689) 4,256 (225) (1,455) 206 (1,474) (204) (1,678) (8) (227) 1,184 (68) – 525 – – 1,459 (76) (227) 3,168 – – (893) (76) (227) 2,275 * The 2016 comparative results have been re‑presented from those previously published following the reassessment of the Group’s operating segments as described in note B1.3. Notes (i) (ii) Other income from external customers includes £7 million (2016: £8 million) relating to financial instruments that are not held at fair value through profit or loss. These fees primarily This measure is the formal profit (loss) before tax measure under IFRS but is not the result attributable to shareholders. related to prepayment fees, late fees and syndication fees. (iii) Unallocated to a segment includes central operations (Group and Asia Regional Head Offices and Group borrowings), Prudential Capital and Africa operations. In addition, this column includes intra‑group eliminations, including the elimination of the intra‑group reinsurance contract between the UK with‑profits and Asia with‑profits operations. Interest income includes £3 million (2016: £3 million) accrued in respect of impaired securities. In Asia, revenue from external customers from no individual market exceeds 10 per cent of the Group total except for Hong Kong in 2017 (2016: no individual market exceeded 10 per cent except for Hong Kong). Total revenue from external customers of Hong Kong is £7,269 million (2016: £6,313 million). (iv) (v) (vi) Due to the nature of the business of the Group, there is no reliance on any major customers. www.prudential.co.uk Annual Report 2017 Prudential plc 187 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB1 Analysis of performance by segment continued B1.5 Other investment return Realised and unrealised gains on securities at fair value through profit or loss Realised and unrealised (losses) on derivatives at fair value through profit or loss Realised (losses) gains on available‑for‑sale securities, previously recognised in other comprehensive income* Realised gains on loans Dividends Other investment income Other investment return * Including impairment. 2017 £m 2016 £m 33,121 (1,624) 28,489 (7,050) (26) 9 2,654 1,558 270 91 2,283 781 35,692 24,864 Realised gains and losses on the Group’s investments for 2017 recognised in the income statement amounted to a net gain of £5.7 billion (2016: a net loss of £1.6 billion). B1.6 Additional analysis of performance by segment components B1.6(a) Asia 2017 £m 2016* £m Insurance Asset management Eliminations Total Total 13,358 253 13,611 27 875 2,042 Earned premiums, net of reinsurance Other income from external customers Total revenue from external customers Intra‑group revenue Interest income Other investment return Total revenue, net of reinsurance 15,032 95 15,127 – 930 8,060 24,117 – 212 212 148 2 3 365 – – – (108) – – (108) 15,032 307 15,339 40 932 8,063 24,374 16,555 Benefits and claims and movements in unallocated surplus of with‑profits funds, net of reinsurance Acquisition costs and other operating expenditure B2 Disposal of Korea life business: D1 Cumulative exchange gain recycled from other comprehensive income Remeasurement adjustments Total charges, net of reinsurance and gain (loss) on disposal of (18,291) (3,911) – (249) – 108 (18,291) (4,052) (11,442) (3,684) 61 5 – – – – 61 5 – (238) businesses (22,136) (249) 108 (22,277) (15,364) Share of profit from joint ventures and associates, net of related tax Profit before tax (being tax attributable to shareholders’ and policyholders’ returns) Tax charge attributable to policyholders’ returns Profit before tax attributable to shareholders Analysis of operating profit Operating profit based on longer‑term investment returns Short‑term fluctuations in investment returns on shareholder‑ backed business Amortisation of acquisition accounting adjustments Loss attaching to disposal of businesses Cumulative exchange gain on the sold Korea life business D1 121 2,102 (250) 1,852 60 176 – 176 1,799 176 (1) (7) – 61 – – – – Profit before tax attributable to shareholders 1,852 176 – – – – – – – – – – 181 148 2,278 (250) 2,028 1,339 (155) 1,184 1,975 1,644 (1) (7) – 61 (225) (8) (227) – 2,028 1,184 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. 188 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continuedB1.6(b) US Earned premiums, net of reinsurance Other income from external customers Total revenue from external customers Intra‑group revenue Interest income Other investment return Total revenue, net of reinsurance Benefits and claims Interest on core structural borrowings Acquisition costs and other operating expenditureB2 Gain on disposal of businessesD1 Total charges, net of reinsurance and gain on disposal of businesses Profit before tax Analysis of operating profit Operating profit 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 disposal of businesses Profit before tax 2017 £m 2016* £m Insurance Asset management† Eliminations Total 14,812 4 14,816 – 2,085 16,448 33,349 (31,205) (16) (1,538) – (32,759) 590 2,214 (1,568) (56) – 590 – 665 665 115 – – 780 – – (770) 162 (608) 172 10 – – 162 172 – – – (51) – – (51) – – 51 – 51 – – – – – – 14,812 669 15,481 64 2,085 16,448 34,078 (31,205) (16) (2,257) 162 Total 14,318 684 15,002 53 2,151 5,461 22,667 (20,214) (15) (1,913) – (33,316) (22,142) 762 525 2,224 2,048 (1,568) (56) 162 762 (1,455) (68) – 525 *The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. † The US total revenue includes asset management gross revenue of £780 million (2016: £785 million), including £542 million of NPH broker‑dealer fees (2016: £550 million), and asset management gross charges of £770 million (2016: £789 million), including £542 million (2016: £550 million) of NPH broker‑dealer fees. www.prudential.co.uk Annual Report 2017 Prudential plc 189 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB1 Analysis of performance by segment continued B1.6 Additional analysis of performance by segment components continued B1.6(c) UK and Europe 2017 £m 2016* £m Insurance Asset management† Eliminations Total Earned premiums, net of reinsurance Other income from external customers Total revenue from external customers Intra‑group revenue Interest income Other investment return Total revenue, net of reinsurance Benefits and claims and movements in unallocated surplus of with‑profits funds, net of reinsurance Acquisition costs and other operating expenditureB2 Total charges, net of reinsurance Share of profit from joint ventures and associates, net of related tax Profit before tax (being tax attributable to shareholders’ and policyholders’ returns) Tax charge attributable to policyholders’ returns Profit before tax Analysis of operating profit Operating profit based on longer‑term investment returns Short‑term fluctuations in investment returns on shareholder‑ backed business Profit before tax 12,076 241 12,317 – 3,412 11,164 26,893 (23,025) (2,692) (25,717) 106 1,282 (424) 858 878 (20) 858 – 1,165 1,165 271 1 7 1,444 – (953) (953) 15 506 – 506 500 6 506 – – – (266) – – (266) – 266 266 – – – – – – – 12,076 1,406 13,482 5 3,413 11,171 28,071 Total 9,285 1,346 10,631 4 4,517 17,578 32,730 (23,025) (3,379) (26,404) (27,710) (2,813) (30,523) 121 34 1,788 (424) 1,364 1,378 (14) 1,364 2,241 (782) 1,459 1,253 206 1,459 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. † The revenue for UK and Europe asset management of £1,087 million (2016: £956 million), comprising the amounts for asset management fee income, other income and performance‑ related fees shown in note B1.1(vi), is different to the amount of £1,444 million shown in the table above. This is because the £1,087 million (2016: £956 million) is after deducting commissions which would have been included as charges in the table above. The difference in the presentation of commission is aligned with how management reviews the business. For further information see note B1.1. 190 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continuedB2 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: 2017 £m 2016 £m (3,712) 911 (6,380) (984) (10,165) (3,687) 923 (5,522) (562) (8,848) (a) Total depreciation and amortisation expense of £(288) million (2016: £(242) million) is included in ‘Administration costs and other expenditure’ and 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 £(2,801) million (2016: £(2,764) million).These amounts comprise £(2,772) million and £(29) million for insurance and investment contracts respectively (2016: £(2,734) million and £(30) 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 comprise a charge of £(719) million (2016: £(485) million) for UK and Europe insurance operations and a charge of £(265) million (2016: £(77) million) for Asia insurance operations. (d) There were no fee expenses relating to financial liabilities held at amortised cost included in acquisition costs in 2017 and 2016. (e) The segmental analysis of interest expense (other than interest expense in core structural borrowings) and depreciation and amortisation included within total acquisition costs and other expenditure was as follows: Asia: Insurance Asset management US: Insurance Asset management UK and Europe: Insurance Asset management Total segment Unallocated to a segment (other operations) Group total Other interest expense Depreciation and amortisation 2017 £m 2016* £m 2017 £m 2016* £m – – (116) – (85) – (201) (39) (240) – – (56) – (102) – (158) (27) (185) (230) (3) 20 (7) (59) (7) (286) (2) (288) (201) (2) 94 (3) (121) (7) (240) (2) (242) * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. B2.1 Staff and employment costs The average number of staff employed by the Group during the year was: Business operations: Asia US UK and Europe* Total * The UK and Europe staff numbers include staff from central operations and Africa which are unallocated to a segment. 2017 2016 15,477 4,564 7,110 27,151 15,439 4,447 6,381 26,267 www.prudential.co.uk Annual Report 2017 Prudential plc 191 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information B2 Acquisition costs and other expenditure continued B2.1 Staff and employment costs continued The costs of employment were: Business operations: Wages and salaries Social security costs Pension costs: Defined benefit schemes* Defined contribution schemes Total * The (credit) charge incorporates the effect of actuarial gains and losses. 2017 £m 2016 £m 1,774 129 (3) 85 1,985 1,483 110 213 79 1,885 B2.2 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 the 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 vested. Prudential Agency Long-Term Incentive Plan Certain agents in Asia are eligible to be granted awards under the Prudential Agency Long‑Term Incentive Plan. These awards are structured in a similar way to the PCA LTIP described above. Restricted Share Plan (RSP) The Company operates the RSP for certain employees. Awards under this plan are discretionary, and the vesting of awards may be subject to performance conditions. All awards are made in Prudential shares or ADRs. Deferred bonus plans Savings-related share option schemes Share purchase plans The Company operates a number of deferred bonus schemes including the Group Deferred Bonus Plan (GDBP), 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. 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. 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 are eligible to participate in the Share Participation Plan. Staff based in Asia are eligible to participate in the Prudential Corporation Asia All Employee Share Purchase Plan. 192 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance 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 2017 and 2016: Options outstanding under SAYE schemes Awards outstanding under incentive plans including conditional options 2017 2016 2017 2016 Number of options millions Weighted average exercise price £ Number of options millions Weighted average exercise price £ Number of awards millions 7.1 1.4 (1.7) (0.1) (0.2) (0.1) 6.4 0.4 10.74 14.55 10.07 10.83 11.19 10.86 11.74 11.06 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 30.2 12.7 (7.3) (1.3) (0.1) (0.6) 33.6 28.4 13.9 (10.5) (1.5) (0.1) – 30.2 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 2017 was £17.51 compared to £13.56 for the year ended 31 December 2016. The following table provides a summary of the range of exercise prices for Prudential plc options outstanding at 31 December. Number outstanding (millions) Outstanding Weighted average remaining contractual life (years) Exercisable Weighted average exercise prices £ Number exercisable (millions) Weighted average exercise prices £ 2017 2016 2017 2016 2017 2016 2017 2016 2017 – – 0.5 4.5 1.4 6.4 0.1 0.2 1.1 5.7 – 7.1 – 0.4 1.4 2.2 3.9 2.5 0.4 1.4 1.4 2.9 – 2.6 – 6.29 9.01 11.21 14.55 11.74 4.66 6.29 9.01 11.27 – 10.74 – – – 0.4 – 0.4 0.1 – 0.5 – – 0.6 – 6.29 – 11.55 – 11.06 2016 4.66 6.29 9.01 – – 8.53 Between £4 and £5 Between £6 and £7 Between £9 and £10 Between £11 and £12 Between £14 and £15 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: 2017 2016 Prudential LTIP/RSP (TSR) SAYE options Other awards Prudential LTIP (TSR) SAYE options Other awards Dividend yield (%) Expected volatility (%) Risk‑free interest rate (%) Expected option life (years) Weighted average exercise price (£) Weighted average share price at grant date (£) Weighted average fair value at grant date (£) – 23.17 0.62 – – 16.80 8.30 2.85 20.15 0.56 3.49 14.55 17.74 3.29 – – – – – – 16.12 – 29.36 0.12 – – 12.82 4.41 3.19 25.41 0.15 3.70 11.04 13.94 3.05 – – – – – – 12.57 www.prudential.co.uk Annual Report 2017 Prudential plc 193 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB2 Acquisition costs and other expenditure continued B2.2 Share-based payment continued The compensation costs for all awards and options are recognised in net income over the plans’ respective vesting periods. The Group uses the Black‑Scholes model to value all options and awards other than those which have TSR performance conditions attached (some Prudential LTIP and RSP awards) for which the Group uses a Monte Carlo model in order to allow for the impact of these 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 yields are determined as the average yield over a period of 12 months up to and including the date of grant. For awards with a TSR condition, volatilities and correlations between Prudential and a basket of 15 competitor companies is required. For grants in 2017, the average volatility for the basket of competitors was 22.93 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 basket of competitors. 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 2017 £m 2016 £m 158 158 126 127 The group has no liabilities outstanding at the year‑end relating to awards which are settled in cash. B2.3 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 2017 £m 2016 £m 17.9 1.3 14.1 33.3 20.7 1.3 18.7 40.7 The share‑based payments charge comprises £8.3 million (2016: £12.9 million), which is determined in accordance with IFRS 2, ‘Share‑based Payment’ (see note B2.2) and £5.8 million (2016: £5.8 million) of deferred share awards. Total key management remuneration includes total Directors’ remuneration of £40.2 million (2016: £37.9 million) less LTIP releases of £15.2 million (2016: £10.1 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. B2.4 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 2017 £m 2016 £m 2.1 8.3 4.3 – 1.5 0.4 0.7 2.0 7.5 3.9 0.1 2.1 – 0.6 17.3 16.2 In addition, there were fees incurred by pension schemes of £0.1 million (2016: £0.1 million) for audit services and £nil million (2016: £0.1 million) for other assurance services. 194 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continuedB3 Effect of changes and other accounting matters on insurance assets and liabilities The following matters are relevant to the determination of the 2017 results: (a) Asia insurance operations In 2017, the IFRS operating profit based on longer‑term investment returns for Asia insurance operations included a net credit of £75 million (2016: £67 million) representing a small number of individually minor items. (b) US insurance operations Changes in the policyholder liabilities held for variable and fixed index annuity guarantees are reported as part of non‑operating profit and are as described in note B1.2. (c) UK and Europe 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. The IFRS credit risk allowance made for the UK shareholder‑backed fixed and linked annuity business equated to 42 basis points at 31 December 2017 (2016: 43 basis points). The allowance represented 28 per cent of the bond spread over swap rates (2016: 26 per cent). The reserves for credit risk allowance at 31 December 2017 for the UK shareholder‑backed business were £1.6 billion (2016: £1.7 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 2017, was a credit of £173 million (2016: credit of £16 million). This included, amongst other items, a benefit to IFRS operating profit based on longer‑term investment returns of £204 million, relating to changes to annuitant mortality assumptions primarily reflecting the adoption of the Continuous Mortality Investigation (CMI) 2015 model. Further information on changes to mortality assumptions is given in note C4.1(d). Longevity reinsurance and other management actions A number of management actions were taken in 2017 to improve the solvency position of the UK and Europe insurance operations and further mitigate market risk, which have generated combined profits of £276 million. Similar actions were also taken in 2016 and 2015. Of this amount £31 million related to profit from an additional longevity reinsurance transactions covering £0.5 billion of annuity liabilities on an IFRS basis, with the balance of £245 million reflecting the effect of repositioning the fixed income portfolio and other actions. The contribution to profit from similar longevity reinsurance and other management actions in 2016 was £332 million (of which £197 million related to longevity reinsurance transactions covering £5.4 billion of IFRS annuity liabilities). At 31 December 2017, longevity reinsurance covered £14.4 billion of IFRS annuity liabilities equivalent to 44 per cent of total annuity liabilities (2016: £14.4 billion, 42 per cent). With-profits sub-fund For the with‑profits sub‑fund, the aggregate effect of assumption changes in 2017 was a net charge to unallocated surplus of £58 million (2016: net charge of £78 million). www.prudential.co.uk Annual Report 2017 Prudential plc 195 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB4 Tax charge On 22 December 2017, a significant US tax reform package, the Tax Cuts and Jobs Act, was enacted into law effective from 1 January 2018. The tax reform package as a whole, which includes a reduction in the corporate income tax rate from 35 per cent to 21 per cent, and a number of specific measures affecting US life insurers, is expected to be beneficial in the longer term. However in 2017 the changes have had an adverse impact on the tax charge attributable to shareholders in the Group’s US operations and a benefit to policyholders in the with‑profits fund of the UK and Europe operations, due to the requirement to remeasure deferred tax balances at the new 21 per cent rate. The 2017 impacts on the Group’s income statement and on other comprehensive income of the US tax changes are set out below and the impact on the balance sheet are set out in note C8. (a) Total tax charge by nature of expense The total tax charge in the income statement is as follows: Tax charge Attributable to shareholders: Asia operations US operations UK and Europe Other operations Tax charge attributable to shareholders’ returns Attributable to policyholders: Asia operations UK and Europe Tax charge attributable to policyholders’ returns Total tax charge 2017 £m 2016 £m Current tax Deferred tax Total Total (164) 56 (302) 122 (288) (92) (316) (408) (696) (89) (564) 35 – (618) (157) (109) (266) (884) (253) (508) (267) 122 (906) (249) (425) (674) (256) 66 (275) 111 (354) (155) (782) (937) (1,580) (1,291) The principal reason for the increase in the tax charge attributable to shareholders’ returns is a £445 million deferred tax charge arising on the remeasurement of the US net deferred tax assets from 35 per cent to 21 per cent. The principal reason for the decrease in the tax charge attributable to policyholders’ returns is a smaller increase in deferred tax liabilities on unrealised gains on investments in the with‑profits fund of UK and Europe compared to 2016, combined with a £92 million credit following the remeasurement of US net deferred tax liabilities in the same with‑profits fund. The reconciliation of the expected to actual tax charge attributable to shareholders is provided in (b) below. The tax charge attributable to policyholders of £674 million above is equal to the profit before tax attributable to policyholders of £674 million. This is the result of accounting for policyholder income after the deduction of expenses and movement on unallocated surpluses and on an after tax basis. 196 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continuedThe total tax charge comprises: Current tax expense: Corporation tax Adjustments in respect of prior years Total current tax charge 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 (charge) credit Total tax charge 2017 £m 2016 £m (746) 50 (696) (531) (353) – (884) (1,464) 87 (1,377) 64 6 16 86 (1,580) (1,291) The reduction in the corporation tax expense from £1,464 million in 2016 to £746 million in 2017 principally relates to US operations where a higher tax deduction arises in 2017 as compared to 2016 in respect of derivative losses. The 2017 impact of changes in local statutory tax rates relates to the remeasurement of US deferred tax balances following US tax reform attributable to both shareholders and policyholders. The current tax charge of £696 million (2016: £1,377 million) includes £59 million (2016: £53 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 deferred tax (charge) credit arises as follows: Short‑term temporary differences Unrealised gains and losses on investments Balances relating to investment and insurance contracts Unused tax losses Capital allowances Deferred tax (charge) credit 2017 £m 2016 £m (526) (185) (156) (12) (5) (884) 573 (437) (90) 36 4 86 The movement in the short‑term temporary differences from a credit in 2016 of £573 million to a charge in 2017 of £526 million principally relates to the US operations due to the combination of the £445 million charge relating to the remeasurement of the deferred tax balances following the US tax reform changes and a £695 million deferred tax charge relating to the amortisation of US operations derivative losses, which are spread across three years for tax purposes. The unrealised gains and losses on investments charge is after including the £92 million benefit from remeasurement of deferred tax balances on unrealised gains of US investments in the with‑profits funds of UK and Europe operations. In 2017, a tax charge of £75 million (2016: credit of £10 million) attributable to shareholders has been taken through other comprehensive income. The 2017 charge includes a £190 million deferred tax charge primarily on unrealised gains on bonds held in the US operations partly offset by £134 million benefit relating to the remeasurement of US net deferred tax liabilities on the bonds. www.prudential.co.uk Annual Report 2017 Prudential plc 197 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information B4 Tax charge continued (b) Reconciliation of shareholder effective tax rate In the reconciliation below, the expected tax rates reflect the corporation 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. Asia operations US operations UK and Europe Other* operations Total attributable to shareholders Percentage impact on ETR 2017 £m Operating profit (loss) based on longer‑term investment returns Non‑operating profit (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 1,975 53 2,028 21% 426 (64) 26 (92) 11 (52) – (10) 2,224 (1,462) 762 35% 267 (11) 6 (238) 17 – – – Total (181) (226) (15) 25 445 12 467 508 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 US tax reform Adjustments in relation to business disposals Total Total actual tax charge (credit) 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 * Other operations include restructuring costs. (3) 19 – (8) 8 253 276 (23) 14% 13% 12% 1,378 (14) 1,364 19% 259 (2) 13 (2) (1) (3) – 6 11 (3) – – – (3) (878) 20 (858) 19% (163) (14) 10 – (5) – 54 (1) 44 (3) – – – (3) 267 (122) 4,699 (1,403) 3,296 24% 789 (91) 55 (332) 22 (55) 54 (5) 23.9% (2.8%) 1.7% (10.1%) 0.7% (1.7%) 1.6% (0.1%) (352) (10.7%) (24) (0.7%) 44 445 4 469 906 1.3% 13.5% 0.1% 14.2% 27.4% 548 (40) 268 (1) (121) (1) 971 (65) 25% 24% 67% 19% 20% 20% 14% 13% 14% 21% 20% 27% 198 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continuedThe more significant reconciling items are explained below: Income not taxable or taxable at concessionary rates £26 million of the £64 million reconciling item in Asia operations is due to non‑taxable gains on domestic securities in Taiwan (no equivalent amount in 2016) with the balance principally relating to income taxable at rates lower than the expected rates in Malaysia and Singapore. Items related to taxation of life insurance businesses The £92 million reconciling item in Asia operations 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. It is higher than the 2016 adjustment of £20 million due to a larger proportion of profits attributable to Hong Kong. The £238 million (full year 2016: £159 million) reconciling item in US operations reflects the impact of the dividend received deduction on the taxation of profits from variable annuity business. US tax reform changes effective from 1 January 2018 are expected to reduce the level of this deduction from 2018 onwards. Effects of results of joint ventures and associates The £55 million reconciling item 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. Irrecoverable withholding taxes The £54 million adverse reconciling items reflects withholding taxes on dividends paid by certain non‑UK subsidiaries, principally Indonesia, to the UK. The dividends are exempt from UK tax and consequently the withholding tax cannot be offset against UK tax payments. Movements in provisions for open tax matters The complexity of the tax laws and regulations that relate to our businesses means that from time to time we may disagree with tax authorities on the technical interpretation of a particular area of tax law. This uncertainty means that in the normal course of business the Group will have matters whereupon ultimate resolution of the uncertainty, the amount of profit subject to tax may be greater than the amounts reflected in the Group’s submitted tax returns. The statement of financial position contains the following provisions in relation to open tax matters: At 1 January 2017 Movements in the current period included in: Tax charge attributable to shareholders Other movements* At 31 December 2017 * Other movements include interest arising on open tax matters and amounts included in the Group’s share of profits from joint ventures and associates, net of related tax. £m (89) (44) (6) (139) www.prudential.co.uk Annual Report 2017 Prudential plc 199 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB4 Tax charge continued Impact of US tax reform As noted earlier, the reduction in the US corporate income tax rate from 35 per cent to 21 per cent from 1 January 2018 was substantively enacted on 22 December 2017, giving rise to a £445 million unfavourable reconciling item in US operations relating to the remeasurement of the net deferred tax asset attributable to shareholders. Separately, a £134 million benefit has been recognised in other comprehensive income. Further detail on the impact of US tax reform is provided in note C8. Asia operations US operations UK and Europe Other* operations Total attributable to shareholders Percentage impact on ETR 2016† £m Operating profit (loss) 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 Total actual tax charge (credit) 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 1,644 (460) 1,184 22% 260 2,048 (1,523) 525 35% 184 1,253 206 1,459 20% 292 (31) 20 (20) (11) (44) – 3 (83) 1 20 – 58 79 256 (18) 8 (159) – – – – (169) (81) – – – (81) (66) (13) 10 (1) 2 (2) – – (4) (7) – (6) – (13) (689) (204) (893) 20% (179) (5) 22 – (14) – 36 (7) 32 5 31 – – 36 4,256 (1,981) 2,275 24% 557 (67) 60 (180) (23) (46) 36 (4) (224) 24.4% (2.9%) 2.6% (7.9%) (1.0%) (2.0%) 1.6% (0.1%) (9.7%) (82) (3.6%) 51 (6) 58 21 2.2% (0.2%) 2.5% 0.9% 275 (111) 354 15.6% 271 (15) 467 (533) 16% 15% 22% 23% 27% (13)% 244 31 19% 21% 19% (88) (23) 894 (540) 13% 18% 12% 21% 22% 16% * Other operations include restructuring costs. † The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. 200 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continued The 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 operations 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 B5 Earnings per share Asia operations Attributable to shareholders 22% 16% 18% 24% 21% 14% 2017 Non- controlling interests Net of tax and non- controlling interests Basic earnings per share Diluted earnings per share £m Pence Pence 3,727 145.2p 145.1p (991) (38.6)p (38.6)p (43) (1.7)p (1.7)p 61 80 (445) 2.4p 3.1p (17.3)p 93.1p 2.4p 3.1p (17.3)p 93.0p (1) 2,389 £m (1) – – – – – Before tax B1.1 £m Note Tax B4 £m 4,699 (971) B1.2 (1,563) 572 20 – (82) (445) (906) (63) 61 162 – 3,296 Before tax B1.1 £m Tax B4 £m 4,256 (894) (1,678) 519 (227) (76) 2,275 (4) 25 (354) 2016 Non- controlling interests Net of tax and non- controlling interests Basic earnings per share Diluted earnings per share £m £m Pence Pence – – – – – 3,362 131.3p 131.2p (1,159) (45.3)p (45.2)p (231) (9.0)p (9.0)p (51) 1,921 (2.0)p 75.0p (2.0)p 75.0p Based on operating profit based on longer‑term investment returns Short‑term fluctuations in investment returns on shareholder‑backed business Amortisation of acquisition accounting adjustments Cumulative exchange gain on the sold Korea life business recycled from other comprehensive income Profit attaching to disposal of businesses Impact of US tax reform 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 Loss attaching to held for sale Korea life business Amortisation of acquisition accounting adjustments Based on profit for the year D1 D1 B4 Note B1.2 D1 www.prudential.co.uk Annual Report 2017 Prudential plc 201 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationB5 Earnings per share continued 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 B6 Dividends 2017 millions 2016 millions 2,567 6 (5) 2,568 2,560 7 (5) 2,562 Dividends relating to reporting year: First interim ordinary dividend Second interim ordinary dividend Total Dividends paid in reporting year: Current year first interim ordinary dividend Second interim ordinary dividend for prior year Special dividend Total 2017 2016 Pence per share 14.50p 32.50p 47.00p 14.50p 30.57p – 45.07p £m Pence per share 375 841 1,216 373 786 – 1,159 12.93p 30.57p 43.50p 12.93p 26.47p 10.00p 49.40p £m 333 789 1,122 332 679 256 1,267 Dividend per share For the year ended 31 December 2016 the second interim ordinary dividend of 30.57 pence per ordinary share was paid to eligible shareholders on 19 May 2017. The 2017 first interim ordinary dividend of 14.50 pence per ordinary share was paid to eligible shareholders on 28 September 2017. The second interim ordinary dividend for the year ended 31 December 2017 of 32.50 pence per ordinary share will be paid on 18 May 2018 in sterling to shareholders on the principal register and the Irish branch register at 6.00pm BST on 3 April 2018 (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 25 May 2018. The second interim ordinary dividend will be paid on or about 25 May 2018 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 2018. 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. 202 Prudential plc Annual Report 2017 www.prudential.co.uk B Earnings performance continued C Balance sheet notes C1 Analysis of Group statement of financial position by segment (a) Position as at 31 December 2017 2017 £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 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 note (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 Total liabilities Total equity and liabilities Note C5(a) C5(b) C8.1 C8.2 D6 C3.3 C3.2 Asia C2.1 US C2.2 305 2,540 125 1,960 112 58 595 2,675 5 – 8,219 214 6,424 2,300 298 492 248 5 912 1,317 – 9,630 29,976 130,630 35,378 40,982 1,611 113 848 – 43 1,291 – – 1,658 1,934 UK and Europe C2.3 1,177 210 447 2,521 157 244 1,558 3,118 16,487 504 5,986 62,670 92,707 2,954 4,774 9,540 38 5,808 Unallo- cated to a segment (other opera- tions) note (v) Elimin- ation of intra- group debtors and creditors Group total 1,482 11,011 789 9,673 2,627 613 2,676 2,963 16,497 – – – (1,235) – (80) – (5,199) – 1,416 – – 17,042 – 223,391 – 171,374 4,801 – 5,622 – 11,236 – 38 – 10,690 – – 42 3 3 58 93 31 2,121 – – 109 115 2,307 123 – 362 – 1,290 84,900 197,998 210,900 6,657 (6,514) 493,941 5,926 5,248 8,245 (3,325) – 16,094 C4.1 63,468 177,728 88,180 31 (1,235) 328,172 C4.1 C4.1 C4.1 C6.1 C6.2 C6.2 C8.1 C8.2 C11 C3.4 337 – 62,340 328 3,474 2,996 – 17,069 13,477 – 1 – – 50 10 184 508 – – 6,096 148 3,706 1,085 – – 4,304 1,358 – – – – – – – – 3,631 1,152 122 6,069 254 79 – 1,845 47 5,109 24 5 5,243 1,703 377 6,609 784 1,661 15 15 71 1,597 61 1,010 – – (80) (5,199) – – 62,677 20,394 16,951 6,280 1,791 3,716 5,662 8,889 4,715 537 14,185 1,123 2,755 78,974 192,750 202,655 9,982 (6,514) 477,847 84,900 197,998 210,900 6,657 (6,514) 493,941 www.prudential.co.uk Annual Report 2017 Prudential plc 203 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C1 Analysis of Group statement of financial position by segment continued (b) Position as at 31 December 2016 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 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 note (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 Total equity and liabilities Note C5(a) C5(b) C8.1 C8.2 D6 C3.3 C3.2 D1 Asia C2.1 US C2.2 306 2,319 124 1,539 107 29 549 2,662 5 16 8,327 247 7,224 3,979 101 628 304 6 – 825 1,303 9,735 23,599 120,747 40,745 36,546 834 47 992 – 49 1,425 – 3,863 1,135 2,157 UK and Europe C2.3 1,306 132 369 2,590 174 308 1,939 3,233 14,635 448 3,572 54,177 90,796 2,927 4,473 10,705 726 5,064 77,405 195,069 197,574 Unallo- cated to a segment (other opera- tions) note (v) Elimin- ation of intra- group debtors and creditors – 29 3 – 55 2 37 2,130 – – 563 29 2,371 128 – 6 – 1,709 7,062 – – – – – – – (1,302) – – – (5,310) – – – – – – – – – – – – – – – – – Group total 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 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 5,376 5,408 7,832 (3,949) – 14,667 (6,612) 470,498 C4.1 54,417 174,328 88,993 (1,302) 316,436 C4.1 C4.1 C4.1 C6.1 C6.2 C6.2 C8.1 C8.2 C11 C3.4 D1 347 – 52,490 254 2,667 3,298 – 16,171 11,650 – 19 4 – 3,093 935 125 5,916 229 265 3,758 202 480 – – 6,596 167 1,345 1,651 – 3,534 1,497 – – 2,832 – 4,920 3 64 – 5,594 1,592 513 6,688 647 1,860 535 – 11 11 1,611 68 1,063 – – – – (5,310) – – – 72,029 189,661 189,742 11,011 (6,612) 455,831 77,405 195,069 197,574 7,062 (6,612) 470,498 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. 204 Prudential plc Annual Report 2017 www.prudential.co.uk Notes (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 2017 £m 2016 £m 1,789 887 2,676 408 4 134 2,417 2,963 5,639 4,957 682 5,639 1,975 1,178 3,153 403 6 90 2,520 3,019 6,172 5,548 624 6,172 2017 £m 2016 £m 6,623 4,067 10,690 328 10,362 10,690 5,581 4,484 10,065 247 9,818 10,065 The Group’s cash and cash equivalents are held in the following currencies: pounds sterling 31 per cent, US dollars 28 per cent, Euro 24 per cent and other currencies 17 per cent (2016: pounds sterling 38 per cent, US dollars 25 per cent, Euro 20 per cent and other currencies 17 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 accruals, deferred income and other liabilities 2017 £m 2016 £m 1,233 7,289 2,296 100 2,664 603 1,150 6,788 2,520 90 2,851 426 14,185 13,825 (iv) Operational borrowings attributable to shareholder‑financed operations within other operations, in respect of Prudential Capital’s short‑term fixed income security programme Commercial paper Medium Term Notes Total Group debt represented by operational borrowings at Group level (v) Unallocated to a segment includes central operations, Prudential Capital and Africa operations as per note B1.3. 2017 £m 2016 £m 485 600 1,085 1,052 599 1,651 www.prudential.co.uk Annual Report 2017 Prudential plc 205 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C Balance sheet notes continued C2 Analysis of segment statement of financial position by business type C2.1 Asia 31 Dec 2017 £m Insurance With- profits business Unit- linked assets and liabilities Note Other business Total Asset manage- ment Elimin- ations 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 – 45 86 76 – 1 230 1,823 – – 725 14,995 24,432 82 246 – 632 – – – – – 2 53 169 – 244 244 2,490 36 1,884 102 55 277 648 5 2,535 122 1,960 102 58 560 2,640 5 – – 768 592 768 1,317 13,199 3,507 5 511 – 287 1,759 13,043 26 499 – 822 29,953 40,982 113 1,256 – 1,741 43,373 17,733 23,250 84,356 – – 5,525 5,525 33,861 15,935 13,672 63,468 C3.3 C3.2 D1 C4.1 C4.1 337 – – 328 – – – 43 – – 7 – 1,219 38 – 206 – – – 260 340 81 3,207 102 20 – 337 328 3,474 50 10 3,631 1,152 105 6,033 164 79 – 3,474 – 10 2,152 774 24 2,620 62 59 – D1 61 5 3 – 10 – 35 67 – 144 – 23 – – 35 – 193 576 401 – – – – – – – – 17 68 90 – – 175 576 31 Dec 2016* £m Total Total 305 306 – – – – – – – (32) – 2,540 125 1,960 112 58 595 2,675 5 – – – – – – – – 912 1,317 29,976 40,982 113 1,291 – 1,934 (32) 84,900 5,926 2,319 124 1,539 107 29 549 2,662 5 825 1,303 23,599 36,546 47 1,425 3,863 2,157 77,405 5,376 – – – – – – – – – – (32) – – – 63,468 54,417 337 328 347 254 3,474 2,667 50 10 3,631 1,152 122 6,069 254 79 – 19 4 3,093 935 125 5,916 229 265 3,758 43,373 17,733 17,725 78,831 43,373 17,733 23,250 84,356 (32) 78,974 (32) 84,900 72,029 77,405 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. 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 2017 www.prudential.co.uk C2.2 US 31 Dec 2017 £m 31 Dec 2016* £m Variable annuity separate account assets and liabilities Note Insurance Fixed annuity, GIC and other business Asset manage- ment Total Elimin- ations 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 Loans Equity securities and portfolio holdings in unit trusts Debt securities Derivative assets Other investments Deposits Cash and cash equivalents Total assets Total equity C3.3 C3.2 Liabilities Insurance contract liabilities Investment contract liabilities without discretionary participation features C4.1 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 – – – – – – – – – – – – 8,216 209 6,424 2,218 284 444 247 5 9,630 8,216 209 6,424 2,218 284 444 247 5 9,630 130,528 – – – – – 102 130,630 35,378 1,611 844 – 1,224 35,378 1,611 844 – 1,224 130,528 66,836 197,364 – 5,013 5,013 130,528 47,200 177,728 – – – – – – – – – – 2,996 2,996 184 508 184 508 4,304 4,304 – 1,844 46 4,728 8 5 – 1,844 46 4,728 8 5 130,528 61,823 192,351 130,528 66,836 197,364 – 3 5 – 82 14 48 77 – – – – – 4 43 434 710 235 – – – – – – 1 1 457 16 – 475 710 Total Total – 16 8,219 214 6,424 2,300 298 492 248 5 9,630 8,327 247 7,224 3,979 101 628 304 6 9,735 – – – – – – – (76) – – – 130,630 35,378 – 1,611 – 848 – 43 – 1,658 – 120,747 40,745 834 992 49 1,135 (76) 197,998 195,069 – 5,248 5,408 – 177,728 174,328 – – – – 2,996 3,298 184 508 202 480 4,304 3,534 – – – (76) – – – 1,845 47 5,109 24 5 – 2,832 – 4,920 3 64 (76) 192,750 189,661 (76) 197,998 195,069 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. www.prudential.co.uk Annual Report 2017 Prudential plc 207 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C2 Analysis of segment statement of financial position by business type continued C2.3 UK and Europe 31 Dec 2017 £m 31 Dec 2016* £m Insurance Other funds and subsidiaries Unit- linked assets and liabilities Annuity and other long-term business With- profits sub-funds note (i) Note Asset manage- ment Elimin- ations Total Total Total 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 – 24 1,153 24 100 406 1,269 70 63 892 1,553 14,153 464 4,268 47,173 50,661 2,420 4,744 7,167 38 4,096 C3.3 C3.2 – – – 133 – – 107 76 682 – – 103 37 1,119 64 181 553 624 1,652 – 1,718 15,369 6,711 8 11 1,139 – 693 9 35,335 526 1 1,234 – 576 203 443 2,521 134 244 1,552 2,253 16,487 464 5,986 62,551 92,707 2,954 4,756 9,540 38 5,365 7 4 – 23 – 6 941 – 40 – 119 – – 18 – – 443 139,561 24,929 43,732 208,222 – – 6,344 6,344 2,754 1,901 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) C4.1 48,894 6,097 33,189 88,180 C4.1 62,323 – 17 62,340 C4.1 C4.1 5 13,477 17,048 – 16 – 17,069 13,477 – 3,706 748 3,409 1,410 119 4,791 55 624 – 4 – – 1,667 – 76 36 – 1 – 123 127 – 3,706 610 1,358 167 274 138 1,293 525 1,036 – 5,243 1,684 333 6,120 580 1,661 – Total liabilities 139,561 24,929 37,388 201,878 – – – – 21 – – – 19 44 565 204 – – 853 – – – – – – – (76) – – – – – – – – – – 1,177 1,306 210 447 2,521 157 244 1,558 3,118 16,487 504 5,986 62,670 92,707 2,954 4,774 9,540 38 5,808 132 369 2,590 174 308 1,939 3,233 14,635 448 3,572 54,177 90,796 2,927 4,473 10,705 726 5,064 (76) 210,900 197,574 – – – – – – – – 8,245 7,832 88,180 88,993 62,340 52,490 17,069 13,477 16,171 11,650 148 167 3,706 1,345 1,358 1,497 – – – (76) – – – 5,243 1,703 377 6,609 784 1,661 – 5,594 1,592 513 6,688 647 1,860 535 (76) 202,655 189,742 Total equity and liabilities 139,561 24,929 43,732 208,222 2,754 (76) 210,900 197,574 * The 2016 comparative results have been re‑presented from those previously published following reassessment of the Group’s operating segments as described in note B1.3. 208 Prudential plc Annual Report 2017 www.prudential.co.uk Notes (i) (ii) Includes the Scottish Amicable Insurance Fund which, at 31 December 2017, have total assets and liabilities of £5,768 million (2016: £6,101 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 £10.6 billion (2016: £11.2 billion) of non‑profits annuities liabilities. The assets and liabilities held for sale for the UK and Europe insurance operations 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. C3 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. Other than the loans which have been designated at fair value through profit or loss, 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 discount rate is updated for 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. www.prudential.co.uk Annual Report 2017 Prudential plc 209 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 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 Borrowings attributable to with‑profits operations 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 2017 £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 – 57,347 29,143 68 (68) 86,490 60% 158,631 4,993 12 – 163,636 97% – 2,105 21,443 7 – 23,555 25% – 4,470 45,602 3,638 (615) 53,095 36% 457 5,226 4 (1) 5,686 3% – 10 64,313 2,270 (1,559) 65,034 71% – 218,083 55,579 87 (68) – 4,937 115,141 5,912 (2,175) 273,681 123,815 – – (17,397) – (4,836) – 268,845 72% (3,640) – 102,778 27% 2,023 351 348 3,540 – 6,262 4% 10 – 8 – 18 0% 2,814 10 306 876 (512) 3,494 4% 4,837 371 654 4,424 (512) 9,774 – (1,887) (413) (3,031) 4,443 1% 2,023 62,168 75,093 7,246 (683) 145,847 100% 159,098 10,219 24 (1) 169,340 100% 2,814 2,125 86,062 3,153 (2,071) 92,083 100% 4,837 223,391 171,374 10,423 (2,755) 407,270 (17,397) (1,887) (8,889) (3,031) 376,066 100% 210 Prudential plc Annual Report 2017 www.prudential.co.uk 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 £35,293 million (2016: £40,645 million) of debt securities classified as available‑for‑sale. The Korea life business was classified as held for sale in 2016, with the sale completed in May 2017. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 211 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 Assets and liabilities continued C3.1 Group assets and liabilities – measurement continued Investment properties at fair value 2017 2016 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 – – – – 16,497 14,646 16,497 14,646 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 2017 £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 – – – – – – 2,756 10,183 12,939 12,205 – (3,032) (3,032) (2,997) (7,023) (1,788) (1,761) – (7,023) (6,280) (3) (71) (1,791) (1,832) (1,791) (1,829) (1,410) (4,318) (5,728) (5,662) 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) Notes (i) (ii) The carrying value of loans and receivables are reported net of allowance for loan losses of £28 million (2016: £15 million). As at 31 December 2017, £312 million (2016: £306 million) of convertible bonds were included in debt securities and £1,311 million (2016: £1,455 million) were included in borrowings. 212 Prudential plc Annual Report 2017 www.prudential.co.uk 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. During 2017, the assumptions applied within the discounted cash flow model used to value the equity release mortgage loans held by the UK insurance operations were refined to reflect developing market practice, including consideration of the Prudential Regulation Authority’s industry wide review in this area and resulting guidance. This refinement incorporates inputs relevant to determining the discount rate that are not market observable. As a result, these loans (£1,429 million at 31 December 2017) have been transferred from level 2 to level 3 in the table above. The fair value included for the subordinated and senior debt issued by the parent company is determined using quoted prices from independent third parties. (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 service 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 £115,141 million at 31 December 2017 (2016: £116,257 million), £13,910 million are valued internally (2016: £12,708 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. www.prudential.co.uk Annual Report 2017 Prudential plc 213 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 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 2017 to that presented at 31 December 2017. Financial instruments at fair value £m Total (losses)/ gains 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 17 11 51 73 4 (235) 2,129 – (311) 236 302 – 4,837 (5) (11) (133) – 186 216 727 – (468) (522) (725) – (6) – – – – – – – 1 – 2 – (70) (22) 371 654 – – 4,424 (512) At 1 Jan 2,699 722 942 4,480 (516) 8,327 156 (384) 3,258 (1,715) (317) 236 305 (92) 9,774 – (13) – – (883) (2,851) (559) 14 – 250 (13) – – – – 115 (1,989) – 1,276 252 (234) (311) – (385) – – – (1,887) (413) (3,031) 4,593 (402) (134) 3,245 (1,715) 1,326 (2,298) (80) (92) 4,443 2,183 607 778 2 59 85 4,276 (353) 359 (163) 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) 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) 4,108 320 402 1,058 (1,186) 361 (214) 138 (394) 4,593 2017 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 Borrowings attributable to with‑profits operations Net asset value attributable to unit holders of consolidated unit trusts and similar funds Other financial liabilities Total financial instruments at fair value 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 214 Prudential plc Annual Report 2017 www.prudential.co.uk Of the total net losses and gains in the income statement of £(402) million (2016: £320 million), £(139) million (2016: £242 million) relates to net unrealised gains and losses of financial instruments still held at the end of the year, which can be analysed as follows: Loans Equity securities Debt securities Other investments Derivative liabilities Borrowings attributable to with‑profit operations 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 2017 £m 2016 £m 20 (12) (5) (22) 4 (13) (123) 12 (139) – 8 71 182 – – (18) (1) 242 At 1 Jan 14,646 13,422 Total gains in income statement 415 273 Total (losses)/ gains in other compre- hensive income (21) 97 2017 2016 Purchases 2,048 1,527 Transfers into level 3 Transfers out of level 3 – – – (41) Sales (591) (632) At 31 Dec 16,497 14,646 Of the total net losses and gains in the income statement of £415 million (2016: £273 million), £394 million (2016: £286 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 a significant volume 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 2017, the Group held £4,443 million (2016: £4,593 million) of net financial instruments at fair value within level 3. This represents 1 per cent (2016: 1 per cent) of the total fair valued financial assets net of fair valued financial liabilities. The net financial instruments at fair value within level 3 at 31 December 2017 include £1,983 million of loans and a corresponding £1,887 million of borrowings held by a subsidiary of the Group’s UK with‑profits fund, attaching to a portfolio of buy‑to‑let mortgages and other loans financed largely by external third‑party (non‑recourse) borrowings (see note C3.3(c) for further details). The Group’s exposure is limited to the investment held by the UK with‑profits fund, rather than to the individual loans and borrowings themselves. The fair value movements of these loans and borrowings have no effect on shareholders’ profit and equity. The most significant non‑observable inputs to the mortgage fair value are the level of future defaults and prepayments by the mortgage holders. Also included within these amounts are loans of £2,512 million at 31 December 2017 (2016: £2,672 million), measured as the loan outstanding balance, plus accrued investment income, attached to REALIC and held to back the liabilities for funds withheld under reinsurance arrangements. The funds withheld liability of £2,664 million at 31 December 2017 (2016: £2,851 million) is also classified within level 3, accounted for on a fair value basis being equivalent to the carrying value of the underlying assets. www.prudential.co.uk Annual Report 2017 Prudential plc 215 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 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 £(152) million (2016: £(179) million), the level 3 fair valued financial assets net of financial liabilities are £4,595 million (2016: £4,772 million). Of this amount, a net asset of £117 million (2016: net asset of £72 million) is internally valued, representing less than 0.1 per cent of the total fair valued financial assets net of financial liabilities (2016: less than 0.1 per cent). Internal valuations are inherently more subjective than external valuations. Included within these internally valued net asset/liability are: (a) Debt securities of £500 million (2016: £422 million), which are 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 in both debt and equity securities of £217 million (2016: £956 million) which are valued internally using discounted cash flows based on management information available for these investments. The significant unobservable inputs include the determination of expected future cash flows on the investments being valued, determination of the probability of counterparty default and prepayments and the selection of appropriate discount rates. The valuation is performed in accordance with International Private Equity and Venture Capital Association Valuation guidelines. These investments were principally held by consolidated investment funds that are managed on behalf of third parties. (c) Equity release mortgage loans of £366 million (2016: £276 million classified as level 2) which are valued internally using the discounted cash flow models. The inputs that are significant to the valuation of these investments are primarily the economic assumptions, being the discount rate (risk‑free rate plus a liquidity premium) and property values. See below for the explanation of the transfer of these investments from level 2 into level 3 during the year. (d) Liabilities of £(403) million (2016: £(883) million) for the net asset value attributable to external unit holders in respect of the consolidated investment funds, which are non‑recourse to the Group. These liabilities are valued by reference to the underlying assets. (e) Derivative liabilities of £(512) million (2016: £(516) million) which are valued internally using the discounted cash flow method in line with standard market practices but are subject to independent assessment against external counterparties’ valuations. (f) Other sundry individual financial investments of £81 million (2016: £93 million). Of the internally valued net asset referred to above of £117 million (2016: net asset of £72 million): (a) A net asset of £67 million (2016: £315 million) is 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 £(184) million (2016: £(243) million) is 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 decreased by 10 per cent, the change in valuation would be £18 million (2016: £24 million), which would reduce shareholders’ equity by this amount before tax. All this amount passes through the income statement substantially as part of short‑term fluctuations in investment returns outside of operating profit. Other assets at fair value – investment properties The investment properties of the Group are principally held by the UK and Europe 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 the year, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to level 2 of £1,389 million and transfers from level 2 to level 1 of £411 million. These transfers which relate to equity securities and debt securities arose to reflect the change in the observed valuation inputs and in certain cases, the change in the level of trading activities of the securities. In addition, in 2017, the transfers into level 3 were a net liability of £(80) million and the transfers out of level 3 were £92 million. The transfers into level 3 include a transfer from level 2 of a net liability of £(83) million relating to the equity release mortgage loans of £302 million and a corresponding liability of £(385) million held by the UK insurance operations that are carried at fair value through profit or loss. During 2017, the assumptions used within the discounted cash flow model used to value these loans were refined to reflect developing market practice, including consideration of the Prudential Regulation Authority’s industry‑wide review in this area and resulting guidance. This refinement incorporates inputs relevant to determining the discount rate that are not market observable. As a result, the loans were reclassified as level 3. There was no material difference in the fair value of these loans recognised in 2017, arising from this change in the valuation model. 216 Prudential plc Annual Report 2017 www.prudential.co.uk (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. In addition the Group has minimum standards for independent price verification to ensure valuation accuracy is regularly independently verified. Adherence to this policy is monitored across the business units. C3.2 Debt securities This note provides analysis of the Group’s debt securities, including asset‑backed securities and sovereign debt securities. With the exception of certain debt securities for US insurance operations classified as ‘available‑for‑sale’ under IAS 39 as disclosed in notes C3.2 (b) to (d) below, the Group’s debt securities are carried at fair value through profit or loss. (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 & 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’. AAA AA+ to AA- A+ to A- BBB+ to BBB- Below BBB- Other Total 2017 £m Asia With‑profits Unit‑linked Non‑linked shareholder‑ backed US Non‑linked shareholder‑ backed UK and Europe 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 and Europe With‑profits Unit‑linked Non‑linked shareholder‑ backed Other operations Total debt securities 2,504 528 10,641 103 990 2,925 3,846 510 3,226 3,234 1,429 2,970 368 6,492 670 5,118 742 17,412 6,352 9,378 2,732 11,005 1,264 44,400 9,578 12,311 11,666 1,308 9,625 182 12,856 1,793 3,267 67 1,810 372 1,879 1,000 2,877 91 258 36 2,397 565 24,432 3,507 1,053 13,043 5,769 35,378 7,392 117 6,062 16 50,661 6,711 35,335 2,307 39,941 37,927 8,323 23,371 171,374 AAA AA+ to AA- A+ to A- BBB+ to BBB- Below BBB- Other Total 2016 £m 3,183 448 1,082 445 5,740 461 4,238 830 16,427 8,522 112 2,435 7,932 9,746 2,660 10,371 1,190 42,968 3,560 525 2,864 2,996 1,321 2,388 10,609 13,950 10,679 1,158 10,558 242 40,195 12,798 1,699 4,515 97 39,764 1,887 494 1,680 1,009 3,289 212 397 10 8,978 1,713 421 21,861 3,321 915 11,364 6,800 6,684 87 5,504 2 40,745 48,936 6,277 35,583 2,371 22,126 170,458 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. www.prudential.co.uk Annual Report 2017 Prudential plc 217 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 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 2017 £m 2016 £m 25 959 69 1,053 63 757 95 915 US Implicit ratings of other US debt securities based on NAIC* valuations (see below) NAIC 1 NAIC 2 NAIC 3‑6 Total US £m Mortgage- backed securities Other securities 2017 total 2016 total 1,843 22 3 1,868 2,075 1,772 54 3,901 3,918 1,794 57 5,769 4,759 1,909 132 6,800 * 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 and Europe Internal ratings or unrated AAA to A‑ BBB to B‑ Below B‑ or unrated Total UK and Europe 2017 £m 2016 £m 7,994 3,141 2,436 6,939 3,257 2,079 13,571 12,275 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† 2017 £m 2016 £m 4,835 22,849 4,468 3,226 35,378 5,856 25,992 4,576 4,321 40,745 * 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 2017 £m 2016 £m 35,293 85 35,378 40,645 100 40,745 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 2017 www.prudential.co.uk (c) Movements in unrealised gains and losses on Jackson available-for-sale securities The movement in the statement of financial position value for debt securities classified as available‑for‑sale was from a net unrealised gain of £676 million to a net unrealised gain of £1,205 million as analysed in the table below. Assets fair valued at below book value Book value* Unrealised gain (loss) Fair value (as included in statement of financial position) Assets fair valued at or above book value Book value* Unrealised gain (loss) Fair value (as included in statement of financial position) Total Book value* Net unrealised gain (loss) Fair value (as included in the footnote above in the overview table and the statement of financial position) * Book value represents cost/amortised cost of the debt securities. † Translated at the average rate of US$1.2889: £1.00. Foreign exchange translation Changes in unrealised appreciation† 2017 2016 Reflected as part of movement in other comprehensive income £m £m £m £m 6,325 (106) 6,219 27,763 1,311 29,074 34,088 1,205 35,293 33 536 (121) 81 (88) 617 14,617 (675) 13,942 25,352 1,351 26,703 39,969 676 40,645 (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: 2017 £m 2016 £m 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 Fair value 6,170 36 – – 10 – 3 13 Unrealised loss Fair value Unrealised loss (95) (6) – – (4) – (1) (5) 12,326 1,598 – 8 9 – 1 18 (405) (259) – (3) (8) – (11) (675) Total 6,219 (106) 13,942 (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 2017 £m 2016 £m (7) (41) (39) (19) (106) (7) (118) (510) (40) (675) www.prudential.co.uk Annual Report 2017 Prudential plc 219 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C Balance sheet notes continued C3 Assets and liabilities continued C3.2 Debt securities continued (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 (4) (1) – (1) – (6) Non- investment grade 2017 £m Investment grade (31) (4) (49) (6) (10) Total (35) (5) (49) (7) (10) (100) (106) Non- investment grade 2016 £m Investment grade (3) – (4) (2) (2) (11) (599) (2) (27) (1) (35) (664) Total (602) (2) (31) (3) (37) (675) 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 2017 £m 2016 £m Fair value Unrealised loss Fair value Unrealised loss 2 1 10 13 – (1) (4) (5) 1 – 17 18 – – (11) (11) (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 operations note (i) US operations note (ii) UK and Europe operations (2017: 34% AAA, 16% AA) note (iii) Other operations note (iv) With-profits operations Asia operations note (i) UK and Europe operations (2017: 58% AAA, 10% AA) note (iii) Total 2017 £m 2016 £m 118 3,226 1,070 589 5,003 233 5,658 5,891 130 4,321 1,464 771 6,686 357 5,177 5,534 10,894 12,220 220 Prudential plc Annual Report 2017 www.prudential.co.uk Notes (i) Asia operations The Asia operations’ exposure to asset‑backed securities is primarily held by the with‑profits operations. Of the £233 million, 98 per cent (2016: 99 per cent) are investment grade. (ii) US operations US operations’ exposure to asset‑backed securities at 31 December comprises: RMBS Sub‑prime (2017: 2% AAA, 4% AA, 3% A) Alt‑A (2017: 3% AAA, 3% A) Prime including agency (2017: 70% AA, 4% A) CMBS (2017: 82% AAA, 15% AA, 1% A) CDO funds (2017: 49% AA, 31% A), including £nil exposure to sub‑prime Other ABS (2017: 21% AAA, 14% AA, 50% A), including £96 million exposure to sub‑prime Total (iii) UK and Europe operations 2017 £m 2016 £m 112 126 440 1,579 28 941 3,226 180 177 675 2,234 50 1,005 4,321 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, £1,913 million (2016: £1,623 million) relates to exposure to the US markets with the remaining exposure being primarily to the UK market. (iv) Other operations Other operations’ exposure to asset‑backed securities is held by Prudential Capital with no sub‑prime exposure. Of the £589 million, 96 per cent (2016: 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, including Asia Total 2017 £m 2016 £m Shareholder- backed business With-profits funds Shareholder- backed business With-profits funds 58 34 23 693 82 890 5,918 5,078 4,638 16,524 63 18 38 301 31 451 3,287 10,156 2,143 16,037 56 33 22 573 83 767 5,510 6,861 3,979 61 18 – 329 33 441 2,868 9,008 2,079 17,117 14,396 * Including bonds guaranteed by the federal government. † The exposure to the United States sovereign debt comprises holdings of the US, UK and Europe and Asia insurance operations. www.prudential.co.uk Annual Report 2017 Prudential plc 221 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C Balance sheet notes continued C3 Assets and liabilities continued C3.2 Debt securities continued Exposure to bank debt securities 2017 £m Senior debt Subordinated debt Shareholder-backed business Covered Senior Italy Spain France Germany Netherlands Other Eurozone Total Eurozone United Kingdom United States Other, including Asia Total With-profits funds Italy Spain France Germany Netherlands Other Eurozone Total Eurozone United Kingdom United States Other, including Asia Total – 42 28 30 – 15 115 695 – 17 827 – – 9 120 – – 129 859 – 532 1,520 – 26 41 – 65 – 132 374 2,457 652 3,615 31 16 213 24 188 27 499 592 2,205 1,256 4,552 Total senior debt – 68 69 30 65 15 247 1,069 2,457 669 4,442 31 16 222 144 188 27 628 1,451 2,205 1,788 6,072 Tier 1 Tier 2 Total sub- ordinated debt – – 17 87 6 – 110 313 162 494 1,079 – – 64 36 11 – 111 487 313 743 – – 7 87 6 – 100 308 161 401 970 – – 64 36 6 – 106 484 296 453 1,339 1,654 – – 10 – – – 10 5 1 93 109 – – – – 5 – 5 3 17 290 315 2017 total £m – 68 86 117 71 15 357 1,382 2,619 1,163 5,521 31 16 286 180 199 27 739 1,938 2,518 2,531 7,726 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 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 2017, net impairment credit of £1 million (2016: charge of £(44) 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 credit (charge) for impairment net of reversals * The impairment charges/reversals relate to loans held by the UK with‑profits fund and mortgage loans held by Jackson. 2017 £m 2016 £m 8 (7) 1 (20) (24) (44) 222 Prudential plc Annual Report 2017 www.prudential.co.uk Jackson’s portfolio of debt securities is managed proactively with credit analysts closely monitoring and reporting on the credit quality of its holdings. Jackson continues to review its investments on a case‑by‑case basis to determine whether any decline in fair value represents an impairment. In addition, investments in structured securities are subject to a rigorous review of their future estimated cash flows, including expected and stress case scenarios, to identify potential shortfalls in contractual payments (both interest and principal). Impairment charges are recorded on structured securities when the Company forecasts a contractual payment shortfall. Situations where such a shortfall would not lead to a recognition of a loss are rare. However, some structured securities do not have a single determined set of future cash flows and instead, there can be a reasonable range of estimates that could potentially emerge. With this variability, there could be instances where the projected cash flow shortfall under management’s base case set of assumptions is so minor that relatively small and 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 2017, the Group realised gross losses on sales of available‑for‑sale securities of £155 million (2016: £152 million) with 97 per cent (2016: 59 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 £155 million (2016: £152 million), £3 million (2016: £94 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 2017, the amount of gross unrealised losses for fixed maturity securities classified as available‑for‑sale under IFRS in an unrealised loss position was £106 million (2016: £675 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 which have been designated at fair value through profit or loss of the UK and Europe 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: Mortgage loans* Policy loans† Other loans‡ Asia With‑profits Non‑linked shareholder‑backed – 177 613 216 112 199 Total 725 592 Mortgage loans* Policy loans† Other loans‡ – 179 577 226 113 208 Total 690 613 2017 £m 2016 £m US Non‑linked shareholder‑backed UK and Europe With‑profits Non‑linked shareholder‑backed Other operations Total loans securities 6,236 3,394 – 9,630 6,055 3,680 – 9,735 2,441 1,681 – 4 – – 10,535 4,227 1,823 37 109 2,280 4,268 1,718 109 17,042 668 1,642 – 8,544 6 – – 4,489 1,218 38 563 2,140 1,892 1,680 563 15,173 * All mortgage loans are secured by properties. † In the US £2,512 million (2016: £2,672 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. www.prudential.co.uk Annual Report 2017 Prudential plc 223 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 Assets and liabilities continued C3.3 Loans portfolio continued (b) Additional information on US mortgage loans In the US, mortgage loans are all commercial mortgage loans that are secured by the following property types: industrial, multi‑family residential, suburban office, retail or hotel. The US insurance operations’ commercial mortgage loan portfolio does not include any single‑family residential mortgage loans and is therefore not exposed to the same risk of defaults associated with residential sub‑prime mortgage loans. The average loan size is £12.6 million (2016: £12.4 million). The portfolio has a current estimated average loan to value of 55 per cent (2016: 59 per cent). At 31 December 2017, Jackson had no mortgage loans where the contractual terms of the agreements had been restructured (2016: none). (c) Additional information on UK mortgage loans During 2017, the UK with‑profits fund invested in an entity that holds a portfolio of buy‑to‑let mortgage loans. The vehicle financed its acquisitions through the issue of debt instruments, largely to external parties, securitised upon the loans acquired. These third‑party borrowings have no recourse to any other assets of the Group and the Group’s exposure is limited to the amount invested by the UK with‑ profits fund. By carrying value, 99.98 per cent of the £1,681 million (2016: 96.29 per cent of £1,642 million) mortgage loans held by the UK shareholder‑backed business relates to lifetime (equity release) mortgage business which has an average loan to property value of 31 per cent (2016: 30 per cent). (d) Loans held by other 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 2017 £m 2016 £m 14 – – 95 – 109 29 100 248 185 1 563 224 Prudential plc Annual Report 2017 www.prudential.co.uk 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 2017 £m After 10 years to 15 years After 15 years to 20 years Over 20 years No stated maturity Total 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 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 6,280 473 784 1,350 1,389 576 3,324 3,160 11,056 1,791 1,130 3,716 905 597 922 5,662 5,662 – 14,185 10,088 469 69 32 – 68 – 29 – 85 – 29 – – 1,796 1,810 104 3,831 – – – 5,662 106 320 3,267 14,403 8,889 8,889 – – – 40,523 27,147 2,772 1,519 1,503 – 711 – – 8,889 5,454 6,531 45,637 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 5,031 5,031 13,825 9,873 607 748 – 320 8,687 8,687 – 69 32 – 61 – – 20 – 80 – – 10 – 103 – 60 – 2,333 144 1,489 – – 5,031 322 3,272 14,031 – – – 8,687 38,007 26,197 2,453 1,367 1,302 1,124 3,821 7,078 43,342 www.prudential.co.uk Annual Report 2017 Prudential plc 225 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 Assets and liabilities continued C3.4 Financial instruments – additional information continued Maturity analysis of derivatives The following table shows the gross and net derivative positions together with a maturity profile of the net derivative position: 2017 2016 Carrying value of net derivatives £m Maturity profile of net derivative position £m Derivative assets Derivative liabilities Net derivative position 4,801 3,936 (2,755) 2,046 (3,252) 684 1 year or less 2,359 1,009 After 1 year to 3 years After 3 years to 5 years (16) (14) (9) (7) After 5 years (1) 18 Total 2,333 1,006 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. 2017 2016 £bn 1 year or less 8 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 29 24 27 23 19 16 13 11 14 9 Total undis- counted value 110 89 Total carrying value 83 73 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 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 £12 billion (2016: £11 billion) which have no stated maturity but which are repayable on demand. 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. The Group’s exposure to credit risk is further discussed in note C7 below. Of the total loans and receivables held, £23 million (2016: £27 million) are past their due date but are not impaired. Of the total past due but not impaired, £17 million are less than one year past their due date (2016: £20 million). The Group expects full recovery of these loans and receivables. Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £22 million (2016: £27 million). In addition, during 2017 and 2016 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. 226 Prudential plc Annual Report 2017 www.prudential.co.uk (iii) Foreign exchange risk As at 31 December 2017, the Group held 24 per cent (2016: 23 per cent) and 16 per cent (2016: 12 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 (2016: 52 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 (2016: 28 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 C3.4(b) below). The amount of exchange loss recognised in the income statement in 2017, except for those arising on financial instruments measured at fair value through profit or loss, is £112 million (2016: £1,005 million gain). This constitutes £1 million gain (2016: £0.4 million gain) on Medium Term Notes liabilities and £113 million of net loss (2016: £1,005 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. Under Article 11 of the European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories (‘EMIR’) and Commission Delegated Regulation (EU) 2016/2251 supplementing EMIR, market participants transacting in non‑cleared OTC derivatives are required to exchange collateral to cover variation and initial margin. However, trades between counterparties belonging to the same group are exempt from these margin requirements subject to certain criteria. Prudential Capital plc (Legal Entity Identifier reference (‘LEI’) CHW8NHK268SFPTV63Z64) has entered into such derivative agreements with the following five entities in the Group. These counterparty pairings meet the criteria to be eligible for intra‑group exemptions to the margin requirements and have been approved by the Financial Conduct Authority: Counterparty Legal Entity Identifier (LEI) Relationship between parties Type of exemption Aggregate notional of OTC derivatives contract £m 31 Dec 2017 Prudential plc Prudential Holdings Limited Prudential (US HoldCo 1) Limited 5493001Z3ZE83NG K8Y12 549300JVAI8CZD4 HD451 549300JNYGDP2X OLWR47 Prudential Corporation Holdings Limited 549300KDOPLFHA Prudential Lifetime Mortgages Limited W51H26 5493001GSK4HF84 IOB02 Part of the same group holding company Part of the same group holding company Part of the same group holding company Part of the same group holding company Part of the same group holding company Full Full Full Full Full 3,615 110 3,123 822 71 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 and Europe 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. www.prudential.co.uk Annual Report 2017 Prudential plc 227 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC Balance sheet notes continued C3 Assets and liabilities continued C3.4 Financial instruments – additional information continued Hedging The Group has formally assessed and documented the effectiveness of the following net investment hedges under IAS 39. At 31 December 2017, the Group has designated perpetual subordinated capital securities totalling US$4.3 billion (2016: US$4.5 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 £3,140 million as at 31 December 2017 (2016: £3,644 million). The foreign exchange gain of £325 million (2016: loss of £389 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 2017, the Group has £8,232 million (2016: £8,545 million) of lent securities and assets subject to repurchase agreements, of which £8,182 million (2016: £8,113 million) related to the PAC with‑profits fund. The cash and securities collateral held or pledged under such agreements were £8,733 million (2016: £9,086 million) of which £8,679 million (2016: £8,653 million) was held by the PAC with‑profits fund. At 31 December 2017, 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 £10,550 million (2016: £9,319 million). Collateral and pledges under derivative transactions At 31 December 2017, the Group had pledged £2,302 million (2016: £1,853 million) for liabilities and held collateral of £3,958 million (2016: £2,788 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. Other collateral At 31 December 2017, the Group had pledged collateral of £3,412 million (2016: £3,384 million) in respect of other transactions. This principally arises from Jackson’s membership of the Federal Home Loan Bank of Indianapolis primarily for the purpose of participating in the bank’s collateralised loan advance programme with short‑term and long‑term funding facilities. 228 Prudential plc Annual Report 2017 www.prudential.co.uk 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: Financial assets: Derivative assets Reverse repurchase agreements Total financial assets Financial liabilities: Derivative liabilities Securities lending and repurchase agreements Total financial liabilities Financial assets: Derivative assets Reverse repurchase agreements Total financial assets Financial liabilities: Derivative liabilities Securities lending and repurchase agreements Total financial liabilities Gross amount included in the consolidated statement of financial position note (i) 4,718 10,280 14,998 (2,301) (1,410) (3,711) Gross amount included in the consolidated statement of financial position note (i) 31 Dec 2017 £m Related amounts not offset in the consolidated statement of financial position Financial instruments note (ii) Cash collateral Securities collateral note (iii) Net amount (946) – (946) 946 – 946 (2,641) – (2,641) (984) (10,270) (11,254) 420 52 472 893 1,332 2,225 31 Dec 2016 £m 147 10 157 (42) (26) (68) Related amounts not offset in the consolidated statement of financial position Financial instruments note (ii) Cash collateral Securities collateral note (iii) Net amount 3,869 9,132 13,001 (2,874) (1,927) (4,801) (1,053) – (1,053) 1,053 – 1,053 (1,895) – (1,895) 698 97 795 (733) (9,132) (9,865) 1,028 1,830 2,858 188 – 188 (95) – (95) Notes (i) (ii) (iii) The Group has not offset any of the amounts included in the consolidated statement of financial position. Represents the amount that could be offset under master netting or similar arrangements where the 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 included in the consolidated statement of financial position would be 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. www.prudential.co.uk Annual Report 2017 Prudential plc 229 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 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 (a) Group overview (i) Analysis of movements in policyholder liabilities and unallocated surplus of with-profits funds At 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 As at 31 December 2016/1 January 2017 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 At 31 December 2017 Comprising: Insurance operations £m Asia note C4.1(b) US note C4.1(c) UK and Europe note C4.1(d) Total 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 11,863 (3,079) (1,909) 6,875 (54) 8,182 (3,948) – – 15,219 (10,017) (2,065) 3,137 – 16,251 (16,290) 11,650 – 14,810 (6,939) (7,135) 736 (233) 11,146 113 14,317 6,401 41,892 (20,035) (11,109) 10,748 (287) 35,579 (20,125) 73,839 180,724 181,066 435,629 – Policyholder liabilities on the consolidated statement of financial position§ (excludes £32 million classified as unallocated to a segment) 62,898 180,724 167,589 411,211 – 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† 2017 2016 3,474 7,467 – – 13,477 – 16,951 7,467 65,241 179,175 162,622 407,038 51,765 158,270 150,003 360,038 * 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 £62,898 million (2016: £53,716 million), shown in the table above, is after deducting the intra‑group reinsurance liabilities ceded by the UK and Europe insurance operations of £1,235 million (2016: £1,302 million) to the Hong Kong with‑profits business. Including this amount, total Asia policyholder liabilities are £64,133 million (2016: £55,018 million). 230 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes 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 but exclude liabilities that have not been allocated to a reporting segment. 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 (surrenders, maturities and deaths) 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 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 2016/1 January 2017 Comprising: – Policyholder liabilities on the consolidated statement of financial position – Group's share of policyholder liabilities relating to joint ventures and associate Net flows: Premiums Surrenders Maturities/deaths Net flows note (a) Investment‑related items and other movements Foreign exchange translation differences At 31 December 2017 Comprising: Shareholder-backed business £m Asia US 27,844 (2,812) 138,913 – 4,749 (1,931) (732) 2,086 1,116 4,617 14,766 (7,872) (1,696) 5,198 5,690 27,825 UK and Europe 52,824 – 1,842 (2,967) (2,521) (3,646) 6,980 – Total 219,581 (2,812) 21,357 (12,770) (4,949) 3,638 13,786 32,442 32,851 177,626 56,158 266,635 26,450 177,626 56,158 260,234 6,401 6,064 (2,755) (1,008) 2,301 3,797 (1,547) – – 6,401 15,219 (10,017) (2,065) 3,137 16,251 (16,290) 2,283 (2,433) (2,571) (2,721) 2,930 – 23,566 (15,205) (5,644) 2,717 22,978 (17,837) 37,402 180,724 56,367 274,493 – Policyholder liabilities on the consolidated statement of financial position (excludes £32 million classified as unallocated to a segment) – Group's share of policyholder liabilities relating to joint ventures 29,935 180,724 56,367 267,026 and associate 7,467 – – 7,467 * 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. www.prudential.co.uk Annual Report 2017 Prudential plc 231 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued (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 2016 Income and expense included in the income statement and other comprehensive income Foreign exchange translation differences At 31 December 2016/1 January 2017 Income and expense included in the income statement and other comprehensive income Foreign exchange translation differences At 31 December 2017 (iv) Reinsurers’ share of insurance contract liabilities Insurance contract liabilities Gross £m 260,753 20,210 35,472 316,435 31,142 (19,405) 328,172 Reinsurers’ share £m 6,992 752 1,221 8,965 422 (667) 8,720 Unallocated surplus of with-profits funds £m 13,096 768 453 14,317 2,949 (315) 16,951 Insurance contract liabilities Claims outstanding Asia 1,912 48 1,960 US 5,672 752 6,424 UK and Europe Unallocated to a segment 2017 £m 2016 £m 1,136 150 1,286 – 3 3 8,720 953 9,673 8,965 1,086 10,051 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 £9,673 million at 31 December 2017 (2016: £10,051 million), 80 per cent (2016: 85 per cent) were ceded by the Group’s UK and Europe and US operations, of which 96 per cent (2016: 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 £28 million and £526 million respectively during 2017 (2016: £38 million and £500 million respectively). There were no deferred gains or losses on reinsurance contracts in either 2017 or 2016. In each of 2017 and 2016, the Group’s UK and Europe 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 B3(c). The gains and losses recognised in profit and loss for the other reinsurance contracts written in the year were immaterial. 232 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(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 2016 Comprising: With-profits business £m Unit-linked liabilities £m 20,934 15,966 Other business £m 11,878 Total £m 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 Foreign exchange translation differences note (a) At 31 December 2016/1 January 2017 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‡ 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 2017 note (b) Comprising: – 3,218 3,183 6,401 1,143 4,656 5,799 (324) (901) 4,574 (54) 4,385 (2,401) 1,298 1,637 2,935 (2,288) (150) 497 – 2,830 (807) 999 2,130 3,129 (467) (858) 1,804 – 967 (740) 3,440 8,423 11,863 (3,079) (1,909) 6,875 (54) 8,182 (3,948) 36,437 20,027 17,375 73,839 – Policyholder liabilities on the consolidated statement of financial position§ – Unallocated surplus of with-profits funds on the consolidated statement 32,963 16,263 13,672 62,898 of financial position 3,474 – – 3,474 – Group’s share of policyholder liabilities relating to joint ventures and associate‡ Average policyholder liability balances† 2017 2016 – 3,764 3,703 7,467 30,115 22,823 18,767 15,643 16,359 13,299 65,241 51,765 www.prudential.co.uk Annual Report 2017 Prudential plc 233 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued * 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 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 £32,963 million, shown in the table above, is after deducting the intra‑group reinsurance liabilities ceded by UK and Europe insurance operations of £1,235 million to the Hong Kong with‑profits business (2016: £1,302 million). Including this amount the Asia with‑profits policyholder liabilities are £34,198 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 £1,093 million to £6,875 million in 2017 predominantly reflecting continued growth of the in‑force book and increased flows from new business. (c) Investment‑related items and other movements for 2017 principally represent equity market gains and falls in bond yields during the year, in a number of business units with the greatest impact being 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 2017 and 2016, 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 2017 £m 62,898 2016 £m 53,716 % 21 19 16 12 10 22 % 23 20 16 11 9 21 (iii) Summary policyholder liabilities (net of reinsurance) and unallocated surplus At 31 December 2017, the policyholder liabilities and unallocated surplus for Asia operations excluding joint ventures and after deducting intra‑group reinsurance liabilities ceded by UK and Europe of £66,372 million (2016: £56,383 million), net of external reinsurance of £1,961 million (2016: £1,539 million), comprised the following: Hong Kong Indonesia Malaysia Singapore Taiwan Other operations Total Asia operations 2017 £m 29,411 3,762 5,014 17,432 3,729 5,062 64,410 2016 £m 23,852 3,405 4,332 15,324 3,504 4,427 54,844 234 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(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 2016 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 2016/1 January 2017 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 2017 Average policyholder liability balances* 2017 2016 * Averages have been based on opening and closing balances. Variable annuity separate account liabilities £m 91,022 10,232 (5,036) (803) 4,393 1,164 5,246 18,586 Fixed annuity, GIC and other business £m Total £m 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 27,825 120,411 57,215 177,626 11,529 (6,997) (1,026) 3,506 2,096 15,956 (11,441) 3,690 (3,020) (1,039) (369) (2,096) 295 (4,849) 15,219 (10,017) (2,065) 3,137 – 16,251 (16,290) 130,528 50,196 180,724 125,469 105,717 53,706 52,553 179,175 158,270 Notes (a) Movements in the year have been translated at an average rate of US$1.29/£1.00 (2016: US$1.35/£1.00). The closing balances have been translated at closing rate of US$1.35/£1.00 (2016: US$1.24/£1.00). Differences upon retranslation are included in foreign exchange translation differences. (b) Net flows were £3,137 million in 2017, reflecting continued strong inflows into the variable annuity business. (c) Positive investment‑related items and other movements in variable annuity separate account liabilities of £15,956 million for 2017 primarily reflects the increases in equities and bond values during the year. Fixed annuity, GIC and other business investment and other movements of £295 million primarily reflect the increase in guarantee reserve in the year. www.prudential.co.uk Annual Report 2017 Prudential plc 235 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued (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 2017 and 2016: 2017 £m 2016 £m Fixed annuity and other business (including GICs and similar contracts) Variable annuity separate account liabilities Fixed annuity and other business (including GICs and similar contracts) Total Variable annuity separate account liabilities Total Policyholder liabilities 50,196 130,528 180,724 57,215 120,411 177,626 2017 % 2016 % 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 50 25 12 7 3 3 42 29 15 8 4 2 44 28 14 8 4 2 49 26 11 7 3 4 43 29 14 8 4 2 45 28 14 7 3 3 (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 in note C4.2(b) as at 31 December 2017 and 2016: 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 2017 6,887 7,385 9,799 1,272 1,744 220 27,307 2016 7,765 8,718 11,249 1,456 1,954 247 31,389 2017 – – 221 2,341 2,059 1,651 6,272 2016 – – 243 2,675 2,333 1,839 7,090 236 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(d) UK and Europe 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 and Europe insurance operations from the beginning of the year to the end of the year is as follows: At 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 Foreign exchange translation differences At 31 December 2016/1 January 2017 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 2017 Comprising: – Policyholder liabilities – Unallocated surplus of with-profits funds Average policyholder liability balances* 2017 2016 Shareholder-backed funds and subsidiaries With-profits sub-funds† £m Unit-linked liabilities £m Annuity and other long-term business £m Total £m 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 12,527 (4,506) (4,564) 3,457 (233) (192) 8,408 113 22,119 – 1,923 (2,342) (612) (1,031) – 192 1,865 – 34,039 – 360 (91) (1,959) (1,690) – – 873 – 157,654 11,650 14,810 (6,939) (7,135) 736 (233) – 11,146 113 124,699 23,145 33,222 181,066 111,222 13,477 106,359 95,511 23,145 – 22,632 21,781 33,222 – 167,589 13,477 33,631 162,622 32,711 150,003 * Averages have been based on opening and closing balances and exclude unallocated surplus of with‑profits funds. † Includes the Scottish Amicable Insurance Fund. Notes (a) (b) Net flows improved from negative £(2,527) million in 2016 to positive £736 million in 2017, 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 withdrawal from this market in the UK. The level of inflows/outflows for unit‑linked business remains subject to annual variation as it is driven by corporate pension schemes with transfers in or out from a small number of schemes influencing the level of flows in the period. Investment‑related items and other movements of £11,146 million principally comprise investment return attributable to policyholders earned in the period reflecting favourable equity market movements. www.prudential.co.uk Annual Report 2017 Prudential plc 237 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.1 Movement and duration of liabilities continued (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 UK and Europe 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 2017 and 2016: With-profits business Insurance contracts Invest- ment contracts Total 2017 £m Annuity business (insurance contracts) Non- profit annuities within WPSF Share- holder- backed annuity Other Total Total Insurance contracts Invest- ment contracts Total Policyholder liabilities 38,285 62,328 100,613 10,609 32,572 43,181 6,714 17,081 23,795 167,589 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 33 23 16 11 7 10 37 27 17 10 4 5 36 25 17 10 5 7 31 24 17 11 7 10 2017 % 26 23 18 13 9 11 2016 £m 27 23 18 13 9 10 41 26 15 9 5 4 31 22 18 13 8 8 34 23 17 12 7 7 34 25 17 11 6 7 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 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 — 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. 238 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(iii) Annuitant mortality Mortality assumptions for UK annuity business are set in light of recent population and internal experience. The assumptions used are based on standard population mortality tables (PCMA08/PCFA08 for males/females in 2017 and PCMA00/PCFA00 in 2016), with an allowance for expected future mortality improvements. The standard population tables are adjusted to reflect the features of the Company’s portfolio. For 2017 these portfolio‑specific adjustments have been revised so that adjustments are now applied on a per policy basis, rather than across larger groupings, and therefore disclosure of broad percentage adjustments to the standard tables would no longer appropriately reflect the methodology applied. Where annuities have been sold on an enhanced basis to impaired lives, an adjustment is made for the additional expected mortality. New mortality projection models are released regularly by the Continuous Mortality Investigation (CMI). The CMI 2015 model was used to produce the 2017 results and the CMI 2014 model was used to produce the 2016 results, calibrated to reflect the Company’s view of future mortality improvements. The tables and range of percentages used are summarised in the table below: CMI Model, with calibration to reflect future mortality improvements 2017 CMI 2015 For males: with a long-term improvement rate of 2.25% pa For females: with a long-term improvement rate of 2.00% pa 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* * In 2016, for both males and females, the initial rates of mortality improvement in the CMI model 2014 were uplifted by 0.25 per cent per annum. For annuities in deferment, the tables used were AM92 – four years (males) and AF92 – four years (females) for 2017 and 2016. C4.2 Products and determining contract liabilities (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. www.prudential.co.uk Annual Report 2017 Prudential plc 239 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (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 with a suitable margin for prudence. This is achieved either through adding an explicit allowance for assumptions to deviate from best estimate or by applying an overlay constraint so that no negative reserves (ie where future premium inflows are expected to exceed prudent future claims and outflows) are derived at an individual policyholder level or a combination of both. 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 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. Additional technical provisions are held for guaranteed benefits beyond the unit fund value using a gross premium valuation method. These additional provisions are recognised as a component of other business liabilities. 240 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(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 with a suitable margin for prudence. This is achieved either through adding an explicit allowance for assumptions to deviate from best estimate or by applying an overlay constraint so that no negative reserves (ie where future premium inflows are expected to exceed prudent future claims and outflows) are derived at an individual policyholder level or a combination of both. (b) US Contract type Description Material features Determination of liabilities 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 2017, fixed interest rate annuities accounted for 7 per cent (2016: 8 per cent) of policy and contract liabilities of Jackson. Guaranteed minimum interest rate. At 31 December 2017, Jackson had fixed interest rate annuities totalling £12.6 billion (2016: £14.2 billion) in account value with minimum guaranteed rates ranging from 1.0 per cent to 5.5 per cent and a 2.93 per cent average guaranteed rate (2016: 1.0 per cent to 5.5 per cent and a 2.96 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. www.prudential.co.uk Annual Report 2017 Prudential plc 241 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (b) US continued Contract type Description Material features Determination of liabilities Fixed interest rate annuities continued 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. Approximately 60 per cent (2016: 62 per cent) of the fixed interest rate annuities Jackson wrote in 2017 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. 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). 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. 242 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(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 US GAAP and therefore this element of the liability is recognised at fair value. Fixed index annuities 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 5 per cent (2016: 6 per cent) of Jackson’s policy and contract liabilities at 31 December 2017. 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. Guaranteed minimum rates are generally set at 1.0 to 3.0 per cent. At 31 December 2017, Jackson had fixed index annuities allocated to indexed funds totalling £6.3 billion (2016: £7.3 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 (2016: 1.0 per cent to 3.0 per cent and a 1.77 per cent average guarantee rate). Jackson offers an optional lifetime income rider, which can be elected for an additional fee. Jackson also offers fixed interest accounts on some fixed index annuity products. At 31 December 2017, fixed interest accounts of fixed index annuities totalled £2.5 billion (2016: £2.6 billion) in account value. Minimum guaranteed rates on fixed interest accounts range from 1.0 per cent to 3.0 per cent and a 2.58 per cent average guaranteed rate (2016: 1.0 per cent to 3.0 per cent and a 2.55 per cent average guaranteed rate). www.prudential.co.uk Annual Report 2017 Prudential plc 243 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (b) US continued Contract type Description Material features Determination of liabilities 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. 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. Variable annuities Variable annuities are deferred annuities that have the same tax advantages and payout options as fixed interest rate and fixed index annuities. They are also used for asset accumulation in retirement planning and to provide income in retirement. At 31 December 2017, variable annuities accounted for 77 per cent (2016: 74 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. Subject to benefit guarantees, 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 2017, 5 per cent (2016: 6 per cent) of variable annuity funds were in fixed accounts. Jackson had variable annuity funds in fixed accounts totalling £5.9 billion (2016: £7.3 billion) with minimum guaranteed rates ranging from 1.0 per cent to 3.0 per cent and a 1.68 per cent average guaranteed rate (2016: 1.0 per cent to 3.0 per cent and a 1.64 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. Jackson hedges these risks using derivative instruments as described in note C7.3. 244 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(b) US continued Contract type Description Material features Determination of liabilities Variable annuities continued The benefit guarantee types are set out below: Benefits that are payable in the event of death (guaranteed minimum death benefit). Benefits that are payable upon the depletion of funds (guaranteed minimum withdrawal benefit). The liability for Guaranteed Minimum Death Benefit (GMDB) is 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 2017, these liabilities were valued using a series of stochastic investment performance scenarios, a mean investment return of 7.4 per cent (2016: 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. The liability for the Guaranteed Minimum Withdrawal Benefit (GMWB) ‘for life’ portion is determined similarly to GMDB above. Guaranteed Minimum Withdrawal Benefit ‘not for life’ features are treated as embedded derivatives under US GAAP. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 245 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (b) US continued Contract type Description Material features Determination of liabilities Variable annuities continued Life insurance Benefits that are payable at annuitisation (guaranteed minimum income benefit). This feature is no longer offered and existing coverage is substantially reinsured, subject to deductibles and annual claim limits. Benefits that are payable at the end of a specified period (guaranteed minimum accumulation benefit). This feature is no longer offered. Excluding the business that is subject to the retrocession treaties at 31 December 2017, Jackson had interest‑sensitive life business in force with total account value of £6.3 billion (2016: £7.1 billion), with minimum guaranteed interest rates ranging from 2.5 per cent to 6.0 per cent with a 4.67 per cent average guaranteed rate (2016: 2.5 per cent to 6.0 per cent with a 4.66 per cent average guaranteed rate). The direct Guaranteed Minimum Income Benefit (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 life of the contract based on total expected assessments. Guaranteed Minimum Income Benefits are 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. Guaranteed Minimum Accumulation Benefit (GMAB) are treated as embedded derivatives under US GAAP. Therefore, provisions for these benefits are recognised at fair value. Volatility and non‑performance risk is considered as per GMWB above. For term and traditional life insurance contracts, provisions for future policy benefits are determined under US GAAP using the net level premium method and assumptions as of the issue date as to mortality, interest, policy lapses and expenses plus provisions for adverse deviation for directly sold business and assumptions at purchase for acquired business. 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. Life products include term life, traditional life and interest‑sensitive life (universal life and variable universal life). Life insurance products accounted for 9 per cent (2016: 10 per cent) of Jackson’s policy and contract liabilities at 31 December 2017. 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. Traditional life provides protection for either a defined period or until a stated age and includes a predetermined cash value. 246 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(b) US continued Contract type Description Material features Determination of liabilities Life insurance continued Institutional products 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 2017 institutional products accounted for 1 per cent of contract liabilities (2016: 1 per cent). 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 2017 and 2016 there were no funding agreements terminable by the policyholder with less than 90 days notice. www.prudential.co.uk Annual Report 2017 Prudential plc 247 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (c) UK and Europe Contract type Description Material features Determination of liabilities With-profits contracts in WPSF 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. Regular bonuses are typically declared once a year, and once credited, are guaranteed in accordance with the terms of the particular product. Final bonuses rates are guaranteed only until the next bonus declaration. 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. Persistency assumptions are set based on the results of the most recent experience analysis looking at the experience over recent years of the relevant business. 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. Expense inflation assumptions are set consistent with the economic basis and based on the inflation swap spot curve. The contract liabilities for with‑profits business also require assumptions for mortality. These are set based on the results of recent experience analysis. 248 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(c) UK and Europe continued Contract type Description Material features Determination of liabilities PruFund contracts A range of with‑profits contracts offering policyholders a choice of investment profiles. Unlike traditional with‑profits contracts no regular or final bonuses are declared. Policyholder return is determined by an Expected Growth Rate (EGR) which is declared quarterly. A different EGR is applied for each of the different PruFund funds within the range, each relating to the individual asset mix of that fund. The relevant EGR is applied to increase the unit value of policyholder funds, calculated daily. In normal investment conditions the EGR is expected to reflect PAC’s view of how the funds will perform over the longer term. An adjustment is made to the smoothed unit value if it moves outside of a specified range relative to the value of the underlying assets. 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. SAIF with-profits As with‑profits contracts, the liability for PruFund contracts are calculated in accordance with the methodology applied to other WPSF contracts, as described above. The process of determining policyholder liabilities of SAIF is similar to that for the with‑profits policies of the WPSF. 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 £503 million was held in SAIF at 31 December 2017 (2016: £571 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. www.prudential.co.uk Annual Report 2017 Prudential plc 249 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 Policyholder liabilities and unallocated surplus continued C4.2 Products and determining contract liabilities continued (c) UK and Europe 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 policyholder’s 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 with‑profits fund, 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 with‑profits fund 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 and expenses 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 adjusted percentages of standard actuarial mortality tables with an allowance for future mortality improvements, the effect of anti‑ selection and characteristics specific to each individual policyholder. Where annuities have been sold on an enhanced basis to impaired lives an additional age adjustment is made. New mortality projection models are released annually by the Continuous Mortality Investigation (CMI). The CMI 2015 model was used to produce the 2017 results calibrated to reflect an appropriate view of future mortality improvements. For annuities in payment, the mortality tables 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. 250 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(c) UK and Europe continued Contract type Description Material features Determination of liabilities Annuities – level, fixed increase and inflation- linked annuities continued Unit-linked UK and Europe insurance operations also have a 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. 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 B3(c). For unit‑linked contracts the attaching liability reflects the unit value obligation and, in the case of policies classified as insurance contracts, 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. www.prudential.co.uk Annual Report 2017 Prudential plc 251 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC4 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. Determination of bonus rates 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 2017 £m 2016 £m 9,985 (8,449) (10,011) 2,071 (16,389) 12,508 35 (1,732) 106 (440) 4,073 (1,769) 2,304 13,185 (7,410) (11,824) 1,934 (17,300) 9,261 177 (1,288) 22 (739) 3,318 (1,169) 2,149 2,071 233 2,304 1,934 215 2,149 252 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedC5 Intangible assets C5(a) Goodwill Cost At beginning of year Disposals/reclassifications to held for sale Additional consideration paid on previously acquired business Exchange differences Net book amount at end of year Goodwill comprises: M&G Other – attributable to shareholders Goodwill – attributable to shareholders Venture fund investments – attributable to with‑profits funds Attributable to: Shareholders With-profits 2017 £m 2016 £m 1,475 (16) – (1) 1,458 153 (139) 9 1 24 1,628 (155) 9 – 1,482 1,648 (56) 7 29 1,628 2017 £m 2016 £m 1,153 305 1,458 24 1,482 1,153 322 1,475 153 1,628 Other goodwill attributable to shareholders represents amounts allocated to entities in Asia and, until August 2017, 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 business (which is now part of the UK and Europe operating segment) has been determined by calculating the value in use of M&G Group Limited and its subsidiaries (considered to be a cash‑generating unit during 2017). This has been calculated by aggregating the present value of future cash flows expected to be derived from the M&G business. 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 iii The set of economic, market and business assumptions used to derive the three‑year plan. The direct and secondary effects of recent developments, such as changes in global equity markets and trends in fund flows, are considered by management in arriving at the expectations for the final projections for the plan; The assumed growth rate on forecast cash flows beyond the terminal year of the plan after considering expected future and past growth rates. A growth rate of 1.7 per cent (2016: 2.0 per cent) has been used to extrapolate beyond the plan period; The risk discount rate. Differing discount rates have been applied in accordance with the nature of the individual component businesses. For the most material component retail and institutional business, a risk discount rate of 12 per cent (2016: 12 per cent) has been applied to post‑tax cash flows. The pre‑tax risk discount rate was 15 per cent (2016: 16 per cent); 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. www.prudential.co.uk Annual Report 2017 Prudential plc 253 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C5 Intangible assets continued C5(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 2017 £m 10,866 145 11,011 2016 £m 10,755 52 10,807 2017 £m 2016 £m 9,170 63 9,233 36 1,597 1,633 9,114 64 9,178 43 1,534 1,577 Total of deferred acquisition costs and other intangible assets 10,866 10,755 2017 £m 2016 £m Deferred acquisition costs Asia insurance US insurance UK and Europe insurance All asset management PVIF and other intangibles* Total 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 788 331 8,303 663 (133) – (133) – (40) (403) 462 59 – (752) 79 14 (10) – (10) – 1 – (76) 946 8,197 – 84 8 3 (5) – (5) – – – 6 1,577 229 10,755 1,240 (158) (7) (165) – (8) (709) 455 (254) – (799) Total 8,422 1,179 (686) 557 (129) (268) 1,475 – (76) 76 1,633 10,866 10,755 * PVIF and other intangibles includes amounts in relation to software rights with additions of £38 million, amortisation of £32 million, foreign exchange losses of £5 million and a balance at 31 December 2017 of £67 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 (2016: 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 (see note C7.3 (iv)). Note 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. 254 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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 2017 £m 2016 £m 8,208 278 (289) 8,197 7,844 696 (237) 8,303 * Consequent upon the positive unrealised valuation movement in 2017 of £617 million (2016: negative unrealised valuation movement of £28 million), there is a loss of £76 million (2016: a gain of £76 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 2017, the cumulative shadow DAC balance as shown in the table above was negative £289 million (2016: negative £237 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 2017, the DAC amortisation charge for operating profit was determined after including a credit for decelerated amortisation of £86 million (2016: credit for decelerated amortisation of £93 million). The 2017 amount primarily reflects the impact of the positive separate account performance, which is higher than the assumed level for the year. 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 2018, it would take approximate movements in separate account values of more than either negative 32 per cent or positive 37 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 Computer software and other intangibles attributable to with‑profits funds 2017 £m 2016 £m – 145 145 2 50 52 www.prudential.co.uk Annual Report 2017 Prudential plc 255 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC5 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 2017 £m 2016 £m Insurance contracts Investment management note Insurance contracts Investment management note 9,114 1,000 (77) (791) – (76) 9,170 64 11 (12) – – – 63 6,948 954 (21) 1,408 (251) 76 9,114 74 3 (13) – – – 64 Note 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 2017 £m 2016 £m 156 (93) 63 145 (81) 64 (ii) Present value of acquired in-force (PVIF) and other intangibles attributable to shareholders 2017 £m Other intangibles 2016 £m Other intangibles PVIF note (i) Distribution rights note (ii) Other intangibles (including software) note (iii) Total PVIF note (i) Distribution rights note (ii) Other intangibles (including software) note (iii) At 1 January Cost Accumulated amortisation Additions Amortisation charge Disposals and transfers Exchange differences and other movements At 31 December Comprising: Cost Accumulated amortisation 226 (183) 43 – (7) – – 36 1,628 (196) 1,432 173 (121) – (3) 321 (219) 2,175 (598) 102 1,577 56 (37) – (5) 229 (165) – (8) 1,481 116 1,633 227 (191) 36 1,793 (312) 1,481 363 (247) 2,383 (750) 116 1,633 209 (164) 45 – (8) – 6 43 226 (183) 43 Total 1,874 (474) 1,400 222 (95) (17) 67 1,387 (129) 1,258 172 (52) (3) 57 278 (181) 97 50 (35) (14) 4 1,432 102 1,577 1,628 (196) 1,432 321 (219) 2,175 (598) 102 1,577 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) 256 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued C6 Borrowings C6.1 Core structural borrowings of shareholder-financed operations Holding company operations: note (i) US$1,000m 6.5% Notes (Tier 2) note (v) 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) US$550m 7.75% Notes (Tier 1) note (vi) US$1,000m 5.25% Notes (Tier 2) US$725m 4.375% Notes (Tier 2) US$750m 4.875% Notes (Tier 2) note (iv) 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) 2017 £m 2016 £m – 185 222 517 407 731 530 548 809 202 243 565 445 800 580 – 3,140 3,644 18 430 397 591 696 2,132 5,272 300 249 5,821 275 184 6,280 17 430 395 590 696 2,128 5,772 300 249 6,321 275 202 6,798 Notes (i) These debt tier classifications are consistent with the treatment of capital for regulatory purposes under the Solvency II regime. The Group has designated all US$4,275 million (2016: US$4,525 million) of its US dollar denominated subordinated debt as a net investment hedge under IAS 39 to hedge the (ii) (iii) (iv) 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 0.33 per cent. The loan was renewed in December 2017 maturing on 20 December 2022 with an option to repay annually. In October 2017, the Company issued core structural borrowings of US$750 million 4.875 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were £565 million. In December 2017, the Company repaid its US$1,000 million 6.5 per cent Tier 2 perpetual subordinated notes. (v) (vi) 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 GBP 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. All ratings stated as at 13 March 2018. www.prudential.co.uk Annual Report 2017 Prudential plc 257 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C6 Borrowings continued C6.2 Other borrowings (a) Operational borrowings attributable to shareholder-financed operations Commercial Paper Medium Term Notes 2018 Borrowings in respect of short‑term fixed income securities programmes Bank loans and overdrafts Obligations under finance leases Other borrowings Other borrowingsnote Total 2017 £m 2016 £m 485 600 1,085 70 5 631 706 1,052 599 1,651 19 5 642 666 1,791 2,317 Note 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. (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 2017 £m 2016 £m 3,570 100 46 3,716 1,189 100 60 1,349 * 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 increase since 31 December 2016 primarily relates to the debt instruments issued by new consolidated securitisation entities backed by a portfolio of mortgage loans (see note C3.3(c) for further details). † 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: Less than 1 year 1 to 2 years 2 to 3 years 3 to 4 years 4 to 5 years Over 5 years Total Shareholder-financed operations With-profits operations Core structural borrowings Operational borrowings Borrowings 2017 £m 2016 £m 2017 £m 2016 £m 2017 £m 2016 £m 275 – – – – 6,005 6,280 275 – – – – 6,523 6,798 1,723 1 1 – – 66 1,791 1,636 599 – 1 1 80 2,317 351 371 184 59 1 2,750 3,716 118 48 108 8 146 921 1,349 258 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedC7 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 ‘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 Risk report referred to above. The most significant items that the IFRS shareholders’ profit or loss and shareholders’ equity for the Group’s life assurance business are 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 Asia insurance operations (see also section C7.2) Investments/derivatives Liabilities/unallocated surplus Other exposure 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) All business Variable annuity business Currency 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 Mortality and morbidity risk Persistency risk Investment performance subject to smoothing through declared bonuses Investment performance through asset management fees Persistency risk Risk that utilisation of withdrawal benefits or lapse levels differ from those assumed in pricing Spread difference between earned rate and rate credited to policyholders Lapse risk, but the effects of extreme events may be mitigated by the application of market value adjustments www.prudential.co.uk Annual Report 2017 Prudential plc 259 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC7 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 and Europe 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 Credit risk for assets covering liabilities and shareholder capital Asset/liability mismatch risk 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 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 diversification benefits achieved through the geographical spread of the Group’s operations and, within those operations, through a broad mix of product types. 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 sensitivities below do not reflect that assets and liabilities are actively managed and may vary at the time any actual market movement occurs. There are strategies in place to minimise the exposure to market fluctuations. For example, as market indices fluctuate, Prudential would take certain actions including selling investments, changing investment portfolio allocation and adjusting bonuses credited to policyholders. In addition, these analyses do not consider the effect of market changes on new business generated in the future. Other limitations on the sensitivities include: the use of hypothetical market movements to demonstrate potential risk that only represent Prudential’s view of reasonably possible near‑term market changes and that cannot be predicted with any certainty; the assumption that interest rates in all countries move identically; the assumption that all global currencies move in tandem with the US dollar against pound sterling; and the lack of consideration of the inter‑relation of interest rates, equity markets and foreign currency exchange rates. 260 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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 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 2017, 10‑year government bond rates vary from territory to territory and range from 1.0 per cent to 7.5 per cent (2016: 1.2 per cent to 8.1 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 2017 and 2016 is as follows: Profit before tax attributable to shareholders Related deferred tax (where applicable) Net effect on profit and shareholders’ equity 2017 £m 2016 £m Decrease of 1% Increase of 1% Decrease of 1% Increase of 1% 2 (7) (5) (443) 20 (423) 213 (41) 172 (509) 62 (447) 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 2017: £1,764 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 2017 and 2016 is as follows: Profit before tax attributable to shareholders Related deferred tax (where applicable) Net effect on profit and shareholders' equity 2017 £m Decrease 2016 £m Decrease of 20% of 10% of 20% of 10% (478) 7 (471) (239) 4 (235) (386) 4 (382) (192) 2 (190) 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. www.prudential.co.uk Annual Report 2017 Prudential plc 261 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC7 Risk and sensitivity analysis continued C7.2 Asia insurance operations continued Insurance risk Many of the business units 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 £66 million (2016: £61 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 2017, 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 insurance 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 2017 £m 2016 £m 2017 £m 2016 £m (155) (135) (492) (97) (77) (442) 189 165 601 118 94 540 C7.3 US insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks Jackson’s reported operating profit based on longer‑term investment returns is sensitive to market conditions, both with respect to income earned on spread‑based products and indirectly with respect to income earned on variable annuity asset management fees. Jackson’s main exposures to market risk are to interest rate risk and equity risk. Jackson is exposed primarily to the following risks: Risks Risk of loss Equity risk — 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 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 sustained fall in interest rates especially if 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. 262 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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, equity volatility, 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. Movements in the carrying value of derivatives 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 mean that 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). Jackson enters into financial derivative transactions, including those noted below to reduce and manage business risks. These transactions manage the risk of a change in the value, yield, price, cash flows or quantity of, or a degree of exposure with respect to assets, liabilities or future cash flows, which Jackson has acquired or incurred. Jackson uses free‑standing derivative instruments for hedging purposes. Additionally, certain liabilities, primarily trust instruments supported by funding agreements, fixed index annuities, certain variable annuity guaranteed benefit features and reinsured Guaranteed Minimum Income Benefit variable annuity features are similar to derivatives. Jackson does not account for such items 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 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 to hedge Jackson’s exposure to movements in interest rates. Swaption contracts 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 Equity index futures contracts and equity index options These derivatives are used to hedge Jackson’s exposure to movements in interest rates. These derivatives (including various call and put options and options contingent on interest rates and currency exchange rates) 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 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. Credit default swaps 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. www.prudential.co.uk Annual Report 2017 Prudential plc 263 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC7 Risk and sensitivity analysis continued C7.3 US insurance operations continued i Sensitivity to equity risk At 31 December 2017 and 2016, 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 2017 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 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* Minimum return 0-6% 0% 0-5%† 0% Account value £m 100,451 2,133 235 38 9,099 2,447 667 0-6% 0-6% 0-8%† 5,694 1,484 93,227 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 Weighted average attained age Period until expected annuitisation 66.0 years 66.5 years 69.0 years 0.4 years Weighted average attained age Period until expected annuitisation 65.6 years 66.0 years 68.7 years 0.5 years Net amount at risk £m 1,665 20 13 – 96 51 47 426 436 4,393 Net amount at risk £m 2,483 39 22 – 346 125 83 699 595 9,293 * 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 guarantees are essentially fully reinsured. 264 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedAccount balances of contracts with guarantees were invested in variable separate accounts as follows: Mutual fund type: Equity Bond Balanced Money market Total 2017 £m 2016 £m 80,843 13,976 19,852 681 73,430 15,044 17,441 994 115,352 106,909 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 futures and options that hedge the risks inherent in these products, while also considering the impact of rising and falling guaranteed benefit fees. Due to the nature and the valuation under IFRS of the free‑standing derivatives and the variable annuity guarantee features, this hedge, while highly effective on an economic basis, would not be completely mute in the financial reporting as the immediate impact of equity market movements reset the free‑standing derivatives immediately while the hedged liabilities reset more slowly and fees are recognised prospectively in the period in which they are earned. 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 2017, 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 2017 £m 2016 £m Decrease Increase Decrease Increase of 20% of 10% of 20% of 10% of 20% of 10% of 20% of 10% 1,107 (233) 336 (71) 619 (130) 262 (55) 1,061 (371) 488 (171) 370 (129) 59 (21) 874 265 489 207 690 317 241 38 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 as at a point in time while the actual impact on financial results would vary contingent upon the volume of new product sales and lapses, changes to the derivative portfolio, correlation of market returns and various other factors including volatility, interest rates and elapsed time. The directional movements in the sensitivities reflect the hedging programme in place at 31 December 2017 and 2016. www.prudential.co.uk Annual Report 2017 Prudential plc 265 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC7 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 under US GAAP as embedded derivatives which are fair‑valued and, therefore, will be sensitive to changes in interest rates. 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 2017 and 2016 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 2017 £m 2016 £m Decrease Increase Decrease Increase of 2% of 1% of 1% of 2% of 2% of 1% of 1% of 2% (4,079) 857 (1,911) 401 1,373 (288) 2,533 (532) (3,222) (1,510) 1,085 2,001 (2,899) 1,015 (1,884) (1,394) 488 (906) 1,065 (373) 2,004 (701) 692 1,303 3,063 (643) 1,700 (357) (1,700) 357 (3,063) 643 3,364 (1,177) 1,883 (659) (1,883) 659 (3,364) 1,177 Net effect 2,420 1,343 (1,343) (2,420) 2,187 1,224 (1,224) (2,187) Total net effect on shareholders' equity (802) (167) (258) (419) 303 318 (532) (884) 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 2017, the average and closing rates were US$1.29 (2016: US$1.35) and US$1.35 (2016: US$1.24) to £1.00, respectively. A 10 per cent increase (weakening of the dollar) or decrease (strengthening of the dollar) in these rates would reduce or increase profit before tax attributable to shareholders, profit for the year and shareholders’ equity attributable to US insurance operations respectively as follows: Profit before tax attributable to shareholders Profit for the year Shareholders’ equity attributable to US insurance operations A 10% increase in US$:£ exchange rates A 10% decrease in US$:£ exchange rates 2017 £m 2016 £m 2017 £m 2016 £m (54) (20) (456) (48) (54) (473) 66 24 557 59 66 578 266 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuediv 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. 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. For variable annuity business, an assumption made is the expected long‑term level of separate account returns, which for 2017 was 7.4 per cent (2016: 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. Jackson is sensitive to mortality risk, lapse risk and other types of policyholder behaviour, such as the utilisation of its GMWB product features. Jackson’s persistency assumptions reflect a combination of recent experience for each relevant line of business and expert judgement, especially where a lack of relevant and credible experience data exists. These assumptions vary by relevant factors, such as product, policy duration, attained age and for variable annuity lapse assumptions, the extent to which guaranteed benefits are ‘in the money’ relative to policy account values. Changes in these assumptions, which are assessed on an annual basis after considering recent experience, could have a material impact on policyholder liabilities and therefore on profit before tax. See further information in note B1.2. In addition, in the absence of hedging, equity and interest rate movements can both cause a loss directly or 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. C7.4 UK and Europe insurance operations Exposure and sensitivity of IFRS basis profit and shareholders’ equity to market and other risks The IFRS basis results of the UK and Europe insurance operations are most sensitive to the following factors: — Asset/liability matching; — Default rate experience; — Mortality; — Longevity assumptions; and — The difference between the return on corporate bond and risk‑free rate for shareholder‑backed annuity business of The Prudential Assurance Company Limited. Further details are described below. The IFRS operating profit based on longer‑term investment returns for UK and Europe 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 are currently one‑ninth of the cost of bonuses declared to with‑profits policyholders. For certain unitised with‑profits products, such as the PruFund range of funds, the bonuses represent the policyholders’ net return based on the smoothed unit price of the selected investment fund. Investment performance is a key driver of bonuses declared, and hence the shareholder results. Due to the ‘smoothed’ basis of bonus declaration, the sensitivity to short‑term investment performance is relatively low. However, long‑term investment performance and persistency trends may affect future shareholder transfers. www.prudential.co.uk Annual Report 2017 Prudential plc 267 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC7 Risk and sensitivity analysis continued C7.4 UK and Europe 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 £66 million (2016: £67 million). A decrease in credit default assumptions of five basis points would increase pre‑tax profit by £198 million (2016: £200 million). A decrease in renewal expenses (excluding asset management expenses) of 5 per cent would increase pre‑tax profit by £40 million (2016: £41 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 £143 million (2016: £144 million). See C4.1(d)(iii) for further details on mortality assumptions. Unit-linked and other business Unit‑linked and other business represents a comparatively small proportion of the in‑force business of the UK and Europe 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 and Europe insurance operations are, except annuity business, not generally exposed to interest rate risk. At 31 December 2017 annuity liabilities accounted for 98 per cent (2016: 98 per cent) of UK shareholder‑backed business liabilities. For annuity business, liabilities are exposed to interest rate risk. However, the net exposure 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. Liabilities are measured differently under Solvency II reporting requirements than under IFRS resulting in an alteration to the assets used to measure the IFRS annuity liabilities. As a result, IFRS has a different sensitivity to interest rate and credit risk than under Solvency II. The estimated sensitivity of the UK non‑linked shareholder‑backed business (principally annuities business) to a movement in interest rates is as follows: 2017 £m 2016 £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 13,497 (9,426) (658) 5,805 (4,210) (254) (4,659) 3,443 190 (8,541) 6,295 348 12,353 (10,023) (396) 5,508 (4,466) (177) (4,527) 3,636 151 (8,313) 6,635 285 Net sensitivity of profit after tax and shareholders’ equity 3,413 1,341 (1,026) (1,898) 1,934 865 (740) (1,393) 268 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedIn addition the shareholder‑backed portfolio of UK non‑linked insurance operations (covering policyholder liabilities and shareholders’ equity) includes equity securities and investment properties. Excluding any offsetting effects on the measurement of policyholder liabilities, 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 2017 £m 2016 £m A decrease of 20% A decrease of 10% A decrease of 20% A decrease of 10% (332) 57 (275) (166) 28 (138) (326) 66 (260) (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 £30 million and £53 million respectively (2016: £12 million and £47 million, respectively). ii Sensitivities to other financial risks for asset management operations The profits of asset management businesses are sensitive to the level of assets under management, as this significantly affects the value of management fees earned by the business in the current and future periods. 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. Other operations are sensitive to credit risk on the bridging loan portfolio of the Prudential Capital operation. Total debt securities held at 31 December 2017 by Prudential Capital were £2,238 million (2016: £2,359 million). 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. www.prudential.co.uk Annual Report 2017 Prudential plc 269 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC8 Tax assets and liabilities C8.1 Deferred tax The statement of financial position contains the following deferred tax assets and liabilities in relation to: Deferred tax assets 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 liabilities Unrealised losses or gains on investments Balances relating to investment and insurance contracts Short‑term temporary differences Capital allowances Total 2017 £m Movement through other comprehensive income and equity Other movements including foreign currency movements Movement in income statement (8) – (1,396) (2) (12) (1,418) (177) (156) 870 (3) 534 – – (1) – – (1) (55) – (26) – (81) (1) – (267) – (1) (269) 18 14 186 (16) 202 At 1 Jan 23 1 4,196 16 79 4,315 (1,534) (730) (3,071) (35) (5,370) At 31 Dec 14 1 2,532 14 66 2,627 (1,748) (872) (2,041) (54) (4,715) Of the short‑term temporary differences of £2,532 million relating to deferred tax assets, £1,799 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 £733 million are expected to be recovered within 10 years. The reduction in the US corporate income tax rate to 21 per cent from 1 January 2018 was substantively enacted on 22 December 2017. The remeasurement to 21 per cent reduced deferred tax assets subject to US taxation by £1,587 million and deferred tax liabilities by £1,368 million. The £219 million net reduction was reflected partly in the income statement (£445 million charge attributable to shareholders and £92 million benefit to policyholders) and partly through reserves in other comprehensive income (£134 million benefit). The deferred tax balances at 31 December 2017 and 2016 arise in the following parts of the Group: Asia operations US operations UK and Europe Other operations Total Deferred tax assets Deferred tax liabilities 2017 £m 2016* £m 2017 £m 2016* £m 112 2,300 157 58 2,627 107 3,979 174 55 4,315 (1,152) (1,845) (1,703) (15) (4,715) (935) (2,832) (1,592) (11) (5,370) * The 2016 comparative results have been re‑presented from those previously published for the reassessment of the Group’s operating segments as described in note B1.3. 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. Deferred tax assets are recognised to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying temporary differences can be deducted. 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 2017 full year results and financial position at 31 December 2017 the following tax benefits have not been recognised: Capital losses Trading losses 2017 2016 Tax benefit £m Losses £bn Tax benefit £m Losses £bn 79 74 0.4 0.3 89 41 0.4 0.2 Of the unrecognised trading losses, losses of £41 million will expire within the next seven years, the rest have no expiry date. 270 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedC8.2 Current tax Of the £613 million (2016: £440 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. The Prudential Assurance Company Limited (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’ appeal against the Court of Appeal’s judgment was heard by the Supreme Court in February 2018. A decision is expected later in 2018. The current tax liability of £537 million (2016: £649 million) includes £139 million (2016: £89 million) of provisions for uncertain tax matters. Further detail is provided in note B4. C9 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 (2016: 82 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 IAS 19 ‘Employee Benefits’ and IFRIC 14 ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’, the Group is only able to recognise a surplus to the extent that it is able to access the surplus either through an unconditional right of refund or through reduced future contributions relating to ongoing service of active members. The Group has no unconditional right of refund to any surplus in PSPS. Accordingly, the PSPS surplus recognised is restricted to the present value of the economic benefit to the Group from the difference between the estimated future ongoing contributions and the full future cost of service for the active members. In contrast, the Group is able to access the surplus of SASPS and M&GGPS. Therefore, the amounts recognised for these schemes are the IAS 19 valuation amount (either a surplus or deficit). The Group asset/liability in respect of defined benefit pension schemes is as follows: Underlying economic surplus (deficit) Less: unrecognised surplus Economic surplus (deficit) (including investment in Prudential insurance policies) note (iii) Attributable to: PAC with‑profits fund Shareholder‑backed operations Consolidation adjustment against policyholder liabilities for investment in Prudential insurance policies IAS 19 pension asset (liability) on the Group statement of financial position note (iv) 2017 £m 2016 £m PSPS note (i) SASPS note (ii) M&GGPS Other schemes Total PSPS note (i) SASPS note (ii) M&GGPS Other schemes Total 721 (485) (137) – 109 – (1) – 692 (485) 717 (558) (237) – 236 (137) 109 (1) 207 165 (55) – 71 (82) 109 – (1) 110 97 159 111 (237) (95) 48 (142) 84 – 84 – 84 (1) – 563 (558) (1) – (1) 5 16 (11) – – (151) – (151) – – (134) – (134) 236 (137) (42) (1) 56 159 (237) (50) (1) (129) Notes (i) (ii) (iii) 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 2017 and 2016. 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 2017, the PSPS pension asset of £236 million (2016: £159 million) and the other schemes’ pension liabilities of £180 million (2016: £288 million) are included within ‘Other debtors’ and ‘Provisions’ respectively on the consolidated statement of financial position. www.prudential.co.uk Annual Report 2017 Prudential plc 271 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC9 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 actuarial valuation differs from the IAS 19 accounting basis valuation in a number of respects, including the discount rate assumption where IAS 19 prescribes a rate based on high‑quality corporate bonds while a more ‘prudent’ assumption is used for the actuarial valuation. The information on the latest completed actuarial valuation for the UK schemes is shown in the table below: Last completed actuarial 5 April 2014* 31 March 2017 31 December 2014* PSPS SASPS M&GGPS 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 75 per cent 99 per cent valuation Deficit funding arrangement agreed with the Trustees based on the last completed valuation No deficit funding required from 1 January 2016 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 £26 million per annum from 1 April 2017 until 31 March 2027, 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 * The triennial valuations for PSPS and M&GGPS as at 5 April 2017 and 31 December 2017 respectively are currently in progress. 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. 272 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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 and the most significant of which are interest rate and investment risk, inflation risk and mortality risk. Corporate governance The Group’s UK pension schemes are established under trust and are subject to UK legal requirements; this includes being subject to regulation by ‘The Pension Regulator’ in accordance with the Pension Act 1995. Each scheme has a corporate trustee to which some directors are appointed by Group employers with the remaining directors nominated by members in accordance with UK legal requirements. The trustees have the ultimate responsibility to ensure that the scheme is managed in accordance with the Trust Deed & Rules. The trustees act in the best interests of the schemes beneficiaries; this includes taking appropriate account of each employer’s legal obligation and financial ability to support the schemes, when setting investment strategy and when agreeing funding with the employers. The employers’ contribution commitments are formally updated at each triennial valuation; between valuations funding levels and employer strength continue to be monitored with the Trustees being able to bring forward the next triennial valuation if they consider it appropriate to do so. All of the Group’s three UK defined benefit pension schemes (PSPS, SASPS and M&GGPS) are final salary schemes, which are closed to new entrants. The Trustees of each scheme set the general investment policy and specify any restrictions on types of investment and the degrees of divergence permitted from the benchmark, but delegate the responsibility for selection and realisation of specific investments to the Investment Managers. The Trustees consult 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 Trustees. The Trustees of each of the schemes manage 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. For PSPS, a significant portion of the scheme assets are invested in liability matching assets such as bonds and gilts including index‑linked gilts to partially hedge against inflation. In addition, PSPS has maintained a portfolio of interest rate and inflation swaps to match more closely the duration and inflation profile of its assets to its liabilities. SASPS and M&GGPS use very limited or no derivatives to manage their risks. The risks arising from these schemes are managed through a diversified mix of investments. SASPS has invested in a mix of both return‑seeking assets, such as equities and property and matching assets including a leveraged liability driven investment portfolio to reflect the liability profile of the scheme. A portion of the M&GGPS assets is invested in index‑linked gilts and leveraged index‑linked gilts as part of its asset liability management. The mix of the investments is kept under review by the Trustees of the respective schemes. (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 2017 % 2016 % 2.5 3.1 3.1 2.1 2.5 2.5 2.5 3.1 2.6 3.2 3.2 2.2 2.5 2.5 2.5 3.2 * 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 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 reflected the CMI’s 2014 mortality improvements model, with scheme‑specific calibrations. For immediate annuities in payment, in 2017 and 2016, 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. www.prudential.co.uk Annual Report 2017 Prudential plc 273 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC9 Defined benefit pension schemes continued (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 2017, M&GGPS held investments in Prudential insurance policies of £151 million (2016: £134 million). Movements on the pension scheme surplus 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 (deficit) 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 2017 £m Surplus (deficit) in schemes at 1 Jan 2017 (Charge) credit to income statement Actuarial gains and losses in other comprehensive income Contributions paid Surplus (deficit) in schemes at 31 Dec 2017 563 (425) 138 (27) 111 (558) 409 (149) 29 (120) 5 (16) (11) 2 (9) (40) 10 (30) 6 (24) (14) 10 (4) – (4) (54) 20 (34) 6 (28) 119 (39) 80 (15) 65 87 (56) 31 (6) 25 206 (95) 111 (21) 90 50 (19) 31 (6) 25 – – – – – 50 (19) 31 (6) 25 692 (473) 219 (42) 177 (485) 363 (122) 23 (99) 207 (110) 97 (19) 78 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† 2017 Other schemes £m 67 272 655 248 – (6) 130 77 1,443 Total £m 76 498 5,695 1,739 164 182 270 293 8,917 PSPS £m 9 226 5,040 1,491 164 188 140 216 7,474 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 % 1 6 63 20 2 2 3 3 100 % 1 7 66 15 2 3 2 4 100 * 89 per cent of the bonds are investment graded (2016: 93 per cent). † 96 per cent of the total value of the scheme assets are derived from quoted prices in an active market (2016: 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 2017 of £8,766 million (2016: £8,872 million) is different from the economic basis plan assets of £8,917 million (2016: £9,006 million) as shown above due to the exclusion of investment in Prudential insurance policies, by M&GGPS as described above. 274 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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 2017 £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 Prudential insurance policies Plan assets Present value of benefit obligations note (i) 9,006 – (8,443) (46) 228 (8) (479) 50 1 119 – (214) – 479 – (1) – – Net surplus (deficit), end of year 8,917 (8,225) 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 Prudential insurance policies Net surplus (deficit), end of year Notes (i) Maturity profile of the benefit obligations 7,819 – 292 (5) (350) 45 2 1,203 – 9,006 (6,858) (34) (254) – 350 – (2) (1,645) – (8,443) 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 surplus (deficit) 563 (46) 14 (8) – 50 – 119 – 692 961 (34) 38 (5) – 45 – (442) – 563 (558) – (14) – – – – 87 – (485) (800) – (32) – – – – 274 – (558) 5 (46) – (8) – 50 – 206 – 207 161 (34) 6 (5) – 45 – (168) – 5 (134) – (3) – – – – (6) (8) (151) (77) – (3) – – – – (13) (41) (134) (129) (46) (3) (8) – 50 – 200 (8) 56 84 (34) 3 (5) – 45 – (181) (41) (129) The weighted average duration of the benefit obligations of the schemes is 18.6 years (2016: 19.5 years). The following table provides an expected maturity analysis of the undiscounted benefit obligations as at 31 December: All schemes £m 2017 2016 1 year or less 255 243 After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years 1,108 1,090 1,589 1,585 1,667 1,694 1,661 1,704 Over 20 years 7,889 8,508 Total 14,169 14,824 (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 2018 amount to £50 million (2017: £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) 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 2017 £m 2016 £m 119 (10) (101) 111 119 87 (6) 200 1,203 (18) (1,733) 106 (442) 274 (13) (181) www.prudential.co.uk Annual Report 2017 Prudential plc 275 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information C9 Defined benefit pension schemes continued (c) Estimated pension scheme surpluses and deficits continued 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 2016 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 sensitivities are calculated based on a change in one assumption with all other assumptions being held constant. As such, interdependencies between the assumptions are excluded. The impact of the rate of inflation assumption sensitivity includes the impact of inflation on the rate of increase in salaries and rate of increase of pensions in payment. The sensitivities of the underlying pension scheme liabilities as shown below do 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 the financial position of 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 2017 2.5% 2016 Sensitivity change in assumption 2017 2016 2.6% Decrease by 0.2% Increase in scheme liabilities by: PSPS Other schemes Discount rate 2.5% 2.6% Increase by 0.2% Decrease in scheme liabilities by: Rate of inflation 3.1% 2.1% 3.2% RPI: Decrease by 0.2% 2.2% CPI: Decrease by 0.2% with consequent reduction in salary increases PSPS Other schemes Decrease in scheme liabilities by: PSPS Other schemes Mortality rate Increase life expectancy Increase in scheme liabilities by: by 1 year PSPS Other schemes 3.5% 5.4% 3.4% 4.9% 0.6% 3.9% 4.0% 3.8% 3.5% 5.3% 3.5% 5.0% 0.6% 4.1% 3.5% 3.7% 276 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued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 2,581,061,573 6,113,872 At 31 December 2,587,175,445 2017 Share capital £m 129 – 129 Share premium £m Number of ordinary shares 1,927 2,572,454,958 8,606,615 21 1,948 2,581,061,573 2016 Share capital £m 128 1 129 Share premium £m 1,915 12 1,927 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 2017, there were options outstanding under save as you earn schemes to subscribe for shares as follows: 31 December 2017 31 December 2016 Number of shares to subscribe for 6,448,853 7,068,884 Share price range from 629p 466p to Exercisable by year 1,455p 1,155p 2023 2022 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 £250 million as at 31 December 2017 (2016: £226 million) is deducted from retained earnings. The Company has established trusts to facilitate the delivery of shares under employee incentive plans. At 31 December 2017, 11.4 million (2016: 10.7 million) Prudential plc shares with a market value of £218 million (2016: £175 million) were held in such trusts all of which are for employee incentive plans. The maximum number of shares held during 2017 was 15.1 million which was in March 2017. 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 2017 share price 2016 share price Number of shares 62,388 65,706 70,139 3,090,167 55,744 182,780 51,984 55,857 51,226 136,563 53,951 53,519 3,930,024 Low £ 15.83 15.70 16.40 16.58 17.50 17.52 17.72 18.30 17.45 17.99 18.38 18.26 High £ 16.02 16.09 16.54 16.80 17.62 18.00 17.93 18.73 17.97 18.22 18.40 18.47 Cost £ 989,583 1,052,657 1,159,950 51,369,760 979,645 3,269,447 927,452 1,025,802 912,151 2,483,879 992,123 986,000 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 66,148,449 4,360,147 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 £ 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 57,183,719 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 2017 was 6.4 million (2016: 6.0 million) and the cost of acquiring these shares of £71 million (2016: £61 million) is included in the cost of own shares. The market value of these shares as at 31 December 2017 was £121 million (2016: £97 million). During 2017, these funds made net acquisitions of 372,029 Prudential shares (2016: net disposals of 77,423) for a net increase of £9.4 million to book cost (2016: net increase of £7.9 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 2017 or 2016. www.prudential.co.uk Annual Report 2017 Prudential plc 277 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC11 Provisions Provision in respect of defined benefit pension schemesC9 Other provisions (see below) Total provisions Analysis of other provisions: At 1 January Charged to income statement: Additional provisions Unused amounts released Used during the year Exchange differences Total at 31 December 2017 £m 2016 £m 180 943 1,123 288 659 947 2017 £m 2016 £m 659 542 (9) (239) (10) 943 519 381 (53) (222) 34 659 Other provisions comprise staff benefits provisions of £453 million (2016: £415 million) that are generally expected to be paid out within the next three years, other provisions of £121 million (2016: £69 million) and a provision for review of past annuity sales after utilisation during the year of £369 million (2016: £175 million). 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 FCA formally released its redress calculation methodology in early 2018 and accordingly Prudential reassessed the provision held to cover the costs of undertaking the review and any potential redress. At 31 December 2017, following this reassessment, the gross provision was increased to £400 million (2016: £175 million), excluding any utilisation during the year. The ultimate amount that will be expended by the Group on the review, which is currently expected to be completed in 2019, remains uncertain. Although the Group’s professional indemnity insurance is expected to mitigate the overall financial impact of this review, with potential insurance recoveries of up to £175 million, no such recovery has been factored into 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 2017 estimated Group Solvency II own funds are £26.4 billion (2016: £24.8 billion). (ii) External capital requirements 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 2017. 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; and 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. 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. 278 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued 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 Asia 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 (i) Asia insurance operations The estimated capital position for Asia life insurance operations with reconciliation to shareholders’ equity is shown below: 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 significant operations are: 2017 £m 2016 £m 5,524 4,992 3,474 2,667 (1,515) 2,411 4,370 9,894 (1,365) 1,628 2,930 7,922 China A risk‑based capital, risk management and governance framework, known as the China Risk Oriented Solvency System (C‑ROSS), applies in China. Under C‑ROSS, insurers are required to maintain a core solvency ratio (core capital over minimum capital) and a comprehensive solvency ratio (actual capital over minimum capital) of not lower than 50 per cent and 100 per cent, respectively. The actual capital is the difference between the admitted assets and admitted liabilities. Hong Kong The capital requirement varies by underlying risk and duration of liabilities, but is generally determined as a percentage of mathematical reserves and 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 100 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 S$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. www.prudential.co.uk Annual Report 2017 Prudential plc 279 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC12 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: 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 2017 £m 2016 £m 5,013 5,204 (8,197) 184 5,325 818 (1,870) 3,143 (8,303) 202 6,657 535 (909) 4,295 In December 2017 a significant US tax reform package, The Tax Cuts and Jobs Act, was enacted into law effective from 1 January 2018. These reforms led to a £628 million reduction in the level of statutory net admitted deferred tax assets. 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 after‑tax factors to various asset, premium and reserve items and a separate model‑based component for market risk associated primarily with variable annuity products. The after‑tax factors were not adjusted to reflect the impact of US Tax Reform. At 31 December 2017, 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 £355 million at 31 December 2017. 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 minimum risk‑based capital requirement level at which corrective action commences. (iii) UK and Europe insurance operations Insurance operations in the UK and Europe are subject to Solvency II capital requirements on an individual basis. The UK solvency capital requirement has been met during 2017. (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 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 2017 £m 2016 £m M&G Prudential US Eastspring Investments Total Total 405 401 (65) – (322) – 419 205 43 – 6 – (19) 235 204 142 (8) – (111) (5) 222 814 586 (73) 6 (433) (24) 876 733 469 (54) – (387) 53 814 280 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continued(c) Transferability of available capital In the UK 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 UK parent entities, provided the statutory insurance fund meets the local regulatory solvency targets. Available capital of the non‑insurance business units is transferable after taking account of an appropriate level of operating capital, based on local regulatory solvency targets, over and above base 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 2017 £m Tangible assets 439 (88) 351 351 (8) (22) 17 – (43) 295 367 (72) 295 1,077 (685) 392 392 (14) (94) 117 178 (85) 494 1,041 (547) 494 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 Total 1,516 (773) 743 743 (22) (116) 134 178 (128) 789 1,408 (619) 789 Total 1,867 (670) 1,197 1,197 102 (159) 348 – (745) 743 1,516 (773) 743 * Arising on an acquisition made for venture fund purposes by the PAC with‑profits fund. Tangible assets Of the £494 million (2016: £392 million) of tangible assets, £360 million (2016: £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 £117 million (2016: £333 million) arose as follows: £41 million in UK and Europe, £19 million in US and £55 million in Asia with the remaining balance of £2 million arising from unallocated corporate expenditure (2016: £251 million in UK and Europe, £18 million in US and £62 million in Asia with the remaining balance of £2 million arising from unallocated corporate expenditure). www.prudential.co.uk Annual Report 2017 Prudential plc 281 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationC14 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 held for sale assets At 31 December 2017 £m 2016 £m 14,646 13,422 2,009 39 (591) 415 (21) – 1,338 189 (632) 273 97 (41) 16,497 14,646 The 2017 income statement includes rental income from investment properties of £876 million (2016: £781 million) and direct operating expenses including repairs and maintenance arising from these properties of £82 million (2016: £67 million). Investment properties of £5,689 million (2016: £6,020 million) are held under finance leases. The present value of minimum lease payments under these leases is £43 million (2016: £49 million) and 73 per cent (2016: 76 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 2017 £m 2016 £m 322 1,073 2,286 3,681 314 1,077 2,634 4,025 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 2017 are £1,527 million (2016: £2,238 million). 282 Prudential plc Annual Report 2017 www.prudential.co.uk C Balance sheet notes continuedD Other notes D1 Disposal of businesses On 18 May 2017, the Group announced that it had completed the sale of its life insurance subsidiary in Korea, PCA Life Insurance Co. Ltd. to Mirae Asset Life Insurance Co. Ltd., following regulatory approvals. The transaction, announced on 10 November 2016, was for a consideration of KRW170 billion (equivalent to £117 million at 17 May 2017 closing rate). The proceeds, net of £9 million of related expenses, were £108 million. On completion of the sale the cumulative foreign exchange translation gain of the Korea life business of £61 million, that had arisen from 2004 (the year of the Group’s conversion to IFRS) to disposal was recycled from other comprehensive income through the profit and loss account in 2017 as required by IAS 21. The adjustment has no net effect on shareholders’ equity. The net contribution from the Korea life business to the 2017 profit after tax is the £61 million gain arising from the recycling of foreign exchange translation gains previously recognised in other comprehensive income and other elements in various line items of £5 million. The 2016 income statement recorded a charge for remeasurement of Korea life business classified as held for sale of £(238) million. For 2016 the result for the year, including short‑term fluctuations in investment returns, together with the adjustment to the carrying value gave rise to an aggregate loss of £(227) million. 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. On 15 August 2017, the Group, through its subsidiary National Planning Holdings, Inc. (NPH) sold its US independent broker‑dealer network to LPL Financial LLC. The initial consideration received was £252 million (US$325 million) resulting in a profit on disposal of £162 million (US$209 million) before tax and after costs and net losses that have been incurred in the year. D2 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. 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 Group 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. www.prudential.co.uk Annual Report 2017 Prudential plc 283 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D2 Contingencies and related obligations continued Litigation and regulatory matters continued 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 £503 million was held within the sub‑fund (2016: £571 million). — Guaranteed annuities – A provision for guaranteed annuity products of £53 million was held (2016: £62 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. D3 Post balance sheet events Dividends The second interim ordinary dividend for the year ended 31 December 2017, that was approved by the Board of Directors after 31 December 2017 is described in note B6. Intention to demerge the Group’s UK businesses In March 2018, the Group announced its intention to demerge its UK and Europe business (‘M&G Prudential’) from Prudential plc, resulting in two separately listed companies. In preparation for the UK demerger process, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019. Sale of £12.0 billion* UK annuity portfolio In March 2018, M&G Prudential also announced the sale of £12.0 billion* of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion* of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. Further details are set out in the CFO Report. * Relates to £12.0 billion of IFRS shareholder annuity liabilities, valued as at 31 December 2017. 284 Prudential plc Annual Report 2017 www.prudential.co.uk 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 2017 and 2016, 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 B2.3. 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 2017 £m 2016 £m 113 284 118 56 123 107 209 96 60 115 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 2017 were £176 million (2016: £458 million). At 31 December 2017, Jackson has unfunded commitments of £414 million (2016: £465 million) related to its investments in limited partnerships and £214 million (2016: £201 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 2017, UK and Europe’s insurance operations had unfunded commitments of £3,225 million (2016: £2,269 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. D6 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. M&G Prudential’s asset management company, M&G Investment Management Limited, 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, 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). www.prudential.co.uk Annual Report 2017 Prudential plc 285 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information D Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued (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 £2.4 billion at 31 December 2017 (2016: £3.5 billion). During 2016, 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 was re‑classified as an associate, and continued 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 Asia US UK and Europe Insurance Asset management Insurance Asset management Insurance Asset management Total segment Joint ventures and associates 2017 £m 2016 £m 196 106 302 Unallo- cated to a segment (other operations) 161 21 182 Group total 2017 Share of profits from joint ventures and associates, net of related tax 2016 Share of profits from joint ventures and associates, net of related tax 121 60 – – 106 15 302 – 302 94 54 – – 21 13 182 – 182 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. 286 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units (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 2017 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 Prudential (US Holdco1) Limited Prudential Capital Holding Company Limited Prudential Corporation Asia Limited Prudential Financial Services Limited Prudential Group Holdings Limited Prudential Property Services Limited The Prudential Assurance Company Limited Classes of shares held Proportion held Registered office address and country of incorporation OS OS OS OS OS OS OS OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 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 Allied Life Brokerage Agency, Inc ANRP II (AIV VI FC), LP BOCHK Aggressive Growth Fund BOCHK Balanced Growth Fund BOCHK China Equity Fund BOCHK Conservative Growth Fund BOCI ‑ Prudential Asset Management Limited BOCI ‑ Prudential Trustee Limited Brier Capital LLC Brooke (Holdco 1) Inc Brooke Holdings (UK) (In liquidation) Brooke Life Insurance Company BWAT Retail Nominee (1) Limited BWAT Retail Nominee (2) Limited Calvin F1 GP Limited Calvin F2 GP Limited Canada Property (Trustee) No 1 Limited Canada Property Holdings Limited Canada Property Jersey No. 2 Trust Canada Property Jersey Trust Cardinal Distribution Park Management Limited Carraway Guildford (Nominee A) Limited Carraway Guildford (Nominee B) Limited Carraway Guildford General Partner Limited Carraway Guildford Investments Unit Trust Carraway Guildford LP Centaurus Retail LLP Central Square Leeds Limited (In liquidation) Centre Capital Non‑Qualified Investors IV AIV Orion, LP Centre Capital Non‑Qualified Investors IV AIV‑ELS, LP Classes of shares held OS LPI OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS LPI LPI OS LPI LPI Proportion held Registered office address and country of incorporation 100.00% 400 East Court Avenue, Des Moines, IA 50309, USA 36.58% Cayman Corporate Centre, 27 Hospital Road, George Town, KY‑9008, Cayman Islands 60.22% 27th Floor, Bank of China Tower, 1 Garden Road, Central and Western District, Hong Kong 48.19% 12th Floor and 25th Floor, Citicorp Centre, 18 Whitfield Road, Causeway Bay, Hong Kong 66.25% 56.35% 36.00% 27th Floor, Bank of China Tower, 1 Garden Road, Central and Western District, Hong Kong 36.00% 12th Floor and 25th Floor, Citicorp Centre, 18 Whitfield Road, Causeway Bay, Hong Kong 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% 1105 North Market Street, Suite 1300, Wilmington, DE 19801, USA 100.00% c/o Mazars LLP, 45 Church Street, Birmingham, B3 2RT, UK 100.00% 1 Corporate Way, Lansing, MI 48951, USA 50.00% Laurence Pountney Hill, London, EC4R 0HH, UK 50.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% Lime Grove House, Green Street, St Helier, Jersey, JE1 2ST 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% Lime Grove House, Green Street, St Helier, Jersey, JE1 2ST 100.00% 66.00% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham, B2 5PP, UK 100.00% 13 Castle Street, St Helier, Jersey, JE4 5UT 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 13 Castle Street, St Helier, Jersey, JE4 5UT 100.00% Lloyds Chambers, 1 Portsoken Street, London, E1 8HZ, UK 50.00% 40 Broadway, London, SW1H 0BU, UK 100.00% c/o Mazars LLP, 45 Church Street, Birmingham, B3 2RT, UK 76.80% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA 76.53% www.prudential.co.uk Annual Report 2017 Prudential plc 287 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Centre Capital Non‑Qualified Investors IV AIV‑RA, LP Centre Capital Non‑Qualified Investors IV, LP Centre Capital Non‑Qualified Investors V AIV‑ELS, LP Centre Capital Non‑Qualified Investors V, LP CEP IV‑A Chicago AIV, LP CEP IV‑A CWV AIV, LP CEP IV‑A Davenport AIV, LP CEP IV‑A Indy AIV, LP CEP IV‑A NMR AIV, LP CEP IV‑A WBCT AIV, LP CF Prudential European QIS Fund CF Prudential Japanese QIS Fund CF Prudential North American QIS Fund CF Prudential Pacific Markets Trust Fund CF Prudential UK Growth QIS Fund CITIC‑CP Asset Management Co., Ltd. CITIC‑Prudential Fund Management Co., Ltd. CITIC‑Prudential Life Insurance Company Limited Clairvest Equity Partners IV‑A LP Cribbs Causeway JV Limited Classes of shares held LPI LPI LPI LPI LPI LPI LPI LPI LPI LPI OS OS OS OS OS MI MI MI LPI OS Proportion held Registered office address and country of incorporation 31.92% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA 73.06% 73.16% 67.16% 31.92% 615 South Dupont Highway, Dover, DE 19901, USA 31.95% 850 New Burton Road, Suite 201, Dover, DE 19904, USA 31.92% 615 South Dupont Highway, Dover, DE 19901, USA 31.92% 31.92% 31.91% 97.68% 17 Rochester Row, London, SW1P 1QT, UK 97.64% 98.33% 135 Bishopsgate, London, EC2M 3UR, UK 97.96% Laurence Pountney Hill, London, EC4R 0HH, UK 94.27% 17 Rochester Row, London, SW1P 1QT, UK 26.95% No.128 North Zhangjiabang Road, Pudong District, Shanghai, China 49.00% Level 9, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong, Shanghai, China 50.00% East Tower, World Financial Centre, No. 1 East Third Ring Middle Road, Chaoyang District, Beijing, China 31.87% 22 St Clair Avenue East, Suite 1700, Toronto, ON M4T 2S3, Canada 50.00% 40 Broadway, London, SW1H 0BU, UK Cribbs Causeway Merchants Association Limited LBG 100.00% The Mall at Cribbs Causeway, Bristol, BS34 5DG, UK Cribbs Mall Nominee (1) Limited Curian Capital, LLC Curian Clearing, LLC (Michigan) Digital Infrastructure Investment Partners GP LLP Digital Infrastructure Investment Partners GP1 Limited Digital Infrastructure Investment Partners LP Digital Infrastructure Investment Partners SLP GP LLP Digital Infrastructure Investment Partners SLP GP1 Limited Digital Infrastructure Investment Partners SLP GP2 Limited Eastspring Al‑Wara’ Investments Berhad Eastspring Asset Management Korea Co. Ltd. Eastspring Infrastructure Debt Fund L.P. Eastspring Investments ‑ Asian Local Bond Fund Eastspring Investments ‑ Asian Smaller Companies Fund Eastspring Investments ‑ Asian Total Return Bond Fund Eastspring Investments ‑ Developed and Emerging Asia Equity Fund Eastspring Investments ‑ Emerging Europe, Middle East and Africa Dynamic Fund Eastspring Investments ‑ Global Emerging Markets Customized Equity Fund Eastspring Investments ‑ Global Emerging Markets Dynamic Fund Eastspring Investments ‑ Global Low Volatility Equity Fund Eastspring Investments ‑ Global Technology Fund Eastspring Investments ‑ Japan Equity Fund Eastspring Investments ‑ Japan Fundamental Value Fund Eastspring Investments ‑ Pan European Fund Eastspring Investments ‑ US Equity Income Fund Eastspring Investments ‑ US High Yield Bond Fund Eastspring Investments ‑ US Total Return Bond Fund Eastspring Investments (Hong Kong) Limited OS OS OS LPI OS LPI LPI OS OS OS OS PI OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% 65.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 16th Floor, Wisma Sime Darby, Jalan Raja Laut, 50350 Kuala Lumpur, Malaysia 100.00% 15th Floor, Shinhan Investment Tower, 70 Yoidae‑ro, Youngdungpo‑gu, Seoul 07325, Korea 100.00% PO Box 309, Ugland House, Grand Cayman, KY1‑1104, Cayman Islands 97.95% 26, Boulevard Royal, L‑2449, Luxembourg 99.69% 100.00% 100.00% 100.00% 99.90% 96.48% 99.57% 84.46% 85.13% 98.45% 56.25% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 100.00% 26, Boulevard Royal, L‑2449, Luxembourg 32.58% 100.00% 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong 288 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units Classes of shares held Proportion held Registered office address and country of incorporation OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS MI OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS 100.00% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Tower 2, Singapore 018983 99.93% 26, Boulevard Royal, L‑2449, Luxembourg 82.70% 90.17% 65.25% 83.03% 47.52% 36.37% 92.37% 95.47% 100.00% 16th Floor, Wisma Sime Darby, Jalan Raja Laut, 50350 Kuala Lumpur, Malaysia 50.03% 26, Boulevard Royal, L‑2449, Luxembourg 97.21% 99.36% 100.00% 23rd Floor, Saigon Trade Center, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam 94.59% 26, Boulevard Royal, L‑2449, Luxembourg 99.99% 97.63% 100.00% 92.37% 99.86% 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront, Port Louis, Mauritius 81.09% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront, Port Louis, Mauritius 100.00% 89.29% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% Marunouchi Park Building, 6‑1 Marunouchi 2‑chome, Chiyoda‑Ku, Tokyo, Japan 100.00% Level 6, Precinct Building 5, Unit 5, Dubai International Financial Centre, Dubai, United Arab Emirates 99.97% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Tower 2, Singapore 018983 100.00% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% 99.95% 100.00% 28.34% 86.49% 92.09% 27.01% 99.72% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 90.97% 88.41% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% PO Box 309, Ugland House, Grand Cayman, KY1‑1104, Cayman Islands 99.54% 4th Floor, No.1 Songzhi Road, Taipei 110, Taiwan 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK LBG 100.00% 1 Exchange Crescent, Conference Square, Edinburgh, EH3 8UL, UK Name of entity Eastspring Investments (Luxembourg) SA Eastspring Investments (Singapore) Limited Eastspring Investments Asia Pacific Equity Fund Eastspring Investments Asian Bond Fund Eastspring Investments Asian Dynamic Fund Eastspring Investments Asian Equity Fund Eastspring Investments Asian Equity Income Fund Eastspring Investments Asian High Yield Bond Fund Eastspring Investments Asian Infrastructure Equity Fund Eastspring Investments Asian Low Volatility Equity Fund Eastspring Investments Asian Property Securities Fund Eastspring Investments Berhad Eastspring Investments China Equity Fund Eastspring Investments Dragon Peacock Fund Eastspring Investments European Investment Grade Bond Fund Eastspring Investments Fund Management Limited Liability Company 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 Eastspring Investments Incorporated Eastspring Investments India Consumer Equity Open Limited Eastspring Investments India Equity Fund Eastspring Investments India Equity Open Limited Eastspring Investments India Infrastructure Equity Open Limited Eastspring Investments Latin American Equity Fund Eastspring Investments Limited Eastspring Investments Limited (In liquidation) Eastspring Investments North America Value Fund Eastspring Investments Services Pte. Ltd. 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 US Bond Fund Eastspring Investments US Corporate Bond Fund Eastspring Investments US High Investment Grade Bond Fund Eastspring Investments US Investment Grade Bond Fund Eastspring Investments UT Singapore ASEAN Equity Fund Eastspring Investments UT Singapore Select Bond Fund Eastspring Investments World Value Equity Fund Eastspring Real Assets Partners Eastspring Securities Investment Trust Co., Ltd. Edger Investments Limited Edinburgh Park (Management) Limited www.prudential.co.uk Annual Report 2017 Prudential plc 289 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Embankment GP Limited Embankment Nominee 1 Limited Embankment Nominee 2 Limited Empire Holding SARL (In liquidation) Euro Salas Properties Limited (In liquidation) European Specialist Investment Funds – M&G Total Return Credit Investment Fund Falan GP Limited Fashion Square ECO LP (In liquidation) First Dakota, Inc Five Hotel Holding, LLC Foudry Properties Limited Furnival Insurance Company PCC Limited Genny GP Limited Genny GP 2 Limited Genny GP 1 LLP George Digital GP Limited George Digital GP 1 LLP George Digital GP 2 Limited GGE GP Limited Green GP Limited Greenpark (Reading) General Partner Limited Greenpark (Reading) Nominee No. 1 Limited GreenPark (Reading) Nominee No. 2 Limited GS Twenty Two Limited Hermitage Management, LLC Holborn Bars Nominees Limited Holtwood Limited Hudson Seasons, LLC Hyde Holdco 1 Limited ICICI Prudential Asset Management Company Limited ICICI Prudential Life Insurance Company Limited ICICI Prudential Pension Funds Management Company Limited ICICI Prudential Trust Limited IFC Holdings, Inc Infracapital (AIRI) GP Limited Infracapital (Belmond) GP Limited Infracapital (Bio) GP Limited Infracapital (GC) GP Limited Infracapital (IT PPP) GP Limited Infracapital (Sense) GP Limited Infracapital (TLSB) GP Limited Infracapital (TLSB) SLP LP Infracapital ABP GP Limited (In liquidation) Infracapital CI II Limited Infracapital DF II GP LLP Infracapital DF II Limited Infracapital Employee Feeder GP Limited Infracapital Employee Feeder GP 1 LLP Infracapital Employee Feeder GP 2 LLP Classes of shares held Proportion held Registered office address and country of incorporation OS OS OS OS OS OS OS LPI OS MI OS OS OS OS LPI OS LPI OS OS OS OS OS OS OS OS OS OS MI OS OS OS OS OS OS OS OS OS OS OS OS OS LPI OS OS LPI OS OS LPI LPI 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 5, rue Guillaume Kroll, L‑1882, Luxembourg 100.00% c/o Mazars LLP, 90 St. Vincent Street, Glasgow, G2 5UB, UK 30.75% 80, route d’Esch, L‑1470, Luxembourg 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 50.00% 314 East Thayer Avenue, Bismarck, ND 58501, USA 100.00% 208 South LaSalle Street, Suite 814, Chicago, IL 60604, USA 50.00% Clearwater Court, Vastern Road, Reading, RG1 8DB, UK 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey, GY1 1WG 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 100.00% 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% International House, Castle Hill, Victoria Road, Douglas, IM2 4RB, Isle of Man 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 49.00% 12th Floor, Narain Manzil, 23, Barakhamba Road, New Delhi 110001, India 25.83% ICICI PruLife Towers, 1089 Appasaheb Marathe Marg, Prabhadevi, Mumbai 400025, India 25.83% 49.00% 12th Floor, Narain Manzil, 23, Barakhamba Road, New Delhi 110001, India 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 290 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units Classes of shares held Proportion held Registered office address and country of incorporation OS OS OS LPI LPI OS OS LPI LPI OS OS LPI OS OS LPI LPI LPI LPI OS LPI OS OS LPI LPI OS OS LPI OS OS LPI LPI OS LPI LPI OS OS OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 100.00% 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 26.52% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 31.56% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 6, rue Eugène Ruppert, L‑245, Luxembourg 33.04% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 34.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 62.22% Boundary House, 91‑93 Charterhouse Street, London, EC1M 6HR, UK 35.00% 100.00% 100 West 10th Street, Wilmington, DE 19801, USA 100.00% 208 South LaSalle Street, Chicago, IL 60604, USA 100.00% 314 East Thayer Avenue, Bismarck, ND 58501, USA NSB 100.00% 1 Corporate Way, Lansing, MI 48951, USA OS OS OS OS OS OS LPI MI OS OS OS LPI OS OS LPI 100.00% 1105 North Market Street, Suite 1300, Wilmington, DE 19801, USA 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% Cedar House, Hamilton, Bermuda 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% 2900 Westchester Avenue, Suite 305, Purchase, NY 10577, USA 21.92% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% 99.98% 53 Merrion Square South, Dublin 2, D02 PR63, Ireland 100.00% 5, rue Guillaume Kroll, L‑1882, Luxembourg 100.00% Montague House, Adelaide Road, Dublin 2, D02 K039, Ireland 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 100.00% Name of entity Infracapital F1 GP2 Limited Infracapital F2 GP1 Limited Infracapital F2 GP2 Limited Infracapital GP 1 LLP Infracapital GP 2 LLP Infracapital GP II Limited Infracapital GP Limited Infracapital Greenfield DF GP LLP Infracapital Greenfield Partners 1 SLP GP LLP Infracapital Greenfield Partners 1 SLP GP1 Limited Infracapital Greenfield Partners 1 SLP GP2 Limited Infracapital Greenfield Partners I Employee Feeder GP LLP Infracapital Greenfield Partners I GP 1 Limited Infracapital Greenfield Partners I GP 2 Limited Infracapital Greenfield Partners I GP LLP Infracapital Greenfield Partners I LP Infracapital Greenfield Partners I SLP2 GP LLP Infracapital Greenfield Partners I Subholdings GP LLP Infracapital Greenfield Partners I Subholdings GP1 Limited Infracapital Long Term Income Partners GP LLP Infracapital Long Term Income Partners GP 1 Limited (In liquidation) Infracapital Long Term Income Partners GP 2 Limited (In liquidation) Infracapital Partners II LP Infracapital Partners II Subholdings GP LLP Infracapital Partners II Subholdings GP1 Limited Infracapital Partners III GP SARL Infracapital Partners LP Infracapital RF GP Limited Infracapital Sisu GP Limited Infracapital SLP II GP LLP Infracapital SLP II LP Infracapital SLP Limited Innisfree M&G PPP LP Innisfree M&G PPP LLP INVEST Financial Corporation Insurance Agency Inc, of Delaware INVEST Financial Corporation Insurance Agency Inc, of Illinois Investment Centers of America, Inc Jackson Charitable Foundation, Inc Jackson Holdings, LLC Jackson National Asset Management, LLC Jackson National Life (Bermuda) Limited Jackson National Life Distributors, LLC Jackson National Life Insurance Company Jackson National Life Insurance Company of New York Jefferies Capital Partners V, LP JNL Strategic Income Fund, LLC Lion Credit Opportunity Fund plc – Credit Opportunity Fund XV LIPP SARL (In liquidation) Livicos Limited London Stone Investments F3 Employee Feeder GP LLP London Stone Investments F3 I Limited London Stone Investments F3 II Limited London Stone Investments F3 SP GP LLP www.prudential.co.uk Annual Report 2017 Prudential plc 291 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity M&G (Guernsey) Limited M&G (Lux) Investment Funds 1 ‑ M&G (Lux) Floating Rate High Yield Solution M&G Alternatives Investment Management Limited M&G Asia Property Fund M&G Corporate Bond Fund M&G Dividend Fund M&G Episode Defensive Fund M&G Episode Macro Fund M&G European Credit Investment Fund M&G European High Yield Credit Investment Fund M&G European Property Fund SICAV‑FIS M&G European Secured Property Income Fund M&G European Select Fund M&G European Strategic Value Fund M&G Financial Services Limited M&G Founders 1 Limited M&G General Partner Inc M&G Gilt & Fixed Interest Income Fund M&G Global Corporate Bond Fund M&G Global Credit Investment Fund M&G Global Leaders Fund M&G Global Select Fund M&G IMPPP 1 Limited M&G International Investments Limited M&G International Investments Nominees Limited M&G International Investments SA M&G International Investments Switzerland AG M&G Investment Funds (10) ‑ M&G Absolute Return Bond Fund M&G Investment Funds (10) ‑ M&G Global Listed Infrastructure Fund M&G Investment Management Limited M&G Investments (Hong Kong) Limited M&G Investments (Singapore) Pte. Ltd. M&G Investments Japan Co., Ltd. M&G Limited M&G Luxembourg SA M&G Managed Growth Fund M&G Management Services Limited M&G Nominees Limited M&G Pan European Dividend Fund M&G PFI 2018 GP LLP M&G PFI 2018 GP1 Limited M&G PFI 2018 GP2 Limited M&G PFI Carry Partnership 2016 LP M&G PFI Partnership 2018 LP M&G Platform Nominees Limited M&G Prudential Limited M&G RE Espana 2016 S.L. M&G Real Estate Asia Holding Company Pte. Ltd. M&G Real Estate Asia Pte. Ltd. M&G Real Estate Debt Fund LP M&G Real Estate Funds Management SARL Classes of shares held OS OS OS OS OS OS OS OS OS OS OS U OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS LPI OS OS LPI LPI OS OS OS OS OS LPI OS Proportion held Registered office address and country of incorporation 100.00% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT 93.99% 49, Avenue J.F. Kennedy, L‑1855, Luxembourg 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 54.49% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 25.71% Laurence Pountney Hill, London, EC4R 0HH, UK 55.09% 91.64% 22.83% 99.98% 80, route d’Esch, L‑1470, Luxembourg 100.00% 51.86% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 22.97% 39.97% Laurence Pountney Hill, London, EC4R 0HH, UK 71.25% 100.00% 100.00% 100.00% Walker House, 87 Mary Street, Grand Cayman, KY1‑9002, Cayman Islands 45.22% Laurence Pountney Hill, London, EC4R 0HH, UK 31.25% 67.28% 80, route d’Esch, L‑1470, Luxembourg 24.91% Laurence Pountney Hill, London, EC4R 0HH, UK 20.09% 100.00% 100.00% 100.00% 100.00% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 100.00% Talstrasse 66, 8001 Zurich, Switzerland 50.23% Laurence Pountney Hill, London, EC4R 0HH, UK 64.83% 100.00% 100.00% 6th Floor, Alexandra House, 18 Chater Road, Central, Hong Kong 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 100.00% 3‑1 Toranomon, 4 Chome, Minato‑ku, Tokyo, Japan 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 26.14% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 25.74% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 25.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% Plaza de Colon, Torre II, Planta 14, 28046, Madrid, Spain 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 100.00% 29.20% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT 100.00% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 292 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units Classes of shares held Proportion held Registered office address and country of incorporation OS OS OS LPI LPI OS OS OS OS OS LPI OS OS OS LPI OS LPI OS OS OS OS OS LPI OS OS OS OS LPI LPI OS OS LPI OS OS OS LPI OS OS OS OS OS OS LPI OS OS OS OS OS OS 100.00% 9th Floor, Shiroyama Trust Tower, 4‑3‑1 Toranomon, Minato‑ku, Tokyo, 105‑ 6009, Japan 100.00% 17th Floor, Kyobo Building 1, Jongno, Jongno ‑Gu, Seoul, Korea 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey, GY1 1WG 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 28.00% 100.00% 100.00% Third Floor, La Plaiderie Chambers, La Plaiderie, St Peter Port, Guernsey, GY1 1WG 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 25.00% 100.00% 44.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 78 Sir John Rogerson’s Quay, Dublin 2, D02 RK57, Ireland 48.32% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 50.00% 40 Broadway, London, SW1H 0BU, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 45.00% Via Romagnosi 18/a, 00196 Roma, Italy 75.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 1999 Bryan Street, Suite 900, Dallas, TX 75201, USA 100.00% c/o Mazars LLP, 90 St. Vincent Street, Glasgow, G2 5UB, UK 21.07% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA 99.00% 300 E Lombard Street, Baltimore, MD 21202, USA 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn 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 12.50% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA 100.00% Barratt House Cartwright Way, Bardon Hill, Coalville, Leicestershire, LE67 1UF, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong 99.79% 8th Floor, No.1 Songzhi Road, Taipei 11047, Taiwan 100.00% Unit Level 13(A), Main Office Tower, Financial Park Labuan, Jalan Merdeka, 87000 Federal Territory of Labuan, Malaysia 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK Name of entity M&G Real Estate Japan Co., Ltd. M&G Real Estate Korea Co., Ltd. M&G Real Estate Limited M&G Real Estate UK Enhanced Value LP M&G Real Estate UKEV (GP) LLP M&G RED Employee Feeder GP Limited M&G RED GP Limited M&G RED II Employee Feeder GP Limited M&G RED II GP Limited M&G RED II SLP GP Limited M&G RED II SLP LP M&G RED III Employee Feeder GP Limited M&G RED III GP Limited M&G RED III SLP GP Limited M&G RED III SLP LP M&G RED SLP GP Limited M&G RED SLP LP M&G RPF GP Limited M&G RPF Nominee 1 Limited M&G RPF Nominee 2 Limited M&G Securities Limited M&G SIF Management Company (Ireland) Limited M&G UK Companies Financing Fund II LP M&G UK Property GP Limited M&G UK Property Nominee 1 Limited M&G UK Property Nominee 2 Limited M&G UKCF II GP Limited M&G UKEV (SLP) General Partner LLP M&G UKEV (SLP) LP Manchester JV Limited Manchester Nominee (1) Limited MCF S.r.l Minster Court Estate Management Limited Mission Plans of America, Inc MM&S (2375) Limited (In liquidation) Murphy & Partners Fund, LP NAPI REIT, Inc National Planning Corporation National Planning Holdings, Inc North Sathorn Holdings Company Limited Nova Sepadu Sdn. Bhd. (In liquidation) Oaktree Business Park Limited Old Kingsway, LP Optimus Point Management Company Limited Pacus (UK) Limited PCA IP Services Limited PCA Life Assurance Co. Ltd. PCA Reinsurance Co. Ltd. PGDS (UK One) Limited www.prudential.co.uk Annual Report 2017 Prudential plc 293 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity PGDS (US One), LLC PGF Management Company (Ireland) Limited PPM America Capital Partners II, LLC PPM America Capital Partners III, LLC PPM America Capital Partners IV, LLC PPM America Capital Partners V, LLC PPM America Capital Partners VI, LLC PPM America Capital Partners, LLC 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 PPM America, Inc PPM Capital (Holdings) Limited PPM CLO 2018‑1 Ltd. PPM Finance, Inc PPM Holdings, Inc PPM Loan Management Company LLC PPM Loan Management Holding Company LLC PPM Managers GP Limited PPM Managers Partnership CI VII (A) LP PPM Ventures (Asia) Limited (In liquidation) PPMC First Nominees Limited Prenetics Limited Property Partners (Two Rivers) Limited Pru Life Insurance Corporation of U.K. Pru Limited Prudence Foundation Prudence Limited Prudential (Cambodia) Life Assurance Plc Prudential / M&G UKCF GP Limited Prudential Africa Holdings Limited Prudential Africa Services Limited Prudential Assurance Company Singapore (Pte) Limited Prudential Assurance Malaysia Berhad Prudential Assurance Uganda Limited Prudential BSN Takaful Berhad Prudential Capital (Singapore) Pte. Ltd. Prudential Capital plc Prudential Corporate Pensions Trustee Limited Prudential Corporation Australasia Holdings Pty Limited Prudential Corporation Holdings Limited Prudential Credit Opportunities 1 SARL Prudential Credit Opportunities GP SARL Prudential Credit Opportunities SCSP Classes of shares held Proportion held Registered office address and country of incorporation OS OS MI MI MI MI MI MI LPI LPI LPI LPI LPI LPI OS OS PS OS OS MI MI OS LPI OS OS PS OS OS OS LBG OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 50.00% 5 George’s Dock, Dublin 1, D01 X8N7, Ireland 63.45% 874 Walker Road, Suite C, Dover, DE 19904, USA 60.50% 34.50% 34.00% 32.00% 52.50% 99.81% 99.81% 99.84% 99.60% 99.84% 99.85% 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% Queensgate House, South Church Street, George Town, Grand Cayman KY1‑1102, Cayman Islands 100.00% 874 Walker Road, Suite C, Dover, DE 19904, USA 100.00% 100.00% 100.00% 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 25.00% 100.00% Gloucester Tower, 15 Queens Road, Central, Hong Kong 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 15.00% 7th Floor, Prosperity Millennia Plaza, 663 King’s Road, North Point, Hong Kong 50.00% Bow Bells House, 1 Bread Street, London, EC4M 9HH, UK 100.00% 9th Floor, Uptown Place Tower 1, 1 East 11th Drive, Uptown Bonifacio, 1634 Taguig City, Metro Manila, Philippines 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 20th Floor, #445, Monivong Blvd, Boeung Prolit, 7 Makara, Phnom Penh Tower, Phnom Penh, Cambodia 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 5th Ngong Avenue, Nairobi, Kenya 100.00% 30 Cecil Street, #30‑01 Prudential Tower, Singapore 049712 51.00% Level 3, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia 100.00% Kampala Road, Kampala, Uganda 49.00% Level 8A, Menara Prudential, No. 10 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% c/o Highgate Legal Pty Limited, 33 Lexington Drive, Bella Vista, NSW 2153, Australia 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 1, Rue Hildegard von Bingen, L‑1282 Luxembourg 100.00% 100.00% 294 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units Classes of shares held Proportion held Registered office address and country of incorporation OS PS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS LPI OS OS LPI LPI OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS OS PS OS OS OS OS OS OS OS OS OS OS 100.00% 100.00% c/o Mazars LLP, 45 Church Street, Birmingham, B3 2RT, UK 100.00% Craigforth, Stirling, FK9 4UE, UK 100.00% IFSC, North Wall Quay, Dublin 1, D01 H104, Ireland 29.81% 17 Rochester Row, London, SW1P 1QT, UK 31.51% 36.60% 38.09% 35.42% 61.66% 42.94% 28.38% 31.01% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% c/o Mazars LLP, 90 St. Vincent Street, Glasgow, G2 5UB, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 59th Floor, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong 100.00% Prudential House, Mumbai, India 100.00% Craigforth, Stirling, FK9 4UE, UK 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 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% Craigforth, Stirling, FK9 4UE, UK 100.00% 59th Floor, One Island East, 18 Westlands Road, Quarry Bay, Hong Kong 100.00% Montague House, Adelaide Road, Dublin 2, D02 K039, Ireland 100.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 34‑38, Avenue de la Liberté, L‑1930, Luxembourg 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% Unit A, 6th Floor, Vientiane Plaza Hotel Office Building, Sailom Road, Hatsady Neua Village, Chanthabouly District, Vientiane Capital, Lao PDR 99.93% 9/9 Sathorn Building, 20th– 27th Floor, South Sathorn Road, Yannawa, Sahtorn, Bangkok 10120, Thailand 100.00% 5th Ngong Avenue, Nairobi, Kenya 100.00% Prudential House, Thabo Mbeki Road, Lusaka, Zambia 100.00% 35 North Street, Accra, Ghana 100.00% 100.00% Craigforth, Stirling, FK9 4UE, UK 100.00% 1, Rue Hildegard von Bingen, L ‑ 1282 Luxembourg 100.00% 100.00% 100.00% Suite 450, 4th Floor, Barkly Wharf East, Le Caudan Waterfront, Port Louis, Mauritius 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 49.00% Prudential House, Thabo Mbeki Road, Lusaka, Zambia 100.00% 02‑670 Warszawa, Pulawska 182, Poland 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK Name of entity Prudential Development Management Limited (In liquidation) Prudential Distribution Limited Prudential Dublin Investments Limited (In liquidation) 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 Prudential Dynamic Focused 0‑30 Portfolio Prudential Dynamic Focused 20 ‑ 55 Portfolio Prudential Dynamic Focused 40‑80 Portfolio Prudential Dynamic Focused 60‑100 Portfolio Prudential Equity Release Mortgages Limited Prudential Europe Assurance Holdings Limited (In liquidation) Prudential Financial Planning Limited Prudential Five Limited Prudential General Insurance Hong Kong Limited Prudential Global Services Private Limited Prudential GP Limited Prudential Greenfield GP LLP Prudential Greenfield GP1 Limited Prudential Greenfield GP2 Limited Prudential Greenfield LP Prudential Greenfield SLP GP LLP Prudential Group Pensions Limited Prudential Group Secretarial Services Limited Prudential Holborn Life Limited Prudential Holdings Limited Prudential Hong Kong Limited Prudential International Assurance plc Prudential International Management Services Limited Prudential International Staff Pensions Limited Prudential Investment (Luxembourg) 2 SARL Prudential Investments Limited Prudential IP Services Limited Prudential Life Assurance (Lao) Company Limited Prudential Life Assurance (Thailand) Public Company Limited Prudential Life Assurance Kenya Limited Prudential Life Assurance Zambia Limited Prudential Life Insurance Ghana Limited Prudential Lifetime Mortgages Limited Prudential Loan Investments 1 SARL Prudential Loan Investments GP SARL Prudential Loan Investments SCSp Prudential Mauritius Holdings Limited Prudential Mortgages Limited Prudential Nominees Limited Prudential Pensions Limited Prudential Pensions Management Zambia Limited Prudential Polska sp. z.o.o Prudential Portfolio Management Group Limited www.prudential.co.uk Annual Report 2017 Prudential plc 295 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationD Other notes continued D6 Investments in subsidiary undertakings, joint ventures and associates continued Name of entity Prudential Portfolio Managers (South Africa) (Pty) Limited Classes of shares held Proportion held Registered office address and country of incorporation OS A Class OS 49.99% 75.00% PO Box 44813, Claremont 7735, South Africa Prudential Portfolio Managers Limited Prudential Properties Trusty Pty Limited Prudential Property Holding Limited Prudential Property Investment Managers Limited Prudential Property Investments Limited Prudential Protect Limited Prudential Real Estate Investments 1 Limited Prudential Real Estate Investments 2 Limited Prudential Real Estate Investments 3 Limited Prudential Retirement Income Limited (In liquidation) Prudential Services Asia Sdn. Bhd. Prudential Services Limited Prudential Services Singapore Pte. Ltd. Prudential Singapore Holdings Pte. Limited Prudential Staff Pensions Limited Prudential Trustee Company Limited Prudential UK Real Estate General Partner Limited Prudential UK Real Estate LP Prudential UK Real Estate Nominee 1 Limited Prudential UK Real Estate Nominee 2 Limited Prudential UK Services Limited Prudential Unit Trusts Limited Prudential Venture Managers Limited Prudential Vietnam Assurance Private Limited Prudential Vietnam Finance Company Limited Prudential/M&G UK Companies Financing Fund LP Prutec Limited PT. Eastspring Investments Indonesia PT. Prudential Life Assurance PVFC Financial Limited PVM Partnerships Limited Randolph Street LP REALIC of Jacksonville Plans, Inc Reksa Dana Eastspring IDR Fixed Income Fund (NDEIFF) Reksa Dana Eastspring Investments Cash Reserve Reksa Dana Eastspring Investments IDR High Grade Reksa Dana Eastspring Investments Value Discovery Reksa Dana Eastspring Investments Yield Discovery Reksa Dana Syariah Eastspring Syariah Equity Islamic Asia Pacific USD Reksa Dana Syariah Eastspring Syariah Fixed Income Amanah Rhodium Investment Fund Rift GP 1 Limited Rift GP 2 Limited ROP, Inc ScotAm Pension Trustees Limited Scottish Amicable Finance plc Scottish Amicable Holdings Limited OS OS OS OS OS PS OS OS OS OS OS PS OS PS OS OS OS OS OS OS LPI OS OS OS OS OS OS OS LPI OS OS OS OS OS LPI OS OS U OS OS OS OS OS OS OS OS OS OS OS OS 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% Darling Park Tower 2, 201 Sussex Street, Sydney, NSW 2000, Australia 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% c/o Mazars LLP, 90 St. Vincent Street, Glasgow, G2 5UB, UK 100.00% 100.00% Suite 1005, 10th Floor, Wisma Hamzah‑Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 1 Wallich Street, #19‑01 Guoco Tower, Singapore 078881 100.00% 30 Cecil Street, #30‑01 Prudential Tower, Singapore 049712 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Craigforth, Stirling, FK9 4UE, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 25th Floor, Saigon Trade Centre, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam 100.00% 23rd Floor, Saigon Trade Centre, 37 Ton Duc Thang Street, District 1, Ho Chi Minh City, Vietnam 34.42% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 99.95% 23rd Floor, Prudential Tower, JI. Jendral Sudirman Kav. 79, 12910, Jakarta Selatan, Indonesia 94.62% 100.00% 13th Floor, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 2711 Centreville Road, Suite 400, Wilmington, DE 19808, USA 100.00% 1999 Bryan Street, Suite 900, Dallas, TX 75201, USA 100.00% 23rd Floor, Prudential Tower, JI. Jendral Sudirman Kav. 79, 12910, Jakarta Selatan, Indonesia 100.00% 44.09% 89.60% 79.21% 99.90% 96.82% 100.00% 10 Marina Boulevard, #32‑01, Marina Bay Financial Centre, Singapore 018983 100.00% 50 Lothian Road, Festival Square, Edinburgh, EH3 9WJ, UK 100.00% 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% Craigforth, Stirling, FK9 4UE, UK 100.00% 100.00% 296 Prudential plc Annual Report 2017 www.prudential.co.uk Key to Classes of shares held LBG LPI MI NSB OS PI PS U Limited by Guarantee Limited Partnership Interest Membership Interest Non‑stock basis Ordinary Shares Partnership Interest Preference Shares Units Name of entity Classes of shares held Proportion held Registered office address and country of incorporation Scottish Amicable Life Assurance Society No share capital 100.00% Craigforth, Stirling, FK9 4UE, UK Scottish Amicable Pensions Investments Limited Scotts Spazio Pte. Ltd. Sealand (No 1) Limited Sealand (No 2) Limited Sectordate Limited Selly Oak Shopping Park (General Partner) Limited Selly Oak Shopping Park (Nominee 1) Limited Selly Oak Shopping Park (Nominee 2) Limited SII Investments, Inc Silverfleet Capital 2004 LP Silverfleet Capital 2005 LP Silverfleet Capital 2006 LP Silverfleet Capital 2008 LP Silverfleet Capital 2009 LP Silverfleet Capital 2011/12 LP Silverfleet Capital II WPLF Smithfield Limited SM, LLC Squire Capital I, LLC Squire Capital II, LLC Squire Reassurance Company II, Inc Squire Reassurance Company, LLC Sri Han Suria Sdn. Bhd. St Edward Homes Limited St Edwards Strand Partnership Stableview Limited Staple Limited Staple Nominees Limited Thanachart Life Assurance Public Company Limited (In liquidation) The Car Auction Unit Trust The First British Fixed Trust Company Limited The Greenpark (Reading) LP The Heights Management Company Limited The Hub (Witton) Management Company Limited (In liquidation) The St Edward Homes Partnership The Strand Property Unit Trust The Two Rivers Trust Three Snowhill Birmingham SARL Two Rivers LP Two Snowhill Birmingham SARL US Strategic Income Bond Fund D USD Acc VFL International Life Company SPC, Ltd. Warren Farm Office Village Limited (In liquidation) Wessex Gate Limited Westwacker Limited Wynnefield Private Equity Partners I, LP Wynnefield Private Equity Partners II, LP Zenith‑Prudential Life Insurance Company Limited OS OS OS OS OS OS OS OS OS LPI LPI LPI LPI LPI LPI LPI OS LPI MI OS OS OS 100.00% 45.00% 30 Cecil Street, #23‑02, Prudential Tower, Singapore 049712 100.00% Lime Grove House, Green Street, St Helier, Jersey, JE1 2ST 100.00% 32.60% 5th Floor Cavendish House, 39 Waterloo Street, Birmingham, B2 5PP, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 100.00% 100.00% 5555, Grande Market Drive, Appleton, WI 54912, 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% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 1209 Orange Street, Wilmington, DE 19801, USA 100.00% 1 Corporate Way, Lansing, MI 48951, USA 100.00% 100.00% 40600 Ann Arbor Road, East Suite 201, Plymouth, MI 48170, USA 100.00% 1 Corporate Way, Lansing, MI 48951, USA OS PS (A & B) 51.00% 100.00% Suite 1005, 10th Floor Wisma Hamzah‑Kwong Hing, No. 1 Leboh Ampang, 50100 Kuala Lumpur, Malaysia OS OS OS OS OS OS OS OS LPI OS OS OS LPI OS OS LPI OS OS OS OS OS OS LPI LPI OS 50.00% Berkeley House, 19 Portsmouth Road, Cobham, Surrey, KT11 1JG, UK 50.00% 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 3 Rajanakarn Building, 20th Floor, South Sathorn Road, Yannawa Subdistrict, Sathorn District, Bangkok, Thailand 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 99.93% 9/9 Sathorn Building, 25th Floor, South Sathorn Road, Yannawa, Sathorn, Bangkok 10120, Thailand 50.00% Dorey Court, Admiral Park, St. Peter Port, Guernsey, GY1 2HT 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 50.00% 100.00% 49.95% Berkeley House, 19 Portsmouth Road, Cobham, Surrey, KT11 1JG, UK 50.00% Liberte house, 19‑23 La Motte Street, St Helier, Jersey, JE2 4SY 50.00% 100.00% 5, rue Guillaume Kroll, L‑1882, Luxembourg 50.00% Bow Bells House, 1 Bread Street, London, EC4M 9HH, UK 100.00% 5, rue Guillaume Kroll, L‑1882, Luxembourg 96.36% 26, Boulevard Royal, L‑2449, Luxembourg 100.00% 171 Elgin Avenue, Grand Cayman, Cayman Islands 100.00% c/o Mazars LLP, 45 Church Street, Birmingham, B3 2RT, UK 100.00% Laurence Pountney Hill, London, EC4R 0HH, UK 100.00% 99.00% 1105 North Market Street, Suite 1300, Wilmington, DE 19801, USA 99.00% 1209 Orange Street, Wilmington, DE 19801, USA 51.00% Plot 280, Ajose Adeogun Street, Victoria Island, Nigeria www.prudential.co.uk Annual Report 2017 Prudential plc 297 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationE1 Other Significant accounting policies In addition to the critical accounting polices 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. 298 Prudential plc Annual Report 2017 www.prudential.co.uk E Further accounting policiesWhere 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, the majority of which are actively traded in a liquid market. The Group consolidates the vehicles that hold the investments where the Group is deemed to control the vehicles. When assessing control over the vehicles, the factors considered include the purpose and design of the vehicle, the Group’s exposure to the variability of returns and the scope of the Group’s ability to direct the relevant activities of the vehicle including any kick‑out or removal rights that are held by third parties. The outcome of the control assessment is dependent on the terms and conditions of the respective individual arrangements. The majority of such vehicles are not consolidated. In these cases 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 2017 £m 2016 £m OEICs/UTs Separate account assets Other structured entities OEICs/UTs Separate account assets Other structured entities 20,718 130,528 – – – 10,894 16,489 – 120,411 – 20,718 130,528 10,894 16,489 120,411 – 12,220 12,220 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 2017, 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. www.prudential.co.uk Annual Report 2017 Prudential plc 299 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationE1 Other continued 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. See note A3.1 for further details of valuation of financial investments. 300 Prudential plc Annual Report 2017 www.prudential.co.uk E Further accounting policies continued(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 2017 and 2016. 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’s derivative programme see note A3.1. (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 measured in accordance with IAS 39. 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. (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. www.prudential.co.uk Annual Report 2017 Prudential plc 301 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationE1 Other continued 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, following a reorganisation during the year, is by business units Asia, US and UK and Europe. All business units contain both insurance and asset management operations. 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. 302 Prudential plc Annual Report 2017 www.prudential.co.uk E Further accounting policies continued(k) Tax Prudential is subject to tax in numerous jurisdictions and the calculation of the total tax charge inherently involves a degree of estimation and judgement. 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. 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 charged to the income statement 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. For further details see note C5(a). (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 note A3.1(c). 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. Impairment testing is conducted when there is an indication of impairment. (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. www.prudential.co.uk Annual Report 2017 Prudential plc 303 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationE1 Other continued Significant accounting policies continued (q) Share capital Shares are classified as equity when their terms do not create an obligation to transfer assets. 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. 304 Prudential plc Annual Report 2017 www.prudential.co.uk E Further accounting policies continuedStatement of financial position of the parent company 31 December Fixed assets Investments 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 2017 £m 2016 £m 5 6 7 8 8 6 9 8 8 8 10 10 11 10,798 10,859 4,732 5 40 5 71 143 4,996 (485) (600) (443) (715) (10) (12) (79) (2,344) 2,652 13,450 (5,272) (549) – (5,821) 7,629 129 1,948 5,552 7,629 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 1,235 840 The financial statements of the parent company on pages 305 to 313 were approved by the Board of Directors on 14 March 2018 and signed on its behalf. Paul Manduca Chairman Mike Wells Group Chief Executive Mark FitzPatrick Chief Financial Officer www.prudential.co.uk Annual Report 2017 Prudential plc 305 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationStatement of changes in equity of the parent company 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 Balance at 1 January 2017 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 2017 Share capital £m 128 Share premium £m Profit and loss account £m 1,915 5,866 Total equity £m 7,909 840 4 844 13 6 (1,267) (1,248) 7,505 – – – 12 – – 12 1,927 840 4 844 – 6 (1,267) (1,261) 5,449 1,927 5,449 7,505 – – – 21 – – 21 1,235 28 1,263 – (1) (1,159) (1,160) 5,552 1,235 28 1,263 21 (1) (1,159) (1,139) 7,629 129 1,948 – – – 1 – – 1 129 129 – – – – – – – 306 Prudential plc Annual Report 2017 www.prudential.co.uk Notes 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 operations in Asia, the US, UK and Europe and Africa. In Asia, the Group has operations in Hong Kong, Indonesia, Malaysia, Singapore and other markets. In the US, the Group’s principal subsidiary is Jackson National Life Insurance Company. In UK and Europe, the Group operates through its subsidiaries, primarily The Prudential Assurance Company Limited and M&G Investment Management Limited. In August 2017 the Company announced that it was bringing together M&G with Prudential’s UK and European savings and retirement business to form M&G Prudential. 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 disclosures, 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’. In 2017, the Company adopted Amendments to IAS 12, ‘Income Taxes’ (recognition of deferred tax assets) and Annual Improvements to IFRSs 2014‑2016 Cycle. Their adoption had no material impact on the financial statements of the Company. 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 Investments in subsidiary undertakings Investments 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. www.prudential.co.uk Annual Report 2017 Prudential plc 307 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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 Benefit’ (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 yield, 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. 308 Prudential plc Annual Report 2017 www.prudential.co.uk Notes on the parent company financial statements continued4 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 2017, 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 2017 £m 2016 £m 1,235 1,155 2,390 840 1,081 1,921 2017 £m 2016 £m 7,629 8,458 7,505 7,161 16,087 14,666 * 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 £1,685 million and £1,318 million for the years ended 31 December 2017 and 2016, 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 Investments in subsidiary undertakings At 1 January Liquidation of subsidiary undertakings Other movements At 31 December 2017 £m 2016 £m 10,859 – (61) 10,798 12,514 (1,600) (55) 10,859 The liquidation in 2016 related to a central finance subsidiary in order to simplify the Group’s corporate structure. Other movements comprise £6 million (2016: £6 million) in respect of share‑based payments, reflecting the value of payments settled by the Company for employees of its subsidiary undertakings, less £67 million (2016: £61 million) relating to cash received from subsidiaries in respect of share awards. Subsidiary undertakings of the Company at 31 December 2017 are listed in note D6 of the Group financial statements. 6 Derivative financial instruments Cross‑currency swap Inflation‑linked swap Total 2017 £m 2016 £m Fair value assets Fair value liabilities Fair value assets Fair value liabilities 5 – 5 – 443 443 4 – 4 – 447 447 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 gain before tax of £5 million (2016: loss of £122 million). www.prudential.co.uk Annual Report 2017 Prudential plc 309 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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 2017. 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, which was finalised in 2015. The triennial valuation for the Scheme as at 5 April 2017 is ongoing and expected to be finalised in the second quarter of 2018. 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 2017, 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 obligation 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 2017 £m 31 Dec 2016 £m Quoted prices in an active market Other Total Quoted prices in an active market Other Total 9 216 5,040 1,430 156 – 188 192 7,231 – 10 – 61 8 140 – 24 243 9 226 5,040 1,491 164 140 188 216 7,474 (6,753) 721 (485) 236 71 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 * 93 per cent (2016: 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. 310 Prudential plc Annual Report 2017 www.prudential.co.uk Notes on the parent company financial statements continuedThe 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 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) 7,627 – 193 (6) 40 11 – (391) 7,474 (6,910) (26) (175) – (33) – – 391 (6,753) 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) 2017 £m Net surplus without the effect of IFRIC 14 Effect of IFRIC 14 for de- recognition of surplus IAS 19 basis net surplus 717 (26) 18 (6) 7 11 – – 721 (558) – (14) – 87 – – – (485) 159 (26) 4 (6) 94 11 – – 236 2016 £m Net surplus without the effect of IFRIC 14 Effect of IFRIC 14 for de- recognition 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 Notes (i) The weighted average duration of the benefit obligations of the Scheme is 17 years (2016: 18 years). The following table provides an expected maturity analysis of the undiscounted benefit obligations as at 31 December: £m 2017 2016 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 238 227 1,030 1,013 1,445 1,439 1,452 1,474 1,375 1,407 5,554 5,930 Total 11,094 11,490 (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) – financial assumptions Total actuarial gains (losses) without the effect of IFRIC 14 Actuarial gains attributable to the Company before tax† 2017 £m 2016 £m 40 70 (10) (93) (33) 7 34 949 87 (32) (1,281) (1,226) (277) 4 * The total return on Scheme assets in 2017 was a gain of £233 million (2016: £1,199 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 2017, the gains included a credit of £31 million (2016: £87 million) for the adjustment to the unrecognised portion of surplus. The gains after tax of £28 million (2016: £4 million) are recorded in other comprehensive income. (iii) Employer contributions to be paid into the Scheme for the year ending 31 December 2018 are expected to amount to £10 million, comprising ongoing service contributions and expenses. www.prudential.co.uk Annual Report 2017 Prudential plc 311 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information8 Borrowings Core structural borrowings note (i) Subordinated liabilities note (ii) Debenture loans Other borrowings: note (iii) Commercial paper 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 2017 £m 2016 £m 2017 £m 2016 £m 2017 £m 2016 £m 5,272 549 5,821 – – 5,772 549 6,321 – – 5,821 6,321 – – 5,821 5,821 – – 6,321 6,321 – – – 485 600 1,085 1,085 – – 1,085 – – – 1,052 599 1,651 1,052 599 – 1,651 5,272 549 5,821 485 600 6,906 1,085 – 5,821 6,906 5,772 549 6,321 1,052 599 7,972 1,052 599 6,321 7,972 Notes (i) (ii) (iii) 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. 9 Deferred tax liability Deferred tax liability Short‑term temporary differences related to pension scheme Total 2017 £m 2016 £m (12) (12) (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 did not have a material impact on the financial statements for the year ended 31 December 2017. 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 2017 is set out in note C10 of the Group financial statements. 312 Prudential plc Annual Report 2017 www.prudential.co.uk Notes on the parent company financial statements continued11 Retained profit of the Company Retained profit at 31 December 2017 amounted to £5,552 million (2016: £5,449 million). The retained profit includes distributable reserves of £3,066 million and non‑distributable reserves of £2,486 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 in previous years and £81 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 intra‑group 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. The retained profit of the Company is substantially generated from dividend income received from subsidiaries. The Group segmental analysis illustrates the generation of profit across the Group (see note B1 of the Group financial statements). The Group and its subsidiaries are subject to local regulatory minimum capital requirements, as set out in note C12 of the Group financial statements. A number of the principal risks set out in the ’Report on the risks facing our business and how these are managed’ could impact the generation of profit in the Group’s subsidiaries in the future and hence impact their ability to pay dividends in the future. In determining the dividend payment in any year the directors follow the Group dividend policy described in the Chief Financial Officer’s report section of this Annual Report. The directors consider the Company’s ability to pay current and future dividends twice a year by reference to the Company’s business plan and certain stressed scenarios. 12 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 B2.3 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 (2016: £0.1 million) and for other services were £0.1 million (2016: £0.1 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 2017, which was approved by the Board of Directors after 31 December 2017, is described in note B6 of the Group financial statements. Intention to demerge the Group’s UK businesses In March 2018, the Group announced its intention to demerge its UK and Europe business (‘M&G Prudential’) from Prudential plc, resulting in two separately listed companies. In preparation for the UK demerger process, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019. Sale of £12.0 billion* UK annuity portfolio In March 2018, M&G Prudential also announced the sale of £12.0 billion* of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion* of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. Further details are set out in the CFO report. * Relates to £12.0 billion of IFRS shareholder annuity liabilities, valued as at 31 December 2017. www.prudential.co.uk Annual Report 2017 Prudential plc 313 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationStatement 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 83 to 87 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. 314 Prudential plc Annual Report 2017 www.prudential.co.uk Independent auditor’s report to the members of Prudential plc only 1 Our opinion is unmodified We have audited the financial statements of Prudential plc (‘the Group and parent company’) for the year ended 31 December 2017 which comprise: — The consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity, consolidated statement of financial position and consolidated statement of cash flows, and the related notes, including accounting policies in notes A3 and E1; and — The statement of financial position, statement of changes in equity, and the related notes, including the significant accounting policies in note 3 of the parent company financial statements. 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 2017 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. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (‘ISAs (UK)’) and applicable law. Our responsibilities are described below. We believe that the audit evidence we have obtained is a sufficient and appropriate basis for our opinion. Our audit opinion is consistent with our report to the audit committee. We were appointed as auditor by the shareholders in October 1999. The period of total uninterrupted engagement is the 19 years ended 31 December 2017. We have fulfilled our ethical responsibilities under, and we remain independent of the Group in accordance with, UK ethical requirements including the Financial Reporting Council (‘FRC’) Ethical Standard as applied to listed public interest entities. No non‑audit services prohibited by that standard were provided. 2 Key audit matters: Our assessment of risks of material misstatement Key audit matters are those matters that, in our professional judgement, were of most significance in the audit of the financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. We summarise below the key audit matters, in decreasing order of audit significance, in arriving at our audit opinion above, together with our key audit procedures to address those matters and, as required for public interest entities, our results from those procedures. These matters were addressed, and our results are based on procedures undertaken, in the context of, and solely for the purpose of, our audit of the financial statements as a whole, and in forming our opinion thereon, and consequently are incidental to that opinion, and we do not provide a separate opinion on these matters. Valuation of policyholder liabilities (2017: £411,243 million, 2016: £388,996 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 168 (accounting policy) and pages 230 to 252 (financial disclosures) The risk Our response The Group has significant policyholder liabilities representing 86 per cent of the Group’s total liabilities. We used our own actuarial specialists to assist us in performing our procedures in this area. Subjective valuation 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, in addition to the appropriate design and calibration of reserving models. The specific application of these judgements to individual components is explained below. For the US component, the valuation of the guarantees in the variable annuity (‘VA’) business is complex 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. Our procedures included: Methodology choice We have assessed the methodology for selecting assumptions and calculating the policyholder liabilities. This included: — Applying our understanding of developments in the business and the impact of changes in methodology on the selection of assumptions; — Comparing changes in methodology to our expectations derived from market experience; and — Evaluating the analysis of the movements in policyholder liabilities during the year, including consideration of whether the movements were in line with the methodology and assumptions adopted. www.prudential.co.uk Annual Report 2017 Prudential plc 315 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationValuation of policyholder liabilities (2017: £411,243 million, 2016: £388,996 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 168 (accounting policy) and pages 230 to 252 (financial disclosures) The risk Our response For the UK component, the valuation of the policyholder liabilities in relation to the annuity business requires significant judgement over the setting of mortality, expenses and credit risk assumptions. This includes the use of complex modelling in order to determine the policyholder liabilities. For the Asia component, the valuation of the policyholder liabilities requires significant judgement over the setting of mortality and morbidity assumptions. Control operation Our procedures included testing of the design, implementation and operating effectiveness of key controls over the valuation process including assessment and approval of the methods and assumptions adopted over the calculation of policyholder liabilities as well as appropriate access and change management controls over the actuarial models. Our procedures for the US component also included: Historical comparison — Assessing the assumptions relating to policyholder behaviour by comparing to relevant company and industry historical experience data. Benchmarking assumptions and sector experience — Assessing the assumptions for investment mix and projected investment returns by comparing to company specific and industry data and for future growth rates by comparing to market trends and market volatility; and — Utilising the results of our industry benchmarking of assumptions and actuarial market practice to inform our challenge of assumptions in relation to policyholder behaviour, including the likely responses to projected changes in investment performance. Model evaluation — Assessing the reserving models by considering the accuracy of the cash flow projections including by reference to product features. We have also assessed the impact of modelling and assumption changes by inspecting pre‑ and post‑change model runs and comparing the outcomes of the changes to our expectations. Our procedures for the UK component also included: Historical comparison — Evaluating the evidence used to prepare the mortality experience investigation by reference to actual mortality experience of the policyholders in order to assess whether this supported the year‑end assumptions adopted; and — Assessing whether the expense assumptions appropriately reflect the expected future costs of administering the underlying policies by analysing current year unit costs and the likely impact of planned actions. Benchmarking assumptions and sector experience — Comparing mortality experience to industry data on current mortality and expectations of future mortality improvements; — Evaluating the credit risk assumptions by reference to industry practice and our expectation derived from market experience; and — Used the results of our industry benchmarking of assumptions and actuarial market practice to inform our challenge of the assumptions in relation to the mortality, credit risk and expense assumptions. 316 Prudential plc Annual Report 2017 www.prudential.co.uk Independent auditor’s report to the members of Prudential plc only continuedValuation of policyholder liabilities (2017: £411,243 million, 2016: £388,996 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 168 (accounting policy) and pages 230 to 252 (financial disclosures) The risk Our response Model evaluation — Evaluating the appropriateness of the calibration of the Continuous Mortality Investigation model adopted based on the analysis of the characteristics of the policyholder population and actual mortality experience. We used our own valuation models to perform an independent recalculation of a sample of policyholder liabilities to ensure that the selected model calibration has been appropriately implemented. Our procedures for the Asia component also included: Historical comparison — Evaluating the experience investigations in respect of the mortality and morbidity assumptions by reference to actual experience in order to assess whether this supported the year‑end assumptions adopted. Benchmarking assumptions — Used the results of our industry benchmarking of assumptions and actuarial market practice together with available industry data to inform our challenge of the assumptions in the areas noted above. Model evaluation — We have assessed the reserving models by checking the accuracy of the cash flow projections including by reference to product features. We have also assessed the impact of modelling and assumption changes by inspecting pre‑ and post‑change model runs and comparing the outcomes of the changes to our expectations. Assessing transparency We considered whether the disclosures in relation to the assumptions used in the valuation of policyholder liabilities are compliant with the relevant accounting requirements and appropriately represent the sensitivities of the liabilities to alternative scenarios and inputs. Our result We found the valuation of policyholder liabilities to be acceptable (2016: acceptable). www.prudential.co.uk Annual Report 2017 Prudential plc 317 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationValuation of investments (2017: £422,230 million, 2016: £393,584 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 174 (accounting policy) and pages 209 to 229 (financial disclosures) The risk Our response The Group’s investment portfolio represents 91 per cent of the Group’s total assets. We used our own valuation specialists in order to assist us in performing our procedures in this area. The portfolio of quoted investments and investments that are valued primarily using observable inputs, make up 89 per cent of the Group’s total assets (by value). We do not consider these investments to be at a high risk of significant misstatement, or to be subject to a significant level of judgement because they comprise liquid, quoted investments. However, due to their materiality in the context of the financial statements as a whole, they are considered to be one of the areas which had the greatest effect on our overall audit strategy and allocation of resources in planning and completing our audit. Subjective valuation The area that involved significant audit effort and judgement in 2017 was the valuation of harder to value 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. The valuation of the portfolio involves judgement depending on the observability of the inputs into the valuation and further judgement in determining the appropriate valuation methodology for harder to value investments where external pricing sources are either not readily available or are unreliable. Our procedures included: Methodology choice We assessed the appropriateness of the pricing methodologies with reference to relevant accounting standards and the Group’s own valuation guidelines as well as industry practice. For quoted investments: Tests of details We performed independent price checks using external quoted prices and by agreeing the observable inputs that were used in the Group’s valuation techniques to external data. For harder to value positions: Control operation We tested the design, implementation and operating effectiveness of key controls over the valuation process, including the Group’s review and approval of the estimates and assumptions used for the valuation including key authorisation and data input controls. Benchmarking assumptions We assessed a sample of the valuation assumptions with reference to the Group’s own valuation guidelines as well as industry practice. Tests of details We performed an inspection of files for loan securities on a sample basis by critically evaluating the performance of the loans and comparing this to the carrying value held. This included examining the existing and prospective investee company cash flows in order to assess whether the loans could be serviced or refinancing may be required, and to identify any potential impairment in relation to the loans. We critically evaluated the valuation assessment and resulting conclusions in order to determine the appropriateness of the valuations recorded. This included an evaluation of the valuation assessment with reference to the Group’s valuation guidelines and industry practice. Assessing transparency We assessed whether the disclosures in relation to the valuation of investments are compliant with the relevant accounting requirements and appropriately present the sensitivities in the valuations based on alternative outcomes. Our result We found the valuation of investments to be acceptable (2016: acceptable). 318 Prudential plc Annual Report 2017 www.prudential.co.uk Independent auditor’s report to the members of Prudential plc only continuedRecoverability and amortisation of deferred acquisition costs (‘DAC’) (2017: £9,233 million, 2016: £9,178 million). The risk compared to the prior year is unchanged. Refer to page 105 (Audit Committee report), page 172 (accounting policy) and pages 254 to 256 (financial disclosures) The risk Our response DAC represents 2 per cent of the Group’s total assets. The DAC associated with the US component, which represents 89 per cent of the total DAC, involves the greatest judgement in terms of measurement and recoverability. Subjective valuation DAC involves judgements in respect of 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 amortisation and recoverability assessment of the DAC asset in the US component 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; therefore there is a greater level of subjectivity involved in relation to the US DAC. We used our own actuarial specialists to assist us in performing our audit procedures in this area. Our procedures included: Methodology choice We evaluated the appropriateness of the deferral methodology by reference to the requirements of relevant accounting standards. Assessing application We evaluated the judgements involved in determining whether the costs incurred are deferred appropriately by reference to the adopted deferral methodology. Benchmarking assumptions and market experience We provided challenge on the reasonableness of the selected assumptions relating to projected investment return based on our understanding of developments in the business and our expectations derived from market experience. Our work included comparing the projected investment returns against the investment portfolio mix and market return data, and corroborating the rationale for any key differences. Historical comparison We have also assessed 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. Our work included critically assessing the judgements that determine the future profit profiles in the context of actual historical experience as well as by reference to market trends. We also compared the estimated future profits to the carrying value of the DAC asset to assess recoverability. Tests of detail We verified the accuracy of the calculations performed including the extent of the amortisation adjustment determined based on an assessment of the future profit profiles. Assessing transparency We assessed whether the disclosures in relation to the valuation and amortisation of DAC are compliant with the relevant accounting requirements. Our result We found the valuation and amortisation of DAC to be acceptable (2016: acceptable). www.prudential.co.uk Annual Report 2017 Prudential plc 319 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationDetermination of pension asset (restricted surplus) in respect of the defined benefit pension scheme (Pension asset (restricted surplus) – 2017: £71 million, 2016: £48 million). The risk relates to the parent company financial statements. Refer to page 105 (Audit Committee Report), page 308 (accounting policy) and pages 271 to 276 (financial disclosures) The risk The parent company assumes a portion of the surplus of the Group’s main defined benefit pension scheme. We do not consider the amounts recognised on the parent company balance sheet in respect of the defined benefit pension scheme to be at a high risk of significant misstatement. However, in the context of the parent company financial statements, we note that the valuation of the defined benefit pension obligation and the computation of the asset ceiling are the aspects of our audit of the pension asset (restricted surplus) that had the greatest effect on our overall audit strategy and allocation of resources in planning and completing our audit given the number of assumptions involved. Subjective valuation Where an entity does not have a right to a refund the asset ceiling is determined by reference to the present value of the difference between the estimated future service cost and the contributions payable by the entity over the future working lives of the active members. Assumptions are made over the future service costs. The calculation of the defined benefit obligation requires the determination of a number of assumptions and judgement is required to determine the appropriateness of these. The most significant assumptions include mortality and the inflation rate. Our response Our procedures included: Methodology choice We assessed, with the support of our pension specialists, the methodology for selecting assumptions underpinning the calculation of the defined benefit pension obligation and the estimated future service cost including the consequent calculation of the restricted surplus by reference to the relevant accounting standards. Tests of detail We assessed the reasonableness of the mortality assumptions and inflation rate by reference to entity specific data in respect of the demographic characteristics of the population of pension scheme members and factors such as salary inflation. We also considered whether the movements in the defined benefit pension obligation and the estimated future service cost, including the consequential calculation of the restricted surplus, were consistent with the changes made in the assumptions from the prior year. Benchmarking assumptions We challenged, with the support of our own pension specialists, the key assumptions applied, being the inflation and mortality rates, against externally derived data. Our result We found the pension asset (restricted surplus) recognised in respect of the defined benefit pension scheme to be acceptable (2016: acceptable). 3 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 (2016: £350 million) determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 2.2 per cent (2016: 2.4 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 consider that this is the most appropriate measure for the size of the business and that it provides a stable measure year on year. 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 £16.09 billion (2016: £14.67 billion) A B C A £350 million Group financial statements materiality (2016: £350 million) B £80 to £186 million Range of materiality at 14 components (2016: £80 to £186 million) C £18 million Misstatements reported to the Audit Committee (2016: £18 million) 1 2 1 IFRS shareholders’ equity 2 Group materiality 320 Prudential plc Annual Report 2017 www.prudential.co.uk Independent auditor’s report to the members of Prudential plc only continuedMateriality for the parent company financial statements as a whole was set at £186 million (2016: £ 186 million), determined with reference to a benchmark of parent company’s net assets, of which it represents 2.4 per cent (2016: 2.5 per cent). We agreed to report to the Group audit committee any corrected or uncorrected identified misstatements exceeding £18 million (2016: £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: Of the 14 (2016: 15) reporting components scoped in for the Group audit, we subjected 10 (2016: 10) to full scope audits for group reporting purposes and 4 (2016: 5) to an audit of account balances. The latter were not individually financially significant enough to require a full scope audit for group reporting purposes, but did present specific individual audit risks that needed to be addressed. The components subjected to full scope audits included the parent company; 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. Additionally, the components subjected to an audit of account balances included Prudential Capital and the insurance operations in China, Taiwan and Vietnam. The account balances audited were 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 Group profit before tax 2% 92% 3% 89% 94% (2016 92%) 10% 86% 4% 90% 96% (2016 94%) Group total assets Group shareholders’ equity 2% 91% 3% 87% 93% (2016 90%) 6% 88% 4% 90% 94% (2016 94%) Full scope for Group audit purposes 2017 Audit of account balances 2017 Full scope for Group audit purposes 2016 Audit of account balances 2016 Residual components www.prudential.co.uk Annual Report 2017 Prudential plc 321 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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. The Group audit team approved the component materialities, which ranged from £80 million to £186 million (2016: unchanged) across the components, having regard to the size and risk profile of the Group. The work on 13 components (2016: 14 components) was performed by component auditors and work on the remaining component, which was the parent company, was performed by the Group audit team. The Group audit team visited 13 component locations, comprising: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, Thailand, Taiwan, Vietnam and China; the fund management operations in M&G and Eastspring Singapore; and Prudential Capital. Video and telephone conference meetings were also held with these component auditors. At these visits and telephone conference 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 inspected 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 and component audit teams, also regularly attended Business Unit audit committee meetings (these were held at a regional level for Asia) and participated in meetings with local components 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 We have nothing to report on going concern We are required to report to you if: — We have anything material to add or draw attention to in relation to the Directors’ statement on page 120 to the financial statements on the use of the going concern basis of accounting with no material uncertainties that may cast significant doubt over the Group and Company’s use of that basis for a period of at least 12 months from the date of approval of the financial statements; or — The related statement under the Listing Rules set out on page 120 is materially inconsistent with our audit knowledge. We have nothing to report in these respects. 5 We have nothing to report on the other information in the Annual Report The Directors are responsible for the other information presented in the Annual Report together with the financial statements. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except as explicitly stated below, any form of assurance conclusion thereon. Our responsibility is to read the other information and, in doing so, consider whether, based on our financial statements audit work, the information therein is materially misstated or inconsistent with the financial statements or our audit knowledge. Based solely on that work we have not identified material misstatements in the other information. Strategic report and Directors’ report Based solely on our work on the other information: — We have not identified material misstatements in the strategic report and the Directors’ report; — In our opinion the information given in those reports for the financial year is consistent with the financial statements; and — In our opinion those reports have been prepared in accordance with the Companies Act 2006. Directors’ remuneration report In our opinion the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006. Disclosures of principal risks and longer-term viability Based on the knowledge we acquired during our audit, we have nothing material to add or draw attention to in relation to: — The Directors’ confirmation within the viability statement on page 62, that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency and liquidity; — The principal risks disclosures on pages 50 to 63 describing these risks and explaining how they are being managed and mitigated; and — The Directors’ explanation in the viability statement of how they have assessed the prospects of the Group, over what period they have done so and why they considered that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. Under the Listing Rules we are required to review the viability statement. We have nothing to report in this respect. Corporate governance disclosures We are required to report to you if: — We have identified material inconsistencies between the knowledge we acquired during our financial statements 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 section of the annual report describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee. 322 Prudential plc Annual Report 2017 www.prudential.co.uk Independent auditor’s report to the members of Prudential plc only continuedWe are required to report to you if the Corporate Governance Statement does not properly disclose a departure from the 11 provisions of the UK Corporate Governance Code specified by the Listing Rules for our review. We have nothing to report in respect of above. 6 We have nothing to report in respect of the matters on which we are required to report by exception 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. We have nothing to report in these respects. 7 Respective responsibilities Directors’ responsibilities As explained more fully in their statement set out on page 314, the Directors are responsible for the preparation of the financial statements including being satisfied that they give a true and fair view. They are also responsible for: such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; assessing the Group and Parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and using the going concern basis of accounting unless they either intend to liquidate the Group or the parent Company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud, other irregularities, or error, and to issue our opinion in an auditor’s report. Reasonable assurance is a high level of assurance, but does not guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud, other irregularities or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. The risk of not detecting a material misstatement resulting from fraud or other irregularities is higher than for one resulting from error, as they may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control and may involve any area of law and regulation not just those directly affecting the financial statements. A fuller description of our responsibilities is provided on the FRC’s website at www.frc.org.uk/auditorsresponsibilities Irregularities – ability to detect Our audit aimed to detect non‑compliance with relevant laws and regulations (irregularities) that could have a material effect on the financial statements. We identified relevant areas of laws and regulations from our sector experience, through discussion with the Directors (as required by auditing standards) and from inspection of the Group’s regulatory and legal correspondence. We had regard to laws and regulations in areas that directly affect the financial statements including financial reporting (including related company legislation) and taxation legislation. We considered the extent of compliance with those laws and regulations as part of our procedures on the related financial statements items. In addition we considered the impact of laws and regulations in the specific areas of regulatory capital recognising the financial and regulated nature of the Group’s activities. With the exception of any known or possible non‑compliance, and as required by auditing standards, our work in respect of these was limited to enquiry of the Directors and other management and inspection of regulatory and legal correspondence. We considered the effect of any known or possible non‑compliance in these areas as part of our procedures on the related financial statements items. We communicated identified laws and regulations throughout our team and remained alert to any indications of non‑compliance throughout the audit. This included communication from the Group to component audit teams of relevant laws and regulations identified at Group level, with a request to report on any indications of potential existence of non‑compliance with relevant laws and regulations (irregularities) in these areas, or other areas directly identified by the component teams. As with any audit, there remained a higher risk of non‑detection of irregularities, as these may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls. 8 The purpose of our audit work and to whom we owe our responsibilities This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. Philip Smart Senior Statutory Auditor For and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants London 14 March 2018 www.prudential.co.uk Annual Report 2017 Prudential plc 323 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information324 Prudential plc Annual Report 2017 www.prudential.co.uk 06 European Embedded Value (EEV) basis results Index to EEV basis results Page 326 www.prudential.co.uk Annual Report 2017 Prudential plc 325 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIndex to European Embedded Value (EEV) basis results Post‑tax operating profit based on longer‑term investment returns Post‑tax summarised consolidated income statement Movement in shareholders’ equity Summary statement of financial position Notes on the EEV basis results 1 2 3 4 5 6 7 8 Basis of preparation Results analysis by business area Analysis of new business contribution Operating profit from business in force Short‑term fluctuations in investment returns Effect of changes in economic assumptions Impact of US tax reform Net core structural borrowings of shareholder‑financed 9 10 11 12 13 14 15 16 17 18 operations Reconciliation of movement in shareholders’ equity Analysis of movement in net worth and value of in‑force for long‑term business Analysis of movement in free surplus Expected transfer of value of in‑force business and required capital to free surplus Sensitivity of results to alternative assumptions Methodology and accounting presentation Assumptions Insurance new business premiums Disposal of businesses Post balance sheet events Statement of Directors’ responsibilities Auditor’s report Page 327 328 329 330 331 331 332 333 335 336 337 337 338 340 342 345 345 347 353 357 358 358 359 360 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 EEV Principles dated April 2016, issued by the European Insurance CFO Forum. 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. 326 Prudential plc Annual Report 2017 www.prudential.co.uk European Embedded Value (EEV) basis results Post-tax operating profit based on longer-term investment returns Asia operations New business Business in force Long‑term business Asset management Total US operations New business Business in force Long‑term business Asset management Total UK and Europe operations New business Business in force Long‑term business General insurance commission Total insurance operations Asset management Total Other income and expenditure note (i) Restructuring costs note (ii) Interest received from tax settlement Operating profit based on longer-term investment returns Analysed as profit (loss) from: New business Business in force Long‑term business Asset management and general insurance commission Other results Note 2017 £m 2016 £m note (iii) 3 4 3 4 3 4 3 4 2,368 1,337 3,705 155 3,860 906 1,237 2,143 7 2,150 342 673 1,015 13 1,028 403 1,431 (746) (97) – 6,598 3,616 3,247 6,863 578 (843) 6,598 2,030 1,044 3,074 125 3,199 790 1,181 1,971 (3) 1,968 268 375 643 23 666 341 1,007 (682) (32) 37 5,497 3,088 2,600 5,688 486 (677) 5,497 Notes (i) (ii) (iii) EEV basis other income and expenditure represents the post‑tax IFRS basis results for other operations (including Group and Asia Regional Head Office, holding company borrowings, Africa operations and Prudential Capital) less the unwind of expected margins on the internal management of the assets of the covered business (as explained in note 14(a)(vii)). Restructuring costs comprise the post‑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 costs are primarily incurred in UK and Europe and Asia and represent business transformation and integration costs. The comparative results have been prepared using previously reported average exchange rates for the year. The 2016 comparative results have been re‑presented from those previously published following the reassessment of the Group’s operating segments as described in note B1.3 of the IFRS financial statements. This approach has been adopted consistently throughout this supplementary information. www.prudential.co.uk Annual Report 2017 Prudential plc 327 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationEuropean Embedded Value (EEV) basis results continued Post-tax summarised consolidated income statement Asia operations US operations UK and Europe operations Other income and expenditure Restructuring costs Interest received from 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 structural borrowings Impact of US tax reform Profit (loss) attaching to disposal of businesses Total non‑operating profit (loss) Profit for the year Attributable to: Equity holders of the Company Non‑controlling interests Basic earnings per share Note 2017 £m 2016 £m 5 6 7 17 3,860 2,150 1,431 (746) (97) – 6,598 2,111 (102) (326) 390 80 2,153 8,751 8,750 1 8,751 3,199 1,968 1,007 (682) (32) 37 5,497 (507) (60) (4) – (410) (981) 4,516 4,516 – 4,516 Based on post‑tax operating profit including longer‑term investment returns after non‑controlling interests (in pence) Based on post‑tax profit attributable to equity holders of the Company (in pence) Weighted average number of shares (millions) 2017 2016 257.0p 340.9p 2,567 214.7p 176.4p 2,560 328 Prudential plc Annual Report 2017 www.prudential.co.uk Movement in shareholders’ equity Profit for the year attributable to equity holders of the Company 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 reserve movements Net increase in shareholders’ equity Shareholders’ equity at beginning of year Shareholders’ equity at end of year Comprising: Asia operations US operations UK and Europe operations Other operations Shareholders’ equity at end of year Representing: Net assets attributable to equity holders of the Company excluding acquired goodwill, holding company net borrowings and non‑controlling interests Acquired goodwill Holding company net borrowings at market value note 8 Note 2017 £m 2016 £m 8,750 4,516 (2,045) (1,159) 40 144 5,730 38,968 44,698 9 9 9 4,211 (1,267) (11) (367) 7,082 31,886 38,968 Group total 19,100 12,009 12,165 (4,306) 31 Dec 2017 £m 31 Dec 2016 £m Long-term business operations Asset management and other operations Long-term business operations Asset management and other operations Group total 21,592 13,492 13,627 (4,013) 401 235 1,914 (4,013) 21,191 13,257 11,713 – 46,161 18,717 11,805 10,320 – 40,842 383 204 1,845 (4,306) (1,463) 44,698 (1,874) 38,968 45,917 244 – 46,161 1,562 1,214 (4,239) 47,479 1,458 (4,239) (1,463) 44,698 40,597 245 – 40,842 948 1,230 (4,052) 41,545 1,475 (4,052) (1,874) 38,968 www.prudential.co.uk Annual Report 2017 Prudential plc 329 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationEuropean Embedded Value (EEV) basis results continued Summary 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 attributable to equity holders of the Company Share capital Share premium IFRS basis shareholders’ reserves Total IFRS basis shareholders’ equity Additional EEV basis retained profit Total EEV basis shareholders’ equity * Including liabilities in respect of insurance products classified as investment contracts under IFRS 4. Net asset value per share Note 31 Dec 2017 £m 31 Dec 2016 £m 434,608 407,928 (418,521) 28,611 (389,910) (393,262) 24,302 (368,960) 44,698 38,968 129 1,948 14,010 16,087 28,611 44,698 129 1,927 12,610 14,666 24,302 38,968 9 9 9 9 9 Based on EEV basis shareholders’ equity of £44,698 million (2016: £38,968 million) (in pence) Number of issued shares at year end (millions) Annualised return on embedded value* 31 Dec 2017 31 Dec 2016 1,728p 2,587 1,510p 2,581 17% 17% * Annualised return on embedded value is based on EEV post‑tax operating profit after non‑controlling interests, as a percentage of opening EEV basis shareholders’ equity. The supplementary information on pages 327 to 358 was approved by the Board of Directors on 14 March 2018. Paul Manduca Chairman Mike Wells Group Chief Executive Mark FitzPatrick Chief Financial Officer 330 Prudential plc Annual Report 2017 www.prudential.co.uk Notes 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, issued by the European Insurance CFO Forum. 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 reclassification of results to reflect the reassessment of the Group’s operating segments as described in the note in B1.3 of the IFRS financial statements, the 2016 results have been derived from the EEV basis results supplement to the Company’s statutory accounts for 2016. A detailed description of the EEV methodology and accounting presentation is provided in note 14. 2 Results analysis by business area The 2016 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2016 CER comparative results are translated at 2017 average exchange rates. Annual premium equivalents (APE) note 16 Asia US UK and Europe Group total Post-tax operating profit Asia operations New business Business in force Long‑term business Asset management Total US operations New business Business in force Long‑term business Asset management Total UK and Europe operations New business Business in force Long‑term business General insurance commission Total insurance operations Asset management Total 2017 £m 2016 £m % change Note 3 3,805 1,662 1,491 6,958 AER 3,599 1,561 1,160 6,320 CER 3,773 1,641 1,160 6,574 AER 6% 6% 29% 10% 2017 £m 2016 £m % change Note AER CER 3 4 3 4 3 4 2,368 1,337 3,705 155 3,860 906 1,237 2,143 7 2,150 342 673 1,015 13 1,028 403 1,431 2,030 1,044 3,074 125 3,199 790 1,181 1,971 (3) 1,968 268 375 643 23 666 341 2,123 1,097 3,220 132 3,352 830 1,241 2,071 (4) 2,067 268 375 643 23 666 341 1,007 1,007 AER 17% 28% 21% 24% 21% 15% 5% 9% 333% 9% 28% 79% 58% (43)% 54% 18% 42% CER 1% 1% 29% 6% CER 12% 22% 15% 17% 15% 9% 0% 3% 275% 4% 28% 79% 58% (43)% 54% 18% 42% Other income and expenditure Restructuring costs Interest received from tax settlement Operating profit based on longer-term investment returns (746) (97) – (682) (32) 37 (688) (32) 37 (9)% (203)% n/a (8)% (203)% n/a 6,598 5,497 5,743 20% 15% www.prudential.co.uk Annual Report 2017 Prudential plc 331 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 2 Results analysis by business area continued Analysed as profit (loss) from: New business Business in force Total long‑term business Asset management and general insurance commission Other results Post-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 structural borrowings Impact of US tax reform Profit (loss) attaching to disposal of businesses Total non‑operating profit (loss) Profit for the year Basic earnings per share Note 3 4 2017 £m 2016 £m % change AER CER AER CER 3,616 3,247 6,863 578 (843) 6,598 3,088 2,600 5,688 486 (677) 5,497 3,221 2,713 5,934 492 (683) 5,743 17% 25% 21% 19% (25)% 20% 12% 20% 16% 17% (23)% 15% 2017 £m 2016 £m % change Note AER CER AER CER 5 6 7 17 6,598 2,111 (102) (326) 390 80 2,153 8,751 5,497 (507) (60) (4) – (410) (981) 4,516 5,743 (567) (54) (4) – (445) (1,070) 4,673 20% 15% 319% 94% 301% 87% Based on post‑tax operating profit including longer‑term investment returns after non‑controlling interests (in pence) Based on post‑tax profit attributable to equity holders of the 257.0p 214.7p 224.3p Company (in pence) 340.9p 176.4p 182.5p 20% 93% 15% 87% 2017 2016 % change AER CER AER CER 3 Analysis of new business contribution (i) Group summary for long-term business operations Asia note (ii) US UK and Europe Total 2017 Annual premium equivalents (APE) note 16 £m Present value of new business premiums (PVNBP) note 16 £m 3,805 1,662 1,491 6,958 20,405 16,622 13,784 50,811 New business contribution New business margin APE PVNBP £m 2,368 906 342 3,616 % 62 55 23 52 % 11.6 5.5 2.5 7.1 332 Prudential plc Annual Report 2017 www.prudential.co.uk Asia note (ii) US UK and Europe Total 2016 Annual premium equivalents (APE) note 16 £m Present value of new business premiums (PVNBP) note 16 £m 3,599 1,561 1,160 6,320 19,271 15,608 10,513 45,392 New business contribution New business margin APE PVNBP £m 2,030 790 268 3,088 % 56 51 23 49 % 10.5 5.1 2.5 6.8 Note After allowing for foreign exchange effects of £133 million, the new business contribution increased by £395 million on a CER basis. This increase is driven by higher sales volumes (a contribution of £188 million), a beneficial effect of changes in long‑term interest rates (£48 million) and pricing, product mix and other actions of £159 million. The £159 million impact reflects the beneficial impact of our strategic emphasis on increasing sales from health and protection business in Asia, together with a positive £76 million effect arising in the US for the impact of US tax reform (see note 7). (ii) Asia new business contribution by business unit 2017 £m 2016 £m China Hong Kong Indonesia Taiwan Other Total Asia 4 Operating profit from business in force (i) Group summary for long-term business operations Unwind of discount and other expected returns Effect of changes in operating assumptions Experience variances and other items Group total Unwind of discount and other expected returns Effect of changes in operating assumptions Experience variances and other items Group total 133 1,535 174 57 469 2,368 2017 £m US note (iii) 694 196 347 1,237 2016 £m US note (iii) 583 170 428 Asia note (ii) 1,007 241 89 1,337 Asia note (ii) 866 54 124 1,044 1,181 AER 63 1,363 175 31 398 2,030 UK and Europe note (iv) 465 195 13 673 UK and Europe note (iv) 445 25 (95) 375 Note The movement in operating profit from business in force of £647 million from £2,600 million for 2016 to £3,247 million for 2017 comprises: Movement in unwind of discount and other expected returns: Effects of changes in: Growth in opening value Interest rates and other economic assumptions Foreign exchange Movement in effect of changes in operating assumptions, experience variances and other items (including foreign exchange of £45 million) Net movement in operating profit from business in force CER 65 1,427 183 35 413 2,123 Group total 2,166 632 449 3,247 Group total 1,894 249 457 2,600 £m 251 (47) 68 272 375 647 www.prudential.co.uk Annual Report 2017 Prudential plc 333 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Notes on the EEV basis results continued 4 Operating profit from business in force continued (ii) Asia Unwind of discount and other expected returns note (a) Effect of changes in operating assumptions note (b) Experience variances and other items note (c) Total 2017 £m 2016 £m 1,007 241 89 1,337 866 54 124 1,044 Notes (a) (b) (c) The £141 million increase in unwind of discount and other expected returns to £1,007 million for 2017 is driven by the growth in the in‑force book, with offsetting effects arising from foreign exchange (£38 million) and movements in long‑term interest rates and changes in other economic assumptions (£(38) million). The effect of changes in operating assumptions of £241 million reflects the net benefit for EEV arising from the annual review of experience, together with the benefit of management actions reflecting our ongoing focus on managing the in‑force book for value. It includes a £107 million benefit arising in China from adopting the principles for embedded value reporting under the China Risk Oriented Solvency System (C‑ROSS) regime in 2017 (see note 14(a)(v)). The £89 million effect of experience variances and other items in 2017 is driven by positive mortality and morbidity experiences in a number of business units, together with positive persistency variances from participating and health and protection products, partially offset by unfavourable persistency variances on unit‑linked products. Experience variances also include expense overruns where these are expected to be short‑lived, including businesses that are growing rapidly or are sub‑scale. (iii) US 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 Amortisation of interest‑related realised gains and losses Other note (c) Total 2017 £m 2016 £m 694 196 71 91 185 347 583 170 119 88 221 428 1,237 1,181 Notes (a) The £111 million increase in unwind of discount and other expected returns to £694 million for 2017 represents a positive £87 million effect for the growth in the in‑force book (after allowing for the benefit of US tax reform) and a net £24 million effect for foreign exchange and interest rate movements. The effect of assumption changes of £196 million in 2017 mainly relates to assumption updates for persistency, mortality and policyholder utilisation. (b) (c) Other experience variances of £185 million in 2017 include the effects of positive mortality and persistency experience in the period, together with the benefit of tax credits relating to the dividend received deduction for variable annuity business. (iv) UK and Europe Unwind of discount and other expected returns note (a) Change in longevity assumptions basis note (b) Reduction in corporate tax rate Other items note (c) Total 2017 £m 2016 £m 465 195 – 13 673 445 – 25 (95) 375 Notes (a) (b) The £20 million increase in unwind of discount and other expected returns to £465 million for 2017 is mainly driven by the underlying growth in the in‑force book. The £195 million relates to changes to annuitant mortality assumptions primarily reflecting the adoption of the Continuous Mortality Investigation 2015 model as the basis for future mortality improvements. (c) Other items comprise the following: Longevity reinsurance Impact of specific management actions to improve solvency position Provision for cost of undertaking past non‑advised annuity sales review and potential redress note (d) Other 2017 £m 2016 £m (6) 127 (187) 79 13 (90) 110 (145) 30 (95) (d) In response to the findings of the FCA’s Thematic Review of Annuities Sales Practices, the UK business has agreed to review all internally vesting annuities sold without advice after 1 July 2008. The FCA formally released its redress calculation methodology in early 2018 and Prudential reassessed the provision held. Reflecting this, the UK 2017 result includes a £(187) million (post‑tax) increase in the provision held for the estimated cost of the review and any appropriate customer redress. The provision held continues to exclude any potential for insurance recoveries. For more information, see note B3 of the IFRS financial statements. 334 Prudential plc Annual Report 2017 www.prudential.co.uk 5 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 and Europe operations note (iv) Other operations Group total (ii) Asia operations The short‑term fluctuations in investment returns for Asia operations comprise: Hong Kong Singapore Other Total 2017 £m 2016 £m 887 582 621 21 2,111 (100) (1,102) 876 (181) (507) 2017 £m 2016 £m 531 126 230 887 (105) 52 (47) (100) Note For 2017, the credit of £887 million mainly reflects unrealised gains on bonds driven by the decrease in bond yields across many of the business units (see note 15(i)), together with higher equity returns than assumed for Hong Kong with‑profits business and higher investment returns than assumed in Singapore for with‑profits and unit‑linked businesses. (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 2017 £m 2016 £m (46) (85) 628 582 (1,017) (1,102) Notes (a) (b) The net result relating to fixed income securities reflects a number of offsetting items as follows: – the impact on portfolio yields of changes in the asset portfolio in the year; – the difference between actual realised gains and losses and the amortisation of interest‑related realised gains and losses that is recorded within operating profit; 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 of 17.5 per cent and that assumed of 5.9 per cent for the year (2016: actual growth of 8.9 per cent compared to assumed growth 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 and Europe operations The short‑term fluctuations in investment returns for UK and Europe operations comprise: Insurance operations: Shareholder‑backed annuity business note (a) With‑profits and other business note (b) Asset management Total 2017 £m 2016 £m 387 229 5 621 431 438 7 876 Notes (a) (b) Short‑term fluctuations in investment returns for shareholder‑backed annuity business include: – gains on surplus assets compared to the expected long‑term rate of return reflecting reductions in corporate bond and gilt yields; and – the difference between actual and expected default experience. The positive £229 million fluctuation in 2017 for with‑profits and other business represents the impact of achieving a 9 per cent pre‑tax return on the with‑profits fund (including unallocated surplus) compared to the assumed rate of return of 5 per cent for the year (2016: achieved return of 14 per cent compared to assumed rate of 5 per cent), partially offset by 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. www.prudential.co.uk Annual Report 2017 Prudential plc 335 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Notes on the EEV basis results continued 6 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 for long-term business operations Asia note (ii) US note (iii) UK and Europe note (iv) Group total (ii) Asia The effect of changes in economic assumptions for Asia comprises: Hong Kong Indonesia Malaysia Singapore Taiwan Other Total 2017 £m 2016 £m (95) (136) 129 (102) 70 45 (175) (60) 2017 £m 2016 £m (321) 81 59 131 (12) (33) (95) 85 46 (20) (60) 12 7 70 Note The negative effect in 2017 of £(95) million largely arises from movements in long‑term interest rates, driven by lower assumed fund earned rates in Hong Kong, partially offset by profits arising from the beneficial impact of valuing future profits at lower discount rates in Indonesia, Malaysia and Singapore (see note 15(i)). In addition, various changes to the basis of setting economic assumptions were made with an overall impact of £5 million (see note 14(a)(viii), note 15(i) and note 15(iv)). (iii) US The effect of changes in economic assumptions for US comprises: Variable annuity business Fixed annuity and other general account business Total 2017 £m 2016 £m (101) (35) (136) 86 (41) 45 Note For 2017, the charge of £(136) million mainly reflects the decrease in the assumed separate account return and reinvestment rates, following the 10 basis points decrease in the US 10‑year treasury yield in the year, resulting in lower projected fee income and an increase in projected benefit costs for variable annuity business. For fixed annuity and other general account business, the impact reflects the effect on the present value of future projected spread income from the combined movement in interest rates and credit spreads. (iv) UK and Europe The effect of changes in economic assumptions for UK and Europe comprises: Shareholder‑backed annuity business With‑profits and other business Total 2017 £m 2016 £m 28 101 129 (113) (62) (175) Note The credit of £129 million mainly reflects the movement in expected long‑term rates of return and risk discount rates as shown in note 15 (iii). 336 Prudential plc Annual Report 2017 www.prudential.co.uk 7 Impact of US tax reform On 22 December 2017, a significant US tax reform package, The Tax Cuts and Jobs Act, was enacted into law effective from 1 January 2018. The tax reform package as a whole, which includes a reduction in the corporate income tax rate from 35 per cent to 21 per cent, and a number of specific measures affecting US life insurers, results in a £390 million benefit in non‑operating profit. The positive impact on an EEV basis represents the benefit of future profits being taxed at a lower rate, partially offset by a reduction in the net deferred tax asset held in the balance sheet to reflect remeasurement at the new lower tax rate, together with a reduction in the benefit from the dividend received deduction on taxable profits from variable annuity business. In accordance with our usual methodology, the new business contribution and unwind of discount and other expected returns are determined by applying operating and economic assumptions as at the end of the year, including the effect of US tax reform. This led to an increase in new business profit of £76 million. 8 Net core structural borrowings of shareholder-financed operations Holding company (including central finance subsidiaries) cash and short‑term investments Central funds Subordinated debt Senior debt Holding company net borrowings Prudential Capital bank loan Jackson surplus notes Group total 31 Dec 2017 £m Mark to market value adjustment IFRS basis EEV basis at market value 31 Dec 2016 £m Mark to market value adjustment IFRS basis (2,264) – (2,264) (2,626) 5,272 549 5,821 3,557 275 184 4,016 515 167 682 682 – 61 743 5,787 716 6,503 4,239 275 245 4,759 5,772 549 6,321 3,695 275 202 4,172 – 182 175 357 357 – 65 422 EEV basis at market value (2,626) 5,954 724 6,678 4,052 275 267 4,594 Note In October 2017, the Company issued core structural borrowings of US$750 million 4.875 per cent Tier 2 perpetual subordinated notes. The proceeds, net of costs, were £565 million. In December 2017, the Company repaid its US$1,000 million 6.5 per cent Tier 2 perpetual subordinated notes. The movement in IFRS basis core structural borrowings from 2016 to 2017 also includes foreign exchange effects. www.prudential.co.uk Annual Report 2017 Prudential plc 337 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 9 Reconciliation of movement in shareholders’ equity Operating profit (based on longer-term investment returns) Long‑term business: New business note 3 Business in force note 4 Asset management and general insurance commission Restructuring costs Other results Operating profit based on longer-term investment returns Non‑operating items Non‑controlling interests 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 Shareholders’ equity at end of year Representing: IFRS basis shareholders’ equity: Net assets (liabilities) Goodwill Total IFRS basis shareholders’ equity Additional retained profit (loss) on an EEV basis EEV basis shareholders’ equity Balance at beginning of year: IFRS basis shareholders’ equity: Net assets (liabilities) Goodwill Total IFRS basis shareholders’ equity Additional retained profit (loss) on an EEV basis EEV basis shareholders’ equity Asia operations note (i) US operations 2017 £m UK and Europe operations Other operations note (i) Group total note (iv) 2,368 1,337 3,705 155 (14) – 3,846 792 4,638 – 4,638 (1,192) (842) – – (111) 2,493 18,855 21,348 5,620 61 5,681 15,667 21,348 5,069 61 5,130 13,725 18,855 906 1,237 2,143 7 – – 2,150 917 3,067 – 3,067 (1,159) (466) – 40 1 1,483 12,009 13,492 342 673 1,015 416 (73) – 1,358 750 2,108 – 2,108 6 (678) – – 26 1,462 12,165 13,627 5,248 – 5,248 8,244 7,092 1,153 8,245 5,382 13,492 13,627 5,392 16 5,408 6,601 6,679 1,153 7,832 4,333 12,009 12,165 – – – – (10) (746) (756) (306) (1,062) (1) (1,063) 300 1,986 (1,159) – 228 292 (4,061) (3,769) (3,331) 244 (3,087) (682) (3,769) (3,949) 245 (3,704) (357) (4,061) 3,616 3,247 6,863 578 (97) (746) 6,598 2,153 8,751 (1) 8,750 (2,045) – (1,159) 40 144 5,730 38,968 44,698 14,629 1,458 16,087 28,611 44,698 13,191 1,475 14,666 24,302 38,968 338 Prudential plc Annual Report 2017 www.prudential.co.uk Notes (i) Other operations of £(3,769) million represents the shareholders’ equity of £(4,013) million as shown in the movement in shareholders’ equity and includes goodwill of £244 million (2016: £245 million) related to Asia long‑term operations. Intra‑group dividends represent dividends that have been declared in the year and investment 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) share‑based payments and treasury shares and intra‑group transfers between operations which have no overall effect on the Group’s embedded value. (iv) Group total EEV basis shareholders’ equity can be further analysed as follows: 31 Dec 2017 £m 31 Dec 2016 £m Asset management and general insurance commission Total long-term business operations note 10 Other operations Group total Total long-term business operations Asset management and general insurance commission Other operations Group total 16,624 2,550 (3,087) 16,087 15,938 2,432 (3,704) 14,666 29,293 45,917 – (682) 2,550 (3,769) 28,611 44,698 24,659 40,597 – 2,432 (357) (4,061) 24,302 38,968 Total IFRS basis shareholders’ equity Additional retained profit (loss) on an EEV basis note (v) Total EEV basis shareholders’ equity (v) The additional retained loss on an EEV basis for other operations represents the mark to market value adjustment for holding company net borrowings of a cumulative charge of £(682) million (2016: £(357) million), as shown in note 8. www.prudential.co.uk Annual Report 2017 Prudential plc 339 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 10 Analysis of movement in net worth and value of in-force for long-term business 2017 £m Free surplus Required capital Total net worth Group Shareholders’ equity at beginning of year New business contribution Existing business – transfer to net worth Expected return on existing business note 4 Changes in operating assumptions and experience variances note 4 Restructuring costs Operating profit based on longer-term investment returns Sale of Korea life business note 17 Other non‑operating items Profit for the year Exchange movements on foreign operations and net investment hedges Intra‑group dividends and investment in operations Other movements Shareholders’ equity at end of year Asia New business contribution Existing business – transfer to net worth Expected return on existing business note 4 Changes in operating assumptions and experience variances note 4 Operating profit based on longer-term investment returns Sale of Korea life business note 17 Other non‑operating items Profit for the year US New business contribution Existing business – transfer to net worth Expected return on existing business note 4 Changes in operating assumptions and experience variances note 4 Operating profit based on longer-term investment returns Non‑operating items Profit for the year 5,364 (913) 3,279 138 635 (38) 3,101 76 (426) 2,751 (274) (1,535) (64) 6,242 (484) 1,275 51 81 923 76 254 1,253 (254) 1,329 56 190 1,321 (1,247) 74 Value of in-force business Total embedded value 24,937 3,829 (2,537) 1,827 40,597 3,616 – 2,166 563 (10) 1,081 (48) 3,672 – 2,601 6,273 (1,800) – – 6,815 – 2,426 9,241 (2,322) (1,535) (64) 10,296 700 (742) 201 (117) – 42 (76) 251 217 (248) – – 15,660 (213) 2,537 339 518 (38) 3,143 – (175) 2,968 (522) (1,535) (64) 10,265 16,507 29,410 45,917 152 (146) 48 151 205 (76) 137 266 304 (219) 53 12 150 (222) (72) (332) 1,129 99 232 1,128 – 391 1,519 50 1,110 109 202 1,471 (1,469) 2 2,700 (1,129) 908 98 2,577 – 401 2,978 856 (1,110) 585 341 672 2,358 3,030 2,368 – 1,007 330 3,705 – 792 4,497 906 – 694 543 2,143 889 3,032 340 Prudential plc Annual Report 2017 www.prudential.co.uk UK and Europe New business contribution Existing business – transfer to net worth Expected return on existing business note 4 Changes in operating assumptions and experience variances note 4 Restructuring costs Operating profit based on longer-term investment returns Non‑operating items Profit for the year 2017 £m Free surplus Required capital Total net worth Value of in-force business Total embedded value (175) 675 31 364 (38) 857 567 1,424 244 (377) 100 (280) – (313) 336 23 69 298 131 84 (38) 544 903 1,447 273 (298) 334 124 (10) 423 (158) 265 342 – 465 208 (48) 967 745 1,712 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 for long‑term business as shown below: 31 Dec 2017 £m 31 Dec 2016 £m 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(iv) 17,539 (588) (186) 16,765 4,182 20,947 10,486 (232) (650) 9,604 3,653 Asia US Total Asia US UK and Europe 3,648 (607) – 3,041 8,672 31,673 (1,427) (836) 29,410 16,507 45,917 15,371 (477) (87) 14,807 3,665 18,472 8,584 (319) (911) 7,354 4,451 UK and Europe 3,468 (692) – 2,776 7,544 Total 27,423 (1,488) (998) 24,937 15,660 40,597 13,257 11,713 11,805 10,320 www.prudential.co.uk Annual Report 2017 Prudential plc 341 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 11 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. In Asia and US operations, assets deemed to be inadmissible on local regulatory basis are included in net worth where considered fully recognisable on an EEV basis. 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 (including Group and Asia Regional Head Office, holding company borrowings, Africa operations and Prudential Capital) 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. 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 2016 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2016 CER comparative results are translated at 2017 average exchange rates. Asia operations Underlying free surplus generated from in‑force life business Investment in new business note (iii)(a) Long‑term business Asset management Total US operations Underlying free surplus generated from in‑force life business Investment in new business note (iii)(a) Long‑term business Asset management Total UK and Europe operations Underlying free surplus generated from in‑force life business Investment in new business note (iii)(a) Long‑term business General insurance commission Asset management Total Underlying free surplus generated from insurance and asset management operations before restructuring costs Restructuring costs Underlying free surplus generated from insurance and asset management operations 2017 £m 2016 £m % change AER CER AER CER 1,407 (484) 923 155 1,078 1,575 (254) 1,321 7 1,328 1,070 (175) 895 13 403 1,210 (476) 734 125 859 1,866 (298) 1,568 (3) 1,565 923 (129) 794 23 341 1,273 (500) 773 132 905 1,961 (313) 1,648 (4) 1,644 923 (129) 794 23 341 1,311 1,158 1,158 16% (2)% 26% 24% 25% (16)% 15% (16)% 333% (15)% 16% (36)% 13% (43)% 18% 13% 11% 3% 19% 17% 19% (20)% 19% (20)% 275% (19)% 16% (36)% 13% (43)% 18% 13% 3,717 (77) 3,582 (16) 3,707 (16) 4% (381)% 0% (381)% 3,640 3,566 3,691 2% (1)% 342 Prudential plc Annual Report 2017 www.prudential.co.uk Representing: Long‑term business: Expected in‑force cash flows (including expected return on net assets) Effects of changes in operating assumptions, operating experience variances and other items before restructuring costs Underlying free surplus generated from in‑force life business before restructuring costs Investment in new business note (iii)(a) Total long‑term business Asset management and general insurance commission Restructuring costs (ii) Underlying free surplus generated – Group total Underlying free surplus generated from insurance and asset management operations note (i) Other income and expenditure Interest received from tax settlement Group total (iii) Movement in free surplus 2017 £m 2016 £m % change AER CER AER CER 3,417 3,159 3,278 8% 4% 635 840 879 (24)% (28)% 4,052 (913) 3,139 578 (77) 3,640 3,999 (903) 3,096 486 (16) 3,566 4,157 (942) 3,215 492 (16) 3,691 1% (1)% 1% 19% (381)% 2% (3)% 3% (2)% 17% (381)% (1)% 2017 £m 2016 £m % change AER CER AER CER 3,640 (756) – 2,884 3,566 (681) 37 2,922 3,691 (687) 37 3,041 2% (11)% n/a (1)% (1)% (10)% n/a (5)% Underlying free surplus generated before restructuring costs Restructuring costs Underlying free surplus generated notes (i)(ii) Profit attaching to disposal of businesses note 17 Other non‑operating items note (b) Net cash flows to parent company note (c) External dividends Exchange rate movements, timing differences and other items note (d) Net movement in free surplus Balance at beginning of year Balance at end of year Asia operations US operations 1,078 (14) 1,064 76 254 1,394 (645) – (421) 328 2,142 2,470 1,328 – 1,328 96 (1,299) 125 (475) – (140) (490) 2,418 1,928 2017 £m UK and Europe operations Total insurance and asset management operations Other operations Group total 1,311 (63) 1,248 – 572 1,820 (668) – 22 1,174 2,006 3,180 3,717 (77) 3,640 172 (473) 3,339 (1,788) – (539) 1,012 6,566 7,578 (746) (10) (756) – 27 (729) 1,788 (1,159) 226 126 1,648 1,774 2,971 (87) 2,884 172 (446) 2,610 – (1,159) (313) 1,138 8,214 9,352 www.prudential.co.uk Annual Report 2017 Prudential plc 343 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 11 Analysis of movement in free surplus continued (iii) Movement in free surplus continued Underlying free surplus generated before restructuring costs Restructuring costs Underlying free surplus generated notes (i)(ii) Loss attaching to the sold Korea life business Other non‑operating items note (b) Net cash flows to parent company note (c) External dividends Exchange rate movements, timing differences and other items note (d) Net movement in free surplus Balance at beginning of year Balance at end of year Asia operations US operations 2016 £m UK and Europe operations Total insurance and asset management operations Other operations Group total 859 – 859 (86) (91) 682 (516) – 162 328 1,814 2,142 1,565 – 1,565 – (770) 795 (420) – 310 685 1,733 2,418 1,158 (16) 1,142 – (64) 1,078 (782) – 21 317 1,689 2,006 3,582 (16) 3,566 (86) (925) 2,555 (1,718) – 493 1,330 5,236 6,566 (628) (16) (644) – (214) (858) 1,718 (1,267) 1,119 712 936 1,648 2,954 (32) 2,922 (86) (1,139) 1,697 – (1,267) 1,612 2,042 6,172 8,214 Notes (a) (b) Non‑operating items include short‑term fluctuations in investment returns and the effect of changes in economic assumptions for long‑term business operations and the effect of Free surplus invested in new business primarily represents acquisition costs and amounts set aside for required capital. business disposals. In addition, for 2017 this includes the impact of US tax reform. 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. Exchange rate movements, timing differences and other items represent: (c) (d) Exchange rate movements Mark to market value movements on Jackson assets backing surplus and required capital note 9 Other items note (e) Exchange rate movements Mark to market value movements on Jackson assets backing surplus and required capital Other items note (e) Asia operations US operations (113) – (308) (421) (190) 40 10 (140) Asia operations US operations 338 – (176) 162 368 (11) (47) 310 2017 £m UK and Europe operations Total insurance and asset management operations 6 – 16 22 (297) 40 (282) (539) 2016 £m UK and Europe operations Total insurance and asset management operations 10 – 11 21 716 (11) (212) 493 Other operations (13) – 239 226 Other operations 48 – 1,071 1,119 Group total (310) 40 (43) (313) Group total 764 (11) 859 1,612 (e) Other items include the effect of movements in subordinated debt for other operations, intra‑group loans and other intra‑group transfers between operations, non‑cash items. 344 Prudential plc Annual Report 2017 www.prudential.co.uk 12 Expected transfer of value of in-force business and required capital to free surplus The discounted value of in‑force business and required capital for long‑term business operations can be reconciled to the 2017 and 2016 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 Free surplus generation from the sale of Korea life business Other items* Total long‑term business operations 2017 £m 2016 £m 10,265 29,410 836 – (1,371) 39,140 10,296 24,937 998 (76) (1,430) 34,725 * ‘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 with‑profits 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 for long‑term business operations is modelled as emerging into free surplus over future years. Asia US UK and Europe Total Asia US UK and Europe Total 2017 £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 5,583 6,247 3,012 14,842 38% 3,638 3,993 2,066 9,697 25% 2,418 1,697 1,289 5,404 14% 1,655 401 899 2,955 7% 3,845 117 704 4,666 12% 1,553 – 23 1,576 4% 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 5,141 5,542 2,890 13,573 39% 3,331 3,203 1,931 8,465 25% 2,209 1,240 1,119 4,568 13% 1,515 372 901 2,788 8% 3,118 199 899 4,216 12% 1,079 – 36 1,115 3% 2017 total as shown above 18,692 12,455 7,993 39,140 100% 2016 total as shown above 16,393 10,556 7,776 34,725 100% 13 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 2017 and 31 December 2016 and the new business contribution after the effect of required capital for 2017 and 2016 for long‑term business operations to: — 1 per cent increase in the discount rates; — 1 per cent increase in interest rates and risk discount rates, including consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets); — 0.5 per cent decrease in interest rates and risk discount rates, including consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets); — 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 in contrast to EEV basis required capital (for embedded value only); and — 5 basis points increase in UK long‑term expected defaults. In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. www.prudential.co.uk Annual Report 2017 Prudential plc 345 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 13 Sensitivity of results to alternative assumptions continued (a) Sensitivity analysis – economic assumptions continued New business contribution from long-term business operations New business contribution note 3 Discount rates – 1% increase Interest rates – 1% increase Interest rates – 0.5% decrease Equity/property yields – 1% rise Long‑term expected defaults – 5 bps increase 2017 £m 2016 £m US 906 (34) 124 (85) 130 – UK and Europe 342 (48) 44 (23) 52 (1) Total 3,616 (559) 65 (167) 312 (1) Asia 2,030 (375) 51 (30) 129 – US 790 (43) 64 (49) 91 – UK and Europe 268 (32) 27 (15) 28 (2) Total 3,088 (450) 142 (94) 248 (2) Asia 2,368 (477) (103) (59) 130 – Embedded value of long-term business operations 31 Dec 2017 £m 31 Dec 2016 £m Asia US UK and Europe Total Asia US UK and Europe Total Shareholders’ equity note 10 20,947 13,257 11,713 45,917 18,472 11,805 10,320 40,597 Discount rates – 1% increase Interest rates – 1% increase 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 (2,560) (944) 121 873 (429) 169 (440) 26 (166) 896 (209) 158 (774) (635) 384 425 (3,774) (1,553) 339 2,194 (479) – (1,117) 327 (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 – – (135) (135) – – (138) (138) The sensitivities shown above are for the impact of instantaneous changes on the embedded value of long‑term business operations and include the combined effect on the value of in‑force business and net assets at the balance sheet dates indicated. If the change in 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, namely 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 2017 and 31 December 2016 and the new business contribution after the effect of required capital for 2017 and 2016 for long‑term business operations 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). 346 Prudential plc Annual Report 2017 www.prudential.co.uk New business contribution from long-term business operations New business contribution note 3 Maintenance expenses – 10% decrease Lapse rates – 10% decrease Mortality and morbidity – 5% decrease Change representing effect on: Life business UK annuities 2017 £m 2016 £m US 906 14 24 4 4 – UK and Europe 342 3 20 (2) 1 (3) Total 3,616 55 177 71 74 (3) Asia 2,030 33 132 57 57 – US 790 10 26 4 4 – UK and Europe 268 3 11 (4) – (4) Total 3,088 46 169 57 61 (4) Asia 2,368 38 133 69 69 – Embedded value of long-term business operations 31 Dec 2017 £m 31 Dec 2016 £m Asia US UK and Europe Total Asia US UK and Europe Total Shareholders’ equity note 10 20,947 13,257 11,713 45,917 18,472 11,805 10,320 40,597 Maintenance expenses – 10% decrease Lapse rates – 10% decrease Mortality and morbidity – 5% decrease Change representing effect on: Life business UK annuities 213 753 668 668 – 169 659 214 214 – 64 64 (442) 13 (455) 446 1,476 440 895 (455) 187 659 554 554 – 104 533 192 192 – 91 79 (302) 12 (314) 382 1,271 444 758 (314) 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 (including Group and Asia Regional Head Office, holding company borrowings, Africa operations and Prudential Capital). 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 Limited (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. www.prudential.co.uk Annual Report 2017 Prudential plc 347 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 14 Methodology and accounting presentation continued (a) Methodology continued (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(vii). 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 and economic assumptions as at the end of the year. 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. Valuation movements on investments With the exception of debt securities held by Jackson, investment gains and losses during the year (to the extent that changes in capital values do not directly match changes in liabilities) are included directly in the profit for the year and shareholders’ equity as they arise. The results for any covered business conceptually reflect the aggregate of the IFRS results and the movements on the additional shareholders’ interest recognised on the EEV basis. Thus the start point for the calculation of the EEV results for Jackson, as for other businesses, 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 Subject to local market circumstances and regulatory requirements, the guarantee features described below in respect of UK and Europe business broadly apply to similar types of participating contracts which are 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 (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 both years, 87 per cent of the account values on fixed annuities are for policies with guarantees of 3 per cent or less, and the average guarantee rate is 2.6 per cent. 348 Prudential plc Annual Report 2017 www.prudential.co.uk 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 for which it contractually guarantees to the contract holder, subject to specific conditions, 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 essentially 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. UK and Europe (M&G Prudential) For covered business the only significant financial options and guarantees in M&G Prudential arise in the with‑profits fund. With‑profits products provide returns to policyholders through bonuses that are smoothed. There are two types of bonuses: annual and final. Annual bonuses are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are guaranteed only until the next bonus declaration. The PAC with‑profits fund also held a provision of £53 million at 31 December 2017 (31 December 2016: £62 million) to honour guarantees on a small number of guaranteed annuity option products. The Group’s main exposure to guaranteed annuity options in M&G Prudential is through the non‑covered business of SAIF. A provision of £503 million was held in SAIF at 31 December 2017 (31 December 2016: £571 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). — 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. For M&G Prudential, 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 for long‑term business operations apply: — Asia: 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. For China operations, the level of required capital as at 31 December 2017 follows the approach for embedded value reporting issued by the China Association of Actuaries (CAA), reflecting the C‑ROSS regime; — US: 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 and Europe: the capital requirements are set at the Solvency II Solvency Capital Requirement (SCR) for shareholder‑backed business as a whole. www.prudential.co.uk Annual Report 2017 Prudential plc 349 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 14 Methodology and accounting presentation continued (a) Methodology continued (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. (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 as included in ‘Other operations’. 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 the US, the risk‑free rates are based on 10‑year local government bond yields. For UK and Europe, 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. 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. In order to better reflect differences in relative market risk volatility inherent in each product group, Prudential sets the risk discount rates to reflect the expected volatility associated with the cash flows for each product category in the embedded value model, rather than at a Group level. Since financial options and guarantees are explicitly valued under the EEV methodology, risk 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 For Asia, 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. 350 Prudential plc Annual Report 2017 www.prudential.co.uk US (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 (0.2 per cent for variable annuity business and 1.0 per cent for non‑variable annuity business for both years), 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 short‑term 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 returns 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 in force 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 and Europe (M&G Prudential) (1) Shareholder-backed annuity business For 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 15(iii). (2) With-profits fund non-profit annuity business For non‑profit annuity business 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 from the with‑profits fund, which are in turn discounted at the risk discount rate applicable to all of the projected cash flows from the fund. (3) With-profits fund holdings of debt securities The 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. An allowance for non‑diversifiable non‑market risks is estimated as set out below: 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. The level of these allowances are reviewed and updated based on an assessment of a range of pre‑defined emerging market risk indicators, as well as the Group’s exposure and experience in the business units. During 2017, the China allowance for non‑market risk was reduced reflecting the growth in the size of the business, increasing management exposure and experience in the country and an improvement in our risk assessment of the market. For the Group’s US business and UK and Europe business, no additional allowance is necessary. (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. www.prudential.co.uk Annual Report 2017 Prudential plc 351 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 14 Methodology and accounting presentation continued (a) Methodology continued (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 structural borrowings; and — The effect of changes in economic assumptions. In addition, non‑operating results include the effect of the disposal of businesses (see note 17) and in 2017, the impact of US tax reform (see note 7). 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 M&G Prudential, 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 reserve 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 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. (iii) Unwind of discount and other expected returns The Group’s methodology in determining the unwind of discount and other expected returns is 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. In applying this general approach, the unwind of discount included in operating profit for M&G Prudential is described below. 352 Prudential plc Annual Report 2017 www.prudential.co.uk M&G Prudential The unwind is determined by reference to an implied single risk discount rate. The EEV risk‑free rate is based on a yield curve (as set out in note 14(a)(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. 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 2017 the shareholders’ interest in the smoothed surplus assets used for this purpose only were £57 million lower (31 December 2016: £77 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‑year 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‑year 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 M&G Prudential, the embedded value incorporates Solvency II transitional measures, which are recalculated using management’s estimate of the impact of operating and market conditions at the valuation date. The effect of changes in economic assumptions is after allowing for this recalculation. 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 over time 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. (i) Asia notes (b)(c) The risk‑free rates of return for Asia are defined as 10‑year government bond yields at the end of the year. In order to reflect Prudential’s most recent assessment of the growth prospects of the region compared to other developed markets and the historically strong relationship between long‑term economic growth and long‑term equity returns, in a number of Asia business units, equity risk premiums were increased during 2017 by between 25 basis points and 75 basis points from those applied at 2016. The related expected return on equity and risk discount rates have also been increased by equivalent amounts. In addition, for a few Asia business units, expected long‑term inflation assumptions were revised during 2017 to better reflect central bank inflation targets and to align with the currency of the underlying exposures. 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 2017 31 Dec 2016 31 Dec 2017 31 Dec 2016 31 Dec 2017 31 Dec 2016 31 Dec 2017 31 Dec 2016 9.7 4.1 10.6 6.4 12.7 3.5 4.3 9.8 12.6 5.3 9.6 3.9 12.0 6.8 11.6 4.2 4.0 9.4 13.0 5.3 9.7 4.1 10.6 6.5 12.7 4.4 3.9 9.8 12.6 5.7 9.6 3.9 12.0 6.9 11.6 5.0 4.0 9.4 13.0 6.1 3.9 2.4 6.4 3.9 5.2 2.0 0.9 2.3 5.1 3.1 2.5 8.1 4.3 4.8 2.5 1.2 2.7 6.3 3.0 2.5 4.5 2.5 4.0 2.0 1.5 3.0 5.5 2.5 2.3 5.0 2.5 4.0 2.0 1.0 3.0 5.5 www.prudential.co.uk Annual Report 2017 Prudential plc 353 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationNotes on the EEV basis results continued 15 Assumptions continued Principal economic assumptions continued Notes (a) The weighted risk discount rates for Asia operations shown above have been determined by weighting each market’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 business units reflect: – the movements in 10‑year government bond yields; – changes in product mix; and – the effect of changes in the economic basis (see note 14(a)(viii) and above). For Hong Kong the assumptions shown are for US dollar denominated business. For other business units, the assumptions are for local currency denominated business. Equity risk premiums in Asia range from 4.0 per cent to 9.4 per cent (2016: from 3.5 per cent to 8.7 per cent). The mean equity return assumptions for the most significant equity holdings of the Asia operations are: (b) (c) (d) Hong Kong Malaysia Singapore (ii) US The risk‑free rates of return for the US 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 spread note 14(a)(viii) Risk discount rate: Variable annuity: Risk discount rate Additional allowance for credit risk included in risk discount rate note 14(a)(viii) Non‑variable annuity: Risk discount rate Additional allowance for credit risk included in risk discount rate note 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 volatility note (v) 31 Dec 2017 % 31 Dec 2016 % 6.4 10.4 8.5 6.5 10.2 8.5 31 Dec 2017 % 31 Dec 2016 % 1.50 1.25 1.75 1.50 0.50 0.19 6.8 0.2 4.1 1.0 6.7 6.5 2.4 6.4 3.0 4.0 18.0 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 * 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. 354 Prudential plc Annual Report 2017 www.prudential.co.uk (iii) UK and Europe The 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. 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). This single implied risk discount rate is shown, along with the 15‑year nominal rate of investment return and 15‑year rate of inflation based on the yield curve. Shareholder-backed annuity in-force business: note (a) Risk discount rate Pre‑tax expected 15‑year nominal rates of investment return note (c) With-profits and other business: Risk discount rate: note (b) New business In‑force business Pre‑tax expected 15‑year nominal rates of investment return: note (c) Overseas equities Property 15‑year gilt yield Corporate bonds Expected 15‑year rate of inflation Equity risk premium 31 Dec 2017 % 31 Dec 2016 % 4.0 2.6 4.7 4.8 4.5 2.8 4.7 4.9 6.2 to 10.1 4.4 1.6 3.4 3.5 4.0 6.2 to 9.4 4.5 1.7 3.5 3.6 4.0 Notes (a) (b) (c) For shareholder‑backed annuity business, the movements in the pre‑tax long‑term nominal rates of return and risk discount rates reflect the effect of changes in asset yields. 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. The table below shows the pattern of the UK risk‑free Solvency II spot yield curve at the end of both years: 31 Dec 2017 31 Dec 2016 1 year 0.6% 0.4% 5 year 10 year 15 year 20 year 0.9% 0.7% 1.2% 1.1% 1.3% 1.3% 1.4% 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 — 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 M&G Prudential 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 1.1 per cent to 2.0 per cent (2016: from 0.9 per cent to 2.3 per cent) following a number of modelling changes at full year 2017 in respect of future bond returns. (v) US (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 2.5 per cent to 2.8 per cent (2016: from 2.3 per cent to 2.6 per cent). (vi) UK and Europe (M&G Prudential) — 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 14 per cent to 20 per cent (2016: from 15 per cent to 20 per cent). www.prudential.co.uk Annual Report 2017 Prudential plc 355 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Notes on the EEV basis results continued 15 Assumptions continued Operating assumptions (vii) 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 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 actions to achieve the savings have been delivered. Expense overruns are reported where these are expected to be short‑lived, including businesses that are growing rapidly or are sub‑scale. 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 restructuring costs; 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. (viii) 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 statutory corporate tax rates applicable for the most significant operations for 2016 and 2017 are as follows: Statutory 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 24.0 17.0 2016 and 2017: 35.0; from 1 January 2018: 21.0 2016: 20.0; from 1 April 2017: 19.0; from 1 April 2020: 17.0 * The US tax reform changes included a reduction in the corporate income tax rate from 35 per cent to 21 per cent effective from 1 January 2018 (see note 7). 356 Prudential plc Annual Report 2017 www.prudential.co.uk 16 Insurance new business premiums note (i) Asia US UK and Europe Group total Asia Cambodia Hong Kong Indonesia Malaysia Philippines Singapore Thailand Vietnam SE Asia operations including Hong Kong China note (ii) Taiwan India note (iii) Total US Variable annuities Elite Access (variable annuity) Fixed annuities Fixed index annuities Wholesale Total UK and Europe Bonds Corporate pensions Individual pensions Income drawdown Other products Total Single premiums Regular premiums Annual premium equivalents (APE) note 14(a)(ii) Present value of new business premiums (PVNBP) note 14(a)(ii) 2017 £m 2016 £m 2017 £m 2016 £m 2017 £m 2016 £m 2017 £m 2016 £m 2,299 16,622 13,044 2,397 15,608 9,836 31,965 27,841 – 582 288 73 62 859 139 8 2,011 179 46 63 2,299 – 1,140 236 110 91 523 80 6 2,186 124 36 51 2,397 11,536 2,013 454 295 2,324 10,653 2,056 555 508 1,836 16,622 15,608 3,509 103 5,747 2,218 1,467 13,044 3,834 110 2,532 1,649 1,711 9,836 3,575 – 187 3,762 16 1,667 268 271 71 361 70 133 2,857 276 208 234 3,575 – – – – – – – 130 32 – 25 187 3,359 – 177 3,536 14 1,798 255 233 61 299 81 115 2,856 187 146 170 3,359 – – – – – – – 121 35 – 21 177 3,805 1,662 1,491 6,958 16 1,725 297 278 77 447 84 134 3,058 294 213 240 3,805 1,154 201 45 30 232 1,662 351 140 607 222 171 3,599 1,561 1,160 6,320 14 1,912 279 244 70 351 89 116 3,075 199 150 175 3,599 1,065 206 55 51 184 1,561 384 132 289 165 190 20,405 16,622 13,784 19,271 15,608 10,513 50,811 45,392 70 10,027 1,183 1,398 287 3,463 421 659 17,508 1,299 634 964 66 10,930 1,048 1,352 278 2,627 404 519 17,224 880 499 668 20,405 19,271 11,536 2,013 454 295 2,324 10,653 2,056 555 508 1,836 16,622 15,608 3,510 533 5,897 2,218 1,626 3,835 479 2,681 1,649 1,869 1,491 1,160 13,784 10,513 Group total 31,965 27,841 3,762 3,536 6,958 6,320 50,811 45,392 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(l) 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. www.prudential.co.uk Annual Report 2017 Prudential plc 357 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information Notes on the EEV basis results continued 17 Disposal of businesses On 18 May 2017, the Group announced it had completed the sale of its life insurance subsidiary in Korea, PCA Life Insurance, to Mirae Asset Life Insurance for KRW 170 billion (£117 million at 17 May 2017 closing exchange rate) following regulatory approval. The proceeds, net of £(9) million of related expenses, were £108 million. Upon disposal, £76 million of required capital was released and a corresponding increase in free surplus was recognised. There were no other impacts on the 2017 results. On 15 August 2017, the Group through its subsidiary National Planning Holdings, Inc. (NPH) sold its US independent broker‑dealer network to LPL Financial LLC. The initial consideration received was £252 million (US$325 million) resulting in a post‑tax profit on disposal of £80 million (US$103 million) after costs and net losses that have been incurred in the year. 18 Post balance sheet events Intention to demerge the Group’s UK businesses In March 2018, the Group announced its intention to demerge its UK & Europe business (‘M&G Prudential’) from Prudential plc, resulting in two separately‑listed companies. In preparation for the UK demerger process, Prudential plc intends to transfer the legal ownership of its Hong Kong insurance subsidiaries from The Prudential Assurance Company Limited (M&G Prudential’s UK regulated insurance entity) to Prudential Corporation Asia Limited, which is expected to complete by the end of 2019. Sale of £12.0 billion* UK annuity portfolio In March 2018, M&G Prudential also announced the sale of £12.0 billion* of its shareholder annuity portfolio to Rothesay Life. Under the terms of the agreement, M&G Prudential has reinsured £12.0 billion* of liabilities to Rothesay Life, which is expected to be followed by a Part VII transfer of the portfolio by the end of 2019. Further details are set out in the CFO report. * Relates to £12.0 billion of IFRS shareholder annuity liabilities, valued as at 31 December 2017. 358 Prudential plc Annual Report 2017 www.prudential.co.uk Statement of Directors’ responsibilities in respect of the European Embedded Value (EEV) basis supplementary information The Directors have chosen to prepare supplementary information in accordance with the 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. www.prudential.co.uk Annual Report 2017 Prudential plc 359 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIndependent 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. Philip Smart for and on behalf of KPMG LLP Chartered Accountants London 14 March 2018 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 2017 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 2017 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 359, 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. 360 Prudential plc Annual Report 2017 www.prudential.co.uk 07 Additional information Index to the additional unaudited financial information Risk factors Glossary Shareholder information How to contact us Page 362 391 398 402 406 www.prudential.co.uk Annual Report 2017 Prudential plc 361 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationIndex to the additional unaudited financial information I a b c d IFRS profit and loss information 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 business unit 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 Solvency II regime II Other information a b c d e f g Holding company cash flow Funds under management Return on IFRS shareholders’ funds IFRS gearing ratio IFRS shareholders’ funds per share Solvency II capital position at 31 December 2017 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 h i j k l m Calculation of return on embedded value n Calculation of EEV shareholders’ funds per share Page 363 370 371 372 373 374 375 375 375 376 380 384 385 387 389 389 390 390 362 Prudential plc Annual Report 2017 www.prudential.co.uk Additional 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 relevant drivers. 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 Changes in longevity assumption basis Provision for review of past annuity sales Long‑term business operating profit based on Average liability note (iv) 88,908 166,839 136,474 Total bps note (ii) 125 156 25 6,958 261,114 (35)% (88) Asia 220 199 59 1,310 2,097 (1,489) (959) 241 121 1,799 US 751 2,343 – 906 – (876) (1,174) 260 4 2,214 2017 £m UK and Europe 137 61 288 55 189 (68) (164) 4 104 606 276 204 (225) Total 1,108 2,603 347 2,271 2,286 (2,433) (2,297) 505 229 4,619 276 204 (225) longer‑term investment returns 1,799 2,214 861 4,874 See notes at the end of this section. www.prudential.co.uk Annual Report 2017 Prudential plc 363 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information I: 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 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. 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) Average liability note (iv) 85,266 145,826 119,170 Total bps note (ii) 142 156 27 6,574 238,392 (36)% (85) 2016 AER £m Asia US UK and Europe 192 174 48 1,040 1,919 (1,285) (832) 148 99 1,503 802 1,942 – 888 – (877) (959) 244 12 2,052 177 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 2016 CER £m note (iii) Asia US UK and Europe 201 181 50 1,087 2,004 (1,343) (866) 153 104 1,571 837 2,040 – 933 – (921) (1,007) 260 13 2,155 177 59 269 63 207 (89) (152) (2) 110 642 332 (175) Total 1,215 2,280 319 2,083 2,211 (2,353) (2,025) 411 227 4,368 332 (175) 1,571 2,155 799 4,525 364 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedMargin analysis of long-term insurance business – Asia Long-term business Spread income Fee income With‑profits Insurance margin Margin on revenues Expenses: 2017 Average liability note (iv) £m 16,359 18,767 30,115 Margin note (ii) bps 134 106 20 Profit £m 220 199 59 1,310 2,097 Acquisition costs note (i) Administration expenses DAC adjustments note (v) Expected return on shareholder assets (1,489) 3,805 (959) 35,126 241 121 (39)% (273) Operating profit based on longer‑term investment return 1,799 See notes at the end of this section. Analysis of Asia operating profit drivers: Asia 2016 AER Average liability note (iv) £m 13,299 15,643 22,823 Margin note (ii) bps 144 111 21 3,599 28,942 (36)% (287) Profit £m 192 174 48 1,040 1,919 (1,285) (832) 148 99 1,503 2016 CER note (iii) Average liability note (iv) £m 13,980 16,475 23,659 Margin note (ii) bps 144 110 21 3,773 30,455 (36)% (284) Profit £m 201 181 50 1,087 2,004 (1,343) (866) 153 104 1,571 — Spread income has increased on a constant exchange rate basis by 9 per cent (AER: 15 per cent) to £220 million in 2017, predominantly reflecting the growth of the Asia non‑linked policyholder liabilities. — Fee income has increased by 10 per cent at constant exchange rates (AER: 14 per cent) to £199 million in 2017, broadly in line with the increase in movement in average unit‑linked liabilities. — Insurance margin has increased by 21 per cent to £1,310 million in 2017 on a constant exchange rate basis (AER: 26 per cent), primarily reflecting the continued growth of the in‑force book, which contains a relatively high proportion of risk‑based products. — Margin on revenues has increased by £93 million on a constant exchange rate basis from £2,004 million in 2016 to £2,097 million in 2017, primarily reflecting growth of the in‑force book and higher regular premium income recognised in the year. — Acquisition costs have increased by 11 per cent at constant exchange rates (AER: 16 per cent) to £1,489 million, compared to the 1 per cent increase in APE sales, resulting in an increase in the acquisition costs ratio. The analysis above uses shareholder acquisition costs as a proportion of total APE. If with‑profits sales were excluded from the denominator the acquisition cost ratio would become 66 per cent (2016: 70 per cent at CER), the decrease being the result of product and country mix. — Administration expenses including renewal commissions have increased by 11 per cent at a constant exchange rate basis (AER: 15 per cent increase) in 2017 as the business continues to expand. On a constant exchange rate basis, the administration expense ratio has decreased from 284 basis points in 2016 to 273 basis points in 2017, the result of changes in country and product mix. www.prudential.co.uk Annual Report 2017 Prudential plc 365 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationI: 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 2017 Average liability note (iv) £m Profit £m 751 38,918 2,343 125,440 906 Margin note (ii) bps 193 187 (876) 1,662 (1,174) 169,725 (53)% (69) 260 4 2,214 US 2016 AER Average liability note (iv) £m Profit £m 802 37,044 1,942 102,027 888 (877) 1,561 (959) 146,043 244 12 2,052 2016 CER note (iii) Average liability note (iv) £m Profit £m 837 38,575 2,040 107,570 933 Margin note (ii) bps 217 190 Margin note (ii) bps 217 190 (56)% (66) (921) 1,641 (1,007) 153,445 (56)% (66) 260 13 2,155 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 See notes at the end of this section. Analysis of US operating profit drivers: — Spread income has decreased by 10 per cent at constant exchange rates (AER: decreased by 6 per cent) to £751 million during 2017. The reported spread margin decreased to 193 basis points from 217 basis points in 2016, due to lower yields in the investment portfolio. Spread income benefited from swap transactions previously entered into so that asset and liability duration can be more closely matched. Excluding this effect, the spread margin would have been 144 basis points (2016 CER: 152 basis points and AER: 153 basis points). — Fee income has increased by 15 per cent at constant exchange rates (AER: increased by 21 per cent) to £2,343 million during 2017, primarily due to higher average separate account balances due to positive net flows from variable annuity business and market appreciation during the year. — Insurance margin represents operating profits from insurance risks, including variable annuity guarantees and other sundry items. Insurance margin decreased to £906 million in 2017 from £933 million in 2016 on a constant exchange rate basis, with higher income from the variable annuity guarantees being more than offset by a decline in the contribution from the closed books of business. — Acquisition costs, which are commissions and expenses incurred to acquire new business, including those that are not deferrable, have decreased by 5 per cent at a constant exchange rate basis, largely due to the continued increase in producers selecting asset‑based commissions, which are paid upon policy anniversary dates and are treated as an administration expense in this analysis, rather than front end commissions. — Administration expenses increased to £1,174 million during 2017, compared to £1,007 million for 2016 at a constant exchange rate (AER: £959 million), primarily as a result of higher asset based commissions. Excluding these asset‑based commissions, the resulting administration expense ratio was relatively flat at 35 basis points (2016: 34 basis points at CER and AER). 366 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued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 Analysis of pre-tax operating profit before and after acquisition costs and DAC adjustments 2017 £m Acquisition costs 2016 AER £m Acquisition costs 2016 CER £m note (iii) Acquisition costs Other operating profits Incurred Deferred Total Other operating profits Incurred Deferred Total Other operating profits Incurred Deferred Total 2,830 2,830 2,685 2,685 2,816 2,816 (876) 663 (213) (877) 678 (199) (921) 716 (205) Total 2,830 (876) 260 2,214 2,685 (877) (489) (489) 86 86 (527) (527) 93 244 93 2,052 2,816 (921) (554) (554) 98 260 98 2,155 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 2017 £m 2016 £m % 317 1,788 109 2,214 10 2,224 AER 323 1,523 206 2,052 (4) 2,048 CER 339 1,601 216 2,156 (4) 2,152 2017 vs 2016 AER (2)% 17% (47)% 8% 350% 9% 2017 vs 2016 CER (6)% 12% (50)% 3% 350% 3% 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. www.prudential.co.uk Annual Report 2017 Prudential plc 367 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationI: 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 and Europe Long-term business Spread income Fee income With‑profits Insurance margin Margin on revenues Expenses: Acquisition costs note (i) Administration expenses DAC adjustments Expected return on shareholder assets Longevity reinsurance and other management actions to improve solvency Changes in longevity assumption basis 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 137 61 288 55 189 (68) (164) 4 104 606 276 204 (225) 861 UK and Europe 2017 Average liability note (iv) £m 33,631 22,632 106,359 Margin note (ii) bps 41 27 27 1,491 56,263 (5)% (29) 2016 Average liability note (iv) £m 32,711 21,781 95,511 Margin note (ii) bps 54 27 28 1,160 54,492 (8)% (28) Profit £m 177 59 269 63 207 (89) (152) (2) 110 642 332 – (175) 799 368 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued Analysis of UK and Europe operating profit drivers: — Spread income reduced from £177 million in 2016 to £137 million in 2017, mainly due to lower annuity sales. Spread income has two components: – A contribution from new annuity business which was lower at £9 million in 2017 compared to £41 million in 2016, reflecting our effective withdrawal from this market. – A contribution from in‑force annuity and other business, which was broadly in line with last year at £128 million (2016: £136 million), equivalent to 38 basis points of average reserves (2016: 42 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 39 bps (2016: 40 bps). — Margin on revenues represents premium charges for expenses of shareholder‑backed business and other sundry net income. — Acquisition costs decreased from £89 million in 2016 to £68 million in 2017, equivalent to 5 per cent of total APE sales in 2017 (2016: 8 per cent). The ratio above expresses the percentage of shareholder acquisition costs as a percentage of total APE sales. It is therefore impacted by the level of with‑profits business in the year. Acquisition costs expressed as a percentage of shareholder‑backed APE sales remained broadly consistent at 38 per cent (2016: 37 per cent). — The contribution from longevity reinsurance and other management actions to improve solvency during 2017 was £276 million (2016: £332 million). Further explanation and analysis is provided in Additional unaudited financial information section I(d). — The £204 million favourable longevity assumption changes reflect the adoption of the Continuous Mortality Investigation 2015 model. Further information on changes to mortality assumptions is given in note C4.1 (d). — The 2017 increase in the provision for the cost of undertaking a review of past non‑advised annuity sales and related potential redress of £225 million (2016: £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 2016 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 Europe 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. The 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. 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 £43 million in respect of joint ventures and an associate in 2017 (2016: AER credit of £28 million). (iv) (v) www.prudential.co.uk Annual Report 2017 Prudential plc 369 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationI: IFRS profit and loss information continued I(b) Asia operations – analysis of IFRS operating profit by business unit Operating profit based on longer‑term investment returns for Asia operations is analysed as follows: 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) Development expenses Total long-term business operating profit Asset management (Eastspring Investments) Total Asia operations note (iii) 2017 £m AER 2016 £m CER 2016 £m 2016 AER vs 2017 2016 CER vs 2017 346 457 171 41 272 107 135 1,529 91 43 64 75 1,802 (3) 1,799 176 1,975 238 428 147 38 235 92 114 1,292 64 35 49 67 1,507 (4) 1,503 141 1,644 250 447 149 37 247 100 117 1,347 66 39 53 70 1,575 (4) 1,571 149 1,720 45% 7% 16% 8% 16% 16% 18% 18% 42% 23% 31% 12% 20% 25% 20% 25% 20% 38% 2% 15% 11% 10% 7% 15% 14% 38% 10% 21% 7% 14% 25% 15% 18% 15% 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* Business in force Non‑recurrent items note (ii) Total 2017 £m 2016 £m 16 1,711 75 1,802 AER (29) 1,469 67 1,507 CER (30) 1,535 70 1,575 * The IFRS new business result corresponds to approximately 0.4 per cent of new business APE premiums for 2017 (2016: approximately (0.8) per cent of new business APE). The new business result reflects the aggregate of the pre‑tax regulatory basis result to net worth after IFRS adjustments for deferral of acquisition costs and deferred income where appropriate. In 2017, the IFRS operating profit based on longer‑term investment returns for Asia insurance operations included a net credit of £75 million (2016: £67 million) representing a small number of individually minor items. (ii) 370 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued 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 Average funds under management Margin based on operating income* Cost/income ratio† 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† 2017 £m M&G Prudential asset management note (ii) Eastspring Investments note (ii) 1,034 53 1,087 (602) 15 – 500 421 17 438 (238) – (24) 176 £275.9bn 37bps 58% £128.4bn 33bps 56% 2016 £m M&G Prudential asset management note (ii) Eastspring Investments note (ii) 923 33 956 (544) 13 – 425 353 7 360 (198) – (21) 141 £250.4bn 37bps 59% £109.0bn 32bps 56% 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 B1.6 of the IFRS financial statements, these amounts are netted and tax deducted and shown as a single amount. (ii) M&G Prudential asset management and Eastspring Investments can be further analysed as follows: 2017 2016 2017 2016 M&G Prudential asset management Operating income before performance-related fees Margin of FUM* bps 85 86 Institu- tional‡ £m 430 419 Margin of FUM* bps 21 22 Eastspring Investments Operating income before performance-related fees Margin of FUM* bps 57 58 Institu- tional‡ £m 172 142 Margin of FUM* bps 20 20 Total £m 1,034 923 Total £m 421 353 Retail £m 604 504 Retail £m 249 211 Margin of FUM* bps 37 37 Margin of FUM* bps 33 32 * 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 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. www.prudential.co.uk Annual Report 2017 Prudential plc 371 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 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 Solvency II regime In 2017, further management actions were taken to improve the solvency of the UK and Europe insurance operations and to mitigate market risks. These actions included extending the reinsurance of longevity risk to cover a further £0.5 billion of IFRS annuity liabilities. As at 31 December 2017, 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. The effect of these actions on the UK’s long‑term IFRS operating profit, underlying free surplus generation and EEV operating profit before restructuring costs is shown in the tables below. IFRS operating profit of UK long-term business* Shareholder‑backed annuity new business In‑force business: Longevity reinsurance transactions Other management actions to improve solvency Changes in longevity assumption basis Provision for the review of past annuity sales With‑profits and other in‑force Total 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 Changes in longevity assumption basis Provision for the review of past annuity sales Changes in operating assumptions and experience variances Underlying free surplus generated from in‑force business New business strain Total EEV post-tax operating profit of UK long-term business* Unwind of discount and other expected return Longevity reinsurance transactions Other management actions to improve solvency Changes in longevity assumption basis Provision for the review of past annuity sales Changes in operating assumptions and experience variances Operating profit from in‑force business New business profit Total * Before restructuring costs. 2017 £m 2016 £m 9 31 245 204 (225) 255 597 861 41 197 135 – (175) 157 601 799 2017 £m 2016 £m 706 15 385 179 (187) 392 (28) 1,070 (175) 895 693 126 225 – (145) 206 24 923 (129) 794 2017 £m 2016 £m 465 (6) 127 195 (187) 129 79 673 342 1,015 445 (90) 110 – (145) (125) 55 375 268 643 372 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedII Other information II(a) Holding company cash flow* Net cash remitted by business units: Total Asia net remittances to the Group US net remittances to the Group UK and Europe net remittances to the Group With‑profits remittance Shareholder‑backed insurance business remittance Asset management remittance Other UK paid to the Group (including Prudential Capital)4 Total UK net 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 2017 £m 2016 £m 645 475 215 105 323 25 668 1,788 (415) 152 (207) (470) 1,318 (1,159) 159 (511) (352) 2,626 (10) 2,264 516 420 215 85 290 192 782 1,718 (333) 132 (215) (416) 1,302 (1,267) 35 335 370 2,173 83 2,626 * 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 4 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 repayment of subordinated debt net of the proceeds from that issued in the year, and payments for distribution rights and acquisition of subsidiaries. Including central finance subsidiaries. 2016 remittance principally represents the outcome of actions completed in that year that facilitated access to central resources previously held at intermediary, holding and other companies. www.prudential.co.uk Annual Report 2017 Prudential plc 373 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information II Other information continued II(b) Funds under management (a) Summary For our asset management businesses, funds managed on behalf of third parties are not recorded on the balance sheet. They are, however, a driver of profitability. We therefore analyse the movement in the funds under management each period, focusing on those which are external to the Group and those primarily held by the insurance businesses. The table below analyses, by segment, the funds of the Group held in the statement of financial position and the external funds that are managed by Prudential’s asset management operations. Business area: Asia operations: Internal funds Eastspring Investments’ external funds US operations – internal funds M&G Prudential: Internal funds, including PruFund‑backed products External funds Other operations Total funds under management note Note Total funds under management comprise: Total investments per the consolidated statement of financial position External funds of M&G Prudential and Eastspring Investments (as analysed in no te b) Internally managed funds held in joint ventures and other adjustments Prudential Group funds under management (b) Investment products – external funds under management 2017 £bn 2016 £bn 81.4 55.9 137.3 69.6 45.7 115.3 178.3 173.3 186.8 163.9 350.7 3.0 669.3 174.0 136.8 310.8 2.9 602.3 2017 £bn 2016 £bn 451.4 219.8 (1.9) 669.3 421.7 182.5 (1.9) 602.3 2017 £m 2016 £m At 1 Jan 2017 Market gross inflows Redemptions Market and other movements At 31 Dec 2017 At 1 Jan 2016 Market gross inflows Redemptions Market and other movements At 31 Dec 2016 64,209 30,949 (19,906) 4,445 79,697 60,801 15,785 (22,038) 9,661 64,209 72,554 15,220 (8,926) 5,310 84,158 65,604 7,056 (8,893) 8,787 72,554 M&G Prudential Wholesale/ Direct M&G Prudential Institutional Total M&G Prudential1 136,763 46,169 (28,832) 9,755 163,855 126,405 22,841 (30,931) 18,448 136,763 Eastspring Investments 45,756 215,907 (211,271) 5,493 55,885 36,287 164,004 (161,766) 7,231 45,756 Total2 182,519 262,076 (240,103) 15,248 219,740 162,692 186,845 (192,697) 25,679 182,519 Notes 1 2 The results exclude contribution from PruFund products (net inflows of £9.0 billion in 2017; funds under management of £35.9 billion as at 31 December 2017, £24.7 billion as at 31 December 2016). The £219.7 billion (2016: £182.5 billion) investment products comprise £210.4 billion (2016: £174.8 billion) plus Asia Money Market Funds of £9.3 billion (2016: £7.7 billion). 374 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued(c) M&G and Eastspring Investments – total funds under management M&G, the asset management business of M&G Prudential and Eastspring Investments, the Group’s asset management business in Asia, manage funds from external parties and also funds for the Group’s insurance operations. The table below analyses the total funds under management managed by M&G and Eastspring Investments respectively. External funds under management Internal funds under management Total funds under management M&G Eastspring Investments 2017 £bn 2016 £bn 2017 £bn note 2016 £bn note 163.9 134.6 298.5 136.8 128.1 264.9 55.9 83.0 138.9 45.7 72.2 117.9 Note The external funds under management for Eastspring Investments include Asia Money Market Funds at 31 December 2017 of £9.3 billion (2016: £7.7 billion). II(c) Return on IFRS shareholders’ funds Return on IFRS shareholders’ funds is calculated as operating profit based on longer‑term investment returns net of tax and non‑ controlling interests divided by opening shareholders’ funds. Operating profit based on longer‑term investment returns is reconciled to IFRS profit before tax in note B1 to the IFRS financial statements. Operating profit based on longer‑term investment returns, net of tax and non‑controlling interests Opening shareholders’ funds Return on shareholders’ funds Note 2017 £m 2016 £m B5 3,727 14,666 25% 3,362 12,955 26% II(d) IFRS gearing ratio Gearing ratio is calculated as net core structural borrowings of shareholder‑financed operations divided by closing IFRS shareholders’ funds plus net core structural borrowings. Core structural borrowings of shareholder‑financed operations Less holding company cash and short‑term investments Net core structural borrowings of shareholder-financed operations Closing shareholders’ funds Shareholders’ funds plus net core structural borrowings Gearing ratio Note C6.1 II(a) 2017 £m 2016 £m 6,280 (2,264) 4,016 16,087 20,103 20% 6,798 (2,626) 4,172 14,666 18,838 22% II(e) IFRS shareholders’ funds per share IFRS shareholders’ funds per share is calculated as closing IFRS shareholders’ funds divided by the number of issued shares at the balance sheet date. Closing shareholders’ funds (£ million) Number of issued shares at year end (millions) Shareholders’ funds per share (pence) 2017 16,087 2,587 622 2016 14,666 2,581 568 www.prudential.co.uk Annual Report 2017 Prudential plc 375 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(f) Solvency II capital position at 31 December 2017 The estimated Group shareholder Solvency II surplus at 31 December 2017 was £13.3 billion, before allowing for payment of the 2017 second interim ordinary dividend and reflects approved regulatory transitional measures as at 31 December 2017. Own Funds Solvency Capital Requirement Surplus Solvency ratio 31 Dec 2017 £bn 31 Dec 2016 £bn 26.4 13.1 13.3 202% 24.8 12.3 12.5 201% * 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 solvency positions include management’s estimates of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. 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 using management’s estimate of the impact of operating and market conditions at the valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority and this recalculation will therefore be reflected in the formal regulatory Quantitative Reporting Templates as at 31 December 2017. The Group shareholder Solvency II capital position excludes: — A portion of Solvency II surplus capital (£1.7 billion at 31 December 2017) relating to the Group’s Asian life operations, including due to the Solvency II definition of ‘contract boundaries’, which prevents some expected future cash flows from being recognised; — The contribution to Own Funds and the Solvency Capital Requirement from ring‑fenced with‑profits funds in surplus (representing £4.8 billion of surplus capital from UK with‑profits funds at 31 December 2017) 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 2017 to 1 October 2018. At 31 December 2017, this approval had the effect of decreasing local statutory capital and surplus (and by extension Solvency II Own Funds and Solvency II surplus) by £0.4 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. The 31 December 2017 Solvency II results above allow for the completion of the sale of the Korea life business and sale of the US broker‑dealer network in 2017, which contributes £0.1 billion to the Group Solvency II surplus. The results also allow for the impact of US tax reforms enacted in December 2017, which reduce the Group Solvency II surplus by £0.6 billion. Further information on the Solvency II capital position for the Group and The Prudential Assurance Company Limited is published annually in the Solvency and Financial Condition Reports. These were last published on the Group’s website on 18 May 2017. 376 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedAnalysis of movement in Group capital position A summary of the estimated movement in Group Solvency II surplus from £12.5 billion at year end 2016 to £13.3 billion at year end 2017 is set out in the table below. The movement from the Group Solvency II surplus at 31 December 2015 to the Solvency II surplus at 31 December 2016 is included for comparison. Analysis of movement in Group shareholder surplus Estimated Solvency II surplus at beginning of period Underlying operating experience Management actions Operating experience Non‑operating experience (including market movements) Other capital movements Subordinated debt issuance / redemption Foreign currency translation impacts Dividends paid Model changes Estimated Solvency II surplus at end of period Full year 2017 Full year 2016 Surplus £bn Surplus £bn 12.5 3.2 0.4 3.6 (0.6) (0.2) (0.7) (1.2) (0.1) 13.3 9.7 2.3 0.4 2.7 (1.1) 1.2 1.6 (1.3) (0.3) 12.5 The estimated movement in Group Solvency II surplus over 2017 is driven by: — Operating experience of £3.6 billion: generated by in‑force business and new business written in 2017, after allowing for amortisation of the UK transitional and the impact of one‑off management optimisations implemented over the period; — Non-operating experience of £(0.6) billion: resulting mainly from the impact of US tax reform and market movements during 2017, after allowing for the recalculation of the UK transitional at the valuation date; — Other capital movements: comprising a loss from foreign currency translation, the net impact of debt raised offset by debt redeemed during 2017 and a reduction in surplus from payment of dividends; and — Model changes: reflecting minor calibration changes made to the internal model during 2017. 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: 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 31 Dec 2017 31 Dec 2016 % of undiversified Solvency Capital Requirements % of diversified Solvency Capital Requirements % of undiversified Solvency Capital Requirements % of diversified Solvency Capital Requirements 57% 14% 24% 13% 6% 26% 5% 14% 7% 11% 6% 71% 23% 38% 7% 3% 21% 2% 17% 2% 7% 1% 55% 12% 25% 13% 5% 28% 5% 16% 7% 11% 6% 68% 19% 41% 7% 1% 23% 2% 19% 2% 7% 2% www.prudential.co.uk Annual Report 2017 Prudential plc 377 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(f) Solvency II capital position at 31 December 2017 continued Reconciliation 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 net deferred tax liabilities resulting from liability valuation differences above Other Estimated Solvency II Shareholder Own Funds 31 Dec 2017 £bn 31 Dec 2016 £bn 16.1 (3.0) (4.0) 5.8 (3.9) 5.3 12.1 (1.6) (0.4) 26.4 14.7 (2.2) (3.8) 6.3 (3.4) 4.0 10.5 (1.3) 0.0 24.8 The key items of the reconciliation as at 31 December 2017 are: — £3.0 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 £0.8 billion, equivalent to the value of 100 per cent of Risk Based Capital requirements (Company Action Level), as agreed with the Prudential Regulation Authority; — £4.0 billion due to the removal of DAC, goodwill and intangibles from the IFRS balance sheet; — £5.8 billion due to the addition of subordinated debt which is treated as available capital under Solvency II but as a liability under IFRS; — £3.9 billion due to the inclusion of a risk margin for UK and Asia non‑hedgeable risks, net of £2.3 billion from transitional measures (after allowing for recalculation of the transitional measures as at 31 December 2017) which are not applicable under IFRS; — £5.3 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; — £12.1 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; — £1.6 billion due to the impact on the valuation of net deferred tax liabilities resulting from the liability valuation differences noted above; and — £0.4 billion due to other items, including the impact of revaluing loans, borrowings and debt from IFRS to Solvency II. 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 2017 31 Dec 2016 Surplus £bn Ratio Surplus £bn 13.3 0.7 (2.1) (1.0) 1.2 (1.4) 202% 9% (11)% (14)% 21% (6)% 12.5 0.0 (1.5) (0.6) 1.0 (1.1) Ratio 201% 3% (7)% (9)% 13% (3)% 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 believes it 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. 378 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedUK Solvency II capital position1,2 On the same basis as above, the estimated shareholder Solvency II surplus for The Prudential Assurance Company Limited (‘PAC’) and its subsidaries2 at 31 December 2017 was £6.1 billion, after allowing for recalculation of transitional measures as at 31 December 2017. 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 2017 £bn 31 Dec 2016 £bn 14.0 7.9 6.1 178% 12.0 7.4 4.6 163% * The UK 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 solvency positions include management’s estimate of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. While there is a large surplus in the UK with‑profits funds, this 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 2017 was £4.8 billion, after allowing for recalculation of transitional measures as at 31 December 2017. Estimated UK with-profits Solvency II capital position* Own funds Solvency capital requirement Surplus Solvency ratio 31 Dec 2017 £bn 31 Dec 2016 £bn 9.6 4.8 4.8 201% 8.4 4.7 3.7 179% * The solvency positions include management’s estimate of UK transitional measures reflecting operating and market conditions at each valuation date. An application to recalculate the transitional measures as at 31 December 2017 has been approved by the Prudential Regulation Authority. Reconciliation of UK with-profits IFRS unallocated surplus to Solvency II Own Funds1 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 2017 £bn 31 Dec 2016 £bn 13.5 11.7 (2.7) (0.7) (0.5) 9.6 (2.3) (0.7) (0.3) 8.4 Annual regulatory reporting The Group will publish its Solvency and Financial Condition Report and related quantitative templates no later than 17 June 2018. 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 £6.6 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 in respect of Solvency II Capital Position at 31 December 2017 The methodology, assumptions and overall result have been subject to examination by KPMG LLP. Notes 1 2 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. The insurance subsidiaries of PAC are Prudential General Insurance Hong Kong Limited, Prudential Hong Kong Limited, Prudential International Assurance plc and Prudential Pensions Limited. www.prudential.co.uk Annual Report 2017 Prudential plc 379 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(g) 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 4 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 2017 results. In addition to showing the amounts, both discounted and undiscounted, expected to be generated from all in‑force business at 31 December 2017, the tables also present the expected future free surplus to be generated from the investment made in new business during 2017 over the same 40‑year period for long‑term business operations. (i) Expected transfer of value of in-force business (VIF) and required capital to free surplus Expected period of emergence 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 to 2042 2043 to 2047 2048 to 2052 2053 to 2057 Undiscounted expected generation from all in-force business* Undiscounted expected generation from new business written* 31 Dec 2017 £m Asia 1,393 1,352 1,299 1,256 1,239 1,202 1,171 1,149 1,154 1,109 1,066 1,032 1,003 980 971 919 898 885 868 854 4,252 4,280 3,948 3,490 US 1,464 1,425 1,483 1,551 1,441 1,433 1,404 1,277 1,158 1,051 897 840 731 612 514 325 333 189 140 90 286 – – – UK and Europe 671 685 674 660 638 618 601 580 553 526 499 473 448 422 532 498 467 434 402 370 1,401 972 385 197 Total 3,528 3,462 3,456 3,467 3,318 3,253 3,176 3,006 2,865 2,686 2,462 2,345 2,182 2,014 2,017 1,742 1,698 1,508 1,410 1,314 5,939 5,252 4,333 3,687 Asia 197 182 181 162 164 139 142 136 131 141 121 125 116 117 134 112 113 112 111 120 581 719 737 714 US 226 113 124 155 129 65 73 179 154 138 125 114 99 89 78 51 32 29 23 21 – – – – UK and Europe 36 38 40 43 48 44 40 39 39 38 36 32 31 30 30 28 26 25 23 22 83 76 9 5 Total 459 333 345 360 341 248 255 354 324 317 282 271 246 236 242 191 171 166 157 163 664 795 746 719 Total free surplus expected to emerge in the next 40 years 37,770 18,644 13,706 70,120 5,507 2,017 861 8,385 * The analysis excludes amounts incorporated into VIF at 31 December 2017 where there is no definitive time frame for when the payments will be made or receipts received. In particular, it excludes the value of the shareholders’ interest in the with‑profits estate. It also excludes any free surplus emerging after 2057. The above amounts can be reconciled to the new business amounts as follows: Undiscounted expected free surplus generation for years 2018 to 2057 Less: discount effect Discounted expected free surplus generation for years 2018 to 2057 Discounted expected free surplus generation for years after 2057 Less: Free surplus investment in new business Other items† Post‑tax EEV new business profit for long‑term business operations 2017 £m US 2,017 (689) 1,328 – (254) (168) 906 UK and Europe 861 (339) 522 1 (175) (6) 342 Total 8,385 (4,181) 4,204 443 (913) (118) 3,616 Asia 5,507 (3,153) 2,354 442 (484) 56 2,368 † 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. 380 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedThe undiscounted expected free surplus generation from all in‑force business at 31 December 2017 shown below can be reconciled to the amount that was expected to be generated as at 31 December 2016 as follows: Group 2016 expected free surplus generation for years 2017 to 2056 Less: Amounts expected to be realised in the 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m 2022 £m Other £m Total £m 3,441 3,195 3,111 3,070 3,030 2,865 45,321 64,033 current year (3,441) – – – – – – (3,441) Add: Expected free surplus to be generated in year 2057* Foreign exchange differences New business Operating movements Non‑operating and other movements 2017 expected free surplus generation for years 2018 to 2057 Asia 2016 expected free surplus generation for years 2017 to 2056 Less: Amounts expected to be realised in the – – – – – – – (180) 459 (130) 184 – (176) 333 (96) 290 – (176) 345 (63) 280 – (175) 360 (34) 286 – (163) 341 (5) 280 578 (2,225) 6,547 578 (3,095) 8,385 2,668 3,660 3,528 3,462 3,456 3,467 3,318 52,889 70,120 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m 2022 £m Other £m Total £m 1,320 1,247 1,202 1,167 1,142 1,122 27,080 34,280 current year (1,320) – – – – – – (1,320) Add: Expected free surplus to be generated in year 2057* Foreign exchange differences New business Operating movements Non‑operating and other movements 2017 expected free surplus generation for years 2018 to 2057 US 2016 expected free surplus generation for years 2017 to 2056 Less: Amounts expected to be realised in the current year Foreign exchange differences New business Operating movements Non‑operating and other movements 2017 expected free surplus generation for years 2018 to 2057 UK and Europe 2016 expected free surplus generation for years 2017 to 2056 Less: Amounts expected to be realised in the current year Add: Expected free surplus to be generated in year 2057* New business Operating movements Non‑operating and other movements 2017 expected free surplus generation for years 2018 to 2057 * Excluding 2017 new business. – – – – – – – (69) 197 11 7 – (66) 182 15 19 – (65) 181 – 16 – (64) 162 (8) 24 – (63) 164 (17) 33 540 (1,511) 4,621 540 (1,838) 5,507 501 601 1,393 1,352 1,299 1,256 1,239 31,231 37,770 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m 2022 £m Other £m Total £m 1,446 1,279 1,273 1,281 1,282 1,152 8,257 15,970 (1,446) – – – – – (111) 226 (72) 142 – (110) 113 (48) 197 – (111) 124 (8) 197 – (111) 155 24 201 – (100) 129 57 203 – (714) 1,270 (1,446) (1,257) 2,017 2,467 3,360 – 1,464 1,425 1,483 1,551 1,441 11,280 18,644 2017 £m 2018 £m 2019 £m 2020 £m 2021 £m 2022 £m Other £m Total £m 675 669 636 622 606 591 9,984 13,783 (675) – – – – – – – 36 (69) 35 – – 38 (63) 74 – – 40 (55) 67 – – 43 (50) 61 – – 48 (45) 44 – (675) 38 656 38 861 (300) (301) 671 685 674 660 638 10,378 13,706 www.prudential.co.uk Annual Report 2017 Prudential plc 381 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(g) Reconciliation of expected transfer of value of in-force business (VIF) and required capital to free surplus continued At 31 December 2017, the total free surplus expected to be generated over the next five years (2018 to 2022 inclusive), using the same assumptions and methodology as those underpinning our 2017 embedded value reporting was £17.2 billion, an increase of £1.4 billion from the £15.8 billion expected over an equivalent period from the end of 2016. This increase primarily reflects the new business written in 2017, which is expected to generate £1,838 million of free surplus over the next five years. At 31 December 2017, the total free surplus expected to be generated on an undiscounted basis in the next 40 years is £70.1 billion, up from the £64.0 billion expected at the end of 2016, reflecting the effect of new business written across all three business operations of £8.4 billion, a negative foreign exchange translation effect of £(3.1) billion and a £3.7 billion net effect reflecting operating, market assumption changes and other items. In Asia, these include the effect of changes in operating assumptions reflecting the net benefit arising from annual review of experience, together with the benefit of management actions. In the US, these mainly reflect the positive effect from persistency assumption updates and increase in equity market returns, together with the benefits from US tax reform, partially offset by lower future separate account return due to the decrease in interest rates. In the UK and Europe, these reflect the impact of management actions which had the effect of accelerating the generation of future free surplus into 2017, partially offset by higher than assumed investment returns on with‑profits funds. 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 2017 from life business in force before restructuring costs at the end of 2017 was £4.1 billion including £0.6 billion of changes in operating assumptions and experience variances. This compares with the expected 2017 realisation at the end of 2016 of £3.4 billion. This can be analysed further as follows: Transfer to free surplus in 2017 Expected return on free assets Changes in operating assumptions and experience variances Underlying free surplus generated from in-force life business before restructuring costs in 2017 2017 free surplus expected to be generated at 31 December 2016 Asia £m 1,275 51 81 1,407 1,320 US £m 1,329 56 190 1,575 1,446 UK and Europe £m 675 31 364 1,070 675 Total £m 3,279 138 635 4,052 3,441 382 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information 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 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038‑2042 2043‑2047 2048‑2052 2053‑2057 Discounted expected generation from all in-force business Discounted expected generation from new business written 31 Dec 2017 £m Asia 1,337 1,218 1,102 997 929 845 777 718 679 619 561 515 477 445 420 376 350 329 309 291 1,314 1,101 837 593 US 1,400 1,282 1,254 1,234 1,077 1,008 930 795 680 580 467 410 337 268 215 124 123 72 52 30 117 – – – UK and Europe 655 645 610 573 529 487 452 415 375 337 303 272 241 212 261 229 202 176 156 136 465 117 89 33 Total 3,392 3,145 2,966 2,804 2,535 2,340 2,159 1,928 1,734 1,536 1,331 1,197 1,055 925 896 729 675 577 517 457 1,896 1,218 926 626 Asia 188 161 150 127 121 98 96 86 78 80 64 62 55 52 56 45 44 42 39 42 180 192 166 130 US 220 103 107 124 99 46 51 112 89 75 64 54 44 37 31 24 16 14 10 8 – – – – UK and Europe 35 36 38 39 41 36 32 30 28 25 22 20 18 16 15 13 12 10 9 7 30 7 2 1 Total 443 300 295 290 261 180 179 228 195 180 150 136 117 105 102 82 72 66 58 57 210 199 168 131 Total discounted free surplus expected to emerge in the next 40 years 17,139 12,455 7,970 37,564 2,354 1,328 522 4,204 The above amounts can be reconciled to the Group’s EEV basis financial statements as follows: Discounted expected generation from all in‑force business for years 2018 to 2057 Discounted expected generation from all in‑force business for years after 2057 Discounted expected generation from all in‑force business at 31 December 2017 Add: Free surplus of life operations held at 31 December 2017 Less: Time value of guarantees Other non‑modelled items Total EEV for long‑term business operations 31 Dec 2017 £m 37,564 1,576 39,140 6,242 (836) 1,371 45,917 www.prudential.co.uk Annual Report 2017 Prudential plc 383 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(h) 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: 2017 Free surplus and Group IFRS results US dollar linked note (1) Other Asia currencies Total Asia UK sterling notes (2)(3) US dollar note (3) Total 2017 Group EEV post-tax results US dollar linked note (1) Other Asia currencies Total Asia UK sterling notes (2)(3) US dollar note (3) Total Underlying free surplus generated for total insurance and asset management operations % 13% 17% 30% 34% 36% Group IFRS pre-tax operating profit notes (2)(3) % Group IFRS shareholders’ funds notes (2)(3) % 24% 18% 42% 11% 47% 21% 16% 37% 50% 13% 100% 100% 100% New business profits % 54% 12% 66% 9% 25% Operating profit notes (2)(3) % Shareholders’ funds notes (2)(3) % 46% 12% 58% 9% 33% 37% 11% 48% 29% 23% 100% 100% 100% Notes (1) US dollar linked comprise the Hong Kong and Vietnam operations where the currencies are pegged to the US dollar and the Malaysia and Singapore operations where the (2) (3) currencies are managed against a basket of currencies including the US dollar. For operating profit and shareholders’ funds, UK sterling includes amounts in respect of M&G Prudential and other operations (including central operations, Africa operations and Prudential Capital). Operating profit for central operations includes amounts for corporate expenditure for Group Head Office as well as Asia Regional Head Office which is incurred in HK dollars. For shareholders’ funds, the US dollar grouping includes US dollar denominated core structural borrowings. Sterling operating profits include all interest payable as sterling denominated, reflecting interest rate currency swaps in place. 384 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued II(i) 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 B2.2 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: 19 May 2021; — Prudential International Assurance sharesave plan: 3 August 2019; and — International savings‑related share option scheme for non‑employees 2012: 12 May 2022. The weighted average share price of Prudential plc for the year ended 31 December 2017 was £17.51 (2016: £13.56). Particulars of options granted to directors are included in the Directors’ remuneration report on page 123. The closing price of the shares immediately before the date on which the options were granted during the year was £17.67. The following analyses show the movement in options for each of the option schemes for the year ended 31 December 2017. UK savings-related share option scheme Date of grant Exercise price £ Beginning End Beginning of year Granted Exercised Cancelled Forfeited Lapsed Exercise period Number of options 16 Sep 11 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 21 Sep 17 21 Sep 17 4.66 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 11.04 14.55 14.55 01 Dec 16 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 01 Dec 20 01 Dec 22 31 May 17 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 31 May 21 31 May 23 36,006 119,886 73,812 70,258 759,088 390,761 933,241 223,807 719,147 164,428 – – – – – – – – – – – 817,979 – 138,385 (36,006) (89,777) (70,920) (1,942) (566,652) (12,686) (15,804) (2,061) (2,096) (747) – – (1,572) – – – (598) – (2,863) (998) (332) (14,043) (14,379) – (2,007) (1,894) (1,184) (7,655) (2,097) (15,159) (29,125) (20,724) (20,042) (3,609) (3,240) (24,643) (18,455) (10,082) (3,328) (4,074) (10,621) – (691) (7,985) – – (288) (1,350) End of year – 25,239 – 66,202 156,359 359,247 847,546 213,547 663,871 145,658 809,303 138,097 3,490,434 956,364 (798,691) (90,225) (67,853) (64,960) 3,425,069 The total number of securities available for issue under the scheme is 3,425,069, which represents 0.132 per cent of the issued share capital at 31 December 2017. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £18.17. The weighted average fair value of options granted under the plan in the period was £3.29. www.prudential.co.uk Annual Report 2017 Prudential plc 385 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(i) Option schemes continued International savings-related share option scheme Exercise period Number of options Date of grant Exercise price £ Beginning End 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 17 21 Sep 17 4.66 6.29 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 14.55 14.55 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 20 01 Dec 22 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 21 31 May 23 Beginning of year 722 2,725 14,501 131,680 43,676 7,709 4,464 23,556 3,240 15,516 – – Granted Exercised Cancelled Forfeited Lapsed – – – – – – – – – – 12,542 3,298 (722) (2,725) (11,708) (126,373) (3,669) (5,138) – – – – – – – – (1,772) (7) (1,655) – – – – – – – – – (359) (149) – (155) – – – – – – – – – (5,151) – (2) – – – – – – End of year – – 662 – 38,352 2,414 4,464 23,556 3,240 15,516 12,542 3,298 247,789 15,840 (150,335) (3,434) (663) (5,153) 104,044 The total number of securities available for issue under the scheme is 104,044 which represents 0.004 per cent of the issued share capital at 31 December 2017. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £16.99. The weighted average fair value of options granted under the plan in the period was £3.32. Prudential International Assurance sharesave plan There are no securities available for issue under the scheme at 31 December 2017. Non-employee savings-related share option scheme Date of grant Exercise price £ Beginning End Beginning of year Granted Exercised Cancelled Forfeited Lapsed Exercise period Number of options 16 Sep 11 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 21 Sep 17 21 Sep 17 4.66 6.29 9.01 9.01 11.55 11.55 11.11 11.11 11.04 11.04 14.55 14.55 01 Dec 16 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 01 Dec 20 01 Dec 22 31 May 17 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 31 May 21 31 May 23 29,936 28,001 346,321 406,850 596,435 502,793 480,825 405,994 334,276 199,230 – – – – – – – – – – – 268,279 – 174,763 (29,936) (12,737) (338,560) (365) (331,618) (121) (18,378) – (25,456) – – – – – (7,761) (4,992) (13,243) (8,802) (5,192) (18,074) (10,287) (8,370) (815) (815) – – – (13,662) (3,749) – – – (618) – (412) – 3,330,661 443,042 (713,337) (93,102) (47,524) – – – – – – – – – – – – – End of year – 15,264 – 388,250 237,637 472,145 452,343 383,962 329,712 198,415 267,661 174,351 2,919,740 The total number of securities available for issue under the scheme is 2,919,740 which represents 0.113 per cent of the issued share capital at 31 December 2017. The weighted average closing price of the shares immediately before the dates on which the options were exercised during the current period was £17.67. The weighted average fair value of options granted under the plan in the period was £3.41. 386 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued II(j) 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 Profit (loss) attaching to disposal of businesses Total charges, net of reinsurance and profit (loss) attaching to Year ended 31 December 2017 £m 2016 £m 2015 £m 2014 £m 2013 £m 44,005 (2,062) 41,943 42,189 2,430 86,562 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 (72,532) (10,165) (59,366) (8,848) (29,656) (8,208) (50,169) (6,752) (43,154) (6,861) (425) 228 (360) (238) (312) (46) (341) (13) (305) (120) disposal of businesses (82,894) (68,812) (38,222) (57,275) (50,440) 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 charge attributable to shareholders’ returns Profit for the year 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 Supplementary IFRS income statement data 302 182 238 303 147 3,970 (674) 3,296 (906) 2,390 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 2017 2016 2015 2014 2013 93.1p 93.0p 45.07p 45.07p – 75.0p 75.0p 49.40p 39.40p 10.00p 101.0p 100.9p 38.05p 38.05p – 86.9p 86.8p 35.03p 35.03p – 52.8p 52.7p 30.52p 30.52p – Operating profit based on longer‑term investment returns note 2 Non‑operating items Profit before tax attributable to shareholders Operating earnings per share (in pence) Year ended 31 December £m 2017 4,699 (1,403) 3,296 145.2p 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 www.prudential.co.uk Annual Report 2017 Prudential plc 387 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationII Other information continued II(j) Selected historical financial information of Prudential continued Supplementary EEV income statement data (post-tax) Operating profit based on longer‑term investment returns note 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) 2017 6,598 2,153 8,751 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 4,358 257.0p 214.7p 189.6p 161.2p 165.8p Year ended 31 December £m 2017 6,958 3,610 52% 2016 6,320 3,088 49% 2015 5,466 2,609 48% 2014* 4,514 2,104 47% 2013 4,310 2,057 48% * 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 2017 2016 2015 2014 2013 Total assets Total policyholder liabilities and unallocated surplus of with‑profits funds Core structural borrowings of shareholder‑financed operations Total liabilities Total equity 493,941 470,498 386,985 369,204 325,932 428,194 6,280 477,847 16,094 403,313 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 £m Other data As of and for the year ended 31 December Funds under management note 3 EEV shareholders’ equity, excluding non‑controlling interests Group shareholder Solvency II surplus note 4 Insurance Groups Directive capital surplus before final dividend 2017 669 45.0 13.4 n/a 2016 602 39.0 12.5 n/a £bn 2015 509 32.4 9.7 5.5 2014 496 29.2 n/a 4.7 2013 443 24.9 n/a 5.1 Notes 1 2 3 4 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 the 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 2017 surplus is estimated. 388 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continuedII(k) 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 Other note (b) IFRS shareholders’ funds 31 Dec 2017 £m 31 Dec 2016 £m 44,698 (29,410) 9,227 (8,428) 16,087 38,968 (24,937) 9,170 (8,535) 14,666 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. For the UK, this would be the difference between IFRS and Solvency II. It also includes the mark to market of the Group’s core structural 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. II(l) Reconciliation of APE new business sales to earned premiums The Group reports APE new business sales as a measure of the new policies sold in the year. This differs from the IFRS measure of premiums earned as shown below: Annual premium equivalents as published Adjustment to include 100% of single premiums on new business sold in the year note (a) 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 2017 £m 6,958 28,769 8,278 44,005 (2,062) 41,943 2016 £m 6,320 25,057 7,604 38,981 (2,020) 36,961 Notes (a) (b) APE new business sales only include one tenth of single premiums, recorded on policies sold in the year. Gross premiums earned include 100 per cent of such premiums. Other adjustments principally include amounts in respect of the following: – Gross premiums earned include 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 year which are classified as investment contracts without discretionary participation features under IFRS 4, arising mainly in Jackson for guaranteed investment contracts and in M&G Prudential 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 and associates. Under IFRS, joint ventures and associates are equity accounted and so no amounts are included within gross premiums earned. www.prudential.co.uk Annual Report 2017 Prudential plc 389 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information II Other information continued II(m) Calculation of return on embedded value Return on embedded value is calculated as the EEV post‑tax operating profit based on longer‑term investment returns, as a percentage of opening EEV basis shareholders’ funds. Operating profit based on longer‑term investment returns (£ million) Opening EEV basis shareholders' funds (£ million) Return on embedded value Note 2 9 2017 6,598 38,968 17% 2016 5,497 31,886 17% II(n) Calculation of EEV shareholders’ funds per share EEV shareholders’ funds per share is calculated as closing EEV shareholders’ funds divided by the number of issued shares at the balance sheet date. EEV shareholders’ funds per share excluding goodwill attributable to shareholders is calculated in the same manner, except goodwill attributable to shareholders is deducted from closing EEV shareholders’ funds. Closing EEV shareholders' funds (£ million) Less: Goodwill attributable to shareholders (£ million) Closing EEV shareholders' funds excluding goodwill attributable to shareholders (£ million) Number of issued shares at year end (millions) Shareholders' funds per share (in pence) Shareholders' funds per share excluding goodwill attributable to shareholders (in pence) Note 31 Dec 2017 31 Dec 2016 9 9 44,698 (1,458) 43,240 2,587 1,728p 38,968 (1,475) 37,493 2,581 1,510p 1,671p 1,453p 390 Prudential plc Annual Report 2017 www.prudential.co.uk Additional unaudited financial information continued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 ‘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, fluctuations or negative trends in international economic and investment climates could have a material adverse effect on Prudential’s business and profitability. Prudential operates in a macroeconomic and global financial market environment that presents significant uncertainties and potential challenges, For example, government interest rates remain low in the US, the UK and some Asian countries in which Prudential operates. Global financial markets are subject to uncertainty and volatility created by a variety of factors. These factors include the reduction in accommodative monetary policies in the US, the UK and other jurisdictions together with its impact on the valuation of all asset classes, effects on interest rates and the risk of disorderly repricing of inflation expectations and global bond yields, concerns over sovereign debt, a general slowing in world growth, the increased level of geopolitical risk and policy‑related uncertainty and potentially negative socio‑political events. The adverse effects of such factors could be felt principally through the following items: — Reduced investment returns arising on the Group’s portfolios including impairment of debt securities and loans, 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, and/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; challenges related to market fluctuations and general economic conditions may continue to emerge. — 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 becoming more 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, which also adds to uncertainty over the accessibility of financial resources and may reduce capital resources as valuations decline. 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. The potential impact of increased illiquidity is more uncertain than for other risks such as interest rate or credit risk. In general, 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 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. In the US, Jackson 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. Jackson uses a derivative hedging programme to reduce its exposure to market risks arising on these guarantees. There could be market circumstances where the derivatives that Jackson enters into to hedge its market risks may not cover its exposures under the guarantees. The cost of the guarantees that remain unhedged will also affect Prudential’s results. In addition, 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. Also, in the US, fluctuations in prevailing interest rates can affect results from www.prudential.co.uk Annual Report 2017 Prudential plc 391 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationJackson which has a significant spread based business, with the significant proportion 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. On 29 March 2017 the UK submitted the formal notification of its intention to withdraw from the EU pursuant to Article 50 of the Treaty on the European Union, as amended. Following submission of this notification, the UK has a maximum period of 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 UK’s decision to leave 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 M&G Prudential, and these may be impacted by a UK withdrawal from the EU. The outcome of the negotiations on the UK’s withdrawal and any subsequent negotiations on trade and access to the country’s major trading markets, including the single EU market, is currently unknown. As a result, there is ongoing uncertainty over the terms under which the UK will leave the EU, whether any transitional arrangements will be agreed between the UK and the EU, the possibility of a lengthy period before negotiations are concluded, and the potential for a disorderly exit by the UK without a negotiated agreement. This uncertainty 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. A significant part of the profit from M&G Prudential’s 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 state 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 adversely affected, as might counterparty relationships between financial institutions. If a sovereign were to default on its obligations, or adopted policies that devalued or otherwise altered the currencies in which its obligations were 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 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 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 that Prudential has in managing its business. 392 Prudential plc Annual Report 2017 www.prudential.co.uk Risk factors continued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), capital control measures on companies and individuals, regulation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, or 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. The adverse impact from these changes may affect Prudential’s product range, distribution channels, competitiveness, profitability, capital requirements, risk management approaches, corporate or governance structure 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. Furthermore, as a result of interventions by governments following recent financial and global economic conditions, there may continue to be changes 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. Recent shifts in the focus of some national governments toward more protectionist or restrictive economic and trade policies could impact on the degree and nature of regulatory changes and Prudential’s competitive position in some geographic markets. This could take effect, for example, through increased friction in cross‑border trade or measures favouring local enterprises such as changes to the maximum level of non‑domestic ownership by foreign companies. 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 began a review in late 2016 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 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 decision to leave the EU could result in significant changes to the legal and regulatory regime under which the Group operates, the nature and extent of which are uncertain while the outcome of negotiations regarding the UK’s withdrawal from the EU and the extent and terms of any future access to the single EU market remains unknown. Currently there are also a number of other global regulatory developments which could impact Prudential’s businesses 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), the Insurance Capital Standard (ICS) being developed by the International Association of Insurance Supervisors (IAIS), the Markets in Financial Instruments Directive (the ‘MiFID II Directive’), which recently came into force in the EU and the EU General Data Protection Regulation that comes into force in May 2018. 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 including any implications from the recently enacted US tax reform legislation and amendments to certain local statutory regimes in some territories in Asia. There remains a high degree of uncertainty over the potential impact of these changes on the Group. The Dodd‑Frank Act provides for a comprehensive overhaul of the financial services industry within the US including reforms to financial services entities, products and markets. 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. There is also potential uncertainty surrounding future changes to the Dodd‑Frank Act under the current US administration. Prudential’s designation as a G‑SII was reaffirmed on 21 November 2016. As a result of this designation, Prudential is subject to additional regulatory requirements, including a requirement to submit enhanced risk management plans (such as a Group‑wide Recovery Plan, a Systemic Risk Management Plan and a Liquidity Risk Management Plan) to a Crisis Management Group (CMG) comprised of an international panel of regulators. The G‑SII regime also introduces capital requirements in the form of a Higher Loss Absorption (HLA) requirement. While this requirement was initially intended to come into force in 2019, this has now been postponed to 2022. The HLA is also now intended to be based on the ICS. The IAIS has announced that the implementation of ICS will be conducted in two phases – a five‑year monitoring phase followed by an implementation phase. During the monitoring phase, Internationally Active Insurance Groups, for which Prudential satisfies the criteria, will be required to report on compliance with the ICS to the group‑wide supervisor on a confidential basis, although these results will not be used as a basis to trigger supervisory www.prudential.co.uk Annual Report 2017 Prudential plc 393 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationaction. The Common Framework (ComFrame) for the Supervision of Internationally Active Insurance Groups will more generally 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. Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event of a failure of a market participant. As a major participant in the majority of its chosen markets, circumstances could arise in which 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, under its standard IFRS 4 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 May 2017, the IASB published its replacement standard on insurance accounting (IFRS 17, ‘Insurance Contracts’), which will have the effect of introducing fundamental changes to the statutory reporting of insurance entities that prepare accounts according to IFRS from 2021. The European Union will apply its usual process for assessing whether the standard meets the necessary criteria for endorsement. The Group is reviewing the complex requirements of this standard and considering its potential impact. The effect of changes required to the Group’s accounting policies as a result of implementing the new standard is currently uncertain, but these changes can be expected to, amongst other things, alter the timing of IFRS profit recognition. The implementation of this standard is also likely to require significant enhancements to IT, actuarial and finance systems of the Group, and so will have an increase on the Group’s expenses. Any changes or modification of IFRS accounting policies may require a change in the way in which future results will be determined and/or a retrospective adjustment of reported results to ensure consistency. 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. Such actions may relate to the application of current regulations for example the Financial Conduct Authority’s (FCA) principles and conduct of business rules or the failure to implement new regulations. 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 FCA to review annuities sold without advice after 1 July 2008 to its contract‑based defined contribution pension customers. This will result in the UK business being required to provide redress to certain such customers, the ultimate amount of which remains uncertain. Regulators may also focus on 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 (DoL). Elements of the DoL fiduciary duty rules, including the impartial conduct standards, became effective on 9 June 2017 but applicability of the remaining components of the rules has been delayed until 1 July 2019. 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. Litigation, disputes and regulatory investigations may adversely affect Prudential’s profitability and financial condition Prudential is, and may in the future be, 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 respects 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 imposed and the inherent unpredictability of litigation and disputes, it is possible that an adverse outcome could 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, the ability to respond to developing demographic trends, customer appetite for certain savings products and technological advances. In some of its markets, Prudential faces competitors that are larger, have greater 394 Prudential plc Annual Report 2017 www.prudential.co.uk Risk factors continued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 include global life insurers such as Allianz, AXA, and Manulife together with regional insurers such as AIA and Great Eastern, and multinational asset managers such as Franklin Templeton, HSBC Global Asset Management, J.P. Morgan Asset Management and Schroders. In most markets, there are also local companies that have a material market presence. M&G Prudential’s principal competitors include many of the major retail financial services companies and fund management companies including, in particular, Aviva, Janus Henderson, Jupiter, Legal & General, Schroders and Standard Life Aberdeen. Jackson’s competitors in the US include major stock and mutual insurance companies, mutual fund organisations, banks and other financial services companies such as Aegon, AIG, Allianz, AXA Financial Inc., Brighthouse, Lincoln Financial Group, MetLife and Prudential Financial. Prudential believes competition will intensify across all regions in response to consumer demand, digital and other technological advances, the need for economies of scale and the consequential 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 by Moody’s, AA by Standard & Poor’s, and AA by Fitch. These ratings are all on a stable outlook. 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. All ratings above are stated as at 13 March 2018. 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. 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 or human error, the effects of natural or man‑made catastrophic events (such as natural disasters, pandemics, cyber‑attacks, acts of terrorism, civil unrest and other catastrophes) or from other external events. Exposure to such events could disrupt Prudential’s systems and operations significantly, which may result in financial loss and reputational damage. Prudential’s business is dependent on processing a large number of transactions across numerous and diverse products, and it employs a large number of models, and user developed applications, some of which are complex, in its processes. The long‑term nature of much of the Group’s business also means that accurate records have to be maintained for significant periods. Further, Prudential operates in an extensive and evolving legal and regulated environment which adds to the operational complexity of its business processes and controls. 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. As part of the implementation of its business strategies, Prudential has commenced a number of change initiatives to be established across the Group, some of which are interconnected and/or of large scale, that may have material financial and reputational implications if such initiatives fail (either wholly or in part) to meet their objectives and could place strain on the operational capacity of the Group. These initiatives include the combination of M&G and Prudential UK & Europe, the proposed demerger of M&G Prudential and the intended sale of part of the UK annuity portfolio. In addition, Prudential outsources several operations, including a significant part of its 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 security 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 www.prudential.co.uk Annual Report 2017 Prudential plc 395 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information(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. The proposed demerger of M&G Prudential carries with it execution risk and will require significant management attention The proposed demerger of M&G Prudential (Prudential’s UK business), is subject to a number of factors (including prevailing market conditions, transfer of the Hong Kong business from The Prudential Assurance Company Limited to Prudential Corporation Asia Limited and approvals from regulators and shareholders). Therefore there can be no certainty as to the timing of the demerger, or that it will be completed as proposed (or at all). Further, if the proposed demerger is completed, there can be no assurance that either Prudential plc or M&G Prudential will realise the anticipated benefits of the transaction, or that the proposed demerger will not adversely affect the trading value or liquidity of the shares of either or both of the two businesses. In addition, preparing for and implementing the proposed demerger is expected to require significant time from management, which may divert management’s attention from other aspects of Prudential’s business. Attempts by third parties to access or disrupt Prudential’s IT systems could result in loss of trust from Prudential’s customers, reputational damage and financial loss 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 key operations, make it difficult to recover critical services, damage assets and compromise the integrity and security of data (both corporate and 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. Prudential’s increasing market profile, growing customer interest in interacting with their insurance providers and asset managers through the internet and social media, improved brand awareness and the classification of Prudential as a G‑SII could also increase the likelihood of Prudential being considered a target by cyber criminals. Further, there have been recent changes to the threat landscape and the risk from untargeted but sophisticated and automated attacks has increased. Developments in data protection worldwide (such as the EU General Data Protection Regulation that comes into force in May 2018) may also increase the financial and reputational implications for Prudential following a significant breach of its (or its third‑party suppliers’) IT systems. 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. The failure to understand and respond effectively to the impacts of transitional and physical risks associated with climate change could adversely affect Prudential’s results of operations and its long-term strategy Climate change poses potentially significant risks to Prudential and its customers, not only from the physical impacts of climate change, driven by specific climate‑related events such as natural disasters, but also from the transition risks, associated with the shift to a low‑carbon economy. The climate risk landscape continues to evolve and is moving up the agenda of many regulators, governments, non‑ governmental organisations and investors. For example, the Financial Stability Board (FSB’s) Task Force for Climate‑related Disclosures recommendations were published in 2017 to provide a voluntary framework on corporate climate‑related financial disclosures following the FSB’s concern that there may be systemic risk in the financial system related to climate change. Global commitments to limit climate change were recently agreed and governmental and corporate efforts to transition to a low‑carbon economy in the coming decades could have an adverse impact on global investment assets. In particular, there is a risk that this transition including the related changes to technology, policies and regulations and the speed of their implementation, could result in some sectors (such as but not limited to the fossil fuel industry) facing significantly higher costs and a disorderly adjustment to their asset values. This could lead to an adverse impact on the value and the future performance of the investment assets of the Group if climate considerations are not effectively integrated into investment decisions and fiduciary and stewardship duties. Where Prudential’s investment horizons are long term, the relevant assets are potentially more exposed to the long‑term impact of climate change. Adverse 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 396 Prudential plc Annual Report 2017 www.prudential.co.uk Risk factors continued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. 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 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. In addition, the level of control exercisable by the Group could also be subject to changes in the maximum level of non‑domestic ownership imposed on foreign companies in certain jurisdictions. 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 therefore 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. 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 relevant to a number of lines of business in the Group, especially for 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. In addition, Prudential’s business may be adversely affected by 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 historically 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, which are subject to the risks discussed elsewhere in this ‘Risk Factors’ section. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 397 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationGlossary 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. Cash surrender value The amount of cash available to a policy holder on the surrender of or withdrawal from a life insurance policy or annuity contract. CER Constant Exchange Rate – Prudential plc reports its results at both actual exchange rates (AER) to 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 year 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 year interim dividend plus the proposed final 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, interest is credited to the contract holders’ account and administrative charges are deducted, as appropriate. 398 Prudential plc Annual Report 2017 www.prudential.co.uk 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 holders’ account and, periodically, interest is credited to the contract holders’ 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 life time 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 Moodys. 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. www.prudential.co.uk Annual Report 2017 Prudential plc 399 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationGlossary continued 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. Open 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. 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. 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 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. The returns from the separate account generally accrue to the policyholder. A separate account allows an investor to choose an investment category according to his individual risk tolerance, and desire for performance. Single premiums Single premium policies of insurance are those that require only a single lump sum payment from the policyholder. Stochastic techniques Stochastic techniques incorporate results from repeated simulations using key financial parameters which are subject to random variations and are projected into the future. 400 Prudential plc Annual Report 2017 www.prudential.co.uk 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. 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 companies 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’ above. Yield A measure of the income received from an investment compared to the price paid for the investment. Normally expressed as a percentage. 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. Unit-linked products or unit-linked contracts See ‘investment‑linked products or contracts’ above. www.prudential.co.uk Annual Report 2017 Prudential plc 401 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationShareholder 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 Annual General Meeting The 2018 Annual General Meeting (AGM) will be held in the Churchill Auditorium at The QEII Centre, Broad Sanctuary, Westminster, London SW1P 3EE on 17 May 2018 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 2017 AGM, including the major items discussed at the meeting and the results of the voting, can be found on the Company’s website. 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. 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 2017. The current Memorandum and Articles are available on the Company’s website. Share capital Issued share capital The issued share capital as at 31 December 2017 consisted of 2,587,175,445 (2016: 2,581,061,573) 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 2017, there were 48,086 (2016: 48,534) accounts on the register. Further information can be found in note C10 on page 277. 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 2017 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 % of total number of shares 285 149 544 1,514 1,661 10,561 33,372 48,086 0.59 0.31 1.13 3.15 3.45 21.96 69.41 100 2,266,393,270 105,678,252 125,935,925 45,754,585 11,504,150 23,172,639 8,736,624 2,587,175,445 87.60 4.08 4.87 1.77 0.44 0.90 0.34 100 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 2017 Capital Group Companies, Inc. BlackRock, Inc Norges Bank % of total voting rights 9.87 5.08 3.99 As at 14 March 2018, 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 14 March 2018, Trustees held 0.48 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 123 to 157. 402 Prudential plc Annual Report 2017 www.prudential.co.uk 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 17 May 2018. Details of shares issued during 2017 and 2016 are given in note C10 on page 277. 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 2017. 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 17 May 2018. Shareholders registered on the UK register and Hong Kong and Irish branch registers 29 March 2018 Holders of US American Depository Receipts Shareholders with ordinary shares standing to the credit of their CDP securities accounts – 29 March 2018 3 April 2018 3 April 2018 3 April 2018 18 May 2018 On or about 25 May 2018 On or about 25 May 2018 Restrictions on transfer In accordance with English company law, shares may be transferred by an instrument of transfer or through an electronic system (currently CREST) and 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 148 of the Directors’ remuneration report. Dividend information 2017 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. www.prudential.co.uk Annual Report 2017 Prudential plc 403 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationShareholder 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, UK. Irish branch register Link Asset Services, Link Registrars Limited, PO Box 7117, Dublin 2, Ireland. Hong Kong branch register Singapore register ADRs 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. JPMorgan Chase Bank N.A, PO Box 64504, St. Paul, MN 55164‑0854, USA. 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 +44 121 415 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 404 Prudential plc Annual Report 2017 www.prudential.co.uk 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, 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/investors/ shareholder‑information/forms or from Equiniti. Further information about ShareGift may be obtained on +44 (0)20 7930 3737 or from www.ShareGift.org 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/investors/ shareholder‑information/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 at www.shareview.co.uk/4/Info/Portfolio/ default/en/home/shareholders/Pages/ ReinvestDividends.aspx 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. www.prudential.co.uk Annual Report 2017 Prudential plc 405 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional informationShareholder contacts Tel +44 (0)20 7548 3300 Email: 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 Depositary 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 Email: media.relations@prudential.co.uk How 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 Executive Directors Mike Wells Group Chief Executive Mark FitzPatrick Chief Financial Officer John Foley Chief Executive of M&G Prudential Nic Nicandrou Chief Executive of Prudential Corporation Asia Anne Richards Deputy Chief Executive of M&G Prudential and Chief Executive of M&G Barry Stowe Chairman and Chief Executive Officer of North American Business Unit James Turner Group Chief Risk Officer Non-executive Directors Philip Remnant Senior Independent Director Sir Howard Davies David Law Kai Nargolwala Anthony Nightingale Alice Schroeder Lord Turner Tom Watjen Group Executive Committee Julian Adams Group Regulatory and Government Relations Director 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 Business units M&G Prudential 12 Arthur Street London EC4R 9AQ www.pru.co.uk Tel +44 (0)800 000 000 www.mandg.co.uk Tel +44 (0)800 328 3192 John Foley Chief Executive of M&G Prudential Anne Richards Deputy Chief Executive of M&G Prudential and Chief Executive of M&G Prudential Corporation Asia 13th Floor One International Finance Centre 1 Harbour View Street Central Hong Kong Tel +852 2918 6300 www.prudentialcorporation‑asia.com Nic Nicandrou Chief Executive of Prudential Corporation Asia 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 406 Prudential plc Annual Report 2017 www.prudential.co.uk 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 Principal place of business in Hong Kong 13th Floor One International Finance Centre 1 Harbour View Street Central Hong Kong 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. www.prudential.co.uk Annual Report 2017 Prudential plc 407 01 Group overview02 Strategic report03 Governance04 Directors’ remuneration report05 Financial statements06 European Embedded Value (EEV) basis results07 Additional information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, the timing, costs and successful implementation of the demerger described herein; the future trading value of the shares of Prudential plc and the trading value and liquidity of the to‑be‑ listed M&G Prudential business following such demerger; 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 decision 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 internal projects and other strategic actions failing to meet their objectives; disruption to the availability, confidentiality or integrity of Prudential’s IT systems (or those of its suppliers); 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 this document and 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. 408 Prudential plc Annual Report 2017 www.prudential.co.uk History 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 over 26 million 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. 1871 The Company becomes one of the first in the City to employ women. Calculating machines are also introduced, bringing efficiencies to the processing of an increasing volume of business. 1879 Prudential moves into Holborn Bars, a purpose‑built office complex designed by Alfred Waterhouse. The building becomes a London landmark, and remains part of Prudential’s property portfolio to this day. 1912 Following the National Insurance Act, Prudential works with the government to run Approved Societies, providing sickness and unemployment benefits to five million people. 1923 Prudential’s first overseas life branch is established in India, with the first policy being sold to a tea planter in Assam. 1924 Prudential shares are floated on the London Stock Exchange. 1949 The ‘Man from the Pru’ advertising campaign is launched. 1986 Prudential acquires Jackson National Life Insurance 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 plc is listed on the New York Stock Exchange. Prudential becomes the first UK life insurer to enter the Mainland China market through its joint venture with CITIC Group. 2010 Prudential plc is listed on stock exchanges in Hong Kong and Singapore. 2014 Prudential acquires businesses in Ghana and Kenya, marking its entry into the fast‑growing African life insurance industry. 2017 M&G and Prudential UK & Europe combine to form M&G Prudential, a leading savings and investments business ideally positioned to target growing customer demand for comprehensive financial solutions. 2018 Prudential plc announces its intention to demerge its UK and Europe business, M&G Prudential, resulting in two separately listed companies, with different investment characteristics and opportunities. www.prudentialhistory. co.uk Adding more to life: The founding of Prudential The Prudential Mutual Assurance, Investment and Loan Association was formed on 30 May 1848, in a room at 12 Hatton Garden, London (the premises of Hanslip and Manning solicitors). The Company’s leather‑bound Deed of Settlement lists the first shareholders and directors, and outlines the Company’s purpose – to offer life assurance and loans to the middle classes. Shareholders including lawyers, doctors, a wine merchant and a number of ‘gentlemen’ accounted for the first 1,530 shares in the Company. Prudential’s first policies were issued in 1849. The Company’s first annual report, published in 1850, stated that: ‘the Directors are pleased to think that they might infix habits of Prudence among many individuals’, focusing on customers such as ‘the clergyman who requires advances for the erection of his parsonage and the officer who seeks the price of his commission’. 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 7 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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