Prudential Regulatory News (PRU)

European Embedded Value (EEV) Basis Results

SUMMARISED CONSOLIDATED INCOME STATEMENT

Notes

(i) EEV basis other income and expenditure represents the post-tax IFRS basis results for other operations (including interest costs on core structural borrowings, corporate expenditure for head office functions in London and Hong Kong, the Group's treasury function and Africa operations) less the unwind of expected margins on the internal management of the assets of the covered business (as explained in note 14(i)(g)).

(ii) Restructuring costs include group-wide costs incurred for IFRS 17 implementation in 2019 from continuing operations.

MOVEMENT IN SHAREHOLDERS' EQUITY

* The 2018 comparative results have been re-presented from those previously published to reflect the change in the Group's presentation currency from pounds sterling to US dollars and the reclassification of the Group's UK and Europe operations as discontinued operations in 2019 (see note 1).

Notes

(i) Intra-group dividends represent dividends that have been declared in the year. Dividends payable by the discontinued UK and Europe operations (M&G plc) to Prudential plc includes a $3,841 million pre-demerger dividend, cash dividends paid in the period of $684 million and restructuring impacts related to the demerger. Investment in operations reflects movements in share capital. The amounts included for these items in the analysis of movement in free surplus (note 11) for Asia 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.

(ii) Other movements include reserve movements in respect of the shareholders' share of actuarial gains and losses on defined benefit pension schemes that were transferred to M&G plc at 30 June 2019, share capital subscribed, share-based payments, treasury shares and intra-group transfers between operations that have no overall effect on the Group's shareholders' equity.

(iii) Based on the number of issued shares at the end of 2019 of 2,601 million shares (end of 2018/beginning of 2019: 2,593 million shares, beginning of 2018: 2,587 million shares).

(iv) On 21 October 2019, the Group completed the demerger of its UK and Europe operations (M&G plc), resulting in two separately listed companies. The demerger dividend in specie of M&G plc has been recorded at the fair value of M&G plc at the date of the demerger. The difference between the fair value and its carrying value, together with profit earned up to the date of the demerger have been recorded as loss for the year from the discontinued UK and Europe operations.

(v) Representing goodwill attributable to shareholders.

SUMMARY STATEMENT OF FINANCIAL POSITION

* Including liabilities in respect of insurance products classified as investment contracts under IFRS 4.

NOTES ON THE EEV BASIS RESULTS

1 Basis of preparation

The EEV basis results have been prepared in accordance with the EEV Principles issued by the European Insurance CFO Forum in 2016. The EEV Principles provide consistent definitions, a framework for setting actuarial assumptions and an approach to the underlying methodology and disclosures. 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.

The Group completed the demerger of its UK and Europe operations, M&G plc, from the Prudential plc Group on 21 October 2019. In line with the treatment of the results under IFRS, the EEV basis results for the Group's UK and Europe operations have been reclassified as discontinued operations and removed from the Group's key performance indicators (KPIs). In the subsequent notes, comparative amounts have been represented to show continuing operations only in order to present the results on a comparable basis. The Directors have also elected to change the Group's presentation currency from pounds sterling to US dollars. The 2018 comparative results have been accordingly re-presented from those previously published for these changes (see note A1 of the Group IFRS financial statements for exchange rates used).

Overview

Results prepared under the EEV Principles represent the present value of the shareholders' interest in the post-tax future profits (on a local statutory basis) expected to arise from the current book of long-term 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 expected future shareholder cash flows from the in-force covered business (value of in-force business), less explicit allowance for the cost of locked-in required capital and the time value of financial options and guarantees across a range of economic scenarios;

- Locked-in required capital, based on the applicable local statutory regulations, including any amounts considered to be required above the local statutory minimum requirements to satisfy regulatory constraints (the application of this principle to each business unit is set out below); and

- The shareholders' total net worth in excess of required capital (free surplus). Free surplus is defined in note 11.

Required capital

For shareholder-backed business, the following capital requirements apply for long-term business:

- Asia: the level of required capital has been set to an amount at least equal to local statutory notification requirements. For China JV life operations, the level of required capital follows the approach for embedded value reporting issued by the China Association of Actuaries (CAA) reflecting the China Risk Oriented Solvency System (C-ROSS) regime; and

- 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).

Key assumptions

The value of in-force business is determined by projecting post-tax future profits (on a local statutory basis) by product, using best estimate assumptions for operating factors such as persistency, mortality, morbidity and expenses. Explicit allowances are made for the cost of holding required capital under the applicable local statutory regimes and the time value of financial options and guarantees (TVOG). The TVOG is determined by weighting the probability of outcomes across a large number of different economic scenarios, and is less applicable to health and protection business that generally contain more limited financial options or guarantees.

As well as best estimate assumptions for operating factors, the projected cash flows assume a level of future investment return and are discounted using a risk discount rate. Both the risk discount rate and investment return are updated at each valuation date in line with changes in the risk-free rates. During 2019, this has had an overall negative effect on new business and in-force profitability. Different products will be sensitive to different assumptions, for example, spread-based products or products with guarantees are likely to benefit from higher assumed investment returns.

Risk discount rates are set equal to the risk-free rate at the valuation date plus a product-specific allowance for market and non-market risks, excluding risks explicitly captured elsewhere such as via the TVOG. Products such as participating and unit-linked business will have typically a higher allowance for market risk as compared to health and protection products due to a higher proportion of equity-type assets within the investment portfolio. Other product design and business features also affect the risks attached to the emergence of shareholder cash flows, for example, the construct of with-profits funds in some business units can reduce the sensitivity of both policyholder and shareholder cash flows for participating products. Risk discount rates in any one business unit will reflect a blend of the risks attaching to the products written in that business.

The value of future new business is excluded from the embedded value.

A description of the EEV methodology and accounting presentation is provided in note 14, including an explanation of the delineation of profit between operating profit based on longer-term investment returns and non-operating items. Further details of best estimate assumptions are provided in note 15.

2 Results analysis by business area

The 2018 comparative results are shown below on both actual exchange rates (AER) and constant exchange rates (CER) bases. The 2018 CER comparative results are translated at 2019 average exchange rates for US dollars following the change in the Group's presentation currency.

Annual premium equivalents (APE) from continuing operationsnote 16

Profit for the year

3 Analysis of new business contribution

Notes

(i) The movement in new business contribution from $4,707 million for 2018 to $4,405 million for 2019 from continuing operations is analysed as follows:

(ii) Asia new business contribution is analysed as follows:

4 Operating profit from long-term business in force

Notes

(i) The movement in unwind of discount and other expected returns from $2,802 million for 2018 to $2,270 million for 2019 from continuing operations is analysed as follows:

(ii) The 2019 effect of changes in operating assumptions of $539 million in Asia principally reflects the outcome from the annual review of persistency, claims and expense experience, together with the benefit of medical repricing management actions and the beneficial effect on the effective tax rate for China JV from changes to tax legislation in the first half of 2019.

(iii) In Asia, the 2019 effect of experience variances and other items of $285 million is driven overall by positive mortality and morbidity experience in a number of local business units, together with positive persistency variance from participating and health and protection products.

In the US, the effect of experience variances and other items is analysed as follows:

5 Short-term fluctuations in investment returns

Notes

(i) For 2019, the credit of $2,451 million mainly represents the increase in bond and equity values in Hong Kong and higher than expected investment returns in Singapore, Thailand and Taiwan. The small losses in Indonesia and Malaysia represent bond gains being more than offset by lower than expected equity returns.

(ii) 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;

- Credit experience versus the longer-term assumption (which in 2019 was positive); and

- The difference between actual realised gains and losses and the amortisation of interest-related realised gains and losses that is recorded within operating profit.

(iii) 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 24.1 per cent and that assumed of 4.8 per cent (geometric) (2018: actual growth of negative 5.4 per cent compared to assumed growth of positive 5.3 per cent (geometric)); and

- Related hedging activity arising from realised and unrealised gains and losses on equity and interest rate derivatives compared to the updated expected long-term allowance for hedging costs recorded in operating profit, and other items.

6 Effect of changes in economic assumptions

Notes

(i) In 2019, the negative effect of $(667) million largely arises from movements in long-term interest rates, resulting in lower assumed fund earned rates in Hong Kong, Thailand and Taiwan, partially offset by the positive effect of lower risk discount rates in Indonesia and Malaysia in valuing future profits for health and protection business and the effect of changes to the basis of setting economic assumptions as described in note 14(i)(h) and note 15(i).

(ii) In 2019, the charge of $(1,556) million mainly reflects the effect of a decrease in the assumed separate account return, following the 80 basis points decrease in the US 10-year treasury yield over the year, partially offset by the increase in US equity risk premium as described in note 15(i), resulting in lower projected fee income and an increase in projected benefit costs for variable annuity business.

(iii) For fixed annuity and other general account business, the impact of $355 million reflects the increase in the present value of future projected spread income from the combined decrease in interest rates and credit spreads in the year.

7 Impact of NAIC reform, hedge modelling and other related changes in the US

Notes

(i) The National Association of Insurance Commissioners (NAIC) has implemented changes to the US statutory reserve and capital framework for variable annuities, effective from 1 January 2020. Jackson has chosen to early adopt the changes at 31 December 2019 for US statutory reporting and the Group has updated EEV accordingly. The impact on Group EEV is a $37 million benefit, with the increase in the cost of capital from higher capital requirements more than offset by the timing benefit from releasing policyholder liabilities earlier than previously anticipated. The impact on the various components of EEV as at 31 December 2019 is shown below. As discussed in note 14(i)(e), the below is based on a capital requirement of 250 per cent of the risk-based capital company action level and so the impact on free surplus is not equal to the effect on Jackson's US statutory position.

Given that the NAIC reform was adopted at 31 December 2019, with the exception of the amounts shown above there are no other impacts from this change recorded in the 2019 EEV consolidated income statement or in the analysis of movement in free surplus. If the changes had been adopted with effect from 1 January 2019, the Group's 2019 EEV results would not be expected to be materially different.

(ii) Following the implementation of the NAIC's changes to the US statutory reserve and capital framework, enhancements were made to the model used to allow for hedging within US statutory reporting. As a consequence, the Group has chosen to utilise the enhanced model within EEV to update its allowance for the long-term cost of hedging under EEV economic assumptions. In common with established practice for such changes, the EEV income statement has been prepared on the basis that this change had been effected at the start of the year, at a cost of $(3,233) million, included in non-operating profit.

The initial impact on EEV is shown as a reduction in the value of in-force business as at 1 January 2019, and so the unwind of those cash flows over the year reduces the expected transfer to net worth and hence operating free surplus generation by $(903) million. This leads to an equal and offsetting benefit in short-term fluctuations as the excess of the actual cost of hedging in 2019 over the expected cost falls accordingly. There is no impact on total free surplus generation for 2019. See note 11 for the US free surplus results.

There were no changes to Jackson's hedging philosophy during 2019, which continues to focus on the underlying economics of the products whilst managing the volatility in the statutory position. The revised allowance for the long-term cost of hedging is expected to give a more refined indication of the expected long-term cost of the dynamic hedging programme under EEV economic assumptions, albeit it is not intended to reflect the exact derivatives held at a given point in time. In common with other long-term assumptions, the allowance for the expected cost of hedging in EEV will be kept under review, particularly in light of future experience under the new variable annuity statutory capital regime.

In addition to the enhancement to the cost of hedging described above, a number of other changes have been made to EEV reporting following the NAIC reform, coupled with the objective of bringing the EEV free surplus more in line with the US statutory basis of reporting. The total impact of these changes as recorded in EEV non-operating profit was $(261) million. A reconciliation of EEV free surplus to surplus under the Group's LCSM capital measure at 31 December 2019 by segment is provided in note I(i) in the additional financial information.

8 Net core structural borrowings of shareholder-financed businesses

Notes

(i) Holding company includes central finance subsidiaries.

(ii) In May 2019, the Company redeemed its £400 million 11.375 per cent subordinated notes.

(iii) In October 2019, Prudential plc transferred subordinated debt to M&G plc as part of the demerger. In addition to the subordinated debt held at 31 December 2018 as shown in the table above, the debt transferred included the further £300 million 3.875 per cent subordinated debt raised in July 2019.

(iv) The movement in the value of core structural borrowings includes foreign exchange effects for pounds sterling denominated debts, which are included in 'Exchange movements on foreign operations'. The movement in the mark-to-market value adjustment can be analysed as follows:

9 Gain (loss) attaching to corporate transactions

Notes

(i) In 2019, the $178 million gain on disposals mainly relates to profits arising from a reduction in the Group's stake (from 26 per cent to 22 per cent) in its associate in India, ICICI Prudential Life Insurance Company, and the disposal of Prudential Vietnam Finance Company Limited, a wholly owned subsidiary that provides consumer finance.

(ii) In 2019, other corporate transactions undertaken by continuing operations resulted in an EEV loss of $(385) million (2018: $(100) million). This primarily reflects costs related to the demerger of M&G plc from Prudential plc.

10 Analysis of movement in total net worth and value of in-force for long-term business

Note

The net value of in-force business for continuing operations 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:

* The time value of options and guarantees (TVOG) arises from the variability of economic outcomes in the future and is, where appropriate, calculated as the difference between an average outcome across a range of economic scenarios, calibrated around a central scenario, and the outcome from one central economic scenario, as described in note 14(i)(d). The TVOG and the outcome from the central economic scenario are linked; as the central economic scenario is updated for market conditions and the outcome reflects more or less of the guaranteed benefit payouts and associated product charges, there will be consequential changes to the TVOG.

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 (total net worth) over the capital required to support the covered business. Where appropriate, adjustments are made to total net worth so that backing assets are included at fair value rather than at cost to comply with the EEV Principles. In the Group's Asia and US operations, assets deemed to be inadmissible on a local regulatory basis are included in net worth where considered recognisable on an EEV basis, with the exception of deferred tax assets in the US that are inadmissible under the local regulatory basis, which have been included in the value of in-force business (VIF) within the Group's EEV results. Free surplus for asset management and other operations (including assets and liabilities of the Group's central operations, the Group's treasury function and Africa operations) is taken to be IFRS basis post-tax earnings and shareholders' equity, net of goodwill attributable to shareholders, with subordinated debt recorded as free surplus to the extent that it is classified as available capital under the Group's capital regime. A reconciliation of EEV free surplus to the Group's Local Capital Summation Method (LCSM) surplus over Group minimum capital requirements is set out in note I(i) in the additional financial information.

Notes

(a) Operating free surplus generated by Asia insurance and asset management operations before restructuring costs can be analysed as follows:

(b) Operating free surplus generated by US insurance and asset management operations before restructuring costs can be analysed as follows:

(c) Free surplus invested in new business primarily represents acquisition costs and amounts set aside for required capital.

(d) The increase in the US in-force free surplus generation before the EEV hedge modelling enhancements described in note 7 includes a $355 million benefit from the release of incremental reserves following the integration of the recently acquired John Hancock business.

(e) Other operating free surplus generated for "other business" includes $(145) million (2018: $(103) million) of interest costs (net of tax) on debt that was substituted to M&G plc in October 2019.

(f) Non-operating items include short-term fluctuations in investment returns, the effect of changes in economic assumptions for long-term business, the impact of NAIC reform, hedge modelling and other related changes in the US (as described in note 7) and the effect of corporate transactions (as described in note 9). In particular, for other business it includes $(383) million for demerger costs (post-tax). In addition, for 2018 this included the impact in the US of changes to RBC factors following the US tax reform, which were formally approved by the NAIC in June 2018.

(g) Free surplus generated from the discontinued UK and Europe operations in 2019 includes profit for the period of ownership up to the demerger in October 2019 and fair value adjustment at the date of the demerger.

(h) Net cash flows to parent company for Asia operations reflect the flows as included in the holding company cash flow.

(i) Foreign exchange movements, timing differences and other items represent: