Notes M-O

M: Goodwill attributable to shareholders

Download as excel file

2013 £m 2012 £m
Half year Half year Full year
Cost  
At beginning of period 1,589 1,585 1,585
Additional consideration paid on previously acquired business 2
Exchange differences 5 2 2
At end of period 1,594 1,587 1,589
Aggregate impairment (120) (120) (120)
Net book amount at end of period 1,474 1,467 1,469

The amounts shown above at 30 June 2013 and for 2012 include £1,153 million in respect of the purchase of M&G in 1999.

Goodwill, other than for M&G, of £321 million at 30 June 2013 (30 June 2012: £314 million; 31 December 2012: £316 million) represents amounts allocated to entities in Asia and the US operations in respect of acquisitions made prior to 2012. There was no goodwill attached to the purchase of REALIC and Thanachart Life as discussed in note X. Other goodwill amounts by acquired operations are not individually material.

N: Deferred acquisition costs and other intangible assets attributable to shareholders

Except for acquisition costs of with-profits contracts of the UK regulated with-profits funds, which are accounted for under the realistic Prudential Regulation Authority (PRA) regime, costs of acquiring new insurance business are accounted for with deferral and amortisation against margins in future revenues on the related insurance policies. Costs of acquiring new insurance business, principally commissions, marketing and advertising and certain other costs associated with policy insurance and underwriting that are not reimbursed by policy charges, are specifically identified and capitalised as part of deferred acquisition costs (DAC). In general, this deferral is presentationally shown by an explicit carrying value for DAC in the balance sheet. However, in some Asia operations the deferral is implicit through the reserving methodology. The recoverability of the explicitly and implicitly deferred acquisition costs is measured, and the capitalised costs are deemed impaired if the projected margins are less than the carrying value. To the extent that the future margins differ from those anticipated, then an adjustment to the carrying value will be necessary.

For UK regulated with-profits funds where the realistic PRA regime is applied, the basis of setting liabilities is such that it would be inappropriate for acquisition costs to be deferred, therefore these costs are expensed as incurred. The majority of the UK shareholder-backed business is individual and Group annuity business where the incidence of acquisition costs is negligible.

The deferred acquisition costs and other intangible assets attributable to shareholders comprise:

Download as excel file

2013 £m 2012* £m
30 Jun 30 Jun 31 Dec

* The 2012 comparative results have been retrospectively adjusted from those previously published for the application of IFRS 11 described in note B whereby equity presentation rather than proportionate consolidation for joint venture operations applies.

Deferred acquisition costs related to insurance contracts as classified under IFRS 4 4,851 3,824 3,776
Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 97 103 100
4,948 3,927 3,876
Present value of acquired in-force policies for insurance contracts as classified under IFRS 4 (PVIF) 85 62 64
Other intangibles 505 248 237
590 310 301
Total of deferred acquisition costs and other intangible assets 5,538 4,237 4,177

Download as excel file

  2013 £m 2012* £m
  Deferred acquisition costs PVIF and
other
intan-
gibles
Total
30 Jun
Total
30 Jun
Total
31 Dec
  UK US
note (i)
Asia Asset
manage-
ment

* The 2012 comparative results have been retrospectively adjusted from those previously published for the application of IFRS 11 described in note B whereby equity presentation rather than proportionate consolidation for joint venture operations applies.

† PVIF and Other intangibles includes software rights of £62 million at 30 June 2013 (31 December 2012: £60 million) with additions of £11 million, amortisation of £10 million and exchange gains of £1 million.

Notes

  1. The DAC amount in respect of US insurance operations comprises amounts in respect of:

    Download as excel file

    2013 £m 2012 £m
    30 Jun 30 Jun 31 Dec
    Variable annuity business 3,917 3,287 3,330
    Other business 953 794 821
    Cumulative shadow DAC (for unrealised gains/losses booked in other comprehensive income) (593) (896) (952)
    Total DAC for US operations 4,277 3,185 3,199
  2. The additions of £288 million for PVIF and other intangibles in half year 2013 include the amount advanced to secure the exclusive 15-year bancassurance partnership agreement entered with Thanachart Bank in Thailand.

    The additions of £21 million for acquisitions of subsidiaries for PVIF and other intangibles in half year 2013 is for the acquisition of Thanachart Life.

    The amount of £5 million for the full year 2012 was for the acquisition of REALIC.
    See note X for further details.
Balance at beginning of period:            
As previously reported 103 3,199 654 10 301 4,267 4,234 4,234
Effect of change in accounting policynote B (90) (90) (90) (90)
After effect of change 103 3,199 564 10 301 4,177 4,144 4,144
Additionsnote (ii) 1 372 92 4 288 757 535 1,059
Acquisition of subsidiariesnote (ii) 21 21 5
Amortisation to the income statement:            
  Operating profit (8) (199) (83) (2) (19) (311) (308) (682)
  Non-operating profit 242 (3) 239 80 76
  (8) 43 (83) (2) (22) (72) (228) (606)
Exchange differences 244 18 2 264 (33) (155)
Change in amortisation of DAC related to net unrealised valuation movement on Jackson’s available-for-sale securities recognised as Other Comprehensive Income 419 419 (181) (270)
Reclassification of Japan Life as held for sale (28) (28)
Balance at end of period 96 4,277 563 12 590 5,538 4,237 4,177

Overview of the deferral and amortisation of acquisition costs for Jackson

Under IFRS 4, the Group applies 'grandfathered' US GAAP for measuring the insurance assets and liabilities of Jackson. In the case of Jackson term business, acquisition costs are deferred and amortised in line with expected profits. For annuity and interest-sensitive life business, acquisition costs are deferred and amortised in line with a combination of historical and future expected gross profits on the relevant contracts. For fixed and indexed annuity and interest-sensitive life business, the key assumption is the long-term spread between the earned rate on investments and the rate credited to policyholders, which is based on an annual spread analysis. Expected gross profits also depend on mortality assumptions, assumed unit costs and terminations other than deaths (including the related charges), all of which are based on a combination of actual experience of Jackson, industry experience and future expectations. A detailed analysis of actual mortality, lapse and expense experience is performed using internally developed experience studies.

As with fixed and indexed annuity and interest-sensitive life business, acquisition costs for Jackson’s variable annuity products are amortised in line with the emergence of profits. The measurement of the amortisation in part reflects current period fees (including those for guaranteed minimum death, income, or withdrawal benefits) earned on assets covering liabilities to policyholders, and the historical and expected level of future gross profits which depends on the assumed level of future fees, as well as components related to mortality, lapse and expense.

The Company adopted the US Financial Accounting Standards Board requirements in the Emerging Issues Task Force EITF Update No 2010-26 on ‘Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts’ from 1 January 2012 into Prudential’s Group IFRS reporting for the results of Jackson and those Asia operations whose IFRS insurance assets and liabilities are measured principally by reference to US GAAP principles. Under the Update insurers are required to capitalise only those incremental costs directly relating to successfully acquiring a contract from 1 January 2012. For Group IFRS reporting the Company chose to apply this new basis retrospectively for the results of these operations.

Mean reversion technique

For variable annuity products, under US GAAP (as ‘grandfathered’ under IFRS 4) the projected gross profits, against which acquisition costs are amortised, reflect an assumed long-term level of equity return which, for Jackson, is 8.4 per cent after deduction of net external fund management fees. This is applied to the period end level of separate account assets after application of a mean reversion technique that removes a portion of the effect of levels of short-term variability in current market returns.

Under the mean reversion technique applied by Jackson, the projected level of return for each of the next five years is adjusted from period to period so that in combination with the actual rates of return for the preceding two years and the current period, the 8.4 per cent annual return is realised on average over the entire eight-year period. Projected returns after the mean reversion period revert back to the 8.4 per cent assumption.

However, to ensure that the methodology does not over anticipate a reversion to trend following adverse markets, the mean reversion technique has a cap and 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) in each year.

Sensitivity of amortisation charge

The amortisation charge to the income statement is reflected in operating profit and short-term fluctuations in investment returns. The amortisation charge to the operating profit in a reporting period comprises:

  1. a core amount that reflects a relatively stable proportion of underlying profit; and
  2. an element of acceleration or deceleration arising from market movements differing from expectations.

In periods where the cap and floor feature of the mean reversion technique are not relevant, the technique operates to dampen the second element above. Nevertheless, extreme market movements can cause material acceleration or deceleration of amortisation in spite of this dampening effect.

Furthermore, in those periods where the cap or floor is relevant, the mean reversion technique provides no further dampening and additional volatility may result.

In half year 2013, the DAC amortisation charge for operating profit was determined after including a credit for decelerated amortisation of £20 million (half year 2012: £25 million; full year 2012: £56 million). The half year 2013 amount primarily reflects the separate account performance of 5 per cent, net of all fees, over the assumed level for the period.

The application of the mean reversion formula has the effect of dampening the impact of equity market movements on DAC amortisation while the mean reversion assumption lies within the corridor. It would take a very significant movement in equity markets in 2013 (outside the range of negative 25 per cent to positive 50 per cent) for the mean reversion assumption to move outside the corridor.

O: Valuation bases for Group assets

The accounting carrying values of the Group’s assets reflect the requirements of IFRS. For financial investments the basis of valuation reflects the Group’s application of IAS 39 ‘Financial Instruments: Recognition and Measurement’ as described further below. Where assets have been valued at fair value, the Group has followed the principles under IFRS 13 ‘Fair value measurement’. The basis applied for the assets section of the statement of financial position at 30 June 2013 is summarised below:

Download as excel file

2013 £m 2012* £m
At fair
value
Cost/
Amortised
cost
note (i)
30 Jun
Total
At fair
value
Cost/
Amortised
cost
note (i)
30 Jun
Total
At fair
value
Cost/
Amortised
cost
note (i)
31 Dec
Total

* The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards described in note B.

Notes

  1. Assets carried at cost or amortised cost are subject to impairment testing where appropriate under IFRS requirements. This category also includes assets which are valued by reference to specific IFRS standards such as reinsurers' share of insurance contract liabilities, deferred tax assets and investments accounted for under the equity method.
  2. Realised gains and losses on the Group's investments for the half year 2013 recognised in the income statement amounted to a net gain of £0.8 billion (half year 2012: £3.6 billion; full year 2012: £6.8 billion).
Intangible assets attributable to shareholders:      
Goodwillnote M 1,474 1,474 1,467 1,467 1,469 1,469
Deferred acquisition costs and
other intangible assetsnote N
5,538 5,538 4,237 4,237 4,177 4,177
Total 7,012 7,012 5,704 5,704 5,646 5,646
Intangible assets attributable to with-profits funds:      
In respect of acquired subsidiaries
for venture fund and other investment purposes
178 178 178 178 178 178
Deferred acquisition costs and
other intangible assets
79 79 84 84 78 78
Total 257 257 262 262 256 256
Total intangible assets 7,269 7,269 5,966 5,966 5,902 5,902
Other non-investment and non-cash assets:      
Property, plant and equipment 868 868 787 787 754 754
Reinsurers’ share of insurance
contract liabilities
7,204 7,204 1,698 1,698 6,854 6,854
Deferred tax assetsnote H 2,637 2,637 2,169 2,169 2,306 2,306
Current tax recoverable 191 191 302 302 248 248
Accrued investment income 2,726 2,726 2,686 2,686 2,771 2,771
Other debtors 2,318 2,318 1,784 1,784 1,325 1,325
Total 15,944 15,944 9,426 9,426 14,258 14,258
Investments of long-term business and other operations:note (ii)      
Investment properties 10,583 10,583 10,532 10,532 10,544 10,544
Investments accounted for using
the equity method
696 696 587 587 635 635
Loansnote P 2,268 10,962 13,230 285 10,515 10,800 2,068 10,675 12,743
Equity securities and portfolio
holdings in unit trusts
112,258 112,258 89,098 89,098 98,626 98,626
Debt securities
note Q
138,256 138,256 127,349 127,349 138,907 138,907
Other investments 6,140 6,140 7,828 7,828 7,547 7,547
Deposits 13,542 13,542 11,951 11,951 12,248 12,248
Total investments 269,505 25,200 294,705 235,092 23,053 258,145 257,702 23,558 281,260
Assets held for sale 1,079 1,079 98 98
Cash and cash equivalents 6,840 6,840 6,335 6,335 6,126 6,126
Total assets 270,584 55,253 325,837 235,092 44,780 279,872 257,800 49,844 307,644
Percentage of Group total assets 83% 17% 100% 84% 16% 100% 84% 16% 100%

i Financial instruments – designation and fair values

The tables below show the fair values of financial assets and liabilities (including those that are not presented in the statement of financial position at fair value).

Download as excel file

30 Jun 2013 £m
note (ii)
Total
carrying
value
Fair
value
Financial assets    
Cash and cash equivalents 6,840 6,840
Deposits 13,542 13,542
Equity securities and portfolio holdings in unit trusts 112,258 112,258
Debt securitiesnote Q 138,256 138,256
Loansnote P 13,230 13,404
Other investments 6,140 6,140
Accrued investment income 2,726 2,726
Other debtors 2,318 2,318
295,310  

Download as excel file

30 Jun 2013 £m
note (ii)
Total
carrying
value
Fair
value

Notes

  1. It is impractical to determine the fair value of investment contracts with discretionary participation features due to the lack of a reliable basis to measure such features.
  2. Following the adoption of IFRS 13, 'Fair Value Measurement', and in accordance with the corresponding amendments to IAS 34, 'Interim Financial Reporting', the tables above show a comparison of the fair value of financial assets and liabilities compared to their carrying amounts. Under IFRS 13, this disclosure has been provided on a prospective basis.
Financial liabilities    
Core structural borrowings of shareholder-financed operationsnote S 4,149 4,534
Operational borrowings attributable to shareholder-financed operationsnote T 2,530 2,530
Borrowings attributable to the with-profits fund held at fair valuenote T 924 924
Obligations under funding, securities lending and sale and repurchase agreements 2,889 2,899
Net asset value attributable to unit holders of consolidated unit trusts and similar funds 5,394 5,394
Investment contract with discretionary participation features held at fair valuenote (i) 33,402 n/a
Investment contract without discretionary participation features held at fair value 19,865 19,872
Other creditors 3,743 3,743
Derivative liabilities 2,226 2,226
Other liabilities 3,661 3,661
78,783  

ii Determination of fair value

The fair values of the assets and liabilities of the Group have been determined on the following bases.

The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange-quoted investments, or by using quotations from independent third parties, such as brokers and pricing services or by using appropriate valuation techniques.

The estimated fair value of derivative financial instruments reflects the estimated amount the Group would receive or pay in an arm’s length transaction. This amount is determined using quoted prices if exchange listed, quotations from independent third parties or valued internally using standard market practices.

The loans and receivables have been shown net of provisions for impairment. The fair value of loans has been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest.

The fair value of financial liabilities (other than derivative financial instruments) is determined using discounted cash flows of the amounts expected to be paid.

Level 1, 2 and 3 fair value measurement hierarchy of Group financial instruments

The table below includes financial instruments carried at fair value analysed by level of the IFRS 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.

The classification criteria and its application to Prudential can be summarised as follows:

Level 1 – quoted prices (unadjusted) in active markets for identical assets and liabilities

Level 1 includes financial instruments where there is clear evidence that the valuation is based on a quoted publicly traded price in an active market (eg exchange listed equities, mutual funds with quoted prices and exchange traded derivatives).

Level 2 – inputs other than quoted prices included within level 1 that are observable either directly (ie as prices) or indirectly (ie derived from prices)

Level 2 includes investments where a direct link to an actively traded price is not readily apparent, but which are valued using inputs which are largely observable either directly (ie as prices) or indirectly (ie derived from prices).

Level 3 – significant inputs for the asset or liability that are not based on observable market data (unobservable inputs)

Level 3 includes investments which are internally valued or subject to a significant number of unobservable assumptions (eg private equity funds and certain derivatives which are bespoke or long dated).

iii Fair value hierarchy of financial instruments measured at fair value on recurring basis

Download as excel file

30 Jun 2013 £m
Level 1 Level 2 Level 3 Total
Analysis of financial investments, net of derivative liabilities by business type        
       
With-profits        
Equity securities and portfolio holdings in unit trusts 23,525 1,807 625 25,957
Debt securities 15,241 44,609 522 60,372
Other investments (including derivative assets) 155 757 2,924 3,836
Derivative liabilities (156) (883) (1,039)
Total financial investments, net of derivative liabilities 38,765 46,290 4,071 89,126
Percentage of total 43% 52% 5% 100%
Unit-linked and variable annuity separate account        
Equity securities and portfolio holdings in unit trusts 85,014 265 63 85,342
Debt securities 3,683 5,932 2 9,617
Other investments (including derivative assets) 4 21 25
Derivative liabilities (2) (5) (7)
Total financial investments, net of derivative liabilities 88,699 6,213 65 94,977
Percentage of total 93% 7% 0% 100%
Non-linked shareholder-backed        
Loans 242 2,026 2,268
Equity securities and portfolio holdings in unit trusts 879 33 47 959
Debt securities 13,551 54,559 157 68,267
Other investments (including derivative assets) 72 1,331 876 2,279
Derivative liabilities (974) (206) (1,180)
Total financial investments, net of derivative liabilities 14,502 55,191 2,900 72,593
Percentage of total 20% 76% 4% 100%
Group total analysis, including other financial liabilities held at fair value        
Group total        
Loans 242 2,026 2,268
Equity securities and portfolio holdings in unit trusts 109,418 2,105 735 112,258
Debt securities 32,475 105,100 681 138,256
Other investments (including derivative assets) 231 2,109 3,800 6,140
Derivative liabilities (158) (1,862) (206) (2,226)
Total financial investments, net of derivative liabilities 141,966 107,694 7,036 256,696
Borrowings attributable to the with-profits fund held at fair value (22) (22)
Investment contract liabilities without discretionary participation features held at fair value (17,342) (17,342)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (3,696) (357) (1,341) (5,394)
Other financial liabilities held at fair value (256) (2,206) (2,462)
Total 138,270 89,717 3,489 231,476
Percentage of total 59% 39% 2% 100%

In addition to the financial instruments shown above, the assets and liabilities held for sale on the condensed consolidated statement of financial position at 30 June 2013 in respect of Japan Life business included a net financial instruments balance of £1,140 million, primarily for equity securities and debt securities. Of this amount, £1,038 million has been classified as level 1, £74 million as level 2 and £28 million as level 3.

Download as excel file

30 Jun 2012* £m
Level 1 Level 2 Level 3 Total

* The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new accounting standards described in note B.

Analysis of financial investments, net of derivative liabilities by
business type
       
       
With-profits
Equity securities and portfolio holdings in unit trusts 21,466 1,389 475 23,330
Debt securities 14,698 43,849 532 59,079
Other investments (including derivative assets) 295 1,412 2,692 4,399
Derivative liabilities (41) (1,413) (1,454)
Total financial investments, net of derivative liabilities 36,418 45,237 3,699 85,354
Percentage of total 43% 53% 4% 100%
Unit-linked and variable annuity separate account
Equity securities and portfolio holdings in unit trusts 64,581 176 22 64,779
Debt securities 3,742 4,955 9 8,706
Other investments (including derivative assets) 24 80 104
Derivative liabilities (8) (9) (17)
Total financial investments, net of derivative liabilities 68,339 5,202 31 73,572
Percentage of total 93% 7% 0% 100%
Non-linked shareholder-backed
Loans 285 285
Equity securities and portfolio holdings in unit trusts 904 12 73 989
Debt securities 11,822 47,591 151 59,564
Other investments (including derivative assets) 21 2,530 774 3,325
Derivative liabilities (132) (1,649) (201) (1,982)
Total financial investments, net of derivative liabilities 12,615 48,769 797 62,181
Percentage of total 20% 79% 1% 100%
Group total analysis, including other financial liabilities held at fair value
Group total
Loans 285 285
Equity securities and portfolio holdings in unit trusts 86,951 1,577 570 89,098
Debt securities 30,262 96,395 692 127,349
Other investments (including derivative assets) 340 4,022 3,466 7,828
Derivative liabilities (181) (3,071) (201) (3,453)
Total financial investments, net of derivative liabilities 117,372 99,208 4,527 221,107
Borrowings attributable to the with-profits fund held at fair value (41) (41)
Investment contract liabilities without discretionary participation features held at fair value (15,221) (15,221)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (2,936) (152) (1,098) (4,186)
Other financial liabilities held at fair value (311) (311)
Total 114,436 83,483 3,429 201,348
Percentage of total 57% 41% 2% 100%

Download as excel file

31 Dec 2012* £m
Level 1 Level 2 Level 3 Total

* The 2012 comparative results have been adjusted retrospectively from those previously published for the application of the new accounting standards described in note B.

Analysis of financial investments, net of derivative liabilities by business type        
       
With-profits
Equity securities and portfolio holdings in unit trusts 22,057 2,496 480 25,033
Debt securities 16,056 45,550 542 62,148
Other investments (including derivative assets) 108 1,743 2,574 4,425
Derivative liabilities (61) (1,075) (1,136)
Total financial investments, net of derivative liabilities 38,160 48,714 3,596 90,470
Percentage of total 42% 54% 4% 100%
Unit-linked and variable annuity separate account
Equity securities and portfolio holdings in unit trusts 72,488 183 39 72,710
Debt securities 3,660 5,409 2 9,071
Other investments (including derivative assets) 26 10 36
Derivative liabilities (1) (1)
Total financial investments, net of derivative liabilities 76,174 5,601 41 81,816
Percentage of total 93% 7% 0% 100%
Non-linked shareholder-backed
Loans 226 1,842 2,068
Equity securities and portfolio holdings in unit trusts 827 7 49 883
Debt securities 13,357 54,146 185 67,688
Other investments (including derivative assets) 24 2,301 761 3,086
Derivative liabilities (16) (1,484) (195) (1,695)
Total financial investments, net of derivative liabilities 14,192 55,196 2,642 72,030
Percentage of total 20% 76% 4% 100%
Group total analysis, including other financial liabilities held at fair value
Group total
Loans 226 1,842 2,068
Equity securities and portfolio holdings in unit trusts 95,372 2,686 568 98,626
Debt securities 33,073 105,105 729 138,907
Other investments (including derivative assets) 158 4,054 3,335 7,547
Derivative liabilities (77) (2,560) (195) (2,832)
Total financial investments, net of derivative liabilities 128,526 109,511 6,279 244,316
Borrowings attributable to the with-profits fund held at fair value (40) (40)
Investment contract liabilities without discretionary participation features held at fair value (16,309) (16,309)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (3,653) (268) (1,224) (5,145)
Other financial liabilities held at fair value (259) (2,021) (2,280)
Total 124,873 92,635 3,034 220,542
Percentage of total 57% 42% 1% 100%

iv Valuation approach for level 2 fair valued financial instruments

A significant proportion of the Group’s level 2 assets are corporate bonds, structured securities and other non-national government debt securities. These assets, in line with market practice, are generally valued using independent pricing services or third-party broker quotes. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances, stale price reviews and variance analysis on prices achieved on subsequent trades.

Pricing services, where available, are used to obtain the third-party broker quotes. Where pricing services providers are used, a single valuation is obtained and applied.

When prices are not available from pricing services, quotes are sourced directly from brokers. Prudential seeks to obtain a number of quotes from different brokers so as to obtain the most comprehensive information available on their executability. Where quotes are sourced directly from brokers, the price used in the valuation is normally selected from one of the quotes based on a number of factors, including the timeliness and regularity of the quotes and the accuracy of the quotes considering the spreads provided. The selected quote is the one which best represents an executable quote for the security at the measurement date.

Generally, no adjustment is made to the prices obtained from independent third parties. Adjustment is made in only limited circumstances, where it is determined that the third-party valuations obtained do not reflect fair value (eg either because the value is stale and/or the values are extremely diverse in range). These are usually securities which are distressed or that could be subject to a debt restructure or where reliable market prices are no longer available due to an inactive market or market dislocation. In these instances, prices are derived using internal valuation techniques including those as described above in this note with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The techniques used require a number of assumptions relating to variables such as credit risk and interest rates. Examples of such variables include an average credit spread based on the corporate bond universe and the relevant duration of the asset being valued. Prudential 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 £105,100 million at 30 June 2013 (30 June 2012: £96,395 million; 31 December 2012: £105,105 million), £8,645 million are valued internally (30 June 2012: £7,287 million; 31 December 2012: £8,248 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.

v Fair value measurements for level 3 fair valued financial instruments

Reconciliation of movements in level 3 financial instruments measured at fair value

The following table reconciles the value of level 3 fair valued financial instruments at 1 January 2013 to that presented at 30 June 2013.

Total investment return recorded in the income statement represents interest and dividend income, realised gains and losses, unrealised gains and losses on the assets classified at fair value through profit and loss and foreign exchange movements on an individual entity’s overseas investments.

Total gains and losses recorded in other comprehensive income includes unrealised gains and losses on debt securities held as available-for-sale within Jackson and foreign exchange movements arising from the retranslation of the Group’s overseas subsidiaries and branches.

Download as excel file

Half year 2013 £m  
At 1 Jan Total
gains/
losses in
income
statement
Total
gains/
losses
recorded
in other
compre-
hensive
income
Purchases Sales Settled Issued Reclassi
-fication
of
Japan
Life
as held
for sale
Transfers
into
level 3
Transfers
out of
level 3
At
30 Jun
Loans 1,842 67 36 (37) 118 2,026
Equity securities and portfolio holdings in unit trusts 568 52 4 13 (11) 25 87 (3) 735
Debt securities 729 27 9 20 (77) (26) 29 (30) 681
Other investments (including derivative assets) 3,335 373 137 177 (272) 50 3,800
Derivative liabilities (195) (14) 2 1 (206)
Total financial investments, net of derivative liabilities 6,279 505 186 210 (358) (37) 143 (26) 166 (32) 7,036
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,224) (80) (2) 26 (61) (1,341)
Other financial liabilities (2,021) (54) (146) 50 (35) (2,206)
Total 3,034 371 38 236 (358) 13 47 (26) 166 (32) 3,489

Of the total net gains and losses in the income statement of £371 million, £333 million relates to net unrealised gains relating to financial instruments still held at the end of the period, which can be analysed as follows:

Download as excel file

30 Jun 2013 £m
Equity securities 50
Debt securities 10
Other investments 355
Derivative liabilities (14)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (80)
Other financial liabilities 12
Total 333

Valuation approach for level 3 fair valued financial instruments

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 which reflects the price at which an orderly transaction would take place between market participants on the measurement date.

The fair value estimates are made at a specific point in time, based upon available market information and judgements about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Group’s entire holdings of a particular financial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the financial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the financial instrument.

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 30 June 2013 the Group held £3,489 million (30 June 2012: £3,429 million; 31 December 2012: £3,034 million), 2 per cent of the total fair valued financial assets net of fair valued financial liabilities (30 June 2012: 2 per cent; 31 December 2012: 1 per cent), within level 3.

Included within these amounts were loans of £2,026 million at 30 June 2013 (30 June 2012: £nil; 31 December 2012: £1,842 million), measured at the loan outstanding balance, attached to REALIC acquired in 2012 and held to back the liabilities for funds withheld under reinsurance arrangements. The funds withheld liability of £2,206 million at 30 June 2013 (30 June 2012: £nil; 31 December 2012: £2,021 million) was also classified within level 3, accounted for on a fair value basis being equivalent to the carrying value of the underlying assets.

Excluding the loans and funds withheld liability under REALIC’s reinsurance arrangements as described above, which amounted to a net liability of £(180) million (30 June 2012: £nil; 31 December 2012: £(179) million), the level 3 fair valued financial assets net of financial liabilities were £3,669 million (30 June 2012: £3,429 million; 31 December 2012: £3,213 million). Of this amount, a net liability of £(272) million (30 June 2012: £(177) million; 31 December 2012: £(213) million) were internally valued, representing 0.1 per cent of the total fair valued financial assets net of financial liabilities (30 June 2012: 0.1 per cent; 31 December 2012: 0.1 per cent). Internal valuations are inherently more subjective than external valuations. Included within these internally valued net liabilities were:

  • Debt securities of £80 million (30 June 2012: £105 million; 31 December 2012: £75 million), which were either valued on a discounted cash flow method with an internally developed discount rate or on external prices adjusted to reflect the specific known conditions relating to these securities (eg distressed securities or securities which were being restructured);
  • Private equity and venture investments of £955 million (30 June 2012: £800 million; 31 December 2012: £904 million) which were valued internally based on management information available for these investments. These investments were principally held by consolidated investment funds which are managed on behalf of third parties;
  • Liabilities of £(1,311) million (30 June 2012: £(1,111) million; 31 December 2012: £(1,199) 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; and
  • Other sundry individual financial investments of £4 million (30 June 2012: £29 million; 31 December 2012: £7 million).

Of the internally valued net liabilities referred to above of £(272) million (30 June 2012: £(177) million; 31 December 2012: £(213) million):

  • A net liability of £(313) million (30 June 2012: £(232) million; 31 December 2012: £(240) million) was held by the Group’s participating funds and therefore shareholders’ profit and equity are not impacted by movements in the valuation of these financial instruments;
  • A net asset of £nil (30 June 2012: £13 million; 31 December 2012: £3 million) was held by the Group’s unit-linked funds for which the investment return is wholly attributable to policyholders; and
  • A net asset of £41 million (30 June 2012: £42 million; 31 December 2012: £24 million) was held to support non-linked shareholder-backed business. If the value of all the level 3 instruments held to support non-linked shareholder-backed business valued internally was varied downwards by 10 per cent, the change in valuation would be £4 million (30 June 2012: £4 million; 31 December 2012: £2 million), which would reduce shareholders’ equity by this amount before tax. Of this amount, a decrease of less than £1 million (30 June 2012: a decrease of £1 million; 31 December 2012: an increase of £1 million) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and a £4 million decrease (30 June 2012: a £3 million decrease; 31 December 2012: a £3 million decrease) would be included as part of other comprehensive income, being unrealised movements on assets classified as available-for-sale.

Valuation processes applied by the Group

The Group’s valuation policies, procedures and analyses for instruments categorised as level 3 are undertaken 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.

vi 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 half year 2013, the transfers between levels within the Group’s portfolio were primarily transfers from level 1 to 2 of £178 million and transfers from level 2 to level 1 of £243 million. These transfers which relate to equity securities and debt securities arose to reflect the change in the observability of the inputs used in valuing these securities.

In addition, as shown in the table in section v above, the transfers into and out of level 3 in half year 2013 were £166 million and £(32) million, respectively. These transfers were between levels 3 and 2 and primarily for equity securities and debt securities.

 
 

Reporting tools

Save pages of the report
to download, print or email

View your pages

Feedback

Your comments and ideas help us
to shape future reports to suit your needs

Tell us your views