Chief Financial Officer’s overview

A resilient business model which delivers profitable growth

‘Our disciplined approach to new business, proactive management of the in-force portfolio and diversification by product and geography allow us to deliver high quality, well-balanced earnings across a wide range of economic conditions.’

Nic Nicandrou
Chief Financial Officer

EEV new business profit

EEV new business profit. Half year 2012: £1,141m. 2013: £1,268m. +11%

IFRS operating profit based on longer-term investment returns1

IFRS operating profit based on longer-term investment returns. Half year 2012: £1,157m. Half year 2013: £1,415m. +22%

Prudential has delivered a strong first half performance, continuing the positive momentum of 2012 and making further progress towards its 2013 financial objectives. The return in the latter part of the period of more volatile equity markets and ongoing uncertainty regarding the financial operating environment in the world’s major economies have again served to highlight the resilience of our business model. Our disciplined approach to new business, proactive management of the in-force portfolio and diversification by product and geography allow us to deliver high-quality, well-balanced earnings across a wide range of economic conditions.

The combination of disciplined execution and prudent management of balance sheet risks, coupled with higher equity market levels and rising long-term interest rates, have benefited all of our key operating profit and underlying capital generation financial metrics. As a result, total EEV new business profit rose by 11 per cent, IFRS operating profit1 by 22 per cent, EEV operating profit1 by 18 per cent, underlying free surplus generated1 by 12 per cent and cash remittances from businesses to Group by 16 per cent. Having taken pricing and product actions to defend the economics of our business when markets fell, our business performance is now positively geared to higher investment returns as markets recover.

We, nevertheless, continue to take steps to protect ourselves from the downside risks to the Group’s financial position associated with the guarantees that we have offered to our customers, which in times of rising equity markets will generally generate negative investment variances. These are compounded by the negative value movements on our holdings of fixed income securities which accompany higher interest rates. The impact of these short-term movements in investment values, reported outside the operating result, contributed to a lower profit before tax1 attributable to shareholders on an IFRS basis of £506 million in the first half of 2013 (2012: £1,166 million). On an EEV basis, which recognises the economic benefit of movements in investment markets, profit before tax1 attributable to shareholders actually increased 33 per cent to £2,511 million (2012: £1,891 million).

In the remainder of my report, I comment on the Group’s operating performance excluding these short-term market effects. Total IFRS operating profit1 increased by 22 per cent in 2013 to £1,415 million (2012: £1,157 million), driven by higher contributions from both life insurance and asset management. Asia life operating profit was up 18 per cent and US life operating profit increased by 32 per cent, partly reflecting the inclusion of REALIC following its acquisition in 2012. M&G (including Prudential Capital), our UK-based asset management business and Eastspring Investments, our Asia asset manager, delivered growth of 13 per cent and 19 per cent, respectively.

EEV new business profit (‘new business profit’) increased by 11 per cent to £1,268 million (2012: £1,141 million). Asia new business profit was 20 per cent higher, reflecting volume growth and management actions to improve product mix, geographic mix and pricing. We are particularly encouraged by the progress of some of our smaller businesses such as the Philippines (new business profit up 80 per cent), Thailand (up 25 per cent) and China (up 21 per cent), as well as further growth in our larger markets of Hong Kong (up 60 per cent, benefiting from higher interest rates as well as pricing actions) and Indonesia (up 27 per cent). US new business profit improved significantly in the second quarter to deliver first half growth of 8 per cent. This increase reflected the positive effect of pricing and product actions taken in the period, the contribution from Elite Access and the beneficial impact of the 75 basis points rise in 10-year treasury yields since the end of 2012, which more than offset the effect of lower sales of variable annuities (VA) with living benefit guarantees. UK new business profit declined 14 per cent in the first half, as we did not write any wholesale business in the first half of 2013. In UK retail, we maintained our new business profit despite the anticipated reduction in sales following the implementation of the RDR, reflecting the positive effects of business mix and pricing activity.

On an EEV basis, Group operating profit1 increased by 18 per cent to £2,479 million (2012: £2,109 million) driven by higher new business profit and higher in-force contributions. In Asia, EEV life operating profit was up 24 per cent to £1,077 million (2012: £871 million), with in-force profits benefiting from increased scale and the recent rise in interest rates. Jackson’s EEV operating profit increased by 26 per cent to £1,016 million (2012: £805 million) mainly due to improved new business profits and higher profits from our existing book as we continue to manage the business for value. In the UK, EEV life operating earnings decreased by 18 per cent to £404 million (2012: £490 million), with 2012 benefiting from the positive effect on our profits stemming from a reduction in UK corporate tax rates substantively enacted in the first half of that year. The half year 2013 result did not include a similar benefit. The recently announced further reductions to UK tax rates were enacted in July 2013, therefore, in accordance with our long-established reporting practice, the benefits arising from these changes will be recognised in the second half of 2013.

Note

  1. For IFRS reporting purposes, the Group adopted new and amended accounting standards in 2013. Accordingly, the IFRS elements and EEV basis shareholders’ interest for the comparative results have been adjusted for the retrospective application of this adoption of IFRS accounting policies, as discussed in note B of the IFRS financial statements and in note 1 of the EEV basis results. In addition, following its reclassification as held for sale at 30 June 2013, operating results exclude the result of the Japan Life insurance business. Profit before tax continues to include these results. 2012 comparatives have been retrospectively adjusted on a comparable basis.

IFRS operating profit1 from our life insurance operations in Asia, the US and the UK increased 18 per cent to £1,397 million (2012: £1,181 million). In 2013, we have continued to focus on improving the quality of our life earnings, by maintaining our bias in favour of less market-sensitive sources of income such as insurance margin and fee income, ahead of spread income. Our emphasis on risk products such as health and protection, together with the acquisition of REALIC, a closed book of traditional US life business, has driven 46 per cent growth in our insurance margin, increasing the proportion of earnings that is least sensitive to economic conditions. In addition, fee income is up 31 per cent, reflecting both a modest improvement in annual management charges and a 26 per cent increase in the average account balances that we manage on behalf of our customers. In contrast, the contribution to our profits from spread income has increased by a much smaller 1 per cent. The fact that a higher proportion of our overall income now comprises insurance margin and fee income represents a healthy evolution in both the quality and the balance of our earnings.

The costs we have incurred in writing new and maintaining the in-force life businesses have also increased but at a more modest rate, highlighting the advantages of increased scale as we build out our business, while maintaining control of costs.

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  Half year 2013 Half year 2012*
  Operating
profit
£m
Average
liability
£m

Margin
bps
Operating
profit
£m
Average
liability
£m

Margin
bps

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

Note

For basis of preparation see note I (a) of Additional financial information.

Spread income 535 65,424 164 529 60,320 175
Fee income 667 93,512 143 509 74,422 137
With-profits 155 97,336 32 164 94,103 35
Insurance margin 613     420    
Margin on revenues 858     696    
Expenses:            
Acquisition costs (1,021) 2,162 (47)% (972) 2,030 (48)%
Administration expenses (682) 166,130 (82) (548) 134,742 (81)
DAC adjustments 175     253    
Expected return on shareholder assets 97     130    
Operating profit based on longer-term investment returns 1,397     1,181    

Our Asia life insurance business continues to benefit from the growth of the in-force portfolio and our focus on building the proportion of our business that is health and protection, with IFRS operating profit1 of £474 million (2012: £403 million) up 18 per cent. The principal driver of our profitability in the region is our health and protection business which delivered 64 per cent or £303 million (2012: £256 million) of total life profits. In geographic terms our largest markets of Indonesia, Hong Kong, Singapore and Malaysia continue to generate good levels of growth, with IFRS operating profit up 13 per cent collectively. We are also encouraged by the progress of two of our smaller but fast-growing businesses in Thailand and the Philippines. Their combined IFRS operating profit of £20 million has increased fivefold compared to the same period last year, while also increasing APE sales by 35 per cent.

In the US, long-term business IFRS operating profit was up 32 per cent in 2013 to £582 million (2012: £442 million), which includes a contribution of £56 million from REALIC. Jackson’s total income increased by 27 per cent to £1,197 million (2012: £945 million) outpacing the growth in total expenses net of deferred acquisition cost adjustments totalling £615 million (2012: £503 million). Fee income has become Jackson’s main source of earnings and has grown by 36 per cent to £554 million (2012: £408 million). The uplift in fee income is in line with the 37 per cent growth in average separate account assets in the period to £57 billion (2012: £41 billion), reflecting the benefit of VA premium inflows and the rise in US equity markets since June 2012. Insurance margin at £262 million (2012: £153 million) is now a more significant contributor to Jackson’s earnings following the acquisition of REALIC’s seasoned book of term insurance business. Spread income has grown more modestly by 8 per cent to £377 million (2012: £349 million). We continue to focus on improving the balance of Jackson’s profits and diversifying its sources of earnings and we are making good progress in delivering the targeted returns from REALIC.

UK long-term business IFRS operating profit was 1 per cent higher at £341 million (2012: £336 million). The comparative result included an £18 million profit from writing a wholesale contract, with no such business being written in the first half of 2013. UK retail IFRS operating profit increased 7 per cent, reflecting the positive impact of a longevity swap entered into this year to further optimise the capital position of the business.

Our asset management businesses also had a successful first half. M&G’s IFRS operating profit of £204 million (2012: £175 million), increased 17 per cent, reflecting the 15 per cent uplift in funds under management to a record £234 billion (2012: £204 billion), following a period of strong net inflows and positive market movements. M&G’s average fee income across all the funds it manages was stable at 36 basis points, with higher income helping to absorb the current phase of infrastructure investment and maintain a cost/income ratio only marginally higher than the prior period at 54 per cent (2012: 53 per cent). The cost run rate of the business is typically higher over the second half of the year so the cost/income ratio is expected to increase by the end of 2013.

Prudential Capital produced IFRS operating profit of £21 million in the first half of 2013 (2012: £24 million). Our Asia asset management business, Eastspring Investments, has also seen the combination of net inflows and more favourable investment conditions contribute to a 19 per cent increase in IFRS operating profit1 to £38 million (2012: £32 million).

Note

  1. The 2012 comparative results have been adjusted from those previously published for the retrospective application of the new and amended accounting standards as discussed in note B of the IFRS financial statements. In addition, following its reclassification as held for sale at 30 June 2013, operating results exclude the result of the Japan Life insurance business. 2012 comparatives have been retrospectively adjusted on a comparable basis.

Our ongoing focus on disciplined capital allocation to new business opportunities that offer the most attractive mix of returns and short payback periods, means we have continued to produce significant amounts of free capital, which we measure as free surplus generated1.

In the first half of 2013, we generated £1,548 million of underlying free surplus (before reinvestment in new business) from our life in-force and asset management businesses. This is 11 per cent higher than the £1,395 million generated in 2012, reflecting increases from all four business operations.

We reinvested £396 million of the free surplus generated in the period into writing new business (2012: £364 million) equivalent to a reinvestment rate of 26 per cent, which is in line with recent periods. The amount of free surplus we reinvested in Asia increased 2 per cent to £165 million (2012: £162 million), while new business profit increased 20 per cent. This reflects improvements in mix as a result of our strategic focus on more capital efficient products and the impact of higher interest rates in the period. In the US, new business investment increased to £211 million (2012: £180 million), primarily due to higher volumes of new business and the increase in capital requirements from 235 per cent of the US Risk Based Capital Company Action Level to 250 per cent (see section ‘C.1 Regulatory capital (IGD)’ of Risk and capital management). Reinvestment levels in the UK remained low at £20 million (2012: £22 million). The IRRs on invested capital were more than 20 per cent in Asia, the US and the UK, with payback periods of four years, two years and four years respectively, consistent with recent trends.

Of the remaining free surplus generated2 after reinvestment in new business, totalling £1,152 million (2012: £1,031 million), £844 million was remitted from the business units to Group. This cash was used to meet central costs of £132 million (2012: £148 million), and meet dividend payments of £532 million (2012: £440 million). The total free surplus stock deployed across our life and asset management operations at the end of June was £4,144 million. We retain capital in the businesses both to finance future growth and to enable them to withstand future economic ‘shocks’. As the business grows in size, so does the level of capital needed to meet these objectives, leading to an increase in the absolute value of free surplus held at 30 June 2013 compared to the £3,689 million held at 31 December 2012.

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  2013 £m2 2012 £m2
  Half year Half year Full year

Notes

  1. Free surplus generated is defined in note 8 of the EEV basis results.
  2. Following its reclassification as held for sale at 30 June 2013, operating results exclude the results of the Japan Life insurance business. 2012 comparatives have been retrospectively adjusted on a comparable basis.
Free surplus generation      
Asia 457 363 827
US 612 591 1,054
UK 304 291 532
M&G 175 150 285
Underlying free surplus generated from in-force business 1,548 1,395 2,698
Investment in new business (396) (364) (618)
Underlying free surplus generated 1,152 1,031 2,080
Market-related movements, timing differences and other movements 147 (277) (612)
Net cash remitted by business units (844) (726) (1,200)
Total movement in free surplus 455 28 268
Free surplus at 1 January 3,689 3,421 3,421
Free surplus at end of period 4,144 3,449 3,689
       
Holding company cash flow      
Net cash remitted by business units:      
Asia 190 126 341
US 294 247 249
UK 226 230 313
M&G 134 123 297
Net cash remitted by business units 844 726 1,200
Net central outflows (132) (148) (289)
Corporate activities/other (including foreign exchange) (70) (116) (76)
Dividend paid (532) (440) (655)
Net movement in holding company cash flow 110 22 180
Holding company cash at 1 January 1,380 1,200 1,200
Holding company cash at end of period 1,490 1,222 1,380

The following discussion contains forward-looking statements that involve inherent risks and uncertainties. Prudential’s actual future financial condition or performance or other indicated results may differ materially from those indicated in any such forward-looking statement due to a number of important factors (including those discussed under the heading ‘Risk factors’ in this document). See the discussion under the heading ‘Forward-looking statements’.

At our 2010 investor conference entitled ‘Growth and Cash’, we announced new financial objectives demonstrating our confidence in continued rapid growth in Asia, and increasing levels of cash remittances from all of our businesses. These objectives have been defined as follows:

  1. Asia growth and profitability objectives1:
    To double the 2009 value of IFRS life and asset management pre-tax operating profit in 2013 (2009: £465 million); and
    To double the 2009 value of new business profits in 2013 (2009: £713 million).
  2. Business unit cash remittance objectives1:
    Asia to deliver £300 million of net cash remittance to the Group in 2013 (2009: £40 million);
    Jackson to deliver £260 million2 of net cash remittance to the Group in 2013 (2009: £39 million); and
    UK to deliver £350 million of net cash remittance to the Group in 2013 (2009: £284 million3).
  3. Cumulative net cash remittances1:
    All business units in aggregate to deliver cumulative net cash remittances of at least £3.8 billion over the period 2010 to end 2013. These net remittances are to be underpinned by a targeted level of cumulative underlying free surplus generation of £6.5 billion over the same period.

As mentioned in the Group Chief Executive’s report we remain focused on these objectives and have continued to make progress towards them. In the first half of 2013, we have achieved four of these objectives and are on track to achieve the remaining two by the end of the year. We set out in more detail below our progress towards these objectives based on our results for the first half of 2013.

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Asia profitability objectives   Actual (2009 to 2012 as originally reported)     Objective  
  2009
£m
2010
£m
2011
£m
2012
£m
Half year
2013
£m
Change
(since
half year
2012)
%
Change
(since
2009)
%
2013
£m
Value of new business:                    
Full year   713 901 1,076 1,266     78 1,426  
Half year   277 395 465 547 659 20 138    
IFRS operating profit4                    
Full year   465 604 784 988     112 930  
Half year   228 295 367 440 512 16 125    

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Business unit net cash remittance objectives Actual Objective
2009
£m
2010
£m
2011
£m
2012
£m
Half year
2013
£m
2013
£m
Asia5 40 233 206 341 190 300
Jackson6 39 80 322 249 294 260
UK7 434 420 297 313 226 350
M&G8 175 202 280 297 134  
Full year 688 935 1,105 1,200    
Half year 375 460 690 726 844  

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Objectives for cumulative period 1 January 2010 to 31 December 2013 Actual Objective Percentage
achieved
1 Jan 2010
to 30 Jun
2013
£m
1 Jan 2010
to 31 Dec
2013
£m
At 30 Jun
2013
%
Cumulative net cash remittances from 2010 onwards 4,084 3,800 107
Cumulative underlying Group free surplus generation (which is net of investment in new business) 6,931 6,500 107

Cash remitted to the Group in the first half of 2013 increased by 16 per cent to £844 million (2012: £726 million), with well-balanced contributions from across the Group. Asia’s remittances increased 51 per cent to £190 million (2012: £126 million), demonstrating the highly cash-generative signature of recent growth, driven by the focus on health and protection products. Asia’s 2013 remittance also includes a stronger first half bias than in 2012, due to timing differences. The 2013 remittance of £294 million from the US exceeds the full year 2013 cash remittance objective of £260 million and represents an increase of 19 per cent on the first half of 2012, reflecting both growth in the size of the in-force portfolio and an additional contribution from REALIC following its acquisition in 2012. The UK insurance operations have continued to make sizeable remittances at £226 million (2012: £230 million), supported by shareholder transfers from the with-profits fund. M&G (including Prudential Capital) delivered net remittances of £134 million (2012: £123 million), reflecting its relatively capital-light business model that facilitates a high dividend payout ratio from earnings.

By 30 June 2013, cumulative net remittances of over £4.1 billion have been delivered by business operations since the beginning of 2010, exceeding the cumulative 2010 to 2013 net remittance objective of £3.8 billion. The remittances have been supported by strong underlying free surplus generated across the four business operations. By 30 June 2013, cumulative free surplus of over £6.9 billion has been generated since the start of 2010, exceeding the cumulative 2010 to 2013 objective of £6.5 billion.

We remain confident of achieving our remaining 2013 objectives to double the Asia 2009 new business profit by 2013 and for the UK to remit £350 million in 2013.

Notes

  1. The objectives assume current exchange rates and a normalised economic environment consistent with the economic assumptions made by Prudential in calculating the EEV basis supplementary information for the half year ended 30 June 2010. They have been prepared using current solvency rules and do not prejudge the outcome of Solvency II, which remains uncertain.
  2. The net remittance objective for Jackson was increased from £200 million to £260 million to reflect the positive impact of the acquisition of REALIC.
  3. Representing the underlying remittances excluding the £150 million impact of proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis.
  4. Total Asia operating profit from long-term business and Eastspring Investments after development costs. For the purposes of this analysis the 2009 to 2012 comparatives represent results as reported in the respective periods and excludes adjustment for adoption of new standards as discussed in note B to the IFRS financial statements or other changes to the presentation of operating profit. In contrast, the 2013 result is shown inclusive of the effect of these changes.
  5. Remittances from Asia in 2012 include net remittance of £27 million, representing cash from sale of Group’s holding in China Life Insurance Company in Taiwan offset by repayment of funding contingent on future profits of the Hong Kong life insurance operations. 2010 remittances included a one-off remittance of £130 million, representing the accumulation of historic distributable reserves.
  6. Net remittances from Jackson in 2011 include releases of excess surplus to Group.
  7. In 2009, the net remittances from the UK included the £150 million arising from the proactive financing techniques used to bring forward cash emergence of the in-force book during the financial crisis. The 2010 net remittances included an amount of £120 million, representing the releases of surplus and net financing payments.
  8. Including Prudential Capital.

We continue to operate with a strong solvency position, while maintaining high levels of liquidity and capital generation. At 30 June 2013, our IGD surplus1 is estimated at £3.9 billion after deducting the 2012 final dividend, generating strong coverage of 2.3 times the requirement. This is testament to our capital discipline, the effectiveness of our hedging activities, our low direct Eurozone exposure, the minimal level of credit impairments and our comparatively low interest rate sensitivity.

All of our subsidiaries continue to hold strong capital positions on a local regulatory basis. In particular, at 30 June 2013, the value of the estate of our UK with-profits funds is estimated at £7.8 billion (31 December 2012: £7.0 billion). Jackson’s risk-based capital ratio level at the end of 2012 was 423 per cent and since then it was able to remit £294 million to Group while supporting its balance sheet growth and maintaining adequate capital.

Furthermore, on a statutory (Pillar 1) basis the total credit default reserve for the UK shareholder annuity funds also contributes to protecting our capital position in excess of the IGD surplus. Notwithstanding the absence of defaults in the period, at 30 June 2013 we have broadly maintained our credit default reserves at £2.0 billion (31 December 2012: £2.1 billion), representing 41 per cent of the portfolio spread over swaps, compared with 40 per cent at 31 December 2012.

Our financing and liquidity position also remained strong throughout the period. The issue of US$0.7 billion (£0.4 billion) of subordinated debt (perpetual tier 1 notes) in January 2013 further supports the financial flexibility of the Group, while taking advantage of very favourable market conditions. Our central cash resources amounted to £1.5 billion at 30 June 2013, up from £1.4 billion at 31 December 2012, and we retain a further £2.1 billion of untapped committed liquidity facilities.

As previously mentioned, Prudential plc has been listed by the Financial Stability Board (FSB) to be designated as a global systemically important insurer (G-SII). At the same time, the International Association of Insurance Supervisors (IAIS) announced details of its assessment methodology and proposed policy measures for G-SIIs, covering enhanced supervision, effective resolution and higher loss absorption capacity. We continue to monitor these developments.

Solvency II remains subject to delays in policy development and therefore the outlook continues to be uncertain. Despite this uncertainty we remain focused on preparing for implementation of the new regime.

Note

  1. Estimated. As disclosed in full year 2012 results, from March 2013 the basis of calculating Jackson’s contribution to the Group’s IGD surplus was changed, further detail can be found in the section ‘C.1 Regulatory capital (IGD)’ of Risk and capital management.

During the first half of 2013, most equity markets recorded strong positive movements, although volatility increased towards the end of the period as fears of a global economic slowdown returned when the Federal Reserve Chairman guided markets to expect an end to quantitative easing. This also led to a sharp rise in US yields to 2.5 per cent at 30 June 2013, compared to 1.8 per cent at the end of 2012, with yields in most other markets following higher. Higher yields generate adverse value movements on our holdings of fixed income securities which have given rise to negative short-term investment variances in some of our operations. However, these higher yields are also expected to generate higher investment returns going forward, whose estimated positive future value is also included within the non-operating results on the EEV basis of reporting and offsets the effect of the negative short-term investment variances. Consequently, the Group’s EEV shareholders’ funds increased by 9 per cent during 2013 to £24.5 billion (31 December 2012: £22.4 billion). On a per share basis EEV at the end of 30 June 2013 stood at 958 pence, up from 878 pence at 31 December 2012.

An equivalent offset against negative short-term investment variances is not available under IFRS as the effect of potential higher future returns will only be recognised as these are earned. IFRS shareholders’ funds at £9.6 billion were, therefore, 7 per cent lower than at full year 2012 (31 December 2012: £10.4 billion) and 4 per cent higher than at half year 2012 (30 June 2012: £9.3 billion).

Summary

The financial progress we have reported in 2013 to date demonstrates both the quality and the resilience of our business model and our earnings. This is a direct consequence of the strategy we have continued to execute, focusing on growing the more stable sources of income, diversifying our business by geography, product and distribution channel and maintaining our disciplined approach to cash generation and capital management. We look forward to the remainder of the year with confidence.

 
 

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