PRUDENTIAL PLC annual report, Q4 FY2018

Business context and reporting period

Prudential plc filed this Form 20-F on 22 March 2019 for the fiscal year ended 31 December 2018. It is an international insurer and asset manager operating principally in Asia, the United States, and the UK and Europe, with developing operations in Africa. The filing reports annual results, not standalone 2018 Q4 results. Financial statements are prepared under IFRS as issued by the IASB.

The company was preparing to demerge its UK and Europe business, M&GPrudential, into a separately listed company. Timing remained subject to further work and was not specified.

Key financial metrics

Total revenue and net earned premiums were affected by the £12.1bn reinsurance premium paid for the UK annuity transaction and volatile investment returns. Investment return was a loss of £10.3bn in 2018 versus a gain of £42.2bn in 2017; these movements largely relate to policyholder funds and should not be read as a comparable measure of underlying operating performance.

• Operating profit by segment: Asia £2.16bn, up 14% on a constant exchange rate basis; US £1.92bn, down 11%; UK and Europe £1.63bn, up 19%. Group adjusted operating profit rose 6% on a constant exchange rate basis, but 3% on actual exchange rates.
• Cash, debt and liquidity: Cash and cash equivalents were £12.1bn, much of it held for policyholders and not available for general Group use. Holding-company cash and short-term investments were £3.24bn. Core structural borrowings were £7.66bn; net of holding-company cash, net core structural borrowings were £4.43bn, with gearing of 20%. The Group also had £2.6bn of undrawn committed facilities expiring in 2023.
• Capital and cash generation: Business-unit remittances were £1.73bn, down from £1.79bn. Solvency II own funds were £30.2bn and the capital requirement £13.0bn. The reported cover ratio is estimated before the second interim dividend.
• Dividend: The full-year ordinary dividend increased 5% to 49.35p per share, including a 33.68p second interim dividend. Management’s stated aim remained annual ordinary-dividend growth of 5%, subject to financial flexibility and investment opportunities.
• Other scale indicators: Group funds under management were £657.3bn, down from £669.3bn. New business premiums were £31.1bn single and £3.69bn annualised regular premium; these are volume indicators, not IFRS premium income.

The filing does not present a single Group operating margin as a key performance measure. Selected asset-management cost/income ratios were 59% for M&GPrudential and 55% for Eastspring.

Material changes versus the prior comparable period

• Profit for the year rose 26% on actual exchange rates; adjusted operating profit grew 6% on a constant exchange rate basis.
• Asia led underlying operating growth. In the US, higher fee income was outweighed by increased market-related deferred acquisition cost amortisation and lower spread income. In UK and Europe, reported operating profit benefited from longevity assumption changes and other items not expected to recur at the same level.
• The £508m pre-tax loss on the Rothesay Life reinsurance of approximately £12bn of UK shareholder-backed annuity liabilities reduced the UK and Europe result. Most of the portfolio was expected to transfer under a court-sanctioned Part VII process by 30 June 2019.
• Short-term investment-return losses were £558m, compared with £1.56bn in 2017. That improvement was partly offset by a swing from a £223m gain on disposals and corporate transactions in 2017 to a £588m loss in 2018.
• Shareholders’ equity increased 7%, reflecting profit and favourable currency translation, partly offset by £1.24bn of dividends and £1.08bn of unrealised losses on Jackson fixed-income securities recorded through other comprehensive income.
• External asset-management flows weakened: total asset-management net outflows were £11.5bn, including £9.9bn from M&GPrudential, partly reflecting an expected £6.5bn low-margin mandate redemption. M&GPrudential assets under management declined to £321bn from £351bn.

Outlook, commentary, risks and contingencies

Management cited continued structural demand for protection, savings, retirement and investment products, particularly in Asia and the US. It also highlighted ongoing investment in digital capabilities, distribution partnerships and business transformation. For M&GPrudential, the company targeted approximately £145m in annual shareholder cost savings by 2022, for an estimated shareholder investment of approximately £250m.

• Separation and financing: The demerger requires legal, operational and financial separation, regulatory engagement and capital rebalancing. The Group had issued £1.6bn of substitutable subordinated debt in 2018 and expected M&GPrudential to hold around £3.5bn of subordinated debt at demerger; these were estimates subject to approvals and changing conditions.
• Markets and business risks: Risks include interest-rate, equity, credit, currency, liquidity, longevity, mortality, morbidity and policyholder-behaviour changes. Jackson’s guarantees, low-rate spread compression and hedging-related accounting volatility are notable exposures. Management described the hedging programme as performing as expected during late-2018 market weakness.
• Political and regulatory risks: Brexit outcomes and potential market or operational disruption remained uncertain. The Hong Kong Insurance Authority was expected to become Prudential plc’s group-wide supervisor after demerger. US annuity regulation, Solvency II developments, LIBOR transition and future IFRS 17 implementation are additional uncertainties.
• Contingencies and unusual items: The £400m gross provision for the FCA review of past non-advised annuity sales was unchanged; most was expected to be used in 2019, but final redress costs remained uncertain. The Group recognised a £166m insurance recovery relating to this review. A £55m provision was recorded for equalising guaranteed minimum pension benefits following a UK court ruling. The filing also notes potential shareholder support obligations to UK with-profits funds in extreme circumstances.
• Post-year-end items: Prudential renewed and expanded its UOB bancassurance alliance to 2034, with an initial £662m fee payable in instalments. The filing also disclosed a proposed majority acquisition of Group Beneficial in Africa, subject to conditions and regulatory approvals.

Important facts for investors to verify

• Reconcile statutory profit, adjusted operating profit and total investment-return movements; confirm the effect of the Rothesay reinsurance and the unusually large 2018 annuity-related items.
• Check the Solvency II ratio and surplus assumptions, including transitional measures, treatment of ring-fenced with-profits funds, and the fact that the reported ratio is before the second interim dividend.
• Track completion, costs, capital allocation and regulatory approvals for the proposed M&GPrudential demerger, including the expected debt allocation to each company.
• Assess Jackson’s DAC amortisation, spread income, guarantee exposures, hedge effectiveness and sensitivity to interest rates and equity markets.
• Monitor the annuity-sales review, estimated redress population and provision utilisation, along with the UK pension equalisation provision and other legal or regulatory matters.
• Verify asset-management flows, especially M&GPrudential external outflows, the expected mandate redemption and the sustainability of fee income.
• Evaluate dividend capacity against holding-company resources, subsidiary distribution restrictions, debt service and the stated 5% annual growth aim.