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November 8, 2013

Milliman Client Report

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Supplementary Report of the Independent Experts on the transfer of the long term insurance business of the Hong Kong Branch of The Prudential Assurance Company Limited to Prudential Hong Kong Limited

Prepared for: The Prudential Assurance Company Ltd.

Prepared by: Paul Sinnott FIA Nick Dumbreck FIA, FSA, CERA


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Table of Contents

1. Summary and overall conclusions ................................................................................................................. 3 Introduction ......................................................................................................................................................... 3 Reliances and limitations .................................................................................................................................... 3 Overall conclusions ............................................................................................................................................. 4 View of the Scottish Amicable Board .................................................................................................................. 6 Preliminary views of the HK Insurance Authority, the PRA and the FCA ........................................................... 6

2. Risk alignment .................................................................................................................................................. 9 Risk alignment ratio ............................................................................................................................................ 9 The Scheme requirements ................................................................................................................................ 10 The alignment of the risks of the with-profits policies of the two territories ...................................................... 11 The risk of misalignment arising prior to the Transfer Date .............................................................................. 12 PAC’s process for monitoring the risk alignment ratios to the Transfer Date ................................................... 12 Confirmation required no more than 2 days prior to the Transfer Date ............................................................ 13

3. The effect of the domestication on the potential impact of Solvency 2 .................................................... 15

4. Review of pro forma apportionment calculations and post domestication balance sheets as at 31 December 2012 ....................................................................................................................................................... 17

5. Other relevant events occurring after the finalisation of the JIA Report .................................................. 18

6. Apportionment methodology at 30 June 2013 ............................................................................................. 22

7. The likely effect of the Scheme on non-transferring policyholders .......................................................... 25 The security of guaranteed benefits ................................................................................................................. 25 Benefit expectations .......................................................................................................................................... 28

8. The likely effect of the Scheme on transferring policyholders .................................................................. 29 The security of guaranteed benefits ................................................................................................................. 29 Benefit expectations .......................................................................................................................................... 33

9. Correspondence from policyholders ............................................................................................................ 35 Conclusion ........................................................................................................................................................ 42

Appendix A Key sources of data ...................................................................................................................... 43


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1. Summary and overall conclusions

Introduction

1.1. We have prepared a report to the Court of First Instance in the Hong Kong Special Administrative Region of the People’s Republic of China (the Hong Kong Court) and the High Court of England and Wales (the UK Court) entitled “Report of the Independent Experts on the transfer of the long term insurance business of the Hong Kong Branch of The Prudential Assurance Company Limited to Prudential Hong Kong Limited” dated 17 August 2013 (the JIA Report). The JIA Report is available on request to policyholders of The Prudential Assurance Company Limited (PAC) and those of its Hong Kong Branch (PACHK), and from PAC’s website.

1.2. Our conclusions in the JIA Report are based upon the financial position of PAC as at 31 December 2012, and on other information available to us when the report was completed.

1.3. In this supplementary report we provide an updated assessment of the likely effects of PAC’s proposals on policyholder security and benefit expectations based upon unaudited financial information as at 30 June 2013. We also comment upon certain other developments since the finalisation of the JIA Report.

1.4. We have received all the information we have requested from PAC for the purposes of preparing this supplementary report. We have listed the key documents which we have considered in the preparation of this supplementary report in Appendix A. A glossary of terms used in this report is set out in Appendix D to the JIA Report.

1.5. We understand from PAC that copies of this report, the supplementary reports prepared by the PAC Actuarial Function Holder and the PAC With-Profits Actuary, and the supplementary certificate issued by the PHKL Appointed Actuary Designate, will be made available from PAC’s website prior to the hearing of the Hong Kong Court scheduled to begin on 26 November 2013 and the hearing of the UK Court scheduled to begin on 10 December 2013.

Reliances and limitations

1.6. This is an update to the JIA Report. Details of the scope of our work, and the reliances, limitations and standards applying to our work, including this supplementary report, are set out in the JIA Report.

1.7. In carrying out our work and preparing this report we have had access to documentary evidence provided by PAC. We have also had access to, and discussions with, staff and management of PAC and PACHK. In coming to our conclusions, except as described below, we have relied upon the accuracy of the information which has been provided to us in written or oral form without independent verification.

1.8. In aggregate, asset shares1 represent the largest liabilities of the PAC WPSF. In addition, as noted in paragraph 1.27 of the JIA Report, under the methodology to be applied to apportion the assets of the PAC WPSF, after attributing specific amounts to UK & Europe or Hong Kong in respect of certain liabilities of those territories (including asset shares), the balance of the value of the assets of the PAC WPSF is to be allocated between the territories broadly in line with asset shares. Accordingly, Prudential has commissioned an external auditor to perform an assurance review to check that its own principles, processes and procedures have been followed in practice in calculating aggregate asset shares, separately for the UK & European business and the Hong Kong business of PAC as at

_______________________________________________________________________________ 1 The asset share of a with-profits policy is the accumulation (with investment returns) of premiums paid less allowances for the cost of risk and other coverages (e.g. benefits on death or disability), for expenses and other charges and for miscellaneous profits and losses. It provides a benchmark against which total payouts for policyholders can be assessed, and hence bonus scales can be determined.


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31 December 2012. Under the terms of the release letter which we were asked to sign to gain access to that report, we are not permitted to rely on the work of the auditor. However, it is clear from the report that the aggregate asset share calculations have been checked, and we have not therefore carried out our own checks on these calculations.

1.9. Milliman has been engaged by PAC to undertake an independent review of the calculations by PAC of the amount of the assets of the PAC WPSF that would have been transferred to PHKL as at 31 December 2012 if the domestication had been effected at that date and to prepare a report to the PAC Board on its findings. We have commented upon the results of this review in paragraphs 4.1 to 4.3.

1.10. We have relied upon the PAC Actuarial Function Holder, the PAC With-Profits Actuary, the PHKL Appointed Actuary Designate and other members of the senior management team of PAC for information about the operation of PAC. In the JIA Report and in this report we have specifically attributed certain statements to such persons, and we have relied upon the accuracy of those (and other statements) made to us.

1.11. We have requested and received copies of legal advice provided to PAC management in respect of certain matters, and have discussed that advice with PAC and its legal advisers. We are not qualified to express opinions on matters of a legal nature. We have therefore made specific reference to such advice where appropriate in the JIA Report and this report, and we have relied upon that advice.

1.12. Other than as described in paragraphs 1.7 to 1.11, we have not relied upon others or their judgement in preparing this report. We have considered the Scheme and the evidence presented to us and reached our own conclusions about the likely effect of the Scheme on the non-transferring policyholders of PAC, the policyholders of Prudential Annuities Limited (PAL) and the transferring policyholders of PAC.

1.13. This report has been prepared by Milliman on an agreed basis for PAC in the context of the Scheme and must not be relied upon for any other purposes. No liability will be accepted by Milliman, or us, for any application of our report for a purpose for which it was not intended nor for the results of any misunderstanding by any user of any aspect of the report. This report must be considered in its entirety, and in conjunction with the JIA Report, as individual parts of one or both documents, if considered in isolation, may be misleading. This report does not provide financial or other advice to individual policyholders.

Overall conclusions

1.14. We have considered relevant developments brought to our attention by PAC since the completion of the JIA Report. We have reviewed all policyholder communications provided to us by PAC up to the date of this report which have been recorded by PAC as objections to its proposals.

The security of guaranteed benefits

1.15. Based upon unaudited financial information as at 30 June 2013, we have not changed our conclusions regarding the security of guaranteed benefits of policyholders of PAC and PAL stated in the JIA Report. In our opinion:

The Scheme is unlikely to have a material adverse effect on the security of guaranteed benefits of non-transferring policyholders of PAC or those of the policyholders of PAL.

Transferring policyholders will enjoy an increased level of security for their guaranteed benefits in the short term, as a result of the amount of assets to be transferred from PAC to PHKL. If the Scheme had been effected at 30 June 2013 then the solvency ratio of PHKL would have exceeded the Hong Kong regulatory requirement to maintain a minimum ratio of 150% by a


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significant margin.

Thereafter the security provided by surplus assets within PHKL is likely to reduce through the writing of new with-profits business, and in the medium term it may fall below the level which would have applied if the Scheme had not been implemented. However, the Scheme includes a number of safeguards which we consider should mean that transferring policyholders will continue to benefit from a high level of security.

The security for transferring policyholders will also be enhanced by undertakings from Prudential plc to provide financial support to PHKL if necessary. Provided these (or equivalent) undertakings remain in place and enforceable, we consider that the Scheme is unlikely to have a material adverse effect on the security for the guaranteed benefits of transferring policyholders.

1.16. We have not been made aware of any matters arising to the date of this report, other than those disclosed in this report, that would affect our conclusions.

Reasonable benefit expectations

1.17. We have not changed our conclusions stated in the JIA Report regarding the impact of the Scheme on the reasonable benefit expectations of policyholders. In summary these are:

There is no reason to believe that:

• the benefit expectations of holders of unit-linked policies of PAC will be adversely affected by the Scheme;

• any changes made to reviewable premiums under existing policies of PAC will be attributable to the implementation of the Scheme; or

• there will be any changes to the variable benefits payable under certain transferring policies of the PAC NPSF as a result of the Scheme.

No changes are expected to the investment, bonus and smoothing policies applied to the non-transferring and transferring with-profits business of PAC as a result of the Scheme.

1.18. Accordingly, we continue to be of the view that the Scheme is unlikely to have a material adverse effect on the reasonable benefit expectations of any group of policyholders of PAC.

The possibility of special bonuses from the working capital of the main with-profits fund of PAC

1.19. We have not changed our conclusions stated in the JIA Report regarding the possibility of special bonuses from the working capital of the main with-profits fund of PAC (the PAC WPSF). These are:

An allocation of a proportion of the working capital of the main with-profits fund of PAC to PHKL would be an appropriate reflection of the way in which the fund is currently managed.

For as long as the whole of the working capital is required to support the in-force business and new business expected to be written, relevant with-profits policyholders have no expectation of receiving special bonuses funded from that capital. However, depending on future experience, and in particular new business volumes, part of the working capital could become available for distribution in the future.

In considering fairness when a with-profits fund is divided into two parts, each with a very different business profile and expected amounts of future new business, it is necessary to recognise the broad range of potential outcomes. For example, if new business were to cease or decline rapidly in both territories shortly after the Transfer Date, the allocation of assets to PHKL to support the writing of new with-profits business could be seen as unfairly favouring transferring policyholders. On the other hand, if PHKL continues to achieve strong new business growth but


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new business declines in UK & Europe, some non-transferring with-profits policyholders could benefit from special bonuses which would not have been granted if the Scheme had not been implemented.

In assessing an appropriate split of the assets of the main with-profits fund of PAC between the two territories when the Hong Kong business is domesticated, we have taken into account the apportionment methodology proposed by PAC, the amount of assets to be allocated to PHKL to support new with-profits business, the projected new business volumes in each territory, and the arrangements for managing the transferring and non-transferring business both before and after the Transfer Date.

Based on this analysis, we consider that the proposal achieves a reasonable balance between the two territories.

Confirmation required no more than 2 days prior to the Transfer Date

1.20. As required by the Scheme2 (see Section 2 of this report), the transfer will not become effective unless we provide confirmation in writing to PAC, PHKL, the HK Insurance Authority, the PRA and the FCA not more than 2 days prior to the Transfer Date that, as far as we are aware and on the basis of discussions with the PAC Actuarial Function Holder:

no event has occurred which would result in the risk level associated with the transferring with-profits business and the non-transferring with-profits business not being aligned; or

if such an event has occurred, the risk levels are capable of being so aligned within an appropriate time frame and in any event within 9 months of the Transfer Date,

in accordance with PAC’s prior practice and the HK PRE documentation3 and taking into account the relevant facts and circumstances.

View of the Scottish Amicable Board

1.21. The Scottish Amicable Board (SAB), a committee of the PAC Board, is solely responsible for the management of the Scottish Amicable Insurance Fund of PAC (SAIF). A statement by the Chairman of the SAB regarding the proposed domestication is available from PAC’s website. The statement does not raise any concerns in respect of the potential impact of the Scheme on the SAIF. It confirms that the SAB, having taken advice from the Monitoring Actuary4, has concluded that the Scheme will not materially adversely affect the security or reasonable benefit expectations of SAIF policyholders.

Preliminary views of the HK Insurance Authority, the PRA and the FCA

1.22. The HK Insurance Authority is not required to express an opinion on a scheme of transfer to the Hong Kong Court for the purpose of a directions hearing of the Hong Kong Court. Accordingly, the HK Insurance Authority reserved its position at the directions hearing relating to the Scheme held on 10 September 2013.

_______________________________________________________________________________ 2 Clause 1.7 of the Main Scheme. 3 The statement of the reasonable expectations of Hong Kong with-profits policyholders maintained by PAC for internal purposes. 4 Under the SALAS Scheme the SAB is required to appoint an actuary as the Monitoring Actuary to advise it as to the proper operation of the SAIF and the Scottish Amicable Capital Fund (SACF) in order to safeguard the interests and reasonable expectations of the holders of policies invested in the SAIF. Mr John McKenzie, a Principal of Milliman LLP, currently acts as the Monitoring Actuary.


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1.23. The directions hearing of the UK Court relating to the Main Scheme was held on 13 September 2013.5 The PRA and the FCA provided their preliminary views on the fairness of the Scheme in reports to the UK Court dated 11 September 20136 and 10 September 2013 respectively. Subject to certain additional requirements being met, the PRA confirmed it was satisfied that the Main Scheme7 is within the range of reasonable and fair schemes on which to consult policyholders and the FCA confirmed it was satisfied that the Scheme is within the range of reasonable and fair schemes available to PAC and PHKL. The reports by the PRA and the FCA indicate that they will update the UK Court on their final reviews prior to the sanctions hearing of the Scheme by the UK Court. The additional requirements applying to the preliminary views of the PRA and the FCA included:

Prior to the scheduled sanctions hearings of the Hong Kong Court and the UK Court, the claims-paying and Hong Kong regulatory components of the risk appetites for the PHKL WPF have been specified and shown to provide appropriate resilience in stressed conditions.

We have received copies of the statements of these components of the risk appetite of PHKL, which we understand from PAC have been provisionally approved by the PHKL Board8. These statements reflect the requirements for consistency with the corresponding statements of the PAC WPSF set out in the Scheme9. In our opinion these statements would provide resilience in stressed conditions.

Confirmation is provided shortly before the Transfer Date that the UK & European business of the PAC WPSF is risk aligned with the Hong Kong business of the PAC WPSF, or that those businesses are capable of being so aligned within an appropriate time period.

This is reflected in the Scheme requirement described in paragraph 1.20 of this report. We comment upon risk alignment in Section 2 of this report.

Confirmation is provided that certain shareholder undertakings are legally enforceable.

Some minor changes have been made to the draft capital support undertakings by Prudential plc and PAC associated with the domestication10 which were available to us at the time of preparing the JIA Report. These changes do not affect our conclusions on the likely impact of the Scheme. We understand that those undertakings have now been approved and executed by the relevant board(s) of directors. We understand that PAC received formal legal opinions regarding, among other matters, the enforceability of those undertakings. We are not qualified to express opinions on matters of a legal nature.

Independent verification is provided that the initial amount transferred from the PAC WPSF to PHKL and the true-up payments are calculated in line with the published methodology, and any discretion has been applied appropriately.

We understand from PAC that such an investigation is to be undertaken.

_______________________________________________________________________________ 5 The transfer will be effected by means of two court schemes: the Main Scheme and the EEA Policies Scheme, which we refer to collectively as the Scheme. The terms of EEA Policies Scheme incorporate those of the Main Scheme, except that it will effect the transfer of long term insurance policies of PACHK which cover risks arising in EEA States over which, in this context, the UK Court has no jurisdiction. Accordingly, the EEA Policies Scheme will not be presented to the UK Court. 6 We understand from the PRA that a draft of its report was provided to the Hong Kong Court ahead of its directions hearing relating to the Scheme. 7 The PRA stated that it has considered the impact of the Main Scheme and the EEA Policies Scheme as a whole. 8 We understand from PAC that the PHKL With-Profits Committee had not been constituted at the date of writing this report, and so the approval of the PHKL Board remains conditional upon it considering the advice of the PHKL With-Profits Committee, it having sought and considered the advice the other parties to which it is required to have regard by clause 4.17 of Schedule 3 to the Scheme. 9 These are set out in clauses 4.19 (for the claims-paying component for the WPF) and 4.21 (Hong Kong regulatory component for the WPF) of Schedule 3 to the Scheme. 10 The undertakings are described in paragraphs 6.13 to 6.16 and 11.16 to 11.19 of the JIA Report.


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(stipulated by the FCA only) Confirmation is provided of the reasonableness of the costs incurred in relation to the domestication that are to be allocated to the PAC WPSF and/or the PHKL WPF because they are deemed to be expenses that would have arisen in the normal course of events but have been accelerated to facilitate the transfer.

We understand from PAC that the cost allocation will be confirmed by the PAC Board, having sought the advice of the PAC Actuarial Function Holder, the PAC With-Profits Actuary and the PAC With-Profits Committee.


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2. Risk alignment 2.1. A proportion of the PAC Inherited Estate will be allocated to PHKL. The Scheme therefore has the

potential to reduce the capital resources that would otherwise be available to support the UK & European business of the PAC WPSF, or the resources that would otherwise be available to support the Hong Kong business of the fund, below the level that would have been available if the Scheme had not been implemented.

2.2. As stated in paragraph 8.17 of the JIA Report, in our view, on the assumption that satisfactory alignment of the risk levels of the two territories is achievable at the Transfer Date, the allocation of assets of the PAC WPSF arising from the application of the apportionment methodology (before allowing for the allocation to support the writing of new business) would be reasonable in conjunction with the proposed transfer of with-profits and non-profit liabilities of the fund to PHKL.

2.3. In Section 8 of the JIA Report we noted that:

PAC undertook an investigation of the robustness of the apportionment methodology based upon the financial position of the PAC WPSF at the end of 2011, which demonstrated that at that date it would have resulted in broad risk alignment between the level of risk associated with the business of UK & Europe on the one hand, and the corresponding level of risk associated with the business of Hong Kong on the other. It also demonstrated that the businesses would be expected to be broadly risk aligned after the application of significant instantaneous adverse economic stresses to both territories.

As a result of de-risking actions in respect of the Hong Kong with-profits business in 2012 and changes to investment conditions, the two territories were no longer closely risk aligned at the end of 2012. PAC had concluded that, in the light of improvements to investment conditions of relevance to the Hong Kong business, it would be appropriate for a degree of re-risking of the Hong Kong business to be undertaken.

2.4. We understand from PAC that, after allowing for the re-risking of the Hong Kong with-profits business that has been agreed by the PAC Board (and is being implemented in 2013) as if those changes had been made at the end of 2012, the arithmetic difference between the risk alignment ratios (see paragraph 2.5) calculated for the two territories as at 31 December 2012 reduced to 0.1%.

Risk alignment ratio

2.5. Risk alignment ratios are used by PAC to compare the level of risk arising from the two territories. For each territory the ratio is calculated as:

[Net Cost of Guarantees + Pillar II capital requirements] x 100% [With-Profits Benefit Reserves + Regular Premium Adjustment11]

2.6. For this purpose, assets of the PAC WPSF are assumed to be allocated in accordance with the apportionment methodology specified in the Scheme. The Net Cost of Guarantees and the Pillar II capital requirements exclude those arising in respect of business which is deemed to give rise to crystallised guarantees, those arising from non-profit business and, for the ratio for UK & Europe, Industrial Branch business, and the assets allocated to each of those liabilities under the apportionment methodology12. The Net Costs of Guarantees are the published figures after making the adjustments referred to in paragraph 7.26 of the JIA Report to be applied for the purposes of the apportionment methodology.

_______________________________________________________________________________ 11 The present value (determined using risk free discount rates) of regular premiums payable over one third of the remainder of the period (if any) to the tenth policy anniversary for with-profits policies. 12 The relevant policies are also excluded from the denominator of the ratio.


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2.7. We understand from PAC that the risk profile of the UK & European business (which currently represents around 90% of the aggregate asset shares of the PAC WPSF) is monitored and changed from time to time with the aim that the fund remains within the risk appetite13 set by the PAC Board, and the risk level of the Hong Kong business is then set to be broadly consistent with that of the UK & European business. Risk alignment ratios are considered annually as part of the business-as-usual monitoring of the two territories, and broad alignment of the ratios is targeted. As part of this risk alignment review, a difference in ratios of up to 2% would be considered by PAC to fall within an acceptable range, and if the difference exceeds 2% then consideration would be given to taking management actions that would reduce the difference to not more than 2%. In particular, PAC might choose to tolerate a temporary movement outside risk appetite, in preference to taking actions to broadly align the risks of the two territories, depending upon the financial circumstances of the fund and PAC. Any actions taken, or not taken, would be those that the Board considered to be most appropriate in the light of the rights and reasonable expectations of the relevant policyholders.

The Scheme requirements

2.8. Clause 1.7 of the Scheme requires that the PAC Actuarial Function Holder, the PAC With-Profits Actuary and we (in our role as Independent Actuary and Independent Expert in respect of the Scheme) each review, and confirm in separate reports prepared shortly before the hearings of the Hong Kong Court and the UK Court seeking the sanction of the Scheme,

the alignment of the risks of the with-profits policies of the two territories;

the risk of misalignment arising prior to the Transfer Date; and

the ability to align those risks in the event of an existing misalignment or a misalignment arising prior to the Transfer Date.

2.9. In addition, clause 1.7 of the Scheme states that it will not become effective unless we (in our role as Independent Actuary and Independent Expert in respect of the Scheme) confirm in writing to PAC, PHKL, the HK Insurance Authority, the PRA and the FCA, not more than 2 days prior to the Transfer Date, that, as far as we are aware and on the basis of discussions with the PAC Actuarial Function Holder,

no event has occurred which would result in the risk level associated with the transferring with-profits business and the risk level associated with the balance of the with-profits business of the PAC WPSF and that of the DCPSF not being aligned; or

if such an event has occurred, the risk levels are capable of being so aligned within an appropriate time period and in any event within 9 months of the Transfer Date,

in accordance with PAC’s prior practice and the HK PRE documentation, and taking into account the relevant facts and circumstances.

_______________________________________________________________________________ 13 A risk appetite is a long term target capital position for the strength of a fund. If the actual capital position of the fund is significantly lower than the target then management actions are likely to be taken to reduce the risks faced by the fund, and vice versa.


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The alignment of the risks of the with-profits policies of the two territories

2.10. The Scheme does not specify the difference in risk alignment ratios which should be considered to represent risk alignment. It makes reference to PAC’s prior practice, the HK PRE documentation, and the requirement to take into account the relevant facts and circumstances.

2.11. PAC has investigated the effect on the risk alignment ratios calculated as at 31 December 2012 for the UK & European business and for the Hong Kong business (after allowing for re-risking in 2013) of applying certain instantaneous adverse economic stresses as at that date considered by PAC to represent 1-in-25 year or 1-in-200 year interest rate or asset share return stress events14 relative to economic conditions at that date.15 The effects of the stresses were calculated from results generated by PAC’s business-as-usual models used for realistic balance sheet and Pillar II reporting. Those models incorporate management actions approved by the PAC Board. Where necessary, further (non-modelled) management actions were identified that would be available following the stress event to bring the ratios of the two territories back to broad alignment (being taken for this purpose as an arithmetic difference of not greater than 2%).

2.12. As noted in paragraph 2.7, for business-as-usual purposes PAC aims for broad risk alignment between the UK & European business and the Hong Kong business of the PAC WPSF. As the businesses of the two territories are currently part of a single fund, it is possible to adjust the balance between the risks of the two businesses in the light of actual experience and the available capital. This adjustment may take place in the normal course of events over a period of time. That is, mis-alignment of risk levels between the two territories may be accepted by PAC in the short-term and closer alignment achieved in the longer term. There is no mechanism in the Scheme to replicate this management of risk levels of the two territories over a period of time: the Scheme provides for a clean break, determining the allocation of the capital of the PAC WPSF between the territories as at the Transfer Date, and the future management of the business of the fund in each territory after the Transfer Date will reflect that allocation without recourse to the capital resources of the other territory.

2.13. Accordingly, we consider that it would be appropriate to demonstrate that management actions could be taken to closely align the risk alignment ratios at the Transfer Date, and that it would not be sufficient to demonstrate only that broad risk alignment (i.e. a difference of 2%) could be achieved. In our view, and we understand also in the view of the PRA and the FCA, a difference of not more than 0.5% would be appropriate as it implies a relatively small differential in financial strengths of the business of the PAC WPSF in the two territories. We do not consider it necessary for actions to be taken to achieve such close alignment, only that it should be demonstrated that there is a range of available management actions consistent with policyholders’ reasonable expectations that could be taken if this was considered to be appropriate and in the interests of policyholders in the circumstances.

2.14. The investigation referred to in paragraph 2.11 considers the effect of adverse stresses applied individually to each territory, and to both territories simultaneously, as at 31 December 2012. PAC has demonstrated that in those scenarios, after allowing where necessary for further management actions, the risk alignment ratios could be closely aligned to within a 0.5% tolerance. Where further management actions, which go beyond those actions currently reflected in PAC’s models, have been assumed to be taken in a scenario, we understand that the PAC Board, having sought advice from the PAC Actuarial Function Holder, the PAC With-Profits Actuary and the PAC With-Profits Committee, is

_______________________________________________________________________________ 14 Consisting of stresses to equity and property values and credit spreads applying to corporate bonds, but no changes to yields on government bonds. 15 The effect of two scenarios incorporating adverse stresses to non-economic assumptions were also considered. These were scenarios covering all of the business of Prudential plc specified by Prudential’s Group Risk Function: one considered to represent a 1-in-25 year capital stress event for Prudential plc and the other considered to represent a 1-in-50 year capital stress event for Prudential plc.


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satisfied that, in principle, such further management actions would be consistent with the reasonable expectations of relevant policyholders in the circumstances applying in that scenario.

2.15. We are therefore satisfied that, after allowing for the re-risking of the Hong Kong business approved by the PAC Board, the risks of the businesses of the two territories were closely risk aligned as at 31 December 2012.

The risk of misalignment arising prior to the Transfer Date

2.16. The risk alignment ratios (after allowing for re-risking) had diverged at 30 June 2013, with the ratio for the Hong Kong business exceeding that for the UK & European business by 2.4%. This primarily reflects the different effects of increases in interest rates in the two territories over the period and, for Hong Kong with-profits business, the consequential changes to applicable guarantee charges and the mix of backing assets arising from the dynamic framework applied to manage that business. A difference in the mix of assets backing asset shares resulted in a positive investment return credited to UK & European asset shares and a negative investment return credited to Hong Kong asset shares in respect of the first half of 2013; this in turn led to a reduction in the cost of guarantees for UK & European business, and an increase in the corresponding amount for Hong Kong business.

2.17. PAC has also undertaken a limited investigation of the effect on the risk alignment ratios calculated as at 30 June 2013 of applying two instantaneous economic stresses at that date. Consideration has been given to (i) a reduction in interest rates, equity and property values and a widening of credit spreads and (ii) an increase in interest rates, equity and property values and a narrowing of credit spreads. Each stress is considered by PAC to represent a 1-in-25 year stress event relative to economic conditions at 30 June 2013.

2.18. Based on actual conditions at 30 June 2013, and after applying the two economic stresses referred to in paragraph 2.17 at the same date, PAC has demonstrated that, after allowing where necessary for further management actions, the risk alignment ratios could be closely aligned at that date. Where further management actions, which go beyond those actions currently reflected in PAC’s models, have been assumed to be taken, we understand that the PAC Board, having sought advice from the PAC Actuarial Function Holder, the PAC With-Profits Actuary and the PAC With-Profits Committee, is satisfied that in principle such further management actions would be consistent with the reasonable expectations of relevant policyholders in the circumstances applying in the applicable scenario.

PAC’s process for monitoring the risk alignment ratios to the Transfer Date

2.19. PAC has developed a model (the monitoring model) to estimate approximately the risk alignment ratios of the UK & European business and the Hong Kong business of the PAC WPSF in the period from 30 June 2013 to 31 December 2013. The model has been calibrated using additional scenario testing performed as at 30 June 2013. The modelled risk drivers include economic parameters for both the UK & Europe and Hong Kong such as portfolio returns, the level of interest rates, and equity and interest rate volatilities; and the new business expected to be written in Hong Kong in the six month period to the end of 2013.

2.20. The greater the difference between economic conditions at the estimation date and 30 June 2013 (the date as at which the scenario tests used to calibrate the model were applied), the lower the accuracy of the estimates produced by the monitoring model is likely to be. We understand from PAC that additional scenario testing will be performed ahead of the Transfer Date to improve the estimates produced by the model if it appears that actual economic conditions shortly prior to the Transfer Date are likely to be sufficiently different from the position applying to the PAC WPSF at 30 June 2013, or other experience is significantly different from that assumed at that date.


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2.21. Using the monitoring model, PAC estimates that the difference between the risk alignment ratios widened further to 2.5% at the end of August 2013 and then reduced to 2.3% at the end of September 2013. There is therefore a reasonable likelihood that the difference between the ratios will exceed 2% (before allowing for further management actions) shortly before the Transfer Date. Based upon the information provided to us, we are satisfied that sufficient management actions would have been available to PAC to demonstrate close risk alignment of the territories in the financial circumstances applying at 30 September 2013.

Confirmation required no more than 2 days prior to the Transfer Date

2.22. PAC plans to provide us with monthly updates in November and December of its estimate of the risk alignment ratios of the UK & European business of the PAC WPSF and the Hong Kong business of the fund determined using its monitoring model. During that period we will review the validation work undertaken by PAC on the monitoring model.

2.23. PAC also plans to provide us with estimated risk alignment ratios for the territories calculated on 30 December 2013 (2 days before the target Transfer Date of 1 January 2014) calculated using the monitoring model.

2.24. If the ratios at that date differ by less than 2% in absolute terms then PAC proposes that this should be considered adequate confirmation of the risk alignability required by clause 1.7 of the Scheme (see paragraph 2.9), and should permit the Scheme to be implemented (subject to the approval of the Boards of PAC and PHKL, and the prior sanction of the HK Court and the UK Court). We consider that such an approach would be reasonable provided that economic conditions at 30 December 2013 do not fall outside the range of outcomes defined by the stress scenarios applied as at 31 December 2012 referred to in paragraph 2.11.16 In such circumstances, based upon the analysis performed on the risk alignment ratios as at 31 December 2012 and 30 June 2013 referred to in paragraphs 2.11 and 2.17, we consider that it would be reasonable to assume that if the difference in ratios is less than 2% then further management actions would be available to narrow this difference to 0.5%. That is, the risks of the PAC WPSF arising from the two territories would be capable of being closely aligned as at the Transfer Date if the assets of the PAC WPSF are apportioned in accordance with the Scheme at that date.

2.25. If the ratios differ by more than 2% in absolute terms, or the ratios differ by less than 2% but economic conditions at 30 December 2013 fall outside the range of outcomes defined by the stress scenarios applied as at 31 December 2012 referred to in paragraph 2.11, then PAC will aim to provide us with details of a range of available further management actions consistent with policyholders’ reasonable expectations that, if taken within 9 months of 30 December 2013, would narrow the difference between the ratios to not more than 0.5% measured at 30 December 2013 if this was considered to be appropriate and in the best interests of policyholders in the circumstances. PAC will also confirm that the PAC Actuarial Function Holder, the PAC With-Profits Actuary and the PAC With-Profits Committee are satisfied that in principle the identified further management actions would be consistent with the reasonable expectations of relevant policyholders in the circumstances applying at 30 December 2013.

_______________________________________________________________________________ 16 We note that interest rates have risen strongly in the UK, US and Hong Kong, so that the financial position of the PAC WPSF at 30 June 2013 is stronger than that considered in the detailed stress testing at 31 December 2012, and the position at the time of finalising this report is outside the range covered by the detailed stress-testing as at 31 December 2012 and the more limited stress testing applied to the 30 June 2013 position of the fund.


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2.26. The PAC Actuarial Function Holder has documented for future reference his views of the reasonable expectations of transferring with-profits policyholders of the PAC WPSF as at 30 June 2013 (the HK PRE statement, which forms part of the HK PRE documentation), which have been agreed by the PAC Board and formally adopted by the PHKL Board. The statement is intended to apply from the Transfer Date and, as a result, reflects the proposed terms of the Scheme. Where the risks of the two territories are not aligned at the Transfer Date it requires:

if the risk level of the Hong Kong with-profits business is lower than that of the UK & European with-profits business then the additional risk capital transferred to the PHKL IFSF (relative to the risk level of the transferring with-profits business at the Transfer Date) will be used to increase the risk profile of the transferring with-profits business to a level broadly equivalent to that of the UK & European with-profits business at the Transfer Date; and

if the risk level of the Hong Kong with-profits business is higher than that of the UK & European with-profits business then the shortfall in capital transferred to the PHKL IFSF (relative to the risk level of the transferring with-profits business at the Transfer Date) will be made good by decreasing the risk profile of the transferring with-profits business.

Proposals for any such action must be developed by the PHKL Board within 9 months of the Transfer Date, but appropriate adjustments may be made for changes in risk profile during that period. Whether or not any such adjustments are made, the HK PRE statement states that the target risk profile of the transferring business at the Transfer Date will constitute an important aspect of the reasonable expectations of the transferring with-profits policies.

2.27. We understand from the PAC Actuarial Function Holder that the PHKL Board has agreed that the requirements described in paragraph 2.26 will apply if the difference in the risk alignment ratios of the two territories exceeds 2% at the Transfer Date.

2.28. There is no explicit requirement for the PAC Board to make corresponding changes to the risk profile of the UK & European with-profits business in the circumstances described in paragraphs 2.26 and 2.27.

2.29. We will provide confirmation in writing to PAC, PHKL, the HK Insurance Authority, the PRA and the FCA not more than 2 days prior to the Transfer Date whether in our view the requirements of the Scheme described in paragraph 2.9 have been met. For this purpose we will consider whether the risks of the PAC WPSF arising from the two territories would be capable of being closely aligned (i.e. to a difference of not more than 0.5%) at the Transfer Date if the assets of the PAC WPSF are apportioned in accordance with the Scheme on the Transfer Date. We do not consider it necessary for actions to be taken to achieve such close alignment, only that it should be demonstrated that there is a range of available management actions consistent with policyholders’ reasonable expectations that could be taken to achieve close alignment if this was to be considered appropriate and in the interests of policyholders in the circumstances.


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3. The effect of the domestication on the potential impact of Solvency 2 3.1. Solvency 2 is a new regulatory solvency reporting regime for EU insurers which aims to introduce

solvency requirements that better reflect the risks that individual insurers and reinsurers face and to introduce consistency across the EU. Its introduction would affect the reserves and the capital that would be required by PAC in respect of its insurance liabilities and could therefore have an impact on the future management of PAC through the application of its risk appetite statement. The scheduled implementation date for Solvency 2 has been postponed several times and is currently 1 January 2016, but it is by no means certain that this date will be met.

3.2. We have discussed with PAC management the possible impact of the proposed Solvency 2 legislation on PAC, and whether the Scheme is likely to affect that impact. As both the timing and final form of Solvency 2 are uncertain, it is difficult to draw firm conclusions. While we have not seen PAC’s assessment of the likely impact of Solvency 2 on transferring and non-transferring policyholders following the Transfer Date, we have been informed by PAC that it does not believe the proposed transfer will have an adverse impact on the impact of Solvency 2 on transferring policyholders or on non-transferring policyholders.

3.3. It appears that Solvency 2 may have the greatest impact on the regulatory reserves and capital that need to be held in respect of non-profit annuity business, of which significant volumes have been written in the PAC WPSF (and PAL, its wholly owned subsidiary) and in Prudential Retirement Income Limited (PRIL) (a wholly owned subsidiary of the PAC SHF). This is a concern for all UK annuity writers, and not specific to PAC. The primary issue is the constraints that may be placed on the rate at which projected future annuity and expense cashflows are discounted, which could significantly increase reserving and capital requirements. The discount rate is determined from the yields on assets held to back the relevant liabilities, and PAC and other insurers have been investigating the potential benefits of changes to the type of assets used to back non-profit annuity business.

3.4. The effect on non-profit annuity business could range from relatively benign, if those constraints are limited and firms are permitted a long period over which to transition reserves and capital requirements held for in-force business to the new requirements, to more adverse, if constraints are more onerous and the transition period is limited. In this regard, a positive recent development has been discussion of a transition period of 16 years (i.e. to 2032 if Solvency 2 is implemented in 2016).

3.5. The apportionment methodology to be applied to determine the amount of assets to be transferred from the PAC WPSF to the PHKL IFSF on the Transfer Date requires the reassurance to the PHKL IFSF of a pro rata share of the UK non-profit annuity business of the PAC WPSF (including that reassured from PAL).17 The PHKL IFSF will immediately deposit the reinsurance premium received back to the PAC WPSF so that no physical transfer will occur, and future profits and losses accruing to PAC and PHKL under the reassurance will be determined in line with actual experience and changes to reserves held for the reassured business on the existing UK Solvency 1 basis even after the introduction of Solvency 2.18 If reserves required for non-profit annuity business were to increase under Solvency 2, PAC’s uncollateralised exposure to PHKL through the UK/HK Annuity Reassurance Treaty would increase and might therefore result in a reduction in the credit that may be taken for that reassurance in the Solvency 2 balance sheet of the PAC WPSF. In principle, PHKL would be required to post additional collateral in the R-custody account equal to a significant proportion of the increase in that exposure.19 In practice there would be no such requirement if the total collateral requirement for

_______________________________________________________________________________ 17 The UK/HK Annuity Reassurance Treaty is described in paragraphs 6.76 to 6.84 of the JIA Report. 18 In practice the Solvency 2 reserves will be used but scaled up or down by the proportion those reserves bear to the UK Solvency 1 reserves when Solvency 2 is introduced. 19 This assumes Solvency 2 does not alter the profile of the run-off of capital required to be held to back the reassured business. If the capital run-off profile under Solvency 2 is different from that under Solvency 1 then this may change the proportion of the increase in exposure that would in principle need to be posted as additional collateral.


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PHKL (after allowing for the increase) determined in accordance with the reassurance treaty is lower than the minimum threshold that will apply to the R-custody account.20

3.6. The burden of any adverse impact of Solvency 2 on the capital requirements of PRIL would fall on the PAC SHF whether or not the domestication is implemented. A potential source of additional capital to the PAC SHF is future profits arising from the significant volume of Hong Kong non-profit business written in the PAC NPSF. Those profits, along with shareholder transfers arising in respect of the future bonuses on transferring with-profits policies, will arise in PHKL rather than PAC after the domestication. Those profits may subsequently be paid to the PAC SHF as dividends from PHKL (subject to PHKL maintaining adequate solvency and the approval of the PHKL Board), but there is likely to be some deferral of cashflows compared to the status quo.

3.7. The capital requirements of PHKL considered on a stand-alone basis are not expected to be changed by Solvency 2; they will continue to be determined in accordance with Hong Kong regulatory requirements.

3.8. The effect of the domestication on the impact of Solvency 2 on the shareholder-owned business of PAC21 will therefore depend upon the manner in which PHKL may be consolidated into the Solvency 2 balance sheet of PAC.

3.9. PAC’s current expectation is that PHKL would be valued on a Solvency 2 basis for consolidation purposes, which would permit the recognition of future profits expected to arise in PHKL. PAC envisages applying an impairment test to give comfort that the emergence of dividends from PHKL would be sufficient to allow other liabilities from the shareholder-owned business of PAC to be met as they fall due if necessary. That is, before taking credit for future profits expected to arise in PHKL, the timing of the release of those profits in accordance with Hong Kong regulatory requirements would be considered. Such an approach appears reasonable to us in principle, although there is no certainty that such an approach will be permitted under the rules of Solvency 2 ultimately adopted.

3.10. The effect of the domestication on the potential impact of Solvency 2 on the shareholder-owned business of PAC will also depend upon future changes to reserving and capital requirements applicable to Hong Kong insurers, which could affect the timing of dividends paid by PHKL. The current expectation is that the regulatory framework for establishing reserves and capital requirements is likely to change, but the form that those changes will take has not yet been decided. However, any such changes would also be expected to have a broadly similar impact on the future emergence of surplus from the Hong Kong business of the PAC NPSF, and shareholder transfers arising in respect of Hong Kong with-profits business, if the domestication were not effected.

3.11. It is not possible to be definitive about the potential effect of the domestication on the impact of Solvency 2 on PAC as the final rules are still subject to discussion and agreement, including the implementation date and any transitional arrangements. There is inevitably a possibility that the domestication could materially exacerbate an adverse impact of Solvency 2 on PAC, but we do not consider the likelihood of such an outcome to be high.

_______________________________________________________________________________ 20 See paragraph 6.82 of the JIA Report. 21 The business of the PAC NPSF and the business of the PAC SHF, including the interest of PAC in its subsidiary and associate companies (other than PAL, which is wholly owned by the PAC WPSF).


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4. Review of pro forma apportionment calculations and post domestication balance sheets as at 31 December 2012

4.1. The report on the Scheme prepared by the PAC Actuarial Function Holder (the AFH Report22) sets out:

summary balance sheets as at 31 December 2012 (in Section 4);

the pro forma allocation of assets of the PAC WPSF to PHKL (in Section 6);

the pro forma post-Scheme balance sheets for the PAC WPSF and the PHKL WPF (in Section 7); and

the pro forma post-Scheme balance sheets for the PAC NPSF and shareholder fund (PAC SHF) and for the PHKL NPF and shareholder fund (PHKL SHF) (in Section 12);

assuming the Scheme had been effected as at 31 December 2012. Milliman was engaged by PAC to review the derivation by PAC of the apportionment figures and the balance sheets set out in tables in Sections 4, 6, 7 and 12 of the AFH Report from published figures at 31 December 2012 and other source documents provided by PAC.

4.2. Milliman has provided a report to the PAC Board on its findings. In summary, the report notes the following difference in excess of £50 million23:

an £83 million understatement in Figure 6.19 of the AFH Report in the determination of the additional assets of the PAC WPSF (in excess of those held locally) that would have been transferred to the PHKL WPF. A corrected version of Figure 6.19 is included in paragraph 5.2.5 (as Figure 5.2) in the supplementary report prepared by the PAC Actuarial Function Holder (the AFH Supplementary Report24).

The determination of the additional assets of the PAC WPSF that would have been transferred to the PHKL WPF was inconsistent with the requirements of the Scheme and we understand from PAC that it will be corrected for the purposes of the calculations as at the Transfer Date.

4.3. Excluding the difference referred to in paragraph 4.2, on the basis of the information provided to Milliman, the report concludes that the pro forma apportionment methodology presented in the tables in Section 6 of the AFH Report and the balance sheets presented in Sections 4, 7 and 12 of the AFH Report are materially correct.

_______________________________________________________________________________ 22 Entitled “Report of the Actuarial Function Holder of The Prudential Assurance Company Limited (PAC) on the proposed transfer of the long-term insurance business of PAC Hong Kong Branch to Prudential Hong Kong Limited (PHKL)” and dated August 2013. 23 Broadly 1% of the amount of the published PAC Inherited Estate at 31 December 2012. It is also the materiality threshold used in the report entitled “Report of the With-Profits Actuary of The Prudential Assurance Company Limited (PAC) on the proposed transfer of the long-term insurance business of the PAC Hong Kong Branch to Prudential Hong Kong Limited” by the PAC With-Profits Actuary dated August 2013. 24 Entitled “Supplementary Report of the Actuarial Function Holder of The Prudential Assurance Company Limited (PAC) on the proposed transfer of the long-term insurance business of the PAC Hong Kong Branch to Prudential Hong Kong Limited (PHKL)” and dated November 2013.


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5. Other relevant events occurring after the finalisation of the JIA Report 5.1. As part of the apportionment of the assets of the PAC WPSF between UK & Europe and Hong Kong,

an allocation of assets is to be made to each territory for with-profits policies with minimum guaranteed benefits that are deemed to have crystallised because PAC considers it unlikely that the relevant asset shares at the time of benefit payment will exceed the corresponding guaranteed benefit.25 The method used to determine crystallised guarantees is the same as that used in PAC’s assessment of risk alignment in its business-as-usual process.26 We understand from PAC that the methodology was subject to annual review by the PAC Board as at 30 June 2013 and the Board confirmed that the methodology remained appropriate for business-as-usual purposes at that date. We also understand from PAC that the Board has no plans to review that methodology ahead of the Transfer Date (assuming this is 1 January 2014), and so the methodology will be adopted for the purposes of the apportionment methodology applied at that date.

5.2. PAC has updated the analysis regarding the likelihood of an excess surplus arising. The original analysis concluded that it was unlikely that there would be a genuine excess surplus27 emerging at 1 January 2014 and that the expected value of the distribution to Hong Kong policyholders, should the Scheme not go ahead, of any such genuine surplus in the ten years following the Transfer Date was small.

5.3. The analysis has been updated using the year-end 2012 Financial Condition Report modelling and adjusted further to reflect the position as at 30 June 2013. The updated analysis shows that the improved financial conditions as at 30 June 2013 act to increase the likelihood of a genuine excess surplus emerging at some point within ten years following the Transfer Date. However, there is no change to the main conclusions of the earlier analysis that the emergence of a genuine excess surplus as at the Transfer Date remains very unlikely and that the value of any potential distribution to Hong Kong policyholders that might emerge in the ten years following the Transfer Date should the Scheme not go ahead would be expected to remain small. Based on the analysis presented, we agree with the conclusions of PAC and have reflected this in our unchanged conclusions in this regard set out in paragraph 1.19.

5.4. PAC and PHKL have agreed to make a small number of amendments to the draft version of the Scheme available to us at the time of preparing the JIA Report. Those changes are included in a draft of the Scheme dated 1 November 2013, and are primarily to address minor typographical errors and to reflect developments since the directions hearings before the UK Court and the Hong Kong Court. The main changes to the Scheme are:

to require the consent of PAC to any proposed changes to the PHKL Pension Mis-selling Costs Assurance28;

the requirement to increase the amount of the PAC Inherited Estate to be apportioned between PAC and PHKL by the accumulated set-up costs of Prudential Financial Planning (PFP) met by the PAC Inherited Estate to the Transfer Date less the accumulated value of recoveries to that date from policy charges in respect of the relevant business sold by PFP to that date (see paragraphs 5.11 and 5.12);

to facilitate the allocation to the PHKL IFSF of an appropriate share of any tax refund received in respect of specific litigation being undertaken by PAC and Prudential Holborn Life Limited (see paragraphs 5.13 to 5.16); and

_______________________________________________________________________________ 25 See paragraphs 7.37 to 7.41 of the JIA Report. 26 See paragraphs 8.5 to 8.7 of the JIA Report. 27 For the purposes of the analysis a genuine surplus was defined as one in which a formulaic measure of surplus, expressed in terms of the PAC WPSF’s Pillar II capital requirement, was met for three consecutive year-ends, and allowed for a buffer such that sufficient capital would be retained such that the distribution of surplus capital did not materially increase the risk of Pillar II insolvency over a specified period. 28 See paragraphs 6.12 to 6.14 of the JIA Report.


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to bring the Scheme into line with the current practice of PAC concerning the form of support provided by the shareholder to the PAC WPSF in the event of new with-profits business would not otherwise be financially self-supporting.

The changes made to the Scheme do not affect our conclusions on the likely impact of the Scheme and we confirm that we have received reasonable notice in writing of those changes.

5.5. Some minor changes have been made to the draft UK/HK Annuity Reassurance Treaty29 available to us at the time of preparing the JIA Report. These changes do not affect our conclusions on the likely impact of the Scheme. We understand from PAC that the treaty has been agreed in principle by the PAC Board and the PHKL Board subject to the finalisation of certain operational matters, which currently appear in square brackets in the draft treaty. We also understand from PAC that the final terms of the treaty are expected to be approved by the end of November 2013, subject to subsequent insertion of the reassurance percentage (which will equal the Apportionment Ratio determined as at the Transfer Date, and so will not be known until after that date).

Management Actions

5.6. The pro forma post-Scheme balance sheets for PAC and PHKL shown in the AFH Report and the JIA Report assume two management actions would be taken in 2013 that in practice have not been taken, or only actioned in part. These are:

to source the initial capital injection of £16 million into PHKL from Prudential plc. The capital has been sourced from the PAC SHF; and

to increase the surplus of assets over liabilities of the Hong Kong business of the PAC NPSF (measured on the Hong Kong regulatory basis) by £50 million so that that business would be adequately capitalised on the Transfer Date. We understand from PAC that a significant proportion of this amount was raised in the first half of 2013 but, because of the improved local regulatory solvency position of the Hong Kong shareholder-owned business in 2013, driven mainly by increases in interest rates, PAC does not plan to raise further amounts in 2013.

These changes do not affect our conclusions on the Scheme. In Sections 7 and 8 of this report we show comparisons of pro forma post-Scheme solvency ratios for PAC and PHKL calculated assuming the Scheme was effected at 31 December 2012 (which supported our conclusions stated in the JIA Report) or 30 June 2013 (which support the conclusions stated in this report). The solvency ratios shown as at 31 December 2012 are taken from the JIA Report without adjustment to allow for the fact that the above management actions are not to be taken in 2013 or, in the case of the second one, completed in 2013. If such adjustments had been made they would have marginally reduce those solvency ratios.

5.7. We understand from PAC that, during the course of 2013, the PAC Board has approved a range of management actions to increase the risk profile of the Hong Kong business to achieve broad risk alignment with the UK & European business. In addition, certain changes were also made to the management of UK & European business. Some of these management actions were completed by 30 June 2013, while others are expected to be implemented in 2013.

5.8. The business-as-usual management action completed by 30 June 2013 was a change to the mix of assets backing future tax on shareholder transfers.

_______________________________________________________________________________ 29 See paragraphs 6.76 to 6.84 of the JIA Report.


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5.9. The additional business-as-usual management actions not completed as at 30 June 2013 are:

the re-risking of Hong Kong asset shares;

a change to the mix of assets backing certain with-profits deferred annuity business in the UK & Europe;

a reduction in credit risk in the PAC Capital Fund, which holds the bulk of the directly invested assets of the PAC Inherited Estate;

de-risking of the proportion of the PAC Inherited Estate expected to be allocated to Hong Kong; and

a number of actions to improve the Pillar II solvency position of PAC’s shareholder-owned business.

We also understand that PAC may undertake further additional management actions during the course of 2013 as part of its business-as-usual management.

5.10. For the purposes of assessing the impact of the domestication, the additional management actions listed in paragraph 5.9 have been assumed to have been implemented. The effect of those management actions (as calculated by PAC) are reflected in the pro forma application of the apportionment methodology at 30 June 2013 shown in Section 6 and in the pre-Scheme and post-Scheme balance sheets at that date shown in Sections 7 and 8 of this report.

Financing of Prudential Financial Planning

5.11. The PAC Inherited Estate is to meet a proportion of the set-up costs incurred in the period 2011 to 2014 in respect of Prudential Financial Planning (PFP), which was launched in 2012 and employs a sales force to sell new long-term insurance business directly to customers in the UK. The agreement applies to set-up costs incurred in the first 3 years of operation, and the fixed proportion of such costs to be met by the PAC Inherited Estate in the second and third years is lower than that applying in the preceding year. The relevant proportion of the costs incurred is to be amortised over 5 years (starting from the calendar year in which the costs are incurred) and the amortised amount charged to the PAC Inherited Estate. The PAC Inherited Estate is expected to recoup this funding by 31 December 2018 (the end of the last of the amortisation periods) from the charges levied on new with-profits business sold through PFP.

5.12. The amount of the PAC Inherited Estate at the Transfer Date to be apportioned between the PAC WPSF and the PHKL IFSF will be increased by the accumulated PFP set-up costs met by the PAC Inherited Estate to that date less the accumulated value of recoveries to that date from policy charges in respect of the relevant business sold through PFP to the Transfer Date.30

Tax litigation

5.13. PAC and Prudential Holborn Life Limited are acting as test claimants in litigation relating to the UK taxation of overseas investment income received from the 1990s through to 2007. On 24 October 2013 a judgement materially in favour of the claimants was received from the UK Court. The effect of the judgement is that the relevant tax would be refunded with interest by Her Majesty’s Revenue and Customs (HMRC)31. At the date of this report, it is not known if HMRC will appeal the judgement. In any event, a refund from HMRC is unlikely to be received before the Transfer Date.

_______________________________________________________________________________ 30 That is, PFP set-up costs charged to the PAC Inherited state to the Transfer Date will be treated in the same manner as other inadmissible assets – see paragraph 7.48 of the JIA Report. 31 PAC would also amend to its tax returns for the PAC WPSF and the SAIF for 2008 and for the six month period to 30 June 2009.


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5.14. We understand from PAC that any refund received by PAC is expected to be due to the SAIF and the PAC WPSF after allowing for the effect of the amended tax returns. The intention is for the rebate to be credited to the asset shares of relevant with-profits policies of the applicable fund where such policies are still in-force, and otherwise to the inherited estate of the applicable fund.

5.15. We also understand from PAC that it will agree with PHKL that, should the claim not be overturned or otherwise eliminated on any subsequent appeal, PAC will pay to PHKL (for credit to the inherited estate within the PHKL IFSF) a share of the rebate credited to the PAC Inherited Estate. The share received by PHKL will be the Apportionment Ratio determined at the Transfer Date32 multiplied by the amount of the rebate credited to the PAC Inherited Estate. Moreover, any rebated amounts attributable to the asset shares of transferring policies will also be paid by PAC to PHKL and PHKL will credit those amounts to the asset shares of the relevant policies. However, as the tax to which the rebate arises is in respect of UK business, PAC does not expect any of the rebate to be attributable to transferring policies.

5.16. The apportionment methodology to be applied as at the Transfer Date will be based inter alia upon the asset shares of with-profits policies of PAC at that date without allowance for the potential increase to those asset shares that would arise if the tax rebate is subsequently received. There will be no retrospective adjustment to that methodology to reflect the receipt of any such tax rebate, other than as described in paragraph 5.15. In our opinion such an approach is reasonable.



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6. Apportionment methodology at 30 June 2013 6.1. For the purposes of illustration, PAC has applied the apportionment methodology to the assets of the

PAC WPSF and the DCPSF assuming that the Scheme had been effected as at 30 June 2013. The result is summarised in Table 6.1. At the top of the table the pro forma allocation of the assets backing the non-profit realistic liabilities of the PAC WPSF between PAC and PHKL at that date is also shown.

Table 6.1: Illustration of applying the apportionment methodology as at 30 June 2013

Adjusted RBS1

at 30/6/13

Allocation of assets to:

UK &

Europe Hong Kong

Amount Apportioned

£m £m £m £m Non-profit realistic liabilities of the PAC WPSF 11,986 1,507 Allocation of assets backing With-Profits Benefit Reserves (WPBR) (WPSF+DCPSF) (A) 68,894 62,248 6,646 Adjusted net cost of guarantees (WPSF only) (B) 1,967 1,229 168 570

Adjusted other liabilities (WPSF+DCPSF) (C) 4,223 3,481 742 Adjusted Inherited Estate (D) 7,946 364 7,582 Apportionment of 10.97% to Hong Kong (E) 7,258 894 Additional transfer of the NBSF Assets (F) (270) 270 Total assets (G=A+B+C+D+E+F) 83,030 74,310 8,721 Realistic with-profits liabilities - WPBR (H=A) (68,894) (62,248) (6,646)

- Net cost of guarantees (I) (1,967) (1,880) (87)

- Other liabilities (J) (4,223) (3,481) (742) Inherited Estate after apportionment (K=G-H-I-J) 7,946 6,701 1,245 As a proportion of liabilities (=K/(H+I+J) 10.6% 9.9% 16.7%

Note: 1. Realistic balance sheet (RBS) (shown in Form 19 of PRA Returns).

6.2. Table 6.1 shows a pro forma allocation of £8.7 billion of assets in respect of with-profits business from the PAC WPSF to the PHKL WPF assuming a Transfer Date of 30 June 2013. This compares to £8.9 billion of assets if the Transfer Date had been 31 December 201233. The main factors contributing to the change are:

an aggregate increase of £28 million in the WPBR of Hong Kong business in the first half of 2013;

an increase of £19 million in the accumulated guarantee charges deducted from the asset shares of Hong Kong with-profits policies;

a reduction of £295 million in the other liabilities of Hong Kong business in the first half of 2013; and

an increase of £48 million in the amount of the PAC Inherited Estate allocated to PHKL. This increase has two components:

_______________________________________________________________________________ 33 See Table 7.1 of the JIA Report.


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• a reduction of £20 million in the allocation of assets backing the non-territory specific Net Cost of Guarantees allocated to PHKL34. The amount of the non-territory specific Net Cost of Guarantees reduced because of favourable investment returns credited to UK & European asset shares, but PHKL’s share of those assets increased marginally because the Apportionment Ratio increased from 10.87% to 10.97%;

• an increase of £69 million in the allocation of assets representing the PAC Inherited Estate. This arises from:

o an increase in the PAC Inherited Estate from favourable investment returns;

o a reduction in the amount of the SAIF adjustment specifically allocated to UK & European business35 arising from the run-off of the business of the SAIF in the first six months of 2013; this results in a corresponding increase in the amount of the PAC Inherited Estate to be apportioned between PAC and PHKL; and

o a marginal increase in PHKL’s share of the PAC Inherited Estate because of the increase in the Apportionment Ratio.

6.3. The final column of Table 6.1 shows some £8,152 million of assets to be apportioned pro rata between the PAC WPSF and the PHKL IFSF (£570 million of assets held in respect of the Net Cost of Guarantees plus £7,582 million of PAC Inherited Estate assets). Allocating 10.97% (£894 million) of this to PHKL (the derivation of the Apportionment Ratio is described in paragraphs 7.59 to 7.61 of the JIA Report) would have resulted in a requirement to transfer total assets backing with-profits business with value equal to some £8,721 million from the PAC WPSF to PHKL as at 30 June 2013, of which £270 million (the NBSF Assets) would be allocated to the PHKL NBSF and the balance to the PHKL IFSF.

6.4. The figure of £7,582 million shown in the final column of Table 6.1 for the Adjusted Inherited Estate apportioned between the PAC WPSF and the PHKL WPF includes an amount of £541 million representing the present value of estimated future margins expected to emerge from the UK regulatory reserves held for certain UK annuity business of the PAC WPSF at 30 June 2013. (No allowance is made in this figure for future releases in the regulatory capital requirements held for that business at that date). As explained in paragraphs 6.76 to 6.84 of the JIA Report, the Apportionment Ratio of the actual profits and losses arising from those regulatory reserves will accrue to PHKL through the operation of the UK/HK Annuity Reassurance Treaty. Accordingly, the assets transferred to PHKL will be reduced in value by the present value of those estimated future margins determined as at the Transfer Date multiplied by the Apportionment Ratio.

_______________________________________________________________________________ 34 See paragraphs 7.17 to 7.43 of the JIA Report. 35 See paragraphs 7.55 to 7.58 of the JIA Report.


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6.5. There will be a further reduction in the value of the assets that would otherwise be transferred to PHKL equal to the Apportionment Ratio of the present value of future profits and losses expected to arise from the Relevant Annuity Business of the PAC WPSF (see paragraph 6.79 of the JIA Report).

6.6. The final rows of Table 6.1 show that applying the apportionment methodology as at 30 June 2013 would have resulted in an Inherited Estate in PHKL of £1,245 million, representing 16.7% of realistic with-profits liabilities of the PHKL at that date. The PAC Inherited Estate would have reduced by £1,245 million to £6,701 million, 9.9% of remaining with-profits liabilities of the PAC WPSF and the with-profits liabilities of the PAC DCPSF.36

6.7. The pro forma PHKL Inherited Estate at 31 December 2012 of £1,245 million shown in the final row of Table 6.1 exceeds by £144 million the corresponding figure of £1,101 million shown in Figure 5.1 of the AFH supplementary report. This is a presentational difference and does not impact the apportionment. The figure in the AFH supplementary report is lower because it excludes the excess of:

the amount of the accumulated guarantee charges levied on Hong Kong with-profits business at 30 June 2013 (£168 million from Figure 5.1 of the AFH Supplementary Report); plus

the pro rata allocation to PHKL of assets backing the Net Cost of Guarantees of the PAC WPSF and the DCPSF which are not allocated specifically to UK & European business or Hong Kong business (£63 million from Figure 5.1 of the AFH Supplementary Report);

over

the actual Net Cost of Guarantees determined for Hong Kong with-profits business at 30 June 2013 (£87 million – see Table 6.1).

6.8. The top row of figures in Table 6.1 also shows a pro forma allocation of £1.5 billion of assets backing the realistic non-profit liabilities in PAC WPSF to the PHKL WPF assuming a Transfer Date of 30 June 2013. This compares to £1.6 billion of assets if the Transfer Date had been 31 December 201237. The main factors contributing to the change are:

a reduction of £55 million in the realistic liabilities for non-profit annuity business that would be reinsured under the UK/HK Annuity Reinsurance Treaty as a result of normal operation of the business; and

a reduction of £18 million in the realistic liabilities for Hong Kong non-profit business.

6.9. In practice the amount of assets allocated to PHKL will depend upon the circumstances at the actual Transfer Date, and so could be larger or smaller than the figures shown in Table 6.1.

_______________________________________________________________________________ 36 In practice it is likely that a PAC Inherited Estate of less than £6.7 billion would have been shown in Form 19 of PAC’s returns at 30 June 2013 if the domestication had been effected at that date because the figures in Table 6.1 include allowance for certain inadmissible assets not recognised for Form 19 purposes. The inadmissible assets at 30 June 2013 are described in paragraph 7.48 of the JIA Report, and in paragraphs 5.11 and 5.12 of this report. 37 See Table 7.1 of the JIA Report.


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7. The likely effect of the Scheme on non-transferring policyholders


7.1. Table 7.1 sets out how the Capital Resources and the Capital Resources Requirement of PAC at 30 June 2013 would have changed had the Scheme taken effect from that date. The figures allow for the management actions listed in paragraphs 5.8 and 5.9.

Table 7.1: Pro forma solvency position of PAC as at 30 June 2013 PAC PAC

Pre Scheme1

Post Scheme1

£m £mAdmissible assets 122,531 110,276 Shareholder net assets 2,953 3,131 Total Assets (A) 125,484 113,407 Total long term business liabilities (B) 101,664 91,365 Capital Resources (CR) (C=A-B) 23,820 22,042 Capital Requirements of PAC (D) 3,760 3,303 Capital Requirements of regulated related undertakings (E) 1,100 1,172 With-Profits Insurance Capital Component (WPICC) (F) 8,875 8,628 Capital Resources Requirement (CRR) (G=D+E+F) 13,735 13,103 Excess assets (=C-G) 10,085 8,939 Ratio of CR (net of WPICC) to CRR (net of WPICC) (=[C-F])/[D+E]) 308% 300% Note: 1. These figures allow for certain management actions that had been implemented by 30 June 2013, and some that are planned to be implemented in 2013 (see paragraphs 5.8 and 5.9).

7.2. Table 7.1 shows that PAC’s Capital Resources would have continued to exceed its Capital Resources Requirement by a significant margin had the domestication taken place at 30 June 2013.

7.3. The excess assets would have reduced by £1,146 million. The components of this reduction are:

a reduction of £1,168 million in the surplus assets of the PAC WPSF (see paragraph 7.12);

a reduction of £93 million in the surplus assets of the PAC NPSF, arising from the excess of £89 million in the value of the assets held by PACHK in respect of the Hong Kong liabilities of the PAC NPSF (which will transfer to PHKL) over the corresponding UK regulatory capital requirements (reserves plus LTICR38) for that business and from an increase of £4 million in the UK & European liabilities of the fund; and

an increase of £115 million in shareholder funds from inclusion of the regulatory value of PHKL39,40, which comprises of capital transferred from the PAC NPSF in excess of the capital requirements of the transferring business calculated using the Hong Kong regulatory basis.

_______________________________________________________________________________ 38 Long Term Insurance Capital Requirement, reported in line 31 of Form 2 of the regulatory returns of UK long term insurers. 39 The regulatory value of PHKL is calculated as shareholder net assets plus surplus capital in the PHKL NPF. No allowance is made for the excess of assets transferred to the PHKL WPF over the capital requirements of the liabilities allocated to the fund. 40 Table 7.1 shows an increase in shareholder funds of £178 million (=[3,131-2,953]). This arises from the inclusion of the regulatory value of PHKL, before deducting the capital requirements, of £195 million arising in respect of the transferring business of the PAC NPSF less the capital injection of £16 million to PHKL sourced from existing PAC shareholder funds. The PHKL capital requirement determined on the Hong Kong basis of £63 million is included in post-Scheme figure in row E of Table 7.1. £178 million minus £63 million = £115 million.


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7.4. In assessing the relative security of contractual benefits, it is helpful to compare ratios of available resources after deducting the WPICC41 (since it forms part of policyholders’ reasonable benefit expectations). Table 7.2 compares the pre-Scheme and post-Scheme ratios for PAC calculated at 31 December 2012 and 30 June 2013.

Table 7.2: Ratio of available resources, after deducting the WPICC, to the Minimum Capital Resources Requirement

30-Jun-13 31-Dec-12 Pre-Scheme PAC 308% 273% Post-Scheme PAC 300% 271%

7.5. The figures in Table 7.2 indicate that, had the Scheme been implemented on 30 June 2013, PAC’s cover for its Minimum Capital Requirement would have reduced by marginally more than had the Scheme been implemented at 31 December 2012. Nonetheless, non-transferring policyholders of PAC would have enjoyed a broadly similar level of security immediately following the implementation. Based on the figures in Table 7.2, the absolute level of security for non-transferring policyholders of PAC increased during the first half of 2013.

The business of the PAC NPSF and the PAC SHF

7.6. Table 7.3 sets out the change in the regulatory (Pillar I, Peak 1) solvency positions of the PAC NPSF and the PAC SHF that would have resulted if the Scheme had been effected at 30 June 2013.

Table 7.3: Pro forma solvency position of PAC NPSF and Shareholder fund as at 30 June 2013 Pre Scheme1 Post Scheme1 NPSF SHF Total NPSF SHF Total

Admissible assets (A) 18,145 4,2732 22,418 16,038 4,4512 20,489 Regulatory liabilities (B) 17,769 1,3202 19,089 15,828 1,3202 17,148 Free assets (C=A-B) 376 2,953 3,329 210 3,131 3,341 Capital Requirements (D) 442 910 1,352 369 973 1,342 Surplus (E=C-D) (66) 2,043 1,977 (159) 2,158 1,999 Ratio of surplus to the sum of liabilities and capital requirement (=E/(B+D))

(0.4)% 9.7% (1.0)% 10.8%

Notes: 1. These figures allow for management actions during 2013 which increase the total surplus of the PAC NPSF by £130 million. 2. These figures are estimates as PAC applies a roll-forward methodology to produce mid-year free assets figures and does not perform a detailed calculation of these individual values.

7.7. Table 7.3 illustrates that the PAC NPSF would continue to rely upon the PAC SHF to cover some of its regulatory capital requirements. The transfer of its Hong Kong business reduces the regulatory surplus of the PAC NPSF by £93 million and (through the inclusion of the regulatory value of PHKL) increases the shareholder fund by £115 million (see paragraph 7.3). As shown in the final row of Table 7.3, based upon the position at 30 June 2013, immediately following the Transfer Date, there would have been an increase in the ratio of surplus to the sum of regulatory liabilities and capital requirements in respect of risks arising in the PAC NPSF and the PAC SHF.

7.8. The pre- and post-Scheme ratios of surplus to the sum of liabilities and capital requirements shown in Table 7.3 are similar to the corresponding figures at 31 December 2012 shown in Table 9.2 of the JIA



November 8, 2013

Report (which showed pre- and post-Scheme ratios of 8.9% and 10.2% respectively for the total of the PAC NPSF and the PAC SHF). These ratios show that there would have been an increase in the absolute level of security for non-transferring policyholders in respect of the risks arising from the shareholder-owned business of the PAC NPSF if the Scheme had been implemented at 31 December 2012 or 30 June 2013.

7.9. The assets of the PAC NPSF were sufficient to cover its economic (Pillar II) capital requirements at 30 June 2013, but this would not have been the case if the domestication had been effected at that date. Those capital requirements would then have been covered in part by assets of the PAC SHF, which would then include PHKL. This is because a significant proportion of the value of the in-force business of the PAC NPSF would have been transferred to PHKL, along with the entitlement to future shareholder transfers on the transferring with-profits business. This is no different from the position if the Scheme had been effected at 31 December 2012.

The business of the PAC WPSF and the DCPSF

7.10. Table 7.4 sets out the change in the Pillar I position for the PAC WPSF and the DCPSF as at 30 June 2013 which would have resulted if the Scheme had been effected at that date.

Table 7.4: Pro forma Pillar I solvency position of the PAC WPSF and DCPSF at 30 June 2013

Pre Scheme1

Post Scheme1

£m £m Admissible assets (A) 96,497 86,349 Regulatory liabilities (B) 77,156 68,798 Capital Resources (C=A-B) 19,341 17,551 LTICR (D) 3,271 2,896 With-Profits Insurance Capital Component (WPICC) (E) 7,963 7,716 Capital Resources Requirement (CRR) (F=D+E) 11,234 10,612 Regulatory excess assets (=C-F) 8,107 6,939 Ratio of Capital Resources (net of WPICC) to Capital Resources Requirement (net of WPICC) (=[C-E])/D) 348% 340% Note: 1. These figures allow for certain management actions that had been implemented by 30 June 2013 and some which are planned to be implemented in 2013 (see paragraphs 5.8 and 5.9).

7.11. If the domestication had been effected at 30 June 2013 then the regulatory surplus of the PAC WPSF and the DCPSF would have decreased as a result of the domestication. The assets of the PAC WPSF, together with those of the DCPSF, would have continued comfortably to exceed the corresponding regulatory capital requirement. This would also have been the case measured on the economic basis.

7.12. The main factors reducing the regulatory capital resources of the PAC WPSF and the DCPSF are:

the domestication would have resulted in a transfer to PHKL of assets with a value of approximately £10.1 billion at 30 June 201342 along with the liabilities of the business of PACHK and (through the UK/HK Annuity Reassurance Treaty) liabilities of PAC in respect of certain UK annuity business of the PAC WPSF;

_______________________________________________________________________________ 42 £1,507 million in respect of non-profit realistic liabilities (see Table 6.1) plus £8,721 million in respect of with-profits business (see Table 6.1) less £81 million of inadmissible assets.


November 8, 2013

measured on a Pillar I, Peak 1 basis (see paragraph 3.8 of the JIA Report), the domestication results in a reduction in capital resources of £1.8 billion and a reduction in capital resource requirements of £0.4 billion: a net reduction of £1.4 billion; and

measured on a Pillar I, Peak 2 basis (see paragraph 3.9 of the JIA Report) the net impact is a reduction of £1,168 million.

7.13. Since the Pillar I, Peak 2 basis continues to be the more onerous, regulatory surplus capital would have reduced by £1,168 million (as shown in Table 7.4).

7.14. The final row of Table 7.4 shows that the ratio of regulatory capital resources to regulatory capital requirements (in each case net of the WPICC) for the PAC WPSF at 30 June 2013 would have reduced slightly. Had the Scheme been effected at 31 December 2012, the equivalent ratios would have been essentially unchanged, reducing from 302% to 301% (see Table 9.3 of the JIA Report). However, due to the improved economic conditions at 30 June 2013, the solvency position of the PAC WPSF has increased since 31 December 2012.

7.15. There will be a reduction in the maximum amount of the Pension Mis-selling Costs Assurance applying to the PAC WPSF and DCPSF from the Transfer Date. PAC has calculated that the reduction would have been 6% if the Transfer Date had been 30 June 2013, the same percentage as at 31 December 2012.

7.16. We have commented upon the potential impact of the Scheme on the introduction of Solvency 2 in paragraphs 3.1 to 3.11.

The business of the SAIF

7.17. Implementation of the Scheme will not change the regulatory or economic solvency position of the SAIF at the Transfer Date.

The business of PAL

7.18. PAL will continue to rely on PAC to meet its liabilities in respect of the annuity benefits reassured to PAC. From the Transfer Date PAC will in turn rely upon PHKL to meet a share (the Apportionment Ratio43) of those liabilities under the UK/HK Annuity Reassurance Treaty.

Conclusion

7.19. As confirmed in paragraph 1.15, we are satisfied that our conclusions regarding the likely effects of the Scheme on the security of non-transferring policyholders of PAC, and policyholders of PAL, remain valid in the light of changes to the financial position of PAC and PAL to 30 June 2013. We have not been made aware of any matters arising to the date of this report, other than those disclosed in this report, that would affect our conclusions.

Benefit expectations

7.20. There have been no changes to the Scheme that affect non-transferring policyholders of PAC, or policyholders of PAL.

7.21. We have commented upon risk alignment in paragraphs 2.1 to 2.29.

7.22. As confirmed in paragraph 1.17, we remain satisfied that the Scheme is unlikely to have a material adverse effect on the reasonable benefit expectations of non-transferring policyholders.



November 8, 2013

8. The likely effect of the Scheme on transferring policyholders


8.1. Table 8.1 compares the solvency position of PAC and PHKL (in sterling) measured on the UK (Pillar I) regulatory basis at 30 June 2013 if the Scheme had taken effect from that date. The figures shown assume the management actions listed in paragraphs 5.8 and 5.9 had been implemented at 30 June 2013. Table 8.1 also shows the solvency position of PHKL (in Hong Kong dollars) measured on the Hong Kong regulatory basis which would have actually applied to PHKL.

Table 8.1: Pro forma regulatory solvency position of PAC and PHKL as at 30 June 2013

UK regulatory basis HK statutory basis

PAC Pre

Scheme1

PHKL Post

Scheme1

PHKL Post

Scheme1,2 £m £m HK$m

Admissible assets 122,531 12,255 144,213 Shareholder net assets 2,953 16 200 Total Assets (A) 125,484 12,271 144,413 Total long term business liabilities (B) 101,664 10,279 120,775 Capital Resources (CR) (C=A-B) 23,820 1,992 23,638 Capital Requirements of own business (D) 3,760 444 5,116 Capital Requirements of regulated related undertakings (E) 1,100 With-Profits Insurance Capital Component (WPICC) (F) 8,875 197 Capital Resources requirement (CRR) (G=D+E+F) 13,735 641 5,116 Excess capital (H=C-G) 10,085 1,351 18,522 Ratio of regulatory working capital (net of WPICC) to MCR (=[C-F]/[D+E]) 308% 404% Ratio of excess capital to capital requirements (=C/D) 449% 462%

Notes: 1. These figures allow for certain management actions that had been implemented by 30 June 2013 and some which are planned to be implemented in 2013 (see paragraphs 5.8 and 5.9). 2. An exchange rate of £1=HK$11.76 has been used.


November 8, 2013

8.2. The effect of the Scheme would have been to transfer HK$144 billion (£12.3 billion) of assets to PHKL. The figures for PHKL shown in Table 8.1 include the HK$200 million (£16 million) of shareholder capital injected into PHKL by PAC in 2013.

8.3. The Hong Kong regulatory balance sheet is not directly comparable with the UK regulatory balance sheet. For example, the Hong Kong regulatory liabilities do not make explicit allowance for the extent to which accrued discretionary with-profits benefits exceed minimum guaranteed values, and the calculation of minimum capital requirements is different. The effect of these differences would have been to increase the excess of capital resources over capital requirements of PHKL determined on the Hong Kong regulatory basis by approximately HK$2.6 billion44 (£0.2 billion) relative to that excess measured on the UK regulatory basis. As shown in the final row of Table 8.1, this would have resulted in a relatively small increase in the Hong Kong solvency coverage ratio, a commonly used measure of financial strength. The reported ratio would have been comfortably in excess of the regulatory requirement to maintain a minimum ratio of 150%.

8.4. In assessing the relative security of contractual benefits, it is helpful to compare ratios of available resources after deducting the WPICC (since it forms part of policyholders’ reasonable benefit expectations) under the UK regulatory basis. Table 8.2 compares the pre-Scheme ratio for PAC and the post-Scheme ratio for PHKL calculated at 31 December 2012 and 30 June 2013.

Table 8.2: Ratio of available resources, after deducting the WPICC, to the Minimum Capital Resources Requirement

30-Jun-13 31-Dec-12 Pre-Scheme PAC 308% 273%

Post-Scheme PHKL 404% 332%

8.5. The figures in Table 8.2 indicate that had the Scheme been implemented on 30 June 2013, the level of security for transferring policyholders would have increased immediately following the implementation of the Scheme as measured by the UK regulatory basis. The increase is broadly similar to the position if the Scheme had been effected at 31 December 2012.

8.6. As noted in paragraph 3.10, the current expectation is that the Hong Kong regulatory framework for establishing reserves and capital requirements is likely to change, but the form that those changes will take has not yet been decided.

The business of the PHKL NPF and the PHKL SHF

8.7. Table 8.3 sets out the combined solvency position of the PHKL NPF and the PHKL SHF measured on the UK regulatory basis and the Hong Kong regulatory basis at 30 June 2013 if the Scheme had been effected at that date. It also shows the pre-Scheme combined solvency position of the PAC NPSF and the PAC SHF at that date.

_______________________________________________________________________________ 44 Calculated using figures in row H of Table 8.1 as [18,522 – 1,351 x 11.76].


November 8, 2013

Table 8.3: Pro forma solvency position of PAC and PHKL Non-Profit and Shareholder funds as at 30 June 2013


PAC NPSF &

SHF Pre

Scheme1

PHKL NPF & SHF Post

Scheme1

PHKL & SHF Post

Scheme1,2,3 £m £m HK$m

Admissible assets (A) 18,145 2,107 24,872 Shareholder net assets (B) 4,273 16 200 Regulatory liabilities (C) 19,089 1,945 22,767 Capital Resources (D=A+B-C) 3,329 178 2,305 Capital Resources Requirement (E) 1,352 72 741 Excess assets (F= D-C) 1,977 106 1,564 Ratio of surplus to the sum of liabilities and capital requirement (=F/(B+E)) 9.7% 5.3% 6.7%

Solvency margin = Ratio of capital resources to capital requirements (=D/E) 247% 311% Notes: 1. These figures allow for certain management actions that had been implemented by 30 June 2013 and some which are planned to be implemented in 2013 (see paragraphs 5.8 and 5.9). 2. An exchange rate of £1=HK$11.76 has been used 3. The Hong Kong regulatory liabilities calculated for the transferring business of the PAC NPSF are slightly lower (circa £25 million) than the current Pillar I Peak 1 reserves held for that business, which are set to the higher of the reserves determined on the Hong Kong regulatory basis and the UK Pillar I Peak 1 basis.

8.8. The penultimate row of Table 8.3 shows that, based upon the position at 30 June 2013, there would be a reduction in security for transferring policies in respect of risks arising from the shareholder-owned business of the PAC NPSF and the PAC SHF measured on both the UK regulatory basis and the HK regulatory basis. This is a function of:

the quantum of assets to be transferred from the PAC NPSF (equal to the value of the locally held assets of PACHK which form part of the PAC NPSF); and

the quantum of shareholder capital of PHKL (£16 million) relative to that of PAC (which includes the regulatory value of its subsidiaries). From the Transfer Date transferring policyholders’ indirect exposure to risks arising from the PAC subsidiaries will be more distant.45

8.9. As shown in Table 8.4, the reduction is slightly lower than that determined based upon the position at 31 December 2012.

Table 8.4: Ratio of surplus to the sum of liabilities and capital requirementfor shareholder-owned business measured using the UK regulatory basis

30-Jun-13 31-Dec-12 Pre-Scheme PAC shareholder-owned 9.7% 8.9%

Post-Scheme PHKL shareholder-owned 6.7% 4.2%

_______________________________________________________________________________ 45 PAC policyholders are currently indirectly exposed to risks from those subsidiaries because shareholder assets of PAC might be required to support those subsidiaries in adverse circumstances. Demands on the shareholder capital of PAC will be of less relevance to transferring policyholders because PHKL will have its own capital resources, but adverse experience in other subsidiaries of PAC might reduce the additional support that might otherwise be available from PAC.


November 8, 2013

8.10. The security provided by surplus assets in non-profit funds may be temporary because the shareholder is able to withdraw them subject to the insurer continuing to meet its capital requirements. As shown in the final row of Table 8.3, on a stand-alone basis, the solvency ratio for PHKL NPF and SHF would have been comfortably in excess of the Hong Kong regulatory requirement to maintain a minimum ratio of 150%.

8.11. Measured on an economic (risk-based) basis, the PHKL NPF will be much stronger than the PAC NPSF. This is because the future profits expected to arise on the transferring business of the sub-fund expressed as a proportion of the transferring liabilities is higher than that for the PAC NPSF considered as a whole. That value (which is expected to arise from prudent margins built into the regulatory reserves, and so cannot be recognised in the regulatory balance sheet) will emerge in PHKL over time, and will strengthen the regulatory solvency position of PHKL until reinvested in new business or paid out in the form of dividends to PAC.

8.12. We understand from PAC that the proposed risk appetite for the PHKL NPF is expected to be approved by the PHKL Board at its meeting scheduled for 2 December 2013.

The business of the PHKL WPF

8.13. Table 8.5 sets out the regulatory solvency position of the PAC WPSF (including the DCPSF) on the UK regulatory basis, and that of the PHKL WPF measured on the UK regulatory basis and the Hong Kong basis, at 30 June 201346 if the Scheme had been implemented on that date.

Table 8.5: Pro forma regulatory solvency position of the PAC WPSF (including the DCPSF) and the PHKL WPF as at 30 June 2013


PAC WPSF& DCPSF

Pre Scheme1

PHKL WPF Post

Scheme1

PHKL WPFPost

Scheme1,2 £m £m HK$

Admissible assets (A) 96,497 10,148 119,340

Regulatory liabilities (B) 77,156 8,334 98,008

Free assets (C=A-B) 19,341 1,814 21,333

UK LTICR3/HK Required Minimum Margin (D) 3,271 372 4,375 UK With-Profits Insurance Capital Component (WPICC) (E) 7,963 197

Capital Resources Requirement (F=D+E) 11,234 569 4,375

Regulatory excess assets (=C-F) 8,107 1,245 16,958 Ratio of Capital Resources (net of WPICC) to Capital Resources Requirement (net of WPICC) (=[C-E])/D) 348% 435%

Solvency margin = Ratio of free assets to capital requirements (Hong Kong) (=C/D) 488% 488%

Notes: 1. These figures allow for certain management actions that had been implemented by 30 June 2013, and some which are planned to be implemented in 2013 (see paragraphs 5.8 and 5.9). 2. An exchange rate of £1=HK$11.76 has been used. 3. Long Term Insurance Capital Requirement, reported in line 31 of Form 2 of regulatory returns of UK long term insurers.

_______________________________________________________________________________ 46 We have been informed by PAC that there are no significant differences between the liabilities for the Hong Kong business of the PAC WPSF determined on a UK regulatory basis and those determined on a Hong Kong regulatory basis as at 30 June 2013.


November 8, 2013

8.14. The pro forma UK regulatory balance sheets indicate that the financial position of the PHKL WPF would have been strong at 30 June 2013, and that there would have been an improvement in strength compared to the PAC WPSF (including the DCPSF).

8.15. Table 8.5 indicates that differences between the UK regulatory basis and the Hong Kong regulatory basis would have resulted in the PHKL WPF reporting additional assets in excess of capital requirements of approximately HK$2.3 billion47 (£0.2 billion). This increase in regulatory surplus is not expected to give rise to a change in bonus practices for transferring with-profits policyholders.

8.16. As shown in Table 8.6, the increase is broadly comparable to that determined based upon the position at 31 December 2012.

Table 8.6: Ratio of available resources, after deducting the WPICC, to the Minimum Capital Resources Requirement for with-profits business using the UK regulatory basis

30-Jun-13 31-Dec-12 Pre-Scheme PAC WPSF & DCPSF 348% 302%

Post-Scheme PHKL WPF 435% 352%

8.17. As shown in the final row of Table 8.5, on a stand-alone basis, the solvency ratio of the PHKL WPF would have been comfortably in excess of the Hong Kong regulatory requirement to maintain a minimum ratio of 150%.

8.18. We understand from PAC that the PHKL Board has provisionally approved risk appetite statements for the IFSF and for the WPF. The advice of the PHKL With-Profits Committee on these statements will be sought and considered by the PHKL Board once the PHKL With-Profits Committee is constituted, so that this requirement of the Scheme is met. In our view the proposed risk appetite statements are consistent with the requirements of the Scheme and should deliver an appropriate level of financial security for the transferring with-profits policyholders.

8.19. The capital resources of the PHKL IFSF would have comfortably exceeded the corresponding economic capital requirement. The economic strength of the PHKL IFSF expressed as the ratio of capital resources to capital requirements, would have been very similar to that of the PAC WPSF (considered together with the DCPSF) at 30 June 2013. The improvement in the overall financial condition of the PAC WPSF during the first half of 2013 and the management actions referred to in paragraphs 5.8 and 5.9 have had the effect of aligning the resulting pre- and post-domestication financial position measured on the Pillar II basis more closely than was the case at 31 December 2012.

Conclusion

8.20. As confirmed in paragraph 1.15, we are satisfied that our conclusions regarding the likely effects of the Scheme on the security of transferring policyholders of PAC remain valid in the light of changes to the financial position of PAC to 30 June 2013. We have not been made aware of any matters arising to the date of this report, other than those disclosed in this report, that would affect our conclusions.

Benefit expectations

8.21. The latest draft of the Scheme (dated 1 November 2013) provided to us contains some changes to the draft version of the Scheme available to us at the time of preparing the JIA Report. Those changes do not affect our conclusions on the likely impact of the Scheme on the benefit expectations of transferring policyholders.

_______________________________________________________________________________ 47 Hong Kong reserving and capital requirements of HK$102,383 (=98,008+4,375) compared to UK Pillar I reserving and capital requirements of HK$104,699 (=[8,334+569]x11.76).


November 8, 2013

8.22. We have commented upon risk alignment in paragraphs 2.1 to 2.29.

8.23. As confirmed in paragraph 1.17, we remain satisfied that the Scheme is unlikely to have a material adverse effect on the reasonable benefit expectations of transferring policyholders.


November 8, 2013

9. Correspondence from policyholders 9.1. PAC has received comments on its domestication proposals from policyholders through its dedicated

call centres in the UK and Hong Kong. Emails and letters relating to those proposals have been received by PAC. PAC has provided us with copies of the correspondence (transcripts in the case of call centre conversations) which it has classed as objections to its proposals, and copies of responses which have been sent to the correspondents. We understand from PAC that copies of these documents will be provided to the HK Court and the UK Court.

9.2. In one case to date we have assisted PAC in preparing its response to a policyholder where the concerns raised included questions relating to the JIA Report (see paragraphs 9.32 and 9.33).

9.3. At the time of finalising this report we have not received any correspondence regarding the domestication proposals directly from PAC policyholders.

9.4. The main arguments put forward by correspondents are listed below. We have set out our comments on these matters in the following paragraphs.

Those arising from an apparent misunderstanding of the proposals:

If a proportion of the fund is transferred to Hong Kong then the profits distributed to UK with-profits policyholders will reduce. (See paragraph 9.5).

Placing around 10% of the investments of UK & European with-profits policies in Hong Kong appears risky. (See paragraph 9.6).

The profits arising from earlier domestications (those in Singapore, Canada, New Zealand and Australia) have not been shared with UK & European with-profits policyholders, so why would this domestication be any different? (See paragraph 9.7).

A new business fund is being set up only in Hong Kong, and new business funding is only being provided to Hong Kong, which is detrimental to UK & European policyholders. (See paragraphs 9.8 to 9.10).

The policyholder circular refers to the “sunset clause” in the Scheme, when the PHKL IFSF (to which transferring policies of the PAC WPSF will be allocated) and the PHKL NBSF (to which new with-profits policies written in Hong Kong will be allocated) can be merged, and the role of the PHKL With-Profits Committee will cease. After this clause is invoked the requirement to distribute not less than 90% of the profits of the with-profits fund to with-profits policyholders would be vulnerable to change. (See paragraphs 9.11 and 9.12).

Those relating to the process:

Policyholders are not required to vote to approve the transfer, and Hong Kong policyholders are not entitled to opt out of the transfer. (See paragraph 9.13).

By transferring our policies, PAC is unilaterally changing the terms of our policies. If we do not consent to the transfer of our policies then we should be entitled to a refund of premiums plus interest. (See paragraphs 9.14 and 9.15).

Why can’t the existing Hong Kong policies stay with PAC (and not be transferred to PHKL), and the new policies be written in PHKL? (See paragraphs 9.16 and 9.17).

All the actuaries, lawyers and independent persons were employed by PAC and will only act in the interests of PAC. (See paragraphs 9.18 and 9.19).

Why have two employees of the same company (Milliman) been appointed as the independent


November 8, 2013

actuaries? They cannot be independent of one another. (See paragraphs 9.20 to 9.22).

Why has the total cost incurred by PAC in respect of the proposed transfer not been disclosed? (See paragraph 9.23).

Those relating to the reasonableness of the proposals

The Hong Kong legislation is much less prescriptive than the UK legislation, and so transferring policyholders will face a much greater risk that their policies do not pay out. (See paragraph 9.24).

Prudential has consistently emphasised to its Hong Kong policyholders the benefits of investing with a branch of a large, financially strong UK company, but the Scheme will transfer our policies to a smaller, regional company. (See paragraph 9.25 to 9.27).

Hong Kong policyholders contributed to the inherited estate, which belongs to Prudential UK. Why do UK & European policyholders receive nothing in return for a £13 billion transfer of assets to Hong Kong? (See paragraph 9.28).

The domestication is unfair because when people purchase policies in the UK they are aware of the strength of the with-profits fund backed by the PAC Inherited Estate, but some of the PAC Inherited Estate is being transferred to Hong Kong and the strength of the fund will reduce. (See paragraph 9.29).

Operating costs will be greater for PHKL than is currently case for the Hong Kong branch of PAC, and this will result in lower dividends for policyholders. (See paragraphs 9.30 and 9.31).

The Joint Independent Actuaries cannot offer a 100% guarantee that after the business transfer there will be no effect on the transferring policyholders. (See paragraphs 9.32 and 9.33).

There is no certainty that UK & European policyholders will not suffer an adverse impact (the Joint Independent Actuaries only consider material adverse impacts). UK & European policyholders should be provided with a guarantee they will be better off as a result of the domestication. (See paragraph 9.34).

Can UK & European policyholders be assured that the effects of any future adverse Hong Kong legislation, regulation or risk will not impact on either the security or future bonus returns of UK & European policyholders? (See paragraph 9.35).

If a proportion of the fund is transferred to Hong Kong then the profits distributed to UK with-profits policyholders will reduce.

9.5. This comment arises from an apparent misunderstanding of the transfer from the PAC WPSF that would be effected by the Scheme. There is no mixing of the asset pools backing the with-profits investments of the policies of the fund in the two territories. Only those asset pools backing Hong Kong policies of the fund will transfer to Hong Kong. The assets of the fund other than those backing the with-profits investments will be apportioned between the two territories.

Placing around 10% of the investments of UK & European with-profits policies in Hong Kong appears risky.

9.6. As noted in paragraph 9.5, the Scheme will not result in the asset pools in which UK & European with-profits policies are invested being reinvested in Hong Kong.


November 8, 2013

The profits arising from earlier domestications (those in Singapore, Canada, New Zealand and Australia) have not been shared with UK & European with-profits policyholders, so why would this domestication be any different?

9.7. This comment also arises from an apparent misunderstanding. The earlier domestications resulted in a clean split of the assets of the PAC WPSF between the relevant territories. Since then the returns credited to UK & European with-profits policyholders of the fund have been determined by reference to the assets remaining in the PAC WPSF; there is no continuing link between the experience of the businesses in the relevant territories. This will also be the case if the Scheme is implemented.

A new business fund is being set up only in Hong Kong, and new business funding is only being provided to Hong Kong, which is detrimental to UK & European policyholders.

9.8. This comment arises from an apparent misunderstanding. The PAC Board regularly sets budgets for the capital that may be used to support the writing of new business. The new business funding (the New Business Sub-Fund Assets48) to be allocated to Hong Kong from the PAC WPSF broadly represents that part of the total new business budget for the fund for 2013-2015 that would be allocated to support the writing of new with-profits business in Hong Kong if the domestication was not implemented.49 The part of the budget that would support the writing of new UK & European with-profits business in the fund will remain in the fund.

9.9. PAC will provide shareholder support (the New Business Support Commitment) to the PAC WPSF to the extent (if any) required to enable PAC to maintain the benefit expectations and security of its policyholders as if the New Business Sub-Fund Assets had not been transferred to PHKL.50 Prudential plc will provide a corresponding undertaking to provide capital support to PAC to the extent that the PAC shareholder fund would otherwise have insufficient assets to meet the New Business Support Commitment.

9.10. The Scheme requires new with-profits business written by PHKL to be written in a separate fund (the PHKL NBSF) to that which the transferring business of the PAC WPSF is to be allocated (the PHKL IFSF). The rationale for such an arrangement is that it facilitates the incorporation of key protections which benefit transferring with-profits policies through being part of PAC (including those arising from the PRA/FCA’s Handbook governing the management of with-profits funds) without requiring the perpetuation of such protections for new with-profits business written by PHKL from the Transfer Date.

The policyholder circular refers to the “sunset clause” in the Scheme, when the PHKL IFSF (to which transferring policies of the PAC WPSF will be allocated) and the PHKL NBSF (to which new with-profits policies written in Hong Kong will be allocated) can be merged, and the role of the PHKL With-Profits Committee will cease. After this clause is invoked the requirement to distribute not less than 90% of the profits of the with-profits fund to with-profits policyholders would be vulnerable to change.

9.11. This is not correct. The “sunset clause”51 is intended to avoid reaching a position where the costs of maintaining separate accounting records for the PHKL IFSF and/or the costs of the PHKL With-Profits Committee are disproportionately large relative to the size of the PHKL IFSF. The “sunset clause” does not permit changes to be made to the requirement, set out in Clause 19 of the Scheme, to distribute not less than 90% of the profits of the PHKL with-profits fund to with-profits policyholders of the fund.

_______________________________________________________________________________ 48 See paragraphs 6.66 to 6.69 of the JIA Report. 49 We understand from the PAC Actuarial Function Holder that the PAC Board has confirmed an unchanged budget for Hong Kong of the fund for the period 2014-2016 if the domestication is not implemented. 50 See paragraph 6.15 of the JIA Report. 51 Clause 25 of the Main Scheme. See paragraphs 6.51 to 6.57 of the JIA Report.


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9.12. Any proposed amendment to Clause 19 of the Scheme would require the prior consent of the Hong Kong Court. Any application to the Court for such consent (whether made before or after the “sunset clause” has been exercised) must be accompanied by a report from an independent actuary confirming that, in his opinion, the amendment is unlikely to have a material adverse effect on any group or generation of the transferring with-profits policyholders or any other policyholders of PHKL. The report must be provided to the HK Insurance Authority, the PHKL Actuary and the PHKL With-Profits Committee at least three months prior to the making of that application.52

Policyholders are not required to vote to approve the transfer, and Hong Kong policyholders are not entitled to opt out of the transfer.

9.13. The court process being followed is a standard approach used to transfer business between companies and the courts will determine whether the proposals are fair to policyholders and so may go ahead. A policyholder vote and an entitlement to opt out are not part of that process, and there is no requirement that the transfer generates direct benefits for policyholders. Policyholders have the right to raise their objections to the domestication at the hearing of the Scheme to be held in Hong Kong Court scheduled to begin on 26 November 2013 and at the hearing of the Scheme to be held in the UK Court scheduled to begin on 10 December 2013.

By transferring our policies, PAC is unilaterally changing the terms of our policies. If we do not consent to the transfer of our policies then we should be entitled to a refund of premiums plus interest.

9.14. We understand that PAC has received legal advice confirming that the terms of Hong Kong policies do not prohibit their proposed transfer to PHKL. As noted in paragraph 9.13 the court process being followed to effect the transfer is a standard approach.

9.15. The Scheme sets out Principles of Financial Management (PFM)53 that will govern the future operation of PHKL. These state that nothing in the PFM will form part of, or vary, the terms and conditions of any policies transferred to PHKL.54 In particular, the Scheme does not introduce an option under policies that will transfer to PHKL for policyholders to receive a refund from their policy rather than have it transferred. If a policyholder elects to surrender a policy then the surrender terms will be determined in accordance with the existing terms and conditions of that policy.

Why can’t the existing Hong Kong policies stay with PAC (and not be transferred to PHKL), and the new policies be written in PHKL?

9.16. Our terms of reference require us to consider the Scheme as presented to us, and we have not considered other possible alternative schemes in the JIA Report. This is a standard approach for independent experts appointed in relation to transfers of insurance business in the UK and Hong Kong. It is PAC’s role to design the Scheme and it is our role to comment upon the potential implications of the Scheme for the relevant policyholders.

9.17. Nevertheless, we have given consideration to this suggestion by some holders of policies that will transfer to PHKL if the Scheme is sanctioned by the Courts and implemented. Writing new with-profits business requires capital to finance initial expenses and enable investment returns to be smoothed. In our view it is unlikely that PHKL could independently source sufficient capital to set up its own with-profits fund to enable it to transact new with-profits business in a similar manner to existing Hong Kong with-profits business, which benefits from the backing of a share of the capital of the PAC Inherited Estate. It would be possible for PHKL to reassure its with-profits investments to the PAC WPSF, but

_______________________________________________________________________________ 52 Clause 27.2 of the Main Scheme. 53 Schedule 3 to the Main Scheme. 54 Clause 1.4 of Schedule 3 to the Main Scheme.


November 8, 2013

this would be cumbersome and would not give PHKL the operational independence that the Scheme is designed to provide.

All the actuaries, lawyers and independent persons were employed by PAC and will only act in the interests of PAC.

9.18. The terms of reference for the Independent Actuary and the Independent Expert were agreed with PAC and reviewed by the HK Insurance Authority and the PRA respectively. An extract of our terms of reference is set out in Appendix A to the JIA Report.

9.19. PAC meets the cost incurred in preparing our reports to the Courts. However, the Independent Actuary owes a duty to the Hong Kong Court and the Independent Expert owes a duty to the UK Court to help them on matters within our expertise. This duty overrides any obligation to any person from whom we have received instructions or by whom we are paid. We have complied with that duty. In particular, we have scrutinised closely, and provided significant challenge to, PAC’s proposals.

Why have two employees of the same company (Milliman) been appointed as the independent actuaries? They cannot be independent of one another.

9.20. The transfer process only requires the appointment of one actuary that is independent of PAC. However, the proposed transfer requires knowledge and experience of the life assurance markets in Hong Kong and in the UK, and involves court proceedings in both territories. As stated in paragraph 2.15 of the JIA Report, the IA (Mr Paul Sinnott) has relied on the expertise of the IE (Mr Nick Dumbreck) for matters relating to the UK and vice versa for matters relating to Hong Kong.

9.21. The IA provided a statement of independence to the HK Insurance Authority for review before the approval of his appointment. The IE provided a statement of independence to the FSA55 for review before the approval of his appointment. Those statements are included in Appendix A to the JIA Report and referred to in paragraphs 2.25 and 2.30 respectively of that report.

9.22. As noted in paragraph 1.3 of the JIA Report, it was agreed by the HK Insurance Authority, the PRA and the FCA that a single, joint report should be prepared for the courts by the IA and the IE.

Why has the total cost incurred by PAC in respect of the proposed transfer not been disclosed?

9.23. We understand from PAC that it considers the total cost incurred to be confidential. As noted in paragraph 1.92 of the JIA Report, none of the costs relating to the domestication will be borne by any with-profits fund, other than amounts which represent an acceleration of costs that would have been incurred in the normal course of business. We understand from PAC that the costs incurred to date, and expected to be incurred, in respect of the proposed transfer are not material in the context of the surplus of the PAC NPSF, from which those costs which are not charged to the with-profits funds will be met.

The Hong Kong legislation is much less prescriptive than the UK legislation, and so transferring policyholders will face a much greater risk that their policies do not pay out.

9.24. The differences in legislation have been considered in our assessment of the Scheme. There are a number of safeguards in the transfer scheme to protect the interests of transferring policyholders, and to limit the effect of the transfer on those policyholders as far as is practically possible. We have reviewed these safeguards and have concluded that the protection they provide is appropriate.

_______________________________________________________________________________ 55 The Financial Services Authority of the UK, the financial services regulator in the UK prior to its replacement by the PRA and the FCA on 1 April 2013.


November 8, 2013

Prudential has consistently emphasised to its Hong Kong policyholders the benefits of investing with a branch of a large, financially strong UK company, but the Scheme will transfer our policies to a smaller, regional company.

9.25. It is true that the proposed transfer will change the nature of the security for transferring policyholders. However, the Scheme contains a number of provisions designed to mitigate the consequences of transferring the Hong Kong business to a subsidiary. Moreover, as described in paragraphs 1.61 and 1.62 of the JIA Report56, Prudential plc will provide two undertakings that will enhance the security of PHKL.

9.26. One of the undertakings is an assurance to the HK Insurance Authority that Prudential plc will provide capital support to PHKL if necessary in order that PHKL’s solvency ratio57 determined on the Hong Kong regulatory basis exceeds 150%58. A time limit does not apply to this undertaking, but it will only apply while Prudential plc remains a controller59 of PHKL. In the event of a change in control we would expect the HK Insurance Authority to require any new controller to provide comparable undertakings, or to put in place alternative arrangements to maintain a similar level of security for PHKL policyholders.

9.27. We consider there would be risk of substantial reputational damage for Prudential plc if it did not honour its undertakings to PHKL or otherwise support its subsidiary.

Hong Kong policyholders contributed to the inherited estate, which belongs to Prudential UK. Why do UK & European policyholders receive nothing in return for a £13 billion transfer of assets to Hong Kong?

9.28. As explained in Section 5 of the JIA Report, based upon the information provided to us, we consider that it is reasonable to regard the policyholders of PACHK as having an interest in the PAC WPSF that is consistent with the interests of UK & European policyholders of the WPSF and the DCPSF (other than holders of former ELAS policies60). That is, in our view UK & European policyholders do not have a prior call on the inherited estate and nor do Hong Kong policyholders.

The domestication is unfair because when people purchase policies in the UK they are aware of the strengths of the with-profits fund backed by the PAC Inherited Estate, but some of the PAC Inherited Estate is being transferred to Hong Kong and the strength of the fund will reduce.

9.29. As noted in paragraph 9.28, we do not consider that policyholders in either territory have a prior call on the PAC Inherited Estate. Moreover, taking into account the shareholder undertaking in the form of the New Business Support Commitment61, it is not expected that the strength of the fund backing UK & European policies will reduce as a consequence of the proposed transfer.

Operating costs will be greater for PHKL than is currently case for the Hong Kong branch of PAC, and this will result in lower dividends for policyholders.

9.30. As noted in paragraph 12.5 of the JIA Report, in his report on the Scheme62, the PHKL Appointed Actuary Designate states that the administration of the transferring business is currently largely carried out independently of that of the UK & European business of PAC. Following the Transfer Date:

the infrastructure, administration and staff of PACHK will transfer to PHKL;

_______________________________________________________________________________ 56 See also paragraphs 11.17 to 11.20 of the JIA Report. 57 Calculated as (assets – liabilities) / required minimum capital requirement. 58 The Hong Kong regulatory minimum requirement. 59 As defined in Section 9(1)(c)(iii) of the Insurance Companies Ordinance (Cap. 41) of the laws of Hong Kong. 60 Holders of former ELAS policies are not entitled to participate in distributions from the PAC Inherited Estate in respect of those policies. 61 See paragraph 6.15 of the JIA Report. 62 “Certificate in respect of the proposed transfer of the long term business of The Prudential Assurance Company Limited’s Hong Kong branch to Prudential Hong Kong Limited” dated 15 August 2013, and available from PAC’s web site.


November 8, 2013

existing contractual relationships of PACHK will be replaced by similar relationships of PHKL; and

governance, controls and other systems will need to be put in place to comply with the requirements of the Scheme.

9.31. The PHKL Appointed Actuary Designate does not anticipate a material adverse impact on the transferring policyholders as a result of the foregoing. We have no reason to believe that implementation of the Scheme will lead to a material increase in the expense charges levied on transferring policies.

The Joint Independent Actuaries cannot offer a 100% guarantee that after the business transfer there will be no effect on the transferring policyholders.

9.32. Under the proposed transfer, policies in the Hong Kong branch of PAC will move to PHKL, a separate company in Hong Kong. The business will be managed by the same team before and after the transfer, but the governance arrangements, responsibility for prudential regulation of the business and applicable regulations will all change. In addition, whereas the branch currently shares in the solvency capital of PAC and is exposed to risks arising from other business of that company, PHKL will have its own allocation of capital and will be largely unaffected by the other business of the Prudential Group. As a consequence of these changes, it is not possible to say that the proposed transfer will have no effect on policyholders.

9.33. The way in which we have expressed our conclusions regarding the potential impact of the transfer recognises that this will depend upon the outcome of uncertain future events and actions. Since it is never possible to be certain what the outcome will be, we have expressed our judgments in terms of what is likely to happen and with a materiality threshold. This is because there will be a range of possible outcomes for all policyholders and the outcomes may vary between different groups of policyholders.

There is no certainty that UK & European policyholders will not suffer an adverse impact (the Joint Independent Actuaries only consider material adverse impacts). UK & European policyholders should be provided with a guarantee they will be better off as a result of the domestication.

9.34. Since it is never possible to be certain what the outcome will be, we have expressed our judgments in terms of what is likely to happen and with a materiality threshold. This is because there will be a range of possible outcomes for all policyholders and the outcomes may vary between different groups of policyholders.

Can UK & European policyholders be assured that the effects of any future adverse Hong Kong legislation, regulation or risk will not impact on either the security or future bonus returns of UK & European policyholders?

9.35. As noted in paragraph 1.34 of the JIA Report, following the implementation of the Scheme, non-transferring policyholders will no longer be directly exposed to risks arising from the transferring business. There will be indirect exposure to such business through the ownership of PHKL by the shareholder fund of PAC, and counterparty risk63 arising from the UK/HK Annuity Reassurance Treaty.

_______________________________________________________________________________ 63 The risk that PHKL is unable to meet its obligations to PAC under the reassurance arrangement.


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Appendix A Key sources of data A.1 The report entitled “Supplementary Report of the Actuarial Function Holder of The Prudential

Assurance Company Limited (PAC) on the proposed transfer of the long-term insurance business of the PAC Hong Kong Branch to Prudential Hong Kong Limited (PHKL)” dated November 2013.

A.2 The report entitled “Supplementary Report of the With Profits Actuary of The Prudential Assurance Company Limited (PAC) on the proposed transfer of the long-term insurance business of the PAC Hong Kong Branch to Prudential Hong Kong Limited” dated November 2013.

A.3 The certificate entitled “Supplementary certificate in respect of the proposed transfer of the long term business of The Prudential Assurance Company Limited’s Hong Kong branch to Prudential Hong Kong Limited” dated 4 November 2013.

A.4 A draft of the scheme of transfer entitled “In the High Court of the Hong Kong Special Administrative Region Court of First Instance Miscellaneous Proceedings No. 2027 of 2013; In the Matter of The Prudential Assurance Company Limited 英國保誠保險有限公司 1st Petitioner and in the matter of the Prudential Hong Kong Limited 保誠保險有限公司 2nd Petitioner and in the matter of an application under Section 24 of the Insurance Companies Ordinance (Cap. 41): Scheme ” dated 1 November 2013.

A.5 The document entitled “Project Redgrave Half Year 2013 Apportionment Methodology, Assumptions and Results” dated 18 September 2013.

A.6 The document entitled “Project Redgrave Risk Alignment to SED” dated 23 October 2013.

A.7 The following capital support undertakings:

• the undertaking by PAC to PHKL in respect of the PHKL Pension Mis-selling Costs Assurance dated November 2013 (see paragraph 6.13 of the JIA Report);

• the undertaking by Prudential plc to PAC in respect of the New Business Support Commitment dated 6 November 2013 (see paragraph 6.16 of the JIA Report);

• the undertaking by Prudential plc to the HK Insurance Authority in respect of the solvency of PHKL dated November 2013 and the undertaking by Prudential plc to PHKL in respect of the solvency of PHKL dated November 2013 (see paragraph 11.17 of the JIA Report); and

• the undertaking by Prudential plc to PAC referred to in paragraph 6.14 of the JIA Report, which is dated 1 November 2013.

A.8 The document entitled “PAC Hong Kong Branch – Policyholders’ Reasonable Expectations” dated 7 August 2013.

A.9 The document entitled “Hong Kong PRE – Appendix” dated 7 August 2013.

A.10 The document entitled “Post Domestication Pillar I Peak 2 balance sheets as at 2013 HY” dated 25 October 2013.

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