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Independent auditor’s report to the members of Prudential plc

1 Our opinion on the financial statements is unmodified

We have audited the financial statements of Prudential plc for the year ended 31 December 2016. In our opinion:

  • The financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2016 and of the Group’s profit for the year then ended;
  • The Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union;
  • The parent company financial statements have been properly prepared in accordance with UK Accounting Standards including FRS 101 Reduced Disclosure Framework; and
  • The financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.

2 Our assessment of risks of material misstatement

In arriving at our audit opinion on the financial statements, the risks of material misstatement, in decreasing order of audit significance, that had the greatest effect on our audit, which are unchanged from 2015 were as follows:

Policyholder liabilities (2016: £388,996 million, 2015: £322,518 million), the risk compared to the prior year is unchanged.

Refer to Audit Committee report, Accounting policy and Financial disclosures

The risk

The Group has significant policyholder liabilities representing 85 per cent of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long term policyholder liabilities. Economic assumptions, including investment return, credit risk and associated discount rates, and operating assumptions including mortality, morbidity, expenses and persistency (including consideration of policyholder behaviour) are the key inputs used to estimate these long term liabilities.

Additionally:

  • In the US, the valuation of the guarantees in the variable annuity business is a complex exercise as it involves exercising significant judgement over the relationship between the investment return attaching to these products and the guarantees contractually provided to policyholders and the likely policyholder behaviour in response to changes in investment performance.
  • In the UK, the valuation of the policyholder liabilities in relation to the annuity business requires the exercise of significant judgement over the setting of mortality and credit risk assumptions.

Our response

We used our own actuarial specialists to assist us in performing our procedures in this area.

Key procedures included assessing the Group’s methodology for calculating the policyholder liabilities and their analysis of the movements in policyholder liabilities during the year, including consideration of whether the movements are in line with the assumptions adopted by the Group, our understanding of developments in the business and our expectation derived from market experience.

Our procedures in the US included:

  • Considering the appropriateness of the assumptions used in the stochastic models for the valuation of the variable annuity guarantees.
  • Assessing assumptions for investment mix and projected investment returns by reference to company specific and industry data and for future growth rates by reference to market trends and market volatility.
  • Assessment of assumptions of policyholder behaviour, including consideration against relevant company and industry historical data.

Our procedures in the UK included:

  • Considering the appropriateness of the mortality assumptions used in the valuation of the annuity liabilities by reference to company and industry data on historical mortality experience and expectations of future mortality improvements, including evaluation of the choice of the Continuous Mortality Investigation (‘CMI’) model and the parameters used in relation to this.
  • Considering the appropriateness of the credit risk methodology and assumptions by reference to industry practice and our expectation derived from market experience.

We utilised the results of KPMG benchmarking of assumptions and actuarial market practice to inform our challenge of management’s assumptions in both areas noted above.

Our work on the policyholder liability adequacy test included assessing the reasonableness of the projected cash flows and challenging the assumptions adopted in the context of company and industry experience data and specific product features. We also performed test work to ensure the appropriateness of changes made to the policyholder liability reserving models during the year. We considered whether the Group’s disclosures in relation to the assumptions used in the calculation of policyholder liabilities are compliant with the relevant accounting requirements and appropriately represent the sensitivities of these assumptions to alternative scenarios and inputs.

Valuation of investments (2016: £421,688 million, 2015: £351,979 million), the risk compared to the prior year is unchanged.

Refer to Audit Committee report, Accounting policy and Financial disclosures

The risk

The Group’s investment portfolio represents 90 per cent of the Group’s total assets. The valuation of the portfolio involves judgement in selecting the valuation basis for each investment and further judgement in determining the appropriate valuation for harder to value investments.

The areas that involved significant audit effort and judgement in 2016 were the valuation of illiquid positions within the financial investments portfolio representing 2 per cent of the Group’s total assets. These included unlisted equity, unlisted debt securities, certain derivatives and loans such as commercial mortgage loans and bridge loans. For these positions a reliable third party price was not readily available and therefore involved the application of expert judgement in the valuations adopted.

Our response

We used our own valuation specialists and pricing services to assist us in performing our procedures in this area. Our procedures included:

  • Assessing the availability of quoted prices in liquid markets;
  • Assessing whether the valuation process is appropriately designed and captures relevant valuation inputs;
  • Testing whether associated controls in respect of the valuation process are operating properly;
  • Performing our own independent price checks from our own pricing services using external quotes for liquid positions and, where available, for illiquid positions;
  • Assessing pricing model methodologies and assumptions against industry practice and valuation guidelines;
  • Evaluating the valuation assessment performed by the Group in order to identify any potential impairment in relation to loans; and
  • Performing our own assessment of loan files to understand the performance of the loans. We examined the existing and prospective investee company cash flows in order to evaluate whether loans can be serviced or refinancing may be required and considered the impact on impairment testing performed.

We also assessed whether the Group’s disclosures in relation to the valuation of investments are compliant with the relevant accounting requirements and appropriately presents the sensitivities in the valuations based on alternative outcomes.

Deferred acquisition costs (‘DAC’) (2016: £9,178 million, 2015: £7,022 million), the risk compared to the prior year is unchanged.

Refer to Audit Committee report, Accounting policy and Financial disclosures

The risk

DAC represents 2 per cent of the Group’s total assets and involves judgements in the identification of the acquisition costs that may be deferred, the appropriateness of the deferral methodology adopted and the assessment of the recoverability of the asset.

The DAC associated with the US business, which represents 90 per cent of the total DAC, involves the greatest judgement in terms of measurement and recoverability. The amortisation and recoverability assessment of the US DAC asset is related to the achieved and projected future profit profile. This involves making assumptions about future investment returns and the consequential impact on fee income.

Our response

We used our own actuarial specialists to assist us in performing our audit procedures in this area, which included

  • Evaluating the appropriateness of the Group’s deferral policy by comparing it against the requirements of relevant accounting standards;
  • Evaluating whether costs incurred are deferred in accordance with the Group’s deferral policy; and
  • Assessing the calculations performed including the appropriateness of the assumptions used in determining the estimated future profit profile and the extent of the associated adjustment necessary to the amortisation of the DAC asset. We compared the estimated future profits to the carrying value of the DAC asset to assess recoverability. Our work included assessing the reasonableness of assumptions such as the projected investment return by comparing against the Group’s investment portfolio mix and market return data.

We also considered the adequacy of the Group’s disclosures about the degree of estimation involved in the valuation of DAC.

3 Our application of materiality and an overview of the scope of our audit

Materiality for the Group financial statements as a whole was set at £350 million (2015: £350 million) determined with reference to a benchmark of IFRS shareholders’ equity (of which it represents 2.4 per cent (2015: 2.7 per cent)). We consider IFRS shareholders’ equity to be the most appropriate benchmark as it represents the residual interest that can be ascribed to shareholders after policyholder assets and corresponding liabilities have been accounted for. We compared our materiality against other relevant benchmarks, such as total assets, total revenue and profit before tax to ensure the materiality selected was appropriate for our audit.

We set out below the materiality thresholds that are key to the audit.

IFRS shareholders’ equity

Materiality

Materiality thresholds that are key to the audit

We report to the Group Audit Committee any corrected or uncorrected identified misstatements exceeding £18 million (2015: £18 million) in addition to other identified misstatements that warrant reporting on qualitative grounds.

We subjected the Group’s operations to audits for Group reporting purposes as follows:

Full scope audits for Group reporting purposes in relation to the financial information of: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia, and Thailand; and the fund management operations of M&G and Eastspring Singapore (new in scope for 2016).

Audits of account balances that correspond to the risks of material misstatement identified above in relation to Prudential Capital and the insurance operations in Korea (full scope audit in 2015), China, Taiwan and Vietnam. The account balances audited are policyholder liabilities, investments, and deferred acquisition costs.

For the remaining operations, we performed analysis at an aggregated Group level to re-examine our assessment that there were no significant risks of material misstatement within these operations.

These components accounted for the following percentages of the Group’s results:

Group revenue

Pie chart showing group revenue

Group profit before tax

Pie chart showing group profit before tax

Group total assets

Pie chart showing group total assets

Group shareholders’ equity

Pie chart showing group shareholders’ equity

The Group audit team in the UK covered the UK Group Head office operations. Component auditors performed the audit work in the remaining locations.

The Group audit team held a global planning conference with component auditors to identify audit risks and decide how each component team should address the identified audit risks. The Group audit team instructed component auditors as to the significant areas to be covered, including the relevant risks detailed above and the information to be reported back. The Group audit team approved the component materialities. These were set as £146 million for key reporting components in Asia, other than Eastspring Singapore which was set as £80 million, and £186 million for all other key reporting components (2015: £146 million - £186 million), having regard to the size and risk profile of the Group.

The Group audit team visited ten component locations, comprising: the insurance operations in the UK, US, Hong Kong, Indonesia, Singapore, Malaysia and Thailand; the fund management operations in M&G and Eastspring Singapore; and Prudential Capital. Video and telephone conference meetings were also held with these component auditors and certain others that were not physically visited. At these visits and meetings, an assessment was made of audit risk and strategy, the findings reported to the Group audit team were discussed in more detail, key working papers were reviewed and any further work required by the Group audit team was then performed by the component auditor.

The Senior Statutory Auditor, in conjunction with other senior staff in the Group team, also regularly attended Business Unit audit committee meetings (at a regional level for Asia) and participated in meetings with local management to obtain additional understanding first hand of the key risks and audit issues at a component level which may affect the Group financial statements.

4 Our opinion on other matters prescribed by the Companies Act 2006 is unmodified

In our opinion:

  • The part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and
  • The information given in the Strategic Report and the Directors’ Report for the financial year is consistent with the financial statements.

Based solely on the work required to be undertaken in the course of the audit of the financial statements and from reading the Strategic Report and the Directors’ Report:

  • We have not identified material misstatements in those reports; and
  • In our opinion, those reports have been prepared in accordance with the Companies Act 2006.

5 We have nothing to report on the disclosures of principal risks

Based on the knowledge we acquired during our audit, we have nothing material to add or draw attention to in relation to:

  • The Directors’ viability statement, concerning the principal risks, their management, and, based on that, the Directors’ assessment and expectations of the Group’s continuing in operation over the three years to 2019; or
  • The Statutory and regulatory disclosures of the Annual Report concerning the use of the going concern basis of accounting.

6 We have nothing to report in respect of the matters on which we are required to report by exception

Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading.

In particular, we are required to report to you if:

  • We have identified material inconsistencies between the knowledge we acquired during our audit and the Directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy; or
  • The Audit Committee Report does not appropriately address matters communicated by us to the audit committee.

Under the Companies Act 2006 we are required to report to you if, in our opinion:

  • Adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or
  • The parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or
  • Certain disclosures of Directors’ remuneration specified by law are not made; or
  • We have not received all the information and explanations we require for our audit.

Under the Listing Rules we are required to review:

We have nothing to report in respect of the above responsibilities.

7 Scope of report and responsibilities

As explained more fully in the Directors’ Responsibilities Statement, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/auditscopeukco2014a which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.

Rees Aronson
(Senior Statutory Auditor)

For and on behalf of KPMG LLP,
Statutory Auditor
Chartered Accountants
London
13 March 2017

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