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Committee reports

Audit Committee report

Ann Godbehere

Dear Shareholder

As Chairman of the Audit Committee, I am pleased to report on the Committee’s activities and areas of focus over the course of 2016.

The Committee met on 10 occasions during the year. The Committee works closely with the Risk Committee to ensure both Committees are updated on matters which impact on their responsibilities. Where a matter requires input from both Committees, joint meetings are held with the Risk Committee. In 2016, one joint meeting with the Risk Committee took place to discuss the Solvency II capital position as at 31 December 2015 and associated governance processes.

We maintained our focus during the year on monitoring the integrity of financial reporting and ensuring suitable accounting policies were adopted and applied consistently. We reviewed management’s annual process for setting assumptions underpinning the Group’s European Embedded Value (EEV) results and IFRS insurance liabilities and requested additional analysis and information where we felt this was required. Clarity of the Group’s external disclosures is an important consideration of the Committee and we assessed whether the financial report for 2016 was fair, balanced and understandable before making a recommendation to the Board. Additional consideration was given to the Group’s disclosure of alternative performance measures in light of new regulatory guidance and the Committee reviewed and agreed the resulting refinements to the Group’s disclosures. We also reviewed the Group’s external Solvency II disclosures following the formal introduction of the Solvency II framework for European insurers at the start of 2016.

We approved all non-audit services, as well as audit services, to ensure our auditor remains independent. We continued with our annual process of monitoring auditor effectiveness through a Group-wide questionnaire of senior finance personnel. We meet privately with both the internal and external auditors to ensure they are able to operate effectively and to satisfy ourselves that management are responsive to their findings and recommendations.

We continued to monitor second and third line of defence functions to ensure their effectiveness. During 2016, the Audit Committee commissioned an external review to provide an independent assessment of compliance monitoring and internal audit reviews. Recommendations from this work have been approved and integrated into the respective functional plans going forward. The focus of the compliance plan is on strengthening the Compliance framework and further enhancing monitoring arrangements and mitigation of key risks. The internal audit plan provides risk-based coverage of financial, business change, regulatory and operational risk drivers and of customer outcomes.

We also refined our governance processes during the year to enhance the information the Committee receives on the activities of our business unit audit committees and to ensure key issues are escalated appropriately. I maintain regular contact with the audit committee chairs of our material subsidiaries and report to the Committee on the issues we discuss.

As Chairman of the Committee, I have responsibility for ensuring the Committee operates effectively. To ensure we do so and provide constructive challenge to management, I encourage open debate and contributions from all Committee members. An annual review of our effectiveness was carried out as part of the Board evaluation, described in more detail in How we operate. The Committee was found to be functioning effectively.

This will be my last report as Audit Committee Chairman and Non-executive Director. Having served nine years on the Board, I will not offer myself for re-election at the 2017 Annual General Meeting. It has been my pleasure to serve as chairman of Prudential’s Audit Committee and I am confident that I leave the Committee functioning well with a clear mandate of its priorities for the future. I would like to take this opportunity to thank my fellow committee members for their diligence and to thank everyone on the Prudential team who have supported me and the Committee over the years with such dedication and professionalism.

Ann Godbehere
Chairman of the Audit Committee

Committee members

  • Ann Godbehere (Chairman)
  • Howard Davies
  • Alistair Johnston (until May 2016)
  • David Law
  • Philip Remnant
  • Alice Schroeder

Regular attendees

  • Chairman of the Board
  • Group Chief Executive
  • Chief Financial Officer
  • Group Chief Risk Officer
  • Director of Group Finance
  • Group Regulatory and Government Relations Director
  • Group General Counsel and Company Secretary
  • Director of Group Compliance
  • Director of Group-wide Internal Audit
  • External Audit Partner

Number of meetings in 2016: 10 (in addition, a joint meeting was held with the Risk Committee)

How the Committee spent its time during 2016

The table below provides an overview of how the Committee spent its time in 2016.

  Jan Feb Mar1 Apr May Jul Aug Nov Dec

Notes

  1. Two meetings were held in March.

Financial reporting and external auditor

                 
Periodic financial reporting including:
—key accounting judgements and disclosures,
—Solvency II results and governance processes, and
—associated audit reports
 
 
 
 
 
 
 
 
 
Developments in tax disclosures  
 
     
 
   
 
Audit planning, fees, effectiveness, independence and re-appointment  
 
   
 
 
 
 
 

Internal control framework effectiveness

                 
Internal control framework effectiveness  
 
             

Internal auditors

                 
Status updates and effectiveness  
 
   
 
 
 
 
 
Internal audit plan for 2017          
 
   
 

Compliance

                 
Status updates  
 
   
 
 
 
 
 
Compliance plan for 2017                
 

Financial crime and whistleblowing

                 
Update on whistleblowing issues raised  
 
   
 
 
 
 
 
Anti-money laundering report  
 
             
Security and resilience development plan        
 
       

Governance

                 
Internal framework effectiveness/refresh  
 
         
 
 
Planning for ESG governance and reporting              
 
 
Business unit audit committee effectiveness and terms of reference                
 
Committee terms of reference                
 

Key matters considered during the year

Matter considered

 

How the Committee addressed the matter

Financial reporting and tax

Overview

 

One of the Committee’s key responsibilities is to monitor the integrity of the financial statements.

The Committee assessed whether appropriate accounting policies had been adopted throughout the accounting period and whether management had made appropriate estimates and judgements over the recognition, measurement and presentation of the financial results. There were no new or altered accounting standards in 2016 that had a material effect on the Group’s financial statements. The Committee also reviewed the accounting for the planned disposal of the Korea life business, together with the presentation in the financial statements.

The Committee considered compliance with accounting standards and obligations under applicable laws, regulations and governance codes. Particular areas on which the Committee focused during the year included the fair, balanced and understandable requirement under the UK Corporate Governance Code, providing advice to the Board in respect of this requirement. This included consideration of any resulting changes to disclosures following the decision by the UK to leave the European Union in June. The Committee also focused on the guidance issued by the European Securities and Markets Authority on Alternative Performance Measures that was effective for the first time in 2016. The Committee reviewed and agreed the refinements to the Group’s disclosures as a result of that new guidance.

Key assumptions and judgements

 

The Committee reviewed the key assumptions and judgements made in valuing the Group’s investments, insurance liabilities and deferred acquisition costs under IFRS, together with reports on the operation of internal controls to derive these amounts. It also reviewed the assumptions underpinning the Group’s European Embedded Value (EEV) metrics. The Committee considered information, including peer comparisons if relevant and available, on the following key assumptions:

  • Persistency, mortality, morbidity and expense assumptions within the Asia life businesses;
  • Economic and policyholder behaviour assumptions affecting the measurement of Jackson guaranteed liabilities and amortisation of deferred acquisition costs; and
  • Mortality, expense and credit risk assumptions for the UK annuity business.

2016 saw the formal introduction of the Solvency II framework for European insurers. The Committee reviewed the Group’s external disclosures of its Solvency II position, together with the consistency of assumptions with those used for IFRS and EEV reporting where relevant. In addition, given the adoption of Solvency II as the local regulatory requirement for the UK business, it reviewed the impact of the change in local capital regime on the EEV results for the UK insurance operations.

The Committee also received information on the nature of goodwill and intangible asset values and the carrying value of investments in the Group’s balance sheet. It considered what factors might give rise to an impairment of the Group’s intangibles and whether those factors had arisen in the period. The Committee was satisfied that there was no impairment of the Group’s intangibles at 31 December 2016. Following the UK referendum in June, where the majority voted in favour of leaving the European Union, and the resulting suspension of trading by some property funds, the Committee reviewed the Group’s valuation basis for property investments and property funds at 30 June. The Committee satisfied itself that these and other investments were valued appropriately.

Solvency II results and associated governance processes were considered in a separate meeting held jointly with the Risk Committee.

No significant issues arose in respect of these items.

Other financial reporting matters and tax reporting

 

The Committee considered various analyses from management regarding Group and subsidiary capital and liquidity prior to recommending to the Board that it could conclude that the financial statements should continue to be prepared on the going-concern basis and the disclosures on the Group’s longer-term viability were both reasonable and appropriate. The Committee reflected on how the viability statement could be enhanced to give more insight on the conclusions reached and updates were made accordingly.

As part of its assessment of the description of performance within the Annual Report, the Committee considered judgemental aspects of the Group’s reporting across the Group’s IFRS and EEV metrics. This assessment included a review to ensure that the allocation of items between operating and non-operating profit was in accordance with the Group’s accounting policy. The Committee considered the impact of equity and interest rate movements on the IFRS results of the Group’s US business and after discussion, the Committee was satisfied that the presentation and disclosure of such impacts was appropriate and consistent with prior periods.

The Audit Committee also considered judgemental matters regarding provisions for certain open tax items including tax matters in litigation. The Committee received information on the Group’s annual risk rating meeting with HM Revenue & Customs. The Committee reviewed the Group’s preparations for new country-by-country reporting disclosure requirements to tax authorities, and the Group’s preparations for public disclosure of the Group’s tax strategy. The Committee was satisfied that management’s approach was reasonable in these areas.

For all the above areas, the Committee received input from management and the external auditor prior to reaching its conclusions.

In addition to these reporting matters, the Committee also received and considered regular updates from management on the status and implications for the Group of financial reporting developments, including updates on discussions by the International Accounting Standards Board on the development of the IFRS 17 Insurance Standard (known previously as “IFRS 4 Phase II”) and the permitted deferral of IFRS 9 by insurers.

External audit, review of effectiveness, non-audit services and auditor reappointment

External audit effectiveness

 

The Group’s external auditor is KPMG LLP and oversight of the relationship with them is one of the Committee’s key responsibilities. The Committee approved KPMG’s terms of engagement for the statutory audit, and approved fees for both audit and non-audit services in accordance with the Group’s policy.

To assess the effectiveness of the auditor, the Committee reviewed the audit approach and strategy, and received an internal report on their performance.

The separate internal evaluation of the auditor was conducted using a questionnaire which was circulated to the Committee, the Chief Financial Officer and the Group’s senior financial leadership for completion. In total, 89 people provided input on the performance of the auditor.

The feedback provided was reviewed and compiled into a report for the Committee which covered areas such as the knowledge and expertise of the partners and team members, their understanding of the Group, the resourcing applied to the audit and continuity of the team, liaison with Group-wide Internal Audit and approach to resolution of issues, as well as factors such as their coordination across the Group’s multiple jurisdictions and quality of their written and oral communication. The degree of challenge and robustness of approach to the audit were key components of the evaluation.

The Committee Chairman invited other Group stakeholders to provide their views on the performance of the auditor, and KPMG was given the opportunity to respond to the findings in the report.

In addition to the usual auditor effectiveness process, early in 2016 the Committee also considered KPMG’s response to a report issued by the Financial Reporting Council’s Audit Quality Review team following inspection of KPMG’s 2014 audit. The Committee discussed the actions undertaken by KPMG as part of their 2015 audit to address the matters raised. It agreed that any identified areas for further improvement had been addressed or had appropriate action plans in place.

On completion of the activities outlined above, the Committee concluded that the audit had been effective and the challenge appropriately robust across all parts of the Group.

Auditor independence and objectivity

 

The Committee has responsibility for monitoring auditor independence and objectivity and is supported in doing so by the Group’s Auditor Independence Policy (the Policy). The Policy is updated annually and approved by the Committee. It sets out the circumstances in which the external auditor may be permitted to undertake non-audit services and is based on four key principles which specify that the auditor should not:

  • Audit its own firm’s work;
  • Make management decisions for the Group;
  • Have a mutuality of financial interest with the Group; or
  • Be put in the role of advocate for the Group.

The Policy has two permissible service types: those that require specific approval by the Committee on an engagement basis and those that are pre-approved by the Committee with an annual monetary limit. In accordance with the Policy, the Committee approved these permissible services, classified as either audit or non-audit services, and monitored the usage of the annual limits on a quarterly basis. All non-audit services undertaken by KPMG were agreed prior to the commencement of work and were confirmed as permissible for the external auditor to undertake under the provisions of the Sarbanes-Oxley Act. In November 2016, the Committee considered and approved revisions to the Policy with effect from 1 January 2017, to reflect final rules and guidance issued by the Financial Reporting Council, in connection with the implementation of broader European Union (EU) reforms to the audit market. The most significant change was to reduce the annual monetary limits for services that are pre-approved by the Committee.

These revisions build on the previous year’s updates, where amendments to the Policy were made to ensure the schedule of prohibited non-audit services was in line with the EU reforms referenced above. These changes were effective throughout 2016.

In keeping with professional ethical standards, KPMG also confirmed their independence to the Committee and set out the supporting evidence for their conclusion in a report that was considered by the Committee prior to publication of the financial results.

Fees paid to the auditor

 

The fees paid to KPMG for the year ended 31 December 2016 amounted to £16.2 million (2015: £16.6 million) of which £2.8 million (2015: £4.3 million) was payable in respect of non-audit services. Non-audit services accounted for 17 per cent of total fees payable (2015: 26 per cent).

A breakdown of the fees paid to KPMG can be found in Note B3.4 to the financial statements.

Of the £2.8 million of non-audit services, the principal types of non-audit engagements approved for 2016 were other assurance services of £2.7 million (of which £1.5 million related to Solvency II reporting and disclosures) and other non-audit services of £0.6 million.

Reappointment

 

Based on the outcome of the effectiveness evaluation and all other considerations, the Committee recommended that KPMG be reappointed as the auditor. A resolution to this effect will be proposed to shareholders at the 2017 Annual General Meeting.

Audit tender

 

The external audit was last put out to competitive re-tender in 1999 when the present auditor, KPMG, was appointed. Since 2005, the Committee has annually considered the need to re-tender the external audit service and it again considered this in May 2016, concluding that there was nothing in the performance of the auditor which required such a tender.

The Committee acknowledges the provisions contained in the UK Code in respect of audit tendering, along with European rules on mandatory audit rotation and audit tendering. In conformance with these requirements, the Company will be required to change audit firm no later than for the 2023 financial year end. The Committee also recognises that the industry is in a period of unprecedented change with the IASB expecting to issue a new insurance accounting standard in 2017, for implementation in 2021. The Committee currently believes any change of auditor should be scheduled to limit operational disruption during such a period of change and, as a consequence, is not currently planning to re-tender the audit before the adoption of IFRS 17. This remains subject to the Committee’s normal annual review.

The Company has complied throughout the 2016 financial year with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 issued by the Competition and Markets Authority.

In line with the Auditing Practices Board Ethical Statements and the Sarbanes-Oxley Act, a new lead audit partner is appointed every five years. A new lead audit partner was appointed in respect of the 2012 financial year who will be replaced following the completion of this 2016 reporting cycle. The replacement lead audit partner has been identified.

Third line oversight – internal audit

Regular reporting

 

The Committee is responsible for approval of the internal audit programme and monitoring the effectiveness of the internal audit function.

The independent assurance provided by Group-wide Internal Audit (GwIA) formed a fundamental part of the Committee’s deliberations on the Group’s overall control environment. The Committee received regular updates on audits conducted and management’s progress in addressing audit findings. Each of the Group’s business units has an internal audit team, the heads of which report to the Director of Group-wide Internal Audit. The function also has a Quality Assurance Director, whose primary role is to monitor and evaluate adherence to industry practice guidelines and Group-wide adherence to GwIA’s own standards and methodology. Internal audit resources, plans, budgets and its work, including the function’s annual review of the control environment and risk, and control culture of the organisation, are overseen by both the Committee and the relevant business unit audit committee. The Director of GwIA reports functionally to the Chairman of the Committee and for management purposes to the Group Chief Executive, and also has direct access to the Chairman of the Board. In addition to formal Committee meetings, the Committee meets with the Director of GwIA in private to discuss matters relating to, for example, the effectiveness of the internal audit function, significant audit findings and the risk and control culture of the organisation.

Annual plan and focus for 2017

 

The Committee approved the half year update of the 2016 plan. It also considered and approved the Internal Audit Plan, resource and budget for 2017.

At the half year, the Committee considered recommendations to refresh the Internal Audit Plan in response to changes in the business unit operating environments and an update to the Group’s top risks. The 2017 Internal Audit Plan was formulated based on a bottom-up risk assessment of audit needs mapped against various metrics combined with top-down challenge by the GwIA Leadership Team and executive management at business unit and Group level. The plan was then mapped against a series of risk and control parameters, including the top risks identified by the Risk Committee, to verify that it is appropriately balanced between financial, business change, regulatory and operational risk drivers and provides appropriate coverage of key risk areas and audit themes within a risk-based cycle of coverage. Key areas of focus for 2017 include programme assurance, cyber security, outsourcing arrangements, customer outcomes and governance.

Internal audit effectiveness

 

The Committee assesses the effectiveness through a combination of external effectiveness reviews, required every five years (last conducted in 2012), and an annual internal effectiveness review, performed by the GwIA Quality Assurance Director. In 2016, Deloitte assessed the overall GwIA annual planning approach and the quality of audit work and concluded that the function ‘is a well-developed group function that applies a number of leading practices on a consistent basis across the Prudential Group, including advanced data analytics capabilities and well embedded approaches for conducting audits’. In addition, an internal effectiveness review was conducted in 2016, in accordance with the professional practice standards of the Chartered Institute of Internal Auditors (CIIA). This review concluded that GwIA continues to comply with the requirements of internal audit policies, procedures and practices, and standards in all material respects relating to audit planning and execution, and continued to be aligned with its mandated objectives and maintained general conformance with the CIIA guidance for Effective Internal Audit in the Financial Services Sector. Having considered the findings of Deloitte’s review and the 2016 internal effectiveness review, the Committee concluded that GwIA had continued to operate in compliance with the requirements of GwIA policies, procedures and practice standards in all material respects and had remained aligned to mandated objectives during 2016.

Business unit audit committee effectiveness

 

The Committee is supported by the work carried out by the material subsidiary and other business unit audit committees and annually reviews the effectiveness of these committees in meeting their defined terms of reference. These audit committees provide oversight of the respective business units. During the year, membership of the committees for all material subsidiaries has been changed to comprise solely of independent non-executive directors. The minutes of all business unit audit committees were provided to the Committee and their meetings were attended by the external auditor, as well as senior management from the business unit (including the Business Unit Chief Executive, heads of Finance, Risk, Compliance and GwIA) and from Group Head Office. In addition, the Committee chairman meets in person or telephonically at least quarterly with the chairs of each of the material subsidiary audit committees.

The Committee’s assessment of these committees was supported by local teams from GwIA and considered whether each of the committees fulfilled the responsibilities documented in their terms of reference. Attendance rates by audit committee members and evidence of the audit committees’ coverage of key business unit issues, as well as the appropriate escalation of concerns to the Committee, formed part of the criteria used for the evaluation.

Business unit model terms of reference

 

The Committee approved the Group’s standard terms of reference for the material subsidiary and other business unit audit committees, which were updated to reflect changes in the Committee’s own responsibilities to align them with best practice, as well as the change in membership for the material subsidiaries. These were adopted by the business unit audit committees with minor variations to address local regulations or the particular requirements of the business.

Second line oversight – compliance, financial crime prevention, whistleblowing

Regular reporting from Compliance

 

Regular updates were provided to the Committee by the Group Regulatory and Government Affairs Director and the Group Compliance Director. The reports kept the Committee apprised of key compliance activities, issues and controls, including progress against the 2016 Compliance Plan, the outcome of compliance monitoring activities across the Group and the effectiveness of business units compliance departments.

Compliance Plan and focus for 2017

 

The Committee considered and approved the 2017 Group Compliance Plan. Areas of focus included strengthening the compliance framework, enhancing compliance monitoring arrangements and mitigation of key risks, including conflicts of interest, the fair treatment of customers and anti-money laundering and sanctions. Following the external review of the effectiveness of compliance monitoring, the Plan includes developing a more consistent approach to the planning, execution and reporting of compliance monitoring activity across the Group.

Financial crime prevention

 

The Committee received the Money Laundering Prevention Officer’s report which assessed the operation and effectiveness of the Group’s systems and controls in relation to managing money laundering and sanctions risk. The Committee noted the regulatory developments relating to initiatives by the Financial Action Task Force and the 4th EU Anti-Money Laundering Directive.

An external review of the Group’s anti-bribery and corruption programme was undertaken this year and the Committee noted the recommendations being taken forward by management.

Whistleblowing

 

The Committee noted the launch of an enhanced, Group-wide whistleblowing programme (‘Speak Out’), reflecting UK regulatory changes and the Group’s geographic expansion. The programme captures and comprehensively records matters raised through the Group’s Confidential Reporting process. Throughout the year, the Committee has continued to receive regular updates on such matters and the actions taken to address them.

The role of the whistleblowing champion, for the purpose of the Senior Insurance Managers Regime, will be carried out by the chair of the UK business unit risk committee. At Group level, the Chair of the Audit Committee remains responsible for oversight of whistleblowing activities across the whole of the Group.

Internal control

Internal control and risk management systems

 

The Committee is responsible for reporting and making recommendations to the Board on the effectiveness of Group-wide internal control and risk management systems.

The Committee considered the outcome of the annual review of the systems of internal control and risk management. The report considered all material controls, including financial, operational and compliance controls and reflected changes in the HK Code which became effective for financial years commencing on or after 1 January 2016. Having considered the review, the Committee made recommendations to the Board regarding the ongoing processes and effectiveness of the risk management and internal control systems in place.

The Board’s statement regarding effectiveness of these systems can be found in Risk management and internal control.

Governance

Group Governance Framework

 

The Group Governance Manual sets out the policies and processes by which the Group operates within its framework of internal governance, taking into account relevant statutory and regulatory matters. Used as a platform for mandating specific ways of working across the Group, each business unit attests annually to compliance with:

  • Mandatory requirements set out in Group-wide policies;
  • Matters requiring prior approval from those parties with delegated authority; and
  • Matters which must be reported to the Group Functions.

The Committee reviewed the results of the Group Governance Manual annual content review to ensure its continued effectiveness and long-term value to the Group, and the results of the year end certification of compliance with Group Governance Manual requirements for the period ended 31 December 2016.

Committee effectiveness

 

A review of the Committee’s activities was conducted against applicable regulation and codes of conduct. The results of this assessment were provided to the Committee alongside the outcome of the part of the annual Board evaluation relating to the Committee.

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