Report of the Actuarial Function Holder of The Prudential Assurance

161 Pages·2013·0.51 MB·English

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)

D J Belsham FIA
Actuarial Function Holder

The Prudential Assurance Company Limited

August 2013
Contents Page

1. Introduction 3

Part A - Background information
2. Information on The Prudential Assurance Company Limited (PAC) 10
3. Information on the PAC Hong Kong Branch and PAC UK & Europe business 35
4. Financial position of PAC prior to the transfer 57
Part B - Domestication of with-profits business
5. Principles governing the proposed transfer of with-profits business 62
6. Proposed transfer of with-profits business 68

7. Financial impact of the proposed transfer on the with-profits funds of PAC and 113
PHKL at the point of domestication
8. Proposed governance arrangements for the transferring with-profits business 125
9. Assessment of the impact of the company’s proposals in relation to with- 155
profits business on transferring and non-transferring policyholders

Part C - Domestication of shareholder-backed business
10. Principles governing the transfer of shareholder-backed business 208
11. Proposed transfer of shareholder-backed business 211
12. Financial impact of the proposed transfer on the non-profit and shareholder 214
funds of PAC and PHKL at the point of domestication
13. Assessment of the impact of the company’s proposals in relation to 218
shareholder-backed business on transferring and non-transferring
policyholders

Part D – Conclusions
14. Conclusions 226
Appendix A - Compliance with Technical Actuarial Standards (TASs) 232

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REPORT OF THE ACTUARIAL FUNCTION HOLDER OF THE PRUDENTIAL
ASSURANCE COMPANY LIMITED

The following is the report by D J Belsham, the Actuarial Function Holder of The Prudential
Assurance Company Limited (PAC), to the directors of PAC, on the proposed transfer of the
long-term insurance business of the PAC Hong Kong branch to Prudential Hong Kong
Limited (PHKL), a company incorporated in Hong Kong to undertake long-term insurance
business. It is proposed that the transfer will take place on 1 January 2014, or on such other
date as may be agreed by PAC and PHKL, and approved by the UK and Hong Kong Courts
(the Transfer Date).

1. INTRODUCTION
1.1 The UK financial services regulators, the Prudential Regulation Authority (PRA) and
the Financial Conduct Authority (FCA), normally expect the Actuarial Function
Holder of a UK company involved in a proposed transfer of long-term insurance
business to produce a report which considers the effect of the transfer on the
policyholders affected.

1.2 The purpose of this report is to review the proposed transfer of the long-term
insurance business of the PAC Hong Kong branch to PHKL.
1.3 PAC is part of a corporate group (the Prudential Group) whose parent company is
Prudential plc. The Prudential Group is structured along geographical lines, with
separate operating units that include Prudential UK & Europe and Prudential
Corporation Asia (PCA). The Hong Kong branch of PAC does not currently fit
comfortably into this structure since, from a legal perspective, it is part of PAC, the
Prudential UK & Europe holding company, while, from an operating perspective, it
is part of PCA. In order to resolve this structural anomaly, the Prudential Group
wishes to transfer the Hong Kong business of PAC into two subsidiary companies
incorporated in Hong Kong, one company transacting long-term business and the
other company transacting general insurance business. This is expected to have the
benefit of:

(i) better aligning the Prudential Group’s operating units along regional lines;

(ii) improving the efficiency of decision making;

(iii) removing the tensions that currently exist within PAC as a result of the
differing risk profiles and regulatory regimes that apply to its Hong Kong and
its UK & Europe businesses, leaving each territory to pursue the strategy that
best fits the need of its market, policyholders and shareholders; and

(iv) improving longer-term corporate flexibility.

1.4 In accordance with the desired position set out above, it is proposed that the long-
term business of the Hong Kong branch should be transferred from PAC to PHKL, a
wholly owned subsidiary of the PAC shareholder fund. This will create a structure
whereby, at a future date, PHKL can readily be transferred from PAC to a Prudential
Group holding company so as to achieve a full separation of the Prudential Group’s
UK & Europe and Asian business. I would note that, historically, the Prudential
Group’s policy has been to transfer any subsidiaries out of PAC’s shareholder fund
for a consideration equal to the relevant subsidiary’s embedded value, and I would
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expect this to be the case in the event of PHKL being transferred to a Prudential
Group holding company.

1.5 Under the proposed terms of the transfer, all of the long-term insurance business of
PAC’s Hong Kong branch, including capital to support the writing of future new
business in Hong Kong, will be transferred to PHKL.

The long-term insurance business to be transferred amounts to c.1.3m policies, with
liabilities (including accounting liabilities and derivative liabilities) on a local Hong
Kong regulatory basis as at 31 December 2012 of c.£9.4bn. The business comprises:

(i) with-profits policies (principally conventional whole of life policies) written in
PAC’s With-Profits Sub-Fund (WPSF);

(ii) non-profit policies (principally conventional and unit-linked whole of life
policies) written in PAC’s Non-Profit Sub-Fund (NPSF); and

(iii) a small amount of non-profit business (mainly riders to with-profits policies)
written in the WPSF.
1.6 The transfer will take place by means of a Scheme (the Main Scheme) which will be
presented for approval to:
(i) the Hong Kong Court, under section 24 of the Hong Kong Insurance
Companies Ordinance (Cap 41); and
(ii) the UK Court, under Part VII of the Financial Services and Markets Act 2000
(the FSMA 2000).
Some policies may have to be excluded from the Main Scheme due to the fact that
they cover risks arising in EEA States, over which, in this context, the UK Court has
no jurisdiction. The transfer of these policies will be effected by means of a separate
Scheme (the EEA Policies Scheme), which will be presented for approval to the
Hong Kong Court only. The terms of the EEA Policies Scheme will be identical to
the Main Scheme. References in this report to the Scheme relate to both the Main
Scheme and the EEA Policies Scheme.
The transfer will not proceed unless the Main Scheme and the EEA Policies Scheme
are approved by the Hong Kong Court on terms that are satisfactory to PAC and
PHKL. The transfer will also not proceed unless the English Court, having accepted
jurisdiction to hear the transfer application, approves the Main Scheme on terms that
are satisfactory to PAC and PHKL.
This report should be read in conjunction with the Scheme.
1.7 The company’s proposed transfer of with-profits business assumes that the risk levels
of the Hong Kong and UK & Europe business will be aligned at, or will be capable of
being aligned within nine months of, the Transfer Date. The alignment of the risk
levels, the risk of misalignment arising prior to the Transfer Date, and the ability of
the company to correct any misalignment, will accordingly be reviewed by various
parties (including myself, as PAC Actuarial Function Holder, and the Independent
Actuaries referred to in section 1.13 below) in supplementary reports shortly before
the sanctions hearings of the Hong Kong and English Courts. The supplementary
reports will be made available to the Hong Kong and English Courts and the Hong
Kong and UK financial services regulators, and the transfer will not proceed if the
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review of risk profiles does not provide the necessary confirmation that the risk
levels will be aligned at, or will be capable of being aligned within nine months of,
the Transfer Date. In addition, the Scheme will not become effective unless the
Independent Actuaries, not more than 2 days prior to the Transfer Date, confirm to
PAC, PHKL and the Hong Kong and UK financial services regulators in writing that,
as far as they are aware and based on discussions with myself as Actuarial Function
Holder:
(i) no event has occurred which would result in the risk levels of the Hong Kong
and UK & Europe with-profits business not being aligned; or
(ii) if such an event has occurred, the risk levels are capable of being aligned
within nine months of the Transfer Date.
1.8 The transfer will also be implemented by means of a reinsurance treaty between PAC
and PHKL (the PAL Reassurance Treaty), under which PAC’s interest in certain UK
non-profit annuity business written in the WPSF and in its subsidiary, Prudential
Annuities Limited (PAL), will be apportioned between PAC and PHKL.
Various capital support arrangements in connection with the transfer will also be put
in place between PAC and PHKL, between Prudential plc and PAC, between
Prudential plc and PHKL, and between Prudential plc and the Hong Kong Insurance
Authority, in order to protect the security and reasonable benefit expectations of both
the transferring and non-transferring policyholders.
1.9 It is intended that the Hong Kong branch business in PAC’s WPSF will be
transferred to the With-Profits Fund (WPF) of PHKL, and that the Hong Kong
branch business in PAC’s NPSF will be transferred to the Non-Profit Fund (NPF) of
PHKL.

The value of the assets to be transferred to the WPF will include a share of the
inherited estate in the WPSF (the PAC inherited estate). The share of the PAC
inherited estate that is allocated to the WPF will take into account PHKL's
anticipated requirement for capital to fund the writing of new business in the WPF
after the Transfer Date. The value of assets to be transferred to the NPF will also
include capital to support the writing of new business in the NPF after the Transfer
Date.
The value of assets to be transferred from PAC to PHKL on the Transfer Date will be
agreed by PAC and PHKL prior to the Transfer Date, and the amount transferred will
subsequently be adjusted to reflect the actual position at the Transfer Date based on
valuations of the UK & Europe and Hong Kong business at that date. The
calculations undertaken at the Transfer Date will be subject to the approval of the
PAC Board and the PHKL Board, having regard to reviews by myself (as PAC
Actuarial Function Holder), the PHKL Actuary and, in the case of with-profits
business, the PAC With-Profits Actuary, the PAC With-Profits Committee and the
PHKL With-Profits Committee appointed under the Scheme. The calculations will
also be subject to independent review under a process approved by the UK financial
services regulators.
1.10 In this report, I have considered the transfer from the perspective of both the
transferring Hong Kong policyholders and PAC’s remaining UK & Europe
policyholders. I have not explicitly considered the transfer from the perspective of
the UK & Europe policyholders in the various insurance companies which PAC owns
or partly owns since, in my opinion:
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(i) the transfer of the long-term insurance business in the Hong Kong branch to
PHKL will not alter the financial strength of these companies on a stand-alone
basis; and
(ii) in view of their reliance on PAC for financial support in adverse scenarios, the
interests of policyholders in these companies are aligned with those of non-
profit policyholders in either the WPSF (for companies owned by the WPSF)
or the NPSF (for companies owned or partly owned by the PAC shareholder
fund).
My conclusions regarding the fairness of the transfer in relation to the remaining
PAC UK & Europe policyholders will therefore apply equally to policyholders in
these subsidiaries.
1.11 I am a Fellow of the Institute and Faculty of Actuaries, having qualified in 1988, and
hold a certificate issued by the Institute and Faculty of Actuaries to act as a Life
Actuary (including with-profits). I am also a Fellow of the Actuarial Society of
Hong Kong.

I have been the PAC Appointed Actuary, and subsequently the PAC Actuarial
Function Holder, since 1998. As such, I have also been the Appointed Actuary of
PAC’s Hong Kong branch since 1998.

I am also a Director of PAC, and a shareholder in PAC’s ultimate owner, Prudential
plc.

I have been employed by Prudential since 1983, and am a member of the company’s
UK defined benefit pension scheme.
1.12 Richard Myers, the With-Profits Actuary of PAC, has produced a separate report that
comments on the Scheme from the perspective of the transferring Hong Kong with-
profits policyholders and the remaining UK & Europe with-profits policyholders.
John McKenzie, the Scottish Amicable Monitoring Actuary, has also produced a
report for the Scottish Amicable Board commenting on the Scheme from the
perspective of policyholders in the Scottish Amicable Insurance Fund and the
Scottish Amicable Account.
1.13 Both the UK and Hong Kong Courts require that an Independent Actuary should be
appointed to produce a report on the terms of the Scheme. In accordance with these
requirements, two Independent Actuaries, one working in each territory, have been
retained by PAC to produce a joint report to both Courts. The Independent Actuary
working in the UK is Nick Dumbreck of Milliman, and the Independent Actuary
working in Hong Kong is Paul Sinnott, also of Milliman. Their joint appointments
have been communicated to the PRA and FCA, and the Hong Kong Insurance
Authority, who have not objected to their appointments. A copy of this report will be
provided to Messrs Dumbreck and Sinnott, who have both had the opportunity to
review various drafts of it.
1.14 This report is structured as follows:
Part A – Background information

Part A of the report, comprising sections 2 to 4, provides background information on
the operation of PAC that is relevant to the domestication proposal. In particular:

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- section 2 sets out information on the current operation of PAC as a whole,

- section 3 sets out information on the current operation of the PAC Hong Kong
branch and PAC’s UK & Europe business, and

- section 4 sets out the financial position of PAC as at 31 December 2012 and
31 December 2011.

Part B – Domestication of with-profits business

Part B of the report, comprising sections 5 to 9, deals with the proposed transfer of
the long-term insurance business of the Hong Kong branch in the WPSF. In
particular:

- section 5 sets out the principles underpinning the transfer,

- section 6 sets out the details of the proposed transfer, including the capital
backing with-profits business that is available for apportionment, and the
company’s proposed method for apportioning that capital,

- section 7 sets out the impact of the proposed apportionment on the financial
position of the with-profits funds of PAC and PHKL, assuming that the transfer
had taken place on 31 December 2012,

- section 8 discusses the governance arrangements that will apply post-
domestication to the transferring with-profits business, and

- section 9 sets out my comments on the company’s proposal for the transfer of
with-profits business, in terms of its impact on the benefit security and
reasonable benefit expectations of the affected policyholders.

Part C – Domestication of shareholder-backed business

Part C of the report, comprising sections 10 to 13, deals with the proposed transfer of
the long-term insurance business of the Hong Kong branch in PAC’s NPSF. In
particular:

- section 10 sets out the principles underpinning the transfer,

- section 11 sets out the details of the proposed transfer, including the company’s
proposed method of apportioning the capital backing the shareholder-backed
business,

- section 12 sets out the impact of the proposed apportionment on the financial
position of the non-profit and shareholder funds of PAC and PHKL, assuming
that the transfer had taken place on 31 December 2012, and

- section 13 sets out my comments on the company’s proposal for the transfer of
non-profit business, in terms of its impact on the benefit security and reasonable
benefit expectations of the affected policyholders.

Part D – Conclusions

Part D of the report (which comprises section 14) sets out my conclusions.

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1.15 It is proposed that, at the same time as the transfer of the long-term insurance
business of the PAC Hong Kong branch to PHKL, the general insurance business of
the PAC Hong Kong branch will be transferred to a Hong Kong incorporated
company, Prudential General Insurance Hong Kong Limited, which has been
established (also as a subsidiary of the PAC shareholder fund) to undertake general
insurance business. The general insurance business will be transferred by way of a
separate process. I have not considered the transfer of the general insurance business
in this report since I would not expect the transfer of this business to have any impact
on the benefit security or reasonable benefit expectations of PAC’s long-term
insurance business policyholders. This reflects the fact that the general insurance
business in Hong Kong is:

(i) operationally separate from the long-term insurance business;

(ii) backed by a separate pool of shareholder capital, which is not used to back
the long-term insurance business; and

(iii) relatively small, with liabilities of c.£40m (measured on the local Hong Kong
solvency basis) as at 31 December 2012.

The transfer amount in respect of this business will comprise assets equal to the
liabilities (of c.£40m), plus additional capital of c.£28m (of which roughly half
comprises the net assets of the business), amounting to c.£68m in total. The
conclusions in this report will therefore remain valid whether or not the transfer of
general insurance business takes place.

1.16 This report is subject to, and complies with, all relevant Technical Actuarial
Standards (TASs) adopted by the Financial Reporting Council (FRC) in the UK, in
particular:

- Technical Actuarial Standard (R) - Reporting Actuarial Information,

- Technical Actuarial Standard (D) – Data,

- Technical Actuarial Standard (M) – Modelling,

- the Insurance Technical Actuarial Standard, and

- the Transformations Technical Actuarial Standard.
In the terminology used by the FRC, this report may be regarded as constituting an
“aggregate report” in that, in places, it summarises results that have been discussed in
more detail in other reports (“component reports”). A list of the relevant component
reports is set out in Appendix A.2.

1.17 This report is an abridged version of a fuller report to the directors of PAC on the
proposed transfer. The full report includes information, including results of the
company’s Pillar II valuation, that are confidential to the company and its regulators.
Copies of the full report have been provided to the PAC Board, PAC With-Profits
Committee, PAC With-Profits Actuary, Scottish Amicable Board, Scottish Amicable
Monitoring Actuary, PHKL Appointed Actuary Designate, the Independent Actuaries,
the PRA, the FCA and the Hong Kong Insurance Authority in order to assist their
assessments of the company’s proposals.
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Part A:

Background information

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2. INFORMATION ON THE PRUDENTIAL ASSURANCE COMPANY
LIMITED (PAC)

2.1 Company information

2.1.1 PAC is a proprietary company, the shares of which are wholly owned by its
immediate parent company, Prudential plc, which is also the ultimate holding
company of the Prudential Group.

2.1.2 PAC’s principal activity is long-term insurance business, which is written in the
company’s long-term insurance fund; PAC also conducts some general insurance
business, which is written in the company’s shareholder fund.

2.1.3 PAC’s long-term insurance business consists of:

(i) Ordinary Branch (OB) life and annuity, pensions, permanent health and linked
long-term insurance business; and

(ii) Industrial Branch (IB) life business.

The OB and IB funds were merged in 1988 to form what is now the WPSF, and the
IB was closed to new business on 1 January 1995.

The company’s long-term insurance business includes conventional with-profits,
accumulating with-profits, non-linked non-profit and linked business. PAC’s long-
term insurance business is predominantly with-profits, and is written mainly in the
UK.

2.1.4 The company’s UK business consists of:

(i) business written directly in PAC,

(ii) business reinsured into PAC from its insurance subsidiaries,

(iii) business transferred into PAC from Prudential Holborn Life Limited (PHLL)
and Prudential (AN) Limited (PANL) on 31 October 2010,

(iv) business transferred into PAC from The Equitable Life Assurance Society
(ELAS) on 31 December 2007,

(v) business transferred into PAC from Scottish Amicable Life plc (SAL) on
31 December 2002, and

(vi) business transferred into PAC from the Scottish Amicable Life Assurance
Society (SALAS) on 30 September 1997.

2.1.5 PAC also contains business written outside of the UK, comprising:

(i) business written by its branches in Hong Kong, Poland, France and Malta,

(ii) business reinsured into PAC by its insurance subsidiaries, including Prudential
International Assurance plc (PIA), or by other external insurers such as Canada
Life Assurance (Europe) Limited, and

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